Unit 5- decision making to improve financial performance

Question 1

what is the value of setting financial objectives?

Answer 1

-they act as a measure of performance
-they provide targets which can be a focus for decision making
-potential investors or creditors may be able to assess the viability of the business

Question 2

what is cash flow?

Answer 2

the difference between the actual amount of money a business receives and the actual amount it pays out (inflows and outflows)

Question 3

what is profit?

Answer 3

the difference between all sales revenue (even if your payment has not yet been received) and expenditure

Question 4

why might a business have cash flow problems?

Answer 4

-holding large amounts of inventory
-having sales on long credit periods
-using cash to purchase fixed assets

Question 5

what is gross profit?

Answer 5

the difference between a sales revenue and the direct costs of production

Question 6

gross profit formula

Answer 6

sales revenue - direct costs of production (eg: materials and direct labour)

Question 7

what is operating profit?

Answer 7

the different between the gross profit and the indirect costs of production (eg: marketing and salaries)

Question 8

operating profit formulas

Answer 8

sales revenue - ALL costs of production
OR
gross profit - expenses

Question 9

profit for the year formula

Answer 9

operating profit + other income - other expenditure

Question 9

what are some cash flow objectives that a business might set?

Answer 9

-targets for monthly closing balances
-reduction of bank borrowings to a target level
-reduction of seasonability in sales
-targets for achieving payment from customers
-extension of the business’s credit period to pay suppliers

Question 10

what is capital expenditure and when will investment happen?

Answer 10

the money spent on fixed assets such as buildings and equipment and represents long-term investment into the business.
Investment will occur:
-when a business first sets up
-as a business grows and develops

Question 11

what will objectives for investment depend on?

Answer 11

-the overall corporate objectives. eg: growth
-the type of business
-the state of the economy
-the market in which the business is operating

Question 12

return on investment formula

Answer 12

profit from investment/ capital invested x100
(could be used when a business is deciding between 2 investments)
(this is only a forecast)

Question 13

what t¡meows the capital structure of a business refer to?

Answer 13

the long term finance of a business

Question 14

what is long term capital made out of?

Answer 14

equity (share capital) and borrowing (loan capital)

Question 15

what is equity and borrowing?

Answer 15

-equity: money that a business raises through the issue off shares
-borrowing: money that a business raises through loan capital

Question 16

gearing ratio formula

Answer 16

loan capital / total capital x100
Gearing refers to the relationship, or ratio, of a company’s debt-to-equity. Gearing shows the extent to which a firm’s operations are funded by lenders versus shareholders, it measures a company’s financial leverage

Question 17

total capital formula

Answer 17

loan capital + equity

Question 18

what are some external influences on financial objectives and decisions?

Answer 18

-competitor actions
-market forces
-economic factors
-political factors
-technology

Question 19

what are some internal influences on financial objectives and decisions?

Answer 19

-corporate objectives
-resources available
-operational factors

Question 20

what is a budget?

Answer 20

a budget is a financial plan. it provides a target for entrepreneurs and managers as well as a basis for a later assessment of the performance of the business

Question 21

what are income budgets?

Answer 21

forecasted earnings for sales and are sometimes called ‘sales budgets’

Question 22

what are expenditure budgets?

Answer 22

sets out the expected spending of a business.

Question 23

what arte profit and loss budgets?

Answer 23

they are calculated by subtracting forecast expenditure (or costs) from forecast sales income

Question 24

why do businesses set budgets?

Answer 24

-they are an essential element of a business plan -can help businesses decide whether or not to go ahead with a business idea -can help with pricing decisions

Question 24

what are the difficulties of setting budgets?

Answer 24

-there may be no historical evidence available to a business, no trading records on the level of sales income, costs or how these figures fluctuated throughout the year -forecasting costs, may lack the experience to estimate costs such as raw materials or wages. -competitors might react by cutting prices or promoting their products heavily

Question 25

what is variance analysis?

Answer 25

the study by managers of the differences between planned activities in the form of budgets and the actual results that were achieved

Question 25

when does a positive (-or favourable variance occur and when does a negative (or adverse) one occur?

Answer 25

-positive:when costs are lower than forecast or revenues higher -negative: when costs are higher than expected or revenues are lower than anticipated

Question 26

what are some possible responses to positive variance?

Answer 26

-increase ion production if prices are rising, giving increased profit margins -to reduce prices if costs are bellow expectations and the business aims to increase its sales -to reinvest into the business or pay shareholders higher profits if profits exceed expectations

Question 27

what are some possible responses to negative variances?

Answer 27

-to reduce costs (buying less expensive materials) -to increase advertising in order to increase sales of the product and revenues -to reduce prices to increase sales (relies on demand being price elastic)

Question 27

benefits of budgets

Answer 27

-targets can be set for each part of the business -inefficiency and waste can be identified so that proper action can be taken -managers will think about the financial implications of their actions -should improve financial control by preventing overspending -improve internal communication -can motivate employees to fulfil their higher level needs (maslow)

Question 28

drawbacks of budgets

Answer 28

-the operation of budgets can become inflexible -have to be accurate to have any meaning -wide variances between budget and actual figures can demotivate staff and waste the resources used to prepare the budget

Question 29

what is contribution?

Answer 29

the amount of money left over after variable costs have been subtracted from sales revenue. it calculates: -the breakeven point -the level of profit

Question 30

contribution formula

Answer 30

sales revenue - variable costs

Question 31

contribution per unit formula

Answer 31

sales price per unit - variable cost per unit

Question 32

total contribution formula

Answer 32

unit contribution x output

Question 33

break even formula

Answer 33

fixed costs x contribution per unit

Question 33

profit formuła

Answer 33

total contribution - fixed costs

Question 34

benefits of a breakeven analysis

Answer 34

-starting a new business: whether the proposal is viable -supporting loan applications -measuring profits and losses -modelling 'what if?' scenarios

Question 35

drawbacks of breakeven analysis

Answer 35

-no costs are truly fixed, fixed costs are likely to increase in the long term -total cost line should not be straight as this does not represent the discounts available for bulk buying -sales revenue assumes that all output produced is sold and at uniform price, which is unrealistic -the analysis is only as good as the info provided

Question 36

gross profit margin formula

Answer 36

gross profit / sales revenue x100

Question 37

operating profit margin formula

Answer 37

operating profit / sales rev x100

Question 38

profit of the year margin formula

Answer 38

profit of the year / sales revenue x100

Question 39

what are payables?

Answer 39

(sometimes called trade creditors) is money owed for goods and services that have been purchased on credit

Question 40

what are receivables?

Answer 40

(sometimes called trade debtors) is money owed by a business's customers for goods and services purchased on credit

Question 41

what are some internal sources of finance?

Answer 41

-retained profits: profit not paid to shareholders, kept for investments -sales of existing assets: sells machinery, space, land, factories that it no longer needs -friends and family: loans from family members and friend

Question 42

what are some external sources of finance?

Answer 42

-equity: money provided by owners or shareholders, no need to pay back and no interest -loans: money raised from creditor, paid back + interest -venture capital: venture capitalist may provide funds as a loan in return for a share of the business -mortgages: loan granted to buy land or business -crowfunding: people contribute amount (gofund me)

Question 43

what are some short term sources of finance?

Answer 43

-overdraft: overspend up to a limit, can be expensive + interest -debt factoring: business sells its bills that have not been paid -trade credit: receiving materials but paying at a later date

Question 44

why might cash flow problems occur?

Answer 44

-poor management -giving too much credit -overtrading -unexpected expenditure

Question 45

how can a business improve their cash inflows?

Answer 45

-factoring: biz can sell its outstanding debtors to a specialist debt collector -sale and leaseback: owner of an asset (eg: property) sells it and then leases it back improved working capital control: working capital cash available to help business with their day-to-day operations

Question 46

how might working capital help improve cash flow?

Answer 46

-selling stocks of finished goods -pay on time for customers, offering less trade credit (might damage sales) -persuading suppliers to offer longer periods of trade credit -stimulating sales, discounts and prompt payment -selling off excess material stocks

Question 47

what is profitability?

Answer 47

measures sales against some yardsticks, such as the sales revenue achieved by the business

Question 48

how might a business improve profits and profitability?

Answer 48

-increasing prices: more revenue but risk of loss of sales which reduces profits, depends on elasticity -cutting costs: can increase profit margins but might lower quality -using capacity as fully as possible -increasing efficiency: avoiding waste in the form of poor quality and unsaleable products, using staff fully and minimal resources

Question 48

what are the difficulties of attempting to improve profit?

Answer 48

-increasing prices: reduce sales and revenue and attract. criticism for customers -cutting costs: reduction of quality, might mean job losses and ups labour reactions -use capacity fully: may cause problems in matching supply with demand, price reductions and lower revenues -increasing efficiency: redundancies if technology is introduced

Question 49

what are the difficulties of attempting to improve cash flow?

Answer 49

-factoring: profit margin is reduced due to the cost, customers might raise concerns about supplier's cash flow problems -sale and leaseback: the asset is removed forever and now rent has to be paid -working capital control: customers may be put off by reduced credit periods and suppliers might be unwilling to expand them