3.5 Decision making to improve financial performance Flashcards
What are financial objectives?
The specific aims and goals of the finance department within an organisation
What are some possible types of financial objectives?
Revenue / costs / profits / cash flow / capital expenditure levels / capital structure / return on investment / debt as a proportion of long-term funding
What are the benefits of setting financial objectives?
-Focus for decision making
-Benchmark against which success and failure can be measured
-Gives teams and departments a common purpose
-Improve efficiency
-Allow shareholders to assess whether the business will provide a worthwhile investment
-Outside organisations (supplers/customers/regulators) can confirm the financial viability of the business
What are the difficulties of setting financial objectives?
-Difficult to make them realistic
-External changes are beyond the control of the business
-Difficult to measure certain objectives
-Responsibilty of achieving objective may rest on financial department but really it depends on other departments aswell
-May conflict with other non-finacial objectives
What is a return on investment?
A measure of the efficiency of an investment in financial terms. Can then be used to compare the returns of an alternate investment.
How is the ROI calculated?
(ROI/cost of investment) x 100 = %
What is debt?
Money owed by an economic agent to another economic agent
What is long-term funding?
All funding available to a business that doesnt need to be paid within a year:
-Share capital = total equity
-Debt that doesnt need to be payed within a year.
ADDED TOGETHER
What is debt as a proportion of long-term funding?
How is it calculated?
A measure of how much of the firms long term funding is debt and how much is shareholder funds. Shareholder funds require no interest payments as shareholders are rewarded with dividends.
(debts that dont need to be payed within a year / total long term-funding) x 100 = %
What is the problem with debt?
-Interest payments must be made, this can create cash-flow problems and increase a firms fixed costs.
What is cash-flow?
The amount of money flowing in and out of a business over a given period of time
What is ‘net cash flow’?
Sum of cash inflows - sum of cash outflows
over a given period of time
Why may a profitable firm be short of cash-flow?
-High inventory levels, meaning its wealth is in assets
-Sales are on credit, wealth is stored in debtors
-Paying out dividends / paying back loans
-Investment into fixed assets
What is liquidity?
The ability to convert an assett into cash without loss or delay
What is profit?
Total revenue - Total costs
What are the 3 different types of profit?
1) Gross profit = revenue - total costs of sales
Total Costs of Sales = it’s the total amount of money you spend on materials, labor and manufacturing expenses to create your product. Excludes indirect expenses such as rent of offices, warehouses, advertising and shipping after good has sold.
Used to indicate how well a business is adding value to its inputs
2) Operating profit = gross profit - operational costs
Profit made from trading, companys best measure of performance
3) Profit for the year = profit available to owners for the year
Includes all revenue and costs including sales of assetts.
Useless measure for shareholders as a business could sell an expensive assett and that is included
What are some examples of revenue objectives?
Sales maximisation
Increase in sales revenue
Exceeding sales volume of competitor
What are some examples of cost objectives?
Achieve a cost reduction in raw materials (careful of quality)
Reduce wage cost per unit
Lower levels of wastage
Reduce variable costs per unit to improve production efficiency
What are some examples of profit objectives?
Profit maximisation
Increases in profit
What are some examples of cash flow objectives?
Maintaining a min. monthly closing balance
Reduce bank overdraft
Maintain a certain level of liquid assetts
Setting contingency fund levels
What are the benefits of cash-flow to a business?
-Stay out of debt, reduced costs through interest payments
-Payroll is easier, improving employee morale
-Invest / upgrade / replace when required
-Grow business
What is the capital structrure of a business?
The balance of debt capital and equity capital
What is debt capital made up of?
Dependitures = External source of funding in return for regular fixed interest payments and a re-payment date, usually for a long time (10yrs +). It can be sold to another economic agent
Loans
What are some external influences on financial objectives?
PESTLE
Market factors
Competitor actions
Suppliers
What are some internal influences on financial objectives?
Business objectives
Human resources
Nature of the product
What is a budget?
A tool that allows managers to plan out the future finances of their organisation.
What are the 3 different types of budgets?
Sales revenue budget - Planned revenue over a period of time
Expenditure budget - Planned expenditure over a period of time
Profit budget - Difference between sales revenue budget and expenditure budget
Why would a business use a budget?
To allow the higher ups to retain control of business activities
What is variance analysis?
Analysing the adherence to a budget at the end of the budgetary period
How is variance analysis presented on a budget?
A budget will show the ‘budgeted figure’, the ‘actual figure’ and the ‘variance’. To the right of these three colums, we write:
-adverse variance if bad
-favourable variance if good
-no variance if nothing
What are some positives of budgets?
-Helps investors and potential investors understand the financials of a business
-Prevents overspending
-Establishes priorities
What are some negatives of budgets?
-Managers making the budget may not knwo enough about the department
-Difficult to accurately gather financial information
-Unforseen changes can occur
-Difficult to predict levels of inflation
What is a cash-flow forecast?
Data that estimates the expected cash inflows and outflows over a period of time
What are the benefits of forecasting cash flow?
-Identifying potential issues in advance
-Np issues w suppliers and creditors
-Evidence for a request for finacial assistance
-Identifying the possibility of holding too much cash
What are the negatives of forecasting cash flow?
-Changes in the economy are unpredictable
-Changes in inflation
-Changes in consumer taste
-Innacurate market research
-Incorrect evaluation of costs
What is working capital?
Includes cash and most liquid assets that can be sold quickly. It is an indication of a firms ability to pay short term debts.
What is break-even?
When a business sells enough for its profits to cover its costs
On a break even diagram, where is the break even point?
Where sales revenue = total cost
On a break even diagram, what is the margin of safety?
The difference between current output and BE
On a break even diagram, what does the difference between total costs and fixed costs represent?
Variable costs
What factors can change the BE point?
Selling price, fixed costs, variable costs
What are some benefits of BE analysis?
You can calculate the time taken to reach profitability
Simple way of assessing financial viability
Can be used as a best-case / worst- case scenario
Can help plan future objectives and strategies
What are some drawbacks of BE analysis?
Forecasts may be unreliable due to assumptions:
-Selling price remains the same regardless of n units sold
-Fixed costs remain the same ‘’
-Every unit of output produced is sold
What is gross profit margin and how do you calculate it?
Profit as a % of sale turnover
(sales revenue - costs) as a % of total sales revenue
What are ‘sources of finance’ to a business?
Options businesses may use to help with liquidity problems or raising large sums of money for capital expenditure
What are the 4 types of sources of finance?
Internal = From within the business
External = From outside the business
Short-term = Repayment under a year
Long-term = Repayment after a year
What are 6 sources of finance? What are they?
-Debt factoring
=Owed money from someone, you sell debt to debt factoring compnany
-Overdraft
=Arranged with banks, spend more than in account
-Retained profit
=saved money
-Raise share capital
=Bring in new owners, sell shares
-Bank loans
-Venture capital
=Inviting people to invest in return for shares OR INTEREST
What are some methods of improving cash-flow?
-Bank over draft
-Debt factoring
-Sales and leaseback
(business sells an asset for cash and rents the asset back from the firm for a given period)
-Leasing of non-current assetts
What are some reasons a firm may experience cash-flow problems?
-Seasonal demand
-Over trading (expanding too quickly)
-Over investment in long term assets
-Unforseen changes
-Losses or lower profits
How can a business increase its profits?
-Changing the price
-Decreasing costs
-Increasing sales volume through marketing
What are some difficulties in improving profits?
-PEDs of products
-Where to cut costs
-Expenditure to improve marketing
