Topic 7 - Analysing the Strategic Position of the Business Flashcards
What does a mission provide?
Strategic perspective for business and vision for future.
An effective mission statement:
- Differentiates business from competitors
- Defines markets or business in which business wants to operate
- Relevant to all major stakeholders - not just shareholders and managers
- Excites, inspires, motivates & guides - particularly important for employees
Mission statements are often criticised because they are:
- Not always supported by actions of business
- Often too vague and general or merely statements of obvious
- Viewed as public relations exercise
- Sometimes regarded cynically by employees
- Not supported wholeheartedly by senior management
Definition of business objectives is:
Objectives are statements of specific outcomes that are to be achieved.
What are objectives often set in?
Financial terms meaning objective is expressed in terms of financial outcome that’s to be achieved.
What financial objectives are there?
- Desired sales or profit levels
- Rates of growth
- Amount of cash generated
- Value of business or dividends paid to shareholders
Some objectives are hard to measure, but are often important. For example, an objective to be:
- An innovative player in market
- Leading in quality of customer service
A summary of the SMART criteria:
- Specific: Objective should state exactly what it is to be achieved
- Measurable: Objective should be capable of measurement - so that is possible to determine whether (or how far) has been achieved
- Achievable: Should be realistic given circumstances in which is set and resources available to business.
- Relevant: Should be relevant to people responsible for achieving them
- Time/Bound: Should be set with time-frame in mind. These deadlines also need to be realistic.
What are corporate objectives those that relate to?
Business as whole
What do corporate objectives tend to focus on?
Desired performance and results of business.
What is it important for corporate objectives to do?
Cover range of key areas where business wants to achieve results rather than focusing on single objective.
What are the 8 key areas Peter Drucker suggested that corporate objectives should cover?
1) Market standing
2) Innovation
3) Productivity
4) Physical & financial resources
5) Profitability
6) Management
7) Employees
8) Public responsibility
Functional objectives are those that relate to:
Specific functions of business (e.g. marketing, operations, HRM, fiance) and which designed to support achievement of corporate objectives.
A well-established business will divide its activities into several business functions. These traditionally include areas such as:
- Finance & administration
- Marketing & sales
- Production & operations
- Human resources management
Functional objectives are:
Set for each major business function and are designed to ensure that the corporate objectives are achieved.
Examples of functional marketing objectives might include:
- Aim to build customer database of at least 250,000 households within next 12 months
- Aim to achieve market share of 10%
- Aim to achieve 75% customer awareness of brand in our target markets
What is SWOT analysis a method for?
Analysing a business, resources and environment. Focuses on internal strengths and weaknesses of business (compared with competitors) and key external opportunities and threats for business).
SWOT is commonly used as part of strategic planning and looks at:
- Internal strengths
- Internal weaknesses
- Opportunities in external environment
- Threats in external environment
Swot analysis aims to discover:
- What business does better than competition
- What competitors do better
- Whether it’s making most of opportunities available
- How business should respond to changes in external environment.
Strengths and Weaknesses are:
- Internal to business
- Relate to present situation
Opportunities and Threats are:
- External to business
- Relate to changes in environment which will impact business
Possible Weaknesses in a business:
- Outdated technology
- Skills gap
- Overdependence on single product
- Poor quality
- High fixed costs
What would possible responses be to the Weaknesses shown?
- Acquire competitor with leading technology
- Invest in training & more effective recruitment
- Diversify product portfolio by entering new markets
- Invest in quality assurance
- Examine potential for outsourcing or offshoring
What does ratio analysis involve?
Calculation and interpretation of key financial performance indicators to provide useful insights.
Regarding financial information, what 3 questions do stakeholders in the business seek information to find out?
1) How is the business trading?
2) How strong is the financial position?
3) What are the future prospects for the business?
Regarding financial information, what questions could be asked about profitability?
- Is business making profit?
- How efficient is it at turning revenues into profit
- Is it enough to finance reinvestment?
- Is it growing?
- Is it sustainable?
- How does it compare with rest of industry?
Regarding financial information, what questions could be asked about financial efficiency?
- Is business making best use of its resources?
- Is it generating adequate returns from its investments?
- Is it managing its working capital properly?
Regarding financial information, what questions could be asked about liquidity and gearing?
- Is business able to meet its short-term debts as they fall due?
- Is business generating enough cash?
- Does business need to raise further finance?
- How risky is finance structure of business?
Regarding financial information, what questions could be asked about shareholder returns?
- What returns are owners gaining from their investment in business?
- How does this compare with similar, alternative investments in other businesses?
What do profitability ratios looks at?
Returns earned by business both in terms of its trading activities (SR) and how much invested in earning those returns (Capital Employed).
What type of questions does inventory (or stock) turnover help with?
Is a financial efficiency ratio which helps ask:
“Have we got too much money tied up in inventory”?
What may indicate poor inventory management?
An increasing inventory turnover figure or one which is much larger than ‘average’ for an industry.
Interpreting the inventory turnover ratio needs to be done with some care. For example:
- Some products/industries necessarily have very high levels of stock turnover.
- Some businesses have to hold large quantities and value of stock to meet customer needs. May have to stock wide range of product types, brands, sizes, etc.
- Can vary during year, often caused by seasonal demand.
A business can take a range of actions to improve its stock turnover:
- Sell-off or dispose of slow-moving or obsolete stocks
- Introduce lean production techniques to reduce stock holdings
- Rationalise product range made or sold to reduce stock-holding requirements
- Negotiate sale or return arrangements with suppliers - so stock only paid for when customer buys it.
What is the current ratio?
Liquidity ratios focus on solvency of business. Business that finds it doesn’t have cash to settle debts becomes insolvent.
What do liquidity ratios focus on?
Short-term and make use of current assets and current liabilities shown in balance sheet.
What does the current ratio estimate?
Whether business can pay debts due within one year out of current assets. Ratio less than 1 often cause for concern, particularly if persists for any length of time.
A current ratio between 1.0-3.0 suggests?
Business has enough cash to be able to pay its debts, but not too much finance tied up in current assets which could be reinvested or distributed to shareholders.
A low current ratio of less than 1.0 might suggest?
Business not well placed to pay its debts. Might be required to raise extra finance or extend time takes to pay creditors. However, depends on nature of business.
What does receivables focus on?
Time takes for trade debtors to settle their bills. Ratio indicates whether debtors being allowed excessive credit.
What may a high figure of receivable days ratio suggest?
General problems with debt collections or financial position of major customers.
Why is the receivable day ratio watched closely in businesses?
Efficient and timely collection of customer debts is vital part of cash flow management.
Among the factors to consider when interpreting debtor days are:
- Industry average debtor days needs to be taken into account.
- Can determine through terms and conditions of sale how long customers officially allowed to take
- Offer early-payment incentives or by using invoice factoring
What does the creditor (payables) days number gives an insight into?
Whether business is taking full advantage of trade credit available to it.
What does creditor days estimate?
Average time takes business to settle debts with trade suppliers. Ratio is useful indicator when comes to assessing liquidity position of business.
What are the risks associated with paying your payables late?
Loss of supplier goodwill; another is potential threat of legal action or late-payment charges.
What could you argue that it is to pay your suppliers on time?
Ethical to pay suppliers on time, particularly if suppliers much smaller and rely on timely payment of their invoices in order to manage own cash flow.
When does overtrading occur?
When business expands too quickly without having financial resources to support such quick expansion. If suitable sources of finance not obtained, can lead to business failure.
Overtrading is most likely to occur if:
- 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
- Long-term contract requires business to incur substantial costs before payments made by customers under contract
Classic symptoms of overtrading:
- High revenue growth but low gross and operating profit margins
- Persistent use of bank overdraft facility
- Significant increases in payables days and receivables days ratios
- Significant increase in current ratio
- Very low inventory turnover ratio
- Low levels of capacity utilisation
Managing the risk of overtrading:
- Reducing inventory levels
- Scaling back pace of revenue growth until profit margins and cash reserves improved
- Leasing rather than buying capital equipment
- Obtaining better payment terms from suppliers
- Enforcing better payment terms with customers
What does gearing focus on?
Capital structure of business - meaning proportion of finance that’s provided by debt relative to finance provided by equity (or shareholders).
Gearing measures:
Proportion of assets invested in business that financed by long-term borrowing.
How can the gearing be evaluated?
- Business with gearing ratio of more than 50% said to be ‘highly geared’
- Gearing less than 25% described as having ‘low gearing’
- Something between 25%-50% would be considered normal for well-established business which happy to finance activities using debt
What is the main strength of ratio analysis?
Encourages systematic approach to analysing performance.
Drawbacks of ratio analysis:
- Ratios deal mainly in numbers - don’t address issues like product quality, customer service, employee morale
- Largely look at past not future
- Most useful when used to compare performance over long period of time or against comparable businesses and an industry - info not always available
What was Kaplan and Norton’s Balanced Scoreboard model an attempt to help?
Firms measure business performance using both financial and non-financial data.
Background to the Balanced Scorecard:
- No single measures can give broad picture of organisation’s health.
- So instead of single measure why not a use composite scorecard involving number of different measures.
- Devised framework based on four perspectives – financial, customer, internal and learning and growth.
- Organisation should select critical measures for each of these perspectives.
The scorecard produces a balance between:
- Four key business perspectives: financial, customer, internal processes and innovation
- How organisation sees itself and how others see it.
- Short run and long run
- The situation at a moment in time and change over time
Main benefits of using the balanced scoreboard:
- Helps companies focus on what has to be done order to create breakthrough performance
- Acts as integrating device for variety of corporate programmes
- Makes strategy operational by translating it into performance measures and targets
Some drawbacks of the balanced scorecard model:
- Danger that business will have too many performance indicators
- Need to have balance between 4 perspectives
- Senior management may still be too concerned with financial performance
- Needs to be updated regularly to be useful
What is the objective of benchmarking?
Understand and evaluate current position of business or organisation in relation to best practice and identify areas and means of performance improvement.
What does benchmarking involve?
Looking outward to examine how others achieve their performance levels, and to understand processes they use.
The application of benchmarking involves 4 key steps:
1) Understand in detail existing business processes
2) Analyse business processes of others
3) Compare own business performance with that of others analysed
4) Implement steps necessary to close performance gap
Types of benchmarking:
- Strategic benchmarking
- Performance or competitive benchmarking
- Process benchmarking
- Functional benchmarking
- Internal benchmarking
- External benchmarking
- International benchmarking
The acronym PESTLE stands for:
- Political
- Economic
- Social
- Technological
- Legal
- Environmental
Political:
- Competition policy
- Industry regulation
- Govt. spending & tax policies
- Business policy & incentives
Economic:
- Interest rates
- Consumer spending & income
- Exchange rates
- Economic growth (GDP)
Social:
- Demographic change
- Impact of pressure groups
- Consumer tastes & fashions
- Changing lifestyles
Technological:
- Disruptive technologies
- Adoption of mobile technology
- New production processes
- Big data and dynamic pricing
Legal:
- Employment law
- Minimum/Living wage
- Health & safety laws
- Environmental legislation
Environmental:
- Sustainability
- Tax practices
- Ethical sourcing
- Pollution & carbon emissions
When does short-termism arise?
When business prioritises short-term rather than long-term performances.
Management who can be described as ‘short-termist’ tend to emphasise certain performance measures, such as:
- Share price
- Revenue growth
- Gross & operating profit
- Unit costs & productivity
- Return on capital employed
As a possible consequence, other more longer-term measures of business performance might become less important, such as:
- Market share
- Quality
- Innovation
- Brand reputation
- Development of employee skills & experience
- Social responsibility
How might you tell that the management of a business have a short-termist outlook?
Potential indicators might include:
- Management bonuses and other financial incentives based on achievement of short-term objectives
- Low or falling investment in R&D (including compared with competitors)
- High dividend payments rather than reinvesting profits
- Overuse of takeovers rather than internal growth
It is often argued that too many firms, particularly quoted companies, have become increasingly short-termist (although there are some notable exceptions such as Unilever plc).
Possible reasons include:
- Stock market (investor) focus on latest financial performance
- Reliance on bonuses based on short-term performance (including to attract new management)
- Frequent changes in leadership & strategy (e.g. through takeover or as result of falling share prices)
In terms of global business, it is important to understand that:
- Globalisation is process in which economies have become increasingly integrated and inter-dependent
- Dynamic rather than an end state
- Not inevitable - can reverse
What is a multinational company (MNC)?
Business that has operations in more than one country.
There are many reasons why a business may wish to become an MNC. These reasons include:
- To operate closer to target international markets
- Gaining access to lower costs of production
- Avoiding protectionism
Key reasons for the growth of MNCs:
- Global brands seeking to drive revenue and profit growth in emerging economies
- Search for economies of scale, whereby MNCs can reduce unit costs by supplying global demand by concentrating production in few key international locations
- Perceived need to supplement relatively weak demand in existing, developed economies
Containerisation
Costs of ocean shipping have come down, due to containerisation, bulk shipping, and other efficiencies. Lower unit cost of shipping products around global economy helps to bring prices in country of manufacture closer to those in export markets, and makes markets more contestable globally.
Technological change
Rapid and sustained technological change has reduced cost of transmitting and communicating information.
Economies of scale
Many economists believe there’s been increase in minimum efficient scale (MES) associated with some industries. If MES rising, domestic market may be regarded as too small to satisfy selling needs of these industries.
Differences in tax systems
Desire of businesses to benefit from lower unit labour costs and other favourable production factors abroad has encouraged countries to adjust their tax systems to attract foreign direct investment.
Benefits from Globalisation:
1) Encourages producers and consumers to benefit from deeper division of labour and economies of scale
2) Competitive markets reduce monopoly profits and incentivise businesses to seek cost-reducing innovations
3) Increased awareness among consumers of challenges from climate change and wealth/income inequality
Drawbacks of Globalisation:
1) Inequality
2) Inflation
3) Unemployment
What is capital expenditure?
Cash spent on investment in business.
What is revenue expenditure?
Spending on day-to-day operations (e.g. paying for materials, staff costs).
Reasons why a business needs to invest in capital expenditure:
- To add extra production capacity
- To replace worn-out, broken or obsolete machinery and equipment
- To support introduction of new products and production processes
- To implement improved IT systems
- To comply with changing legislation & regulations
What is the problem for most businesses regarding finance?
Limited for capital investment. Usually more possible capital investment opportunities than available finance. So choices have to be made and some capital investments rejected.
What is a key consideration with capital investment?
Rate of return that investment will make. Vital because owners of business look to management to maximise their return. If business cannot earn acceptable return, then owners would be better off taking their cash out of business and investing elsewhere.
What methods available can help management make the decisions about which projects to invest in?
- Payback
- Net Present Value (NPV)
- Average Rate of Return (ARR)
Payback period
Time takes for project to repay its initial investment.
Average rate of return
Looks at total accounting return for project to see if meets target return
Discounted cash flow (NPV)
Net present value (NPV) calculates monetary value now of project’s future cash flows.
Key issues of investment appraisal:
- Risks and uncertainties
- Length of project
- Source of data
- Size of investment
- Economic and market environment
- Experience of management team
- Qualitative influences
- Quantitative influences
How is payback measured in terms of?
Years and months, through any period could be used depending on life of project.
What does payback focus on?
Cash flows and looks at cumulative cash flow of investment up to point at which original investment has been recouped from investment cash flows.
Advantages of payback:
- Simple and easy to calculate & easy to understand results
- Focuses on cash flows - good for use by businesses where cash is scarce resource
- Emphasises speed of return; may be appropriate for businesses subject to significant market change
- Straightforward to compare competing projects
Disadvantages of payback:
- Ignores cash flows which arise after payback been reached
- Takes no account of ‘time value of money’
- May encourage short-term thinking
- Ignores qualitative aspects of decision
- Doesn’t actually create decision for investment
A positive NPV for a project suggests?
Investment project should go ahead.
A negative NPV would suggest?
Project should be rejected.
Advantages of using NPV:
- Takes account of time value of money, placing emphasis on earlier cash flows
- Looks at all the cash flows involved through the life of the project
- Use of discounting reduces the impact of long-term, less likely cash flows
- Has a decision-making mechanism – reject projects with negative NPV
Disadvantages of using NPV:
- More complicated method users may find it hard to understand
- Difficult to select the most appropriate discount rate – may lead to good projects being rejected
- The NPV calculation is very sensitive to the initial investment cost
