Unit 5 - Finance

Question 1

What are the benefits of setting finance objectives

Answer 1

• May act as a measurement 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

Question 2

Whats the difference between cash flow and profit

Answer 2

• Cash flow is the difference between (inflows) the money flowing into the business and (outflows) the money flowing out of the business.
• Profit is the difference between all sales revenue (even if payment isn’t yet received) and the expenditure.

Question 3

What are some problems that cause businesses to have cash flow problems

Answer 3

• Holding large am. inventory (stock)
• having sales on long term credit periods
• using cash to purchase fixed assets

Question 4

How is it possible for a seemingly profitable business to fail

Answer 4

Even profitable business can fail if they do not have a great cash flow.
Problems of cash flow can cause the business to fail and causes may be holding stock for too long, having long periods of credit time or paying with money for fixed assets

Question 5

Whats the distinction between gross profit, operating profits and profit for they year

Answer 5

GROSS PROFIT
-diff <> a business’s sale revenue and the direct costs of production eg. materials
SALES REVENUE - DIRECT COSTS OF PRODUCTION

OPERATING PROFIT
-diff <> gross profit and the operating costs like marketing and salaries
SALES REVENUE - ALL COSTS OR GP - OPERATING COSTS

PROFIT FOR THE YEAR
-The figure including other expenditure eg. interest payments
OPERATING PROFIT+OTHER INCOME-OTHER EXPENDITURE

Question 6

What are Revenue (budget) Objectives

Answer 6

-Budgeted revenue might be created on the objective of increasing revenue in a certain time
-The objective set might depend on:
Type of market they’re in
State of Economy
Other areas of the business

Question 7

What are Costs (budget) Objectives

Answer 7

• Businesses in extremely competitive environments face increasing pressures on costs
• Cost minimisation is trying to achieve the lowest possible unit costs of production
• They might set objectives of reducing costs by a certain percentage or target a specific area in the business thats underperforming.

Question 8

What are Profit (budget) Objectives

Answer 8

• May set specific objectives for profit

- Profit maximisation is sometimes mentioned but hard to tell if its been achieved

Question 9

What is Cash flow

Answer 9

The flow of money in and out of the business in a period of time and is vital to the health of an business

Question 10

What are the cash flow objectives

Answer 10

-Vital for a business to manage their cash flow carefully as its impossible to survive long without cash to make immediate payments
This may imvl setting objectives such as:
Targets for monthly closing balances
Reduction of bank borrowing
Reduction of seasonality in sales
Targets for achieving payment from customers
Extension of the business credit period to pay suppliers
These are likely to vary according to the circumstances of the individual business

Question 11

What is capital expenditure?

Answer 11

The money spent on fixed assets such as factories/equipment and represents long-term investment.

Question 12

What are the objectives for investment (capital expenditure) levels

Answer 12

Depend on:

• Overall corporate objectives of the company eg if theres an overall objective of growth this is likely to require further capital expenditure.
• Type of business
• State of Economy/Market Eg. with oil pricing falling, many oil companies such as BP and Shell are cutting back on investment on exploration

Question 13

What is Return on Investment and how do you calculate it

Answer 13

ROI mesures how efficient an investment is:
“ROI(or profit) / Capital Invested x100”
Used when a business is deciding <> 2 diff investments but with this type of decision any returns are only forecasts and may be influenced by managers own bias towards a particular investment

Question 14

What is Equity

Answer 14

The money a business raises through issues of shares

Question 15

What is “borrowing”

Answer 15

The money a business raises through loan capital

Question 16

What is Capital Structure

Answer 16

-capital structure of a business refers to the long term capital of a business / the way a business raises capital to purchase assets
-Long term capital is made of equity(shares) and borrowing(loan).
-The proportion of borrowing to equity is important:
higher borrowing , greater the interest repayment
high interest payment could put a business at risk if profits fall for any reason.
Any rise in interest rates could have significant impact on profit
»may set targets in terms of the proportion of long-term capital thats debt
Gearing Ratio LOAN CAPITAL/TOTAL CAPITAL X100

Question 17

What are some external influences on financial objectives and decisions

Answer 17

-COMPETITOR ACTIONS
financial objectives may be affected by the actions of competitors - may be due to competitors launching new marketing campaigns, price cuts, or the development of new products/ services
-MARKET FORCES
markets and fashions change over time so unless a business can lead/keep ups with the changes financial targets may be missed eg.Blockbuster
-ECONOMIC FACTORS
Changes in economy like recession may result in financial targets being missed where as increasing growth may lead to better performances
Interest rates can also impact performance so business need to review financial targets when theres economical change.
-POLITICAL FACTORS
Changes in government or legislation have an impact eg. an increase for a minimum wage/ introduction of new health and safety legislation will incur additional costs - affecting financial targets
-TECHNOLOGY
Changes in technology may impact in a no. ways eg. facilitating quicker and easier monitoring of financial data
May lead to greater efficiency and improved performance, is likely to have a significant cost in the short term

Question 18

What are some Internal Influences of Financial Objectives

Answer 18

-CORPORATE OBJECTIVES
Eg. Company with strong environmental standpoint might be more interested in minimising carbon footprint than maximising profit

-RESOURCES AVALIABLE
Ability to achieve financial targets may be limitedly the resources avaliable Eg.skilled workers/money to finance targets set

-OPERATIONAL FACTORS
The ability to achieve financial targets will be limited in the short term by the physical capacity of a business

Question 19

Whats a Budget

Answer 19

A financial plan

Question 20

Whats an income budget

Answer 20

The forecasted earnings from sales, sometimes called a ‘sales budget’

Question 21

What is the structure of Income budgets

Answer 21

Income budgets can be based on the results of market research for newly established businesses and established businesses can also use past trading info to provide info fo sales forecasts.
Income Budgets are normally drawn up for the next financial year on a monthly basis

Question 22

Whats an Expenditure Budget

Answer 22

the expected spending of a business, broken down into a no. categories

Question 23

What is the structure of Expenditure Budgets

Answer 23

It varies depending on the type of business.

Eg. a manufacturing business may have sections entitled ‘raw materials’ whereas a service business wont

Question 24

Whats the structure of Profit (or loss) Budget

Answer 24

Calculated by subtracting the forecast expenditure from the forecast of sales income.
Depending on the balance <> expenditure and income, a loss or profit may be forecasted.
Its not usual for a business to forecast a loss during its first period of trading

Question 25

Whats the process of setting budgets

Answer 25

• Stage 1: Prepare Income Budgets (market research or trading records)
• Stage 2: Construct Expenditure Budgets (Use income budget as a guide + Potential suppliers may offer info on costs)
• Stage 3: Forecast profit/loss (by comparison of income and expenditure)

Question 26

Why does businesses set budgets

Answer 26

-They’re an essential element of a business plan. A bank is unlikely to grant loan w/o evidence of this particular form of financial planning

• Budgets can help businesses to decide whether or not to go ahead with a business idea. If the budget shows significant loss in its first year of trading,w. little improvement evidence, then the business idea may be abandoned
• Budgets can help w, pricing decisions. If a large loss is forecast, the business may decide to adjust the price to improve the business’s financial process

Question 27

What are the difficulties of setting budgets

Answer 27

• No historical evidence available eg. no trading records to show the level of sales income, costs or how these figures fluctuated throughout the year
• Forecasting costs can be problematic - a business may lack the experience to estimate costs such as raw materials
• Competitors may respond to the actions of a business by cutting prices or promoting their products heavily - affects sales income and it may receive less income than it forecasts = result expenditure on promotion may have to increase so incs costs

Question 28

Whats variance analysis

Answer 28

The study by managers of diff <> planned activity in form of budgets and the actual results that were achieved

Question 29

How to calc/interpret variances

Answer 29

A positive (favourable) variance - costs are lower/profit are higher than expected
A negative (adverse) variance - costs are higher/profits are lower than expected

Question 30

What are some possible Responses to Favourable Variance

Answer 30

might occur due to good budgetary control ,improving efficiency or by accident eg, rising market prices

Possible Responses:

• Set more ambitious targets
• Get everyone doing whatever was responsible for improvement
• Increase production/take on additional staff to meet demand as indicates more sales
• Increase production if prices are rising, giving increased profit margins
• Reduce prices if costs are below expectations and the business aims to incs sales
• Reinvest into business/pay shareholders higher dividends if profits exceed expectations

Question 31

What are some possible Responses to Adverse Variance

Answer 31

might occur due to inadequate control or factors outside the firms control eg. rising material costs, competitors and changes in economy

Possible Responses:

• reduce costs(eg. economies of scale)
• incrs advertising in order to incrs sales of the product and revenues
• change marketing mix eg.incrs prices to incurs sales (relies on demand being price elastic)

Question 32

Issues ab using results of variances

Answer 32

Just because a variance is favourable or adverse doesn’t mean that everything is in order or the area responsible has been ineficient.

• A favourable production material variance could be generated from using lower quality material which could manifest into a drop in sales etc
• An adverse cost variance may occur because sales are higher than forecast and the business has incurred extra costs in supplying customer demands

Question 33

What are the Benefits of Budgetting

Answer 33

• Targets can be set, allowing managers to identify the extent to which each part contributes to the business’s performance
• Inefficiency and waste can be identified, so that the appropriate remedial action can be taken
• Budgets make

Question 34

To what extent is profitability a better measurement than cash flow

Answer 34

FOR-
-help identify areas for improvement
-of interest to stakeholders like shareholders who will be imvl in future decisions
-important to consider for how future expansion plans can be financed
-can compare performance of identifiable areas in the business eg products lines/branches and help decide which to invest/close
AGAINST
-Profitability may not be the main financial objective in the business
-Cash flow may be better as it ensures decisions made allow the business to survive
OVERALL
-it depends on the business’ corporate and financial objectives
-Shareholders will have a diff view on ST profitability and LT growth/gains
-Cash flow is the most important in the short term but looking at the long term, making a profit is the main objective.