Unit 7

Question 1

Objectives

Objectives must be SMART

Specific
Measurable
Achievable
Realistic
Time Frame

Answer 1

Needed Because:

• To provide them with some sort of target to aim for and provide sense of direction
• Business dont solely seek maximal profits but hold other aims such as survival and growth
• Targets help to bring a business and workforce together as a collective work towards the achievement of a goal

Question 2

Objectives Hierarchy

Answer 2

Mission Statement
|
Corporate Objectives
|
Strategic Decisions
|
Functional Decisions

Question 3

Functions

Answer 3

Finance - Control money
Operations - product development and production
Human Resources - workforce
Marketing - promotion

Question 4

Mission Statement

Answer 4

> Overall Purpose of a Business
Guides everyday operations and decision making and helps strategic planning
Influenced by the owners of a business (shareholders own the business)

Question 5

Influences on the Mission Statement

Answer 5

> The Founders belief and culture

> Legal Structure (Public Sector?, do they have shareholder?)

> The level of competition in the industry

> The relative power of the different stakeholders

Question 6

Benefits of a Mission Statement

Answer 6

> Helps discover a starting point for the company

> Help ensure everyone is focused upon the purpose and seek to achieve the same goals and objectives

> Allows investors to identify where their money will be spent

> Assists customers with understanding ethics and objectives of a company

Question 7

Evaluation : Mission Statements

Answer 7

> Provides a sense of cohesion so everyone understands and is working towards the same goal

> Deliberately vague and aspirational to achieve these overtime

> Might not always be achieved and may be considered unrealistic it is better to have an aim than nothing at all

Question 8

The Main Aims and Objectives of a Business are:

Answer 8

Survival

Growth

Profit Maximisation

Sales Maximisation

Increased Shareholder Value

Corporate social responsibility / ethics / environment

Question 9

Survival

Answer 9

• 30% of new businesses fail within 2 years
• Initial aim is therefore to keep trading by gaining customers, establishing a positive reputation for the business and managing their finances successfully
• Even large firms can collapse and sometimes need time to reposition themselves in the market to avoid failure

Question 10

Growth

Answer 10

• Next step after survival as a business aims to become bigger so as to increase market power
• Commonly achieved by reinvesting profits to finance expansion
• Impacts upon shareholder and investor returns in short run but if successful generates higher returns in the long term
• Aim is to attract new customers and to increase market power at the expense of rivals

Question 11

Profit Maximisation

Answer 11

• One of the main objectives of businesses in the private sector
• Owners seek a profitable return on their investment
• Comparisons are often made against rival firms in the same industry to assess how successful a business is being managed
• Measurements incude ratios such as the gross profit margin and ROCE
• Long - term profit growth will motivate investors and ecourage additional investment as well as helping to secure jobs

Question 12

Increased Shareholder Value

Answer 12

• Shareholder are keen to measure the amount of dividend that they get paid and any increases in the share price
• The key objective for a business is to try and increase the share stock price on the stock market
• Improve investor confidence and secure management positions and jobs
• Senior managers have bonuses tied to increases in share price as an incentive
• A low or rapidly falling share price, puts risk on the business being taken over by a competitor

Question 13

Corporate Social Responsibility

Answer 13

• Consider their impact upon society and minimise their negative effects whenever possible
• Can affects profits as firm has to pay more to ensure workers are paid fairly, suppliers dont exploit their labour forces and resources are sustainably sourced
• If not they risk negative publicity and pressure group activity - can harm firms sales and image

Question 14

Corporate Objectives

Answer 14

Provide specific and measurable targets
Relate to entire business are not necessarily specific to a particular functional area or department.
They are established by the senior management of a business

Question 15

Functional Objectives

Answer 15

Also known as departmental objectives. These are the objectives of each department necessary to help the business achieve their overall business objectives.

Each Objective is specific to each department. For example, marketing objectives will be applied to the marketing department

E.g.
Operations: Reduce Waste by 20%

Human Resources: Reduce Labour turnover by 5% in the next year

Sales and Marketing: Increase sales by 12% in the next year

Question 16

Constraints on Objectives

Answer 16

INTERNAL

Availability of resources
Business Culture
A new leader
Size of the business

EXTERNAL

Changing legislation
Economic conditions
Technological change
Demographic change

Question 17

Tactics

Answer 17

Short term responses to opportunities or threats faced by a business

Less critical decisiosn that are easier to reverse

E.g. change suppliers for certain good or increase spending on marketing to combat competitor actions

Question 18

SWOT Analysis

Consider the strengths weakness opportunities and threats facing a business

Answer 18

Internal Factors
- Relate to the current position within a firms control

STRENGTHS
E.g.
- Strong Brand Name
- Strong Distribution Network

WEAKNESSES
E.g.
- High levels of unskilled staff
- Increasing labour turnover

External Factors
- Factors expected to occur in the future and outside a firms direct control

OPPORTUNITIES
E.g.
- Expansion into China
- Develop college - business links

THREATS
E.g.
- Entry of new competition
- Uncertainty over brexit

Question 19

Why Use SWOT

Answer 19

Help in creation of corporate objectives

Build upon identified strengths
Minimise of the business’ weaknesses and threats facing it

Used to help with strategic plan

Question 20

Balance Sheets (statement of financial position)

Answer 20

This is a financial statement that records all the assets and liabilities of a firm over a particular period

Would be of Interest to

MANAGERS (determine finanicial position and identify suitable method of raising more finance in the future)

EMPLOYEES ( determine if the business has a successful future or if financial trouble may happen)

SHAREHOLDERS ( determine possible returns of a company and if the firm is a potential investment)

SUPPLIERS AND LENDERS ( determine level of debt the firm is in and they will struggle to payback any loans or additional borrowing

Question 21

Components of a Balance Sheet

Assets - Possesion

Liabilities - Debt

Answer 21

NON CURRENT ASSETS:
Assets owned by the firm that are unlikely to be converted into cash within the next 12 months

Goodwill:
Value above the purchase price of a company bought by the firm

Intangible Assets:
Assets without a physical form such as patents

Property, plant and equipment:
Physical property and capital owned by a firm that they will not sell within the next 12 months

CURRENT ASSETS:
Assets that are most likely to be converted into cash within the next 12 months

Inventories:
Stock the business owns

Trade and other recievables:
Money owed to the firm from customers that will be paid back within the next 12 months

Cash:
Actual cash owned by the firm in the bank

TOTAL ASSETS:
non current assets + current assets

CURRENT LIABILITIES:
Payments or debt the firm must pay back within the next 12 months

Payables:
Money that the firm owes to a supplier from a previous purchase

Dividend:
These are dividends not yet paid shareholders

Current tax liabilities:
this is tax that has to be paid by the firm within the next 12 months

NON - CURRENT LIABILITIES:
Debts that are paid back over a period longer than a year

Borrowings:
long term borrowing or loans taken out by the firm

Provisions:
Money set aside by the firm to cover any future losses made by the firm

Pensions:
Pension contributions paid by the firm over the next 12 months

TOTAL LIABILITIES:
Current Liabilities + Non Current Liabilities

NET ASSETS:
Total Assets - Total Liabilities
Total value of the firm if all liabilities were paid off with the total assets owned by the firm

SHAREHOLDERS EQUITY (AKA EQUITY):
total equity or total wealth of the firm

Share Capital:
Money invested by shareholders into a company

Other Reserves:
Retained earnings after paying taxes but not dividends

Retained Earnings:
Previous earnings or profits earned by the firm after taxation and dividends are paid

TOTAL EQUITY:
the total money invested by shareholders into the firm

Question 22

In a balance sheet, the net assets and total equity must ALWAYS balance (equal)

Question 23

Working Capital

Answer 23

Money available to the firm to pay for daily expenses

Current Assets - Current Liabilities

Daily expenses can include bills and wages

Can be shown on a balance sheet as a net current assets

where current assets are higher than current liabilities, meaning the firm has workin capital to pay for costs

If current liabilities are higher than current assets, then the firm has net current liabilities

Means firm does not have working capital to pay off daily costs

Therefore, higher level of working captial held by the firm, the more liquid the firm is, meaning the ability of the firm to convert assets into cash to pay debts

Difficult to determine the optimal level of working captial for a firm:

The firm will need working captial to ensure it can pay off costs
Holding onto too much in terms of cash and other liquid forms, such as recievables has an opportunity cost
Because this money could be put into the business in more profitable ways, such as capital or equipment that could generate a return
Therefore, the firm will need to identify the most suitable level of working capital for its costs and ensure they do not allocate too much in an unprofitable way

Question 24

Factors that can influence level of working capital needed

Answer 24

1) Volume of Sales
- Higher volumes of sales = more working capital needed (raw materials and supplies)
- If no working captial can not afford these and are unable to produce
- If firm has low volume of sales, need lower amounts of working capital to pay for costs
- Therefore, firm has to identify volume of sales to determine correct amount of working capital necessary to pay for materials

2) Level fo Trade Credit Given by the Firm:
- Amount will determine correct working capital
- Essentially a interest free loan that allows customers to purchase a good now and pay later
- If firm given out high amount of working capital to pay for materials for goods that have not been paid for yet
- If firm gives little or no trade credit amount of working capital required is lower
- Means amount of trade credit given by the firm will influence the amount of working capital necessary

3) Growth of the firm:
- If firm is growing - require more working capital - costs of growth (materials and equipment
- Means amount of working capital needed increases
- If firm is not growing currently, amount of working capital is likely to be lower
- Amount of growth the firm is planning to do will influence the amount of working capital needed

4) Level of operating cycle:
- operating cycle is time between the firm purchasing raw materials for goods and recieving payment from customers
- Longer the operating cycle more working capital needed as firm will need it to pay off costs
- Longer operating cycle = more working capital needed

5) Rate of Inflation:
- Rate of inflation is the general increase in price
- If prices rise considerably - more working capital required to pay off higher costs for materials to continue operations
- If rate of inflation is very low or decreasing (deflation), firm will not need as much working capital as prices will not change considerably
- Therefore, inflation can determine the amount of working capital necessary

Question 25

Depreciation

Answer 25

This is the reduction in the value of an asset over a period of time

• Found in balance sheets under non current assets
• Value of assets will decrease, or depreciate over time
• Because of wear and tear
• This means firms will need to ensure they correctly identify the current value of an asset as this will give a clearer picture of the true value of the company overall
• E.g. if a vehicle decreases by 5000 in value every year, firm will need to reduce non current assets by 5000 each year
• Therefore depreciation of non current assets is essential in a balance sheet to ensure correct value of the firm is given

Question 26

Financial Ratios

Answer 26

Return on Capital Employed (ROCE)

Current Ratio (Liquidity ratio)

Gearing

Payable days (efficiency ratio)

Recievables Days (efficiency ratio)

Inventory Turnover (efficiency ratio)

Question 27

Return on Capital Employed (ROCE)

Answer 27

This is a financial ratio that compared the operating profit against the capital employed by the firm. This is used to monitor the overall financial performance of the capital used by the business.

Formula:
Operating profit / capital employed (total equity + non current liabilities) X 100

• Operating profit is found in the income statement
• Total equity and non current liabilities are found in the balance sheet
• Higher ROCE = firm is making more profit as a percentage total of money put into the business
• Profitability ratio that measures how much profit is made compared to the total amount of money put into the business
• Managers and shareholders would comare ROCE value this year vs last to determine overall profitability performance of the firm
• Normally compared against current rate of interest at banks
• Shareholders will want to determine if ROCE of a firm is going to give a better return than just putting money into a savings account
• ROCE is an important profitability ratio to determine the overall financial performanc of the firm

Method:
1) Identify the operating profit from the income statement
2) Identify the total equity and non current liabilities from the balance sheet to identify the capital employed
3) Formula: Operating profit / capital employed x100

Improving ROCE
1) Increasing Operating Profits
2) Reduce Total Debt
- Reducing non current liabilities such as loan or mortgage
- Paying off long term debt means non current liabilities value will decrease
- Means total capital employed will fall, meaning ROCE value will be higher as the same operating profit is compared against a lower capital employed value
- therefore paying off long term debt found in non current liabilities will improve the ROCE value of the firm

Question 28

Current Ratio

Answer 28

This is a liquidity ratio that measures the ability of the firm to cover its current liabilities or debts over the next 12 months

Formula:
Current Assets / Current Liabilities

• CA + CL can be found in balance sheet
• RATIO so expressed as Value:1
• E.g. if ratio is 2:1 means the fim has £2 of current assets for every £1 of current liabilities
• If greater than 1, means firm has more current assets than liabilities, means firm can easily pay their liabilities in the next 12 months
• If less than 1 - more current liabilities than assets, meaning firm will have to sell some of their non current assets or go into further debt to pay off their current liabilities over the next 12 months

Methods:
1) Using the balance sheet, identify current assets and current liabilities
2) plug into formula: Current assets / current liabilities
E.g.
Current Assets- 15.1m
Current Liabilities - 13.4m
= 15,100,000/ 13,400,000 = 1.12:1
- Means firm has £1.12 current assets for each 1 current liability that has to be paid in 12 months

Possible Current Ratio Values:

0:1 to 0.9:1
- If between this range means less current assets than liabilities
- Means firms wont be able to pay of liabilities with current assets that they have
- Either sell non current assets (property/equipment) or source more long term finance
- Not desirable as firm is illiquid and not able to pay their current liabilities

1:1 to 2:1
- Most suitable range for a current ratio
- Means firm have more assets than liabilities currently means they can easily pay of liabilities
- Means firm do not have too many current assets that are not being used in another way that can be profitable
- Because assets such as cash could be used elsewhere in the business which can generate profit, such as purchasing more non current assets

Greater than 2:1
- Generally ineffective
- Because firm has more than £2 of current assets for every £1 of liabilities
- Firm being too catious with money and not using it effectively
- Because firm has too much cash laying dormant in the bank that is doing nothing
- Instead, money could be used paying off non current liabilities or investing in assets such as equipment or property
- Would be more profitable for the frim as they can generate more income or at least reduce non current debt
- Firm would aim to have a current ratio lower than 2:1

Question 29

Gearing

Answer 29

Measures the long term liqudity position of the firm. This measures the percentage capital that is borrowed against the total capital employed by the firm.

Formula:
Non current liabilities / capital employed (total equity + non current liabilities) X100

• Gearing is another liquidity ratio like the current ratio and is also sourced from the balance
  sheet.
• This ratio shows the long-term liquidity position of the firm, mainly how much of the long-term
  finance of the business is raised from debt.
• This is because there are two main sources of long-run finance available to a firm: total equity
  and non-current liabilities.
• Total equity is the total amount raised by selling shares to the public.
• Non-current liabilities includes long-term loans and debentures, and is known as loan capital.
• Therefore, the Gearing ratio is important to shareholders as it identifies how much of the overall
  finance used by the firm is from long term debt.
  Method:
  1) Identify the non-current liabilities of the firm.
  2) Identify the capital employed: total equity and non-current liabilities.
  3) Formula: Non-current liabilities / capital employed (total equity + non-current liabilities) X 100
  So, from the example balance sheet above:
  Non-current liabilities: 36.4 million.
  Total equity: 108.7 million.
  Capital employed = 108.7 million + 36.4 million = £145,100,000
  36,400,000 / 145,100,000 x 100 = 25% gearing.
• This means that 25% of the firm’s total finances is from long-term debt.
• As this value is below 50%, the firm is considered to be low-geared.
  Possible Gearing Values:
  50% or more
• A firm with a gearing value that is 50% or greater is classed as highly geared.
• This means more than half of the firm’s overall finance is sourced from long-term debt.
• Being highly geared could be risky for the firm as they are vulnerable to increased interest
  rates.

14
- If interest rates increase in the future, then the firm will have to pay more back in interest
charges.
- But as the firm has most of its finance from debt, this could severely worsen the cash flow
position of the firm as they spending more on interest.
- If this happens, then the firm is increasingly at risk of defaulting on their loans, meaning that
assets could be sold off to pay debt, or the firm could be forced to cease trading.
- However, being highly geared may not be so problematic if the firm is rapidly expanding and is
generating high profits.
- This is because the firm could easily pay higher interest rates charges in the future.
- Therefore, being highly geared of 50% or more could be problematic for the firm unless they
are expanding and generating high profits.
Less than 50%:
- A firm with a gearing value that is less than 50% is classed as low geared.
- This means less than half of the company is financed through long-term debt, so the firm is
mainly financed by share capital.
- Generally, a low geared company can be seen as a safe option as the firm is not vulnerable to
increases interest rates in the future.
- This is because if interest rates do rise in the future, the firm will not see a significant increase
in debt repayments as they carry so little debt.
- However, whilst the firm maybe considered cautious and safe, some shareholders maybe
reluctant to put money into a firm with low gearing.
- This is because it could be argued that the firm is not expanding as much as it could be, as
shown by borrowing money to increase their productive capacity.
- Therefore, low geared companies are generally considered safe, but could be argued to be too
cautious if they are not expanding enough for shareholders.

Question 30

Payable Days

Answer 30

Payables is money that the firm owes to a supplier from a previous purchase. This ratio measures the time it takes the firm to pay suppliers the money it owes

Formula:

Payables / Cost of sales x 365