UNIT 5- decision making to improve financial performanceš¤ Flashcards
what is the definition of a financial objective?
a specific goal or target of relating to the financial performance, resources and structure of a business
what are the key benefits of using financial objectives?
a focus for the entire business, important measure of success of failure for the business, reduce the risk of business failure, helps to coordinate the different business functions
how is profit closely linked to cash flow?
profits are the main source of funds for an established business. revenues eventually turn into cash inflows, costs eventually turn into cash outflows
how does cash flow differ from profit?
timing differences
- sales to customers made on credit
-payments to suppliers
the way fixed assets are accounted for
-payment for fixed asset=cash outflow
-cost of fixed asset
cash flows arising from the way the business is financed
- inflows from shareholders, bank loans, factoring etc
-payments of dividends
what is the explanation of cost of sales?
direct costs of generating revenues go into ācost of salesā. includes the cost of raw materials, components, goods bought for resale and the direct labour costs of production
what is the explanation of gross profit?
the difference between revenue and cost of sales.
what is the explanation of administration expenses?
operating costs and expenses that are not directly related to producing the goods or services are recorded here. includes distribution costs and the wide range of expenses or overheads that a business incurs.
what is the explanation of operating profit?
records how much profit has been made in total from the trading activities of the business before account is taken of how the business financed.
what is the explanation of finance expenses?
interest paid on bank and other borrowings, less interest income received on cash balances. useful figure for shareholders to assess how much profit is being used up by the funding structure of the business
what is the explanation of taxation?
an estimate of the amount of corporation tax that is likely to be payable on the profits for the period.
what is the explanation of profit for the year?
the amount of profit that is left after the tax has been accounted for.shareholders then decide how much is paid out to them in dividends and how much is left for the business
what is a cost minimisation objective?
aims to achieve the most cost-effective way of delivering goods and services to the required level of quality
what are the key benefits of effective cost minimisation?
lower unit costs, higher gross profit margin, higher operating profits, improved cash flow.
what are the most common profit objectives?
specific level of profit, rate of profitability, profit maximisation
what are some possible cash flow objectives?
reduce borrowings to target level, minimise interest costs, reduce amounts held in inventories, reduce seasonal swings in cash flows
what is the capital structure of a business?
equity- amounts invested by owners of the business. i.e. share capital, retained profit.
debt - finance provided to the business by external parties. i.e. bank loans, other long-term debt.
what are examples of capital structure objectives?
reasons for higher equity in the capital structure
- where more flexibility is required
- where there is greater business risk
reasons why high levels of debt can be an objective
-where interest rates are very low
- where profits and cash flows are strong
what are examples of internal influences on financial objectives?
business ownership
size and status of the business
other functional objectives
what are some examples of external influences on financial objectives?
economic conditions
competitors
social and political change
what are the main cash inflows?
cash sales, receipts from trade debtors, grands, loans from the bank
what are the main cash outlows?
payments to suppliers, tax on profits, repayment of loans, wages and salaries
what is the key to effective cash flow forecasting?
updated regularly
allows for unexpected changes
is updated regularly
what are common problems with cash flow forecasts?
sales prove lower than expected
customers do not pay up on time
costs prove higher than expected
imprudent cost assumptions
describe the steps to the working capital cycle.
inflow, inventories ordered from supplier, production turns inventory into products, out flow, finished goods held until a customer is found, products sold to customers, customers pay for their purchases
what are the main causes of cash flow problems?
low profits or losses, excess inventories held, allowing customers too long to pay, too much production capacity
how do you manage cash flow problems?
make and action reliable cash flow forecasting, manage working capital effectively, choose the right sources of finance
what does effective working capital management focus on?
inventories, debtors and creditors
what are debtors?
amounts owed by customers
what are creditors?
amounts owed to suppliers
what are inventories?
cash tied up in raw materials, work in progress and finished goods
how to manage amounts owed by customers?
credit control, selling off debts to debt factors, cash discounts for prompt payments
what is debt factoring?
selling of debtors to a third party, generates cash, guarantees from a percentage of money owed to it but will reduce income and profit margin made on sales
what is credit control?
establishing credit limits for new customers, credit checking new and existing customers, setting realistic credit limits
what is trade credit?
amounts owed to suppliers for goods supplied on credit and not paid for
how to manage cash paid to suppliers?
delay payments, trade credit, donāt damage reputation and rating
how to manage inventories?
keep smaller balances, computerise ordering to improve efficiency
how to improve cash position in the short term?
reduce current assets, increase current liabilities, sell surplus fixed assets
how to improve cash position in the long term?
increase equity finance, increase long term liabilities, reduce net outflow on fixed assets
what is a budget?
a financial plan for the future concerning the revenues and costs of a business
in budgeting, what are managers reponsible for?
controllable costs within their budgets, take remedial action if adverse variances are regarded as excessive
what are 5 uses of budgets in management?
assign responsibilities, monitor performance, control income/expenditure, forecast outcomes, improve efficiency
what are the principles of good budgeting?
managerial responsibilities are clearly defined, managers have a responsibility to adhere to their budgets, performance is monitored against the budget
what are the two main approaches to budgeting?
historical budgeting and zero budgeting
what is historical budgeting?
using last years figures as a basis for the budget, realistic in that its based on actual results however circumstances may have changed. does not encourage efficiency
what is zero budgeting?
budgeted costs and revenues are set to zero. budget is based on new proposals for sales and costs. makes budgeting more complicated and time consuming but more realistic
what are the three main types of budgeting?
revenue budget, cost budget, profit budget
explain revenue/income budgets.
expected revenues and sales, broken down into more detail
explain cost/expenditure budgets.
expected costs based on sales budget
overheads and other fixed costs
explain how a profit budget is constructed.
analyse market e.g. market growth, size, prospects
draw up sals budget e.g. sales forecast, new products, pricing changes
draw up cost budget e.g. based on sales budget, allow for known changes in supplier prices
what are the difficulties in budgeting accurately?
costs
sales forecasting
what is the definition of variance analysis?
calculating and investigating the differences between actual results and the budget
what are the two types of variance
positive/favourable
adverse/unfavourable
when does a variance arise?
when there is a difference between actual and budget figures
what are favourable variances?
actual figures are better than budgeted figure
what are adverse variances?
actual figure is worse than budgeted figures
what are the possible causes of favourable variances?
stronger market demand than expected, selling prices increased higher than budget, competitor weakness leading to higher sales, better than expected productivity
what are the possible causes of adverse variances?
unexpected events, overspends by budget holders, sales forecast were overoptimistic
what do variances depend on?
size, cause, whether it is temporary problem or not
how does variances allow management by exception?
focuses on activities that require attention, highlights areas of business that differ from whatās expected
what are some problems/limitations of budgets?
are only as good as the data being used, can lead to inflexibility in decision making, need to be changed as circumstances change, time consuming
how do you calculate contribution?
total sales- total variable costs OR contribution per unit x number of units sold
how do you calculate contribution per unit?
selling price per unit - variable costs per unit
how do you calculate profit the contribution way?
contribution - fixed costs
what are the three methods of calculating breakeven levels of output?
table, formula, graph
what are some key assumptions of breakeven analysis?
fixed costs do not vary with output, all output is sold, variable costs do vary in direct proportion to output
how do you calculate breakeven output?
fixed costs/contribution per unit
what are some weaknesses of break even analysis?
unrealistic assumtions, sales are unlikely to be same as output, most businesses sell more than one product
examples of long term term business sources of finance?
share capital, retained profits, venture capital, mortgages
examples of medium term business sources of finance?
bank loans, leasing hire purchase
examples of short term business sources of finance?
bank overdraft, trade creditors, factoring
what is finance needed for?
business set up, day-to-day trading, growth and development
what are the main internal sources of finance for a start-up business?
founder finance, retained profits, friends and family
what are the main external sources of finance for a start-up business?
bank loan, bank overdraft, business angels
why are personal sources important to a start-up?
cheap, little red tape or delay focuses the mind, more control
what are the main internal sources of finance for an established business?
retained profits, working capital, asset disposals
what are the main external sources of finance for an established business?
issue shares, bank loans, suppliers, venture capital
what are asset disposals?
another one-off boost to finance, often occur after acquisitions
what are the benefits of issuing shares?
able to raise substantial funds if business has good prospects, broader base of shareholders, equity rather than debt
what are the 3 types of loan capital?
bank overdraft, bank loan, debentures
what are bank loans?
long term finance, timing and amount of payments are set, good for financing investment in fixed assets.
what are bank overdrafts?
short term finance, loan facility, flexible, helps business handle seasonal fluctuations
what are the advantages of bank overdrafts?
relatively easy to arrange, flexible, not secured on assets of business
what are the advantages of bank loans?
lower interest rate than bank overdraft, appropriate method of financing fixed assets, greater certainty of funding
what are the drawbacks of bank overdrafts?
can be withdrawn at short notice, interest charge varies with changes in interest rate, higher interest rate than bank loan
what are the drawbacks of bank loans?
requires security, harder to arrange, interest paid on full amount outstanding
what is a debenture?
form of bond or long term loan which is issued by the company usually with a fixed rate of interest
what are the key features of debentures?
long term, fixed rate of interest, can be traded
what are venture capitalists?
specialist investors in private companies, back management buy-outs, manage investment funds designed to achieve high rates if returns, focus on larger investments.
what are the benefits of venture capital?
can raise substantial amounts, business benefits from specialist investor support, brings better discipline
what are the drawbacks of venture capital?
requires high rate of return, high level of bank debt, loss of control
what are the 2 approaches to raising profit?
absolute - Ā£ value of profits earned
relative- profit earned as a proportion of sales achieved or investment made
what is ratio analysis?
analysing relationships between financial data to assess the performance of a business
how do you calculate gross profit?
revenue- cost of sales
how do you calculate gross profit margin?
margin= gross profit/revenues x 100
how do you work out operating profit?
what is left after all costs of business are taken away from revenues
how do you calculate operating profit margin?
margin= operating profit/revenues x100
what does operating profit margin tell us?
how effectively a business turns sales into profit, how efficiently a business is run, whether a business can add blur during the production process
