Business studies unit 3

Hard bits of unit 3

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Financial ratios

ROCE shows the operating profit as a percentage of capital employed: capital employed equates to the value of the capital that a business has at its disposal. Operating profit is considered the best measure of performance. A higher ROCE percentage indicates a high level of profitability

Liquidity ratios are used to assess the ability of a business to meet its short term liabilities. 

Current ratio ideal ratio would be between 1.5:1 and 2:1

Acid test ratio ideal acid ratio would be between 0.75:1 and 1:1

Gearing above 50% is consdered high capital gearing, below 25% would be low. High gearing shows that the businss has borrowed a lot of money in relation to its total capital. High gearing is good as it means fewer shareholders, so it easier for existing hsareholders to keep control, and he company can benefit from a veyr cheap source of financewhen interest rates are low. Low gearing is good because less chance of payables forcing it into liquidation, and the company avoids having to pay high levels of interest. 

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Financial ratios

Asset turnover a high figure shows that the business is using its assets efficiently to achieve sales. a low figure shows that the business is not uuing its assets as efficiently. 

Inventory\stock turnover how quickly inventory is turned into sales. Higher figure means that stock is sold quickly bringing in more money to the company more rapidly. 

Receivables (debtor) days number of days it takes to convert receivables into cash, generally, firms will want as lower number as possible

Payables (creditors) days number oda days it takes to pay back any payables owed by a a business. Firms that recieve loong-term credit form their suppliers may expect a high number, but companies who play suppliers in cash, will have a lower number. 

Dividend per share limited usefulness, lacks context. depends on how much the share costs to buy

Dividend yield shows annual percentage return on the money needed to purchase the share. Good measure of short-term rewards from owning shares but tens to ignore long-term consequences. 

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Investment appraisal

Payback period the length of time that it takes for an investment to pay for itself from the net returns provided by that particular investment. Firms will want as quick payback as possible. It is calculated by adding the annual returns form an investment until the cumulative total equals the inital cost of the investment. The exact time at which this occurs, is the payback period. It is usually measures in years, but can be in months or weeks. Firms will hope for a shorter payback as possible. 

Average rate of return is total net returns divided by the expected life time of the investment (usually in years), expressed as a percentage of the initial cost of the investment. Firms will want as higher percentage return as possible. A benchmark that is often used to see if the ARR is satisfactory, is the interest rate that the firm must pay on any money borrowed to finance the investment. If the percentage return on the project exceeds the interest rate tat the business is paying, the project is financially worthwhile. 

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Investment appraisal

Net present value the net return on an investment when all revenues and costs have been converted to their current worth. £1 now would be worth more than £1 in the future. Net present value takes this into consideration. The choice of discount rate may be critical in an investment appraisal. It can be seen that £1 received in 5 years' time is equivalent to 78.4p today, if a discount rate of 5% is applied but only 62.1p if 10% is used. An appropriate discount rate should be based on circumstance such as current interest rates or the firm's expected percentage return on its investments.  

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Ansoff's matrix

Existing products, existing markets 

  • Market penetration - promoting growth and trying to increase market share
  • Consolidation - maintaing market share, or retrenchment
  • Withdrawal - through the sale of all or part of the business
  • Doing nothing - continuing with the existing strategy

Existing products, new markets

  • Market development extended to new markets, e.g. new geographical areas or entering new market segments.

New products, existing markets 

  • modification or additions to a products range in order to maintain a competitive position within existing markets.

New products, new markets

  • high-risk strategy, known as diversification. Requires both market and product development
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Economies of Scale

Economies of scale - the advantages that an organisation gains due to an increase in size, These cause an increase in productive efficiency (a decrease in the average cost per unit of production). 

Diseconomies of scale - the disadvantages that an organisation experiences due to an increase in size. These cause a decrease in productive efficiency (an increas in the average cost per unit of production). 

Fixed costs such as the depreciation of machinery and administrative expenses, must be paid regardless of the number of units that an organisation produces and sells. This enables large firms that utilise their equipment to produce at much lower costs per unit. Variable costs, such as labour and raw materials, can be combined more effectively in  large firm also leading to a saving in unit costs. 

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Critical path analysis

CPA is the process of planning the sequence of activities in order to discover the most efficient and quickest way of completing it. 

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