3.5 - Decision Making To Improve Financial Performance Flashcards
What is a financial objective? Two examples could be to increase revenue or lower costs, how could businesses do this?
Target likely containing numerical element and time scale, act as a focus, improve co-ordination, measure success/failure, allows shareholders to assess whether its a worthwhile investment
1 increase revenue-by:
- put price of necessities up or lower to encourage multiple purchase
2 lower costs-by:
- switch to supplier but check quality or barter with suppliers perhaps buy in bulk
- redundancies and reduce wastage
Return on capital is the percentage of return on that investment, how is this calculated? What does return on investment show?
Return on capital = (net profit (before tax) / capital invested) x 100
- How good a business is at converting money invested into profit
- Provides a mean of comparison with other investment opportunities
- Opportunity cost - what an investor could have achieved by investing elsewhere
What is financial safety and how can it be achieved?
Being able to pay bills/make repayments
- Keep debt levels under control
- Hold reserves (retained profit to fall back on in future)
Briefly explain the 2 types of capital objectives
CAPITAL STRUCTURE
- Directors must carefully consider the right capital structure (where capital in business has come from-money to pay for day today operations) for business based on operational risks faced
CAPITAL SPENDING
- in some markets key to long term success is to fund high levels of investment spending on capital equipment (better quality and standards) and research and development, meaning business is more efficient and produce goods of higher quality
In cost minimisation how can a business reduce its costs? In which 2 ways is the business benefitted from doing this and why must they be cautious when working to cost reduction objectives?
CAN REDUCE BY:
- negotiate/switch suppliers to reduce costs of purchase in raw materials
- move to a lower cost location or delayer management
- lower levels of waste
BENEFITS
+ they keep prices the same and benefit from higher profit margin
+ use cost reduction to reduce selling price and attract more customers and become more competitive
CAUTIOUS
- cheaper materials may lead to lower quality
What are the 3 internal and 3 external influences on financial objectives?
INTERNAL
- ambitions of leader (depending on thier beliefs)
- finance (coudl cash flow problems restrict growth)
- operational (close to full capacity so cant gain more profit/revenue)
EXTERNAL
- competitive environment (strong focus on survival)
- economic environment
- government (legislation introduced increasing costs eg/higher pay)
What are the 4 ethical and environmental influences on financial decisions?
Interest in the environment
- rising concern has increased costs, profits reduced-savings made in waste
Bargaining with suppliers
- lower prices to suppliers lead to poorer supplies-unacceptable conditions for animals
Taxation avoidance
- legal but unethical
Public image
- spend money on charitable causes-reduces profit as higher costs but better brand and public relations
What is working capital?
internal source of income
Cash tied up in stock (inventory) and payments due from customers (receivables) where goods sold on credit
Holding stock and shortening credit terms could improve cash holdings
Explain what the 5 sources of external finance are
DEBT FACTORING (short term) - raise cash by selling outstanding receivables to a factoring company at a discount OVERDRAFTS (short term) - allowing business to be overdrawn for set period
BANK LOAN (medium term) - repaid in instalments or at end of set period
VENTURE CAPITAL (long term) - outside investment
SHARE CAPITAL (long term)
- look for more from private investors or venture capital funds
- once a PLC, may consider floating on stock exchange
Explain what the 3 sources of internal finance are
RAISING MONEY FROM SELLING AN ASSET(short term)
- selling products no longer used
+ raises money quickly
- you might not get the whole amount asked for
RETAINED PROFIT(long term)
- when a business makes a profit, it can leave some or all of this money in the business and reinvest it in order to expand
+ doesn’t incur costs or interest charges
- may be too little profit to allow business to grow to full capability
ENTREPRENEURS SAVINGS (long term)
- money/personal savings invested by owner
+ does not cost the business and no interest charges applied
- the owner might not have enough savings or may need the cash for personal use and once its gone its gone
Give an advantage and disadvantage of each of the 5 external sources of finance
DEBT FACTORING (short term) \+ can now focus on selling rather than collecting debts (immediate injection of cash) - customers may feel relationship with business has changed
SHARE CAPITAL (long term)
+ no need to repay and can bring new ideas
- involves giving away some control
BANK LOAN (medium term) \+ wont dilute control or claim company profits - interest rates may change
VENTURE CAPITAL (long term) \+ brings new ideas - involves giving away some control as its a risky investment-have been unable to raise own funds
OVERDRAFTS (short term)
+ small interest for firms using it to smooth short term cash variations
- incur higher interest than other sources-could be demanded to be repaid anytime
Give an advantage and disadvantage of each of the 3 internal sources of finance
RAISING MONEY FROM SELLING AN ASSET(short term)
+ raises money quickly
- you might not get the whole amount asked for
RETAINED PROFIT(long term) \+ doesn't incur costs or interest charges - may be too little profit to allow business to grow to full capability
ENTREPRENEURS SAVINGS(short term) \+ does not cost the business and no interest charges applied - the owner might not have enough savings or may need the cash for personal use and once its gone its gone
What is cash flow?
Movement of cash into and out of a firms bank account
Cash sales and credit sales are REVENUE
If receivables are delayed/not paid, the inflow isn’t received, business faces cash flow problems
Dividends and during expansion, assets are cash OUTLOWS not cost
Why might a profitable business run out of money?
Overtrading (growing too quickly)
- too much cash out, additional fixed costs but additional sales not coming in soon enough
Seasonality
- may not be able to keep sufficient cash ni business to see it through times of lower demand
Credit periods (giving too long) - paying for production of expensive goods but waiting for payments to cover
If you experience cash flow problems, what 4 business factors could you manipulate to boost cash flow and how? What difficulties in practice could this cause?
Credit from suppliers - could delay payment to them
- they may lose confidence in your solvency so demand cash on delivery
Credit to customers - could cut credit period
- risk them looking for more generous supplier
Short of working capital - could use debt factoring
- hard to carry on for long as fees take chunk of profit
Use your assets - could sell underperforming assets for cash
- risk business will end up with few assets for future
In which ways could you improve profit? What are the difficulties associated with these 3 ways?
Changing prices
- depends on elasticity (attract competition who see large profit margins, therefore reducing market share)
Selling more
- require additional spending on advertising and promotion
Cutting costs
- quality and reliability of new suppliers
- move abroad (ethical issues-unemployment)
Why do small firms have to focus on cash flow rather than profit?
Cashflow forecasts predict impact on bank balance and may show the need for extra overdraft facilities to be negotiated
How can cash flow be monitored? What is the importance if cash flow mangaement?
Cashflow forecasts - estimate when cash inflows and outflows will occur and how much they will be-see if thers enough to keep going
IMPORTANCE
- without cash availabilty business fails
- must be cash to pay bills when due-if not paid suppliers may refuse to deliver or staff leave
What are payables and receivables?
Payables are moeny owed to suppliers by business when goods bought on credit
Receivables are money owed to business by customers who bought goods on credit
Give 3 examples of cash inflows and 3 of cash outflows
INFLOWS
- sales of spare assets
- investment of share capital/personal funds invested/receipts from bank loans and debt factoring
- government grants
OUTFLOWS
- payments of wages and suppliers
- buying equipment
- payment of dividends/repayment of loans/interest on bank loan or overdraft
What is opening and closing balance? How can this be calculated on a forecast?
Opening - amount of cash in bank at start of month
- for new start with 0 or existing use closing from previous month
Closing - net cashflow + opening balance (becomes opening for following month)
What’s the difference between an overdraft and short term loan?
Overdraft used as and when required and interest only paid in proportion used whereas short term loan is less flexible interest paid on whole sum borrowed but is usually lower
What is a budget and what are the aims of a budgeting system?
Agreed financial plan for future concerning revenues and costs of business - 3 types
Budgeting system shows how much can be spent per time period-gives manages way to check they’re on track
Help keep costs under control (show warnings so managers can respond) and allow delegation of power
May be variances (amount actual result differs from budgeted figure) which are adverse or favourable
- an adverse is forgivable if a new product or technique (learning curve)
- favourable variances should be investigated-why have they done well to do it again
What are the 3 types of budget?
Income (a minimum target)
- Aka revenue/sales budget over period of time
- links to marketing targets
- assess expenditure needs and includes sources of income like rent
Expenditure (a maximum target)
- Agreed, planned spending of department over period of time
- eg/ raw materials, labour costs, rent
Profit
- Agreed, planned profit of business over time
- annual focus to avoid seasonal distortions
- regular review to see if budget targets are hit
- Profit budget = Income budget - Expenditure budget
