3.5 Decision Making To Improve Financial Performance Flashcards
1
Q
What are financial objectives?
A
Financial objectives are financial goals that a business wants to achieve. Businesses usually have specific targets in mind, not just profit maximisation, and a specific time period for completion
2
Q
Who sets financial objectives?
A
Financial managers
3
Q
What can financial objectives be based on to ensure that they are relevant?
A
Past financial data
4
Q
What are the 3 types of financial objectives?
A
- Revenue objectives
- Cost objectives
- Profit objectives
5
Q
What is cash flow?
A
Cash flow is all the money flowing in and out of the business on a day to day basis
6
Q
Why are cash flow objectives put in place?
A
To prevent cash flow problems
7
Q
What does ROI stand for?
A
Return on investment
8
Q
What does ROI measure?
A
Return on investment measures how efficient an investment is - it compares the return from a project to the amount of money that’s been invested
9
Q
ROI formula
A
(ROI / Cost of investment) X 100
10
Q
What does capital structure refer to?
A
Capital structure refers to the way a business raises capital to purchase assets
11
Q
What combination makes up capital structure?
A
Capital structure is a combination of debt capital and equity capital
12
Q
What are two internal factors that influence financial objectives?
A
- The overall objectives of the business
- The status of the business
13
Q
What are 5 external factors that influence financial objectives?
A
- The availability of finance
- Competitors
- The economy
- Shareholders
- Environmental and ethical influences
14
Q
Explain the influence the economy has on financial objectives
A
In a period of economic boom, businesses can set ambitious profit targets. In a downturn, they have to set more restrained targets and they might set targets that minimise costs.
15
Q
Percentage change in profit formula
A
(Current year’s profit - previous year’s profit) / previous year’s profit) X 100
16
Q
What are the 3 types of profit?
A
- Gross profit
- Operating profit
- Profit for the year (net profit)
17
Q
Gross profit formula
A
Gross profit = sales revenues - cost of sales
18
Q
Operating profit formula
A
Operating profit = gross profit - operating expenses
19
Q
Profit for the year formula
A
Profit for the year = operating profit - net finance costs - tax
20
Q
Gross profit margin formula
A
(Gross profit / sales revenue) X 100
21
Q
Operating profit margin formula
A
(Operating profit / sales revenue) X 100
22
Q
Net profit margin
A
(Net profit / sales revenue) X 100
23
Q
Give examples of cash inflows
A
- Sales revenue
- Payment from debtors (recievables)
- Sale of assets
- Owners’ capital invested
- Sources of finance
24
Q
What is the difference between credit sales and cash sales?
A
Cash sales appear in the month of sale and credit sales usually appear in the month after
25
Give examples of cash outflows
- Purchasing stock
- Wages
- Paying debts
- Purchasing assets
26
What is the difference cash payments and credit payments?
Cash payments appear in the month of purchase and credit purchases appear in the month of cash outflow
27
What 2 things is the length of the cash flow cycle dependent on?
- The type of product - this determines the length of time it’s takes to produce and how long it’s held in stock
- Credit payments
28
Give 6 ways that businesses can improve cash flow
1) Overdrafts
2) Hold less stock, so less cash is tied up in stock
3) Try to reduce the time between paying suppliers and getting money from customers
4) Credit controllers keep debtors in control
5) Debt factoring
6) Sale and leaseback
29
What are cash flow forecasts?
Cash flow forecasts show the amount of money that managers expect to flow into the business and flow out of the business over a period of time in the future
30
Why isn’t cash forecasting always accurate? (Think about the two main reasons)
- Cash flow forecasts can be based on false assumptions about what’s going to happen
- Business environment can suddenly change and costs and demand can change rapidly
31
Give two reasons why a cash flow forecast is useful to someone setting up their own small business
- They can use it to support themselves when applying for loans and sources of finance
- It can give them an idea of when they will have large payment months (e.g when bills are paid quarterly or yearly)
32
What is a budget?
A budget is a financial plan for the future
33
What are the three types of budget?
- income
- expenditure
- profit
34
What are budget holders?
Budget holders are people responsible for spending or generating the money for each budget.
For example, the budget holder of the expenditure budget for marketing could be the head of the marketing department
35
Give 3 advantages of budgeting
- help achieve targets
- control income and expenditure
- assists managers to review their activities and make decisions
36
Give 3 drawbacks of budgets
- can cause resentment and rivalry if departments have to compete for money
- restrictive
- time-consuming to set and review the budget
37
What are the two methods used to set budgets?
Zero-based budgeting and historical budgeting
38
What is zero-based budgeting?
When businesses develop their budgets from scratch
39
Define liquidity
Liquidity is the ability of a firm to pay its short term debts
40
What is variance?
Variance is the difference between actual figures and budgeted figures
41
What does a favourable variance lead to?
Increased profit
42
What does an adverse variance lead to?
Reduced profits
43
What are the two types of variance?
Adverse and favourable
44
Give 3 external influences that cause variance
- competitor behaviour
- changes in the economy
- the cost of raw materials
45
Give 3 internal influences that cause variance
- improvements in efficiency
- overestimated/ underestimated budgets
- changes in selling price
46
What are 3 examples of decisions based on adverse variances?
- changing the marketing mix
- streamlining production
- motivate employees
47
What are 3 examples of decisions based on favourable variances?
- set more ambitious budgets
- improve responsibility of employees to be able to set higher targets in the next budget
- increase production
48
What is the break-even output?
The break even output is the level of sales a business needs to cover its costs
49
What is contribution?
Contribution is the difference between the selling price of a product and the variable costs it takes to produce it
50
Contribution per unit formula
selling price per unit - variable costs per unit
51
Total contribution formula
total revenue - total variable costs OR contribution per unit X number of units sold
52
Break-even output formula
fixed costs / contribution per unit
53
Margin of safety formula
Actual output - break-even output
54
Give 3 advantages of break-even analysis
- Easy to carry out
- Quick way to find out break-even output and margin of safety
- Forecasts how variations in sales will affect costs, revenue and profits
55
Give 3 disadvantages of break-even analysis
- Assumes that variable costs always rise steadily
- The analysis is for only one product and the majority of businesses sell a whole portfolio of products
- It only tells you how many units you need to sell and not how many you are actually going to sell
56
Give two types of internal sources of finance
Retained profit and rationalisation (sales of assets)
57
What is retained profit?
Profit kept within a business from profit for the year to help finance future activities
58
Give two advantages of retained profit
– Avoid interest repayments
| – does not dilute the business ownership
59
Give two disadvantages of retained profit
– Only an option if sufficient retained profit exists
– may cause shareholder dissatisfaction if this is at the expense of dividend payments
– reduces the security blanket of keeping profit for emergencies
60
What is rationalisation?
Sales of assets
61
Give an advantage of rationalisation
Quick and easy
62
Give two disadvantages of rationalisation
– Small amount if the asset is old
| – replacing the asset is usually more expensive
63
Give six examples of external sources of finance
```
– Debt factoring
– overdraft
– share capital
– loans
– venture capital
– crowdfunding
```
64
What is debt factoring?
Selling debts owed to a business to a financial institution. Businesses will receive funds immediately but at a reduced rate, all of the money will be returned but the company will keep a fee
65
Give two advantages of debt factoring
Guaranteed payments and saves time
66
Give one disadvantage of debt factoring
The business doesn't get all of the payment because the factoring company will take a percentage of it
67
Is debt factoring short term or long term?
Short term
68
What does an overdraft allow for?
An overdraft allows for the facility to overspend on a current account up to an agreed sum
69
Give two advantages of overdrafts
– Good for small businesses and emergencies they face
| – only borrowed when required allowing flexibility
70
Give two disadvantages of overdrafts
– Interest is changed on the overdrawn amount day to day
| – only available from a current bank account
71
Are overdrafts short term or long term?
Short-term
72
What is share capital?
Finance raised from selling shares
73
Give three advantages of share capital
– Good for large businesses
– quick access to large sums
– no interest repayments
74
Give four disadvantages of share capital
– Only for LTDs and PLCs
– complex and costly process
– pay dividends
– dilutes ownership
75
Is share capital short-term or long-term?
Long-term
76
What is a loan?
A set amount borrowed from the bank, to be repaid with interest over a set period of time
77
Give three advantages of loans
– Large sums of money
– improve cash flow
– no loss of ownership
78
Give two disadvantages of loans
– Interest is added on top of the repayment
| – can be more expensive than other financing options
79
Are loans short-term or long-term?
They can be both
80
What is venture capital?
Investment from an established business into another business in return for a percentage of equity in the business
81
What is venture capital also known as?
Private equity finance
82
Give three advantages of venture capital
– Potential for large sums of money
– gain of expertise
– makes it easier to attract other sources of finance
83
Give three disadvantages of venture capital
– Venture capitalists look for a high rate of return in a specific time period
– long and complex process
– partial loss of ownership
84
Is venture capital short-term or long-term?
Long-term
85
What is crowdfunding?
Raising finance from a large number of people each investing different, often small amounts of money
86
Give two advantages of crowdfunding
– No interest
| – way to get large sums quickly
87
What is the biggest disadvantage of crowdfunding?
The investor is only tied into their promise contribution if the total amount is raised, otherwise they will have to return all the money if the projected amount isn't raised
88
Is crowdfunding short term or long term?
Can be both
