Unit 5: Finance Flashcards
Name 5 types of financial objectives
- revenue obj
- cost obj
- profit obj
- cash flow obj
- objectives for investment
- return on investment obj
- objectives relating to debts as a proportion of loans by long-term funding
Give 3 benefits of setting financial objectives
- acts as focus for decision making and effort
- key context for making investment decisions
- reduced risk of business failure
- helps co-ordinate the different business functions
- important measure of success/ failure
Give 3 difficulties in using financial objectives
- external changes may affect ability to achieve financial objective
- certain objectives may be difficult to measure accurately
- financial objectives may conflict
What are the three major forms of revenue objectives
- sales maximisation
- targeting a specific increase in sales revenue
- exceeding the sales of a competitor
Give 3 cost minimisation objectives
- achieving a certain cost reduction in the purchase of raw materials
- reducing wage cost per unit
- lowering levels of wastage
- relocating a business to a ‘least-cost’ site
- improving efficiency of production
Give 3 benefits of cost minimisation
- lower unit costs (competitiveness)
- higher gross profit margin
- higher return investment
- improved cash flow
What are the 3 main profit targets
- profit maximisation
- targeting a specific increase in profit
- exceed industry/ market profit margins
Why is setting profit maximisation difficult to set
It’s hard to know if it’s been achieved
Give an example of a cash flow objective
- spreading costs more evenly
- reduce amount held in inventories
- reduce bank overdraft by a certain sum by end of the year
How do you calculate return on investment
Financial gain from investment - cost of investment
How do you calculate return on investment as a percentage
(Return on investment ÷ cost of investment) x 100
What is business investment?
Capital expenditure or the purchase of other businesses or brands
What 4 things should return on investment enable a business to recognise
- trends in financial performance
- changing levels of return for activities
- the total level of investment it should undertake
- the relative financial returns on different investments
Give 3 factors that influence investment decisions and objectives
- expected return on investment
- interest rates
- attitude to risk/ org confidence
- nature of production
- expected demand
- availability of finance
What is debt capital and give an example
Borrowed funds such as bank loans or debentures
What is debentures
When external sources provide funding to a business in return for regular fixed interest payments and an agreed repayment date. This is usually for a long period of 10 years or longer
What is equity capital
Funds provided by shareholders
What’s more risky debt capital or equity capital
Debt capital because is had to be repaid
Why could high level of debt be an objective
- interest rates are very low and therefore cheaper than dividends
- profits and cash flow strong so debts can be repaid easily
Give the 2 reasons for higher equity in capital structure
- there’s a greater business risk
- more flexibility is required
What’s the equation for debts as a proportion of long term funding
(debts ÷ long term funding) x 100
Give 3 internal influences on financial objectives
- business objectives
- finance
- HR
- operational factors
- available resources
- nature of product
Give 3 external influences on financial objectives
- PESTLE
- market factors
- competition
- suppliers
Give 3 examples of cash inflows
- The receipts of cash (typically from sales of products)
- payments by debtors
- Loans received
- Sale of assets and interest received
Give 3 examples of cash outflows
- payments of cash
- payments to creditors
- loans repaid/ given
- purchase of assets
Give two reasons why profitable firms may be short of cash
- the firm has built up its inventory levels
- firm’s sales is on credit
- firm has used its profit to pay dividends to shareholders or repay long term loans
- company has purchased non-current assets
What are the 3 key measures of profit
- gross profit
- operating profit
- profit of the year
How do you calculate net cash flow
Sum of cash inflows - sum of cash outflows
How do you calculate gross profit
Revenue - costs of sales
What does gross profit show
How efficiently a business is converting raw materials into finished products
What does gross profit indicate
How well a business is adding value to its raw materials
How do you calculate operating profit
Gross profit - administrative expenses
What is regarded as the best measure of profit
Operating profit
What is profit of the year
Profit that is left after the tax has been accounted for
Which measurement of profit is useful to shareholders
Profit of the year
What is a budget
A financial plan for the future based on estimates of income and expenditure
Give 4 uses of budgets in management
- establish priorities and set targets
- forecast outcomes
- allocate resources
- improve efficiency
- control income and expenditure
- provide direction and coordination
What are the 4 principles of budgeting
- managerial responsibilities are clearly defined
- performance is monitored against the budget
- corrective action taken if results differ significantly from the budget
- unaccounted for variances are investigated
What is the historical budgeting approach
The use of last years figures as a basis of budget
What is an advantage and a problem with the historical budgeting approach
Advantage: realistic bc it’s based on actual results
Problem: circumstances may have changed and doesn’t encourage efficiency
What is the zero budgeting approach
Costs and revenue is set to zero and the budget is based on new proposals for sales and costs
What is a problem with the zero budgeting approach
It makes budgeting more complicated and time consuming
What are the 3 types of budgets
Income/revenue/sales budget
Expenditure/cost budget
Profit budget
Give 3 costs that can be found in expenditure budgets
- raw materials
- labour costs
- capital costs
- rent
- marketing expenditure
- administration costs
What is a capital budget and name 3 costs in it
A budget for a new business or project
- construction costs
- premises
- legal costs
- furniture/office equip
- insurance
What should you take into consideration when analysing the market
- market size and growth
- market share
- market prospects
What should you take into consideration when making the sales budget
- sales forecast
- new products
- pricing changes
What should you take into consideration when making the costs budget
- the sales budget
- changes in supplier’s prices
- contingencies
What is a variance
The difference between budgeted and actual figures
How do you calculate variance
Budget figure - actual figure
When is a favourable variance shown
- when the actual revenue is higher than the budgeted revenue
- actually costs lower than budgeted costs
When is an adverse variance shown
- actual revenue less than budgeted revenue
- actual costs above budgeted costs
Give 2 possible causes of a favourable variance
- stronger market demand than expected
- selling price increased higher than budget
- cautious sales and cost assumptions
- competitor weakness led to higher sales
Give 2 possible causes of an adverse variance
- unexpected events leads to unbudgeted costs
- overspends by budget holders
- sales forecast proves over optimistic
- effects of market conditions
What do adverse variances indicate
- may indicate inefficiency
- may indicate external influences making it more difficult to meet objectives
What do favourable variances indicate
- may indicate efficiency
- may indicate external influences making it easier to meet objectives
What does the significance of a variance depend on
- was the variance foreseen
- size
- cause
- whether it’s a temporary problem or a result of a long term trend
Give 4 reasons for setting budgets
- to ensure the org doesn’t overspend
- to turn obj into practical reality
- to gain financial support
- to improve efficiency
- allocate resources
- establish priorities and set targets
Give 3 problems with setting budgets
- managers may not know enough about the division/department
- unforeseen changes will undermine process
- budgets are only as good as the data being used
- can lead to inflexibility in decision making
- takes time to complete, manage and review
Give a behaviour implication of setting budgets
- demotivating if it’s imposed rather than negotiated
- unrealistic targets are demotivating
- can lead to departmental rivalry
Give 3 features of a good budget
- monitored at regular intervals
- consistent with aims of business
- based on opinion of many ppl
- flexible
- challenging but realistic targets
Give 3 causes of cash flow problems
- low profits/losses
- too much production capacity
- excessive inventory held
- allowing customers too much credit/ too long to pay
- seasonal demand
- overtrading - growing business too fast
What 3 ways can businesses manage cash flow problems
- make reliable cash flow forecasting
- manage working capital
- choose right sources of finance
What does the extent to which cash flow problems are an issue depend on
- amount of cash held at beginning of cash flow cycle
- length of time required to convert inputs into outputs
- credit payments
Name 3 sources to compile a cash flow forecast
- previous cash flow forecasts
- cash flow statements
- consumer/ market research
- banks
- consultants/national enterprise network advisors
- early drafts of the cash flow forecast
What are the key items in a cash flow forcast
- cash inflows
- cash outflows
- net cash flow
- opening balance and closing balance
How do you calculate closing cash balance
Opening cash balance + net cash flow
why are cash flow forecasts valuable
cash flow forecasts enables the org to foresee times in the future when the org will be short of liquidity. If shortages are anticipated far enough in advance the other may be able to take measures to prevent it from occurring
Give 3 benefits of forecasting cash flow
- identifying potential cash flow problem in advance
- guides from towards appropriate approach
- provides evidence in support of request for financial assistance
- identify possibility of holding too much cash
- makes sure there’s sufficient cash available to pay suppliers and make other payments
Give 3 problems with cash flow forecasts
- changes in economy
- changes in consumer taste
- inaccurate market research
- competition
- uncertainty
What is breakeven
The point at which revenue and total costs are the same
Contribution ignores variable cost
TRUE or FALSE
False - it ignores fixed costs
What does contribution look at
The profit made on individual products
How do you calculate contribution per unit
Selling price per unit - variable cost per unit
What is total contribution
The difference between total revenue and total variable costs
What are the two ways to calculate total contribution
1) contribution per unit x number of units sold
2) sales revenue - total VC
What are the 4 assumptions of breakeven analysis
- the selling price remains the same regardless of number of units sold
- fixed costs remain the same regardless of number of units of output
- VC vary in direct proportion to output
- every unit of output that is produced is sold
How do you calculate break-even output
Fixed costs ÷ contribution per unit
Where is the breakeven point on a chart
Where the total revenue and total costs cross over
What is the margin of safety
Difference between actual output and breakeven output
How do you calculate margin of safety
Actual output - breakeven output
Does a change in output have an impact on breakeven output
No
How do you calculate target profit output
(Fixed costs + target profit) ÷ contribution per unit
Give 3 strengths of breakeven analysis
- calculations quick and easy
- orgs can use it to assess whether a project/product is viable by seeing the level of output needed to make a profit
- business can use it to determine the most profitable price
- indicates level of risk involved
- illustrates importance of keeping FC to a minimum
- useful to know when to expect to reach profit level bc it can help an org get financial support
Give 3 weaknesses of breakeven analysis
- info may be unreliable
- sales unlikely to be same as output
- in practice, the selling price may change as more is sold
- fixed costs won’t stay the same as output changes
- most businesses sell more than one product
- assumes VC per unit are always the same but ignores factors like bulk buying
What does profitability mean
The ability of a business to generate profit or the efficiency of a business in generating profit
What are the two ways to measure the size of an organisation
- sales revenue
- capital employed
What are the three profitability measures
- gross profit margin
- operating profit margin
- profit for the year margin
Give two useful insights of profitability ratios
- if the business is making profit
- how efficient is the org at turning revenues into profits
- how does the profit achieved compare with the rest of the industry
How do you calculate gross profit margin
(Gross profit ÷ revenue) x 100
How do you calculate operating profit margin
(Operating profit ÷ revenue) x 100
How do you calculate profit for year margin
(Profit for year ÷ revenue) x 100
What comparisons should business make to draw conclusions about profitability
- comparisons to competitors
- comparisons over time
- comparison to a standard
What is working capital
The amount of money needed to meet everyday financial obligations (the difference between current assets and current liabilities)
What is the working capital cycle
The length of time it takes for a firm to convert into net current assets and labilities to cash
How do you calculate the length of working capital cycle
(Length of time goods held as inventories + time taken for receivable to pay) - period of credit received from payables
What does effective working capital management focuses on
- inventories
- receivables/debtors
- payables/creditors
From a cash flow perspective, what does the ideal working capital situation look like
- holding low inventory levels that sell quickly
- receivables paying their debt very quick
- payables allowing orgs a long period of time to pay for the items supplied
What factors influence the length of time goods are held as inventories
- nature of product
- competition
What factors influence the time taken for receivables to pay
- bargaining power
- type of product
Give two ways to manage amounts owed by customers
- cash discounts for prompt payments
- credit control (policies)
- improve record keeping
Give two ways to manage amounts paid to suppliers
- use trade credit
- delayed payments - have to be careful with doing this
Give two ways to manage inventory
- keep smaller balances
- should computerise ordering to improve efficiency
Give two ways to improve cash position in the short term
- reduce current assets
- increase current liabilities
- sell surplus fixed assets
Give two ways to improve cash position in the long term
- increase equity finance
- increase long term liabilities
- reduce net outflow on fixed assets
What is management accounting
The creation of financial info for use by internal users in the organisation to predict, plan, review and control the financial performance
What is financial accounting
The provision of financial info to show external users the financial position of the org; concentrates on historical data
Give 4 examples of management accounting data
- revenue, cost and profit objectives
- decision trees
- investment data
- capital structure data and sources of finance
- cash flow forecasts and their outcomes
- budgets and their incomes
- breakeven charts
Give 3 examples of financial accounting data
- cash flow statements
- data on profitability
- capital structure data and sources of finance
- income statements
- balance sheets (SOFP)
What are the 3 things finance is needed for
- business set up
- day to day trading
- growth and development
What is capital expenditure
Spending on items that can be used time and time again (non-current assets)
What is revenue expenditure
Spending on day to day costs
Is a long term source of finance ideal for capital expenditure or revenue expenditure
Capital expenditure
What type of source of finance is debt factoring
External source of short-term finance
What is debt factoring
A financial arrangement in which a business sells its receivables to a third party business
Give 2 advantages of debt factoring
- improved cash flow in short term
- lower administration costs
- reduced risk of bad debts
- increased efficiency (can encourage orgs to be more careful w/ their provision of credit)
Give 2 disadvantages of debt factoring
- loss of revenue
- high costs (have to pay factoring company for its service)
- customer relations problems
What type of source of finance is a bank overdraft
External source of short term finance
Is interest for bank overdrafts fixed or variable
Variable
What are 2 advantages of bank overdrafts
- extremely flexible and relatively easy to arrange
- interest only paid on amount of overdraft
- security not usually required
What are 2 disadvantages of bank overdrafts
- banks usually charge a higher interest rate for overdraft than a loan
- banks can demand immediate repayment
- flexible rate = difficult to budget
- paperwork needed e.g. cash flow forecasts
What source of finance is retained profits
Internal source of long term finance
Give 2 advantages of retained profits
- cheap source of finance
- no security required
- independent and confidentiality
- shareholder goodwill
Give 2 disadvantages of retained profits
- funds can be misused
- possibility of overcapitalisation
- this is an opportunity cost for shareholders
What source of finance is ordinary share capital
External source of long term finance
What is ordinary share capital
When a company issues shares and shareholders buy shares = more cash and shareholders
Give 2 advantages of ordinary share capital
- limited liability encourages shareholders to invest
- new shareholders = more expertise
- its permanent and the org doesn’t have to repay
- increasing ordinary share capital can make it easier to borrow funds from bank
Give 2 disadvantages of ordinary share capital
- possible high dividend payments
- conflict of obj and values
- possible loss of control of original owners
What source of finance is a bank loan
External source of long term finance
Give 2 advantages of a bank loan
- easy budgeting
- lower interest rates than overdraft
- designed to meet needs of company
Give 2 disadvantages of a bank loan
- inflexibility
- limitations of amount available (size of loan may be limited to collateral available)
- potential expense
What type of finance is venture capital
External source of long term finance
Give 2 advantages of venture capital
- suited to high risk companies
- brings better disciple to business management and strategy
- source of advice and contacts
Give 2 disadvantages of venture capital
- requires high rate of return
- loss of control
- venture capitalist may exert too much influence
What is venture capital
Specialist investors in private companies who seek a large share of the share capital and representation on the board in return for funding for large investments such as expansion plans
What source of finance is crowdfunding
External source of short term finance
What is crowdfunding
Where businesses raise finance online by detailing their project online and inviting ppl to help provide funding. It can also be based on a loan with agreed interest
Give 2 advantages of crowdfunding
- provides a form of free marketing
- good credit rating not required (good for new businesses)
- business in full control of what’s offered
- relatively easy to set up campaign
Give 2 disadvantages of crowdfunding
- the crowdfunding platform will take a percentage of the amount invested
- lots of competition
- no guarantee the finance raising target will be met
- leaking valuable info about business ideas
Name 3 factors that influence the choice of the source finance
- legal structure of business (sole traders rely on personal finance while LTDs sell shares)
- use of finance
- amount required
- firms profit levels
- level of risk
- views of owners
What 5 ways can a business improve cash flow
- bank overdraft
- debt factoring
- sales and leaseback
- leasing of non current assets
- improving working capital
What is sales and leaseback
The process of selling assets to raise cash. The property is generally rented back so the firm can still use them for an agreed period of time
What is leasing of non current assets
Where businesses get their machinery from a leasing company so the outflow of cash is more even. This will also reduce costs such as maintenance because it’s the leasing company’s problem not the business’s
What’s are the three main methods of improving profit
- changing price
- decrease costs
- increase sales volume
Give 2 less common ways of improving profit/profitability
- investment in non-current assets
- product development and innovation
- marketing
- HR strategies
Give 3 external factors that make it difficult to improve profit
- competition
- market conditions
- consumers incomes
- environmental issues
- demographic factors
- interest rates
What problem may a business face changing the prices of their product(s)
The impact is difficult to predict bc the effect depends on the price elasticity of demand and the profit margin, both of which may be unknown when the decision is made
What problem may a business face when reducing wages to increase profit
Morale might be negatively effected which could lead to lower labour productivity and higher staff turnover
What problem may a business face when cutting raw material costs to increase profit
Could lead to a lower quality which could reduce the sales volume and customer loyalty
What problem may a business face when cutting the marketing budget to increase profit
less brand awareness and the sales potential is cut
What problem may a business face when trying to increase sales to increase profit
To increase sales, the business neeeds to have effective marketing, high quality production and effective coordination of all departments which will add to expenditure and so possibly not increase profits
Give 3 difficulties improving cash flow
- seasonal demand
- overdrawing which can put a strain on working capital
- over investment in long term assets = inadequate cash flow
- unforeseen changes
- low profits/ losses can make creditors/investors less likely to put money into a business not expecting to make a profit
