Unit 5 Decision Making To Improve Financial Performance Flashcards
What is return on investment objective
Target for the min acceptance return on an investment
Return on investment formula
Profit made from investment/cost of investment x 100
Define debt
Borrowing money from lenders such as banks
Define equity
Receiving funding from shareholders
Why is equity good
Safe
Funds from investors don’t need to be repaid
Investors cannot ask for their investment back
Investors are only entitled to a dividend of the business makes a profit
Why is debt not as good as equity
Debts need to be repaid in full
If the business isn’t able to repay its debts a lender can take the business to court and the business could be put into liquidation
Capital structure
The percentage or ratio of debt to equity
What are the 4 types of finance objectives
Profit focus - maximise profit
Revenue focus - market share focus
Cost focus - maximise costs
Cash flow focus - increase cash flow
Risks of capital structure made of debts
Risk of interest rates
Creditors become wary
Favourable variance
When actual performance is better than what it had been budgeted for
Eg - actual sales may have been higher than budgeted for or actual costs may have been lower
Adverse variance
Actual performance was worse than had been budgeted for
Reasons for setting budget
Support bank loan application or share issue
Financial control - prevent overspending
Decision making
Help forward planning
Pros of budgeting
Gives senior and functional managers spending guidance which encourages spending discipline.
Helps support a business if they are looking to obtain profits
Net cash flow
Difference between cash inflow and outflow
Causes of cash flow problems
Too much production capacity
Excess inventories
Allowing customers too much credit
Overtrading
Seasonal demand
Methods of improving cash flow
Apply for short term loan
Managed customers and suppliers to ensure a positive net cash flow each month
Pros and cons of applying for a short term loan
Pros - usually at a fixed rate of interest, also interest rate is less than overdraft
Cons - business will have to provide the bank with security
What are receivables
Money owed to a business by its customers
What are payables
The value of money owed to suppliers by a business
How to improve profits and profitability
Increase sales - increase promotion and find new markets - could be expensive and may fail
Reduce costs - find cheaper suppliers and cut wages costs - could reduce quality and reduce motivation
Increase price - improve current product and increase price - customers may switch to competition
Reduce fixed costs - reduce marketing and relocate to cheaper premises - could increase transport costs and could damage image
