Decision Making to Improve Financial Performance 3.5

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  • Decision Making to Improve Financial Performance 3.5
    • Setting Financial Objectives
      • Importance of Financial Objectives
        • Poor financial management is a reason why businesses fail
        • The level of long term debt in a business increases risk
        • Financial measures are key reasons why people invest in businesses
        • Financial objectives are easier to manage than other objectives
        • Financial measures determine the success of other functioning areas
      • Cash vs Profit
        • Profit is measured over a given period of time
        • Cash flow considers the timing of payments and receipts
        • Cash balance = cash inflows - cash outflows
        • Profit = revenue - expenses
        • The Profit Hierarchy
          • Direct costs taken away from revenue to give gross profit
          • Indirect costs taken away from gross profit to give operating profit
          • Other incomes and taxation taken from operating profit to give profit for the year
            • Profit for the year = net profit
      • Objectives
        • Costs
          • Lowering costs may be important when improving efficiency
          • Costs can be an important factor in a recession
            • Or when competing on price
        • Profit
          • Clear to understand and key performance indicator
          • Profits shared with stakeholders and are the indicators businesses will be judged against
          • If profits have fallen shareholders and public may see the business as under performing
        • Revenue
          • Earnings generated by a business from its trading activities
          • Helps drive business ambition to grow
          • Increased revenue indicates product popularity
        • Cash Flow
          • Business will fail if unable to meet financial obligations and pay bills
          • Businesses with long cash cycles will find it more challenging to manage cash flow
          • Maintaining specific level of cash reserves
          • Extending payment periods to suppliers
          • Shortening payment periods from customers
        • Investment and Return
          • Targets for capital investment will support business strategy for growth
          • May want to reduce capital over the year to reduce debts
          • May refer to returns received on investment
            • Return on investment = (operating profit / capital invested) X 100
        • Capital Structure
          • The balance between loan capital and share capital
          • Some businesses will want to balance both capitals
          • Loan Capital
            • High gearing
            • Risk of increasing interest payments
            • Difficult to find further lending
          • Share Cpaital
            • Low gearing
            • Danger of loosing control of business
            • High dividend payments to shareholders
      • Influences on Financial Objectives
        • Corporate obejctives
        • Nature of the product
        • Other objectives set
        • The competitive environment
        • Economic environment
        • Technological
    • Analyzing Financial Performance
      • Budgets
        • Types of Budgets
          • Setting budgets helps businesses achieve objectives
          • Revenue and earnings budgets create expenditure budgets
            • This will inform profit budgets
        • Budgeting Process
          • 1) Analyse market
          • 2) Set financial objectives
          • 3) Set revenue budgets
          • 4) Forecast expenditure
          • 5) Set expenditure budgets
          • 6) Set profit budgets
          • 7) Revue and adjust as appropriate
        • Problems with Budgets
          • Only as accurate as the data its based on
          • Past trends can be poor indicators of what will happen
          • New decisions taken by governments and public bodies
          • Unexpected changes
          • Unrealistic budget looses all value as motivator
        • Variance Analysis
          • Compares foretasted data to actual figures
          • Used to analyse the accuracy of budgeting process and hep make decisions
          • Favorable is better than budgeted
          • Adverse is worse than budgeted
          • Keep an eye on if it is outflows or inflows
      • Cash flow Forecasts
        • Constructing Cash Flow Forecasts
          • Cash in, cash out, net cash flow
          • (Inflows - outflows = net cash flow) + opening balance = closing balance
          • Closing balance is what the business has available to use
        • Value of Cash Flow Forecasting
          • Used to support application for lending
          • Supports budgeting process
          • Identifies potential cash flow crisis
        • Analyzing Cash Flow Forecasts
          • Monthly inflows greater than outflows?
          • Foretasted periods of high expenditure?
          • Positive cash flow sustaniable?
          • Are inflows increasing?
          • Seasonal trend?
          • Cash reserves to cover unexpected costs?
      • Break Even
        • Uses of Break Even Analysis
          • Decide whether business idea is profitable
          • Identify level of output and sales to generate profit
          • Assess changes in level of production
          • Assess effects of costing and pricing
        • Contribution
          • Difference between variable cost of one unit and selling price
          • Total contribution = total output X contribution per unit
        • Understanding Break Even
          • 1) Plot total revenue line from 0
          • 2) Plot fixed costs line, this will be horizontal
          • 3) Plot total costs line, this will start at fixed costs line
          • 4) Where total costs meet total revenue is where break even is
          • Break even point = fixed costs / contribution
        • Changing Variables
          • Raising selling price will increase revenue and lower BEP
          • Using cheaper supplier might lower variable costs, decreaing total costs and lowering BEP
          • Increase in rent may increase fixed costs and increase costs, raising BEP
        • Margin of Safety
          • Difference between BEP and current output
          • Size of margin of safety will determine risk of business
          • Margin of safety = current level of output - BEP
        • Value of BEP
          • + Can be used to analyse impact of varying factors on profit
          • + Simple and easy to use
          • + Useful guideline to help businesses make decisions
          • - Simplifies what can be complex
          • - Costs are rarely consistent
          • - Focuses on output and assumes all output is same price
      • Profitability
        • Gross Profit Margin
          • Indicator to analyse how business has performed in direct trading activity
          • Doesn't take into account indirect costs
          • Gross Profit Margin = (gross profit / sales revenue) X 100
        • Operating Profit Margin
          • Takes into account performance more fully
          • Useful when used along side gross profit margin
          • Operating Profit Margin = (operating profit / sales revenue) X 100
        • Net Profit Margin
          • Takes into account all revenues and costs incurred
          • Good measure of how effectively the business performed over the year
          • Net Profit Margin = (net profit / sales revenue) X 100
        • Financial information does not take into account human or ethical factors
    • Sources of Finance
      • Internal Sources
        • Retained Profit
          • Net profit reinvested back into the business
          • Long term
          • + Free source that doesn't incur interest
          • -Shareholders may wish to receive dividends
        • Sale of Assets
          • Short term
          • Selling off items of value to free up capital
          • + Frees up value of unwanted assets
          • - Business looses the benefit of the asset
        • Owners Capital
          • Long term
          • Personal savings used to start or expand business
          • + Free source that doesn't incur interest
          • - Owners could loose personal investment
      • External Sources
        • Overdrafts
          • Short term
          • Where a bank allows a firm to take out more money than in its account
          • + Flexible way to fund working capital
          • - Bank may ask for repayment at any time with high interest rates
        • Debt Factoring
          • Where a firm sells on its debt to a third party
          • Short term
          • + Allows business to receive cash immediately
          • - Customers could be aware if debts are factored and loose faith in the company
          • - No not get the whole value of debt in cash
        • Bank Loans
          • Long term
          • Borrowing from a bank
          • + Can be negotiated to meet business requirements
          • - Has to pay interest on whole loan even if only used half
        • Mortgages and Debentures
          • Long term
          • Mortgage is a loan for purchasing property
          • Debentures are loans secured against assets
          • + Ideal for long term investments
          • - Large amounts of interest can be charged over its lifetime
        • Venture Capital
          • Capital invested at an early stage by individual or company in return for equity in business
          • Long term
          • + Can bring expertise into business
          • - Owner may not want input from elsewhere into running of business
        • Share Capital
          • An owners investment into limited company to become shareholder
          • Long term
          • + Can access very large amounts of capital with no interest
          • - Only available to Ltd and Plc
        • Crowd Funding
          • Long term
          • Raising monetary contributions from a large number of people
          • + Cheap and easy to set up
          • - Not suitable for raising large amounts of money
    • Improving Cash Flow and Profits
      • Improving Cash Flow
        • Speed Up Inflows
          • Incentivise early repayment
          • Reduce trade credit given to customers
          • Sell of stock at a discounted price
          • Inject fresh capital into business
        • Slow Down Outflows
          • Delay payments to suppliers
          • Increase trade credit agreements with suppliers
          • Cut costs
        • Causes of Cash Flow Problems
          • Inaccurate cash flow management
          • Overtrading
          • Allowing too much trade credit to custoemrs
          • Poor credit control
          • Unforeseen costs
      • Increasing Profitability
        • Ways to Increase Revenue
          • Increase prices
          • Reduce process
          • Create awareness and desire through marketing
          • Add value to the product
        • Ways to Reduce Costs
          • Reduce production costs
          • Improve efficiency
          • Use capacity more fully
          • Eliminate unprofitable processes
          • Reduce variable costs
          • Lower overheads
        • Why Businesses are Unprofitable
          • No demand for product
          • Selling at the wrong time
          • Lower contribution per unit
          • Poor management of costs
          • Expansion of the business
        • Problems with Managing Finance
          • Impact on stakeholders
          • Spending money to make money
          • Short term solutions hindering long term sucess

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