5 - Decision making to improve financial performance 💰 Flashcards
Define financial objectives
the monetary targets a business wants to achieve within a period of time
What can a financial objective include?
- profit
- costs
- cash flow
- revenue
- return on investment
- capital structure
Define return
how much money the business gets back
Define investment
how much capital isbeing used
Define ROI %
a measure of a business’ profitability and performance
What are some likely ROI targets?
- benchmark to industry standard
- internal benchmarking
- external factors eg. interest rates
How do you calculate ROI
operating profit / capital invested X100
Define long-term funding
the amount of capital invested in a business that will stay in the business for over a year
What 2 sources does long term funding come from?
- equity
- debt
What is the formula for gearing?
debt / total long term funding X 100
Define cash
physical existence of money within the business
Define cash flow
timings of cash flowing into and out of the business
What makes cash and profit different?
- credit sales
- bad debts
- heavy stock holding
- investment in fixed assets
- seasonality
- repayments of loans
What can an income statement also be known as?
profit and loss accoun
How do you calculate the gross profit?
sales revenue - cost of sales
How do you calculate operating profit?
Gross profit - expenses (FC)
How do you calculate profit for the year?
Operating profit - interest and taxation
In an income statement, what are the rows going down?
Sales revenue
Cost of sales (VC)
Gross profit
Expenses (FC)
Operating profit
Interest and taxation
Profit for the year
Internal influences on financial objectives
- Business ownership
- Size and status of business
- Corporate culture
- Budgets
External influences on financial objectives
- Economy
- Competitors
- Social and political change
- Legislation
- Market changes`
Define budgets
forecasts or plans for the future finance of a business
What can budgets be?
income
expenditure
profits
Problems in setting budgets
- dependent on predictions
- costs are subjective to change
- actions of competitors are unknown
- managers may lack expertise
- may be subject to bias
- takes time and effort = opportunity cost
What are the steps of setting a budget?
- Set clear objectives
- Carry out market research
- Produce a sales forecast
- Set income budget
- Set expenditure budget
- Set profit budget
- Set divisions target
- Review against objective
What is the difference between the budget and the actual called?
variance
A positive variance is called…
favourable
A negative variance is called…
adverse
What happens to income, expenditure and profit if variance is adverse?
Income goes down
Expenditure goes up
Profit goes down
What happens to income, expenditure and profit if variance is favourable?
Income goes up
Expenditure goes down
Profit goes up
Define the break-even point
the point where TR = TC and the business is not making a profit/loss
Formula for break-even point
fixed costs / contribution per unit
Formula for contribution per unit
selling price - variable costs per unit
How do you calculate the margin of safety
actual output level - break even level of output
Pros to break even
- provides a target
- aids decision making
- helps to secure finance
- predicts outcome of changing variables
- calculates profit/loss
- calculates minimum number of sales
Cons to break even
- based on predictions
- even FC can vary in reality
- ignores changes in FC
- only indicates the number of sales needed, doesn’t ensure sales are true
List examples of cash inflows
- cash sales
- payment from debtors
- sales of assets
- bank loan
- owner’s investment
List examples of cash outflows
- purchasing stock
- wages/salaries
- paying debt = loans/creditors
- purchasing assets
What is a credit sale?
When it takes time before the business gets it
What is a cash sale?
The business gets the money immediately
Formula for net cash flow
Inflows - outflows
Formula for closing balance
Net cash flow + opening balance
What are debtors?
Someone who owes a business money
What are creditors?
someone the business owes money to
What does an insufficient liquid cash flow mean?
An inability to meet short-term debts
When might a business miss opportunities?
When they have limited cash
What should a business consider when they encounter cash flow problems?
Whether the cash flow problem is short term or long term
Direct causes of cash flow problems:
- credit sales
- overtrading (additional overheads)
- internal management (poor planning/stock control)
- seasonality
- unexpected events
How can a business improve their cash flow?
- increasing volume of inflows
- speeding up timings of inflows
- reducing the volume of outflows
- slowing down timings of outflows
Sources of Finance
List the external sources of finance X10
- debt factoring
- overdraft
- share capital
- loans
- venture capital
- crowd funding
- trade credit
- mortgage
- grants
- lease/hire purchase
Sources of Finance
List the internal sources of finance X3
- retained profits
- sale of assets
- personal savings
Sources of Finance
What is debt factoring?
When a business sells its accounts to a 3rd party at a discount, enabling companies to immediately unlock cash tied up in unpaid invoices without having to wait the usual payment terms
Sources of Finance
What are the short-term sources? X7
- debt factoring
- overdraft
- trade credit
- sale of assets
- personal savings
- grants
- lease/hire purchase
Sources of Finance
What are the long-term sources? X6
- retained profits
- share capital
- loans
- venture capital
- crowd funding
- mortgage
Sources of Finance
Pros and cons to debt factoring
✅ Receives debt asap
Addresses cash flow issues
Debt chased by experts
Time saving
❌ Reduces profitability as have to pay fee
May damage rep if seen having poor finances
Sources of Finance
Pros and cons to overdraft
✅ Timely payments
Flexible
Helps time mismatch flow of finance
❌ High interest
Risk of seizing
Owe money
Sources of Finance
Pros and cons to retained profits
✅ No interest
No debt
❌ must have good cash flow to save
Sources of Finance
Pros and cons to share capital
✅ No interest
Large finance raised
Only need to pay dividends not fixed
❌ Loss of ownership
Potential loss of control
Complex system
Sources of Finance
Pros and cons to loans
✅ Lower interest rate than overdraft
Greater certainty
❌ Requires security
Interest
Harder to arrange
Sources of Finance
Pros and cons to venture capitalists
✅ Exposure
Expertise and advice
Opportunity to grow
Doesn’t need to be repaid
❌ Loss of control
Pressure to grow fast
Mismatched interests
Sources of Finance
Pros and cons to crowd funding
✅ Brand loyalty
Exposure
You’re in control
❌ Risk of public failure
Don’t get any money if target isn’t raised
Sources of Finance
Pros and cons to trade credit
✅ No interest
More future cash
❌ Still has to be paid back within a time period
Sources of Finance
Pros and cons of sale of assets
✅ Can raise considerable sums
Improve profitability if no longer used
❌ May receive low value if product sold fast
Reduced ability to make a profit
Sources of Finance
Pros and cons of mortgages
✅ Greater certainty of funding
Lower interest rate than others
❌ Requires security (collateral)
Hard to arrange
Interest
Sources of Finance
Pros and cons to personal savings
✅ No interest
Owner keeps control
Opportunity cost is low
❌ Lack of savings
Nothing to fall back on
Risk
Sources of Finance
Pros and cons to grants
✅ Free money
Targeted at businesses
May come with free publicity
❌ Very specific eligibility
Time consuming to get
Competitive and May have strings attached
Sources of Finance
Pros and cons to lease
✅ Convenience in pay
Helpful for smaller businesses
Encourages savings
❌ Risk
Financial debt
If unable to pay, can’t keep goods
