Finance 3.5-3.9

Question 1

What is the gross profit margin?

Answer 1

the % of the sales revenue that turns into gross profit

Question 2

Why are percentages useful when calculation margins?

Answer 2

The company’s size becomes irrelevant, allowing for easier comparisons

Question 3

Gross profit margin =

Answer 3

gross profit/sales revenue x 100

Question 4

What are some strategies to improve the gross profit margin?

Answer 4

• decrease COGS - technology/efficiency/cheaper materials or labor
• increase sales revenue and keep COGS the same
• decrease COGS and increase sales revenue - economies of scale

Question 5

What is the net profit margin?

Answer 5

the % of how much of the sales revenue is net profit

Question 6

Net profit margin =

Answer 6

net profit/sales revenue x 100

Question 7

What is net profit used for?

Answer 7

1. paying banks and the government
2. dividends

Question 8

How could one improve their net profit margin?

Answer 8

• decrease expenses and indirect costs through marketing/administration etc
• decrease COGS - technology/efficiency/cheaper materials or labor
• increase sales revenue and keep COGS the same
• decrease COGS and increase sales revenue - economies of scale

Question 9

What is capital employed and operating profit?
What is return on capital employed?

Answer 9

Capital employed: all the finance that has been invested into the company so that it could perform
Operating profit: net profit
ROCE: how efficient the company is in being profitable from investments, how efficient in their trading activities

Question 10

ROCE =

Answer 10

operating profit/capital employed x 100

Question 11

How can one improve ROCE?

Answer 11

• increase operating profit - increase sales revenue or decrease COGS/expenses
• reduce capital employed - difficult, NCL may turn into retained earnings/equity, or company would need to sell NCA which would affect sales revenue
• an increase in capital employed may lead to an increase in operating profit

Question 12

What is working capital?

Answer 12

the amount of cash the company has for daily opertions, necessary so that it can continue its activities until their debtors pay for the sale

Question 13

Working capital =

Answer 13

Current assets - current liabilities (= net current assets)

Question 14

Whatis the current ration?

Answer 14

the amount of $ you have to pay for each $ in liabilities
measures if the working capital is sufficient

Question 15

current ratio =

Answer 15

current assets/current liabilities

Question 16

What would be the optimum current ratio?

Answer 16

1 - all of the cash would be used to pay up
less than 1 - not enough to pay
more than 1 - more than enough to pay

close to 2 - most desirable
too high would be undesirable because it means cash is not being used for reinvestment and growth

Question 17

Acid test and what does it measure?

Answer 17

measures healthy liquidity, does not include less liquid stocks, good to be around 1.2-1.5
current assets - inventory/current liabilities

Question 18

How can a business improve its current ratio?

Answer 18

Increase current assets
* Increase sales - some strategies can increase liabilities, so the benefits may be cancelled out
* Reduce debtors - may cause the business to lose customers
* Sell unused fixed assets
* Reduce drawings

Reduce current liabilities
* Extend credit period - can threaten relationships with suppliers.
* Decrease overheads
* Reduce current liabilities - business may not have enough working capital to pay down debts, limits the funds available for daily working

Question 19

Limitations of ratio analyses

Answer 19

• Incomplete picture of current and future finances
• External influences can influence the ratios unexpectedly
• Qualitative factors ignored like customer satisfaction, quality of goods, staff motivation
• Different interpretation by social enterprises

Question 20

Capital employed =

Answer 20

non current liabilities + equity

Question 21

What is the difference between profit and cash flow?

Answer 21

Profit does not take into account the timings of your costs and revenues, cash flow takes inflows and outflows into account, which may not align with its profitability timewise

Question 22

Why is the cash flow important?

Answer 22

allows company to plan for when they receive/pay in order to have enough cash on hand for daily operations

Question 23

How often/and how are P&Ls released vs cash flows?

Answer 23

P&L - each year or quarter, public
cash flow - monthly or even daily, not public

Question 24

What does a better cash flow mean?

Answer 24

a better working capital cycle, the business is better at withstanding market fluctuations

Question 25

Structure of a cash flow forecast

Answer 25

1. Opening balance 2. Cash inflows A B C 3. Total inflows 4. Cash outflows D E F 5. Total outflows 6. Net cash flow 7. Closing balance

Question 26

What are some reasons for poor cash flow?

Answer 26

- Poor stock management - too much stock, having spent much purchasing the inventory - Poor pricing strategy or low sales - trying to penetrate the market or increase sales, the business may have priced the product too low - Expanding too fast - heavy investments in expansion can result in large debts that can cause cash flow problems - High expenses - Seasonal demand

Question 27

How can one increase cash flow? | 8 ways

Answer 27

1. Effective debt collection system - ensures that the company is paid in time. Eg: frequent phone calls/emails, credit checks on customers to reduce slow payment or bad debts 2. Cash transactions only 3. Increased promotion 4. Expanding the product portfolio - diversifies risk, increases the revenue or cash inflow streams 5. Going public - IPO 6. Overdrafts 7. Loans 8. Government assistance - grants/subsidies to companies that produce essential goods/ services/employment

Question 28

How can one decrease cash outflows? | 5 ways

Answer 28

1. Better stock management 2. Renegotiate credit terms 3. Switch to cheaper suppliers 4. Reduce expenses 5. Lease rather than purchase equipment

Question 29

What is investment appraisal?

Answer 29

A process of quantitative and qualitative evaluation of an investment decision

Question 30

What is an opportunity cost?

Answer 30

The potential cost of missing an opportunity by choosing one option and foregoing another

Question 31

What is the payback period?

Answer 31

the number of years and months it will take for the investment to pay for itself

Question 32

What is the average rate of return (ARR)?

Answer 32

expresses the annual forecast returns as a percentage of the initial capital cost

Question 33

ARR =

Answer 33

((total returns - capital cost)/years of use)/capital cost x 100

Question 34

Limitations of payback period?

Answer 34

- ignores the long-term profitability of an investment - assumes that future cash flows have the same value as those of today - different businesses will weigh up the payback period differently - eg Social enterprises may not prioritise the length of the payback period, and instead qualitative data - simplistic view and only relies on cash flow forecasts, which are estimates

Question 35

Why is payback period good?

Answer 35

its simplicity

Question 36

What causes cash flow problems?

Answer 36

insufficient funds to run the business internal reasons (eg poor cash flow management) or external reasons (changes in consumer preferences and tastes)

Question 37

What are some examples of cash flow problems?

Answer 37

- sales rev. lower than expected - poor credit control leading to bad debts - poor cost control, high costs of production - poor inventory control, overstocking - seasonal - unexpected events

Question 38

What are some strategies to reduce cash outflows?

Answer 38

- Negotiate with creditors and suppliers - Pay with trade credit rather than cash - Opt for leasing instead of purchasing some assets - Reducing stock levels to reduce cash outflows needed for purchasing stocks (especially for long working capital cycles)

Question 39

What is the effect of shortening the working capital cycle?

Answer 39

improves cash flows

Question 40

What are strategies to increase cash inflows?

Answer 40

- Raising prices of products that have few substitutes or a high brand loyalty - Reduce prices of products that have a high degree of competition - Reducing the credit period - Encourage debtors to pay their invoices early by offering discounts - Improved marketing strategies - Debt factoring service

Question 41

What are strategies to seek additional sources of finance due to cash flow problems?

Answer 41

- overdrafts or loans - sponsorships, donations, financial gifts - selling shares - sell fixed assets