Topic 7 Analysing Strategic Position Flashcards
What is SWOT analysis?
strengths, weaknesses, opportunities, threats
Value of SWOT
- inform if business has competitive advantage or disadvantage
- useful for developing strategy
Formula for payback
(outlay outstanding/ cash inflow in year of payback) x 12
Steps to ARR
- average rate of return
1. total profit
2. average annual profit
3. ( average annual return/ investment) x 100
Steps to NPV
- net present value
1. net cash flow column x discount factor column = NPV column
2. add NPV column
Purpose of payback
- tells you how quickly investment cost is covered
Pros of payback
- easy to calculate and understand
- higher accuracy because it is short term BUT long term because inaccurate
- good for cash flow problems
Cons of payback
- assumes no change in future and external factors
- no insight into profitability and relevance to profit/ cost
Other than quantitative factors
- company objectives
- company finances
- confidence in data: bias
- social responsibilities: ethical considerations eg. job losses when moving abroad
Purpose of ARR
- compares two or more projects to find out which has the best return in relation to investment
- compares whether an investment return is better than bank return
Purpose of NPV
- shows the value of money in the future (the value of money decreases over time) by taking into account interest rates
Pros of NPV
- creates opportunity cost of investing elsewhere eg. bank
- repeat calculations for different interest rates: optimistic VS pessimistic
Cons of NPV
- difficult to choose a discount rate
What do businesses think about when investing?
- interest rate
- profit level
- alternative investments
2 Main risks and uncertainties of investment decisions
- costs higher than expected
2. sales lower than expected
The issues with forecasting future sales
- timescales: future is uncertain
- new markets: less past information/ data
- competitors
Solving the issue of costs being higher than forecast
- negotiate prices with suppliers: fixed or variable
- create what-if scenarios
- ensuring sufficient financial assets are available
APPLICATION TO EXAM
- think about the type of manager:
1. inexperienced = too-optimistic
2. experienced = pessimistic - think about the industry:
1. fast growth, subject to rapid change = risky, volatile
2. highly predictable, stable = safe, secure, reliable
What is Sensitivity Analysis?
comparing pessimistic, expected, and optimistic figures and seeing the difference between pessimistic and optimistic: larger the difference, larger the risk
What does a balance sheet show?
- current assets and liabilities
- non-current assets and liabilities
- equity/ capital
What does an income statement show?
- revenues
- cost of goods
- gross profit
- overhead costs
- operating profit
- taxes
- profit for the year
What time period does a balance sheet show?
one day
What time period does an income statement show?
one year
Who looks at income statements?
- shareholders: to assess the profitability
- government: corporation tax and investment
- suppliers: reliability, stability
Uses of income statements
- measure success compared to previous years
- assess actual performance against expectations
- help obtain loans or other credit
- enables owners to plan future investment
What happens to profit after taxation?
- dividends
- retained
What is the liquidity ratio and its formula?
current ratio
= current assets/ current liabilities : 1
How to get working capital?
current assets - current liabilities
What does the current ratio show?
- short-term health
- ability to survive day-to-day without running out of cash
Current ratio interpretations
- less than 1: inability to pay debts
- more than 1: the ability to pay debts BUT opportunity cost - not making most efficient use of resources
To improve the current ratio
- sell under-used fixed assets
- raise more share capital
- increase long-term borrowing
Issues with current ratio
ratio suggests you receive all receivables and sell all stock
The formula for gearing ratio
(non-current liabilities/ capital employed) x 100
The formula for capital employed
total equity + non-current liabilities
The mark for highly geared business
50% and above
What does the gearing ratio show?
- long-term health
- how much long-term borrowing a firm has
- how vulnerable and susceptible a firm is to interest changes
Gearing ratio interpretations
- over 50% mark significantly: riskier to invest, fewer investments by banks and investors
- less than 50% mark: less risk, secure, stable firm to invest into
- too small: a firm that does not take risks, investors less likely to invest as return may be small
Altering gearing ratio
to increase:
- buyback shares
- obtain more loans
to decrease:
- sell (issue) more shares
- retain more profits
- repay loans
Why would a firm want to increase its gearing ratio?
- to invest and grow
- opportunity cost
What are the 3 types of profitability ratios?
- ROCE: return on capital employed
- gross profit margins
- net profit margins
The formula for gross/ net profit margins
[(gross profit/ net profit)/ revenue] x 100
Formula for ROCE
(operating profit/ capital employed) x 100
How does the type of industry effects profitability ratios?
supermarkets: more price competitive, making profit across a wide range of products
VS
restaurants: more quality competitive, making profit from each product
What does ROCE show?
the % of the profit generated from the funds invested
ROCE interpretations
the higher the value the better:
- resources are being used efficiently
- good profitability
- higher dividends for shareholders
- more investors
- easier to gain loans
ROCE compared to the bank interest rates
If ROCE is lower than the % return offered on interest-bearing bank accounts, the firm owner would have been better off keeping the money in the bank, taking little risk
Altering ROCE ratio
- increase the level of profit generated by the same amount of capital
- maintain levels of profit and decrease the amount of capital
The 3 types of efficiency ratios
- inventory turnover
- receivables days
- payables days
The formula for inventory turnover
cost of goods sold/ inventories
The formula for receivables days
(receivables/ annual revenue) x 365
The formula for payables days
(payables/ cost of sales) x 365
How to calculate how many days it takes to re-order inventory?
365/ inventory turnover
What does inventory turnover measure?
the number of times per year a firm sells and replaces its inventories
Inventory turnover interpretation
depends on the industry:
- bakery: the higher the better as goods are more perishable
- second-hand car dealer: lower turnover as it takes longer to sell
Altering inventory turnover ratio
- reducing level of inventories held: JIT
- increasing sales without increasing inventory level
What does receivables days show?
how long on average it takes the firm to collect debts owed by customers
What does payables days show?
how long on average it takes for a firm to pay its suppliers
Interpretation of receivables days
depends on the industry
Reducing receivables days
- offering early-payment incentives: discount
- debt factoring firms
Decreasing payables days
paying bills more promptly:
- but worsens short-term cash and working capital position
- however, may have long-term benefits if relationships with suppliers improve
Comparing receivables and payables
ideally, payables should be equal to or longer than receivables which benefits working capital position
What is PESTEL?
political, economical, social, technological, environmental, and legal
Example of political and legal changes
- international trade: taxes and tariffs
- environmental laws: congestion charges
- labour market laws: health and safety legislation
- competition laws: protect consumers from effects of anti-competitive prices
Examples of the economic environment
- GDP
- government economic policy
- exchange rates
- inflation
- unemployment
GDP
- gross domestic product: the number of goods and services produced within a country
- economic growth or decline/ recession
- impacts unemployment and business demand
The Economic Cycle
recession, slump, recovery, boom
Government economic policy
Fiscal:
- government spending and taxation
- spending: infrastructure, healthcare, and education
- taxations: income, VAT, national insurance, and corporation tax
Monetary:
- interest rates set by the Bank of England (MPC) to control inflation and exchange rates
Exchange rates SPICED
stronger pound imports cheaper, exports dearer
Exchange rates impact on businesses
- increase or decrease revenue
- increase or decrease quantities sold: rise or fall in sales
Inflation
- a general increase in price levels over a period of time
- measured by CPI index
- target of 2%
- low = price stability
2 types or Causes of inflation
- demand-pull inflation: demand increase = price increase
- cost-push inflation: cost increase = price increase
Advantages of inflation
- assets worth more eg. value of property
- borrowings repayments decrease
Disadvantages of inflation
- sales lost to foreign competition as imports become cheaper
- decrease spending = decrease profitability
Definition of unemployment
number of people able, available, and willing to find work and are actively seeking work but are not employed
Types of unemployment
seasonal: tourist areas
structural: mismatch skillset
frictional: transition from one job to another
cyclical: caused by demand
Business impacts from rising unemployment
- lower spending
- demand for inferior goods increase
- greater supply of labour force so recruitment is easier
- decreases staff morale: feel insecure and worried about their job
Business impacts of low unemployment
- staff feel secure = higher morale and motivation
- demand increases
- harder to recruit and gain new skills = possibly having to increase salaries to attract new staff
How long can a change in interest rate take its full effect?
up to 2 years
Impact of an increase in inflation
- Bank of England increases the base rate
- High St. Banks increase their interest rates eg. savings, mortgages, loans, and overdrafts
- direct impact on businesses:
- existing loans: variable rates = costs increase
- new loans: decrease investments = growth, R&D, technology spending decreases
- overdrafts: costs increase -> highly geared businesses at most risk - indirect impact to consumers/ households:
- incentive to save increases = spending decreases
- variable-rate mortgages increase = decreases disposable income - demand falls = prices fall = inflation decreases
Interest rates and exchange rates
UK interest rates increase = reward on savings increase = other countries attracted to the UK to save their money in UK banks = need to buy pounds = demand for pounds increase = price of pounds increase = exchange rate increases
