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Business Studies Unit 3 > Topic 2 > Flashcards

Topic 2 Flashcards

1
Q

Give 5 reasons for financial objectives

A 
Focus for decision making
To measure success and failure
Improve coordination and efficiency 
Shareholders can assess investments
Outside organisations can confirm financial viability
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2
Q

What are the four main financial objectives

A

Cost minimisation
Cash flow targets
Return on capital employed
Shareholders return

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3
Q

Name 7 ways of achieving cost minimisation

A 
Reduce waste
Reduce staff with automation 
Adopt lean production
Stop unprofitable activities
Find cheaper suppliers 
Delayering and reorganisation
Outsourcing
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4
Q

Having poor cash flow causes liquidity problems, but holding too much cash creates an opportunity cost, name 6 examples of cash flow targets

A 
Maintain minimum monthly closing balance
Reduce overdraft
Create even spread of revenue
Spread costs more evenly
Raise certain levels of cash
Set contingency fund levels
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5
Q

Why is it important to make sure shareholders get a good return?

A

If become dissatisfied, they may sell their shares, shares become available at a lower price, could become vulnerable to a takeover

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6
Q

ROCE is a measure of return achieved from investment - profitability and performance - to what 4 things can it be set as?

A

Benchmark to industry standards
Internal benchmarking
External factors
In recognition of risk being taken

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7
Q

From the calculation for ROCE, what is capital employed?

A

The money put in

Total equity plus non current liabilities

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8
Q

What are 2 main external influences of financial objectives

A

Competitors actions

Economic conditions

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9
Q

Name 3 main internal influences of financial objectives

A

Characteristics of the firm
Relationship between owners and directors
Sector

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10
Q

What is an income statement?

A

Summarises trading activities and expenses to show whether it has made a profit or loss
Considers:
Gross/operating profit
Profit margins
Profit quality – degree to which profit is sustainable for the future
Profit utilisation – how profit is used

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11
Q

4 key analysis points for an income statement

A

Insight into performance
Identify trends to show success in the market
Details on cost controlling ability
Trends in profit

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12
Q

5 key evaluation points for an income statement

A 
Rising profits – damaged market share due to rising prices
Growing/declining markets
New competition
Extent of achieving objectives
Sustainability/quality of profit
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13
Q

What is a balance sheet?

A

Summarises net worth of a business at a set moment in time – what business owns and owes

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14
Q

What 4 key features need to be considered in a balance sheet?

A

Working capital – ability to meet short term daily expenses
Depreciation
Noncurrent liabilities as a % of capital employed – gearing
Trade receivables/trade payables

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15
Q

3 key analysis points for a balance sheet

A

Insight to strengths and weaknesses (potential for growth, stability and how financed)
Only one day snapshot
Must compare with previous balance sheets to identify trends and changes

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16
Q

4 key evaluation points for a balance sheet

A

Wrong to assume high assets mean success, must see how financed
Rising interest will be a problem if high debt, but may appear stable
Importance on short term asset structure
Consider internal problems with workforce and obsolete products

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17
Q

What are the 4 main uses of financial data?

A

Inter-firm comparisons (different firms/.competitors)
Intra-firm comparisons (same firm, different branches, divisions, locations and product ranges)
Decision making
Trend analysis

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18
Q

Outline 4 strength/weakness points of financial data

A

Accounts by PLC are audited independently to check accuracy
Income statement looks at many years of trading so should be true and fair image of activities
Balance sheet shows true representation at time of creation
Accounts can be window dressed

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19
Q

Explain window dressing

A

Manipulating accounts to look more favourable, done by altering methods of inventory valuation, valuation of intangible assets and depreciation calculations

Can be identified by reading notes to accounts which explain how financial decisions were made

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20
Q

what are the 5 main types of ratio analysis

A 
Profitability ratios
Liquidity ratios
Financial efficiency ratios
Shareholder returns
Gearing
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21
Q

What are profitability ratios?

A

Analyse profits in relation to trading performance or capital utilised in generating profit
Eg) operating profit margins or ROCE

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22
Q

Explain the operating profit margin

A

Can be compared year on year, with other firms in same industry or whole market
Declining OPM can mean they are not managing costs effectively or sales are declining
`

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23
Q

Explain ROCE

A

Performance as % of capital invested
How effectively a business is using capital to make profit
Can be compared to assess
Higher % is better
Low quality profit boosts ROCE
Leased equipment is not included in capital employed

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24
Q

What are liquidity ratios?

A

Measure of ability to meet daily expenditure – having sufficient short term assets to cover short term debts
Eg) current ratio or acid test ratio

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25
Explain current ratio
Ability to pay off short term debts 1:1.5/2.0 would be sufficient Low ratio means cash problems High ratio means too much working capital
26
Explain acid test ratio
Ability to pay off short term debts without including stock Recognises that it can be difficult to turn stock to cash quickly 1:1.5 is sufficient Less relevant if they have a high stock turnover
27
What is gearing?
the % of a firms capital that is financed by long term loans debt can be cheaper than equity high gearing is risky if interest rates rise low gearing may miss out on investment opportunities
28
Give 4 ways to reduce gearing
Profit improvement Repay loans Retain profits More shares
29
Give 3 ways to increase gearing
Growth Buy back shares Pay more dividends
30
What are the 4 main financial efficiency ratios?
Asset turnover Stock turnover Creditor days Debtor days
31
What is asset turnover?
how efficiently assets generate sales
32
Give 3 imitations of asset turnover
no account of profitability less relevant if labour intensive varies between industry
33
What is stock turnover?
How many times a business turns over inventories in a year | Low number means problem with stock held
34
Give 4 issues with stock turnover
Varies between industries Holding stock may improve customer service Seasonal fluctuations not represented Irrelevant if service sector
35
Give 3 ways to improve stock turnover
Sell off/dispose of slow stock Lean production Rationalise product range
36
What are creditor days?
Average time to pay for supplies purchased on credit High figure is better but may suggest liquidity problems Evidence from liquidity ratios to see if problems with paying debts Easy to window dress
37
What are debtor days?
Number of days to receive payments from customers Varies between industries but can compare with competitors Can offer discounts for prompt payments and try to avoid cash flow problems Small businesses with large customers may be forced to give good terms
38
Dividend per share calculates the dividend returned to shareholder per share held, what are the 2 main problems?
Don’t know how much was paid per share | Don’t know how much profit per share was earned which could’ve been paid as dividends
39
Explain dividend yield
It is the dividend received compared to market share price High yield might suggest undervalued share price Allows for meaningful comparison against other potential investments Shareholders can compare if more interest could be earned in a bank
40
state 2 main values of ratio analysis
Provide structure and context for analysing financial documents Ratios provide framework for meaningful comparisons
41
Name 8 limitations of ratio analysis
Ratios don’t include quality, customer service and employee morale Look at past not future Most useful to compare with other businesses but isn’t always available Can be window dressed/manipulated Only a snapshot – only true on that day – working capital fluctuates daily Missing qualitative data Don’t know trade conditions Inflation
42
What is window dressing?
More favourable accounts attract more investors and help fight off takeovers – so manipulate them to appear financially stronger than it is – helps secure loans and support sale of new shares
43
What are 4 main ways of window dressing?
Sale and leaseback of fixed assets – generates cash injection, hide liquidity problems Bring forward sales – include sale when order made not when payment received Change in approach to depreciation – increase life expectancy Write off bad debt – treat as expense, reduces profit, reduces tax
44
What are 3 main sources of finance?
Retained profit Equity share capital Debt
45
3 advantages of retained profit
cheap flexible doesn't dilute ownership
46
2 disadvantages of retained profit
Shareholders may prefer dividends if not earning sufficient ROCE High profits and cash flows suggest could afford debt instead
47
what are 4 main financial strategies to improve business?
finding new sources of finance implement profit centres cost minimisation capital expenditure
48
what is cost minimisation?
Aims to achieve most cost effective way of delivering products to required level of quality Allows to compete on price Businesses with higher market share or is a market leader will be in higher power position to negotiate terms with suppliers
49
Name 9 sources of cost minimisation
``` Lean production Outsourcing Better supplier deals Improved communication Eliminate unprofitable business Effective training Flexible working Reducing overheads ```
50
6 problems with cost minimisation
Business may be left with insufficient capacity to handle unexpected increases in demand Cost reduction in one area may affect other functions if not properly communicated and coordinated Customer dissatisfaction Poor quality Poorly trained staff Damage to relationships with employees and suppliers due to pressure
51
What is capital expenditure?
The purchase of a long term asset which is regarded as essential A high cost so decisions must be taken seriously Must monitor performance of asset closely to ensure does achieve predicted benefits Must consider opportunity cost
52
What is a profit centre?
Involves delegating responsibility for revenues, costs and profits to identifiable subsections within business Helps to achieve objectives as it makes it easier to monitor financial performance Identified by product, department or location With each subsection working towards targets and aware of responsibilities which helps to achieve a competitive advantage Increases motivation
53
3 advantages of profit centres
Success of individual areas can be easily identified Delegation of control may increase motivation Localised decision making will be quicker and better suited to local conditions
54
2 disadvantages of profit centres
Not all costs/revenues can be easily associated with specific area of operation Areas of business may end up competing with each other
55
Give 4 reasons for capital expenditure and investments
add extra production capacity replace machinery and equipment support introduction of new products and processes comply with changing legislation
56
what are the 3 main ways of calculating investment appraisals
payback period average rate of return net present value
57
What is investment appraisal?
An evaluation of the attractiveness of an investment proposal
58
Payback period is the length of time is will take to payback the initial cost of the investment, what are the 2 steps to calculate?
1) add up all net cash flows until value covers initial investment = years 2) amount actually needed from year of payback divided by that years net cash inflow x12 = month
59
4 advantages of payback period
simple and easy focuses on cash emphasises speed of return (good for fast changing markets) shorter period = less risk = quicker generate profits
60
4 disadvantages of payback period
doesn't look at overall project return no account of 'time value of money' ignores qualitative aspects assumes inflow in year of payback is steady across whole year
61
Average Rate of Return is the average profit each year as a % of the initial investment, what are 4 advantages?
provides % to compare with target return considers whole profitability higher ARR = more potentially profitable easily compared with alternatives and ROCE
62
what are 4 disadvantages of ARR?
doesn't consider cash flows doesn't consider timings no account of time value of money may appear profitable but if takes a long time then may threaten short term survival
63
What is Net Present Value?
total return from investment in todays terms, changes in value for money, using a discount factor
64
what is a discount factor?
the rate at which future cash flows reduced by to reflect current interest rates
65
4 advantages of NPV
considers time value of money looks at all cash flows discounting reduces impact of less likely cash flows provides a decision (+ve means accept / -ve means reject)
66
4 disadvantages of NPV
complicated non financial managers may find it hard to understand doesn't consider speed of repayment difficult to choose correct discount factors

Business Studies Unit 3 (5 decks)

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