Unit 5- Decision making to improve financial performance

Question 1

What are key financial objectives?

Answer 1

-Profit objective
-Cash Flow objective
-ROI objective
-Capital structure objective

Question 2

What is cash flow?

Answer 2

Cash flow is the flow of money into and out of a business over period of time

Question 3

Check the key formulas

Answer 3

check business formulas for all formulas

Question 4

What is capital structure?

Answer 4

The structure of capital in your business, debt and equity.

Question 5

What is debt?

Answer 5

Debt is borrowing money from lenders such as banks

Question 6

What is equity?

Answer 6

Equity is receiving funding from shareholders

Question 7

Why is debt dangerous?

Answer 7

Need to be repaid in full regardless whether the business has good cash flow or not

Interest is charged on debt, interest rate can increase over time

If the business isn’t able to repay its debts a lender can take the business to court and the business could be put into liquidation

Question 8

Why is equity safe?

Answer 8

The funds from investors do not need to be repaid

Investors are only entitled to a dividend if the business makes a profit

Investors cannot ask for their investment back

Question 9

What is the value of setting financial objectives?

Answer 9

-Measure how well a business is doing financially and to compare the performance over time/years

-Control spending

Identify areas a business can improve

Provide sales targets

prevents a business running out of cash

Measure the reward that shareholders receive or set expectations when making an investment

Question 10

What are some internal factors affecting financial objectives?

Answer 10

-Business ownership
-Size and form of business
-Other functional areas

Question 11

What are some external factors affecting financial objectives?

Answer 11

PESTLE + C

Question 12

What is variance?

Answer 12

The difference between a budgeted figure vs an actual figure

Question 13

What is a favourable variance?

Answer 13

When actual performance is better in some ways than it has been budgeted for

-Actual sales may have been higher than budgeted for
-Actual costs may have been lower than budgeted for

Question 14

What is an adverse variance?

Answer 14

When the actual performance is worse than had been budgeted for?

-Actual sales may be lower than budgeted for
-Actual costs may have been higher than budgeted for

Question 15

What is a budget?

Answer 15

A financial plan that shows the forecasted figures and the actual figures for revenue, expenses and profit side by side.

Question 16

Ways of addressing adverse revenue variances?

Answer 16

increase promotions
Withdraw the product if it is clear that there is no longer sufficient demand for it and all improvements have been exhausted
Reduce the price only if PED is below -1
Improve the product
Change the distribution
Train staff to improve customer service
Look for new segments or new geographical markets to sell the product

Question 17

Ways of addressing adverse cost variances?

Answer 17

Find cheaper supplies
Change production method to reduce unit cost
Invest in automation and replace all staff with machines or robotics to reduce the staff cost and reduce unit cost
Increase the size of orders to benefit from purchasing economies of scale
Find cheaper premises
Invest in better machinery to reduce unit cost

Question 18

Responding to favourable variances?

Answer 18

Increase price or increase production and benefit from higher profit margins

Reduce the price of the product if costs are below expectations this may increase sales

Reinvest into the business or pay shareholders higher dividends if profits exceed expectations

Question 19

Pros of budgeting?

Answer 19

-Gives senior and functional managers spending guidance which encourages spending discipline

-Helps support a business if they are looking to obtain profit budget and increases the changes of them obtaining profit budget

Question 20

Cons of budgeting?

Answer 20

Lack of expertise may lead to over ambitious targets and demotivation

Historical or amended budgets are based on previous years which may encourage the the use it or lose it mentality which could lead to short terms

If frequently revised it can lead to budgetary slack
middle management may overestimate costs

Question 21

What are the limitations of cash flow forecasts?

Answer 21

-Sales prove lower than expected (Easy to be over-optimistic about sales potential)

-Costs prove higher than expected (Purchase prices may turn out to be higher, unexpected costs)

-Customers do not pay up on time

Question 22

Potential causes of cash flow (or liquidity) problems?

Answer 22

-Too much production capacity

-Excess inventories held (Excess stock tie up in cash and increased stock that may become obsolete)

-Allowing customers too much credit

-Overtrading

-Seasonal demand

Question 23

What can cash flow or liquidity problems lead to?

Answer 23

An increase in financial costs
Poor credit score
Suppliers may ask for cash payments upfront or even refuse to supply business all together
Unpaid suppliers may take legal action

Question 24

Methods of improving cash flow?

Answer 24

Ask for an increase or an overdraft

Manage customers and suppliers and to ensure a positive net cash flow

Apply for a short term flow

Debt collection specialists

Lease or rent

Sale assets

Question 25

Methods of improving profitability

Answer 25

-Increase sales (increase promotion, find new markets)

-Reduce variable costs (Find cheaper suppliers, cut wages costs)

-Increase price (Improve current product and increase price)

-Reduce fixed costs (Relocating for a cheaper premises, sell premises and rent back reducing administration costs)

Question 26

Breakeven charts and what they represent

Answer 26

• Horizontal axis represent the number of units sold
  -Vertical axis represents the amount of revenue and costs

-Break even outputs is the intersection between the revenue line and the total cost line

-Fixed costs at 0 unit the total costs = fixed costs only

Question 27

Pros of breakeven analysis?

Answer 27

• Useful for tool management
  -Highlights the importance of fixed costs
  -Data can be generated in a business plan
  -Changes the sales prices and predict new breakeven output and margin of safety

Question 28

What are the cons of breakeven analysis?

Answer 28

-Based on predicted data and not actual data
-Many unrealistic assumptions like all units produced are sold, productions cost is the same, no waste

Question 29

What are some internal sources of short term finance?

Answer 29

-Retained profits
-Sale and leaseback

Question 30

What are some external sources of short term finance?

Answer 30

-Overdrafts
-Debt factoring

Question 31

What are some internal sources of long term finance?

Answer 31

Retained profit
sale of assets

Question 32

What are some external sources of long term finance?

Answer 32

-Bank loans
-Venture capital
-Share capital
-Crowdfunding

Question 33

What are the advantages and disadvantages to retained profit

Answer 33

• Very flexible, management controls how it is reinvested

-Does not dilute the ownership of the company

-But danger of hoarding cash
-high profits and cash flow would suggest the business could afford debt

Question 34

What are the advantages and disadvantages to bank overdraft

Answer 34

-Only borrowed when required allowing flexibility
-Only pay for borrowed money

-But the bank can call it any time
-Only available from your current bank account

Question 35

What are the advantages and disadvantages to bank loans

Answer 35

-Quick and easy to secure
-Fixed interest rates allows firms to budget

-interest must be paid regardless of financial performance

-A firm that is highly geared may be seen as high risk

Question 36

What are the advantages and disadvantages to debt factoring?

Answer 36

-Recieves a large amount of the debt immediately
-good source of short term finance to address cash flow

-but may damage reputation
-Reduce profitability

Question 37

What are the advantages and disadvantages to venture capital>

Answer 37

-Can raise substantial amounts
-Brings better discipline to business managements and strategy

-But requires high rate of return

-Investment supported by a high level of bank debt in business

Question 38

What are the advantages and disadvantages to share capital or share issue?

Answer 38

Broader base of share holders
-Equity rather than debt

-Equity has a cost of capital higher than debt

-Existing shareholders holdings may be diluted