theme 2 (in papers 2 & 3) Flashcards
managing business activity
what are some internal sources of finance?
- owners capital
- retained profit
- sale of assets
What are the benefits to using internal sources of finance?
- Internal finance is often free (e.g. it does not involve the payment of interest or charges)
- It does not involve third parties who may want to influence business decisions
- Internal finance can usually be organised very quickly and without significant paperwork
- Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily
what are the drawbacks of using an internal source of finance?
- opportunity cost, once retained profit has been used, it is not available for other purposes
- may not be sufficient to meet the needs of the business
what are some external sources of finance?
- loans
- share capital
- venture capital
- overdrafts
- leasing
- trade credit
- grants
what is limited liability?
- Limited liability means that the business owner or owners are only responsible for business debts up to the value of their financial investment in the business.
- This means that a creditor can only take assets or finances belonging to the company.
what is unlimited liability?
- is when an owners personal assets are at risk.
- This means that if the business were to fail and go bankrupt, the owner’s personal assets would be sold in order to try and recover the debt.
what are the implications of unlimited liability?
- There is no legal distinction between owners with unlimited liability and the business
- As a result, these business owners may have to use their own personal assets to pay debts or legal fees
- E.g. a sole proprietor may need to sell their home to pay creditors if their business fails.
what are the implications of limited liability?
- Companies are incorporated and owners are considered a separate legal entity to the business.
- This means that if a company fails, the owners would lose their investment but would not have to use their assets to meet additional debts or legal fees.
what does a business plan do?
- helps finance providers assess te business model.
- provides structure assesment of the opportunities and risks.
- encourages analysis of the competitive position of the business and the market.
- helps determine the amount of finance required.
why is cash flow forecasting important?
- cash flow problems are why most businesses fail.
- cash is king, its the lifeblood of a business.
- cash is limited so it needs to be managed carefully.
what are the benefits of cash flow forecasting?
- advanced warning of cash shortages.
- makes sure that the business can afford to pay suppliers and employees.
- spot problems with customer payments.
- provide reassurance to investors and lenders that the business is being managed properly.
how do you work out net cash flow?
cash inflow - cash outflow
how do you work out closing and opening balance?
opening = amount business starts with each month.
closing = opening balance + net cash flow
- a negative closing balance suggests business needs bank overdraft or additional financing.
define cash flow forecast.
- an analysis of estimated cash inflows and cash outflows over a future period and the resulting impact on cash balance.
what are the limitations of a cash flow forecast?
- theres some uncertainty.
- sales could prove lower than expected.
- customers pay not pay on time.
- costs pay proof higher than expected.
what does sales forecasting help with?
- human resource plan
- production / capacity plans
- cash flow forecasts
- profit forecasts and budgets
- a very useful part of competitve analysis and helps to focus market research.
what are the key factors that affect sales forecasts?
- consumer trends
. demand in markets change as consumer tastes do. - economic variables
. intrest rates, GDP, tax, exchange rates - competitor actions
when is sales likely to be inaccurate?
- business is new
- market subject to significant distruption from tech change.
- demand is highly sensitive to changes in price and income (elasity)
- product is a fashion item.
- significant changes in market share
- business has demonstrated poor forecasting abilities in the past.
how do you calculate sales revenue?
selling price x no. of units sold
how do you work out average total costs?
total costs
–.————–
quantity
what is economies of scale?
occurs when production rises at a rate faster than costs, with costs then being spread over a larger amount of goods.
what is diseconomies of scale?
occurs when a business grows so large that the costs per unit increase.
how do you calculate contribution?
selling price - variable costs
what is contribution?
the amount contributes towards paying off the fixed costs of the business.
Once the fixed costs have been paid off, then the contribution starts to contribute to the profits of the business.
define break-even.
The Point where a total revenue earned for a product is exactly equal to its total costs and where the business is making neither a profit nor a loss.
how do you calculate the break-even point using contribution?
fixed costs / contribution
what is the margin of saftey?
the difference between the actual level of output of a business and its break even level of output.
how do you calculate the margin of saftey?
actual level of output - break-even level of output
what are the limitations of break-even analysis?
- less useful if the business sells more than 1 product.
- the accuracy depends on the quality of the data.
- it assumes all output is sold.
what is a budget?
- A financial plan that a business sets about costs and revenue.
- The budget is usually closely aligned with the business objective.
why do business’ have budgets?
- planning and monitorting
- control
- coordination and communication
- motivation and efficiency
what ae the different types of budgets?
- historical budgeting
- zero budgeting
what is historical budgeting?
- uses last years figures as the basis of the budgets.
- realistic in that its based on actual results.
- however circumstances might have changed i.e. new products, lost customers.
- doesnt encourage efficiency.
what is zero budgeting?
- budgeted costs and revenue are set to 0.
- its based on new proposals for sales and costs.
- makes budgeting more complicated and time consuming, but potentiallymore realistic.
what is variance analysis?
- the difference between a figure budgeted and the actual figure achieved by the end of the budgetary period.
- Variance analysis seeks to determine the reasons for the differences in the actual figures and budgeted figures.
what is adeverse variance?
where the actual figure achieved is worse than the budgeted figure.
An adverse variance in a revenue or profit budget is where the actual figure is lower than the budgeted figure.
An adverse variance in a costs budget is where the actual figure is higher than the budgeted figure.
what are the 3 types of budgets?
- revenue
- costs
- profit
what is favorable variance?
- where the actual figure achieved is better than the budgeted figure.
- A favourable variance in a revenue or profit budget is where the actual figure is higher than the budgeted figure.
- A favourable variance in a costs budget is where the actual figure is lower than the budgeted figure.
what are the limitations of budgeting?
- Budgeting requires significant expertise to be of genuine use to a business and there are several difficulties associated with their construction.
- can lead to conflict and competition.
- encourages the focus on the short term rather than long term.
- can have a negative impact on motivation.
- depends on the data.
how do you calculate gross proft?
revenue - cost of sales
how do u calculate operating profit?
gross profit - operating expenses
how to calculate net profit?
operating costs - interest
whats a statement of comprehensive income (profit loss account)?
- The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months.
- Each type of profit is calculated within the Statement of Comprehensive Income
- The previous year’s figures are also shown for comparison purposes
whats a profit margin?
- A profit margin is the amount by which the sales revenue exceeds the costs.
- Profit margins can be compared to previous years to better understand business performance
- Higher and increasing profit margins are preferable as it means that more revenue is being converted to profit
how do you calculate gross profit margin?
gross proft
……………………….-……………………x100
revenue
how do you calculate operating profit margin?
operating costs
—————————x100
revenue
how do you calculate net profit margin
net profit
—————x100
revenue
what are ways to improve profitability?
- raising prices
- reduce costs
- delay time to pay suppliers
whats a statement of financial position (balance sheet)?
- The Statement of Financial Position shows the financial structure of a business at a specific point in time
- It identifies a businesses assets and liabilities and specifies the capital (money) used to fund the business
- contains the financial information required to draw conclusions about the liquidity of the business
define liquidity.
- Liquidity is the ability of a business to meet its short term commitments (e.g. payments to creditors) with its available assets.
- A business that cannot pay its bills will usually fail very quickly, even if they are profitable
- Managing liquidity is a key way to manage risk in a business - and helps a business to prepare for the unexpected
whats a non-current assest?
- items owed by the business long term
- i.e. machinery
whats a current asset?
- items that are converted to cash within 12 months.
- i.e. inventory
whats a non-current liability?
- debts that dont need to be paid within the year
whats a current liability?
- debts that need to be paid within the year
how to you calculate net assets?
assets - liabilities
what are the 2 ways to meausure liquidity?
- acid test ratio
- current ratio
what is current ratio?
- The Current Ratio is a quick way to measure liquidity and the outcome is expressed as a ratio
- The current ratio is an effective liquidity measure for businesses that hold little stock
- The result indicates how many £s of current assets it has available to cover each £1 of short term debt.
current assets
————–a———
current liabilties
what is acid test ratio?
- Is a precise way to measure liquidity and is expressed as a ratio
- The least liquid form of current assets (inventory/stock) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly
- It is a particularly important measure of liquidity for businesses that hold a large amount of stock
current assets - inventory
————.—————————–
current liabilities
how can you improve liquidity?
- Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action
- Budget effectively and consider adopting zero budgeting to carefully control spending.
- Set clear financial objectives and look for ways to reduce costs and increase income wherever possible.
whats is working capital?
- Working capital is the money that a business has to fund its day to day activities
- current assets - current liabilties
why is too much working capital bad?
- If a business is holding large amounts of cash it is likely to be missing out on the benefits of investing it in fixed assets or investments
- This may represent a significant opportunity cost especially when interest rates are high
- If a business is holding large amounts of inventory it may incur extra storage costs and could use the cash ‘tied up’ in this stock for other purposes
what are internal causes of business failure?
- Ineffective management is a key cause of business failure, leaders may lack the experience or skills to run a business effectively, especially during periods of crisis
- Financial factors (e.g. a lack cash flow or working capital) can cause swift business failure as it becomes difficult to operate on a day-to-day basis
what are external causes of business failure?
- A change in legislation can mean that products or processes may require significant redesign or withdrawal
- Economic challenges (e.g. rising interest rates or a recession) are a key cause of business failure
- The entry of new competitors into a market can cause significant problems for incumbent businesses, who may have to slash prices or spend heavily on promotional activity to maintain their market share
what are the 4 methods of production?
- cell
- flow
- job
- batch
what is job production?
- Producing one item at a time, as ordered by the customer
Advantages
- High quality product
- Motivated and highly skilled workers
- Customised products can be produced
Disadvantages
- Production is slow
- Labour costs are high
what is batch production?
- Groups of the same product are produced, before moving on to a group of different products
Advantages
- Workers can specialise
- Production can take place as the previous ‘batch’ starts running out
Disadvantages
- Requires careful coordination to avoid shortages
- Money is tied up in stock as completed products need to be stored
what is flow production?
- Continuous manufacturing of standardised products, usually on a production line
Advantages
- Low unit costs due to economies of scale
- Rapid production
- Usually highly automated (capital intensive)
Disadvantages
- Customisation is difficult
- Capital equipment can be expensive to purchase
what is cell production?
- This involves workers being organised into multi-skilled teams, with each team responsible for a particular part of the production process
Advantages
- Cell production is often more efficient than other methods as workers share their skills and expertise
- Motivation is usually high as employees work as a team
Disadvantages
- Requires extensive reorganisation of production processes
- Teams efficiency may be reduced by weaker workers
how do you workout productivity?
output
——.——
number of workers
what factors influence productivity?
- employee motivation
- Skills, education & training staff
- Business organisation & working practices
- Investment in capital equipment
what does efficieny refer to?
- Efficiency refers to the ability of a business to use its production resources as cost-effectively as possible
total costs
——–.———
number of units
what factors influence efficiency?
- Standardisation of the production process
- Relocation or downsizing
- Investment in capital equipment
- Organisational restructuring
- Outsourcing
- Adoption of lean production techniques
what is labour intensive production?
- Labour-intensive production predominantly uses physical labour in the production of goods/services
- The delivery of services is usually more labour-intensive than manufacturing
- In countries where labour costs are low (e.g. Bangladesh) labour-intensive production is common
- Small-scale production is likely to be labour-intensive
what is capital intensive production?
- Capital-intensive production predominately uses machinery and technology in the production of goods and services
- Large-scale production of standardised products is likely to be capital-intensive
- Manufacturing in developed countries where labour costs are relatively high is likely to be capital intensive
disadvantages and advantages of labour intensive production?
Advantages
- Low-cost production where labour costs are low
- Provides opportunities for workers to be creative
- Workers are flexible (e.g. they can be retrained)
Disadvantages
- Workers may be unreliable and need regular breaks
- Incentives may be needed to motivate staff
- Training costs can be significant
disadvantages and advantages of capital intensive production
Advantages
- Low-cost production where output is high
- Machines are usually consistent and precise
- Machines can run without breaks
Disadvantages
- Significant set-up and maintenance costs
- Breakdowns can severely delay production
- May not provide flexibility in production
what is capacity utilisation?
- Capacity utilisation is measure of the level to which a businesses assets are being used to produce output
- It compares current output to the maximum possible output a business can produce using all of its assets and is expressed as a percentage
current output
———————————-x100
total maximum output
what are the implications of under-utilisation?
- If a business has a low level of capacity utilisation it will not be making the most of its resources and is likely to have increased unit costs
. Fixed costs are spread over fewer units of output resulting in higher average total costs
. Workers may be under-deployed leading to fears of redundancy - Operating under capacity does provide a business with flexibility
. There may be the opportunity to engage workers in maintenance tasks
.The business can respond to sudden increases in demand
what are the implications of over-utilisation?
- If a business has a high level of capacity utilisation it may not have the flexibility to respond to new orders from customers
. Staff will be under a lot of pressure to produce high levels of output
. Overworked staff may be inclined to leave increasing staff turnover
. Machinery may be pushed to its limits and prone to breakdowns which disrupts production and increase costs - High capacity utilisation will minimise average total costs and increase business competitiveness
. If workers are busy they are likely to feel secure in their employment
. A business that is busy is likely to be well thought-of and is likely to attract customers who are willing to wait for products to be delivered
what are ways of improving capacity utilisation?
- increase sales (more items will need to be produced)
- increase usage
- reduce capacity
- outsourcing
- redeployment
explain a stock diagram?
- The maximum stock level is the maximum amount of stock a business is able to hold in normal circumstances
- The reorder level is the level at which a business places a new order with its supplier
- The **minimum stock level **is also known as the buffer stock level and is the lowest level to which a business is willing to allow stock levels to fall
- The lead time is the length of time from the point of stock being ordered from the supplier to it being delivered
- The stock level line shows how stock levels change over the given time period
. As stock is used up a downwards slope is plotted
. When an order is delivered by a supplier the stock level line shoots upwards
what is buffer stock?
- Buffer stock is a quantity of goods/raw materials kept in case of stock shortages
- This can provide a competitive edge over rivals unable to meet demand
- This approach is commonly called ‘just in case’ stock control
- The decision to keep buffer stocks is one that businesses have to weigh up very carefully
- The decision will be influenced by the nature of the business and the product/service it provides
what are the disadvantages and advantages of buffer stock?
Advanatages
- Stability in supply
- Price stabilisation
- Raw materials security
- Competitive advantage
Disadvantages
- Cost
- Risk of obsolescence
- Opportunity cost
what are the implications of poor stock control?
- Problems may arise from holding too much stock
. Storage costs (e.g. warehouse rental, security costs) will be higher than necessary
. The risk of spoilage and stock shrinkage will be increased, leading to increased costs - Similarly, holding too little stock is risky
. A business may run out of stock, resulting in production stoppages and higher unit costs related to underused capacity
. A sudden increase in demand may not be capable of being met and this leads to a loss of potential sales revenue
what is just in time stock management?
- Just in Time (JIT) stock management is a process in which raw materials are not stored onsite
- Stock is ordered as required, and delivered by suppliers ‘just in time’ for production
- Careful coordination is needed to ensure that raw materials and components are delivered by suppliers at the moment that they are to be used
what are the advantages and disadvantages of JIT?
Advanatages
- Stockholding costs, including storage costs, are minimised
- Close working relationships are developed with a small number of trusted suppliers
- Cash flow is improved as money is not tied up in stocks
- Unused storage space is available for productive use
- Teamwork is encouraged so employee motivation is likely to be improved
Disadvantages
- Bulk buying economies of scale are not generally possible
- The ability to respond to unexpected increases in demand is reduced
- Administrative costs related to frequent ordering are increased
- Unreliable suppliers can quickly halt production
- Significant changes to organisational structure and production controls are required
what are ways to achieve waste minimisation?
The minimisation of waste will depend upon the nature of the product
- For perishable items, refrigeration and careful stock rotation can reduce waste
- Staff training and computer inventory management systems may also reduce waste as fewer errors are likely to be made
- Effective sales forecasting can help to reduce the amount of wasted stock
what is lean production?
- Lean production involves the minimisation of the resources used in production
. Less time is required as the production process is organised in the most efficient way
. Fewer materials are used as there is a focus on waste reduction
. Less labour is used as lean production is typically capital intensive
. The space required for production is reduced as a result of just in time stock management
. A small number of trusted suppliers work closely with the business - The use of lean production is likely to lead to a competitive advantage
. Lower unit costs are achieved due to minimal wastage, so prices may be lower than those offered by competitors
. Better quality of output is likely as a result of supplier reliability and carefully managed production processes
what is quality control?
- Inspecting the quality of output at the end of the production process
Benefits
- Quality specialists are employed to check standards
- An inexpensive and simple way to check that output is fit for purpose
Drawbacks
- The rejection of finished goods is a significant waste of resources
- There is little focus on the cause of defects
what is quality assurance?
- Inspecting the quality of production throughout the production process
Benefits
- Quality issues are identified early so products may be reworked rather than rejected
- The cause of defects is the focus so future quality issues may be prevented
Drawbacks
- Staff training and a skilled workforce is required so labour costs may be increased
- Reworking may lengthen the production process
what are quality circles?
- Groups of workers meet regularly to solve quality problems identified in the production process
Benefits
- Workers may be motivated as they are involved in decision making
- Relevant and focused solutions are likely as workers are familiar with processes
Drawbacks
- Management need to have trust in workers’ views and solutions
- Meetings and structures must be organised regularly
what is total quality management?
- Organisation of the business with quality at its core and with every worker responsible for quality
Benefits
- Quality in all aspects of the business improves efficiency
- A culture of constant improvement exists within the business
Drawbacks
- All workers must be committed and receive significant continued training
- Careful monitoring and control is required
what is kaizen?
- Kaizen involves a business taking continuous steps to improve productivity through the elimination of all types of waste in the production process
- Changes are small and ongoing rather than significant one-off’s and are constantly reviewed to ensure that the desired positive impact on productivity is achieved
what are elements of kaizen?
- Total Quality Management
- Just in Time stock management
- Teamwork and quality circles
- Zero defects in manufacturing
- High levels of automation
- High levels of cooperation between workers and management
what are the benefits of quality management?
- The quality of a businesses products can provide a competitive advantage
. Unit costs are likely to be low
. Low costs may allow a business to reduce its selling price to better compete with or undercut its rivals
. Increased finance may be available to fund marketing activity to improve brand recognition and attract new customers
. High levels of quality can be used in promotional activity and provide a unique selling point for businesses in competitive markets - Successfully developing a USP for quality can ease expansion into new markets as a result of the positive reputation it creates
what is inflation?
- Inflation is the general rise in prices in an economy over time
. The Consumer Price Index (CPI) measures monthly changes in the prices of a range of goods and services and compares these changes to earlier periods, calculating the rate of inflation
. In the UK government, monetary policy focuses on achieving a 2% inflation rate and tasks the Bank of England to take steps to maintain this (e.g. raising the interest rate)
what are the effects of inflation?
- Increased costs
. Suppliers increase the cost of raw materials and components
. Utilities such as electricity become more expensive - Higher repayments on loans
- Consumers change spending habits
. Deters consumers from making significant purchases and they may reduce demand for usual lower priced wants too e.g cinema tickets - Purchasing on credit becomes more expensive
- International competitiveness
. UK businesses are less likely to be competitive and lose sales
. Imports of overseas competitors are likely to cheaper than domestic goods - Uncertainty
. Occurs when businesses cannot predict prices even in the short term
. Survival may need to become the key business objective until stability returns
. Spending and contract decisions are likely to be delayed
what are the effects of pound appreciation?
Exporting:
- Sales are likely to fall as products become more expensive when compared to overseas competitors
- In order to remain competitive exporting businesses may need to lower prices and accept lower profit margins
Importing:
- Costs are likely to fall as supplies from overseas become cheaper when compared to those domestically-produced
- Businesses may seek to expand the pool of overseas suppliers to further reduce costs and maximise profits
what are the effects of pound depreciation?
Exporting:
- Sales are likely to rise as products become cheaper when compared to overseas competitors
- Businesses may choose to increase selling prices to increase profit margins
Importing:
- Costs are likely to rise as supplies from overseas become more expensive when compared to those domestically-produced
- Businesses may seek domestic suppliers to reduce costs and maintain profit levels
define interest rates
- The interest rate is a percentage reward offered for saving money and the percentage charged for borrowing money
what are the effects of interest rates?
- If interest rates rise businesses will have to pay more on new or variable rate borrowing, which will increase their costs
- Businesses may be less willing to make capital investments when their retained profit may be more profitably invested into savings schemes
- Customers are less likely to purchase goods on credit when interest rates are high leading to a fall in sales
- Exporting businesses may see demand for their products overseas fall as higher interest rates usually strengthen the value of the domestic currency and make their products comparably more expensive abroad
what are the effects of increased taxation?
- Revenue may fall for many businesses
- Operating costs will rise as a result of increased taxes such as VAT and National Insurance contributions
- import costs increase
- Business spending and investment affected as less profit will be retained to cover future expenses and make plans for business expansion
- Operational decisions may be affected by increases in business rates and taxes related to employing workers
- Businesses may choose to forego business improvement or relocation, or employ fewer workers as a result of increased costs
. Move the business to a low-tax location
. Change production methods to reduce the use of highly-taxed components
what is a business cycle?
- The business cycle describes the upturns and downturns in the level of a country’s economic activity (Gross Domestic Product or GDP) over time
what is a reccesion?
- occurs when an economy experiences two consecutive quarters (6 months) or more of negative economic growth
what is a boom?
- defined as a period of time where an economy experiences increasing/high rates of economic growth
what are characteristics of a reccesion?
- Increasing/high unemployment
- Low confidence for firms/households
- Low inflation or deflation
- Increase in government expenditure
what are the imapcts of a reccesion?
- Customers have less disposable income and are likely to reduce spending or postpone significant spending decisions, leading to lower revenue
- Businesses may find it relatively easy to recruit workers from a larger pool of candidates
- Businesses may delay spending decisions and focus on reducing risk and survival
- Production levels are likely to be reduced
- Businesses often stockpile products
- Increased spending on welfare benefits and spending on infrastructure projects to inject demand into the economy may benefit some businesses
what are characteristics of a boom?
- Decreasing unemployment and increasing job vacancies
- High confidence and more risky decisions taken
- Increasing rate of inflation
- An improvement in the government budget as tax revenues rise and government expenditure falls
what are the impacts of a boom?
- Customers’ disposable income increases leading to higher sales revenue
- Recruitment and staff retention may become more challenging and businesses may need to pay higher wages
- Businesses look to expand and maximise profit
- Production levels are likely to increase
- Product or market development strategies are more likely
- Interest rates are likely to rise and the higher cost of borrowing will increase the risk of capital investment
- Lower government spending may impact on business growth plans
- Public sector pay controls may cause Industrial unrest and affect business operations
what is economic uncertainty?
- Economic uncertainty occurs when it is difficult to forecast the level of supply and demand in an economy
what are the effects of economic uncertainty?
- Businesses will find planning difficult and are likely to be reluctant to make significant decisions, especially with regards to capital expenditure
Economic uncertainty may occur as a result of:
- Fluctuating exchange rate
- Economic growth uncertainty
- Turbulence in the price of key commodities such as oil
Businesses must always be prepared for economic uncertainty by:
- Building up cash reserves when times are good
- Keeping informed about the economic climate
- Being ready to take advantage of opportunities when they arise
