Improvements P2 May 2019 Flashcards
(22 cards)
Liquidity
The cash and other current assets businesses have available to quickly pay bills and meet short-term business/financial obligations.
2 ways to measure liquidity?
Current ratio
Acid test ratio
Current ratio
The “quicker”, slightly less precise, way to measure liquidity. It is an effective liquidity measure for businesses that hold little stock.
Current Assets / Current Liabilities
The result ratio (e.g. 2.1) means that for every $1 of current liabilities, the business has $2.10 in current assets (which includes stock) to cover those liabilities.
Acid Test Ratio
It is a precise way to measure liquidity by deducting the least liquid form of current assets (inventory) since it takes some time to sell to provide a realistic reflection of a business’s liquidity.
Current assets - stock / Current Liabilities
so in a acid test ratio of 2.1, that means that for every 1 usd of short-term debt, the business has 2.1 usd in current assets (not including inventory) that it can sell to cover those debts
3 methods to improve liquidity/financial position (and one potential disadvantage)
- Reduce the credit period offered to customers. This means that owed money from customers will be collected more quickly, increasing the amount of current assets in the business. However, customers may move to competing businesses that offer better credit terms.
- Increase creditor days by asking suppliers for an extended repayment period meaning the business has more current assets in the business, and can use this cash, that it would have otherwise paid to suppliers, for other purposes. However, this may harm supplier relations and the supplier may be unwilling to extend credit terms.
- Make use of an overdraft, which means the business can spend more money than it has in its bank account, however its current liabilities will increase and banks may be reluctant to lend to businesses with cash-flow problems.
Stock turnover days, apply to CM whose stock turnover days went from 20 days to 40 days in a year in terms of liquidity.
measures how long, on average, it takes a business to sell its inventory.
CM takes 20 days longer to sell inventory compared to last year. This is not beneficial for liquidity as, especially perishable organic meals, are very prone to spoilage which means inefficient inventory management (and a worse current ratio so worsened liquidity), and tying up cash. It also suggests lower demand.
Decision Tree, what it is, how to draw
🔷 Square = Decision Node
Label with a letter (e.g. A).
Represents the decision being made (e.g. launch product, expand market).
Draw branches from the square to your chance nodes (circles) for each option.
🔘 Circle = Chance Node
Label each with a letter (e.g. B, C).
Each chance node is linked to an option.
Represents uncertainty about what might happen (e.g. success or failure).
🔁 Between Decision and Chance Node:
Draw a line from the square to each chance node.
Below this line, write the initial cost of that option (e.g. investment cost).
This is the amount you’ll subtract later when calculating net expected value.
✅ From Each Chance Node:
Draw 2 lines from each circle:
One for success
One for failure
Label above each line: Success / Failure
Write the probability under each line (e.g. 0.65 and 0.35 — must add to 1)
At the end of each line, write the outcome (expected revenue).
💰 Expected Value Calculation:
At the end of each chance node branch, calculate:
𝐸𝑉 = (Success/Failure Revenue × Probability)
🔻 Net Expected Value (Final Step):
For each option, calculate:
NetEV =
Success ExpectedValue + Failure expected value − InitialCost
This Net EV is what you compare between options.
Circle or tick the higher Net EV option to show the best decision.
2 Limitations of using Decision Trees
- Constructing decision trees that can actually support effective decision-making requires skill and expertise to avoid bias. Similarly, it also takes significant amounts of time to gather accurate data
- A decision tree is constructed using estimates which rarely take into full account of external factors and cannot predict all potential events (e.g. economy worsening)
(a) Define the term corporate social responsibility (CSR). [2]
CSR is the effort a business takes to take responsibility of their business activity by considering the interests of and impact on a wide range of stakeholders in society. It does this by forming ethical objectives which it integrates into its decision making that goes beyond solely making a profit.
Horizontal Integration and 2 pros
A merge/acquisition of a firm at the same stage of the production process
pros:
- Rapid increase of market share
- Reductions in the cost per unit due to economies of scale
Horizontal integration 2 cons
- A potential culture clash between the 2 businesses that have merged
- Diseconomies of scale may arise as costs may unnecessarily increase (e.g. duplication of management roles)
Vertical integration and 2 pros
A merge/acquisition of a firm at a different stage of production in the supply chain
pros:
- Lowers costs making the firm more competitive
- Greater control over the supply chain which reduces risk as that means access to raw materials is more certain
What is a reason, regarding resources, for why a small company merging with a big company is good?
The small company will have access to larger and more effective resources (e.g. a bigger, more advanced IT department)
Rationalization of resources (in a merger)
This is streamlining combined resources (e.g. departments) from the 2 firms merging to achieve economies of scale.
What is a reason, regarding culture, for why a small company merging with a big company is bad?
If a small company merges with a big company, there is the risk that the small company’s culture becomes cannibalized as a result of adjusting to the big company’s culture.
Vertical integration 2 cons
- Diseconomies of scale may arise as costs may unnecessarily increase (e.g. duplication of management roles)
- A potential culture clash between the 2 businesses that have merged
Capacity
The capacity of a business is a measure of how much output it can achieve in a given period.
Capacity is a ________ concept, and briefly outline
dynamic
Capacity can change (e.g. machine under maintenance decreases capacity)
Capacity must take into account of seasonal or unexpected changes in demand (e.g. ice cream factors need to quickly increase capacity during warm temperature)
Capacity utilization and formula
The percentage of a business’ capacity that is actually being used over a specific period
(Actual level of output / Maximum level of output) * 100
2 reasons why capacity utilization matters
It is a useful measure of productive efficiency as it measures whether there are unused resources in the business.
Business can look at capacity utilization to understand if there can be higher utilization, which reduced cost per unit and ultimately, makes the business more competitive.
2 cons of operating at low capacity utilization
- Higher cost per unit (negatively impacts competitiveness)
- Capital tied up in under-utilized assets
2 cons of operating at high capacity utilization
- Employees have increased workload and stress which leads to demotivation and less productivity if sustained for too long
- Machinery is more likely to break down, stopping production
