3.5 - Finance Flashcards
What is revenue (aka turnover, sales, sales turnover, sales revenue)? How is it calculated? How can a firm increase revenue? What would this decision depend on?
The value of total sales made by a business within a period, usually one year
Sales revenue = quantity sold x average selling price
Higher or lower their price This depends on: - whether it’s essential or luxury - what price originally was - if any competition
What is profit, how is it measured and what is its importance?
Made when sales revenue exceeds total costs - measured by deducting all business costs from revenues generated within trading period
Profits are important because :
- provide measure of success
- source of capital for business growth
- attract further funds from investors enticed by high return on investment (shareholders/dividends)
What are the types of costs?
FIXED
doNOT vary directly with level of output - they exist even if the business does not produce any goods or services eg/rent, salaries, insurance, business rates
VARIABLE
costs that vary directly with the level of output
(the more a business produces the higher these costs would be eg/raw materials, packaging, piece rate labour, commission - a variable cost per unit)
How is profit calculated? What are the different types of profit?
Profit = total revenue - total costs
- GROSS profit
sales - cost of sales - NET profit (profit from operations)
gross profit - expenses - PROFIT FOR THE YEAR
net profit - all other costs (such as interest and tax)
How is gross profit calculated?
Gross profit = sales - cost of sales
How is net profit (profit from operations) calculated?
Net profit = gross profit - expenses
How is profit for the year calculated?
Profit for the year = net profit - all other costs (such as interest and tax)
This is the profit left for the business to reinvest and/or pay cut to shareholders
What is profit margin? How is it calculated?
Profits as a percentage of sales revenue
Profit margin = (profit / sales revenue) x 100
Can be calculated for gross profit or net profit
Proportion of sales revenue left over as profit after costs been paid
Name cost minimisation objectives
Cutting costs and reducing wastage in factories will increase profitability
1 To cut fixed costs:
- consider closing loss making branches
- consider moving head office to lower cost locations
- consider removing layer of management
2 To cut variable costs:
- renegotiate with existing suppliers to get better deal
- look at new suppliers from low cost countries eg/China
- redesign goods to make cheaper packaging
Why set a capital structure objective
To maximise chance of LT financial safety, directors need to think of the right capital structure for their business, it’s should be based on an assessment of the operational risks they face
Why set capital spending objectives and include a business example of this
Spending on capital equipment enables the quality&efficiency of production to rise while spending on research and development can lead to product innovation
Eg/ Apple vs Samsung
To achieve LT market share designed by directors, general objectives may be needed for capital spending and spending on research and development
Why set financial safety objectives
Include an example of one
To keep debts under control - financial analysts check on the LT finances of the business
Would be a good financial target to say 50% should be max allowable debt level for the business. This would help to avoid business collapses such as la senza retail outlets in 2014
What is a financial objective? List 4 examples of financial objectives
Goal/target pursued by finance department within an organisation
Likely that it’ll contain a specific numerical element&time scale within which it is to be achieved
Stem from overall company aims
Eg
- cash flow
- financial safety
- capital structure/spending
- cost minimisaion
Why set return on investment objectives?
Why set revenue, costs, profit objectives?
Why set cash flow objectives?
FINANCIAL OBJECTIVES
RETURN ON INVESTMENT
- hope of making profit on investment
- profit is functional return business earns from its activities
REVENUE, COST, PROFIT
- increase revenue
(growth, expansion, new products, advertising)
- lower costs
(negotiate with suppliers, shop around, savings/wastage)
- increase profits
(more revenue, lower costs)
CASH FLOW
- ensure enough cash to pay expected bills in coming months with a bit spare
- more requiems profits and reserves
- HOW - cash flow forecast, monitor, plan, control, lower/delay outflows, increase inflows
Why set any objectives?
To plan ahead which may help to minimise risks
Helps motivation of staff working towards a realistic goal
What is profit vs profitability
Absolute number VS relative measure (comparing profits to another variable eg/sales revenue)
How is gross profit margin calculated and what does a higher gross profit margin show about the business?
Gross profit margin = (gross profit/sales revenue) x 100
The higher the gross profit margin the more a business has added as a Mark-up on the cost to produce
Are comparisons important in deciding whether a business has a good profit margin and has added value to their business?
YES
In order to fully analyse whether the figure is good comparisons must be made with competitors/similar businesses and figures from previous years
If performing well = adding value, high mark up, strong brand
How can the gross profit margin be improved?
Need to increase difference between sales revenue and direct costs
Increase selling price
- changing price depends on elasticity (may result in keeping or losing customers)
Decrease direct costs
- if you switch suppliers (quality/service implications)
- reduce wastage (make things right the first time)
- better bargaining with suppliers (long term/large quantity deals)
How is net/operating profit and net/operating profit margin calculated?
Who focuses on this figure?
How can you know if a business has a good operating profit margin?
Operating profit = gross profit - fixed overheads
O/N margin = (operating profit/sales revenue) x100
Figure focused on, judged&assessed by shareholders
Can’t say whether its good/bad, high/low without comparing it, knowing industry norms or bench marks and can’t without last years figures
How can operating profit margin be improved?
Increase selling price
Decrease costs (both direct and overheads)
- fewer staff
- get rid of least effective advertising
- reduce wastage
- move production abroad
- outsourcing (getting another company to make some of your goods/do some work for you-eg/cleaning company to do cleaning - can result in getting it done cheaper)
Both
What is profit for the year?
Profit after all other costs deducted (interest charges, taxes)
Profit business has to refrain for investment or pay out to shareholders as dividends
How can profits be increased in general?
Increase revenue by putting more money in advertising, expanding product range, changing prices
Decrease costs by having less money go out
A combination of both
How can you increase profitability?
Increase price
Cut costs
Give examples of revenue and cost objectives including how they could be achieved
Increase revenue (growth, expansion, new products, advertising)
- put price up (people still need necessities)
- lower price (more buy it)
- promotion and advertising
- additional product range
Lower costs (negotiate with suppliers, shop around, savings/wastage)
- switch to cheaper supplier (check quality)
- barter price with suppliers (economy of scale-buy in bigger bulks)
- redundancies/restructure staff/re-layering
- wastage (eg/energy savings)
How is return on capital calculated and what 4 things does it show?
(net profit before tax/capital invested) x100
- Measure of returns made from investing in business
- How good business is at converting money invested into profit
- Provides means of comparison with other investment opportunities
- Opportunity cost - what an investor could have achieved by investing elsewhere
What does financial safety mean and how can it be achieved?
Being able to pay bills/make repayments
Achieved by keeping debt levels under control, recommended no more than half of firms financing should come from debt
- if more than 50% of finance is from borrowing there’ll be high repayments to make every month&will be vulnerable to interest rate changes
Hold reserves - retain profit (to fall back on in future)
What is capital structure? Whats the importance of it?
Proportion that’s debt - where capital in the business has come from
To maximise chance of financial safety, directors must carefully consider right capital structure for business based on operational risks faced
In a risky market low debt is advised (eg/fashion - tastes change)
Eg/ Northumbrian water can be risky - always needed so know they’ll have people paying) - moderate debt is fine
What is capital spending? Whats its importance?
In some markets the key to LT success is to fund high levels of investment spending on capital equipment and research and development (like
PS4 have to keep up to date-better standards and quality)
Spending on capital equipment can allow a business to become more efficient and produce goods of higher quality
Applicable for technology products - spending on R&D results in innovative products
How does cost minimisation benefit a business (2 ways)? Why must a business be cautious when working to cost reduction objectives? (Cost minimisation)
+ Keep price same&benefit from a higher profit margin
+ Use cost reduction to reduce selling price&attract more customers (become more competitive)
- Cheaper materials may lead to lower quality
Why do businesses set financial objectives (4)?
Act as focus for decision making and effort
Allow business to measure success or failure
Improves co ordination - all working together towards a goal
Allows shareholders to assess whether a business may be a worthwhile investment
Who reaped a high return on investment in e commerce?
John Lewis
Realised people wanted to shop online before most retailers so invested half a billion pounds online
VERY successful
What are 3 internal influences on financial objectives?
Ambitions of leader
(own agenda - pick up their own objectives for business - may pursue growth, innovation)
Financial
(strong/weak position, may want to grow, cash flow - does the company have the finance available to fund the pursuit of profit or revenue growth?)
Operational
(close to full capacity may face fewer opportunities for improving profitability unless it has confidence and resources to increase capacity eg/buying a new factory - maybe unable to gain more revenue and profit)
What are the 3 external influences on financial objectives?
Competitive enviro
(plans of every business can be affected by behaviour&reaction of competitors-plans to increase profit margins by increasing price may be wrecked if competitors react by reducing theirs-focus on survival, focus on quality)
Economic enviro (state of economy plays a vital part in ability of a business to meet its financial objectives-higher taxes could reduce disposable income&therefore spending eg/changing interest rates can affect a business)
Government
(legislation can be introduced that increases costs - minimum wage change, taxation rates, health&safety, pensions)
What are 4 ethical and environmental influences on financial objectives?
Interest in environment
Bargaining with suppliers (relationship, speed, quality)
Taxation (avoidance)
Public image (could objectives change the reputation and how public think of you - lower price but lower quality)
What makes a good financial objective?
ACRONYM
Specific
Measurable
Achievable
Realistic
Time bound
What are the 2 advantages and 2 disadvantages of setting financial objectives?
+ Objectives vital to give direction to business
+ Enable plans for each sector of business to be developed (each individual will know what role they play)
- Can stifle entrepreneurship and initiative
- Feel managers operate to satisfy objectives but don’t go beyond them, dampening risk taking which may prevent business from taking leaps forward
Why might a small, fast growing company focus its financial objectives on cash flow objectives?
Because cash flow difficulties are common among fast growing firms
Why might a firm focus on financing higher R&D spending?
To stay competitive with other perhaps overseas high technology companies
Why might employees think that senior management see business ethics as subordinate to profit?
Because financial objectives that only mention profit or profitability implicitly suggest ethics come second
Why may a firms financial objectives seem impossible to achieve when a recession kicks in?
If company mainly produces luxury goods it may be impossible in ST to overcome falling sales&profits
Why might a plc keep its financial objectives secret?
Doesn’t want competitors to plan accordingly
“if they’re focusing on cost minimisation we can increase our advertising spending and they won’t follow us”
How might a private school be affected by a capital structure based largely on debt?
Like any other business a period a poor trading may cause debts to accumulate, threatening schools future
What is the need for finance during growth?
A business may make enough profit to reinvest into growth or it may have paid profits out to shareholders and need to fund growth externally such as through bank loans
What are 4 internal sources of finance come from within the business and it’s resources?
Comes from within business and it’s resources
1 personal savings
+ doesnt cost business
+ no interest charged
2 retained profit (best source)
+ doesn’t incur interest charges or require payment of dividends
3 holding less stock and shortening credit terms could improve cash holdings
What is an overdraft as a form of loan capital?
external finance source
ST loan
allows business to be overdrawn-period of time this runs for will be negotiated
Interest charges usually higher than on loans but only apply to actual debts instead of facility itself
For firms that use overdraft as way of smoothing short term cash variations the interest payments can be quite small
Explain how debt factoring might benefit a retailer that offers long term credit to its customers
Provides immediate injection of cash flow in situations where goods have been sold on credit
Retailer will have cash and so will be able to replenish its inventory/stock
Factoring company takes responsibility for collecting the money - don’t have a team to do this not common
Risk been passed to factoring company to some extent - still may struggle to get money
What is contribution?
What is total contribution and how is it calculated? What is the significance of it?
Money after VC paid
Selling price - variable cost per unit
Contribution per unit x no. units sold
Difference between revenue and total variable costs
SIGNIFICANCE
- if it exceeds FC profit made, firm breaks even if they’re equal
Break even analysis relationship between total costs and total revenue to identify the output
What are 2 strengths and 2 limitations of break even analysis?
+ focuses on what output is required before profitability reached
+ illustrates importance of keeping FC to minimum
- Unrealistic assumptions (costs may vary with output, BE assumes everything made is sold-build up of stock)
- Most businesses sell more than one product
What are 2 external sources of finance, what is the most usual form of each? Include advantages and disadvantages of each
1st - 2 advantages
2nd - 3 advantages, 3 disadvantages
1 Loan capital (overdrafts and loans)
most usual way=borrowing from bank set for period of time (form of bank loan or overdraft)
either paid in instalments or at end of a loan period
bank will charge interest (fixed/variable) and demand collateral to provide security incase loan can’t be repaid
+ won’t dilute control of founder
+ makes no claim on company profits
2 Share capital (outside investors)
can be family and friends
+ doesn’t dilute control
OR money raised by shareholders through sale of shares giving buyer part ownership, therefore certain rights eg/right to vote on changes to business
+ permanent source of capital (can’t get refund of shares-just sell them on)
+ not promised dividends if no money made
- dilute control of owners
- takeover (as business grows & sells more shares, becomes vulnerable to threat of takeover bc shares sold publicly and if individual or group buys enough, can persuade other shareholders to vote for new management team)
- can slow decision-making processes
What is margin of safety and hows it calculated?
How can margin of safety be expanded?
Difference between actual level of output and breakeven output
Amount by which sales can fall before firm starts making loss
Current output-BE output
Higher margin of safety, less likely loss making situation will develop
To expand=sell more, change price/costs (which would change BE)
Break even output is the level of output at which total revenue is equal to total costs of porduction
How do you calculate the break even output?
What factors affect break even output?
Fixed costs/(selling price-variable cost per unit)
```
Changes to:
-selling price
-variable costs
-fixed costs
changes in demand don’t affect level of BE output
~~~
What are costs and what is the importance of them to a business?
Expenses incurred by a firm in producing and selling its products (eg/ wages and raw materials)=critical element in successfully managing a business
Importance:
- can the price customers are willing to pay cover the costs of production?
- how do actual costs compare to budgeted? Is the business working cost efficiently?
In relation to setting financial objectives, what should a business accept/look to do to remain successful
Accept lower profits
Lower prices
Extend their own range of inferior goods
What is capital?
Amount invested in a business
