Measures of business performance

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Business performance

List 5 ways employee's contribution towards objectives is measured

  • Productivity (output per worker)
  • Absenteeism (staff absences)
  • Labour turnover (the proportion of staff leaving in a year)
  • Quality and waste (proportion of defective items produced by staff)
  • Accidents (the number of accidents per year of per 000 employees)

How is productivity measured?

Labour productivity is measured by dividing the total output by the number of wokers.

How is absenteeism measured?

(Is the number of staff asbent divided by the average number of staff) x 100

How is labour turnover calculated?

(Number of staff leaving/ average number of staff employed) x100

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Profitability ratios

Return on capital employed

  • Net profit/Capital employed x100% 
  • Higher is better

Gross profit margin

  • Gross profit/Sales turnover x 100%
  • Only direct costs are considered
  • Overheads are ignored
  • 20% means 20p gross profit for every 1 pound of sales

Net profit margin

  • Net profit/Sales turnover x100%
  • Both direct and indirect costs are considered
  • Higher is better
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Shareholder ratios

Return on equity

  • Net income/Shareholders equity x100 %
  • Shows the amount of net income returned to owners as a percentage of shareholders equity

Dividend per share

  • Total dividends/No. of Shares 

Dividend yield

  • Dividend per share/ Market price per share x100%
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Return on investment

Average rate of return

  • Annual average profit/Investment x 100%
  • Projects whose ARR exceeds the rate of interest are worth taking

Liquidity ratios

Current ratio

  • Current assets/Current liabilities
  • A ratio of 2:1 suggest a firm has more than enough liquidity to pay bills

Acid test ratio

  • Current assets (minus stock) /Current liabilities
  • 1:1 is ideal as there is sufficient working capital to pay short-term bills
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Efficiency ratios

Asset turnover ratio

  • Sales/Assets employed
  • Shows the amount of sales generate by each 1 pound of asset

Stock turnover ratio

  • Cost of sales/Average stock held x100% 
  • Shows how many times a trading period a business sells all its stock 

Debtor days

  • Debtors/Sales x365
  • Shows the number of days a firm waits to be paid for good supplied on credit
  • Low debtor days, improves cash flor and working capital

Creditor days

  • Creditors/Purchaes x365 
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Gearing ratios

Gearing ratio

  • Long term liabilities/Capital employed x100%
  • Shows the reliance of a business on long term loan as a source of finance, rather than share capital and reserves
  • High gearing (50+%) means a high proportion of finance is through loans

Interest cover

  • Operating profit/Interest payable
  • Shows the number of times a business can pay interest charges from operating profits
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How does Return On Capital Employed measure performance?

  • Compared to industry average
  • An above average, means management is making relatively effective use of long term capital employed

What is capital employed?

Is the total long term funds uses by a business (share capital and debt)

Define gross profit

Gross profit= sales revenue - cost of sale (direct costs/raw materials)

Define net profit

  • Net profit is gross profit - other expensese (rent etc..)
  • It is income left from sales after all expenses are deducted
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What determines dividend per share?

Dividend is the amount of profits distributed to owners. Higher profits increase the amount available to reward shareholders

What is market value?

Is the current value place on the firm's net assets by investors

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Explain liquidty ratios

Indicate solvency: the ability of a firm to pay its debts

Define assets

An asset is anything that is owned by a business that can give a value in money terms (land, buildings, equipment, brand names and good will)

Distinguish between current and long term assets and liabilities:

  • Current: repaid or converted into cash within 12 months
  • Long term: reapid of converted into cash more than 12 motnhs ahead

How can stakeholders identify liquidity problems?

  • Current ratio below 2:1, the firm may have difficulties meeting current liabilities
  • Insufficient working capital
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How can a firm improve its liquidity?

  • Securing an overdraft
  • Chasing debtors
  • Restricting credit
  • Moving to Just-in-time management- reducing the need to hold stock 
  • Better credit control management to reduce debtors without losing customers
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Financial efficiency

How does an economic slowdown effect asset turnover?

An economic slowdown reduces total output income an demployment in the economy (sales fall)

How can a firm improve its asset turnover ratio?

Improving capacity utilisation, closing down underperforming areas, increasing sales through better marketig and downsizing

How is stock turnover ratio used?

High stock turnover ratio suggests the business is efficient and selling goods quickly to customers

How can firms increase its stock turnover ratio?

Hold less stock or increase sales

How are JIT and stock turnover related?

Reduces stock holdings and increase the stock turnvoer ratio

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Financial efficiency

How is the debtor day ratio used?

Shows the averafe amount of time taken to collect debts from customers sold items on credit. The lower the ratio, the more efficient the firm's credit control sstem is in improving cash flow and working capital

How can a firm reduce its debtor day ratio?

By improving credit control (chasing late payers and reducing credit terms)

How can a firm improve its creditor day ratio?

Delaying payment of debt improves cash flow but risks supplier relations. Suppliers may respond by insisting on payment in cash

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Explain gearing

Gearing is proportion of long term finance made up of debt rather than shareholder funds

What are debentures?

Long-term loan (bond)- pay a fixed rate of interest and are secured against an asset

Why is gearing important?

Measures the firm's reliance on long term debt in its capital structure to finance its operrations and growth

Explain high gearing

Gearing ratio > 50% suggesting excessive borrowing

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Ratio analysis

What are the limitations of ratio analysis:

  • Accounts manipulated to give the appearance of improved performance (assets are sold or debts repaid to improve the appearance) 
  • Data is historic: accounts show last years figures
  • Comparisons between firms must take acocount the different product mix of different firms
  • Changes in the external environment- inflation, exchange rates, interest rates can alter a rati without any change in the performance of the organisation
  • Ratios ignore qualitative factors (quality of staff and products and labour relations)
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Investment appraisal

Define investment

Investment is the purchase of fixed assets e.g equipment by a business

Give examples of investment decisions

  • New products associated with R & D
  • Expansion by investing in new fixed assets, takeovers or alternative locations
  • Investment in technology

Why is investment uncertain and risky?

  • Decisions based on historical and projected data that may or may not be correct
  • Projects are generally expensive 

Explain investent appraisal

Series of techniques that help managers assess the financial implications of decisions to purchase new fixed assets 

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Investment appraisal

List 3 examples of investment appraisal techniques

  • Payback method: measures the time taken for the project to generate sufficient revenue to recover the sum of money invested
  • ARR: calculates the annual profit from a project

What are the limitations of investment appraisal techniques?

  • Ignore qualitative non-financial factors such as woker relations
  • Calculations depend on historical data and forecasts from market research

List 4 other non-quantitative factors considered in investment decisions

  • Corporate objectives
  • Capacity- complement current operations
  • Economic conditions- recession?
  • Stakeholder response
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What is a budget?

A financial or quantitative statemnt of an agreed action plan

List 5 advantages to using budgets

  • Planning- translate action plans into financial terms
  • Control- departments cannot exceed agreed spending limits without permission
  • Monitoring- budget holders must account for overspends
  • Enabling delegation- passing down authority for spending and meeting sales targets
  • Improving communication- agreed action plan

3 types of budget

  • Income- forecasts expected reveneu from sales
  • Expenditure- predicts expected costs of production
  • Profit- uses the income and expenditure to estimate future profit


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How are budgets set?

  • Historical budgeting- last years budget is used as a guide
  • Zero budgeting- reset to zero and budget holdes have to justify every pound to be spent (time-consuming)

Explain variance

The difference between budgeted and actual figures

What is the difference between favourable and adverse variance?

  • Favourable or positive: actual business activity exceeds budgeted activity
  • Adverse or negative: actual business activity under performs budgeted activity

What causes negative variance?

  • Internal factors: failure to control costs or poor market research
  • External factors: increased competition or unexpected recession
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