Topic 5 - Decision Making To Improve Financial Performance

Question 1

What does financial performance get compared against ?

Answer 1

Business objectives

Question 2

What are the benefits of financial objectives ?

Answer 2

Financial objectives provide direction and can be used to measure financial performance.

Financial objectives can be used to support decision making throughout the business.

Financial objectives can be used to motivate employees and teams of employees.

Question 3

How can return on investment be measured ?

Answer 3

(profit from investment) ÷ investment cost) × 100

Question 4

What does return on investment allow business to calculate ?

Answer 4

calculate the efficiency of a project by comparing the amount invested with the amount returned

Question 5

What is long term funding ?

Answer 5

A business may use long-term funding targets as a financial objective. A business may set an objective of ensuring that no more than 25% of its long-term funding comes from debt.

Setting targets to reduce long-term funding from debt can protect a business if there is an increase in interest rates.

Question 6

A business invests in a project. It costs £1 million. The revenue generated by the investment is £2.5 million. What is the return on investment?

Answer 6

150%

Question 7

What are examples of financial objectives ?

Answer 7

Revenue - quantity of goods sold x selling price per item
Costs - Total cost is calculated by adding together fixed costs and variable costs
Cash flow - Cash flow compares cash inflows and cash outflows to ensure a business always has enough cash to meet its short-term debts
Investment - Investment objectives cover the total expenditure planned by a business to develop capital projects
Capital structure - Capital structure targets focus on the proportion of capital received from different sources of finance

Question 8

A company has a revenue of £75,000,000. It sells 50,000,000 units. What is the sale price per unit?

Answer 8

£1.50

Question 9

What are some influences on financial objectives ?

Answer 9

Overall business objectives
Different departments
Shareholders
Competitors

Question 10

How do overall business objectives influence financial objectives?

Answer 10

Financial objectives must support the overall aim of the business
If the business’ strategy is to maximise revenue, then financial objectives to maximise profits may not line up incentives well. Amazon could be an example of someone who chooses to maximise revenue.

Question 11

How do different objectives of departments influence financial objectives ?

Answer 11

The objectives of other departments must be considered when setting finance objectives as all departments must be working towards the same overall aim.

Question 12

How do shareholders influence financial objectives?

Answer 12

shareholders need to be satisfied.

For example, Tesco considers the views of its shareholders when deciding on objectives as the influence of shareholders and their desire to receive dividends may affect investment objectives.

Question 13

How does the presence of competitors influence financial objectives?

Answer 13

competitors can affect demand and therefore revenue

Question 14

Who, primarily, needs to be satisfied by the objectives of the financial department?

Answer 14

Shareholders

Question 15

What does a businesses cash flow forecast ?

Answer 15

estimates their total cash inflows and their total cash outflows for a future period of time

Question 16

In a cash flow what do total inflows include ?

Answer 16

all cash inflows coming into the business during the period

Question 17

In cash flow what does total outflows include ?

Answer 17

all cash outflow leaving the business during the period

Question 18

In cash flows what is net cash flows ?

Answer 18

Net cash flow is the difference between total inflows and total outflows

Question 19

In cash flows what is opening balance ?

Answer 19

The opening balance is the balance at the start of the month and is the same as the closing balance of the previous month.

Question 20

How can businesses that are profitable become bankrupt ?

Answer 20

Business that have cash-flow or liquidity problems can become bankrupt as they lack short-term cash to pay short-term debts.

Question 21

What are money owed to businesses known as ?

Answer 21

Receivables

Question 22

Money owed to the business is known as a receivable and businesses can reduce the trade credit period given to do what to their receivables ?

Answer 22

to increase how quickly they receive their receivables, which improves cash-flow

Question 23

Money owed by the business to others is know as what ?

Answer 23

debtor

Question 24

How can business reduce how quickly they have to pay their payables ?

Answer 24

ask others for longer trade credit to reduce how quickly they must pay payables, which improves cash-flow.

Question 25

Businesses can use what to forecast revenue, expenditure, and profit during a period ?

Answer 25

Budgets

Question 26

If actual revenue is higher than the forecast, what do we call this ?

Answer 26

‘favourable variance’

Question 27

If revenue is less than expected, what do we call this ?

Answer 27

‘adverse variance’

Question 28

A higher actual cost than forecast is what ?

Answer 28

An adverse variance

Question 29

A lower actual cost than forecast is a what ?

Answer 29

A favourable variance

Question 30

How are profit budgets made ?

Answer 30

Revenue and expenditure put together

Question 31

If overall profit is higher than forecast, there is a what ?

Answer 31

a favourable variance

Question 32

If overall profit is lower than forecast, there is a what ?

Answer 32

an adverse variance

Question 33

What are the advantages of budgeting?

Answer 33

Budgets help businesses achieve targets and objectives.
Budgets help managers and leaders focus on cost control which can increase profit.
Budgets can be used to motivate staff by providing spending authority to individual departments and teams.
For example, many hospitals assign budgets to individual departments and this motivates department managers and staff within departments as they are given authority to place orders

Question 34

What is used to predict the level of output at which total costs and total revenues will be the same ?

Answer 34

Break even analysis

Question 35

What is contribution per unit ?

Answer 35

the amount of revenue which contributes to covering a business’ fixed costs after the variable cost per unit has been taken away from revenue per unit

Question 36

How do you calculate contribution per unit ?

Answer 36

selling price per unit – variable costs per unit

Question 37

What is total contribution?

Answer 37

the amount of revenue from the sale of all products which contributes to fixed costs once total variable costs have been taken away

Question 38

How is total contribution calculated ?

Answer 38

total revenue – total variable costs

Question 39

How can businesses analyse their profitability ?

Answer 39

By using gross profit, operating profit, and profit for the year objectives

Question 40

What is gross profit ?

Answer 40

the amount of profit remaining once direct costs (cost of sales) have been paid by the business

Question 41

How do you calculate gross profit margin ?

Answer 41

Gross profit margin = (gross profit ÷ sales revenue) × 100

For example, a supermarket may use gross profit margin targets to compare performance across years. A decrease in gross profit margins may lead the supermarket to focus on reducing the supermarket’s cost of sales

Question 42

What is operating profit ?

Answer 42

the amount of profit remaining once direct costs (cost of sales) and indirect costs (expenses) have been paid by the business

Question 43

How do you calculate operating profit margin ?

Answer 43

Operating profit margin = (operating profit ÷ sales revenue) × 100

Question 44

What is profit for the year ?

Answer 44

the amount of profit remaining once all costs and financing fees have been considered.

Question 45

What is profit for the year margin ?

Answer 45

Profit for the year margin = (profit for the year ÷ sales revenue) × 100

Question 46

A business’ revenue is £4.5 milllion. Its indirect costs are £0.75 million. What is the business’ operating profit?

Answer 46

£3.75 million

Question 47

A business’ profit for the year is £40 million. The business’ sales revenue is £95 million. What is the profit margin?

Answer 47

42.11%

Question 48

What are internal sources of finance ?

Answer 48

the money that is created or raised within a business

Question 49

What are examples of internal sources of finance ?

Answer 49

Selling assets
Personal savings
Retained profit

Question 50

How does selling assets raise (internal) finance ?

Answer 50

A business can sell its assets to raise cash. For example, a business can sell buildings or machinery that they do not use.
They are usually a cheap source of finance because the business does not have to pay interest.
However, selling assets can harm a business’ operations.

Question 51

How does personal savings raise (internal) finance ?

Answer 51

This is personal money that is invested by the owner of a business.
It is most relevant for start-up businesses, in which the entrepreneur has saved up to fund his/her business venture.
A downside is that it can be very risky for an entrepreneur to put a significant amount of their personal savings into a business. They may not be able to afford this.

Question 52

How does retained profit raise (internal) finance ?

Answer 52

This is the profit that the business has effectively saved whilst it has been operating (running).
Retained profit is a cheap source of finance because a business does not have to pay any interest.
Retained profit is limited. A business can only spend profits that have been saved.
Retained profit may not be high enough to fund big, long-term projects

Question 53

What are external sources of finance?

Answer 53

finance (money) from a third party

Question 54

What is external finance used to fund ?

Answer 54

fund large, long-term investments

Question 55

What’s the issue with external finance ?

Answer 55

external finance can be more costly, because loans usually charge interest (which isn’t paid if a company funds growth with retained earnings)

Question 56

What are some sources of external finance ?

Answer 56

Government grants
Trade credit
Bank loans or mortgages
Loans from family and friends
Hire purchases
Share capital
Venture capital
Overdraft
Debt factoring

Question 57

What are government grants as a source of (external) finance ?

Answer 57

A government may give grants (money) to businesses to research things that the government is interested in.
The Horizon 2020 fund is a set of grants given out by the countries in the European Union.

Question 58

What is trade credit as a source of (external) finance ?

Answer 58

Trade credit describes when businesses pay suppliers at a later date. It involves buying something now and paying for it later.
Supermarkets use trade credit and trade creditors a lot, taking delivery of food and then paying the suppliers at a later date.

Question 59

What are bank loans and mortgages as a source of (external) finance ?

Answer 59

Bank loans and mortgages are very important for many businesses. A business borrows money from a bank and then pays interest on the money borrowed.
It is often harder for new businesses to get bank loans because banks see them as riskier.

Question 60

What are family and friends as a source of (external) finance ?

Answer 60

Start-ups often use loans from family and friends. This is usually because the entrepreneur doesn’t have enough personal savings to finance the investment.
If the entrepreneur gives up equity (a share of the business) then this is not a loan.

Question 61

What are hire purchases as a form of (external) finance ?

Answer 61

This is when a business buys something and instead of paying for it upfront pays for it in installments.
When PSG bought Kylian Mbappe from Monaco, they didn’t pay the whole amount at the time and instead completed the purchase in different stages.
This lets businesses buy things (like machinery) for the business that they otherwise wouldn’t be able to afford.

Question 62

What is share capital as a source of (external) finance ?

Answer 62

A business can sell share capital (some of its shares) to other people or businesses. They give away a percentage of the business in return for getting finance invested in the business.

This is usually what happens on Dragon’s Den on the BBC. Public limited companies may do new share issues, creating shares and issuing them to investors through a stock market.

Private limited companies can sell share capital (shares) to family, friends or even a private equity company.

Question 63

When a business sells shares for a % of the business, which external method of finance is this business using?

Answer 63

Share capital

Question 64

What is venture capital as a source of (external) finance ?

Answer 64

Venture capital involves investors, or venture capitalists, providing a business with loans and share capital which is usually to support business growth.

Venture capitalists will often ask for some control of the business they are investing in and this can be through the issue of shares or through the appointment of venture capitalists as non-executive directors of the business.

Question 65

What is an overdraft as a source of (external) finance ?

Answer 65

An overdraft is a service offered by banks allowing businesses to borrow an amount of money up to a limit which has been agreed in advance.

Overdrafts are flexible as they allow a business to borrow as much as it wishes provided that the amount stays within an agreed limit.

Businesses often pay for this flexibility through higher interest rates.

Question 66

What is debt factoring as a source of (external) finance ?

Answer 66

Debt factoring involves businesses selling their debt to a third party business.
The business selling its debt will gain cash immediately rather than wait for debts to be settled although the business will sell its debt for less than its original value.
The third party that buys this debt will then arrange and organise invoices and ensure that the debt money is collected. The third party business will retain a fee to cover the costs of its debt collection service.

Question 67

What different factors affect what is the best source of financing for a business ?

Answer 67

Cost
Long-term vs short-term
Financial situation
New vs established business

Question 68

How can the costs affect what is the best source of financing for a business ?

Answer 68

External financing tends to be more expensive because a business normally has to pay interest on external financing

Question 69

How can long-term vs short-term affect what is the best source of financing for a business ?

Answer 69

The length of time that finance is needed for affects which type of finance is best.
Trade credits are an example of short-term finance. A supplier is likely to only give the business an extension of a few days or weeks.
Bank loans and mortgages are a long term source of finance and may only be paid back in full after 20 years.

Question 70

How can the businesses financial situation affect what is the best source of financing for a business ?

Answer 70

Whether a business is in a good financial situation can impact the availability and cost of finance.
A business that is struggling may not be able to get loans as it is much more likely that they won’t pay them back. Even if they are able to get loans, these loans will have much higher interest payments.
A business that is struggling is also less likely to be able to use internal sources of finance.

Question 71

How can how new a business is affect what is the best source of financing for a business ?

Answer 71

A business’ size and track record can affect the availability and cost of finance.
New businesses are likely to find it harder to get loans from a bank but can take advantage of hire purchases and trade credit.
Established businesses are also much more likely to be larger and therefore require larger investments.
External sources of finance are preferred when the size of the investment is large as internal sources of finance are often limited.

Question 72

If a business is viewed as less risky than it was, and it is getting new debt, what happens to the interest rate that a business pays on its debt?

Answer 72

It goes down

Question 73

How does diversification help business live through debt ?

Answer 73

Diversified businesses are more likely to operate in lots of markets. If one market or product goes wrong, the business is not likely to be insolvent or bankrupt. So diversified businesses may have a lower cost of debt.

Diversification can spread risk as it gives businesses an alternative if the demand for one product declines. An example of diversification is Uber ride-sharing & Uber Eats.

Question 74

What are businesses that are able to raise more debt, more likely to be able to do?

Answer 74

Expand into new geographic markets
Expand product portfolio

Question 75

If a business grows by launching its own products into new markets, what is this an example of ?

Answer 75

Organic growth

Question 76

What can be problem for a business diversifying their products and attempting to penetrate a new market ?

Answer 76

But diversified businesses are operating in more products, markets and countries. They need to be able to compete against businesses that focus on only 1 product and 1 country in every market. Does the lack of strategic focus harm their business or not, is the key question!

Question 77

How can business increase profits ?

Answer 77

Profit and profitability can be increased by reducing expenditure on fixed and variable costs.
Profit and profitability can be increased by increasing the selling price per item.
For example, in 2015, Morrisons delayered its structure by removing department supervisors which reduced costs to increase profitability

Question 78

What are the challenges of increasing profitability?

Answer 78

Trying to reduce expenditure on fixed and variable costs can reduce quality which may reduce sales and therefore also reduce revenue.

Increasing the selling price can deter customers from purchasing products which can decrease sales volume and market share.

Question 79

What are the challenges of improving cash flow ?

Answer 79

Removing or reducing trade credit periods for customers can reduce customer satisfaction which may reduce sales volume and market share.

Asking suppliers to increase trade credit periods can create tension between the business and its suppliers which may result in poorer relationships and reduced dependability.

For example, a sofa store wishing to improve its cash-flow may tell customers that they need to pay within 6 months instead of 12 months and this may reduce customer satisfaction leading to customers shopping elsewhere.

Question 80

How is increasing the selling price per item likely to affect profit per unit sold if the price elasticity of demand is -5?

Answer 80

Decreases

Question 81

Why are strong relationships with suppliers important ?

Answer 81

The Toyota Production System involves building strong relationships with suppliers. Large businesses like Toyota may not demand any trade credit in order to forge strong relationships and have a more efficient operational manufacturing system.