3.3 - Effective financial management

Question 1

What is Financial Management?

Answer 1

Changing monetary variables such as cash flows to achieve financial objectives such as improved cash flow.

Question 2

Why is cash important?

Answer 2

If a business’s outflows are greater than its inflows then it could run out of cash and trading will cease.

Question 3

What are the 5 main ways of improving Cash OUTFLOWS (i.e. decreasing it) ?

Answer 3

1. Delay paying invoices
2. Leasing rather than buying
3. Reduce stock orders.
4. Improve credit terms with suppliers.
5. Use cheaper suppliers.

Question 4

What are the 5 main ways of improving Cash INFLOWS?

Answer 4

1. Increasing sales revenue.
2. Destocking.
3. Reduce credit terms with customers.
4. Encourage customers to pay early (incentives).
5. Use short-term sources of finance, e.g. overdrafts and short-term loans.

Question 5

What can profit-improving techniques do to a business?

Answer 5

It can affect the performance of a business and in the long term, this could reduce profits.

Question 6

What are the 5 profit-improving techniques and what are its consequences (outcomes) ?

Answer 6

1. Cutting material costs - Lower quality products
2. Cutting labour costs - lower motivation of workforce
3. Cutting investment - damages long-term competitiveness
4. Improve products - expensive development costs
5. Increase prices - customers switch to competitor’s products

Question 7

What are the 2 main areas that a business can focus on to improve profit?

Answer 7

1. Increasing revenue

2. Lowering costs

Question 8

What is the formula for Total Revenue?

Answer 8

Total Revenue = Number of Products Sold x Average Price

Question 9

What 3 methods can a business perform to increase revenue?

Answer 9

1. Improved marketing
2. Better products
3. Increasing its selling price.

Question 10

What is the impact of a business increasing its selling price?

Answer 10

The impact an increase in price has on revenue depends on how sensitive demand is to a change in price.

Question 11

What is the formula for Total Costs?

Answer 11

Total Costs = Fixed Costs + Variable Costs

Question 12

What are the 2 main ways in which a business could reduce its costs?

Answer 12

1. Cutting costs of raw materials, labour or research and development costs.
2. Cutting its marketing

Question 13

What are Variable Costs?

Answer 13

Costs that change directly with the number of products made.

e.g. materials

Question 14

What is the Break-Even Point?

Answer 14

The point where total costs is equal to the total revenue, thus equalling to ZERO profit.

Question 15

How can you locate the B/E point on a graph?

Answer 15

The point on the graph where total costs and revenue meet.

Question 16

On a B/E chart, how can you indicate that a business is making a profit/loss?

Answer 16

When TOTAL REVENUE is above the break even point.

When TOTAL REVENUE is below, it makes a loss.

Question 17

What is Fixed Costs?

Answer 17

Costs that do not change at any level of output.

e.g. rent

Question 18

How can you indicate a line of FIXED Costs on a B/E chart?

Answer 18

A horizontal line.

Question 19

What is ‘Total Costs’ ?

Answer 19

The sum of all the costs at any level of output.

Question 20

What is Total Revenue?

Answer 20

The amount of money earned by a business from selling products. It increases directly with the number of products sold.

Question 21

What is the formula for Break-Even?

Answer 21

Break even = Fixed Costs / Contribution

Question 22

What is the formula for Contribution?

Answer 22

Contribution = Revenue - Variable Costs

Question 23

What is the Margin of Safety?

Answer 23

The difference between the number of units of planned or actual sales and the number of units of sales at break even point.

Question 24

What can the Margin of Safety indicate?

Answer 24

How much production could fall before the business starts to make a loss.

Question 25

What is Break-Even analysis?

Answer 25

A useful tool to help a business make decisions and set targets, and plan for the future.

Question 26

In detail, what can Break-Even analysis enable a business to do?

Answer 26

It answers 'what if' questions, e.g. what would be the impact of an increase in variable costs on profit? An increase in fixed or variable costs is likely to lower the break-even point. An increase in price will also lower the number of units required to break even.

Question 27

What can Break Even analysis do in terms of the B/E point?

Answer 27

Break-even analysis can identify strategies for lowering the break-even point and increasing profit.

Question 28

When might a business use break-even analysis?

Answer 28

1. Understanding the past 2. Setting and achieving production targets 3. Launching a new product 4. Starting a new business 5. Developing a business plan

Question 29

What are the two sources of funds to finance growth?

Answer 29

1. INTERNAL (from within a business) | 2. EXTERNAL (from outside a business)

Question 30

What are the 4 types of 'borrowing' EXTERNAL sources of finance?

Answer 30

1. Overdraft 2. Loans 3. Bonds 4. Trade Credit

Question 31

What are 2 types of Stock Market Flotations of EXTERNAL Sources of finance?

Answer 31

1. Private Limited Companies (LTD) | 2. Public Limited Companies (PLC)

Question 32

What are 3 types of Internal Sources of finance?

Answer 32

1. Owner's funds 2. Retained profit 3. Asset Sales

Question 33

What are three factors when comparing sources of finance?

Answer 33

1. RISK - Selling shares may mean owners lose control. 2. COST - The cost of borrowing varies across different sources. 3. AVAILABILITY - Some sources, such as loan or share capital, might not be accessible.

Question 34

What are 5 questions to consider when choosing sources of finance?

Answer 34

1. Is it a short term or long-term requirement? 2. How much finance is required? 3. If we borrow it how much will it cost (interest rate %) 4. What sources are available to our business? 5. What level of debt can we manage?

Question 35

What are 3 advantages of Break-Even analysis for a small business?

Answer 35

1. Illustrates the importance of a start-up, keeping fixed costs down to a minimum. 2. Helps a business understand the level of risk involved in a start-up 3. Focuses the business on how long it will take to reach profitability

Question 36

What are 3 disadvantages of Break-Even analysis for a small business?

Answer 36

1. Unrealistic assumptions (products are not sold at the same price at different output levels) 2. Sales are unlikely to be the same as output 3. Variable costs do not stay the same.