Unit 5- Decision making to improve financial performance Flashcards
What are key financial objectives?
-Profit objective
-Cash Flow objective
-ROI objective
-Capital structure objective
What is cash flow?
Cash flow is the flow of money into and out of a business over period of time
Check the key formulas
check business formulas for all formulas
What is capital structure?
The structure of capital in your business, debt and equity.
What is debt?
Debt is borrowing money from lenders such as banks
What is equity?
Equity is receiving funding from shareholders
Why is debt dangerous?
Need to be repaid in full regardless whether the business has good cash flow or not
Interest is charged on debt, interest rate can increase over time
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
Why is equity safe?
The funds from investors do not need to be repaid
Investors are only entitled to a dividend if the business makes a profit
Investors cannot ask for their investment back
What is the value of setting financial objectives?
-Measure how well a business is doing financially and to compare the performance over time/years
-Control spending
Identify areas a business can improve
Provide sales targets
prevents a business running out of cash
Measure the reward that shareholders receive or set expectations when making an investment
What are some internal factors affecting financial objectives?
-Business ownership
-Size and form of business
-Other functional areas
What are some external factors affecting financial objectives?
PESTLE + C
What is variance?
The difference between a budgeted figure vs an actual figure
What is a favourable variance?
When actual performance is better in some ways than it has been budgeted for
-Actual sales may have been higher than budgeted for
-Actual costs may have been lower than budgeted for
What is an adverse variance?
When the actual performance is worse than had been budgeted for?
-Actual sales may be lower than budgeted for
-Actual costs may have been higher than budgeted for
What is a budget?
A financial plan that shows the forecasted figures and the actual figures for revenue, expenses and profit side by side.
Ways of addressing adverse revenue variances?
increase promotions
Withdraw the product if it is clear that there is no longer sufficient demand for it and all improvements have been exhausted
Reduce the price only if PED is below -1
Improve the product
Change the distribution
Train staff to improve customer service
Look for new segments or new geographical markets to sell the product
Ways of addressing adverse cost variances?
Find cheaper supplies
Change production method to reduce unit cost
Invest in automation and replace all staff with machines or robotics to reduce the staff cost and reduce unit cost
Increase the size of orders to benefit from purchasing economies of scale
Find cheaper premises
Invest in better machinery to reduce unit cost
Responding to favourable variances?
Increase price or increase production and benefit from higher profit margins
Reduce the price of the product if costs are below expectations this may increase sales
Reinvest into the business or pay shareholders higher dividends if profits exceed expectations
Pros of budgeting?
-Gives senior and functional managers spending guidance which encourages spending discipline
-Helps support a business if they are looking to obtain profit budget and increases the changes of them obtaining profit budget
Cons of budgeting?
Lack of expertise may lead to over ambitious targets and demotivation
Historical or amended budgets are based on previous years which may encourage the the use it or lose it mentality which could lead to short terms
If frequently revised it can lead to budgetary slack
middle management may overestimate costs
What are the limitations of cash flow forecasts?
-Sales prove lower than expected (Easy to be over-optimistic about sales potential)
-Costs prove higher than expected (Purchase prices may turn out to be higher, unexpected costs)
-Customers do not pay up on time
Potential causes of cash flow (or liquidity) problems?
-Too much production capacity
-Excess inventories held (Excess stock tie up in cash and increased stock that may become obsolete)
-Allowing customers too much credit
-Overtrading
-Seasonal demand
What can cash flow or liquidity problems lead to?
An increase in financial costs
Poor credit score
Suppliers may ask for cash payments upfront or even refuse to supply business all together
Unpaid suppliers may take legal action
Methods of improving cash flow?
Ask for an increase or an overdraft
Manage customers and suppliers and to ensure a positive net cash flow
Apply for a short term flow
Debt collection specialists
Lease or rent
Sale assets
Methods of improving profitability
-Increase sales (increase promotion, find new markets)
-Reduce variable costs (Find cheaper suppliers, cut wages costs)
-Increase price (Improve current product and increase price)
-Reduce fixed costs (Relocating for a cheaper premises, sell premises and rent back reducing administration costs)
Breakeven charts and what they represent
- Horizontal axis represent the number of units sold
-Vertical axis represents the amount of revenue and costs
-Break even outputs is the intersection between the revenue line and the total cost line
-Fixed costs at 0 unit the total costs = fixed costs only
Pros of breakeven analysis?
- Useful for tool management
-Highlights the importance of fixed costs
-Data can be generated in a business plan
-Changes the sales prices and predict new breakeven output and margin of safety
What are the cons of breakeven analysis?
-Based on predicted data and not actual data
-Many unrealistic assumptions like all units produced are sold, productions cost is the same, no waste
What are some internal sources of short term finance?
-Retained profits
-Sale and leaseback
What are some external sources of short term finance?
-Overdrafts
-Debt factoring
What are some internal sources of long term finance?
Retained profit
sale of assets
What are some external sources of long term finance?
-Bank loans
-Venture capital
-Share capital
-Crowdfunding
What are the advantages and disadvantages to retained profit
- Very flexible, management controls how it is reinvested
-Does not dilute the ownership of the company
-But danger of hoarding cash
-high profits and cash flow would suggest the business could afford debt
What are the advantages and disadvantages to bank overdraft
-Only borrowed when required allowing flexibility
-Only pay for borrowed money
-But the bank can call it any time
-Only available from your current bank account
What are the advantages and disadvantages to bank loans
-Quick and easy to secure
-Fixed interest rates allows firms to budget
-interest must be paid regardless of financial performance
-A firm that is highly geared may be seen as high risk
What are the advantages and disadvantages to debt factoring?
-Recieves a large amount of the debt immediately
-good source of short term finance to address cash flow
-but may damage reputation
-Reduce profitability
What are the advantages and disadvantages to venture capital>
-Can raise substantial amounts
-Brings better discipline to business managements and strategy
-But requires high rate of return
-Investment supported by a high level of bank debt in business
What are the advantages and disadvantages to share capital or share issue?
Broader base of share holders
-Equity rather than debt
-Equity has a cost of capital higher than debt
-Existing shareholders holdings may be diluted
