Fundamentals of business economics Flashcards

Question

What are the main 7 Not-for-profit organisation (NFPs/NPOs) types?

Answer 1

* museums * World Bank Group * Schools * government funded hospitals (e.g. NHS hospitals) * charities (e.g. Oxfam, Red Cross, Red Crescent, Caritas) * clubs * councils

Answer 2

They must stay within their budget to survive but that may conflict with its objectives.

Answer 3

Voluntary not-for-profit associations formed for the purpose of raising funds by subscriptions/deposits of members, out of which common services can be provided to those members.

Answer 4

* building societies * co-operatives * credit unions * trade unions and * some social clubs.

Answer 5

Mutual building societies exist for the benefit of their members. This is reflected in setting: * interest rates for borrowers as low as possible * interest rates for savers as high as possible. The aim is not to make a profit so the borrowing and saving rates are moved as close as possible to each other with a small margin sufficient to cover costs. Once it becomes a bank the building society must then seek to maximise shareholder wealth and become profit seeking. This is done by increasing borrowing rates and reducing saving rates. Members will thus find that the terms offered by the building society become less attractive. However, when demutualising most building societies give their members windfalls of shares so members become shareholders, thus benefiting from dividends and share price increases.

Answer 6

* Public sector organisations * Private sector organisations

Answer 7

The public sector is that part of the economy that is concerned with providing basic government services and is thus controlled by government organisations.

Answer 8

* police * military * public roads * public transit * primary education and * healthcare.

Answer 9

The private sector, comprising non-government organisations, is that part of a nation’s economy that is not controlled by the government.

Answer 10

Ccharities, clubs and community groups, can be classified as being in the ‘third sector’. Organisations in this sector are set up to make a difference to society while still belonging to the private sector.

Answer 11

A company is an organisation where the owners (shareholders) have a limited liability in relation to debts of the company.

Answer 12

Through the process of incorporation, with the company becoming a legal entity in itself, separate from its owners. This distinguishes it from sole traders and simple partnerships, where the owners and the organisation are considered the same from a legal standpoint.

Answer 13

They buy shares in the company, gaining ownership of the company proportional to their shareholding. The liability of the shareholders in relation to the company is limited to what they have already invested. They cannot be held personally responsible for the company’s debts.

Answer 14

Private (the shares cannot be traded on a stock market) Public (shares are traded on a stock market)

Answer 15

An autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly owned and democratically controlled enterprise.

Answer 16

* They are owned and democratically controlled by their members – the people who buy their goods or use their services. They are not owned by investors. * Co-operatives are organised solely to meet the needs of the member-owners, not to accumulate capital for investors.

Answer 17

Co-operatives are similar to mutual organisations in the sense that the organisations are also owned by the members/clients that they exist for. However, they tend to deal primarily in tangible goods and services such as agricultural commodities or utilities rather than intangible products such as financial services. However, such co-operatives as the Co-Op in the UK have diversified into insurance and legal services.

Answer 18

Mutual organisations that offer financial services similar to banks. Many demutualised in the 1980s and 1990s to become plcs. For instance, Abbey National converted to a plc, Abbey, and then was taken over and incorporated into Santander.

Answer 19

Member-owned financial cooperatives, which offer finance to their members at competitive rates. Members tend to have a ‘common bond’, such as living in the same area or working in the same industry.

Answer 20

B Charities, unlike companies, do not have shareholders. Charities could not operate without the work of employees and volunteers, or without donations from their donors, so these are both important stakeholder groups. The objective of a charity is to provide help or support for its beneficiaries. So beneficiaries are also an important stakeholder group

Answer 21

D While protecting the environment is to be encouraged and is reinforced within statute to some degree, it is not a primary objective of the company. Companies exist primarily to maximise the return to their owners.

Answer 22

False. Schools run fund-raising activities to help pay for extra books, e.g. to improve the quality of education given to pupils. The primary objective is educational, not profit. The money made at the fête is thus a means not an end.

Answer 23

* higher share prices * higher dividend payments

Answer 24

Notional; and it can only be crystalised if the shares are sold at that price.

Answer 25

The consistent rise of the company's share price over time.

Answer 26

Distributions of the profit of the company. Company profits can be reinvested to help the company grow or paid out to the shareholders as a reward for share ownership.

Answer 27

Managers will aim to have a policy that allows for growth of the company whilst managing shareholder expectations of income.

Answer 28

* Cash is preferable to profit. * Exceeding the cost of capital * Managing both long- and short-term perspectives

Answer 29

Cash flows have a higher correlation with shareholder wealth than profits.

Answer 30

The cost of capital represents the cost to the company of providing appropriate returns to the investors. For instance if an equity shareholder requires a 15% return in order to be encouraged to buy shares, the company therefore has a 15% cost of securing equity finance and providing that return (in the form of dividends and growth in share price). Profits should exceed this cost.

Answer 31

Investors are increasingly looking at long-term value. When valuing a company’s shares, the stock market places a value on the company’s future potential, not only its current profit levels.

Answer 32

Sales minus expenses. Cash receipts minus cash payments.

Answer 33

For instance, if sales of $1,000 are made on credit and only 75% of these have been paid so far then the cash flow in relation to the sales is only $750. Cash is more important to investors than profits. Their returns are received either in the form of dividends (cash received by the investor from a distribution made by the company) or in the form of a capital gain from a rise in share price (and therefore the potential to earn more cash from sale of the shares). Share prices themselves are determined by investors’ perceptions of how well the company will generate cash in the future.

Answer 34

Operating profit or net profit.

Answer 35

They are distributions of profit rather than a deduction from them. "Retained earnings" are left after this distribution.

Answer 36

Since "preference share dividends" are rare the two will often be the same amount.

Answer 37

* Return on capital employed (ROCE) * Earnings per share (EPS)

Answer 38

The funds that have been invested into the business by shareholders and lenders.

Answer 39

An indication as to how well a business uses its capital (or the assets purchased with the capital) to generate profits.

Answer 40

It produces a percentage.

Answer 41

They are very similar as net asset values are often used as an approximation to the capital figure.

Answer 42

The higher the figure is, the more profitable the company is.

Answer 43

It only gives the earnings per share that each owner of ordinary shares might expect to receive. It is up to the Directors (who manage the company) to decide whether/how much to pay out as a dividend.

Answer 44

They do not correlate directly to the goal of maximising shareholder wealth.

Answer 45

* establishing the cost of capital to finance the investment project * estimating the flow of income derived from the capital investment over the whole life of the investment * valuing that flow of income. To solve these problems we calculate the present value of future cash flows by a process of discounting.

Answer 46

The sum of the discounted future cash flows minus the capital cost of the project.

Answer 47

* Any information that reaches the market that suggests that future cash flows will be higher than previously forecast should result in a share price rise. * If bad news reaches the market then as well as revising forecast cash flows downwards, investors may reassess the investment as having higher risk. This will result in a higher cost of capital and thus future receipts will be less valuable than previously estimated. The result is a fall in the share price.

Answer 48

* Factors external to the business which may affect a wide range of shares: the onset of a recession would tend to depress share values in general, as would a rise in interest rates. * actors internal to the business that might affect the future flow of profits such as the failure of a new product, an expected decline in sales or a significant rise in costs.

Answer 49

* Future cash flows Assuming the markets believe, and have confidence in, the directors' claims, then they should revise their estimates of the company's future cash flows upwards. * Cost of capital/discount rate The new venture is likely to be seen as increasing the company's risk and hence investors will want a higher return to compensate. This will be reflected in a higher discount rate being used to discount the (revised) future cash flows. * Share price The impact on the share price will depend on the net effect of the above factors. If the shareholders are optimistic about the future growth plans without being overly concerned about the extra risk, then the share price should increase. A fall in share price would indicate more serious concerns over the risks and/or a lack of belief that the high growth in cash flows will materialise.

Answer 50

Those persons and organisations that have an interest in the strategy of an organisation. These are usually customers, shareholders, staff and the local community.

Answer 51

An interest or concern that a stakeholder has in an organisation's actions, objectives or policies.

Answer 52

The level of involvement that a stakeholder has in the functions of an organisation and the ability to bring about a desired change.

Answer 53

Internal (e.g. employees), connected (e.g. shareholders) and external (e.g. government).

Answer 54

Solving such conflicts will often involve a mixture of compromise and prioritisation.

Answer 55

Unlike firms, NFPs (not-for-profit organisations) may not have one dominant stakeholder group. Consequently, the NFP seeks to satisfy several different groups at once, without having the touchstone of one primary objective, such as profit, to adhere to. For example, a council may express its mission as ‘caring for the community’. Suppose it is considering building a new car park in the city centre where there is currently a small green park. This would affect the community as follows: * Local businesses would see more trade. * More jobs would be created for local residents. Better parking for shoppers. * More traffic, congestion and pollution for local residents. * Loss of a park, thus reducing the quality of life for locals. * The receipts from the car park could be used to reduce council tax bills and/or fund additional services for the community. This type of decision is particularly difficult as: * How do you decide which stakeholder group should take preference? * Most of the factors being considered are very difficult to quantify (e.g. quality of life) and * How do you offset different issues measured in different ways (e.g. how many extra jobs justify the extra congestion and pollution?) Some public sector organisations try to quantify all of the issues financially to see if the benefits outweigh the costs (‘cost-benefit analysis’). For example, congestion will delay people, thus adding to journey times. The value of people’s time can be estimated by looking at the premium they will pay for quicker methods of transport such as train versus coach.

Answer 56

The legal owners of the organisation – the shareholders.

Answer 57

Those appointed by the principals to act on their behalf such as the board of directors and senior managers in a company.

Answer 58

How can the principal ensure that the agent will behave in such a way as to achieve the aims and intentions of the principal?

Answer 59

* Management will have to balance the interests of different stakeholders in the company. Since these stakeholders have a variety of objectives, profit is unlikely to be the sole aim of management. * Management may have objectives of its own. These may include salaries, non-salary benefits (‘perks’), power, status and prestige, safety and security and a ‘quiet life’. The problem with these is that they may conflict with the objectives of profitability. For example, many of the management’s objectives, such as salary, power and prestige, may be related more strongly to the size of the company (sales, market share, number of employees) than to the underlying profitability of the company (return on capital employed). * Focus on short-term objectives at the expense of long-term ones: Common short term objectives include – sales maximization – this is often simpler than profitmaximisation as it excludes costs. Focusing on sales may mean sacrificing profitability, e.g. offering discounts to generate more sales. Proponents would argue that highersales usually results in greater profit – growth maximisation – in the longer term a larger company is likely to be more profitable due to increased revenue and cost economies of scale. But if growth is at the expense of profitability, shareholder wealth can suffer – "satisfying" – for example trying to achieve sales growth subject to a minimum increase in profit of 5%. Such targets are often seen as more practical than "maximise profits", which is seen as unachievable. Managers may want to do ‘just enough’ to achieve their targets (and perhaps their bonuses) in a particular year, rather than strive for maximising shareholder wealth, so that next year’s targets will also be achievable.

Answer 60

* ‘Fat cat’ salaries and benefits * Mergers and acquisitions - research suggests that the majority of acquisitions erode shareholder value rather than create it. * Poor control of the business * Short-termism

Answer 61

* Corporate governance (see below) tries to improve ways companies are run through a mixture of principles and regulation. * A review of the remuneration and bonus schemes given to directors; Offers of shares to managers.

Answer 62

To resolve the principal-agent problem. The system used to direct, manage and monitor an organisation and enable it to relate to its external environment. * to control the managers/directors by increasing the amount of reporting and disclosure * to increase level of confidence and transparency in company activities for all investors (existing and potential) and thus promote growth in the company * to increase disclosure to all stakeholders * to ensure that the company is run in a legal and ethical manner * to build in control at the top that will ‘cascade’ down the organisation.

Answer 63

* the board of directors should meet on a regular basis and that active responsibilities at board level should be spread over the board and not concentrated in a few hands; in particular, the roles of chairperson and chief executive should be kept separate * directors should have limited contracts (e.g. 3 years) and all director reward and payments should be publicly disclosed * there should be three sub-committees of the board: an auditcommittee, a nominations (to the board) committee and aremunerations (of board members) committee * greater use should be made of non-executive directors with no direct financial interest in the company in order to provide some independence within the board, especially on the board’s sub committees * the annual accounts should contain a statement, approved by the auditors, that the business is financially sound and is a going concern * the annual accounts should contain a statement, approved by the auditors, that the business is financially sound and is a going concern.

Answer 64

C While governance would ensure compliance with relevant legislation concerning employee working conditions, the primary focus is not employees per se.

Answer 65

A "best practices" model in corporate governance.

Answer 66

* separation of powers especially in relation to roles of the chairman and the chief executive * board membership to include an appropriate balance especially in relation to executive and non-executive directors * the adoption of the principles of transparency, openness and fairness * to adopt an approach which reflects the interests of all stakeholders * to ensure that the board of directors are fully accountable * detailed disclosure and reporting requirements * remuneration committees to determine the pay of directors * nomination committees to oversee appointments to the board * arrangements for organising the Annual General Meeting (AGM).

Answer 67

There may be a divorce of ownership from control because: – companies may become too big for shareholders to effectively control – companies may become too complex for shareholders to control – individual shareholders may lack the power, knowledge, interest or time to control the companies they own.

Answer 68

The term corporate governance refers to the systems by which companies and other organisations are directed and controlled. For public companies this means the role of the Board of Directors and its relationship to the shareholders.

Answer 69

QUasi Autonomous NGO. A semi-public administrative body outside the civil service but receiving financial support from the government, which makes senior appointments to it. (derogatory)

Answer 70

Not-for-profit organisations include state-owned (public sector) activities, mutual societies, charities, private clubs, QUANGOs and voluntary organisations.

Answer 71

In-house or outsourcing.

Answer 72

Transaction costs will occur when dealing with an external party. * Search and information costs – to find the supplier * Bargaining and decision costs – to determine contractual obligations * Policing and enforcement costs – to monitor quality

Answer 73

It is in the interests of management to internalise transactions as much as possible, to remove the costs and the resulting risks and uncertainties about prices and quality that comes with outsourcing (transaction costs).

Answer 74

* Frequency: how often such a transaction is made. The more frequent, the higher the bargaining and decision costs. * Uncertainty: long-term relationships are more uncertain (due to, for example, changes in the economic environment), lack of trust leads to uncertainty. A higher degree of uncertainty means more needs to be spent on transaction costs to ensure that the supplier will be trustworthy and able to fulfil its contracted obligations. * Asset specificity: how unique the component is for the business needs. Unique products / services will lead to a greater ‘tie-in’ between the outsourcer and the supplier. The outsourcer becomes more reliant on the supplier and will spend more on transaction costs to ensure that they are the right supplier for the work.

Answer 75

Small businesses in particular may choose to outsource despite high transaction costs, because they may not have the expertise to perform functions in-house, or because the work is intermittent and does not need a full time member of staff dedicated to it.

Answer 76

Comparing production costs with transaction costs. The lower the production costs, the less likely outsourcing will be.

Answer 77

A shared service centre (SSC) is a business unit that performs business functions on behalf of the other business units. The staff in the SSC are able to consolidate work from across the business in order to perform it more efficiently and at cheaper cost. Because their work is effectively independent from the business’s operations, SSC’s are often outsourced to specialist firms. There will be significant transaction costs in relation to SSCs as the business will be entirely reliant on the services provided by the SSC and must ensure that the right supplier is chosen. The business will monitor the SSC regularly to ensure compliance with service level agreements. If these costs rise, the business may consider insourcing the function.

Answer 78

A network organisation, rather than having departments that all report up to board level, has autonomous units that co-ordinate with each other. These units can be departments, divisions or even separate companies. In this kind of organisation, outsourcing is common due to the separable nature of each unit.

Answer 79

Flexible staffing is a convenient way for employers to fill staff vacancies and can involve taking on contracted staff rather than permanent employees. The roles are effectively outsourced. If the costs of outsourcing increase, the employer may consider a move back to permanent staff. Examples: Uber Eats or Deliveroo.

Answer 80

* What goods and services should be produced? * In what quantities? * Who should make them? * Who gets the output?

Answer 81

* A market economy * A command economy * A mixed economy

Answer 82

Interaction between supply and demand (market forces) determines what is made, in what quantity and who gets the output. Patterns of economic activity are determined by the decisions made by individual consumers and producers.

Answer 83

Production decisions are controlled by the government.

Answer 84

In reality most modern economies are a mix of free markets and government intervention.

Answer 85

The independent variable goes in the y-axis.

Answer 86

Individual demand curve It presuposes that ceteris paribus and that the individual actually has available money to spend in the market and is willing to do it.

Answer 87

Is the total amount of effective demand from all the consumers in a market, aggregated together. Market demand is usually shortened to demand and represented by a straight-line curve on a graph. The demand curve for most normal goods is negatively inclined sloping downwards from left to right.

Answer 88

That the price is constant.

Answer 89

It is important to distinguish between: * increases and decreases in demand that result from a shift in the demand curve as a whole * expansions and contractions in demand that result from price changes leading to movements along the demand curve itself.

Answer 90

* income * tastes * the price of goods * population

Answer 91

Changes in income often affect demand. For example, lower direct taxes would raise disposable incomes and, other things being equal, make consumers better off and so they spend more on discretionary expenditure. For normal goods, an increase in income leads to an increase in demand. Examples could include cars, jewellery, fashion clothing and music streaming services. For inferior goods, however, a rise in income leads to a lower demand for the product as consumers, now being richer, substitute better quality and preferred goods and services for the original (‘inferior’) good or service. An example of this is public transport. Here, as incomes rise, the demand for public transport falls as consumers substitute more expensive, private transport such as cars.

Answer 92

Tastes, in particular fashions, change frequently and it may make the demand for certain goods volatile. A good example of this was the rapid rise in demand for fidget spinners seen in 2017 followed by a decline as people’s attention moved elsewhere. Tastes, of course, can be manipulated by advertising and producers to try to ‘create’ markets, particularly for ostentatious goods, for example, air purifiers, which our ancestors survived perfectly well without. Some goods are in seasonal demand (e.g. cooked meat) even though they are available all year round, because tastes change (e.g. more salads are consumed in the summer).

Answer 93

Goods may be unrelated, or they may be complements or substitutes. The former have no effect (a price change in one doesn’t affect demand for the other), but the latter two are significant. If goods are in joint demand (i.e. complements such as burgers and burger buns), a change in the price of one will also affect the other. Therefore, if the price of burgers falls, there is likely to be an increase in demand for burger buns. Where goods are substitutes (e.g. Coke and Pepsi, or McDonald's and Burger King), a rise in the price of one will cause an increase in demand for the other (and thus the demand curve for the other will shift to the right). Sometimes, technological breakthroughs mean that new products come into the market. For instance, the introduction of affordable streaming services for music and films has reduced the demand for CDs and DVDs (the latter leading to the closure of the Blockbuster chain).

Answer 94

An increase in population creates a larger market for most goods, thereby shifting demand outwards. For instance, an influx of seasonal workers from other countries will raise the demand for most essential goods during the season in which they are working. Changes in population distribution will also affect demand patterns. If the proportion of old people relative to young people increases, then the demand for products such as false teeth, wheelchairs and old people’s homes will increase relative to that of gripe water, nappies and cots.

Answer 95

C When drawing a demand curve only the price is allowed to vary but all conditions of demand are kept constant.

Answer 96

D A larger population would presumably want more supplements, especially if they are older and more health conscious. A and B would shift the curve to the left. C would result in movement along the curve but not a shift in the curve itself.

Answer 97

D Correct answer is D since a change in exchange rates effectively changes the price of foreign holidays and leads to a movement along the demand curve, not a shift in the curve itself.

Answer 98

Elasticity, generally, refers to the relationship between two variables and measures the responsiveness of one (dependent) variable to a change in another (independent) variable: There are several types of elasticity that are useful to economists and accountants. Management accountants are particularly interested in knowing price elasticity of demand as this can give a good indication of the optimal price for a good or service.

Answer 99

A concept that explains the responsiveness of demand to changes in price.

Answer 100

The formula can be applied either at one point on the demand curve or over part (arc) of it. It is critical that percentage or proportional changes are used rather than absolute ones.

Answer 101

It shows unit elasticity (% change in demand = % change in price).

Answer 102

It shows inelastic demand (% change in demand smaller than % change in price).

Answer 103

It shows elastic demand (% change in demand larger than % change in price).

Answer 104

The value of PED will change.

Answer 105

A normal one will always slope downwards from left to right.

Answer 106

Which part of the demanad curve is selected is also important

Fundamentals of business economics Flashcards

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