5. Decision making to improve financial performance Flashcards
what are budgets
a financial plan for the future anticipating the revenues, costs and profit of a business
two types of variance
favourable - better than expected
adverse - worse than expected
what is a cash flow forecast
a budget for the cash flowing into and out of a business over a period of time
formula for closing balance
net cash flow + opening balance
formula for net cash flow
inflows - outflows
value of cash flow forecasts 5
- highlights when a business will be short of cash and by how much
- allows a business to take action (overdraft or loan)
- can see if payments can be delayed
- avoids running out of cash and liquidation
- can manage extra cash (invest or expand)
3 key cash flow problems
- customers paying late
- holding too much stock
- seasonal demand
gross profit
sales revenue - cost of sales
operating profit
sales revenue - cost of sales - operating expenses
profit for the year
operating profit + profit from other activities - net finance costs - tax
contribution per unit
selling price - variable costs per unit
total contribution
contribution per unit x units produced or sold
OR
total revenue - total variable costs
break-even output
fixed costs / contribution per unit
margin of safety
actual level of output - breakeven level of output
gross profit margin %
gross profit / sales revenue x 100
payables (creditors) days
payables / cost of sales x 365
receivables (debtors) days
receivables / sales revenue x 365
profit (m)
margin of safety x contribution per unit
profit (tc)
total contribution - fixed costs
3 advantages of retained profit
- Cheapest source of finance (no interest)
- Doesn’t not need to be repaid
- No loss of control
1 con of retained profit
Shareholders may want to receive the money (dividend) & refuse to leave the profit in the business
2 pros of overdraft
- flexible way of borrowing money
- useful for business with unpredictable cash inflows
5 cons of overdraft
- Interest charged can be high (higher than bank loan): likely to be an expensive way of borrowing money
- No set interest rate
- The bank can cancel this facility at any time
- Difficult to calculate the real cost of borrowing as interest is charged daily on the amount borrowed
- Mustn’t go over the limit!
3 pros of bank loan
- The cost of borrowing money is clear & fixed: it is the interest charged
- Easy to set a budget as repayment dates & amounts are set in the loan contract
- No loss of control or interference in the running of the business
4 cons of bank loan
- The full amount borrowed plus interest must be repaid
- Repayments must be done on time whether the business has enough cash or not
- If repayments are not made the bank can take the business to court (risk of liquidation)
- A collateral (asset with a value worth the same as the loan e.g. house) may be needed to secure the loan
4 pros of debt factoring
- Cash is received upfront (% of invoice value)
- Possible solution to a cash flow problem due to late payers
- Relieves the business from having to chase customers for late payment of invoice
- Can provide credit checks on customers
2 cons of debt factoring
- The Debt recovering or Factoring business will charge a fee (cost of recovering the money)
- Customers may not want to deal with a Factoring business & this may damage the business’ relationship with its customers
4 pros of venture capital
- No interest charged
- No set repayment date(s)
- Venture capitalists can provide advice, experience or useful contacts
- Venture capitalists are usually willing to take risks (a bank will not!). This may be the only option available to risky businesses.
4 cons of venture capital
- Loss of control of the business: venture capitalists will ask for shares in the business in return for their investment
- Venture capitalists may interfere in the running of the business
- The profit will be shared with the venture capitalists
- Venture capitalists may want their money back & force the sale of the business
3 pros of share capital
- Large amounts of capital can be raised (millions!)
- No interest charged
- No set repayment date(s)
6 cons of share capital
- Loss of control of the business: shareholders will have shares & own part of the business
- The profit will be shared among the shareholders
- Financial performance & key decisions must be communicated to shareholders & the public
- Shareholders have voting rights for key decisions (AGM)
- Being listed on the Stock Exchange is costly & time consuming
- For Plcs only
what is retained profit
Profit retained (not distributed to shareholders) in the business from previous years
what is bank overdraft
Facility or agreement with a bank to take out more money from an account than a business has in it but only up to an agreed limit
what is bank loan
Set amount of money borrowed from a bank with fixed interest & set repayment dates (the money must be repaid at specific dates)
what is debt factoring
Using the services of a Debt Recovering or Factoring business to collect invoice payments from customers
what is venture capital
Finance obtained from the sale of shares to wealthy individuals also called venture capitalists, Business Angels or Private investors.
Wealthy individuals can ‘team up’ & pull their capital together to form a venture capital firm to lend larger amounts.
what is share capital or shar issue
Finance obtained the sale of shares via the Stock Exchange
9 ways of improving cash flow
- make a cash flow forecast
- chase late payers and incentivise customers to pay early
- check customers’ credit rating
- negotiate longer trade credit with suppliers
- negotiate monthly repayments to spread out the outflows or rent
- don’t over stock
- don’t take on too many orders
- set up an overdraft
- use debt factoring
5 ways of improving profit - increase sales
- increase promotions
- reduce price (if -1 PED)
- use a product life extension strat
- find new markets or segments
- launch a new product
4 ways to improve profit - lower fixed costs
- find cheaper premises
- reduce staff number
- replace staff by machines
- increase capacity utilisation
2 ways of improving profit - lower variable costs
- find cheaper suppliers
- find ways of achieving purchasing economies of scale (bulk buying)
