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Business - Miss Parkin > Topic 5 - Decision-Making to Improve Financial Performance > Flashcards

Topic 5 - Decision-Making to Improve Financial Performance Flashcards

1
Q

Internal influences likely to affect the financial objectives:

A
  • Business ownership
  • Size and status of business
  • Other functional objectives
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2
Q

External influences likely to affect the financial objectives:

A
  • Economic conditions
  • Competitors
  • Social and political change
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3
Q

What are 2 main ways in which net cash flow differs from net profit during any accounting period:

A

1) Timing differences
- Arise because business may not received cash straightaway from customer and may also delay payments for its costs.
2) Way fixed assets accounted for
- Assets that business means to keep. Treated as capital expenditure in financial statements - meaning cost of assets not treated as operating cost. So:
- Payment for fixed asset = cash outflow
- Cost of fixed asset = treated as asset not cost
- Depreciation charged as cost when value of fixed assets reduced.

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4
Q

What is profit?

A
  • Return on investment
  • Reward for taking risks
  • Key source of finance
  • Measure of business success
  • Motivating factor & incentive
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5
Q

Define profit:

A

Reward or return for taking risks & making investments.

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6
Q

What would profit in absolute terms measure?

A

£ value of profits earned in specific period.

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7
Q

What is profit in relative terms?

A

Looks at profit earned as proportion of revenues achieved or investment made.

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8
Q

Why is profit important?

A

Business will struggle to survive if suffers sustained losses.

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9
Q

What could happen if a business runs out of cash?

A

Likely to become insolvent and will without further injection of finance.

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10
Q

What happens if a business generates strong profits?

A

Turns into positive cash flow and in much stronger position to achieve all of its objectives.

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11
Q

What could be examples of possible cash flow objectives?

A
  • Minimise time taken by customers who pay on credit to settle outstanding invoices
  • Reduce bank borrowings to target level
  • Minimising amounts paid out in interest charges.
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12
Q

A cash flow problem can be defined as:

A

When business doesn’t have enough cash to be able to pay its liabilities.

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13
Q

Main causes of cash flow problems are:

A
  • Low profits or (worse) losses
  • Over-investment in capacity
  • Too much stock
  • Allowing customers too much credit
  • Overtrading
  • Unexpected changes
  • Seasonal demand
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14
Q

The keys to the ability of a business to handle cash flow problems are:

A
  • Have reliable cash flow forecasting system
  • Actively manage working capital
  • Choose right sources of finance for business needs.
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15
Q

A good cash flow forecast:

A
  • Updated regularly
  • Makes sensible assumptions
  • Allows for unexpected changes
  • Reviewed regularly by senior management
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16
Q

Working capital management focuses on:

A
  • Striking right balance between offering customers credit and ensuring pay on time
  • Holding appropriate level of stock
  • Managing relationships with suppliers so that maximum amount of trade credit obtained without damaging supplies to business.
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17
Q

Credit control covers areas such as:

A
  • Policies on how much credit to give and repayment terms and conditions
  • Measures to control doubtful debtors (chasing, threatening legal action)
  • Credit checking
  • Selling off debts to debt factors
  • Cash discounts and other incentives for prompt payment
  • Improved record keeping
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18
Q

What is factoring?

A

Selling of debtors (money owned to business) to third party.

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19
Q

What is a good thing about factoring?

A

Generates cash and guarantees firm percentage of money owed to it.

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20
Q

What is the downside to factoring?

A

Reduces income and profit margin made on sales. Costs involved in factoring can be high.

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21
Q

What is trade credit?

A

Amount owed to suppliers for goods supplied on credit and not yet paid for.

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22
Q

Why do businesses have to be careful about delaying payment to suppliers?

A

Can damage its credit reputation and rating. Trade creditors seen (wrongly) as “free” source of capital. Some firms habitually delay payment to creditors to enhance cash flow - a short sighted policy which also raises ethical issues.

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23
Q

What does stock refer to?

A

Goods purchased and awaiting use or produced and awaiting sale. Stocks take form of raw materials, work-in-progress and finished goods.

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24
Q

Stockholding is costly and therefore it is sound business to:

A
  • Keep smaller balances (just in time stocks)
  • Computerise ordering to improve efficiency
  • Improve stock control
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25
Q

What is one of the key issues in cash flow management?

A

Ensuring that business has right kind of finance. Essential choice between bank overdraft and bank loan.

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26
Q

2 essential main types of financial reports (or ‘accounts’):

A
  • Financial accounting: formally records, summarises and reports transactions of business.
  • Management accounting: presents and analyses financial data to help management take decisions and monitor performance.
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27
Q

3 main elements of financial accounts are:

A

1) Income statement
2) Balance sheet
3) Cash flow statement

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28
Q

Income statement:

A

Measures business’ performance over given period of time, usually one year. Compares income of business against cost of goods/services and expenses incurred in earning that revenue.

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29
Q

Balance sheet:

A

Snapshot of business’ assets and liabilities on particular day - usually last day of financial year.

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30
Q

Cash flow statement:

A

Shows how business has generated and disposed of cash and liquid funds during period under review.

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31
Q

Some useful analytical tasks would include:

A
  • Comparing performance over time
  • Comparing performance against competitors or industry as whole
  • Benchmarking against best-in-class businesses
  • Potential weaknesses in using published financial information to assess performance
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32
Q

Income statement:

A

Historical record of trading of business over specific period. Shows profit/loss made by business - which is difference between firm’s total income and total costs.

33
Q

The income statement serves several important purposes:

A
  • Allows shareholders/owners to see hoe business has performed and whether made acceptable profit
  • Helps return whether profit earned by business is sustainable
  • Enables comparison with other similar businesses and industry as whole.
34
Q

What is the main strength of ratio analysis?

A

Encourages systematic approach to analysing performance.

35
Q

Drawbacks of ratio analysis:

A
  • Ratio deal mainly in numbers
  • Ratios largely look at past
  • Most useful when used to compare performance over long period of time or against comparable businesses and industry
36
Q

What does the balance sheet provide?

A

Summary of assets and liabilities of business. is a snapshot of those assets at particular moment in time.

37
Q

Why does the balance sheet always balance?

A

Because of us of ‘double-entry’ bookkeeping to record business transactions.

38
Q

Why was the Kaplan & Norton’s Balanced Scoreboard devloped in the early 1990’s?

A

As attempt to help firms measure business performance using both financial and non-financial data.

39
Q

What is the aim if the Balanced Scoreboard?

A

To align business activities to vision and strategy of business, improve internal and external communications, and monitor business performance against strategic goals.

40
Q

What does the Balanced Scoreboard provide?

A

Relevant range of financial and non-financial information that supports effective business management.

41
Q

Background to the Balanced Scoreboard:

A
  • No single measures can give broad picture of organisation’s health
  • Organisation should select critical measures for each of these perspectives
  • Framework based on 4 perspectives: financial, customer, internal and learning and growth.
42
Q

Scoreboard produces a balance between:

A
  • Four key business perspectives: financial, customer, internal processes and innovation
  • How organisation sees itself and how others see it
  • Short run and long run
  • Situation at moment in time and change over time.
43
Q

Main benefits of using the balanced scoreboard:

A
  • Acts as integrating device for variety of corporate programmes
  • Makes strategy operational by translating it into performance measures and targets
  • Helps break down corporate level measures so local managers/employees can see what need to do well if want to improve organisational effectiveness.
44
Q

Some drawbacks of the balance scoreboard model:

A
  • Danger that business will have too many performances indicators
  • Need to have balance between four perspectives
  • Senior management may still be too concerned with financial performance
  • Needs to be updated regularly to be used.
45
Q

What do current liabilities represent?

A

Amounts that are owed by business and which are due to be paid within next 12 months.

46
Q

Main elements of current liabilities:

A
  • Trade and other payables
  • Short-term borrowings
  • Current tax liabilities
  • Provisions
47
Q

What are current assets?

A

Assets business owns which either cash, cash equivalents, or expected to be turned into cash during next 12 months.

48
Q

Why are current assets important to cash flow management and forecasting?

A

They’re assets business uses to pay its bills, repay borrowings, pay dividends.

49
Q

What are current assets listed in order of?

A

Their liquidity - how easy is to turn each category of current asset into cash.

50
Q

Main elements of current assets are:

A
  • Inventories
  • Trade and other receivables
  • Short-term investments
  • Cash and cash equivalents
51
Q

The current ratio is one of 2 main liquidity ratios. What are they used to assess?

A

Whether business has sufficient cash or equivalent current assets to be able to pay for its debts as they fall due.

52
Q

What does liquidity ratios focus on?

A
  • Solvency of business. Business that finds it doesn’t have cash to settle debts becomes insolvent.
  • Short-term and make use of current assets and current liabilities shown in balance sheet.
53
Q

What does the current ratio estimate?

A

Whether business can pay debts due within one year of current assets. Ratio of less than one often cause for concern if persists for length of time.

54
Q

What current ratio is encouraging for a business and what does it suggest?

A

1-3, suggests business has enough cash to be able to pay debts, but not too much finance tied up in current assets.

55
Q

What is a low current ratio and what would it suggest?

A

Less than 1, suggests business not placed well to pay its debts. Might be required to raise extra finance or extend time takes to pay creditors.

56
Q

What is return on capital employed (ROCE)?

A

Sometimes referred as ‘primary ratio’. tells us what returns (profits) business has made on resources available.

57
Q

The capital employed figure normally comprises:

A

Share capital + Retained earnings + long-term borrowings

58
Q

With ROCE, the ____ the figure, the better

A

Higher figure, the better. Figure needs to be compared with ROCE from previous years to see if there’s trend of ROCE rising/falling.

59
Q

Why is it important to ensure that the operating profit used for the top half of the calculation doesn’t include any exceptional terms?

A

Might distort ROCE percentage and comparisons over time.

60
Q

To improve its ROCE a business can try to do 2 things:

A

1) Improve top line without corresponsing increase in capital employed, or
2) Maintain operating profit but reduce value of capital employed

61
Q

Working capital =

A

Current assets less current liabilities

62
Q

If there was an increase in the length of the working capital cycle, what would it suggest?

A

Takes longer to turn stocks and debtors into cash, or that payment period for settling creditors has shortened.

63
Q

Factors affecting the level of working capital:

A
  • Businesses with lot of cash sales and few credit sales should have minimal trade debtors. Supermarkets good example.
  • Businesses that exist to trade in completed products will only have finished goods in stock.
  • Some finished goods, notable foodstuffs, have to be sold within limited period.
64
Q

The amount of working capital held by a business depends on a variety of factors:

A
  • Need to hold investors
  • Production lead time
  • Lean production
  • Expected credit period by customers
  • Effectiveness of credit control function
  • Credit period offered by suppliers
  • Main causes of working capital problems.
65
Q

What do payables estimate?

A

Average time takes to settle debts with trade suppliers.

66
Q

How could a business maximise its cash flow?

A

Take as long as possible to pay its bills.

67
Q

What are the risks associated with taking more time than is permitted to pay suppliers?

A

Loss of supplier goodwill; another is potential threat of legal action or late-payment charges.

68
Q

When does overtrading happen?

A

When business expands too quickly without having financial resources to support such quick expansion.

69
Q

What is an important point to remember about overtrading?

A

Can occur even if business is profitable. Is an issue of working capital and cash flow.

70
Q

Overtrading is most likely to occur if:

A
  • Growth achieved by making significant capital investment in production or operations capacity before revenues generated.
  • Sales made on credit and customers take too long to settle amounts owed.
  • Significant growth in inventories required in order to trade from expanding capacity.
71
Q

Classic symptoms of overtrading:

A
  • High revenue growth but low gross and operating profit margins
  • Persistent use of bank overdraft facility
  • Very low inventory turnover ratio
  • Low levels of capacity utilisation.
72
Q

Most effective steps to avoid overtrading are those that would be taken as part of a sensible cash flow and working capital management. For example:

A
  • Reducing inventory levels
  • Leasing rather than buying
  • Obtaining better payment terms from suppliers
  • Enforcing better payment terms with customers.
73
Q

What does gearing measure?

A

Proportion of assets invested in business that are financed by long-term borrowing.

74
Q

How can the gearing ratio be evaluated?

A
  • Gearing ratio more than 50% traditionally said to be ‘highly geared’
  • Gearing ratio less than 25% traditionally said as having ‘low gearing’.
  • 25%-50% considered normal for well-established business happy to finance activities using debt.
75
Q

Why can long-term debt be good?

A

Normally cheap, reduces amount shareholders have to invest in business.

76
Q

Long-term capital structure of the business is in the control of who?

A

Shareholders and management.

77
Q

What may a higher figure of receivables suggest?

A

General problems with debt collection or financial position of major customers.

78
Q

Among the factors to consider when interpreting debtor days are:

A
  • Industry average debt days needs to be taken into account.
  • Can determine through terms and conditions of sale how long customers officially allowed to take
  • Several actions business can take to reduce debtor days, including offering early-payment incentives or using invoice factoring.

Business - Miss Parkin (4 decks)

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