5. Decision making to improve financial performance

Question 1

what are budgets

Answer 1

a financial plan for the future anticipating the revenues, costs and profit of a business

Question 2

two types of variance

Answer 2

favourable - better than expected

adverse - worse than expected

Question 3

what is a cash flow forecast

Answer 3

a budget for the cash flowing into and out of a business over a period of time

Question 4

formula for closing balance

Answer 4

net cash flow + opening balance

Question 5

formula for net cash flow

Answer 5

inflows - outflows

Question 6

value of cash flow forecasts 5

Answer 6

• highlights when a business will be short of cash and by how much
• allows a business to take action (overdraft or loan)
• can see if payments can be delayed
• avoids running out of cash and liquidation
• can manage extra cash (invest or expand)

Question 7

3 key cash flow problems

Answer 7

• customers paying late
• holding too much stock
• seasonal demand

Question 8

gross profit

Answer 8

sales revenue - cost of sales

Question 9

operating profit

Answer 9

sales revenue - cost of sales - operating expenses

Question 10

profit for the year

Answer 10

operating profit + profit from other activities - net finance costs - tax

Question 11

contribution per unit

Answer 11

selling price - variable costs per unit

Question 12

total contribution

Answer 12

contribution per unit x units produced or sold
OR
total revenue - total variable costs

Question 13

break-even output

Answer 13

fixed costs / contribution per unit

Question 14

margin of safety

Answer 14

actual level of output - breakeven level of output

Question 15

gross profit margin %

Answer 15

gross profit / sales revenue x 100

Question 16

payables (creditors) days

Answer 16

payables / cost of sales x 365

Question 17

receivables (debtors) days

Answer 17

receivables / sales revenue x 365

Question 18

profit (m)

Answer 18

margin of safety x contribution per unit

Question 19

profit (tc)

Answer 19

total contribution - fixed costs

Question 20

3 advantages of retained profit

Answer 20

• Cheapest source of finance (no interest)
• Doesn’t not need to be repaid
• No loss of control

Question 21

1 con of retained profit

Answer 21

Shareholders may want to receive the money (dividend) & refuse to leave the profit in the business

Question 22

2 pros of overdraft

Answer 22

• flexible way of borrowing money

- useful for business with unpredictable cash inflows

Question 23

5 cons of overdraft

Answer 23

• Interest charged can be high (higher than bank loan): likely to be an expensive way of borrowing money
• No set interest rate
• The bank can cancel this facility at any time
• Difficult to calculate the real cost of borrowing as interest is charged daily on the amount borrowed
• Mustn’t go over the limit!

Question 24

3 pros of bank loan

Answer 24

• The cost of borrowing money is clear & fixed: it is the interest charged
• Easy to set a budget as repayment dates & amounts are set in the loan contract
• No loss of control or interference in the running of the business

Question 25

4 cons of bank loan

Answer 25

- The full amount borrowed plus interest must be repaid - Repayments must be done on time whether the business has enough cash or not - If repayments are not made the bank can take the business to court (risk of liquidation) - A collateral (asset with a value worth the same as the loan e.g. house) may be needed to secure the loan

Question 26

4 pros of debt factoring

Answer 26

- Cash is received upfront (% of invoice value) - Possible solution to a cash flow problem due to late payers - Relieves the business from having to chase customers for late payment of invoice - Can provide credit checks on customers

Question 27

2 cons of debt factoring

Answer 27

- The Debt recovering or Factoring business will charge a fee (cost of recovering the money) - Customers may not want to deal with a Factoring business & this may damage the business’ relationship with its customers

Question 28

4 pros of venture capital

Answer 28

- No interest charged - No set repayment date(s) - Venture capitalists can provide advice, experience or useful contacts - Venture capitalists are usually willing to take risks (a bank will not!). This may be the only option available to risky businesses.

Question 29

4 cons of venture capital

Answer 29

- Loss of control of the business: venture capitalists will ask for shares in the business in return for their investment - Venture capitalists may interfere in the running of the business - The profit will be shared with the venture capitalists - Venture capitalists may want their money back & force the sale of the business

Question 30

3 pros of share capital

Answer 30

- Large amounts of capital can be raised (millions!) - No interest charged - No set repayment date(s)

Question 31

6 cons of share capital

Answer 31

- Loss of control of the business: shareholders will have shares & own part of the business - The profit will be shared among the shareholders - Financial performance & key decisions must be communicated to shareholders & the public - Shareholders have voting rights for key decisions (AGM) - Being listed on the Stock Exchange is costly & time consuming - For Plcs only

Question 32

what is retained profit

Answer 32

Profit retained (not distributed to shareholders) in the business from previous years

Question 33

what is bank overdraft

Answer 33

Facility or agreement with a bank to take out more money from an account than a business has in it but only up to an agreed limit

Question 34

what is bank loan

Answer 34

Set amount of money borrowed from a bank with fixed interest & set repayment dates (the money must be repaid at specific dates)

Question 35

what is debt factoring

Answer 35

Using the services of a Debt Recovering or Factoring business to collect invoice payments from customers

Question 36

what is venture capital

Answer 36

Finance obtained from the sale of shares to wealthy individuals also called venture capitalists, Business Angels or Private investors. Wealthy individuals can ‘team up’ & pull their capital together to form a venture capital firm to lend larger amounts.

Question 37

what is share capital or shar issue

Answer 37

Finance obtained the sale of shares via the Stock Exchange

Question 38

9 ways of improving cash flow

Answer 38

- make a cash flow forecast - chase late payers and incentivise customers to pay early - check customers' credit rating - negotiate longer trade credit with suppliers - negotiate monthly repayments to spread out the outflows or rent - don't over stock - don't take on too many orders - set up an overdraft - use debt factoring

Question 39

5 ways of improving profit - increase sales

Answer 39

- increase promotions - reduce price (if -1 PED) - use a product life extension strat - find new markets or segments - launch a new product

Question 40

4 ways to improve profit - lower fixed costs

Answer 40

- find cheaper premises - reduce staff number - replace staff by machines - increase capacity utilisation

Question 41

2 ways of improving profit - lower variable costs

Answer 41

- find cheaper suppliers | - find ways of achieving purchasing economies of scale (bulk buying)