Selecting Financial Strategies-Chapter 5

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  • Selecting Financial Strategies-Chapter 5
    • Raising Finance
      • Internal Sources of Finance
        • Retained profit-Allows the organisation to use the surplus for future activities- Shareholders expect a dividend from the profit and the rest can be retained and invested into the business
        • Sale of assets-A firm usually sell non-current assets for the following reasons:
          • The firm no longer needs the assets-firm will use the funds as a long-term/medium-term source of firm
        • The firm is in difficulties and needs cash as a short-term source of finance in order to survive a cash-flow crisis
        • Sale and leaseback
      • External Source of Finance
        • Ordinary Share Capital
          • More shares you sell, the more shares you lose and companies have to pay dividends
        • Loan capital
        • Debentures (long term source of finance)
        • Bank overdrafts
      • Internal or External will be determined by:
        • The legal structure
        • The use of the finance
        • The amount required
        • Profit levels
        • The views of the owners
      • Short or Long term is determined by how long the finance is needed for:
        • Capital expenditure
          • This is spending on items that can be used time and time again. It may take a long time before these items generate enough revenue to pay for themselves, so a long-term finance is ideal
        • Revenue expenditure
          • This is on current, day-to-day costs, such as the purchase of raw materials and payment of wages. Such expenditure provides a quick return, so the company should rely on a short or medium-term source of finance.
    • Introducing and Implementing Profit Centres
      • Profit Centre- An identifiable part of an organisation (e.g. a department, a product or branch) for which costs and revenue and thus profits can be calculated.
      • Reasons for Profit Centres
        • They allow a more focused study of a firms finances
        • Benchmarking can take place
        • Responisibility may help to motive the individual responsible
        • Finances may be run and controlled more efficiently
      • Disadvantages of profit centres
        • Allocating costs-may be difficult to do this to each division
        • Demotivation- may add pressure to the staff at each profit centre who may have technical skills but do not have financial management skills
        • Diseconomies-If too much financial management is delegated, it is possible that all the managers may be carrying out the same tasks, such as buying raw materials on a small scale when they could all buy it together.
        • External Changes-Businesses need to assess the efficiency of the manager responsible for each profit centre
    • Cost minimisation
      • The business might try to reduce its variable costs in order to increase profit e.g. reduce wages or reduce raw materials costs
      • Main dangers of this strategy
        • Losing quality
        • Disatisfied customers
        • Demotivated staff-reduced labour turnover
      • The business might try to reduce fixed costs, its overheads such as rent, offices expenses machinery costs
        • Main dangers of this strategy
          • Higher footfall in the town centre- lose customers by locating in a less accessible place
      • Before implementing a cost strategy the finance department must liaise with the other functional areas and there will be conflicts between deparments
        • e.g. production uses lower quality materials to keep within budget but for marketing, this means trying to sell inferior good causing decreased sales
        • e.g. for HR it means making redundancies
        • Cutting costs in one department can cause problems in other department
    • Allocating Capital Expenditure
      • Capital Expenditure:spending on non-current assets- those assets used repeatedly in the production process, such as buildings, vehicles and machinery
      • The business has to decide on:
        • Whether to replace labour with machinery/ capital equipment
        • Whether the capital expenditure is viable, will it make a profit
        • Finance is limited. Any spending in one functional area will have an opportunity cost and implications for other departments.


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