Topic 2.4 Making financial decisions Flashcards
What is gross profit
The difference between a product’s selling price and what it cost the business to produce the product itself
Gross profit formula
Sales revenue - cost of sales (the cost of buying, producing and distributing products and services)
What is net profit?
The final profit that the businesses has after covering ALL expenses, this is returned to shareholders and/or reinvested back into the business.
Net profit formula
Gross profit - Others operating expenses and interest (like salaries, rent, electricity etc.)
What is profit margin?
It is the ratio of profit compared to the sales revenue. Business will calculate the gross profit margin, GMP, and net profit margin, NPM, of their products and services. Profit margins give an indication of a product’s profitability.
Gross Profit Margin
The GPM indicates the proportion of
sales revenue turned into gross profit.
Gross profit margin (%) =
Gross profit÷Sales revenue X 100
Net profit margin
The NPM indicates the proportion of sales revenue turned into net profit.
Net profit margin (%) =
Net profit÷Sales revenue X 100
What is average rate of return (ARR)?
The percentage increase or decrease in value of the cost of initial investment. In other words, the amount, as a percentage, that an investment has grown or decreases by over a year.Helps identify which investment is the most profitable.
Formula for average rate of return
ARR(%)=Average annual profit(Total profit/Number of years) ÷ Cost of investment X 100
Why do firms invest?
Firms may invest in capital e.g machines or labour e.g training which will increase productivity by the firm, therefore increasing profits.
Why do firms need finance?
-To expand the business by investing
-To improve cash flow
-To use to start the business up e.g new entrepreneurs
What are some good uses of quantitative data analysis?
- Monitor the performance of the business.
- Compare it’s performance with that of its competitors.
- Anticipate the needs of customers or identify trends in the market.
- Make business decisions: e.g. production volume and sales targets.
- Set business aims and objectives.
Quantitative data
Quantitative date is information that can be expressed in numbers, such as percentages ratios, profits and indices.Financial data is a particularly important type of quantitative data used in business.It helps businesses make informed business decisions so the accuracy and reliability f this data is extremely important in order to help the business make the right decisions.
What are the limitations of using quantitative data analysis?
- It is historical and not always reliable/accurate because businesses will be making decisions based of data from the past for the future
- The reasons behind the numbers-the fact the sales revenue has fallen might not be as important as understanding then market factors that led to the fall in revenue
- Statistics can be manipulated
- Business performance is not judged solely on financial performance- there are many qualitative factors that also need to be considered, e.g. business reputation and employee motivation.
Types of data that business use to make decisions
-FINANCIAL DATA (tax rates, interest rates, financial accounts, costs,sales revenue)
-MARKET DATA (demographics, number of competitors, size of market, growth of market)
-MARKETING DATA (customers visits, customer satisfaction ratings)
-Interpreting information from graphs and charts
Why are graphs and charts useful to show quantitative data?
-Demonstrate the relationships or correlation between two sets of data
-Represent proportions (percentages)
-Show trends over time and make forecasts
-Measure the performance of a business
-Identify unusual factors or events, and their impact on the business.
what are 3 ways to improve profitability?
-to increase revenue
-to reduce costs
-to do both of the above options
what are 3 ways to increase sales revenue?
-to increase price of products or services
-use marketing to create awareness and desirability
-add value to the product by increasing benefits and features
what are 5 ways to reduce costs
-cut production costs
-improve efficiency
-eliminate unprofitable processes (e.g closing down unprofitable product lines)
-reduce the variable costs (e.g negotiate better deals with suppliers)
-reduce the overheads (e.g cheaper location)
How can improving profit by lowering costs or increasing revenue cause problems?
-The problem with increasing revenue is that methods used can also increase costs
-Problem with lowering costs I that doing so can detract from the value of the product or service,reducing the. businesses’s ability to make revenue
Define average rate of return
The average annual amount of profit generated over the life of an investment
Discuss why a business should be cautious when using financial data to make business decisions (6 marks)
A business should be cautious when using financial data to make business decisions because financial data only informs a business of financial performance. It does not give the business an insight into the attitudes of its customers or their reasons for purchasing the product or service. For example, poor financial performance may be explained by a slow-down in the economy and have little to do with poor business performance.
Another reason is that financial data is always historical.
This means that it is a representation of what happened in the past and this can often be a poor indicator of what will happen in the future or the current position of the business.
A business should always use financial data alongside other information on the market and other indicators of the business’s performance.
Bar chart
Is a very easy to interpret visual representation e.g a pie chart that shows difference in info
A graph
Is a visual representation of business date e.g a scatter graph-allow relationships between two variables to be identified.
-A positive correlation exists when an increase in one variable leads to an increase in another
-A negative correlation exists when an increase in one variable leads to a decrease in another
-A strong correlation allows a line of best fit to be applied with ease
-Where a weak correlation exists it is difficult to identify a line of best fit
Explain one way a business might use its historical sales revue figures? (3 marks)
A business might use historical sales revenue figures to predict its future sales. Past data may give the business an indication of how much it could sell in the future. A business can then make sure that it has enough stock to meet this demand.
