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3.5 DECISION MAKING TO IMPROVE FINANCIAL PERFORMANCE Flashcards

(109 cards)

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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 has 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 raising selling prices and reducing variable costs per unit), Lowering the breakeven output (by lowering fixed costs and 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, Prevent overspending.

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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
Define 'historic budgeting'
Use last year's figures as basis of budget.
26
Advantage of 'historic budgeting'
Realistic, based on actual results.
27
Disadvantage of 'historic budgeting'
Circumstances may have changed, Does not encourage efficiency.
28
Define 'zero budgeting'
Budgeting costs set to zero, Budget based on new proposals AS YOU GO ALONG.
29
Advantage of 'zero budgeting'
More realistic and up-to-date.
30
Disadvantages of 'zero budgeting'
Time consuming, More complicated.
31
Define 'management by exception'
Process of focusing on activities that require attention and ignoring those that appear to be running smoothly.
32
How do variances make “Management by exception” easier?
Highlights areas of a business which don't meet standards of the budgeting. Adverse = pay attention to these.
33
Define 'variances'
Difference between actual and budget figures.
34
Define 'adverse variance'
NEGATIVE. Worse than expected. If actual is lower than budget.
35
Define 'favourable variance'
POSITIVE. Better than expected. If actual is higher than budget.
36
What do variances depend on?
What is foreseen, Size of budget, If temporary problem or result of long-term trend.
37
How should a business act on variances?
Act only if variance is outside of agreed margin, Investigate the cause, Was it avoidable?, Act to solve the problem.
38
In what way could an adverse variance be positive for a business?
May be a result of something good (e.g. higher production costs due to higher sales).
39
Problems with budgeting
Can lead to inflexibility, Needs to be changed with circumstances, Takes time and resources, Costs and competition unpredictable, Manager inexperience, Opportunity costs.
40
Behavioural Affects of Budgeting
Use-it-or-lose-it mentality, Demotivating if not agreed upon, Department rivalry over budget.
41
Suggest some internal sources of finance
Retained profit, Rationalisation, Owner investment.
42
Suggest some external sources of finance
Debt factoring, Overdrafts, Share capital, Loans, Venture capital, Crowdfunding.
43
Advantages of 'retained profit'
Avoids interest, Doesn't dilute ownership, Increases share price, Improves financial safety net.
44
Disadvantages of 'retained profit'
Only usable if profit exists, May upset shareholders, Reduces backup funds.
45
Define 'rationalisation'
INTERNAL. Selling assets. Reorganise business for efficiency.
46
Advantages of 'rationalisation'
Less risky, No cost if privately sold, Quick and easy source of finance.
47
Disadvantages of 'rationalisation'
Replacement costs, May reduce productivity, No guaranteed return.
48
Define 'debt factoring'
EXTERNAL. Selling debts/accounts receivable to a third party.
49
Advantages of 'debt factoring'
Improves cash flow, Expert handling of debts, Debt protection, Reduces admin work.
50
Disadvantages of 'debt factoring'
Reduces long-term profitability due to fees, Less control, May increase debt overall.
51
Define 'overdrafts'
EXTERNAL. Facility to overspend on account up to a set limit. Short-term, emergency use.
52
Advantages of 'overdrafts'
Small/no interest, Quick and flexible, Only borrow when needed, No charges.
53
Disadvantages of 'overdrafts'
Must repay quickly, Variable interest, Can harm bank relationship, May be recalled any time, Bank-specific.
54
Define 'share capital'
Finance raised from shares.
55
Advantages of 'share capital'
Shareholders benefit from dividends and share value, No interest, Can raise large funds, Low risk, Permanent capital.
56
Disadvantages of 'share capital'
Must be PLC, Loss of ownership/control, Complex, Dependent on investor interest.
57
Define a 'loan'
EXTERNAL - LONG TERM. Money for specific purpose with interest based on risk.
58
Advantages of a 'loan'
Quick to secure, Builds bank relationship, Fixed interest allows budgeting, Improves cash flow, Borrow large sums.
59
Disadvantages of a 'loan'
Interest must be paid, No flexibility, May require collateral, Adds to debt.
60
Define 'venture capital'
Investment in return for equity. For early-stage/high growth businesses.
61
Advantages of 'venture capital'
Large funds quickly, Access to expertise, Easier to attract more finance, No personal assets, Supports expansion.
62
Disadvantages of 'venture capital'
Reduced ownership and control, Long/complex process, Time-consuming, Requires projections, Share profit.
63
Define 'crowdfunding'
Finance from many contributors (e.g. GoFundMe) possibly with incentives.
64
Advantages of 'crowdfunding'
Cheap, Fast with publicity, No debt, Public support and feedback.
65
Disadvantages of 'crowdfunding'
Time-consuming to publish, May fail, Risk of fraud, All funds returned if goal unmet.
66
Define 'financial objectives'
Monetary targets for a set period.
67
Examples of financial objectives
Return on investment, Capital structure, Revenue, Costs, Profit, Cash flow.
68
Define 'return on investment'
MEASURED IN %. Compares investment cost to return to evaluate efficiency.
69
Define 'capital structure'
Proportion of long term funding that is debt.
70
How long is 'long-term funding'?
Over a year.
71
How long is 'long-term' in business?
Over a year.
72
Define 'cash flow'
Movement of money into and out of a business. Needed for survival.
73
Give examples of 'economic conditions'
Stable/unstable, Economic growth/decline, Optimistic/pessimistic.
74
External influences on financial objectives
Competitor actions, Consumers, Economic conditions.
75
What are the 3 types of budgeting?
Income, Expenditure, Profit.
76
Define 'income budgeting'
Target revenue in a time period, based on forecasts, split by products/departments.
77
Define 'expenditure budgeting'
Limit on spending, informs outflows, separate per department.
78
Define 'profit budgeting'
Target profit (income - expenditure) for a time period.
79
What could an 'adverse variance' suggest about the expenditure budget?
Expenditure higher than budget.
80
What could an 'adverse variance' suggest about the income budget?
Income lower than budget.
81
What could an 'adverse variance' suggest about the profit budget?
Profit lower than budget.
82
What could a 'favourable variance' suggest about the expenditure budget?
Expenditure lower than budget.
83
What could a 'favourable variance' suggest about the income budget?
Income higher than budget.
84
What could a 'favourable variance' suggest about the profit budget?
Profit higher than budget.
85
External influences on 'variances'
Competition, Suppliers, Economic changes.
86
Internal influences on 'variances'
Internal efficiency, Productivity, Decision-making, Leadership.
87
What decisions could variance analysis help to inform?
Change budget, Train staff, Reward staff, Change suppliers, Reallocate budgets, Use new marketing, Review products.
88
Strengths of break-even analysis
Calculates minimum sales for profit, Estimates profits/losses, Provides targets, Supports decisions.
89
Weakness of break-even
Based on predictions, Fixed costs may vary, Ignores variable price changes, Doesn’t guarantee sales.
90
Name all parts of a breakeven chart (not including axis)
Revenue, Total costs, Fixed costs, Breakeven point.
91
Where is the breakeven point located on a breakeven chart?
Where Revenue and Total Costs meet.
92
Define 'profitability'
Measures business performance by comparing profit to variables like revenue.
93
What does a falling Gross Profit Margin suggest?
Poor cost of sales management.
94
What does a falling Operating Profit Margin suggest?
Falling sales or poor expense management.
95
Define 'gross profit margin'
Gross profit compared to sales revenue.
96
Define 'operating profit margin'
Operating profit compared to sales revenue.
97
What does a falling Net Profit Margin suggest?
Decline in gross/operating profit or increased interest/tax costs.
98
How to increase profitability
Sell same quantity at higher price, Sell more, Reduce costs.
99
Define 'receivables'
Payments owed to a business (opposite of payables).
100
Examples of 'cash inflows'
Cash sales, Debtor payments, Owner investment, Asset sales, Bank loans.
101
Examples of 'cash outflows'
Stock purchases, Wages, Debt repayment, Asset purchases.
102
Ways to improve cash flow
Increase inflow volume/speed, Reduce or delay outflows, Use finance, Sell assets, Delay supplier payments, Cut fixed costs.
103
Factors affecting cash flow
Transaction type (cash/credit), Timing of inflows/outflows.
104
Define the term 'liquid cash'
Cash readily available, can be quickly used.
105
What may insufficient liquid cash cause?
Inability to meet short-term debts
106
Causes of cash flow problems
Offering trade credit, Overtrading, Internal management issues, Seasonality, Unexpected events (e.g. COVID).
107
Suggest the 'cash conversion cycle'
Cash → Materials/Services → Accounts Payable → Pay AP → Sales → Accounts Receivable.
108
Define 'payables'
Debts a business needs to pay
109
Define “overheads”
Costs that do not change when production levels change.

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