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BUSINESS > Decision making to improve Financial Performance (3.5) > Flashcards

Decision making to improve Financial Performance (3.5) Flashcards

1
Q

Financial Objectives are the…

A

Are the monetary targets a business wants to achieve within a set period of time.

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2
Q

Financial Objectives Example (6) :

A

~ Return on investment.
~ Capital structure.
~ Revenue.
~ Costs.
~ Profit.
~ Cash flow.

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3
Q

(Financial Objectives) Return on Investment (ROI) :

A

A measure of a business’ profitability and performance.
~ Allows for comparison between alternative investment opportunities.
~ How effective it is to use the money tied up in the business to generate profit.

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4
Q

‘Return’ meaning…
‘Investment’ meaning…

A

‘Return’ is how much money a business gets back.
‘Investment’ is how much capital is being used within the business.

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5
Q

(Financial Objectives) ROI targets will be set as a % :

A

~ Benchmark to industry standards.
~ Internal benchmarking.
~ External environment e.g. Interest rate.

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6
Q

(Financial Objectives) Return on Investment Formula :

A

Operating profit
———————— x 100
Capital invested

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7
Q

Things on an Income Statement (7) :

A

Sales revenue, Cost of sales, Gross profit, Expenses, Operating profit, Interest and taxation, Profit for the year.

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8
Q

(Income Statement) Sales Revenue :

A

Money coming in from sales.
Quantity Sold x Selling Price.

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9
Q

(Income Statement) Cost of Sales :
(variable costs)

A

Costs directly linked to the production of the goods or services sold e.g. Raw materials.

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10
Q

(Income Statement) Gross Profit Formula :

A

Sales Revenue - Cost of Sales.

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11
Q

(Income Statement) Expenses :
(fixed costs)

A

All other costs associated with the trading of the business e.g. Salaries and Marketing Expenditure.

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12
Q

(Income Statement) Operating Profit Formula :

A

Gross Profit - Expenses.

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13
Q

(Income Statement) Interest and Taxation :

A

Interest paid on debt or received on positive balances.
- Less tax payable on profit.

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14
Q

(Income Statement) Profit for the Year Formula :
(end profit)

A

Operating Profit - Interest and Taxation.

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15
Q

(Financial Objectives) Cash Flow :

A

The movement of money into and out of a business.
- It’s important for survival.

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16
Q

(Financial Objectives) A business may have a specific Cash Flow Target, e,g, :

A
  • To ensure all debts are received (paid) within 30 days.
  • To maintain a cash balance of £25,000.
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17
Q

Capital Structure :

A

Refers to the relative ways in which the capital has been raised i.e. the ratio of equity to debt.

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18
Q

Long-term Funding :

A

Amount of capital that has been invested in a business and will stay in the business for over a year.
- Normally for the purchase of assets.

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19
Q

Long-term Funding can come from two sources :

A
  • Equity, i.e. capital invested by shareholders of a company.
  • Debt, i.e. money borrowed from financial institutions.
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20
Q

Gearing :

A

The relationship, or ratio, of a company’s debt-to-equity (D/E).
- A business can be described as highly geared if the % is thought to be high as this increases the element of risk.

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21
Q

Gearing Formula :

A

Debt
—————————- x 100
Total Long-Term Funding
(equity + debt)

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22
Q

(Influences on financial objectives) INTERNAL, can control (4) :

A
  • Corporate and other functional adjectives.
  • Characteristics of the firm.
  • Relationship between owners and directors.
  • Public or private sectors.
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23
Q

(Influences on financial objectives) EXTERNAL, can’t control (4) :

A
  • Competition.
  • Economic climate/conditions (interest rates, etc).
  • External environment.
  • Consumers.
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24
Q

Budgets are…

A

Forecasts or plans for the future finances of a business.
- These can be for the business as a whole or set for specific functions e.g. Marketing Budget.

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25
Q

Budgets can be on : (3)

A
  • Income.
  • Expenditure.
  • Profit.
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26
Q

Budgets Flow Chart (8) :
1) Set clear…
2) Carry out…
3) Produce a…
4) Set…
5) Set…
6) Set…
7) Set…
8) Review…

A

1) Set clear objectives.
2) Carry out market research.
3) Produce a sales forecast.
4) Set income budget.
5) Set expenditure budget.
6) Set profit budget.
7) Set divisional targets.
8) Review against objective.

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27
Q

Variance analysis is the process…

A

Of calculating and interpreting these variances (between budget and actual income).

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28
Q

Variance :

A

The difference between the actual income, expenditure or profit and the figure that has been budgeted.
- (may not always be a variance)

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29
Q

Adverse Variance :

A

Is one that is bad for the business.
- Expenditure higher than budget.
- Income&profit lower than budget.

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30
Q

Favourable Variance :

A

Is one that is good for the business.
- Expenditure (costs) lower than budget.
- Income&profit higher than budget.

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31
Q

Once a variance has been identified, it is important to (3) :

A

1) Identify the cause of the variance.
2) Consider the effect of the variance.
3) If appropriate, look for a solution.

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32
Q

Possible causes of variances (5) :

A
  • Actions of competitors (new products/lower prices).
  • Actions of suppliers (change prices, offer a discount).
  • Changes in economy (change in interest rates, increase to minimum wage).
  • Internal inefficiency (demotivated sales team).
  • Internal decision making (change suppliers, special promotion).
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33
Q

Benefits of Budgeting (3) :

A

+ Provides a quantifiable target, against which ‘actual outcomes’ can be measured e.g. ‘Are sale targets being achieved?’.
+ Informs decision making e.g. ‘Where can cuts be made?’.
+ Motivates budget holders due to increased responsibility.

34
Q

Drawbacks of Budgeting (3) :

A
  • Potential for conflict e.g. short-term saving may be detrimental to long-term objectives.
  • May be restrictive e.g. opportunities may be missed.
  • Time consuming to set and monitor.
35
Q

Break-Even is the point at which…

A

A business is not making a profit or loss i.e it is just breaking even.
~ At this point total costs must be the same as total revenue. TC = TR.

36
Q

Break-Even Output is the…

A

Number of items that a business must sell to reach this point.

37
Q

~ Before reaching Break-Even a business is operating at a…
~ After reaching Break-Even each additional…

A

~ Before reaching BE, a business is operating at a loss.
~ After reaching BE, each additional unit sold will contribute towards profit.
Charity/Public sector businesses may just be looking to break-even.

38
Q

Contribution per unit is the…

A

Difference between selling price per unit and variable cost per unit i.e. how much is left to contribute.
~ firstly to fixed costs and secondly to profit.

39
Q

Contribution per Unit formula :

A

Selling price - Variable cost per unit.

40
Q

Total Contribution formula (2) :

A

Total Revenue - Total Variable Costs
Contribution per unit x Units sold

41
Q

Break-Even Output Formula :

A

Fixed Costs
—————————
Contribution per unit
(sp-vc)

42
Q

Calculating Break-Even, Strengths (5) :

A

+ Allows business to calculate minimum no. of sales needed before making profit (see if venture is viable).
+ Can calculate the level of profit or loss at different levels.
+ Provides a target.
+ An integral part of business plan when seeking finance.
+ Aids decision making.

43
Q

Calculating Break-Even, Weaknesses (4) :

A
  • Is based on predicted costs + revenue.
  • Even fixed costs can vary in reality, especially in the long run.
  • Ignores changes in VC or SP as items are brought or sold in larger quantities.
  • Only indicates the number of sales needed, does not ensure actual sales will materialise.
44
Q

Margin of Safety is…

A

How much actual output is above the Break-Even level of output.

45
Q

Margin of Safety Formula :

A

Actual output level - Break-even level of output

46
Q

Profitability :

A

Measures the financial performance of a business by comparing profits achieved to a second variable e.g. revenue & ROI.

47
Q

Profitability Ratio :

A

Gross-Profit Margin, Operating Profit Margin, Profit for the Year Margin and Return on Investment.

48
Q

Gross Profit Margin :

A

Is a measure of a firm’s profitability by looking at the relationship between Gross Profit and Sales Revenue.
- If it’s low/falling may means sales are in decline/not managing its cost of sales effectively.

49
Q

Gross-Profit Margin, FORMULA :

A

Gross Profit
—————— x 100
Sales Revenue

50
Q

Operating Profit Margin :

A

Is a measure of a firm’s profitability by looking at the relationship between Net Profit and Sales Revenue.
- If low/falling may mean its not managing expenses properly/sales are in decline.

51
Q

Operating Profit Margin, FORMULA :

A

Operating Profit
———————– x 100
Sales Revenue

52
Q

Profit for the Year Margin :

A

Is a measure of a firm’s profitability by looking at the relationship between profit for the year and sales revenue.
- If low/falling may mean GP/OP are in decline/interest rates have changed.

53
Q

PFTY Margin, FORMULA :

A

Profit for the Year
————————– x 100
Sales Revenue

54
Q

Increasing Profitability is often a major aim for growing businesses, Some ways it can be achieved are (3) :

A
  • Sell the same quantity at a higher price (BUT customers may go to cheaper alternative).
  • Sell more at the current price (BUT have to inc production&wages&advertising).
  • Sell the same, at the same price but reduce costs (BUT may have to reduce quality which can have knock on implications).
55
Q

Sources of finance are the options…

A

The options available to a business when seeking to raise funds to support future business actions.
- For Start-up, might be raising sufficient capital to establish the business.
- For an Established Business, might be to fund growth or implement a new strategy e.g. relocation.

56
Q

(Source of Finance)
Short-Term : … (3)
Long-Term : … (5)

A

ST : Overdraft, Factoring, Crowd funding
LT : Share issue, Retained profits, Loan, Mortgage, Venture capital.

57
Q

(Source of Finance) Overdraft, + (3) AND - (2):

A

A sum of money which has been borrowed. The amount may vary on a daily basis.
(EXTERNAL, SHORT-TERM, EMERGENCY)
+ Flexible&quick&easy can borrow what you need, Can be used regularly, Only pay for money borrowed.
- Expensive if used for LT due to interest, Higher interest rates than a bank loan.

58
Q

(Source of Finance) Share Issue, + (3) AND - (3):

A

The sale of part of the business in return for an amount of money.
(EXTERNAL, LONG-TERM)
+ New finance, No interest, Only pay dividends when profit’s made.
- Loose a % of the business to others (diluted), Don’t get all the profits since you have to pay dividends, Complex&Costly process (especially for PLC).

59
Q

(Source of Finance) Retained Profits, + (4) AND - (3) :

A

Finance obtained from within the business following successful trading.
(INTERNAL, LONG-TERM)
+ Flexibility, Business owners in control, Low cost, No interest (don’t owe anyone).
- A drain on finance if loss-making, Only an option if sufficient profits, Shareholders may become unhappy (if its at expense of dividends).

60
Q

(Source of Finance) Trade Credit, + (3) AND - (2) :

A

Goods obtained from a supplier which does not have to be paid for immediately.
(EXTERNAL)
+ Flexible (business decides when to pay), Commonly available, Improve cash flow.
- Risk of late payment fees, May affect creditworthiness.

61
Q

(Source of Finance) Hire Purchase, + (3) AND - (3) :

A

A method of obtaining an asset in return for a series of monthly payments. Ownership of the asset doesn’t transfer until the final payment has been made.
(EXTERNAL)
+ Flexible, Immediate access of thing, Spreads costs over a fixed term.
- No ownership until contract ends, More expensive than buying, Late payments damage credit score.

62
Q

(Source of Finance) Grants, + (3) AND - (5):

A

Finance obtained for a specific purpose usually at no cost to the business. Doesn’t have to be paid back.
(EXTERNAL)
+ Don’t have to be repaid, Allow for growth, No impact on business ownership.
- Competitive , Not widely available for most, Time-consuming to apply, No guarantee of success, One-off.

63
Q

(Source of Finance) Loan, + (2) AND - (3):

A

Finance obtained, usually for a fixed period of time which has to be paid back.
(EXTERNAL, LONG-TERM)
+ Lower interest rate than a bank overdraft, Greater certainty of funding.
- Interest has to be paid, Harder to arrange, Not very flexible.

64
Q

(Source of Finance), Mortgage, + (2) and - (2) :

A

Finance obtained to help with the purchase of property.
(EXTERNAL)
+ Lower interest rates than other unsecured borrowing, Fixed monthly payment (structure finance plans etc).
- Long-Term financial commitment, Higher down payment.

65
Q

(Source of Finance) Lease, + (3) AND - (4):

A

The right to use goods, in return for a monthly payment. The goods are not owned by the business.
(EXTERNAL)
+ Predictable cash flows, Widely available, Lower interest than a bank loan.
- More expensive (in total) than buying assets outright, Don’t own the asset, May need up-front deposit, Some long-term contracts are difficult to cancel.

66
Q

(Source of Finance) Debenture, + (3) AND - (2) :

A

A long-term secured loan. Process of selling the debts owed to a business to a financial institution.
(EXTERNAL)
+ Fixed interest rate, Secured investment, Business will receive funds immediately (but at a reduced rate).
- Not backed by any form of collateral, Risky.

67
Q

(Source of Finance) Factoring, + (2) AND - (2) :

A

The sale of debt to a specialist firm who secures payment and charges commission for the service.
(EXTERNAL, SHORT-TERM)
+ Receivable (amounts owed by customers) are turned into cash quickly, Business can focus on selling rather than collecting debts.
- Quite as high cost, Customers may feel their relationship with their business has changed.

68
Q

(Source of Finance) Sale of Assets, + (3) AND - (3) :

A

Selling something that the business already owns.
(INTERNAL)
+ A significant amount of money can be raised, Doesn’t need to be paid back, No effect on the ownership of the business.
- Limited to businesses with spare assets (not all have them), May take some time to sell asset, Businesses lose future use of assets.

69
Q

(Source of Finance) Business Angels, + (4) AND - (4):

A

A small sum of capital invested from an individual.
(EXTERNAL)
+ A significant amount of money can be raised, Relatively quick to organise, Provide skills, expertise, contacts etc. Can lead to further investment.
- Usually involves selling a significant stake (therefore loss of control), Will usually want to have large involvement in decision-making, Will want dividends, Not easy to find right angels.

70
Q

(Source of Finance) Venture Capital, + (4) AND - (3) :

A

Finances obtained from limited companies willing to invest in fast-growing companies.
(EXTERNAL, LONG-TERM)
+ Get investors expertise & resources & technical existence, A significant amount of money can be raised, Opportunity to make business connections, Easier to attract other sources of finance.
- Demand a significant return against the investment, May lose ownership and autonomy (∴ risk of conflict/perceived interference), Don’t fund start-ups from the onset.

71
Q

(Source of Finance) Crowd Funding, + (4) AND - (3) :

A

Raising finance through a large number of people of people, who each contribute a small amount usually via the internet.
(EXTERNAL, SHORT-TERM)
+ Relatively low-risk, Form of free marketing & generate publicity, Relatively fast & easy way to raise capital, Can do it online.
- Potential failure to meet goals and not received money, Fees can be expensive, Your business idea can be swiped.

72
Q

Cash INFLOWS examples (5) :

A
  • Cash sales.
  • Payments from debtors (owe money, e.g. electricity).
  • Owners’ capital invested.
  • Sale of assets.
  • Bank loan.
73
Q

Cash OUTFLOWS examples (4) :

A
  • Purchasing stock.
  • Paying wages.
  • Paying debts (bank loans, creditors, they take money).
  • Purchasing assets.
74
Q

Cash flow is interested in the balance between…

A

The cash inflows and cash outflows in terms of their relative size and timings.

75
Q

What’s the difference between Cash Flow Forecasts and Cash Flow Statement :

A
  • CF Forecast is PREDICTED, usually new businesses.
  • CF Statement ACTUALLY HAPPENED, you can analyse financial performance).
76
Q

Net Cash Flow & Formula :

A

The net result of cash inflows and cash outflows each month.
NCF = Cash Inflow - Cash Outflow.

77
Q

Closing Balance & Formula :

A

How much the business has at the end of each month.
CB = Opening Balance + Net Cash Flow

78
Q

Cash sales VS Credit sales :

A

Cash sales, customers pay immediately, Credit sales aren’t paid immediately e.g. Laptop or electricity bill.

79
Q

The opening balance is the…

A

Closing balance of the previous month.

80
Q
A

BUSINESS (9 decks)

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