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BUS > 3.5 DECISION MAKING TO IMPROVE FINANCIAL PERFORMANCE > Flashcards

3.5 DECISION MAKING TO IMPROVE FINANCIAL PERFORMANCE Flashcards

1
Q

Define ‘net profit’ / ‘operating profit’

A

Amount of money your business earns after deducting all operating, interest, and tax expenses over a given period of time.

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2
Q

Define ‘gross profit’

A

Profit after deducting costs associated with making and selling the products

  • HIGH cost of sales = LOW gross profit
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3
Q

Define ‘profit’

A

The reward/return for taking risks and making investments

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4
Q

What are the two ways of measuring profit/return?

A
  • Absolute: the £ value of profits earned
  • Relative: difference between the absolute return and the performance of the market (or other similar investments) - COMPARE TO RELATIVE FIGURES
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5
Q

What is ratio analysis?

A

Analysing relationships between financial data to assess the performance of a business

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6
Q

What are the main profitability ratios?

A
  • Gross profit margin
  • Operating profit margin
  • Return on capital employed
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7
Q

What is net profit margin / operating profit margin ?

A
  • What is left after all costs have been taken from its sales revenue
  • Percentage return made on sales
  • Measure of firm’s profitability by looking at the relationship between net profit and sales revenue
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8
Q

What does operating profit tell us?

A
  • How effective a business turns sales into profit
  • To see if the business needs to be more profitable
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9
Q

What is a concern around cash flow?

A

It is dynamic and unpredictable, can change at any moment

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10
Q

Why create a cash flow forecast?

A
  • Advanced warning for cash flow issues
  • Makes sure the business have enough money to pay suppliers and employees
  • Reassures investors that there is full control over finance
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11
Q

Equation for net cash flow

A

Inflows - outflows

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12
Q

When is breakeven output reached?

A

When…

Total revenues = total costs

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13
Q

Equation for breakeven output

A

Fixed costs / contribution per unit

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14
Q

Equation for contribution per unit

A

Revenue - Variable Costs

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15
Q

Define ‘margin of safety’

A

The amount sales can fall before the break-even point is reached and the business makes no profit

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16
Q

Equation for margin of safety

A

Difference between…

Actual Output and Breakeven Output

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17
Q

What does a positive margin of safety mean for a business?

A

Profitability

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18
Q

What does a negative margin of safety mean for a business?

A

Loss being made

BELOW THE BREAKEVEN POINT LINE, looking at how much more £££ needs to be made to reach the breakeven point

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19
Q

Ways to improve margin of safety

A
  • Increase contribution per unit, by:
    – Rising selling prices
    – Reducing variable costs per unit
  • Lowering the breakeven output
    – Lowering fixed costs
    – Turning fixed costs into variable costs
  • Increase actual output
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20
Q

Define ‘contribution per unit’

A

Coverage of fixed costs

All sales revenue not consumed by variable costs

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21
Q

Define ‘breakeven output’

A

How many products need to be sold to reach breakeven point

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22
Q

Define ‘budget’

A

A financial plan for the future concerning revenues and costs of a business

How much you are allowed to spend on something

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23
Q

How do managers use budgeting?

A
  • Set targets
  • Provide direction
  • Assign responsibilities
  • Motivate staff
  • Prevents overspending, keep within budget
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24
Q

Explain a good budgetary control

A
  • Responsibilities clearly defined
  • Make sure don’t go over the budget
  • Corrective action taken if results differ from budget
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25
Q

Define ‘historic budgeting’

A

Use last year’s figures as basis of budget

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26
Q

Advantage of ‘historic budgeting’

A
  • Realistic, based on actual results
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27
Q

Disadvantage of ‘historic budgeting’

A
  • Circumstances may have changed
  • Does not encourage efficiency
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28
Q

Define ‘zero budgeting’

A
  • Budgeting costs set to zero
  • Budget based on new proposals

AS YOU GO ALONG

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29
Q

Advantage of ‘zero budgeting’

A
  • More realistic and up-to-date
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30
Q

Disadvantages of ‘zero budgeting’

A
  • Time consuming
  • More complicated
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31
Q

Define ‘management by exception’

A

Process of focusing on activities that require attention and ignoring those that appear to be running smoothly

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32
Q

How do variances make “Management by exception” easier?

A

Highlights areas of a business which don’t meet standards of the budgeting

Adverse = pay attention to these

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33
Q

Define ‘variances’

A

Difference between actual and budget figures

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34
Q

Define ‘variances’

A

Difference between actual and budget figures

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35
Q

Define ‘adverse variance’

A

NEGATIVE

Worse than expected

If actual is lower than budget

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36
Q

Define ‘favourable variance’

A

POSITIVE

Better than expected

If actual is higher than budget

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37
Q

What do variances depend on?

A
  • What is foreseen
  • Size of budget
  • If temporary problem or result of long-term trend
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38
Q

How should a business act on variances?

A
  • Act only if variance is outside of agreed margin, don’t waste time
  • Investigate the cause
  • Was it avoidable?
  • Act to save the problem
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39
Q

In what way could an adverse variance be positive for a business?

A
  • May be a result of something good that has happened to the business

(e.g.) higher production costs than budget occur because sales are higher than budget

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40
Q

Problems with budgeting

A

MAY BE BIAS?

  • Can lead to inflexibility in decision making, as the business must remain within the budget
  • Needs to be changed as the circumstances change
  • Takes time to complete and manage
  • Costs are subject to change
  • Competitor actions unknown
  • Managers may lack experience
  • Takes time and effort: associated with opportunity costs
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41
Q

Behavioural Affects of Budgeting

A
  • May create a ‘use it or lose it’ approach amongst businesses, costing the business
  • De-motivating if not negotiated, stakeholders may not agree with it
  • Department rivalry, battles over budget allocation
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42
Q

Suggest some internal sources of finance

A
  • Retained profit
  • Rationalisation - through selling assets
  • Owner investment
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43
Q

Suggest some external sources of finance

A
  • Debt factoring
  • Overdrafts
  • Share capital
  • Loans
  • Venture capital
  • Crowdfunding
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44
Q

Advantages of ‘retained profit’

A
  • Avoids interest repayments
  • Doesn’t dilute business ownership
  • Increase share price
  • Improve financial safety net
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45
Q

Disadvantages of ‘retained profit’

A
  • Only an option if sufficient retained profit exists within the business
  • May cause shareholder dissatisfaction if this is at the expense of dividend payments
  • Reduces security blanket of keeping retained profit for unforeseen situations or to take advantage of new opportunities
46
Q

Define ‘rationalisation’

A

INTERNAL

Selling assets

Reorganise the business to make it more efficient

47
Q

Advantages of ‘rationalisation’

A
  • Less risky (as its internal)
  • No cost involved, if privately sold
  • Quick and easy source of finance
48
Q

Disadvantages of ‘rationalisation’

A
  • Cost to replace these assets later
  • Can decrease productivity if machinery is sold
  • No guarantee of improved return
49
Q

Define ‘debt factoring’

A

EXTERNAL

Selling debts to another organisation

Sells its accounts receivables to a third party

50
Q

Advantages of ‘debt factoring’

A
  • Improves cash flow: can pay threatening debt / cash-flow problems off immediately (short-term)
  • Debts dealt with by experts, saving managers time
  • Debt protection: reduces risk of a debt getting out of hand
  • Improves cash flow
  • Reduces stress in the short-term: improving productivity
  • Less admin work to organise the debt: taken care of elsewhere
51
Q

Disadvantages of ‘debt factoring’

A
  • Reduces profitability in the long term as fee must be paid to debt factorer when it is sorted
  • Less control
  • Creates more debt in long term
52
Q

Define ‘overdrafts’

A

EXTERNAL

  • Facility to overspend on a current account up to agreed sum
  • Short term
  • USED IN EMERGENCIES!
53
Q

Advantages of ‘overdrafts’

A
  • Small/no interest
  • Quick / easy - available whenever
  • Only borrowed when essential
  • No charges
  • You’re in control: only pay for what you use - FLEXIBLE
54
Q

Disadvantages of ‘overdrafts’

A
  • Needs to be paid back asap (short term)
  • Interest payment vary, hard to budget
  • If go over, may damage connection with bank, meaning borrowing will be harder in the future
  • Bank can call in at any time, unreliable
  • Limitation: only available from current bank account
55
Q

Define ‘share capital’

A

Finance raised from shares

56
Q

Advantages of ‘share capital’

A
  • Happy shareholders: shareholders get dividends and benefit from increase in share price
  • Dividends are flexible, business can maximise profit by decreasing
  • No interest repayments
  • If successful. business can raise large amounts of finance
  • LOW RISK: source of permanent capital: source of permanent capital
57
Q

Disadvantages of ‘share capital’

A

Must become a PLC…

  • Loss of ownership
  • Risk of loss of control: PLC with a threat of hostile takeover. More than 50% = owner
  • Complex and costly
  • Reliant on people actually wanting to invest
58
Q

Define a ‘loan’

A
  • EXTERNAL - LONG TERM (but depends on situation of a business)
  • Money provided for a specific purpose (apply)
  • Interest rate is based on risk placed on the loan
59
Q

Advantages of a ‘loan’

A
  • Quick and easy to secure
  • Build connection with bank for better future interest
  • Fixed interest rates allow budgeting
  • Improves cash flow in short term
  • Ability to borrow large amounts of money
60
Q

Disadvantages of a ‘loan’

A
  • Interest must be paid at some point, regardless of financial performance
  • No flexibility, no more than given amount
  • May require collateral security: ASSETS pledged by a BORROWER as security for a LOAN (which a business may not be able to provide)
  • Creates debt, making cash flow a problem
61
Q

Define ‘venture capital’

A
  • Investment from an established business into another business in return for % equity
  • Form of investment for early-stage, innovative businesses with strong growth potential
62
Q

Advantages of ‘venture capital’

A
  • Large sum of money quickly, to get started with
  • Gain expertise from the venture capitalist
  • Easier to attract other sources of finance
  • Allows for easy expansion
  • No personal assets pledged
63
Q

Disadvantages of ‘venture capital’

A
  • Ownership reduced
  • Control reduced: loss of full decision making
  • Long/complex process
  • Time consuming: may be hard to find people willing to invest
  • Expert financial projections likely to be required to present to VC’s
  • Proportion of profit lost to venture capitalists
64
Q

Define ‘crowdfunding’

A

Raising finance from a large number of people, voluntarily contributing

e.g. GoFundMe

Possible incentives

65
Q

Advantages of ‘crowdfunding’

A
  • Cheap
  • Can be fast if publicised well: MEDIA ATTENTION
  • Alternative to loan which is more risky
  • No debt!
  • Support: gain feedback and expert guidance
66
Q

Disadvantages of ‘crowdfunding’

A
  • Patience: takes longer
  • Takes time and resources to publish the crowdfunding page
  • Ineffective: possibility of no engagement
  • Risk of accusations of fraud
  • If full amount not raised, business will have to return all £ to contributors
67
Q

Define ‘financial objectives’

A

Monetary targets a business wants to achieve within a set period of time

68
Q

Examples of financial objectives

A
  • Return on investment
  • Capital structure
  • Revenue
  • Costs
  • Profit
  • Cash flow
69
Q

Define ‘return on investment’

A

MEASURED IN %

Measure of a business’ profitability of an investment

Compares how much paid for an investment to how much you earned, evaluating the efficiency.

Method of benchmarking / comparison

70
Q

Define ‘capital structure’

A

Proportion of long term funding that is debt

71
Q

How long is ‘long-term funding’?

A

Over a year

72
Q

How long is ‘long-term’ in business?

A

Over a year

73
Q

Define ‘cash flow’

A

Movement of money into and out of a business

(Required to meet the short term objective of survival)

74
Q

Give examples of ‘economic conditions’

A
  • Stable vs unstable
  • Economic growth or decline
  • Optimistic or pessimistic
75
Q

External influences on financial objectives

A
  • Competitor actions
  • Consumers
  • Economic conditions
76
Q

What are the 3 types of budgeting?

A
  • Income
  • Expenditure
  • Profit
77
Q

Define ‘income budgeting’

A
  • Target set for amount of revenue to be achieved in a set time period
  • Can be split by products, services or departments
  • Informed by market research and sales forecasts
  • Informs predicted cash inflows in the cash flow forecast
78
Q

Define ‘expenditure budgeting’

A
  • Limit placed on the amount to be spent in a given period of time
  • Informs predicted cash outflows
  • Possible separate expenditure budget per department
79
Q

Define ‘profit budgeting’

A

Target set for the surplus between income and expenditure in a given time period

Target for how much profit a business wants to make

80
Q

What could an ‘adverse variance’ suggest about the expenditure budget?

A

Expenditure higher than budget

81
Q

What could an ‘adverse variance’ suggest about the income budget?

A

Income lower than budget

82
Q

What could an ‘adverse variance’ suggest about the profit budget?

A

Profit lower than budget

83
Q

What could an ‘favourable variance’ suggest about the expenditure budget?

A

Expenditure lower than budget

84
Q

What could an ‘favourable variance’ suggest about the income budget?

A

Income higher than budget

85
Q

What could an ‘favourable variance’ suggest about the profit budget?

A

Profit higher than budget

86
Q

External influences on ‘variances’ of a business’ budget

A
  • Actions of competition
  • Action of suppliers
  • Changes in economy
87
Q

Internal influences on ‘variances’ of a business’ budget

A
  • Internal efficiency / labour productivity
  • Internal decision making / leadership
88
Q

What decisions could variance analysis help to inform?

A
  • Change in budget?
  • Staff training?
  • Reward staff, to improve motivation?
  • Change suppliers?
  • Reallocate budgets?
  • New marketing tactics?
  • Review product portfolio?
89
Q

Strengths of break-even analysis

A
  • Calculate minimum sales needed before starting to make a profit and therefore see if a venture is viable
  • Calculate level of profit/loss
  • Provides targets
  • Aids decision making
90
Q

Weakness of break-even

A
  • Based on predicted costs and revenue
  • Even fixed costs can vary in reality, especially in long run
  • Ignores change in variable costs or selling price if items are bought or sold in large quantities, BULK BUYING
  • Only indicates the number of sales needed, does not ensure actual sales will materialise
91
Q

Name all parts of a breakeven chart (not including axis)

A
  • Revenue
  • Total costs (Variable + Fixed)
  • Fixed costs
  • The Breakeven point
92
Q

Where is the breakeven point located on a breakeven chart?

A

Where the…

REVENUE and TOTAL COSTS meet.

93
Q

Where is the breakeven point located on a breakeven chart?

A

Where the…

REVENUE and TOTAL COSTS meet.

94
Q

Define ‘profitability’

A

Measures the financial performance of a business by comparing profits achieved to a second variable e.g. revenue

95
Q

What does a falling Gross Profit Margin suggest?

A
  • Not managing costs of sales effectively
96
Q

Define ‘gross profit margin’

A

Measure of firm’s profitability by looking at the relationship between gross profit and sales revenue

97
Q

Define ‘operating profit margin’

A

Measure of firm’s profitability by looking at the relationship between operating profit and sales revenue

98
Q

What does a falling Net Profit Margin suggest?

A
  • Gross profit / operating profit in decline
  • Interest rates have changed (as after interest and taxation costs)
99
Q

How to increase profitability

The ‘Sell’ strategy

A
  • Sell same quantity but at a higher price
  • Sell more at a current price
  • Sell the same at the same price but reduce costs
100
Q

Define ‘receivables’

A

OPPOSITE TO PAYABLES

Payment from debtors

Amount owed to a business

101
Q

Examples of ‘cash inflows’

A
  • Cash sales
  • Payment from debtors (receivables)
  • Owner’s capital invested
  • Sales of assets
  • Bank loan
102
Q

Examples of ‘cash outflows’

A
  • Purchasing stock
  • Paying wages
  • Paying debts - bank loans, creditors
  • Purchasing assets
103
Q

Ways to improve cash flow

A
  • Increasing the volume of the inflow of cash
  • Speeding up the timing of the inflow of cash
  • Reducing the volume of the outflow of cash
  • Slowing down the timing of the outflow of cash
  • Taking out a source of finance (eg overdraft) to mend it in the short term
  • Selling assets
  • Delay payments to suppliers
  • Reduce fixed costs spending
104
Q

Factors affecting cash flow

A
  • Transaction types - cash vs credit
  • Timings of cash flow: trade credit?
  • Nature of the business
105
Q

Define the term ‘liquid cash’

A

Cash readily available, can be quickly used

106
Q

What may insufficient liquid cash cause?

A

Inability to meet short term debts

Limited cash = limited opportunity

107
Q

Causes of cash flow problems

A
  • Offering trade credit
  • Overtrading
  • Internal management
  • Seasonality
  • Unexpected events (COVID)
108
Q

Suggest the ‘cash conversion cycle’

A
  1. Cash
  2. Material / services
  3. Accounts payable
  4. Pay AP
  5. Sales
  6. Accounts receivable
109
Q

Define ‘payables’

A

OPPOSITE TO RECEIVABLES

Debts owed by a business; liabilities.

110
Q

Define ‘payables’

A

OPPOSITE TO RECEIVABLES

Debts a business needs to pay; liabilities.

BUS (13 decks)

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