BUSS 3 - FINANCE STRATEGIES, ACCOUNTS AND OBJECTIVES

BUSS 3 - FINANCE STRATEGIES, ACCOUNTS AND OBJECTIVES

1. Financial strategies and accounts

   • Profit = TC - TR
     • Cash flow is the movement of cash into and out of a business over a period of time
       • ROCE is the net profits of a business expressed as a % of the value of the capital employed
   • Financial strategies
     • Ratio Analysis
       • Liquidity ratios
         • Current ratio
           • High 1.6:1
           • The use of automation (JIT) enables businesses to hold less current assets
         • Acid test ratio
           • High 1:1
           • Depends on the business. Retailers operate with 0.4:1 because they mainly trade in cash
           • Firms should not operate with high acid test ratios over long periods because holding assets in the form of cash is not profitable
         • Assess the ability of the business to pay its immediate debts
       • Efficiency Ratios
         • Asset turnover ratio
           • High
         • Inventory turnover
           • High
             • Selling out of inventories results in customer disatisfaction
           • Low figure could be due to obsolete inventories
           • Could be improved by holding lower levels of stock or increasing sales without increasing stock
         • Payables
           • Low but higher than receivables
         • Receivables
           • Low
         • Evidence on how well the managers have controlled the business
       • Profitability ratios
         • Return on capital employed
           • High
             • Between 20%-30%
               • Could be improved by increasing its operating profit without raising further capital or reducing capital employed
         • Gross profit margin
           • High
         • Net profit margin
           • High
         • Fundamental measure of the success of the business
       • Gearing
         • Assess the extent to which the business is based on borrowed money
         • >50% bad
           • Vulnerable to an increase in interest rates
           • However, could be considered good in a business that is growing quickly and generating high profits
         • <50% good
           • A low geared business could be considered too cautious and not expanding as quickly as possible
       • Shareholders; ratios
         • Dividend per share
         • Dividend yield
         • Give investors information on the returns on their investment
         • Do shareholders want long term or short term profits?
       • Operating cash flow ratio
         • Operating cash flow/Current liabilities
           • A ratio less than 1 means that company has generated less cash over the year than needed to pay off short term liabilities
     • Capital investment appraisal
       • Average rate of return
         • Average profit/assets initial cost x 100
         • Allows comparison with returns on investments
         • Ignores the payback period
       • Payback period
         • Amount not recovered/revenue generated next year x 12
         • Easy to calculate
         • Simple to understand
         • Excludes income received after payback
       • Net present value
         • Net cash flow x Discount factor
         • Makes an allowance for the opportunity cost of investing
         • Easily misunderstood
     • Profit centre
       • Makes its own decisions separately from the larger organisation
   • Accounts
     • A balance sheet is a financial statement that records the assets and liabilities of a business
       • Only represents the business' assets and liabilities at a point in time
         • Recording assets and liabilities sets out the ways in which the business has raised its capital
         • Provides good information for stakeholders
           • Shareholders
             • Assess a business' potential to generate profits in the future. High proportion of non current assets could signify potential profit
           • Suppliers
             • Investigate the short term position of the company. How liquid is the business? can it pay off its debts?
           • Managers
             • Information to help them make decisions on how to raise further capital for future investment, the amount of existing loans may be one factor influencing the decision.
       • Assets
         • Non current
           • Assets owned by a business that it expects to retain for over a year, these are not bought for the purpose of resale. E.g. land
         • Current
           • Assets that are likely to be converted into cash before the next balance sheet. E.g. cash and inventories
         • Tangible
           • Machinery
         • Intangible
           • Patent
       • Liabilities
         • Current
           • Debts own by the business due for payment within one year or less. E.g. Overdrafts or trade payables (suppliers)
         • Non current
           • Debts that the business is not due to pay within the period of one year. E.g. mortgages and bank loans
         • Total equity
           • Money invested into the business is a liability because if the business ceases trading, shareholders would hope for their repayment of their investment
       • Assessing the performance of a business
         • Short term
           • Does the business have the ability to pay its bills over the next 12 months?
             • Current assets should be greater than current liabilities
               • Positive working capital
             • However, if not then it could cause liquidity or cash problems
         • Long term
           • Increase in non current assets may mean the business financial performance might improve over medium term
             • Reserves show healthy position with profits
           • Considering how the business has raised its capital.
             • Risks over borrowing too much (non current liabilities) than through share capital
         • Working capital
           • Measures the amount of money available to a business to pay its day to day expenses
             • What causes working capital problems?
               • One of the main problems is poor financial management
                 • Managers who plan ahead and forecast their needs for working capital are less likely to encounter problems with working capital, because future cash problems can be found and solutions can be prepared
                 • External changes
                   • Changes in the economy such as a rise in interest rates can place pressure on a business' working capital
                   • Restriction in demand if economy goes into a recession whilst sales decline expenditure remains the same
                 • Poor credit control
                   • A business that fails to collect is debts on time will experience cash inflow problems resulting in a loss of revenue
                 • Financial mismanagement
                   • Managers underestimate costs of production or invest too much in non current assets
             • Working capital = current assets - current liabilities
               • Net current assets
               • Current assets= Cash in the bank or Inventories
               • Current liabilities= Debts repayable to the bank. E.g. overdraft
           • Too much working capital?
             • It is arguable that a business should hold large amounts of working capital to ensure it can always pay its debts
             • However, having too much working capital means that liquid assets such as cash earn little or no return for the business
             • What influences the amount of working capital a firm needs to hold?
               • The volume of sales
                 • Businesses that have high level of sales will need more factors of production to meet demand therefore its need for working capital will be higher
               • Rate of inflation
                 • If prices raise rapidly, business will need more working capital to fund the increased costs of factors of production
               • Amount of trade credit given to customers
                 • Lengthy period of time means the business needs more working capital
           • How important is working capital?
             • Every business needs effective management of working capital because if is unable to pay its debts then it may be forced to close down
               • However, working capital is of particular importance for certain types of businesses
                 • Small business
                   • Small businesses are vulnerable to problems with working capital because they don't have access to sufficient funds to be able to improve their liquidity
                     • Banks not wanting to make loans to small businesses
                 • Expanding business
                   • When a business grows its expenditure is likely to increase first, therefore the business will be in a position where it pays off in the long term
                 • Business with long working capital
                   • Mostly manufacturing businesses have substantial working capital requirements
                     • E.g. Shipbuilding may incur costs up to 3 years before they receive a complete payment
           • Solving working capital problems
             • Reduce trade credit
               • Suitable for small firms
               • Could result in loss of customers
               • Quick to implement
             • Sale and leaseback
               • Provides major injection of cash
               • Difficult to price an asset when selling under pressure
               • Suitable for large firms with valuable fixed assets or with surplus assets
         • Depreciation
           • The reduction of the value of an asset over a period of time
             • Firms depreciate their assets to spread the costs over its useful life
             • Assets lose value as a result of wear and tear
               • Becomes obsolete
             • Depreciating assets makes future balance sheets more accurate
               • Accurate view of the profitability of the business over the lifetime of the equipment
           • Effects
             • Balance sheet
               • Too much depreciation - value of the business understated
                 • Too little depreciation - value of the business is overvalued
             • Income statement
               • Too much depreciation - expenses are overestimated
                 • Too little depreciation - reduces the expenses incurred by a business = higher profits
             • Wider effect
               • Too much depreciation - business may look unattractive to investors
                 • Too little depreciation - makes the company more attractive to investors
     • Income statement
       • Shareholders interested in the profitability of the business
         • Gross profit
         • Net profit

2. Objectives

   • Marketing
     • A goal or target pursued by the marketing department
       • Should be feasible
         • Sales targets
           • Increasing sales for a product/service
         • Market share targets
           • Businesses will want to compare how well they are doing in the market relative to others
             • When releasing a new product the business might have a target of achieving 10% of market share in a year
         • Brand awareness
           • Make sure the business' good is in the consumers shopping list
       • Influences
         • Internal
           • Operations
             • The capacity of the business will limit how much can be produced
             • Operation process will affect the quality and flexibility that the business can offer
           • Human resources
             • What a business can produce depends on the skills of its staff
               • High skills = High quality service
           • Finance
             • Does the business has the right finance to undertake marketing strategies?
         • External
           • PESTLE
             • Economical
               • A fall in UK national income = fall in demand for goods
   • Operational
     • Aim or target related to the delivery of the product/service
       • Should be specific and measurable
         • Volume targets
           • Ensuring the firm can produce the output demanded at the time wanted
         • Quality targets
           • Achieving an appropriate level of service and quality
         • Efficiency targets
         • Environmental targets
           • Ensuring operations are not harmful to the environment. E.g. reducing waste and pollution
         • Innovation targets
         • Ethical targets
     • Influeces
       • The corporate mission
       • Other functions
         • Demand
           • Volume of targets
         • Competitors actions
           • Are competitors increasing their quality of their service?
         • Customer expectations
           • Customers needs and wants change all the time. What are they currently expecting from the business?
   • Human resource
     • Aim or target pursued by the HR department
       • Matching the workforce to the needs of the business
         • Changes in the business may require the HR department to make sure the business has the right number of employees with the right skills
       • Making full use of the workforce's potential
         • A business will want to maximise output so they could do so without increasing costs. E.g. skills audit
       • Maintaining good employer-employee relations
         • Businesses that have good industrial relations attract better employees in the future which therefore leads to higher productivity and quality of the good/service
       • Influences
         • Internal
           • Corporate objectives
             • All HR objectives must assist the business to achieve its overall objectives
           • Attitudes and beliefs of managers
             • Are employees the heart of the business?
         • External
           • Corporate image
             • Businesses want to make sure they maintain good relationship with staff to avoid bad reputation
           • PED for the product
             • Suitable HR objectives to match elasticity
               • PED elastic = reduce labour costs
   • Financial
     • A goal or target pursued by the finance department
       • Likely to contain a specific numerical element and a timescale to be achieved
         • Return on capital employed
           • Achieve a ROCE of 25%
         • Shareholders' returns
           • Increase dividend payments to shareholders
         • Cost minimisation
         • Cash flow targets
       • Internal influences on financial objectives
         • Corporate objectives
           • Financial objectives must assist the business in achieving its overall corporate objectives
             • Corporate objective is to profit maximise
             • Financial objective is to cost minimise
         • Nature of the product that is sold
           • Price elasticity of demand
           • Does the business need to reduce costs?
       • External influences on financial objectives
         • Competition
           • Develop a USP
             • Increase profit margin and competitive advantage
         • Availability of external finance
           • If the business is struggling to raise capital then the objectives will centre on profits and profitability
   • Corporate
     • Overall goals of the whole business
       • Vary accordingly to the size and is senior managers' personal aims
         • Growth
         • Diversification
         • Develop innovative goods and services
         • Achieve maximum profits in long term