9BS0/02 · Paper 2 (co-assessed with Theme 3) · 2 hours · 35% of A-Level · Topics 2.1 – 2.5
2.1 - Raising finance
Internal finance comes from within the business itself. It does not involve taking on debt or giving up ownership.
Internal finance is often preferred because it avoids interest payments and does not dilute ownership. However, it is limited by the size of the business's reserves and assets. In an exam, match the source to the business context.
Sources of external finance (who provides the money):
Methods of external finance (how the money is structured):
Exam questions on sources of finance often ask you to justify a choice. Key factors: the size and maturity of the business (start-up vs established), whether the owner wants to retain control, the cost of finance, and the timescale of the need (short-term gap vs long-term investment).
Finance appropriate to each:
Liability is a key factor when choosing a business structure. A sole trader bears unlimited risk but has total control; a private limited company offers protection but involves more administration and shared ownership.
Business plan: a written document that sets out the business's aims, strategy, and financial projections. Typically includes:
Relevance for obtaining finance: lenders and investors require a business plan to assess the viability of the business and the risk of lending. It also forces the entrepreneur to think systematically about the business.
Cash flow forecast: a prediction of all cash inflows and outflows over a future period (typically monthly). Used to:
Key calculations:
Use and limitations of a cash flow forecast:
Cash flow forecast questions often ask you to complete a table (fill in net cash flow or closing balance) or to interpret a negative closing balance. A negative closing balance means the business needs additional finance that month.
2.2 - Financial planning
Sales forecast: a prediction of future sales volumes and/or revenue over a given time period.
Purpose of sales forecasts: to plan production levels, staffing, and stock requirements; to set revenue and profit targets; to underpin cash flow forecasts; to support applications for finance; to identify seasonal patterns.
Factors affecting sales forecasts:
Difficulties of sales forecasting: markets are inherently unpredictable; past trends do not always predict future performance; unexpected events (economic shocks, pandemics, technological disruption) invalidate assumptions; competitors' actions are unknown; consumer tastes can shift rapidly.
Quantitative forecasting techniques:
Forecasting questions often ask you to evaluate the reliability of a forecast. Use context clues: is the market stable or volatile? Is the business established (more past data) or a start-up? Are there economic uncertainties? Moving averages reduce volatility in the data but do not remove uncertainty about the future.
In calculations, always check whether the question gives costs per unit or total costs. Variable cost per unit multiplied by output gives total variable costs. Fixed costs do not change with output.
Contribution is the amount each unit sold contributes towards covering fixed costs, and then to profit once fixed costs are covered.
Break-even point: the level of output (or sales) at which total revenue exactly equals total costs. The business makes neither a profit nor a loss.
Margin of safety: the difference between actual output (or sales) and the break-even output. Shows how much output can fall before a loss is made.
Break-even chart: a graph with output on the x-axis and costs/revenue (£) on the y-axis.
When drawing a break-even chart, always label both axes, mark the break-even output on the x-axis, and shade or annotate the profit and loss areas. The margin of safety is shown as a horizontal distance on the x-axis between break-even output and actual output.
Limitations of break-even analysis:
Budget: a financial plan that sets targets for revenue and expenditure over a specific period, typically a year broken into monthly periods.
Purpose of budgets: to allocate financial resources across departments; to set performance targets that motivate managers; to monitor actual performance against plan; to identify areas of overspending or underperformance; to support decision-making and coordination.
Types of budget:
Variance analysis: comparing actual financial performance against budgeted figures to identify differences (variances).
Difficulties of budgeting: forecasts are estimates and may be wrong; external conditions (inflation, competitor actions) can make budgets rapidly out of date; setting unrealistic targets can demotivate staff; the process is time-consuming, particularly for zero-based budgets.
Variance questions ask you to calculate and interpret a variance. Always state whether it is favourable or adverse and explain what may have caused it. Link adverse variances to corrective actions the business could take.
2.3 - Managing finance
Three levels of profit appear on the statement of comprehensive income (profit and loss account):
Profitability ratios (from the statement of comprehensive income):
These ratios show what percentage of revenue is retained at each stage. A higher margin is generally better; comparisons should be made against previous years or industry averages.
Ways to improve profitability:
Distinction between profit and cash: profit is an accounting measure of revenue minus costs over a period; it includes credit sales (not yet received) and accruals. Cash is actual money in the bank. A profitable business can still face insolvency if it runs out of cash (for example, if customers are slow to pay or if it overexpands too quickly).
Profitability ratio questions often ask you to calculate and then evaluate. Always compare against a benchmark (last year's figure or a competitor). A falling profit margin despite rising revenue may indicate rising costs, which is a concern.
Liquidity is the ability of a business to meet its short-term financial obligations as they fall due. It is measured using data from the statement of financial position (balance sheet).
| Ratio | Ideal value | Interpretation |
|---|---|---|
| Current ratio | ~2:1 | For every £1 of current liabilities, the business holds £2 of current assets. A ratio below 1:1 may indicate difficulty meeting short-term obligations, though this varies by sector. |
| Acid test ratio | ~1:1 | Excludes inventory (least liquid current asset). A tighter test of short-term solvency. Below 1:1 is a warning sign of potential liquidity problems. |
Working capital = Current assets - Current liabilities. Must be positive for the business to meet day-to-day obligations. Working capital management ensures the business has enough cash, receivables, and stock to operate without excess.
Ways to improve liquidity:
Do not confuse liquidity with profitability. A business can be profitable but illiquid (profit tied up in receivables) or liquid but unprofitable. Exam questions on the balance sheet often ask you to calculate both the current ratio and acid test ratio and compare them.
Internal causes of business failure:
External causes of business failure:
Business failure questions often ask you to distinguish between internal and external causes. Internal causes are within the business's control; external causes are not. A well-managed business can mitigate but not eliminate external risks.
2.4 - Resource management
Methods of production:
Productivity: output per unit of input per time period.
Higher productivity reduces unit labour costs, making the business more competitive. Factors influencing productivity include: motivation and skills of the workforce, quality of machinery and technology, effectiveness of management, and the production method used.
Link to competitiveness: higher productivity lowers unit costs, allowing the business to either reduce prices to compete on cost, or maintain prices and improve profit margins.
Efficiency: producing output at the minimum average (unit) cost. A business is efficient when it minimises waste of resources relative to output.
A question may ask whether a business should switch from labour-intensive to capital-intensive production. Consider: the cost and availability of capital equipment, the volume of output, whether the product requires customisation, and the impact on the workforce (redundancies, retraining).
Ideal capacity utilisation is around 90%: high enough to spread fixed costs efficiently, but leaving a small reserve for maintenance and unexpected demand increases. Operating at exactly 100% is risky.
Ways of improving capacity utilisation:
Capacity utilisation questions may ask you to calculate it or to evaluate the implications of a given percentage. A very low figure (e.g. 40%) suggests serious problems; a figure above 95% suggests the business may need to invest in additional capacity.
Stock control diagram: a graph showing stock levels over time (time on x-axis; stock level on y-axis). Key features:
Implications of poor stock control:
Just-in-time (JIT) stock management: stock is ordered and delivered only when it is needed for production or sale. Key features:
Waste minimisation and lean production: lean production aims to eliminate all forms of waste (over-production, waiting time, excess inventory, defects, unnecessary movement). Businesses gain a competitive advantage through lower costs and faster response times.
JIT is high-risk, high-reward. In an exam question asking whether a business should adopt JIT, consider: how reliable are its suppliers? How predictable is demand? Does the business have strong supplier relationships? A business with unpredictable demand or unreliable suppliers should retain buffer stocks.
Kaizen (continuous improvement): a Japanese management philosophy based on making small, incremental improvements to processes continuously, involving all employees. Improvements are cumulative over time and can deliver significant gains in quality and efficiency without large capital investment.
Benchmarking: comparing a business's performance, processes, or products against those of competitors or industry best practice. Internal benchmarking compares departments within the same organisation; external benchmarking compares against rival businesses or sector leaders. Helps identify performance gaps, set realistic targets, and adopt best-practice methods.
Competitive advantage from quality management: consistent quality builds brand reputation and customer loyalty; enables premium pricing; reduces costs of defects, returns, and reworking; lowers the risk of reputational damage; can be a sustainable differentiator that is hard for competitors to replicate quickly.
Questions on quality often ask you to compare quality control and quality assurance. The key distinction: control is reactive (finding defects); assurance is proactive (preventing them). TQM extends this to a whole-organisation culture.
2.5 - External influences
Effect of economic uncertainty on the business environment: when the future economic outlook is unclear, businesses tend to: reduce capital investment; hold larger cash reserves; use flexible (short-term, temporary) contracts rather than permanent hires; delay major strategic decisions; cut costs to maintain liquidity. Uncertainty reduces innovation and long-term planning.
Exchange rate questions are commonly tested. Remember: a stronger pound is bad for exporters and good for importers. A weaker pound is good for exporters and bad for businesses that rely on imported inputs. Always consider both sides.
Legislation questions often ask you to evaluate the impact on a specific business. Always consider: the direct compliance cost, the potential cost of non-compliance (fines, legal action, reputational damage), and whether the regulation could lead to long-term efficiency gains or competitive advantage.
Competition and market size: the degree of competition in a market is determined by the number and size of competitors, the ease of entry, the availability of substitutes, and the rate of market growth.
Changes in the competitive environment: competition increases when new entrants join the market (lower barriers to entry, e-commerce reducing geographic barriers), when close substitutes emerge, or when the market matures and slows. Businesses must continuously monitor the competitive environment and adapt their strategy accordingly.
The competitive environment links closely to 1.1.1 (dynamic markets) and 1.1.3 (competitive advantage). In an exam, use Michael Porter's idea of competitive advantage implicitly: businesses respond to greater competition by competing on either cost or differentiation.