Unit 5- decision making to improve financial performance Flashcards
what is the value of setting financial objectives?
-they act as a measure of performance
-they provide targets which can be a focus for decision making
-potential investors or creditors may be able to assess the viability of the business
what is cash flow?
the difference between the actual amount of money a business receives and the actual amount it pays out (inflows and outflows)
what is profit?
the difference between all sales revenue (even if your payment has not yet been received) and expenditure
why might a business have cash flow problems?
-holding large amounts of inventory
-having sales on long credit periods
-using cash to purchase fixed assets
what is gross profit?
the difference between a sales revenue and the direct costs of production
gross profit formula
sales revenue - direct costs of production (eg: materials and direct labour)
what is operating profit?
the different between the gross profit and the indirect costs of production (eg: marketing and salaries)
operating profit formulas
sales revenue - ALL costs of production
OR
gross profit - expenses
profit for the year formula
operating profit + other income - other expenditure
what are some cash flow objectives that a business might set?
-targets for monthly closing balances
-reduction of bank borrowings to a target level
-reduction of seasonability in sales
-targets for achieving payment from customers
-extension of the business’s credit period to pay suppliers
what is capital expenditure and when will investment happen?
the money spent on fixed assets such as buildings and equipment and represents long-term investment into the business.
Investment will occur:
-when a business first sets up
-as a business grows and develops
what will objectives for investment depend on?
-the overall corporate objectives. eg: growth
-the type of business
-the state of the economy
-the market in which the business is operating
return on investment formula
profit from investment/ capital invested x100
(could be used when a business is deciding between 2 investments)
(this is only a forecast)
what t¡meows the capital structure of a business refer to?
the long term finance of a business
what is long term capital made out of?
equity (share capital) and borrowing (loan capital)
what is equity and borrowing?
-equity: money that a business raises through the issue off shares
-borrowing: money that a business raises through loan capital
gearing ratio formula
loan capital / total capital x100
Gearing refers to the relationship, or ratio, of a company’s debt-to-equity. Gearing shows the extent to which a firm’s operations are funded by lenders versus shareholders, it measures a company’s financial leverage
total capital formula
loan capital + equity
what are some external influences on financial objectives and decisions?
-competitor actions
-market forces
-economic factors
-political factors
-technology
what are some internal influences on financial objectives and decisions?
-corporate objectives
-resources available
-operational factors
what is a budget?
a budget is a financial plan. it provides a target for entrepreneurs and managers as well as a basis for a later assessment of the performance of the business
what are income budgets?
forecasted earnings for sales and are sometimes called ‘sales budgets’
what are expenditure budgets?
sets out the expected spending of a business.
what arte profit and loss budgets?
they are calculated by subtracting forecast expenditure (or costs) from forecast sales income
why do businesses set budgets?
-they are an essential element of a business plan
-can help businesses decide whether or not to go ahead with a business idea
-can help with pricing decisions
what are the difficulties of setting budgets?
-there may be no historical evidence available to a business, no trading records on the level of sales income, costs or how these figures fluctuated throughout the year
-forecasting costs, may lack the experience to estimate costs such as raw materials or wages.
-competitors might react by cutting prices or promoting their products heavily
what is variance analysis?
the study by managers of the differences between planned activities in the form of budgets and the actual results that were achieved
when does a positive (-or favourable variance occur and when does a negative (or adverse) one occur?
-positive:when costs are lower than forecast or revenues higher
-negative: when costs are higher than expected or revenues are lower than anticipated
what are some possible responses to positive variance?
-increase ion production if prices are rising, giving increased profit margins
-to reduce prices if costs are bellow expectations and the business aims to increase its sales
-to reinvest into the business or pay shareholders higher profits if profits exceed expectations
what are some possible responses to negative variances?
-to reduce costs (buying less expensive materials)
-to increase advertising in order to increase sales of the product and revenues
-to reduce prices to increase sales (relies on demand being price elastic)
benefits of budgets
-targets can be set for each part of the business
-inefficiency and waste can be identified so that proper action can be taken
-managers will think about the financial implications of their actions
-should improve financial control by preventing overspending
-improve internal communication
-can motivate employees to fulfil their higher level needs (maslow)
drawbacks of budgets
-the operation of budgets can become inflexible
-have to be accurate to have any meaning
-wide variances between budget and actual figures can demotivate staff and waste the resources used to prepare the budget
what is contribution?
the amount of money left over after variable costs have been subtracted from sales revenue.
it calculates:
-the breakeven point
-the level of profit
contribution formula
sales revenue - variable costs
contribution per unit formula
sales price per unit - variable cost per unit
total contribution formula
unit contribution x output
break even formula
fixed costs x contribution per unit
profit formuła
total contribution - fixed costs
benefits of a breakeven analysis
-starting a new business: whether the proposal is viable
-supporting loan applications
-measuring profits and losses
-modelling ‘what if?’ scenarios
drawbacks of breakeven analysis
-no costs are truly fixed, fixed costs are likely to increase in the long term
-total cost line should not be straight as this does not represent the discounts available for bulk buying
-sales revenue assumes that all output produced is sold and at uniform price, which is unrealistic
-the analysis is only as good as the info provided
gross profit margin formula
gross profit / sales revenue x100
operating profit margin formula
operating profit / sales rev x100
profit of the year margin formula
profit of the year / sales revenue x100
what are payables?
(sometimes called trade creditors) is money owed for goods and services that have been purchased on credit
what are receivables?
(sometimes called trade debtors) is money owed by a business’s customers for goods and services purchased on credit
what are some internal sources of finance?
-retained profits: profit not paid to shareholders, kept for investments
-sales of existing assets: sells machinery, space, land, factories that it no longer needs
-friends and family: loans from family members and friend
what are some external sources of finance?
-equity: money provided by owners or shareholders, no need to pay back and no interest
-loans: money raised from creditor, paid back + interest
-venture capital: venture capitalist may provide funds as a loan in return for a share of the business
-mortgages: loan granted to buy land or business
-crowfunding: people contribute amount (gofund me)
what are some short term sources of finance?
-overdraft: overspend up to a limit, can be expensive + interest
-debt factoring: business sells its bills that have not been paid
-trade credit: receiving materials but paying at a later date
why might cash flow problems occur?
-poor management
-giving too much credit
-overtrading
-unexpected expenditure
how can a business improve their cash inflows?
-factoring: biz can sell its outstanding debtors to a specialist debt collector
-sale and leaseback: owner of an asset (eg: property) sells it and then leases it back
improved working capital control: working capital cash available to help business with their day-to-day operations
how might working capital help improve cash flow?
-selling stocks of finished goods
-pay on time for customers, offering less trade credit (might damage sales)
-persuading suppliers to offer longer periods of trade credit
-stimulating sales, discounts and prompt payment
-selling off excess material stocks
what is profitability?
measures sales against some yardsticks, such as the sales revenue achieved by the business
how might a business improve profits and profitability?
-increasing prices: more revenue but risk of loss of sales which reduces profits, depends on elasticity
-cutting costs: can increase profit margins but might lower quality
-using capacity as fully as possible
-increasing efficiency: avoiding waste in the form of poor quality and unsaleable products, using staff fully and minimal resources
what are the difficulties of attempting to improve profit?
-increasing prices: reduce sales and revenue and attract. criticism for customers
-cutting costs: reduction of quality, might mean job losses and ups labour reactions
-use capacity fully: may cause problems in matching supply with demand, price reductions and lower revenues
-increasing efficiency: redundancies if technology is introduced
what are the difficulties of attempting to improve cash flow?
-factoring: profit margin is reduced due to the cost, customers might raise concerns about supplier’s cash flow problems
-sale and leaseback: the asset is removed forever and now rent has to be paid
-working capital control: customers may be put off by reduced credit periods and suppliers might be unwilling to expand them
