3.7 Analysing the strategic position of a business Flashcards
PESTLE Analysis
A framework for assessing the key features of the external environment in which a business operate
Political factors:
Competition policy
Industrial regulation
Government spending and tax policies
Business policy and incentives
Economic factors:
Interest rates
Exchange rates
Consumer spending and income
Economic growth (GDP)
Social factors:
Demographic change
Impact of pressure groups
Consumer tastes and fashion
Changing lifestyles
Technological factors:
Disruptive technologies
Adoption of mobile technology
New production processes
Big data and dynamic pricing
Legal factors:
Employment law
Minimum/living wage
Health and safety laws
Environmental legislation
Environmental and ethical factors:
Sustainability
Tax practices
Ethical saving (supply chain)
Pollution and carbon emissions
Internal influences on corporate objectives:
Business ownership
Attitude to profit
Ethical stance
Organisational culture
Leadership
Strategic position & resources
Stakeholder influence
External influences on corporate objectives:
Short-termism
Economic environment
Political/legal environment
Competitors
Social & technological change
What is business strategy?
Business strategy is mainly concerned with the longer-term.
Business strategy is focused on:
The long-term business plan, based on the business vision and mission
What needs to be done to achieve corporate objectives.
What resources the business needs and to obtain and use them.
What are business strategies concerned with?
Mission statements
Vision and core values
Organisational culture
Business planning
Growth strategy
Segmentation, targeting & positioning
What are business tactics?
Tend to be focused on short-term issues, responding to opportunities & threats
Are often influenced by functional objectives and decision-making
What are business tactics concerned with?
Marketing mix
Financial and non-financial rewards
Inventory management
Location decisions
Day-to-day customer service decisions
Recruitment, selection, and training processes
Mission
The overriding goal of the business and the reason for its existence. A mission provides a strategic perspective for the business and a vision for the future
Corporate Objectives
Those that relate to the business as a whole. They are usually set by the top management of the business and they provide the focus for setting more detailed objectives for the main functional activities of the business
SWOT analysis
A method for analysing a business, its resources and its environment – it focuses on the internal strengths and weaknesses of a business (compared with competitors) and the key external opportunities and threats for the business.
SWOT looks at:
Internal strengths
Internal weaknesses
Opportunities in the external environment
Threats in the external environment
Aims of a SWOT analysis:
What the business does better than the competition
What competitors do better
Whether it is making the most of the opportunities available
How a business should respond to changes in its external environment
Strengths and weaknesses of SWOT:
Are internal to the business
Relate to the present situation
Opportunities and threats of SWOT:
Are external to the business
Relate to changes in the environment which will impact the business
Balance Sheet
This shows the assets (what a business owns) and liabilities (what a business owes) at a particular time throughout the financial year
Assets and liabilities must equal each other else the balance sheet won’t balance. If a firm owes more than what it owns, then this will limit their growth potential and they may have to consider retrenching (selling off stock)
Fixed Assets
Anything the firm owns as long as it is useful to operating the firm (must last longer than a year)
Current Assets
These represent the working capital and are directly linked to what is sold to the customers (lasts less than 12 months)
Current Liabilities
Things that a firm will need to pay out for within 12 months
Working Capital (Net Current Assets)
This shows the liquidity of the business – so if liabilities acceded assets, they the firm would go into liquidation
= current assets – current liabilities
Influences on the amount of working capital:
The volume of sales
The amount of trade credit offered by a business
Growth of the business
Length of the operating cycle
The rate of inflation
Depreciation
When the value if a non-current asset decreases
Assets will eventually become worthless over time without continuous investment
Income Statement
This describes the income and expenditure of a business over a given period of time (usually a year) – it shows the profits and losses of a firm
Calculations on an income statement:
Gross Profit = revenue – cost of sales
Operating Profit = gross profit – expenses
Profit Before Tax = operating profit – finance costs + finance income
Profit for the Year = profit before tax – tax expenses
Purpose of an income statement:
Legal requirement
Review progress
Allows shareholders to access if investment is needed
Comparisons can be made
Used to show potential investors
Capital expenditure
When spending money on items that will be used in the long run (e.g. property, machinery, vehicles, and office equipment)
Revenue expenditure
Spending on day to day items (e.g. raw materials, wages, and power)
Order of an income statement:
Revenue
Cost of sales
Gross profit
Expenses
Operating (net) profit
Finance costs
Profit before tax
Taxation
Profit for the year (retained)
The Current Ratio
This is used the keep track of the working capital within a business and make sure it can pay off the debts
= current assets / current liabilities
The ratio should be between 1:1 and 3:1
If the figure is below 1, the business doesn’t have sufficient short term assets and many need to raise additional finance
If the figure is above 3, then they may have to much cash and aren’t using it effectively
The Gearing Ratio
This is used to show whether a firm’s structure is likely to be able to co tune to meet interest payments and to repay long term borrowing
= long term liabilities / capital employed x 100 (capital employed = long term liabilities + total equity (total capital and reserves))
Between 25% and 50% is considered normal for a well established business
If too high or toolow then its too highly or lowly geared.
Profit Margins
This is an indication of a business’ ability to control costs
= ‘X’ profit / sales revenue x 100
Profit includes gross, operating, net, and retained
The higher the percentage the better as they are receiving more profit for the money they are investing in to the business and its products
The percentage reduces as further costs are subtracted
Profit margins depend upon the product life cycle and the placing of the product on the Boston matrix
Return on Capital Employed (ROCE)
This shows what returns (profits) the business has made on the resources available to it
= operating profit / capital employed x 100
The higher the figure the better as the firm will be getting more profit back for the resources and money it has used
The figures can be compared with previous figures as other competitors to gain an idea of where they stand in the market
Payables (Creditor Days)
This estimates the average time it takes a business to settle its debts with the trade suppliers
= trade payables / cost of sales x 365
In general, a firm that wants to maximise its cash flow should take as long as possible to pay its bills
However a high figure could illustrate liquidity problems which could cause legal claims
Thus figure should be higher than the debtor days
Receivables (Debtor Days)
This is the time is takes for trade debtors to settle its bills
= trade debtors / sales revenue x 365
A high figure could suggest a general problem with debt collection or the financial position of major customers
This should be lower than the payables
Inventory Turnover
This helps firms to answer questions like ‘how much money do we have tied up in stock?’
= cost of sales / average stock held
The quicker a firm turns over its inventories, the better
But, it is also important to do that profitable rather than sell inventory at a low gross profit margin or worse a loss
A high inventory turnover figure could indicate poor stock management
Internal users who need to know the financial position of the business:
Managers – whether the firm is reaching objectives and using resources efficiently
Employees – whether the firm is stable and secure and if they are receiving the right amount of pay for the job they are doing
Shareholders – how does the return on investment compare with other investors
External users who need to know the financial position of the business:
Creditors – how much cash a firm had and if it will be able to pay its bills
Government – the tax liability
Competitors – how the business is performing in relation to others in the industry
Core Competence
Something unique a business has or can do strategically well
Short-term metrics:
Helps to indicate whether growth and return on investment for shareholders can be sustained (e.g. sales productivity and capital productivity)
These measures or performance indicate the current health of the business
Medium-term metrics:
Helps to predict whether a business can maintain or improve its performance over the next few years (e.g. commercial health, cost structure health, asset health)
Long-term metrics:
Helps measure the ability of a business to sustain or expand its current operations (e.g. anticipated changes in consumer tastes, new technology, share price)
The Kaplan and Norton Balanced Scorecard
A framework based on four perspectives which is a strategic planning and monitoring system used to ensure that a firms a citizens are linked to its vision statement
Elkington’s Triple Bottom Line
This is a bottom line that continues to measure profits, but also measures the organisation’s impact on people and the planet (a way of expressing a company’s impact and sustainability on both a local and global scale)
Competition legislation
Refers to the laws and regulations that businesses need to comply with in relation to how they compete in markets.
Anticompetitive agreements
Abuse of dominant postition
Labour Market legislation
Focuses on protecting the rights of employees at work and also managing the relationship between employers and employees.
e.g being able to have a break at work
Environemtal legislation
The collection of laws and regulations pertaining to air quality, water quality, the wilderness, endangered wildlife and other environmental factors.
Gross Domestic Product (GDP)
A measure of economic activity (the total value of a countries output) over a given period of time, usually provided as quarterly or annual figures
The difference between GDP and real GDP is that on its own, GDP is nominal, whereas real means that the effect of inflation has been removed
Exchange Rates
The rate between two distinct countries
Currency demand
Demand from currency comes from a need to purchase the currency of a particular economy
Sources of demand include:
Exports of goods
Exports of services
Inflows of foreign investment
Speculative demand
Official buying of sterling by the Bank of England
Currency supply
Supply of currency comes from economic agents needing to demand overseas currency in exchange for their own
Sources of demand include:
Imports of goods
Imports of services
Outflows of foreign investment
Speculative selling
Official selling of sterling by the Bank of England
Inflation
A measure of how much the price of goods and services have gone up over time
Effect of inflation on consumers:
As prices rise (inflation) money loses its value and people lose confidence in money as the value of savings is reduced
Inflation can get out of control – price increases lead to higher wage demands as people try to maintain their living standards
Consumers on fixed incomes (e.g. pensioners) lose out because the their real incomes fall
Positive effects of inflation on businesses:
Industry-wide price rises enable revenues to grow
Growing revenues + constant gross margin = higher gross profit
Negative effects of inflation on businesses:
If costs are rising due to inflation, a business may not be able to pass them onto customers (PED)
Inflation can disrupt business planning and lead to lower investment
Rising inflation is associated with higher interest rates - this reduces economic growth and can lead to a recession
Fiscal policies
Involves the use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand in the economy, output and jobs.
Fiscal policy is also used to change the pattern of spending on goods and services e.g. spending on health care and scarce resources allocated to renewable energy.
Fiscal policy is also a means by which a redistribution of income & wealth can be achieved for example by changing tax rates on different levels of income or wealth.
There two main parts to fiscal policy:
Government spending
Taxation
Monetary policies
Involves the use of interest rates and changes to the money supply to achieve relevant economic objectives.
Protectionism
This involves any attempt by a country to to impose restrictions on the open trade in goods and services
Open Trade
This involves the removal or reduction of barriers to international trade
Globalisation
The process through which an increasingly free flow of ideas, people, goods, services, and capital leads to the integration of economies and societies
T
he main driver of globalisation are businesses as multinationals was to increase sales, profit, and shareholder value; and the government wants to encourage domestics firms to expand further
Advantages of globalisation:
Opportunities for trade and investment overseas
Access to cheaper goods and services
Lifted millions out of poverty
More intense competition
Bigger export markets (economies of scale)
Opportunities to live, study, and travel overseas
Disadvantages of globalisation:
Increased unemployment for firms that lose demand to lower cost competition
Rising income and wealth inequality
Surge of inward migration of labour has brought economic and social tensions
National governments gave less control
Globalisation of brands means there is a loss of cultural diversity
Environmental damage
Emerging economies
The country is becoming a developed nation often driven by relatively high economic growth and a rapid expansion of trade and investment flows.
Emerging economies as an opportunity for business
High rates of economic growth compared with more mature developed economies like the UK, US, Japan and Europe.
Many emerging economies have seen the rapid growth of a “middle class” with rising disposable incomes that might simulate demand for the products of businesses located in developed economies.
Emerging economies may be a suitable location for international operations - either as a location for production and/or to sell into the domestic market
Emerging economies as a threat for business
Many domestic businesses based in emerging economies are now actively pursuing expansion into developed economies. For example, Chinese businesses such as Lenovo, Huawei, Alibaba and Xiaomi are now world-leaders in their target markets.
Increased risk of intellectual property theft, restrictions on the methods of doing business and competitive challenges from established domestic businesses are threats that need to be overcome
Urbanisation
The movement of people within a country from the countryside to urban areas (towns and cities)
Migration
The movement of people between countries or regions
Immigration - the movement of people into a country
Emigration – movement of people out of a country
Corporate Social Responsibility (CSR)
The duties a business has towards its stakeholders
Changes from making money to becoming socially responsible
Sustainability and long term profitability
Advantages of CSR:
Improved financial performance
Reduced operating costs
Enhanced brand image and reputation
Increased sales and customer loyalty
Attracts and retains employees
Access to capital
Disadvantages of CSR:
May decrease efficiency
Can be costly
Stakeholders tend to have differing views/opinions
Goes to the back of the queue in terms of priority when the economy is struggling
Not legally binding
May only be done to meet changing consumer tastes instead of real commitment
Carroll’s CSR Pyramid
CSR is built on the foundation of profit – profit must come first
Then comes the need for a business to ensure it complies with all laws & regulations
Before a business considers its philanthropic options, it also needs to meet its ethical duties
How markets differ:
Size (e.g. sales revenue, volumes, numbers of customers)
Structure (e.g. the number of brands and competitors)
Distribution channels (how the product gets from producer to final consumer)
Customer needs and wants (the basis of marketing segmentation)
Growth (the rate of growth and which businesses are growing faster or slower than the market)
Product life cycle (the stage of the life cycle for the industry as a whole and for products and brands within it)
Alternatives for the consumer (e.g. substitute products)
Financial methods of assessing investment:
Payback
Average rate of return
Net present value (NPV)
Reasons why businesses invest:
Investment is the process of purchasing non current assets like buildings and machinery
Investment considers the buying of an asset that will pay for itself over a period of more than one year
It is done to replace and renew assets, and to introduce additional assets
Payback
The length of time it takes for an investment to recover the initial expenditure (usually measured in months or years)
Advantages and disadvatages of payback:
Advantages of payback:
Simple and easy to calculate, and easy to understand the results
Focuses on cash flows – good for use by businesses where cash is a scarce resource
Emphasises speed of return; may be appropriate for businesses subject to significant market change
Straightforward to compare competing projects
Disadvantages of payback:
Ignores cash flows which arise after the payback has been reached (i.e. does not look at the overall project return)
Takes no account of the time value of money
May encourage short-term thinking
Ignores qualitative aspects of a decision
Does not actually create a decision for the investment
Average rate of return (ARR)
The total net returns divided by the expected lifetime of the investment, expressed as a % of the initial cost of investment
Business investment projects need to earn a satisfactory rate of return if they are to justify their allocation of scarce capital
The ARR looks at the total accounting return for a project to see if it meets the target return
= average rate of return / asset’s initial cost x 100 (average annual profit (AAP) = total net profit before tax over the assets lifetime / life of asset in years)
Net present value (NPV)
This compares the amount invested today to the present value of the further cash receipts from the investment
I
t reflects the time value of money by discounting the value of future cash flow
When applying the discount factor, divide by 1.(the rate) (e.g. 10% = 1.1 and 5% = 1.05)
Advantages and disadvantages of NPV:
Advantages of net present value:
Takes account of time value of money, placing emphasis on earlier cash flows
Looks at all the cash flows involved through the life of the project
Use of discounting reduces the impact of long-term, less likely cash flows
Has a decision-making mechanism – reject projects with negative NPV
Disadvantages of net present value:
More complicated method – users may find it hard to understand
Difficult to select the most appropriate discount rate – may lead to good projects being rejected
The NPV calculation is very sensitive to the initial investment cost
Factors that affect investment decisions:
Interest rates (the cost of borrowing)
Economic growth (changes in demand)
Confidence/expectations
Technological developments (productivity in capital)
Availability of finance from banks
Others such as depreciation, wage costs, inflation, and government policy
Sensitivity analysis
It is a very useful technique for use in investment appraisal, sales and profit forecasting and lots of other quantitative aspects of business management.
Advantages and disadvantages of sensitivity analysis:
Advantages of sensitivity analysis:
Helps assess risks and prepare for a less than favourable scenario
Identifies the most significant assumptions (which therefore enquire closer attention)
Helps make the process of business forecasting more robust
Disadvantages of sensitivity analysis:
Only tests one assumption at a time
Only as good as the data which the forecast is based upon
Complicated concept
