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Unit 5: Decision Making to Improve Financial Performance - Coggle Diagram
Unit 5: Decision Making to Improve Financial Performance
Understanding the difference between cash flow and profit
Financial objectives
The specific, focused aims or goals of the finance within an organisation
Benefits of setting financial objectives
- can vary depending on an economic situation and the objective that is being considered.
Shareholders will be able to assess whether the business is going to provide a worthwhile investment, as well as enabling stakeholders to confirm the financial viability of a business.
Business can also improve their efficiency, by examining reasons for success or failure from the yardstick provided. Co-ordination becomes significantly improved as it gives employees an understanding of purpose.
Difficulties of setting financial objectives
Setting realistic objectives can be difficult, which is more specific to new start up companies. Similarly, certain objectives may be difficult to measure accurately.
External changes may also be beyond control of a business, but affect the success in achieving their financial objectives.
Budgets and Budgeting
A financial plan for the future that concerns revenues, costs and profits. Used to compare with what actually was achieved within the year to calculate and adverse or favourable variance.
Revenue budgets:
Determine the expected revenue which tends to have more detail
Cost budgets:
Based on the revenue budget and work out the expected variable costs. Used to determine the fixed costs.
Profit budgets:
Based on combined sales and costs budgets which form a basis of performance
It is important to assess the market before determining the revenue budget as things may have changed in the space of a year, budgets become more useful when they are based off of accurate knowledge.
Sales forecasting can be difficult to get accurate as the market is rapidly changing, its hard for start up firms to estimate as they have not got previous data to go on, competitor actions can be difficult to determine.
Costs can be unexpected in the process, can vary depending on sales and change in environment can impact costs.
Variance Analysis
Calculating and then investigating the differences between budgets and actual
Favourable- better than expected
Adverse- worse than expected
Favourable caused by: stronger demand than expected, selling price increasing, assumptions too pessimistic, more efficiency
Adverse caused by: unexpected events, over-spends, sales forecasts too optimistic, lower demand than expected
Sources of Finance
Debt factoring
- external and short term use of finance where businesses raise cash by selling receivables to a third party at a discount
Receivables are turned back into cash quickly, focus on selling rather than collecting debts, no security required.
Quite a high cost from the investment of the factoring company and customers may feel their relationship with business has changed
Bank loans
- medium term external source of finance where money is provided over a fixed period, interests rates are fixed or variable, timings and amount of repayments are set and security is required for the loan
Certainty of funding, plans for repayments, usually hold lower interest rates
Interest is paid in full so amount that is owed stays complete even if not used. Opportunity costs? Harder to arrange as bank has no obligation so small businesses are usually left out.
Bank overdrafts
- external short term method of finance that is only used when necessary.
Helps seasonal fluctuations when business have short term cash flow problems, much easier to organise, only need to be pay interest on what has been borrowed.
Interest charge is higher, it can withdrawn on short term notice at any time and asked to be paid back at any time.
Retained Profits
- internal long term source of finance. Works as a source of finance by using a cash profit as a way to re-invest in the business
Flexible- owners in control, low cost, substantial source
Making a loss- drains cash flow, hoarding profits, opportunity costs for shareholders.
Venture capital
- an external source of finance that invests in the share capital of a business
significant finance is raised- can make big payments, business receives professional support
expensive and time consuming to raise finance- thorough review as they are professional. loss in control- venture is a mix of loans and share capital which gives investor greater control. May be picky, hard to achieve because ventures are worried about a high rate of return so will be looking at the position of the business in a few years time