U5: Analysing Profits + Cash Flow Management

Question 1

What are the different types of profit?

Answer 1

REVENUE from sales)
DIRECT COSTS (cost of sales eg. raw materials, shop-floor labour)
GROSS PROFIT
INDIRECT COSTS (eg. rent, salaries)
OPERATING PROFIT
INTEREST (paid/received) AND TAX
PROFIT FOR THE YEAR

Question 2

What are the ways of calculating different costs?

Answer 2

revenue - direct costs = gross profit.
gross profit - indirect costs = operating profit
operating profit -/ + interest and tax = profit for the year

Question 3

What is the difference between Profit and Profitability?

Answer 3

Profit is just a sum of money whereas profitability relates the sum to the size of the business

Question 4

When will firms be happy?

Answer 4

Firms will only be happy with their profit level if it compares favorably with the amount invested in the business or its sales figures.

Question 5

What does Ratio Analysis mean?

Answer 5

Ratio analysis involves looking at the relationships between financial data to assess the performance of a business.

Question 6

Why do we use ratios to analyse ratio?

Answer 6

To make a meaningful judgement about a business’ pertormance we need to compare its profit figures to its revenue and also to the capital initially invested into the business.

Question 7

What is a profit margin?

Answer 7

A profit margin compares a business’s profit to its sales revenue and expresses the outcome as a percentage.

Question 8

What is a Gross Profit Margin formula?

Answer 8

(Gross Profit/ Sales Revenue) X 100

Question 9

What is an Operating Profit Margin formula?

Answer 9

(Operating Profit/ Sales Revenue) X 100

Question 10

What is an Net Profit Margin formula?

Answer 10

(Net Profit [before tax] / Sales) X 100

Question 11

What must profit margin figures be compared with?

Answer 11

To be meaningtul profit & profit margin figures must be compared with:
Past data - trends
Targets set
Industry averages

Question 12

Why should there be an Increase in the Quantity Sold (Higher sales)?

Answer 12

Higher sales volumes = higher sales, assuming that the selling price is not
lowered
Makes better use of production capacity (i.e. fixed costs should not rise)
May result in higher market share

Question 13

Will an Increase in the Quantity Sold (Higher sales) work?

Answer 13

Depends on elasticity of demand
Sales value may actually fall if price has to be reduced to achieve higher
sales volumes
Does business have capacity to sell more?

Question 14

Why might an Increase in the Quantity Sold (Higher sales) not work?

Answer 14

Competitors are likely to respond
Marketing efforts may fail - e.g. promotional campaign does not generate results
Fixed costs might actually rise - e.g. higher marketing.

Question 15

Why should there be an Increase in Selling Prices (Higher sales)?

Answer 15

Higher selling price = higher sales (assuming quantity sold does not
fall in response)
Maximises value extracted from customers
Customers may perceive product as higher quality
No need for extra production capacity

Question 16

Will an an Increase in Selling Prices (Higher sales) work?

Answer 16

Depends on price elasticity of demand
Sales value may actually fall price rise is matched by an even bigger fall in quantity sold
It will work if customers remain loyal and still perceive product to be good value

Question 17

Why might an Increase in Selling Prices (Higher sales) not work?

Answer 17

Competitors are likely to respond (e.g. prices lower)
Customers may decide to switch to competitors

Question 18

Why should there be a Reduce variable costs per unit (lower cost of
sales = higher gross profit margin%)?

Answer 18

Increase the value added per unit sold
Higher profit margin on each item produced and sold
Customers do not notice a change in price

Question 19

Will a Reduce variable costs per unit (lower cost of sales = higher gross profit margin%) work?

Answer 19

Yes, if suppliers can be persuaded to offer better prices
Yes, if quality can be improved through lower wastage
Yes, if operations can be organised more efficiently

Question 20

Why might a Reduce variable costs per unit (lower cost of sales = higher gross profit margin%) not work?

Answer 20

Lower input costs might mean lower quality inputs - which can lead to greater wastage
Customers may notice a decrease in product quality

Question 21

Why should there be an Increase production output (spread fixed costs over higher output)?

Answer 21

Provides greater quantity of product to be sold
Enables business to maximise share of market demand
Spreads fixed costs over a greater number of units

Question 22

Will an Increase production output (spread fixed costs over higher output) work?

Answer 22

Yes, if the extra output can be sold (e.g. finding a new market, offering a lower price for a more basic product) Yes, if the business has spare capacity

Question 23

Why might an Increase production output (spread fixed costs over higher output) not work?

Answer 23

A dangerous option - what if the demand is not there?
Fixed costs might actually rise (e.g. stepped fixed costs)
Production quality might be compromised (lowered) in the rush to produce more

Question 24

Why should there be a Reduce fixed costs (lower costs = higher profits)?

Answer 24

A drop in fixed costs translates directly into higher profits
Reduces the break-even output
Often substantial savings to be made by cutting unnecessary overheads

Question 25

Will a Reduce fixed costs (lower costs = higher profits) work?

Answer 25

Yes, provided costs cut don't affect quality, customer service or output A business can nearly always find savings in overheads

Question 26

Why might a Reduce fixed costs (lower costs = higher profits) not work?

Answer 26

Might reduce ability of business to increase sales Intangible costs - e.g. lower morale after making redundancies

Question 27

How does cash flow through a business?

Answer 27

-> cash -> purchases -> inventories-> sales -> receivables

Question 28

What is Cash Flow?

Answer 28

Cash flow is the movement of money into and out of a business in a given period of time

Question 29

How does cash flow into businesses?

Answer 29

Cash flowing into the business from selling products/services or from investments, loans etc. -> Cash in bank or hand -> Overheads (Rent, salaries, insurance) -> Wages -> Raw materials (Inventories/stock)

Question 30

What is the of Importance of Cash-Flow Forecasting?

Answer 30

• Managing cash-flow is one of the most important aspects of financial management in a business. Cash is king! • Without available cash, even successful businesses may fail! • Cash-flow problems are the most common cause of business failure - this is particularly true for new businesses

Question 31

Approximately how many businesses fail?

Answer 31

Approximately 80% of businesses fail

Question 32

What is the Difference between Profit and Cash?

Answer 32

• Cash-flow is not the same as profit. • Profit is the difference between revenue and costs • Cash-flow is the movement of money through the business

Question 33

Benefits of a carefully prepared cash-flow forecast

Answer 33

• Advanced warning of cash shortages • Business can afford to pay suppliers and employees • Spot problems with customer payments • As an important part of financial control • Provide reassurance to investors and lenders that the business is being managed properly

Question 34

How to Construct a Cash-Flow Forecast?

Answer 34

To construct a cash flow forecast businesses need to estimate all the money: • Coming into the business month by month (Inflows) • Going out of the business month by month (Outflows)

Question 35

What is a Monthly Balance?

Answer 35

• This is cash inflow minus cash outflow. • It shows month by month if there is a positive or negative movement of cash • When outflow is greater than inflow the monthly balance is negative - shown by brackets

Question 36

What is a Opening Balance and Closing Balance?

Answer 36

• This is like a bank statement • It shows the amount the business has at the beginning of the month (opening balance) and what cash position is at the end of the month (closing balance) • The closing balance is the opening balance plus the monthly balance e.g. £3,000 + (8,500) =(5,500)

Question 37

What are Receivables?

Answer 37

People who owe the business money. Receivables are also known as debtors.

Question 38

What are Payables?

Answer 38

People who are owed money by the business, usually these are suppliers awaiting payments. Payables are also known as creditors.

Question 39

What are the main ways to analyse a cash flow forecast?

Answer 39

1. Calculate the difference between the closing balance at the end of the period and the opening balance at the start. 2. Use the monthly closing balance to assess trends in the data. 3. Analyse the timings of cash inflows and outflows. Money outstanding from customers is known as "receivables" (this figure should be as low as possible!)

Question 40

What are the Importance of forecasting cash flow?

Answer 40

• Identifies potential shortfalls in cash balances in advance — think of the cash flow forecast as an "early warning system" • Makes sure that the business can afford to pay suppliers and employees. Suppliers who don't get paid will soon stop supplying the business; worse if employees are not paid on time • Spot problems with customer payments -encourages the business to look at how quickly customers are paying their debts. Note - not really a problem for all businesses (like retailers) • As an important discipline of financial planning - the cash flow forecast is an important management process, similar to preparing business budgets • External stakeholders such as banks may require a regular forecast. If the business has a bank loan, banks may look at cash flow forecasts at regular intervals

Question 41

What are the Common Issues with Cash Flow Forecasts?

Answer 41

Sales prove lower than expected: • Easy to be over-optimistic about sales potential • Market research may have gaps Customers do not pay up on time: • A notorious problem for businesses, particularly small ones Costs prove higher than expected: • Perhaps because purchase prices turn out higher • Maybe also because the business is inefficient • A common problem for a start-up • Unexpected costs always arise - often significant