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Formula

Business organization and management

1.1 Intro to Business Management

• The Nature of Business

  • Business: An organization engaged in commercial, industrial and professional activities. Features of business are: A decision-making organization, made up of groups of workers, managers, directors, shareholders; uses factors of production; product/sell goods or services

  • Factors of Business: Land, Labour, Capital, Entrepreneurship

  • Business Activity (Inputs, processes, outputs)

    • Inputs (Factors of Production): Land, Labour, Capital, Enterprise

      • Enterprise: an organization or corporation involves in commercial, industrial or professional activities to gain profits

    • Outputs (goods and services)

  • Goods and Services

    Goods = Visible or tangible items

    • Consumer goods: consumer durables like furniture, items bought regularly

    • Producers goods: capital goods that can be used to produce consumer goods. Consumables: items with short life and little value, eg. paper

    Services = Invisible or intangible items cannot be seen or touched but have visible results

  • Business Functions

    All 4 of the business functions are interdependent and are reliant upon one another.

    Human resources: Managing people in an organization, including recruitment and training

    • Deal with employees, wages, recruitments, manage the workforce

    Finance and accounts: Financial operations. Accounting is recording and reporting transactions.

    • budget control, manage assets, funds documentation

    Marketing: Identifying the needs and wants of consumers

    • promoting, price, packaging

    Operations Management: Management of resources used for production of goods and services, process of producing goods

  Adding values is the process of producing a particular good or service that is worth more than the cost of the resources used to produce it.

  Explain the nature of businesses in combining factors of production to create goods and services.

• Business Sectors

  Chain of production is the stages of production of a particular product

  primary production, manufacturing, services (tertiary & quaternary), consumers

  

  • primary production refers to the economic activities involved in the extraction or cultivation of natural resources, such as agriculture, fishing, and mining. These industries are focused on the production of basic goods and materials, and they typically operate with little government control

  • Primary sector activities tend to dominate in LEDCs

  • Tertiary and quaternary sector activities tend to dominate in MEDCs

  • Secondary-sector activities tend to dominate in newly industrialized or emerging economies (NICs)

  • Added Values

    Primary sector: The added value in the ps is relatively low. Workers in the ps are typically paid less than those in the ss or ts.

    Tertiary sector: The added value of tertiary sector output is very high. As an economy grows and develops, the significant of the primary sector diminishes (in terms of output and employment), whereas the importance of the tertiary sector becomes more prominent

    Quaternary: The added value is extremely high in the quaternary sector because it involves higher education and requires a highly educated population

• Sectoral Change

  https://www.savemyexams.com/igcse/geography/edexcel/19/revision-notes/4-economic-activity--energy/4-2-impacts-of-economic-sectors-on-resources/4-2-1-impacts-of-economic-sectors/

  Industrialization: Country moves towards the manufacturing sector as its principle output.

  • Urbanization

  • increase in GDP/ Living standards

  • Increasing employment and job opportunities

  Developed nations: As development continues, moves towards the tertiary sector

  • higher incomes and increasing consumption of goods

  • increasing specialization

  • increasing demands for services

  • growth in technology and communication

• Opportunities and challenges when starting a business

1.2 Business Entities

unincorporated organization: sole traders and partnerships

incorporated organization: business owned by shareholders, business and owners are separated legal entities

• Key Vocabulary

  liability

  • Limited = biggest risk is losing initial investment

  • Unlimited: responsible for all debts and loss, owners can lose their personal procession to pay for the organization’s debt

  Legal identity=Identity existed from a law perspective

  Corpus= Total money invested in a particular scheme by investor

  Transparency = Public accounts, revenue, profit

  Market capitalization = one measurement of a company's size.

  Initial Public Offering (IPO) = occurs when a company sells its shares on a public stock exchange for the first time.

  Silent Partner = Partners that are not actively involved

  IPO = Initial Public Offering selling stock to company in the primary market.

• Privately held company

  A private limited company (LTD) is a privately held business entity held by private stakeholders.

  small number of shareholders - stocks are not for sale to the public

  Difficult to cash out/ Usually owned by families

  only family and friends an buy stocks

  No need to publish much financial information

  The company and its owners are separate legal entities

  eg. Lego, IKEA, Mars, Chanel, Rolex

  • Advantages of privately held company

    • There is better control of a privately rather than publicly held company

    • Privately held companies have greater privacy compared to publicly held companies

    • Shareholders have limited liability, so cannot lose more than what they invest in the company

  • Disadvantages of Privately held company

    • They are more expensive to operate than a sole trader or partnership (higher legal fees and auditing fees) higher tax

    • A privately held company can become a target for a takeover by a larger company which purchases a majority stake

• Publicly Held company

  If a private company decide to go public, their have to offer shares to public place (stock exchange, stock market) PLC public limited company

  • In order to protect shareholders, publicly held companies are strictly regulated and are required to publish their final accounts each year.

  IPO = Initial public offering (after have no direct control on the share price)

  Greater access to capital

  eg. Coca Cola, Apple, Nike

  • Advantage

    • easier to borrow loans from banks

    • more capital from selling stocks

    • higher capacity for expansion

    • higher chance of continuity if a principal or major shareholder leaves the organization or passes away.

  • Disadvantage

    • There is a lack of privacy because the general public have access to the financial accounts of publicly held companies.

    • corporate

    • Publicly held companies are the most administratively difficult and expensive form of commercial for-profit business to set up and run.

    • hostile takeover from rival companies

    • Large companies can suffer from diseconomies of scale: higher cost of production

• For-profit Social enterprise

  Social Enterprise = a form of business that has a social purpose (eg, improve environment, human, social) two types for-profit and non-profit

  • Common features of for-profit social enterprise

    • For-profit enterprise aim to make profit but do not want to maximize profits if it compromise their social purpose.

    • limited liability organizations

    • Generate revenues in a social responsible ways and uses the surplus to directly benefit the society or environment rather than distributing the profit to owners in the form of dividend payments.

    • high collaboration between businesses and local communities

    • All members of a cooperative have equal voting rights, irrespective of their role in the business or their level of investment in the cooperative.

    • More democratic

  • Advantages of for-profit social enterprise

    • strong communal identity: employees are motivated working together with a common sense of purpose

    • Often qualify for governmental financial support

    • There is an absence of pressure from external investors and shareholders

  • Disadvantages of for-profit social enterprise

    • Decision making is complex and time-consuming

    • Higher cost to be ethical

    • income is hard to forecast

    • lack in financial motivation (lower profit margins)

    • Capital is insufficient so they have lower profit margins than traditional for-profit businesses.

    • Most cooperatives are unable to hire a range of specialist managers to run the business, due to the lack of financial rewards

  • Private sector

    sole trader, partnerships, company

    Ex. TOMs shoes

  • Public sector

    Provide public services run or funded by the government such as recycling, medicine, education

    • Often public sector are unable to provide necessary resources to operate an enterprise so some fundings are from

    • Advantages

      • As the product is provided by the government, there are fewer risks involved

      • By charging its services, the public sector companies help to reduce the debt burden of the economy

      • Public sector companies create secure employment opportunities and have a positive impact on local communities

    • Disadvantages

      • it can be difficult to persuade private sector partners or investors to help fund public sector companies

      • most public sector enterprises are expensive to operate (involving high set-up costs and running costs)

  • Cooperatives

    An autonomous association of persons united voluntarily to meet their common needs, owned by its members (democratically controlled enterprise)• Organizations that are jointly owned and run by its members who share in profits and benefits

    • financial cooperative: financial institution with ethical and social aims that is more important than profits.

    • Housing cooperative: run. to provide housing for its members. The surpluses are reinvested in the building and its operation, so costs to individual members are lower.

    • Workers’ cooperative owned and operated by workers themselves. Providing employment to workers is a priority. It is often created when a business is about to fail so workers take over the managers

    • Consumer cooperative: provide service to its consumers

    • difficulties in making decision/difficulties in generating finance

    ex. kampot pepper, ibisrice,

• Non-Profit Social Enterprise

  Non-governmental organization (NGOs)

  Non-profit social enterprises operate in a commercial-like way but they do not distribute any profits or financial surplus to their owners or shareholders. Eg. Red Cross, United Way,

  ISPP is a not for profit social enterprise

  Social enterprises are an example of social purpose organizations (SPOs) that aim to primarily provide a solution to important social or environmental issues

  Surplus = total revenues - total costs

  • Common features

    • Profits are not generated, instead they generate surplus to advance the social purpose of the business.

    • Donations are important - does not rely on government funding so most of the revenues come from voluntary donations from individuals.

    • Unclear ownerships and control

  • NGOs vs NPOs

    • NGOs operates in the private sector of the economy, it is a voluntary groups working for a social cause. eg. Khan Development Network, Amnesty international, Oxfam.

    Usually funded by government grants or donations, Charitable organizations, commercial business (CSR)

  • Charities

  • Pressure groups

    • Organized groups that do not run for election

    • Advocate certain interests such as environment, sexuality, religion, rights, etc.

    • Seeks to manipulate the public or private sector for certain causes.

    • e.g. PETA, Greenpeace, Church, LGBT

  • Advantages

    • Help people or cause in need, benefit local communities and societies

    • They are exempt from paying corporate and profits taxes

    • foster a philanthropic spirit in the community

    • NPOs also qualify for government assistance in the form of grants and/or subsidies, thereby reducing their costs of production.

    • experiment with new innovative ideas

  • Disadvantages

    • lack of financial control

    • Intense lobbying: give arguments to persuade business or governments to pass legislation or engage in activity. Companies can lobby government to add legislation or reduce tax.

    • sometimes employees have a passion that ill serve the organization or its causes.

    • NPOs depend on the goodwill of the general public and donors to fund their operations - funding is irregular

  • Garde Cards

    A.

    B. Other than unlimited liability, explain 2 features of a sole trader

    • Ownership by one individually who typically runs the business

    • Business is not a seperate legal entity from the owner

    • No requirement to make accounting records publicly available

    • More limits on sources of finance than in a limited liability company

    C. Explain one advantage and one disadvantage of phillipe operating as a sole trader

    • Advantages of a sole trader

    • Philipe keeps all profits which he seems to value to value considering that he doesn't really want to give up decision making or profits

    • Philippe controls all devision making preserves his autonomy and may allow him to make strategic or tactical decisions faster

    • Financial privacy

    • Operations may be more consistent

    • Philipe can offer personalised service

    • Disadvantages of a sole trader↓

    • Unlimited liability

    • Workload and stress, clearly seen in case study

    • Lack of continuity, if Philipe is out and operations depend on him

    • Limited options for raising finance. There's no indication here that he needs additional finance, but if he had any cash flow problems at some point or a need for big capital spending, he can't take on investment finance

    D. Recommend whether or not phillipe should find a business partner

    • Give intro on both arguments

    • give disadvantages and advantages of sole trader (x2)

    • give disadvantages and advantages of partnership (x2)

    • Evaluate which one is your choice

    Possible advantages

    • more financial strength as a sole trader

    • more division of labor than in sole trader’s business

    • partners may bring in additional skills, expertise

    • while decision making is inevitably allowed down with multiple owners, partnership still enables faster decision making than in larger orgs, without drawbacks such as further loss of financial privacy if he were to sell shares, or further profit sharing with shareholders

    Possible Disadvantages

    • He’s run the store for 15 years, hence he may be reluctant to add another owner

    • Slower decision making than sole trader

    • each owner gives up a certain amount of control

    • Partners may have disputes

    • If he’s going to give up some share of ownerships, doing so through a partnership would give him more limited financial power than if he sold shares to multiple owners.

• Review

1.3 Business Objectives

Common business objectives:

• growth - achieving an increase in the following (market share, profit, capital employed, workforce, volume of output)

• shareholder value - what shareholders get though the company’s increase in market capitalization (dividends increase through profits)

• ethical objectives - refers to the tasks/target that go beyond profit making in line with moral behavior, sustainability, CSR

• Aims, objectives, strategies, and tactics

  Vision statement: more long-term objective and highest aspirations of a business.

  Mission statement: The things done to achieve the vision statement, aim of accomplishing that objective.

  • internal impact

    • provide stability during periods of significant change

    • set performance standards for the whole organization

    • provide employees with a focus on common goals

    • inspire employees to work more productively

    • help establish framework for ethical behavior

  • external impact

    • create goodwill and attract similar-minded individuals or groups to invest

    • create closer links and better communication with customers, suppliers, local community and shareholders

    • serve to promote the business and its operations to the general public

    • act as a marketing tool, defining what the business represents

  

  Aim, objectives, strategies, tactics.

  aims: long term goals, more specific than vision and mission statment

  objectives: medium to short term goals to clarify how the business will achieve its aim

  Strategies - medium or long-term plans, methods and approaches set to achieve goals and objectives

  Tactics - Short term or medium term actions that need to take in order to achieve objectives

  Business objectives - targets the business must meet to achieve long-term goals of a business.

  • hierarchy of objectives

    operational objectives - floor managers will determine specific objectives

    strategic objectives	Tactical objectives
    long-term objectives about the future direction of the organization	Short-term objectives to help implement the organization’s strategy
    high-risk objectives because of uncertainties	Lower-risk objectives because there is less uncertainty
    Set by senior managers	Set by employees lower in the hierarchy usually department level
    involve major capital investment or resource commitment	Fewer resource commitment
    Once implemented, are difficult and expensive to alter	Easy to change with little financial implications

  A business tactic is a plan to achieve a tactical objective to work towards the strategies of the business, which themselves are the path to reaching the aims of the business.

• Need for organization to change objectives

  A business tactic is a plan to achieve a tactical objective to work towards the strategies of the business, which themselves are the path to reaching the aims of the business.

  

  • Changes in the internal environment

    Leadership - change in leadership lead to change in objectives and aims

    HR - conditions in HR can change Organization - business organization can change (merger or acquisition)

    Product -

    Finance - when the circumstances of finance change, fewer source of finance, company have to modify strategies. ex: cost of living

    Operations - developing better methods of producing or delivering their core services

  • Changes in external environment

    social - demographic change or cultural change

    technological - changes in innovative technologies

    economic - changes in market conditions (new competitors), changes in economy (financial crisis).

    ethical - values of society changes

    political - changes in political system, carry out country risk assessment to determine the likelihood that drastic political change that could put risks in the investments or operations.

    Legal - legislation changes from one party to another, or coalition. Regulations, taxes.

    Ecological - growing environmental awareness. sustainability, green revolution

• CSR corporate social responsibility

  • Concept whereby organizations consider the interests of society by taking responsibility for the impact of their activities on various stakeholders

  • Should be sustainable for environment, social, economic

  • CSR objectives adapt and conforms to social norms

    • opinions changes overtime - “socially acceptable”

    • Societal expectations and the growing popularity of social media have caused CSR to become more integrated into today’s corporate cultures

    • CSR to have positive impact on the triple bottom line: ecological, social and economic sustainability

  • corporate citizen: acting responsibly in a manner that benefits society as a whole in all matters.

  • create a positive impact on the reputation of the organization

  • organizations sets ethical objectives

    • Ethical objectives are specific goals that a business may set for itself based on established codes of behavior

    Benefits

    • building customer loyalty, customer’s expectations for ethical behavior

    • creating a positive image, create a competitive advantage

    • developing positive work environment, attract like-minded employees and improve motivation. Staff turnover may fall and productivity may increase.

    • reducing the risk of legal redress - money that someone pays you because they have caused you harm or loss.

    • increasing profits - bank don’t lend to dubious business

    Disadvantage

    • Forced to use materials that are higher priced so may reduce profits

    • High compliance cost can reduce profits/ Compliance costs of always trying to act in a socially responsible way

    • all of this can cause conflict between shareholders

  • impact of implementing ethical objectives

    • Business itself- costs are likely to rise, practices may change

    • Competitors - competitions might respond to maintain their market position

    • Suppliers

    • local community - community can benefit in terms of employement and goodwill

    • Government - create government-business environment fostering ethical objectives

• SWOT Analysis

  tool is used for organization and its contexts. strengths and weakness are internal. Opportunities and threats are external. SWOT is meant tot be the first stage in the planning process

  • swot matrix for apple inc

    Strengths	Weakness
    Qualified professionals
    Well recognized amongst most customers
    Largest percentage of global market share in cellphone market 28.52% (
    Strong brand image which provides an edge over competitors
    Very profitable $166.816 Billion in 2023
    Focused research and development creating stylish products.
    Major increase in share value over the last 5 years.
    Effective marketing campaign
    Apple products lack compatibility with much non-Apple software.
    Limited distribution network.
    Price – other similar products are more affordable, high price compares to its competitors
    Dependence on few key products - especially the iphone models (Yahoo finance)
    Perceived as lack of innovation
    Opportunities	threats
    Strong growth in smartphone and tablet markets
    Consistent customer growth
    Expand its distribution network
    Mobile advertising market is forecast to reach approximately $240 billion by 2022
    Increased scope in the educational market
    Development of new products and product lines in online services
    Lack of green technology	Very dependent on Chinese suppliers.
    Aggressive competition from major firms like Samsung and Amazon
    Many low-cost firms imitate Apple’s products
    Rising labour costs in China
    The Covid-19 pandemic supply chains
    Counterfeits
    Market penetration
    China Tariffs

  • SWOT analysis and market position

    • Growth strategies - combining strengths with market opportunities, produce short term strategy. Business should pursue growth strategies when it is confident there are no issue in other areas.

    • Defensive strategies - adopted when biz is most vulnerable. Combine threats and weakness. They are the most “negative” short term strategies.

    • Re-orientation strategies - adopted when a business focus on addressing weakness use for opportunities in the market. Positive and long-term

    • Defusing strategies - eliminate threats in the market focusing on strengths. Does not look for new market opportunities but just defuse threats and focus on core strengths. Neutral and medium to short term strategies.

  • ISPP SWOT

    Strengths	Weakness	Opportunities	threats
    Good reputation	Expensive fees	Has opportunities to attract donors	Economic Stagnation
    IBO and student leadership	Not enough sport activities and co-curricular activities	Growth in population and economic growth 7.8%	Competitors - Kings school, CIS
    Eco-friendly, Non-profit
    High graduation

• Ansoff Matrix

  looks at growth potential of a business in terms of market and product. Tool to help business plan and set objectives. To provide a visual decision-making tool for Business Management

  There are 4 possible growth strategies, learn to draw ansoff matrix

  Holding company: A diversified business that owns a controlling interest in other diverse companies.

  

  • Market Penetration (low risk)

    Business grows by increasing its markets selling more of its existing products. seeks to maintain or increase market share (low risk) use BOGOF = buy one get one free

    • safetest option for growth, limited opportunities

    • Price adjustments, selling more existing products (use of e-commerce, opening more stores)

    • relies on promoting brand loyalty, increase of market promotion

    • Intense competition

    Can exploits on customer needs, unlikely to nod more research,

  • Market Development (Medium risk)

    Expand market by looking for new markets or new market segments in the existing markets. Eg. new geographical market, new distribution channels, different pricing policies

    Key factors to reduce the risks of market development are:

    • Effective Market research, focus on costumers needs (localization)

    • Capitalize on technology (eg. Dyson)

    • innovation to replace existing products

    • Having local knowledge on the ground

    • Having an effective distribution channel

    Existing products may not suite new markets. Saturated market - when everybody already have your product

  • Product development (Medium risk)

    Development of new products in the existing markets. Can be new products or “new” upgrades of existing products (like apple)

    • effective market research, attract new market segments

    • New distribuition channel

    • Having a strong research and development market

    • Having first-mover advantage

    Plays on the strengths of an established business, strong emphasis on market research (customer’s need), better to be first to market

  • Diversification (High risk)

    the riskiest eg Samsung . Introducing new product into new markets, combines two element of risks:

    • Lack of familiarity and experience in the new market

    • The fact that new product is untested.

    Key factors to reduce the risks of diversification:

    • Attractiveness of the market

    • costs of entering new market

    • recognition of the existing business

    Related diversification - Diversifying into business within the same industry (eg.Mcdonald and McCafe)

    Unrelated diversification - Diversifying into new industries (eg. Amazon moving to groceries)

• r paper 3 focus n ngo

  a) Define the term corporate social responsibility

  b) with reference to …, analyse the advantages and disadvnatges of ebing socially responsible

  c) Discuss why attitudes to CSR may change overtime

  d) Define triple bottom line

  A) what is the differ`ence between mission statement and vision statement

  B) what is strategic and tactical objectives

  C) Distinguish between tactical objectives and strategic objectives

• Business test answers

  B) generating positive returns on ivesntments for shareholders. This is generalliy the same thing as short-term profits. Getting value to shareholders means that the firm contunues to add value in a way thats sustainable generate positive returns

  C) answers:

  • change in managers

  • age of the firm

  • production problem/issues

  • internal innovations

  • staff turnover

  • any steeple factors and change in social preferences or demographic makeup

  D) advantages include:

  • improved csr

  • rising profitability

  • may pen new market segments

  • lower costs

  Disadvantages

  • increase cost of production

  • lack fo expertise in this area

  • lack of available materials to implement

  • possible med to partner with another organisation

  E)

  • growth: lute may want to increase its market share and reach in order to generate more profits

  • profit

  • proividing shareholder value:

  F)

  • could allow for greater efficiency gains than jjst the housing design alone

  • may lower cost of production for lute

  • mo need for coordination with another organization

  • May be less expensive because no profit sharing, fees or any other added financial constraints that come with working with another firm

  • could allow for lower up from price to customers, whereas the second option would save customers money int he long run

  • more global locations are moving towards some sort of price on carbon emissions.

  Possible reasons for establishing a relationsip with other firms

  • lute benefits from partner’s expertise

  • may save customers more money in the long run and be more environmental friendly long term

  • may be less difficult and less costly than identifying low carbon materials

  • Improve CSR image from fosuing on long terms benefits over the lifetime of its structures.

1.4 Stakeholders

• Stakeholders

  Internal stakeholders - individuals or grouos that work within the business

  External stakeholders - individuals or groups that work outside the business

  competitors are stakeholders because they can effect operations

  Market stakeholders - that the organization has a commercial relationship .

  Non-market stakeholders - stakeholders with which money does not change hands, like media or the community.

  Stakeholders are individuals, organizations or groups with a vested interest in the actions and outcomes of a specific organization

  • Mcdonald increase in price

    If increase pay

    shareholders: negative impact, increase in cost, reduced dividend payment

    Managers: increased salary, may demotivate if not increase

    employees increase wage

    customers: increase in price, lost in quality

    suppliers: negotiate prices, change suppliers

    local community: boost local economy

• Interests Internal stakeholders (employees, managers, workers)

  • Shareholders focus on returns on their investments

  • CEO or managing directors focus on coordinating the business startegies and delivering profits and returns.

  • senior managers focus on strategic objectives for their functional tasks

  • Middle managers focus on the tactical objectives for their functional areas

  • Foremen and supervisors focus on organizing tactical objectives and formulating operational objectives

  • Foremen are responsible for scheduling and coordinating and supervisor

  • Employees and their unions focus on protecting their rights and working conditions

• Interests of external stakeholders (suppliers, community, pressure groups)

  • Government focuses on how the business operates in the business environment = following labor laws

  • Suppliers focus on maintaining a stable relationship

  • Customers and consumers focus on the best product that meets their needs

  • People in the local community focus on the impact in local areas

  • Financers focus on returns in their investments

  • Pressure groups focus on how the business has impact on their area of concern

  • The media focuses on business for news stories

• Conflict of interests stakeholders

  • employees who want higher wages, ceo responsible for ensuring profits targets and return on investment ratios are met, so may be against pay rise

  • Managers may use extrinsic motivating factors, pay rise might undermines efforts to foster a culture of intrinsic motivation, extrinsic include

    • pay increases or bonuses

  • Arbitration: resolve disputes between workers and managers

    • Advantages:

    • Disadvantages: Decision is binding, no stakeholders is likely to recieve what they want

  • Workers participation: improve communication, decision making

    • Advantages: gain cooperation of workers - intrinsic motivation

    • Disadvantages: waste of time and resource to get all information

  • Profit-sharing scheme: Reduce conflict between workers and shareholders over allocation of resource and profits

    • Advantages: Sharing profits can encourage workers to work in ways to increase profits long-term

    • Disadvantages: retained profits (business net income is kept within its accounts) and/or profits paid out to shareholders unless the scheme pays off

  • Share-ownership scheme: reduce conflict between workers, managers and shareholders

    • Advantages:

    • Disadvantages:

  pressure groups: satisfied as their cause succeed, less pressure on the business

  government: more tax revenue

• Stakeholders Analysis

  

  • Decision makers try to satify those stakeholders closest to the center

  • Stakeholders mapping

    Group A: have minimal interest in the business in the business and limited power.

    Group B: for owners and managers, making them feel included is important

    Group C: Pivitol group, must be satisfied.

    Group D: most important, must consult with them before making any decisions. Business focus on their references and needs, failure to keep them satifies with result in negative consequence for the business.

    

1.5 Growth and Evolution

• impact of external environment on a business

  STEEPLE analysis - Sociocultural, Technological, Economic, Environmental (also known as Ecological), Political, Legal and Ethical.

  Examine external that influences a company, used by companies before entering foreign market

  Social mobility - changes in a person socio-economic status

  

• Economies and Diseconomies of scale

  Economies of scale - As a company increases its output the cost per unit decreases.

  • reduction in average unit cost as the business increases in size

  Diseconomies of scale - the increase in per unit production cost as output or activity increases

  • an increase in average unit cost as the business increases in size.

  Total cost of production = fixed cost + variable cost. TC = FC+VC

  • Fixed cost = cost that does not change as production change eg, rent

  • Variable cost = cost that vary as production changes.

  • further cost are known as Average cost

    Average cost = total cost/quantity produced AC = FC+VC/Q A business expand its production year on year, causing economies of scale. One reason for this is the fixed cost of rent is spread out over large number of units produced. But when it reach its maximum production level, they need additional space to expand production. When the space is doubled but production remain the asmae, the capacity utilization will decrease. The increase in rent will havea. higher average unit cost, then the business will achieve diseconomies of scale.

  

• Internal and External Economies and Diseconomies of scale

  • Internal and External Economies of scale

    Internal economies of scale

    type	Explanation
    Technical	Bigger units of production can reduce cost because of the law of variable production - the increase in variable cost spread against a set of fixed costs.
    Managerial	More managers specializing in one job as opposed to one who does everything
    Financial	Less risky, loans area easier to get. eg. Banks can charge lower rates of interests on loans or overdraft.
    Marketing	Run more effective marketing campaigns
    Purchasing	Bigger business can gain more discounts on bulk buying (buying in large quantities)
    Risk Bearing	Diversification: by producing many products, a firm can compensate for falling demand for one product by increasing output of another.

    External economies of scale

    Type	Explanation
    Consumers	the ease of one-stop shopping. So, a whole range of other businesses benefit from someone else building the infrastructure.
    Employees	Labour concentration occurs when some cities in geogrpahic areas concentrate on certain industries or sectors.

  • Internal and External Diseconomies of scale

    As a business becomes larger, it becomes less efficient, leading to a higher average cost of production (unit cost).

    Internal Diseconomies of scale

    type	Examples
    Technical	a container may be too big to berth a harbour
    Managerial	Business may have “over-specialized” managers who can’t work outside their expertise. mainly in investment and commercial banking sectors
    Financial	sometimes business have large “surplus” and make poor investments.
    Marketing	Sometimes business makes big marketing mistakes
    Purchasing	Large business often buy too much stock, which can be costly if the cost of the capital funds used to purchase the stock is greater than the cost savings from buying in large quantities
    Risk Bearing	risks bearing is the share of responsibility for accepting losses if projects goes wrong.

    external diseconomies of scale

• Reasons for business to grow or stay small

  • Reasons for business to grow

    • survival - large firms have a greate chance of surviving

    • economies of scale

    • Higher status

    • Market Leader status

    • Increased market share - large companies have a large market share and can control the market by determining prices and deciding which services.

  • Reasons for business to stay small

    Advantages of being a small business includes:

    • Greater focus

    • Greater prestige - have greater sense of exclusiveness than large businesses.

    • Greater motivation - having more prestige can motivate managers and other employees.

    • Competitive advantage- can provide more personalized service and be flexible

    • Less competition

• Decision trees

  help simplify complex decisions. Follows certain conventions, give options: profitability of success: expected return

• Difference between internal and external growth

  Internal Growth = organic growth happens slow and steady

  • sells more of its product

  External Growth is quicker and riskier method of growth than internal growth. Requires external financing, can increase market share and decrease competition very. quickly.

  The business expands by entering some type of arrnagment to work with another business such as:

  • merger and acquisition (M&A)

  • Takeover

  • Joint venture

  • strategic alliance

  • Mergers & Acquisition

    when two businesses become integrated, either by joining together and forming a bigger combined business (merger) or when one business takes over another (acquisition).

    when the acquisition is unwanted by the company being acquired, the term is takeover or hostile takeover (can only be done by publicly held companies)

    • Horizontal integration = two business are in the same sector, same line of production, same chain of production. When this occurs, the business will have greater market share and market power. often can take advantage of economies of scale

    • vertical integration = when business integrates with one at a different stage in the chain of production thta is up or down stream in the same secotr

      • Backwards vertical integration - If a purchaser buys a company in the earlier stage in the chain of production. usually occur when a business want to protect its supply chain production

      • Forward vertical integration - If the purchaser buys a company further stage in the chain of production

    • Conglomeration (diversification) = when two business in unrelated lines integrate, mainly to reduce overall corporate risk or to have complementary seasonal activity

  • Joint Ventures

    Occurs when two business agree to combine resources for a specific goal over a finite period of time (a partnership). A separate business is created with funding by two “parent” business. After the period is over, the business is either dissolved or incorporated into one of the parent business. Benefit from the sharing of skills, knowledge, expertise. The businesses enjoy from greater shares.

    Divest (sell off) upstream and downstream

    • examples: Uber-Volva

  • Strategic Alliances

    Business collaborating for a business goal. The more business are involved, the harder it is for coordiantion. eg. strategic alliance

    • More than 2 business can be part of an alliance

    • No new business is created: no new legal entity is created

    • Individual businesses in the alliance remain independent.

    • Strategic alliances are more fuid than joint ventures: membership can change without destroying an alliance

    • Advantages

      • Businesses in SA retain their individual corporate identities without the expense of establishing a new company with its own legal status

      • Similar to joint ventures, strategic alliance fosters corporation instead of competition

      • Greater flexibility with SA than JV cuz membership can change without having to terminate the coalition

      • More straightforward to terminate SA than JV

    • Disadvantages

      • Many of SA is in a strategic alliance

      • Can have many members so the organization is exposed to potential misconduct of members of the firm

  • Franchises

    is a form of external growth, expanding locally or globally. There are two cost: franchisees must pay for the franchise itself and pay royalties (a percentage of sales or flat fee) that goes to the franchisor. For small franchisor there are less bargaining strength when setting the rights and responsibilities. Selling franchises is an easy and fast way to break into new markets with a minimum of difficulty and risk, and it is a way to gain an advantage over its competitors.

    • The franchiser developed the business concept and product or services then sells it to other businesses that want to offer the same concept and sell the product or service.

    • The franchisees buys the right to offer the same concept and sell the product or service.

    

    • Advantages to the franchisees

      • The product is usually well-known

      • The format for selling the product is established

      • The set-up costs are reduced because don’t have to cover the cost for investing

      • The franchise have a secure supply of stocks

      • The franchisor can provide legal, fnancial, managerial, and technical help.

    • Disadvantages to the franchisses

      • Has unlimited liability for the franchise

      • has to pay royalties to the franchiser

      • has no control over what to sell

      • has no control over supplies

    • Advantages to the franchisor

      • Gain quick acsess to wider markets

      • Make use of local knowledge and expertise

      • does not assume the risks and liability of running the franchise

      • gain more profits and sign up fees

      • makes all of the global decisions

    • Disadvantages of the franchisor

      • Loses some control in the day-to-day running of the business

      • can see its image suffer if a franchise fails or does not perform properly

• R

  1. State features of an acquisition

  2. Distinguish between economies of scale and diseconomies of scale

  3. Define internal economies of scale

     occur for a particular organization (rather than the industry as a whole) as it grows. These cost savings are generated within the business by operating on a larger scale.

  4. Explain why a company grew and why it should’ve remain small

1.6 Multinational Companies (MNCs)

• Globalization

  Globalization is the process by which the world’s regional economies are becoming one intergrated global unit. Current globalization is being characterized by a relatively small number of extremely large “post-national” businesses. Globalization can have a significant impact on the growth of domestic businesses for the following reasons: eg. silk road, age of exploration,

  • Increased competition: large foreign businesses can force domestic producers to become more efficient as the domestic consumer has more choice.

    • greater efficiency can be lower costs of goods and services for consumers. Businesses become more efficient by slowing the growth in wages of its workers to get more productivity. increase productivity by upskilling

  • Greater brand awareness: domestic producers have to compare with big names so they need to crate their own unique selling point (USP). They can do this by emphasising on local national origins compared to “foreign” products sold by multinationals and global firms.

  • Skill transfer: foreign businesses must use some local knowledge: at least some of the workforce must be local which lead to a two-way transfer of knowledge and skills.

  • Closer collaboration: joint ventures, franchises or strategic alliances, domestic producers can create new businesses opportunities.

• Reasons for growth of multinational companies

  A multinational company is a business that operates in more than one country or is legally registered in more than one country. “Multinational” suggests that a company is global or open in many countries, but that is not always the case. 4 factors that have allowed multinational companies to grow rapidly:

  • Improved coms: not only ICT but also transport and distribution networks

  • Dismantling of trade barriers: allowing easier movement of raw materials, components and finished products

  • Deregulation of the world’s financial markets: allowing for easier transfer of funds as well as tax avoidance. eg: facebook make their EU quarter in Ireland because of its low corporate tax (only 10%)

  • Increasing economic and political power of the multinational companies: can bring enormous benefit, especially middle and low-income countries.

• Impact of multinational companies on the host countries

  advantages for the host country includes:

  • economic growth: boost domestic economy by providing employment, developing a local networks of suppliers, and paying taxes and providing capital injections. Multipliers effect: the effect on national income and product of an exogenous increase in demand.

    • tax increases GDP

    • VAT

  • New ideas: multinational companies may introduce new ways of doing businesses and new ways of interesting social.

  • Skills transfer: may help develop the skills of local employees. Domestic businesses can benefit from starting their own business with the skills learned.

  • Greater choice of products: domestic market will benefit as the variety of products will increase.

  • Short-term infrastructure projects: multinational companies often help build infrastructure (eg. road to the factory, schools for workers’ children)

  Disadvantages:

  • profits being repatriated: the multinational companies may pay into the local tax system, but the bulk of their profits will be rerouted away from the host. eg. ham to sweden

  • Loss of cultural identity: cultural norms, domestic products may suffer. younger generations most likely to buy global brands.

  • Brain drain: many highly skilled employees may look to work for the multinational company in another country. work oversees

  • loss of market share: as mc take over more of the domestic market,domestic products may suffer.

  • short-term plans: mc may not intend to stay for a long time - if lower cost producers can be found elsewhere, they may move out at short notice.

• Franchise

Finance and Accounts

3.1 Introduction to Finance

all forms of business organziation need funding or finance for various activities they undertake. The role of finance for businesses can be categorise as either capital expenditure or revenue expenditure.

Capital expenditure

Fixed Assets: This money spent to acquire items in a business that will lasy for more than a year and may be used over and over again. eg. machinery, land, buildings, vehicles and equipment. (last more than one year)

Due to high initial cost, most fixed assets can be used as collateral (financial security pledged for repayment of a particular source of finance such as bank loans)

Capital expenditure are long term investments intended to assist businesses to succeed and grow.

Revenue expenditure

Money spent on the day-to-day running of a business. These payments or expenses include rent, wages, raw materials, insurance, and fuel. Don’t involve purchase of longer term, fixed assets. Funds for RE must be available immediately, unlike CE which has long-term focus.

Business need to be cautious not to have consistently high revenue expenditure becasue hardd to build sufficient capital required for long-term investments.

r: why an understanding of both capital expenditure and revenue expenditure would be beneficial.

Capital expenditures are typically one-time large purchases of fixed assets that will be used for revenue generation over a longer period. Revenue expenditures are the ongoing operating expenses, which are short-term expenses used to run the daily business operations.

3.2 Sources of Finance

• Internal source of finance

  Money obtained from within the business and is easier to access by business that are already established.

  • Personal funds

    key source of finance for sole traders and mainly comes from personal savings. By investing with personal savings, sole traders maximize their control over the business. their investment shows commitment tot h investor or financial institution.

    Advantages

    • The sole trader knows hm money is available to run the business

    • It provides the sole trader with much control over finance. Also mean don’t need to pay the funds back or reply an outside investors or lenders who could decide to withdraw their support at any time.

    Disadvantages

    • poses a large risk to the owners of sole traders because they could be investing their life savings, hence put strain on family or personal life.

    • If the savings are not sufficient it may prove difficult to start or maintain a business, especially if this is the only source of funding.

  • Retained profit (Ploughed-back profit)

    profit that remains after a business (profit-making entity) has paid out dividends to its shareholders. May be reinvested into the business for growth purposes, can be considered the most important long-term sources of finance

    Advantages

    • Cheap, no incur interest charges like bank loans do

    • permanent source, no repay

    • Flexible can be used in any way the busienss deemed fit

    • owners have control over their retained profits without interference from banks

    Disadvantages

    • Start-up have no retained profit since they are new ventures

    • If retained profit too low, not sufficient for growth or expansion

    • High retained profit may mean

    For non-profit businesses, money remained is referred to as “retained surplus”

  • Sale of assets

    when businesses sells off its unwanted or unused assets to raise funds. Assets no longer required for business to incldue obsolete machinery or redundant buildings.

    Advantages

    • This is a good way of raising cash from capital that is tied up in assets which are not being used.

    • No interest or borrowing costs are incurred

    Disadvantage

    • This option is only avaliable to established businesses as new business as new businesses may lack excess assets to sel

    • It can be time-consuming to find a buyer for the assets, especially for obsolete machinery

    Businesses adopts a sale and leaseback approach which involve selling an asset that the busines still needs to use.

• External source of finance

  External finance is obtained outside the business usually from financial instituition or individuals. Some of these external sources are:

  • Share capital ()

    Equity capital: money raised by investors for shares/stocks. shareholders have dividents when profits are made.

    Authorized share capital: the maximum number of shares a company is legally allowed to issue or offer based on its corporate charter.

    Public limited company sell shares on stock exchange: regulated and organized market where securities are purchased and sold to investors.

    Advantages:

    • Permanent source of capital

    • no interest payments which relieve business from additional expenses

    Disadvantages

    • Shareholders expect dividends when business make profits

    • for public limited companies, the ownership of the company may be changed from original shareholders to new ones via stock exchange.

  • Loan Capital (loan capital)

    Debt capital: the capital that a business raises by taking out a loan. repayments (installments) are usually spread evenly until the full loan amount (principle plus interest)

    Advantages

    • loan capital is accesible and can be arranged quickly

    • repayment is spread out over a predetermined period of time reducing the burden to the busines sof having to pay full in one period.

    • Large org. can negotiate for lower interest rates depending on the amount they want to borrow

    • owners have full control is no shares are issued to dilute their ownership

    Disadvantages

    • Capital will have to be redeemed even if the business is makign a loss

    • collateral (security) will be required before any funds are lent

    • failure to repay the loan may lead to the seizure of a firm’s assets

    • If variable interest rates increase, a foirm has a variable rate loan may be faced with a high debt repayment burden

  • Overdrafts (short-term loan)

    Overdrawing from the account: Lending institution allows a firm to withdraw more moeny that it currently has in its account. Interest charged on the amount overdrawn that exceed the limit set (may attract higher additional costs)

    Advantages:

    • provide opportunity for firms to spend more money than thye have, help settle short-term debts

    • Flexible as demands iwll depends on the needs of the business ay a particular point in time.

    • Charging interest on the amount overdrawn can make it a cheaper option than loan capital

    Disadvantages;

    • banks can request overdraft to be paid at a very short notice

    • Bank can charge higher itnerest rate

  • Trade credit (long-term)

    Agreement between business an arrangement to buy goods and/or services on account without making immediate cash or cheque payments.

    Advantages

    • By delaying payments to suppliers, biz have better cash flow position

    • interest-free means raising funds for the length of the credit period

    Disadvantages

    • debtors (trade credit receivers) lose out on the possibility of getting discounts had they pucheshed via paying cash

    • Delaying payment to creditors or suppliers afetr the agreed period may lead to poor relations.

  • Crowdfunding

    Business venture or project is funded by a large number of people contributing a small amount of money. makes use of networks who can be acessed primaly thru crowdfunding websites or social media. eg. Indiegogo, kickstarter

    advantages:

    • provides acess to throusands of investors who can interact with and share a project’s fundraising campaign

    • It is a valuable form of marketing - media attraction

    • provides oppetunity for feedback and expert guidnace

    • Business still maintains full control and won’t have to forfeit control when raising funds.

    • Good alternative finance option as it provides another pathway to business who struggle with bank loans or traditional funding.

    Disadvantages

    • Have strong competition

    • Subject to thorough scrutiny and rejection. SOme paltform (eg. kickstarter) have very detailed rules on what is allowed and what not

    • fees need to be paid. Many paltform takes a percent of the contribution riased. fees are usually minimal but can reduce amount of moeny the project get.

    • potential risk of failure. If fail, hard to recover.

  • Leasing

    where the business (lessee) enters a contract with a leasing company (lessor) to acquire or use particular assets such as machinery, equipment or property. This allows a firm to use an asset without having to purchase it with cash. Business get into a finance lease agreemen, where the end of the leasing period, they are given the option of purchasing the asset.

    Advantages

    • A firm does not need to ahve a high initial cpaital outlay to purchase the asset

    • The lessor takes on the responsibility of repair and maintenance of the asset

    • Leasing is useful when particular assets are required only ocassionally or for short period of time

    Disadvantages:

    • Leasing can turn to be more expensive tham the outright purchase of an asset due to accumulated total costs of the leasing charge

    • A leased asset cannot act as collateral for a business seeking a loan as an additional source of finance.

  • Microfinance providers (short term)

    Offers banking services to low-income or unemployed individuals or gorup who would otherwise have no access to financial services. These include small businesses that lack access to conventional banking services. Microfinance can include microcredit, which is a provision of small loans to poor clients.

    The ultimate goal of microfinance is to reach excluded customers and provide them with an opperunity to become self-sufficient.

    Advantages:

    • Most microfinance institutiions do not seek any collateral for providing financial credit

    • Provide or disburse loans quickly and with less formalities to individuals, groups or small businesses, can meet financial emergency.

    • extensive portfolio of loans, including work capital

    • promote self-sufficiency and entrepreneurship

    Disadvantages:

    • Microfinance institutions can adopt harsh recovery methods int he event of a default if the customers don’t have legal representation.

    • offer smaller loan amounts or financial capital than other financial institutions that provide much larger amoutns

    • interest rates are high cuz they dont operate the same way as traditional banks that find it easy to accumulate funds

  • Business angels

    Also angel investors, affluent individuals who provide financial capital to small start-ups or entrepreneurs in return for ownerhsip equity in their business. They invest in high-risk biz that show good protential for high returns or futrue growth

    Advantages

    • More open to negotiations because they are usually sucessful entrepreneurs who understand the amount of risk involved with establishing a business

    • no repayment and interest required. They fund for an exchange of ownership stake in the business

    • offer valuable knowledge by using their extensive experience coupled with good financial capital

    Disadvantages

    • angels may assume a large degree of control or ownership in the biz they invest in, therefore diluting the ownership fo the entrepreneurs

    • they expect substantial return on their investment within the first few years, sometimes equal to 10 times their original investment. can create additional pressure

• Short and long term finance

  Short term finance: money needed for day to day running of a business and provide required working capital. external short term fianncing is usually expected to be paid back after 12 months or less. eg. bank overdrafts, trade credit, short-term loans

  Long term finance: funding obtained for the purpose of purchasing long-term fixed assets or other expansion requirements of a biz. normally used to improve the overall biz. External long-term fiannce have span of more than one year to pay it back. eg. long-term bank loans, and share capital.

• Factors influencing the choice of a source of finance

  • Purpose or use of funds

  • Costs: costs include interest payments, administration costs and cost associated with share issue. Oppertunity cost

  • Status and size: Public limited company have more options like issuing shares than sole traders. Large organization have collateral that can be used to negotiate lower interest rates.

  • Amount required: for small amounts, firm consider short term sources. For larger amounts, use long-term finance.

  • Flexibility

  • State of the external environment: eg. interest rates or inflation (persisittent increase in average price of an economy) can effcet purchasing decisions.

  • Gearing: refer to the relationship between shared capital and loan capital. High gearedIf a company ahve large proportion of loan capital to share capital. Low geared: smaller proportion of loan capital to share capital.

    • high geared business are viewed as risky by financial instituitions.

    • measure grear by calculating gearing ratio.

• r

3.3 Costs and Revenues

• Costs: an expenditure or amount paid to produce or sell a good or service, including the acquisition of business resources

• Revenue: Income earned or money generated from sale of goods or services

• Profit: calculated by subtracting costs from revenue. High positive difference (revenue is higher than costs) is a good indicator of bsuiness success.

• Types of Costs

  • Fixed costs and Variable cost

    Fixed cost: costs that don’t change or vary with the amount of goods or services produced. mostly time related and usually paid per month, per quarter, bi-annually or per year. eg. rent, insurance, salaries and interest payments, utility bills

    • insurance for business: health insurance, building insurance, theft insurancee

    Variable costs: Costs that vary or change according to the numebr of goods or services produced. Volume related and paid per quanitty produced. Can incurred both in the short run or in the long run. eg. Raw material costs, sales commissions, packaging and energy usage costs.

  • Direct cost and Indirect costs

    Direct costs: costs that can be identified with or attributed to the production of specific goods or services. They are expenses that can be traced directly to a particular product, department or process (aka cost centres). eg. cost of materials, cost of labour, packaging costs.

    Indirect costs: Expenses that are not directly tracable to a given cost centre such as a product, actviity or department. Difficult to assign to particular cost centres. eg. rent, staff salaries, audit fees, legal expenses, insurance, advertising expenditure, security, interest on loans and warehouse costs.

  • Total Revenue

    Total revenue = price per unit x quantity sold

    other streams of revenue include:

    • rental income - business could receive income from rent it collects property it has invested in.

    • Sale of fixed assets - this could be from the sale of unused or underutilized assets in a buisness

    • Dividends - business could be a shareholder in other businesses and is entitled to a share of the profits

    • Interest on deposits - holding substantial amounts of cash in the bank elad to a business earning good levels of accumulated interest on the money if interest rates are favourable.

    • Donations - could be cash gifts made by an individual or organizaition targeting mostly charitable organization.

• Contribution: Absorption costing

  providing a platform where various cost situations are analyzed and evaluated. Absorpotion costing (aka full costing) is a mangerial accounting method that captures all costs associated with producing a given product.

  • how does absorption costing differ from variable costing

  • what are advnatages and disadvanatges of absorption costing in accounting

• Descriptive statistics

  involve the use of statistical data and they help to present large amounts of data

• test

  memorize table on 175

  be able to write thay out for memory 178=179

3.4 Final accounts

• Purpose of accounts to different stakeholders

  Shareholders: interested in knowing how valuable the business has become throughout the financial year. Keen to know how profitable the business is before investing. want to know the dividends

  Managers: final accounts are used by managers to set targets which they can use to judge and compare their performance within a particular financial year. Help with setting budgets and controlling expenditure patterns.

  Employees: signal to to the employee that their jobs are secure, indicate that they could get pay rise.

  Suppliers: use final accounts to negotiate better cash or credit terms. can either extend trade credit periods or demand immediate cash payments. Security of a buisness relies of their ability to pay off debts.

  The government and tax authorities: check whether business abide by law regarding accounting regulations. Interested int he profitability of the business to see hm tax it pays

  Competitors: Want to compare financial statements with other firms to see how they perform financially.

  Financiers: Bank check the creditworthiness of the business to establish hm money they can lend.

  Local community: residents near want to know the profitability and expansion potential. Can create job oppertunities for them and lead to growth in the community.

• The main final accounts

  Income statement shows the record of income and expenditure flows of a business over a given time period. Divided into three parts: trading accounts, the profit and loss account and the appropriation account.

  The Trading account

  • Gross profits = sales revenue - cost of sales

  • Net profit reflects the amount of money you are left with after having paid all your allowable business expenses, while gross profit is the amount of money you are left with after deducting the cost of goods sold from revenue.

  Sales revenue is the income earned from selling goods or services over a given period. COGS (cost of goods sold) is the direct costs of producing or purchasing the goods that were sold during that period.

  • Cost of sales = opening stock + purchases - closing stock

    • Opening stock - stock of raw materials at the start of trading period

    • closing stock - cost of stock at the end of trading period

  • stock is material to be using

  • The profit and loss statement

    Second part before the income statement shows the profit b efore interest and tax, profit before tax, profit before period.

    • profit before interest and tax = gross profit - expenses

    • profit before tax = profit before interest and tax - interest

    • profit before period = profit before tax - corporation tax

  • Appropriation account

    final part of the profit and loss account that shows how the company profit for the period is distributed. Two form of distribution: dividends to shareholders or retained profits

    • retained profits = profits for period - dividends

    for non-profit entities, surplus is used instead of profits. The organization is exempted from corporation tax and nothing is deducted from the surplus before tax to get surplus for the period. No dividends are paid so the surplus for period is also the retained surplus.

  • The balance sheet (Statement of financial position)

    statement of financial position, outlines the assets, liabilities, and equity of a firm at the specific point in time. → Shows the financial position of a firm and calculate firm’s net worth. The balance sheet represents a valuation of the firm’s assets and liabilities at a particular time – a snapshot of the business’s wealth.

    Basic requirement for balance sheet is total assets (what the business owns) and total liabilities (what the business owes) plus hwo the assets are equity (financed). Three main components: assets, liabilities and equity

    • For a balance sheet to balance, a firm’s net assets should equal its equity.

• Assets, Liabilities and Equity

  Non-current assets are called fixed assets are long-term assets that last in a business for more than 12 months. Eg. buildings, equipment, vehicles and machinery. These usually depreciate, the accumulated depreciation is deducted from the non-current assets.

  Current assets are short term assets that last for up to 12 months.. include

  • cash is money received from the sales of goods and services, which could be held at bank or by the business

  • debtors are individuals or other firms that bought goods on credit and owes the business money

  • stock (inventory) includes raw materials, semi-finished goods and finished goods.

  Total assets = non-current assets + current assets

  Liabilities

  firm’s legal debt or what it owes to other firms, institution or individuals.

  • Non current assets (long term liabilities) are long term debts or borrowing payable after 12 months by the business. Include long term bank loans and mortgages

  • Current liabilities (short term) debt that are payable by the business within 12 months. Include creditors, bank overdraft and tax.

  • non current liabilities are payable after a year, while current laibilties are payable within a year

  Total liabilities = current liabilities + non-current liabilities

  Net assets = total assets - total liabilities

  Equity

  refers to amount of money that would be returned to a business if all of the assets were liquidated. Liquidation is a situation where all of a firm’s assets are sold off to pay any funds owing. Two aspect to equity: share capital and retained earnings. But for non-profit, only one aspect of equity (retained earnings)

  • Share capital: original capital invested into the business through shares bought by shareholders. Permanent source of capital and does not include the daily buying and selling of shares in a stock exchange market

  • Retained earnings: current and prior retained profits or retained surpluses.

  Equity = share capital + retained earnings

  Equity = retained earnings

  Net assets = equity

• Intangible Assets

  • non physical in nature, do not have physical value

  Patents: is an intellectual property that provide inventors withe exclusive rights to manufacture, use, sell, or control their inventions of a product. Inventora are provided with legal protection that prevents others from copying their ideas.

  Goodwill: refers to the value of positive or favorable attributes that relate to a business. Includes good customer base and relations, strong brand name, highly skilled employees etc. Usually arise when one firm is purchased by another. During acquisition, goodwill is valued to the amount paid by the purchasing firm. eg. customer loyalty, brand reputation

  Copyright laws: provide creator with exclusive rights to protect the production and sale of their artistic or literary work.

  Trademarks: a sign that officially registered that identifies a product or business. Help distinguish one firm over another. Anyone who infringes trademark can be sued by trademarks owners. could be a symbol

• Depreciation (HL)

  The decrease in value of a non-current asset over time. It is a non-cash expenses that is recorded in the profit and loss account in order to determine the profit before interest and tax two reasons why assets depreciate are:

  • Wear and tear - repeated use of non-current assets such as cars or machinery cause them to fall in value.

  • Obsolescence - existing non-current assets fall in value when new or improved versions are introduced in the market. “old” asset can become obsolete or out of date.

  Formula: Annual depreciation = original cost - residual value/ expected useful life of asset

  • Straight line method

    spreads out the cost of an asset equally over its lifetime by deducting a given constant amount of depreciation of the asset’s value per annum. requires the following in its calculations

    • expected useful life of the asset

    • original cost of the asset

    • residual, scrap or salvage value of the asset

    Formula = cost of the asset – estimated salvage value) ÷ estimated useful life of an asset

    Salvage value is the amount an asset is estimated to be worth at the end of its useful life

    Advantages

    • simple to calculate as it is predictable expenses that is spread over a number of ueaars

    • suitable for less expensive items

    Disadvantages

    • not suitable for expensive assets such as property/land and machinery since it does not cater for the loss in efficiency or increase in repair expenses over the useful life of the asset

    • can inflate the value of some assets which may have lost the greatest account of value in their first or second years

    • does not take into account the fast changing technological environment that may render certain fixed assets obsolete very quickly

  • Units of production method

    called the units of activity method, calculates the depreciation of the value of an asset based on usage. Assumes that an asset’s useful life is more closely related to its usgae than jsut the passage of time. The following information are needed to calculate the depreciation using the units of production method:

    • cost basis of the asset. The cost basis of a non-current asset is the total amount paid to acquire the asset for use in the business.

    • Salvage value of the asset: the estimated value of the asset if it were sold at the end of its useful life

    • Estimated total number of units to be produced. The wear and tear on the machinery is the result of the number of untis it is expected to produce over its useful life.

    • Estimated useful life: The length of time an asset is expected to be used before it wears out and need to be replaced

    • Actual units produced: The number of units an asset produce during its current year.

    • equation

      

    • If calculated from july to december, use 6/12 then multiplied by the equation

    • Advantages of using units of production depreciation

      • Depreciation expense is tied to the wear and tear on the asset, this method writes down an asset based on its usage as opposed to time.

      • It accurately matches revenue and expenses. This method is based on asset usage, important to note that the expenses fluctuates with customer demand. Tjis allows revenues generated to be matched to expenses when producing financial statements.

    • Disadvantages of using units of production depreciation

      • Only useful to manufacturers or producers. Makes little sense to tie depreciation to asset usage if a business does not manufacture or produce a product

      • Method is not allowed for tax purposes. Cannot be used when a business computes its tax returns at the end of the year.

      • Can be complicated to compute the units of depreciation. Measuring output can be tricky and depreciation expense must be recalculated each period.

• Review

  

  

3.5 Profitability & liquidity ratio analysis

Ratio analysis is a financial tool used in the interpretaton and assesment of a firm’s financial statements. Two type of ratio: Profitability and liquidity ratios. test mainly on this

• help evaluate the firm’s financial performance (strengths and weaknesses)

• aids in decision making by making inter-firm comparisons through past ratios and ratios of other businesses.

• the use of profitability and efficiency ratio analysis enables managers and decision makers to analyse and judge the financial performance of a business.

• Profitability ratios

  Assess the performance of a firm in terms of profit-generating ability. Two types: gross profit margin and profit margin

  • Gross profit margin

    

    Possible strategies to improve gross profit margin

    • A firm can increase prices for products in markets where there is less competition or markets where consumers are less sensitive to price changes.

      • can increase sales revenue in markets that have very few substitutes.

      • Drawback: can damage the image of the business with loyal consumers.

    • Business can source cheaper suppliers of materials in order to cut down on its purchase costs.

      • can reduce the cost of sales and increase the gross profit margin

      • Drawback: business need to be careful not to compromise the quality of the material bought, which can lead to customer resentment

    • A firm can adopt more aggressive promotional strategies that could persuade customers to buy its products.

    • A business can reduce direct labour costs by ensuring that its staff are more productive or able to sell more. Unproductive staff may need to be shed.

      • However, care should be taken not to demotivate or reduce the morale of the remaining staff.

  • Net Profit margins

    Measure a firm’s overall profit as a percentage of its sale revenue. It is also an indicator on how the business manage its indirect costs

    Profit margin = (profit before interest and tax/ sales revenue) x 100

    A high profit margin could mean that a firm is meeting its expenses very well; low profit margin indicates difficulties in controlling its overall costs.

    Additional strategies to improve profit margin:

    • Firm can check indirect costs to see where unessesary expenses could be avoid.

      • eg, reducing expenditure on expensive holiday packages for senior managers. But this could demoralize the managers who have been used to expensive holidays

    • Could negotiate key stakeholders with the aim of cutting costs.

      • eg. Landlords for cheaper rent or with suppliers for product discounts. But can lead to firm moving to another location that is less than ideal.

  • Return on capital employed (ROCE)

    Capital employed = non-current liabilities + equity

    capital employed could be share capital

    ROCE = (profit before interest and tax/capital employed) x 100

    The higher the ROCE, the greater the return business gets from their capital employed.

    ROCE is important because it analyze and judges how well a firm is able to generate profit from its key sources of finance.

    Possible strategies to improve ROCE

    • firm should try to produce the amount of long term loans while still ensuring that profit b interest and tax remains unchanged or does not fall.

      • Problem is long term laons may be needed to purchase essential fixed assets such as machinery (aid in production of goods)

    • A firm could declare and pay additional dividends to shareholders, this will have the effect of reducing the retained profits, hence raising the ROCE (assuming profit before tax and interest remain unchanged or does not decrease).

      • Drawback is reducing retained profits leads to less ploughed-back profit for future investmnet

      • Ploughed-back profit: not distributing all the profits to the shareholders and investing some profit back in the business

• Liquidity ratios

  These ratio measure the ability of a firm to pay off its short-term debt obligations. Business need sufficient level of liquid assets to help them pay their day-to-day bills

  • Liquidity measure how quickly an asset can be converted into cash

  • Liquid asset include cash, stock and debtors can be quickly turned into cash.

  • Current ratio

    compares a firm’s current asset to its current liabilities. Calculate the ability a firm is able to meet its short-term debts

    Current ratio = current assets/current liabilities

    Many recommend a range of 1.5:2. → allow for the availability of sufficient working capital to pay off the short term debts of the business.

    Current ratio of 1:1 means that the current assets are less than the current liabilities, which can put the firm in financial difficulties when it comes to paying creditors.

    The higher the ratio means more money is tied in liquid assets

    A high current ratio should also be avoided since it could mean:

    • There is too much cash being held and not being invested. → could be used to purchase non-current assets

    • There are many debtors, increasing the possibility of bad debts

    • Too much stock is being held, leading to high warehouse storage costs.

    Possible strategies to improve current ratio

    • firm could reduce bank overdrafts and seek long-term loans.

      • helps reduce current liabilities and hence improve current ratio

      • But increasing long-term loans could increase the interest payable and the gearing ratio (compare company debt to some form of its sharing capital or equity) of the business

    • Sell existing long-term assets for cash

      • increase the available working capital fro the business

      • Disadvantage is if the long-term assets are needed back, the business will have to lease them (costly).

  • Acid test (Quick) ratio

    more stringent indicator of how well a firm is able to meet its short-term obligators.

    Acid test ratio = (current assets - stock)/current liabilities

    • Answer type: for every $1 of current liabilities, the business has $1.4 of current assets less stock.

      Ratio indicates to creditor how much of a firm’s short-term debts can be met by selling its liquid assets at short notice. Acid test ratio less than 1:1 indicates the business is not well→ might face liquidity crisis (inability to pay short term debts)

    Possible strategies to improve the acid ratio test

    • Sell off stock at a discount for cash

      • help improve liquidity position of the business and make working capital avaliable to pay off its short-term debts.

      • selling stock at a discount could reduce the revenue generated fromt he sold stock

    • Firm could increase the credit period for debtors to enable them to purchase more stock on credit

      • Drawback: is that it may lead to increased bad debts in the business if the debtors do not pay.

  • Review

    • Ratio analysis is a financial analysis tool that assesses a firm’s financial statements and aids its decision making. It makes meaningful historical inter-firm comparisons through analysisng past ratios and ratios of other businesses.

    • profitability ratios asses a firm’s ability to generate profit include gross profit margin, profit margin and ROCE

    • liquidity ratios measure the ability of a firm to pay off its short-term debt obligations. eg. current ratio and acid test ratio.

3.6 Efficiency Ratio Analysis (HL)

Efficiency ratio is used by managers and other decision maker to ensure how well as resource of a buisness is used in order to generate income for the firm capital. Efficiency ratio examines the firm’s resources in terms of its assets and liabilities.

• Stock turnover ratio

  measure how quickly a firm’s stock is sold and replaced over a given period for days. shows the number of times the stock is sold and replenished.

  stock turnover ratio (Number of times) = cost of sales/average stock

  Average stock = (opening stock +closing stock)/2

  another approach in calculating stock turnover to consider the number of days it takes to sell the stock.

  stock turnover ratio (number of days) = (average stock/cost of goods sold) x 365

  The higher stock turnover in terms of number of times is preferrred by a business - or a lower stock turnover ratio (in number of days)

  A higher stock turnover ratio means that the firm sells stock quickly, thereby earning more profit its sales. Stock turnover ratio help assess the effectiveness of working capital management. The faster the business turns over its stock the better.

  • Business that sells perishable goods rely on high stock turnover rate because any unsold stock cannot be stored so they need to be disposed of.

  • Business like online platforms, insurance companies etc, the stock turnover ratio is less relevant because they do not need to hold any stocks for sale

  Possible strategies to improve stock turnover ratio

  • Slow-moving or obsolete goods should be disposed of,

    • help reduce the firm’s level of stock.

    • Drawback: Could lead to losses due to the lost sale revenue thatr these goods could have generated

  • Firms have a wide range of products, need to have narrower better-selling range of products.

    • Drawback: may minimize the variety of products offered to consumers.

  • Keep low level of stock will reduce cost of holding stock.

    • Drawback: sudden increase in demand for goods by consumers, business with low level stock may not have sufficient amount to sustain the market.

  • Sometime firm adopt the just-in-time (JIT) production method = stock and material are ordered only when they are needed

    • Drawback: if there are any delays in delivery of raw material to producers could effect production and eventually sales.

• Debtor Days

  Means the number of days it takes on average for a firm to collect its debt from customers it has sold goods to on credit. The ratio is refer to as debt collection period = assesses how efficient a business sis in its credit control systems. measure the average collection period for a business. effective credit control is important for a business to control its cash flow and liquidity position.

  Debtor days ratio (Number of days) = (debtors/total sales revenue) x 365

  The shorter the debtor days, the better it is for the business because it provides the business with working capital to run its day-to-day operation and it can also invest this money in other projects. High debtor days mean the customer is given more credit than the firm could afford

  Trade credit period is given to customers varies from biz-to-biz and could range from 30-120 days. Allowing long trade credit period can lead to serious cash flow problem for the business and a liquidity crisis.

  Possible strategies to improve debtors days

  • provide discounts or incentives to encourage debtors to pay their debts earlier

    • Drawback is that the business received less income from the customers that was originally agrees.

  • Could impose stiff penalties such as fines for late payers

    • Drawback: they might lose long-term loyal customers

  • Firm could stop any further transactions with overdue debtors until payment is finalized.

    • Drawback: does not guarantee payment although some debtors may opt to seek alternative suppliers for their goods

  • Business can resort to legal means, such as court action for consistently late payers.

    • Drawback: May harm the reputation that a business has with its customers

• Creditor days

  This ratio measures the average number of days a firm takes to pay its creditor → assess how quickly a firm is able to pay its suppliers.

  Creditor days ratio (number of days) = (creditors/cost of sales) x 365

  High creditor ratio enables the firm to use available cash to fulfill its short term obligations. Allowing this period to extend too long may strain the firm’s relation with its supliers leading to future financial problems. Other stakeholders such as investors may perceive this as a firm in financial trouble and may reconsider investing in it.

  Possible strategies to improve the creditor days ratio

  • Having a good relationsjip with creditors such as suppliers may enable a firm to negotiate for an extended credit period.

    • Drawback: some suppliers could object to the extension and refuse to support the business in the future

  • Effective credit control will improve the creditor days ratio. Managers need to assess the risks of paying creditors early versus how long they should delay in making their payemnt.

    • Drawback: may not be an easy task and will depend on cashflow position and needs of business at that time.

• Gearing ratio

  measures the extent to which the capital employed by a firm is financed by loan capital or nay external source of finance. Loan capital is a non-current liability in the business, while capital employed includes loan capital, share capital and retained profits. → help assess the level of debt a business is burdened with.

  Gearing ratio = (loan capital/capital employed) x 100

  A business is considered high geared if their ratio is over 50% and low geared if below 50%. High geared is viewed as risky by financiers. May not foresee anu future dividends payments due to the fact that the main obligation of these firms is to pay their long term loans.

  Low geared business may be viewed as “safe” and may in fact not be borrowing enough to fund future growth and expansion initiatives. Shareholders see business as minimal returns.

  Possible strategies to improve the gearing ratios

  • Business can seek alternative sources of funding that are not “loan related” like issuing more shares and it may go against the objective of any existing shareholders who do not want to lose ownership of the business.

  • Firm could decide not to issue dividends to shareholders so as to increase the amount of retained profit. May lead to resentment among shareholders.

• Insolvency and Bankruptcy (HL)

  Insolvency is a financial state where a person or firm cannot meet thier debt payments on time. The person or firm no longer has the money to pay off their debt obligations and their debts exceed their assets.

  • One of the solution is declaring bankruptcy

  Bankruptcy is a legal process that happens when a person or firm declares that they can no longer pay back their debts to creditors. It is a legal process for liqudiating the property and assets a debtor owns in order to pay off their debts. → can provide protection and relief for people or firms that are unable to pay off their debts.

  In some cases, when a firm files for bankruptcy, a licensed Insolvency Trustees is assigned to liquidate their assets, contact their creditors and investigate their affairs. Firm will have to comply with bankruptcy which include attending credit counselling sessions.

  Insolvency does not mean bankruptcy, it is a financial state whereas bankruptcy is a legall declaration and process. Insolvency is a state of economic distress that an organization may be able to work through, while bankruptcy usually leads to a court order dictating how debts will be covered.

• Revision checklist

  • efficiency ratios assess how fims utilize thier resources in terms of assets and liabilites. These ratio include stock turnover ratio, debtor days, creditor days and gearing ratios.

  • Stock turnover ratio measures how fast aa firm’s stock is sold and replenished over a given peirod. It canbe meaured by assesing how many times in a given peirod a firm sells its stock and secondly consider the number of days it takes for a firm to sell its stock

  • Debtor days measure the average number of days its takes for a firm to collect money from its debtors. (debt collection period)

  • to answer pratcie question, look at debtor days, gearing ratio, creditor days and analyze to discuss if they are bad or nto

    • are they holding too much stock?

    • is stock turnover days increasing too much?

    • if gearing ratio too high, could thye negotitate their loans?

    • analyze all of them and discuss to make a conclusion

    • if some of the data could be changes easily, if their debtors days could be improved easily by … then they can avoid bankruptcy

    • after make an informed decision if they shoudl declare bankruptcy or not

3.7 Cash Flow

• The difference between profit and cash flow

  Cash is the money that a business obtains through either direct sales of its goods or services, borrowing from financial instituitions, or investiments by shareholders. It is a liquid asset in a business placed under current assets in the balance sheet.

  Cash flow is the money that flows in and out of a business over a given period of time. Cash inflows are the moneys recieved by a business over a peirod of time, eg: bank loans, bank overdrafts, government grants

  while cash outflows are the moneys paid out by a business over a peirod of time. eg: advertising costs, cost of sales, advertising costs

  Profit = total costs- total revenue. Profit is a great indicator of the financial success of a firm.

  net cash flow = cash inflow - cash outflow

  • Positive means the total cash inflow is greater than outflow

  • negative suggest there might be a liquidity problem

  Profit and cash flows are different. If most of the purchases is were credit purchases, then cash flow position aat that point in time for the busienss will be different from its profitability.

  A business can be profitable but have little to no cash. this is known as insolvency, can be brought by:

  • poor collection of funds, possibly by allowing customers a very long credit period.

  • paying suppliers too early and leaving little or no cash for operationd

  • purchasing capital equipment or many non-current assets at the same time

  • overtrading - purchasing too much stock with cash that is eventually tried up in the business

  • servicing loans with cash

  A business can have positive cash flow but be unprofitable. It can achieve a positive cash flows in the following ways:

  • sourcing cash from bank loans

  • gaining cash from the sales of a firm’s fixed assets

  • obtaining cash from shareholder’s funds

  Insolvent - When a business cannot meet its short term debts

• Working Capital and Liquidity position

  Working capital is the money a business need to purchase its raw materials, run day-to-day operations, utility bills and wages. Working capital helps measure a firm’s liquidity, efficiency and overall financial health. Working capital is the money available to meet current and short-term obligations.

  Working capital = current assets - current liabilities

  Liquidity = the extent an organization is able to convert its asset into cash

  Liquidity position = indicated the extent the organization has sufficient liquidity to continue its business activities.

• Cash flow forecasts

  These are future predictions of a firm’s cash inflows and outflows over a given period of time. Forecast is a financial document that shows the expected month-by-month receipts and payments of a business that have not yet occurred.

  Examples of cash inflows are: cash sales from selling goods or business assets, payments from debtors, cash investments from shareholders, borrowing from banks.

  Examples of cash outflows: purchasing materials, fixed assets for cash, cash expenses such as rent, wages and saleries, paying creditors, repaying loans, making dividend payments to shareholders.

  • Constructing cash flow forecasts

    Cash-flow forecasts is based on estimates, hence the accuracy of the figures depends on how well the business is able to predict its futrue cash inflows and cash outflows.

    • opening cash balance - cash that a business starts with every month. Also xash held by business at the start of the trading year

    • total cash inflows - this is a summation of all cash inflows during a particular month

    • total cash outflows - this is a summation of all cash outflows during a particular month.

    • net cash flow - this is the difference between total cash inflows and total cash outflows

    • closing cash outflows - this is the estimated cash available at the end of the month. net ash flow of one month + operating balance of the same month

    • closing balance = opening balance + net cash flow

    

  • Benefits of cash flow forecasts

    • Useful planning document for anyone wishing to start a business.

      • helps clarify the purpose of the business that provides estimated projections for future performance.n

    • Provide a good support base for business intending to apply for funding from financial institutions, enable banks to check on the businesses solvency and creditworthiness.

    • predicting cash flow can help managers identify in advance periods when the business may need cash, therefore plan accordingly to source it.

    • Help with monitering and managing cash flow. By making comparisons between estimated cash flow figures and its actual figures, buisness should be able to assess where the problem lies and seek and respective solutions to solve it.

  • The relationship between investment, profit, and cash flow

    Investment generally refers to the act or state of investing. In finance or business, investing is spending money on purchasing an asset with the expectation of future earnings. Investing involves wealth creation, including hoping that the bought asset appreciates in value overtime. Eg of financial investment including buying bonds, stocks, or property. All forms of investment comes with risks, especially risks brought about by unexpected changes in the market conditions of the economy

    Business stage	Investment (owner’s funds)	Profit	cash flow
    Start-up	Involves high investment due to the purchases of initial assets or set-up costs	There is no profit because costs are not yet met	cash flow is negative - cash outflow is significantly higher than cash inflow
    growing	Investment could still be high because the business is not yet fully established	there is a small profit, more revenue starts to be generated to cover costs	Cash flow may be positive, but low until cash flow increase, especially from sales revenue
    Established-Thriving	Investment may be minimal as the business can plough back profits	high profit is achieved	Cash flow is positive - cash inflow is higher than cash outflow

  • Strategies for dealing with cash flow problems

    Business can be profitable yet insolvent, which means it is facing a liquidity crisis and is having difficulties in sustaining its working capital to run its day to day operations. Major causes of cash flow problems in a business are lack of effective planning and poor credit control.

    Reducing cash outflows

    The following methods aim to decrease the amount of cash leaving a business

    • Business can negotiate with the suppliers or creditors to delay payment.

      • Helps it to have working capital for its short-term needs.

      • Drawback: negotiations may be time consuming and delaying payments to suppliers could affect future relationships-suppliers may refuse to supply in the future.

    • Purchases of fixed assets to be delayed. Assets such as machinery and equipment might take up a lot of a business cash, delaying, purchases of them helps to avail cash in the business.

      • Drawback: if the machinery or equipment are becoming obsolete or outdated, delaying the purchase of replacements may lead to decreased efficiency and higher costs in the long term

    • Business can decrease specific expenses that will not affect production capacity, such as advertising costs. If not well checked, may reduce future demand for a business products.

    • Business could look into sourcing cheaper suppliers

      • helps to reduce cost for materials or essential stock, decreasing the outflow of funds.

      • Drawback: A possible danger of this is that the quality of the finished product may be more compromised, affecting futurw customer relationships.

    Improving cash inflows

    • Business can insist that customers pay with cahs only when buying goods. This avoids the problems of delayed payments from debtors, which ties up in cash.

      • Drawback: business may lsoe customers who prefer to buy goods on credit

    • Offering discounts or incentives can encourage debtors to pay early. reduce amount of credit for them to pay on time

      • reduce debt burden on debtors as tey will pay less than earlier greed

      • Drawback: after the discount, businesses will recieve less cash than previously expected

    • Firms may diversify its product offering.

      • Help increase the variety of goods on offer to customers, potentially increasing sales.

      • Drawback: diversification comes with higher costs with no clear guarantee of sales.

    Looking for additional finance sources

    • Sales of assets - the focus should be on selling obsolete fixed assets to generate cash. Selling assets that are still needed could lead to reduced production.

    • Arranging bank overdrafts - short term loan facility that allows firms to overdraw from their accounts. It is a great help during times of immediate cash setbacks. However there will be interest payments on the overdraft, which are usually high.

    • Sale and leaseback - assets can be sold to generate cash and these assets can then be hired back by the business for use in production

      • Drawback: leasing can be proved costly in the long run, and this denies the business the use of asset as collateral when seeking future loans.

    Limitations of cash flow forecasting

    • Unexpected change in the economy - eg. fluctuating interest rates could affect borrowing by firms and have a negative impact on their cash flow needs.

    • Poor market research - improperly done sales forecasts due to poor demand predictions can have a negative effect on future cash sakess, thereby affecting cash inflows.

    • Difficulty in predicting competitors behaviour - competitors may change their strategies often and make it hard for other business to predict their actions and compete with them.

    • Unforeseen machine or equipment failure - breakdown of machinery is difficult to predict and can drastically effect the cash position in a business

    • Demotivated employees - being demotivated can negatively affect the productivity of workers, reducing output or sales and leading to less cash inflow.

be able to produce cash flow forecast

calculate return on investment approaisal suing one of two methods

two methods on the test: payback period and the avaerage rate if return

make discussion based on the company’s priorities is” rapid payback period or higher average rate of return.

for 10 mark questions what calculations should bear in mind? opportunity to discuss the impact on the human resource issues, impact on employees (demotivation?), impact on environmental issues

3.8 Investment Appraisal

Investment appraisal refers to the quantitative techniques used in evaluating the viability or attractiveness of an investment proposal (pros and cons of investment opportunities ). It assesses and justifies the capital expenditure allocated to a project. It therefore aims to establish whether a particular business venture is worth pursuing and whether it will be profitable. Investment appraisal also assists businesses in comparing different investment projects.

cost of investment, capital investment = the initial cost

• Payback period

  estimates the length of time required for an investment project to pay back its initial cost outlay. Looks at how long the business takes to recover its principle investment amount from its net cash flow. The time for the initial amount of money invested to be prepaid using the gains from the initial investment

  If asset becomes obsolete before PBP, they are not worth purchasing

  cumulative net cash flow = the cumulative net cash flow in the previous year + net cash flow of current year

  Payback period = initial investment cost/annual cash flow from investment

  (Extra cash flow required/annual cash flow in year 4) x 12 month

  The business decides on an internal payback period or “cut off” that an investment should not go below. such as four years.

  To find the exact months where the cumulative cash flow exceeds the initiation investment

  1. Calculate the cumulate net cash flows (see table above).

  2. Identify the year in which the cumulative NCF is equal to or greater than the initial cost of the investment (Year 4 in this example).

  3. Calculate the monthly NCF in that year (so in Year 4, the monthly NCF = $24,000 ÷ 12 = $2,000 per month.

  4. Find the shortfall to reach payback in the previous year ($78,000 – $74,000), i.e., the initial amount spent on the investment minus the cumulative NCF in the previous year before reaching payback.

  5. Divide the difference found in Step 4 by the answer in Step 3, i.e., $4,000 ÷ $2,000 = 2 months.

  Advantage of payback period

  • simple and fast to calculate

  • useful method in rapidly changing industries such as tech where assets quickly become outdated. Helps estimates how fast the initial investment will be recovered before another machine, can be purchased

  • helps firms with cash flow problem because they can choose the investment projects that can pay back more quickly than others

  • since it is a short term measure of quick returns on investment, it is less prone to the inaccuracies of long term forecasting

  • business managers can easily understand and use the results obtained.

  Disadvantages of payback period

  • it does not consider the cash earned after the payback period, which could influence major investment decisions

  • ignores the overal profitability of an investment project by focusing only on how it will be paid back

  • annual cash inflow could be affected by unexpected external changes in demand, which could negatively affect the payback period

• Average rate of return

  this method measures the average annual net return on an investment as a percentage of its capital cost. assess the profitability per annum generated by a project over a period of time. Known as accounting rate of return.

  

  A business can compare the ARR with the ARR of other projects and chooses the project with the highest rate of return

  ARR can be compared with bansk interest rates on loans to assess the level of risk.

  Advantage rate of return

  • shows the profitability of an investment project over a given period of time

  • makes use of all the cash flow in a business unlike Payback period.

  • allows for easy comparison with other competing projects for better allocation of investment

  • Busienss can use it own criterion rate anc check this with the ARR for a project to assess the viability of the venture.

  Disadvantage of average rate of return

  • Since it considers a longer time period or useful life of a projectm there are likely to be forecasting errors. Long term forecast can reduce the accuracu of results

  • does mot consider the timing of cash flow. Two projects might have the same ARR but one could pay back more quickly compared to the other due to faster cash inflows.

  • effects on the time value of money are not considered.

• Net Present value (HL only)

  This is the difference in the summation of present values of future cash inflows or returns and the original cost of investment. PV is today’s value of an amount of money avaliable in future.

  Discounted cash flow = consider the interest rates affect the present value of future cash flows. It use a discount factor that converts these future cash flows to their present value only.

  To get the present value of future cash flows, the appropriate discount factor is multiplied by net cash flow in the given year.

  present value = net cash flow x discount rate

  NPV = Total present values - original cost

  If the value is negative value then the viability of the project would be in question and should not be pursued. An increase in the disocunt rate reduces the NPV because future cash flows will be worth less when discounted at higher rates.

  Advantages

  • The opportunity cost and time value of money is put into consideration in its calculation.

  • All cash flows, including their timing, are included in it computation

  • The discount rate can be changes to suit any expected changes in economic variables, such as interest rate variations.

  Disadvantages

  • more complicated to calculate than the payback period or ARR

  • can only be used to compare investment projects with the same initial cost outlay.

  • The discount rate greatly influences the final NPV result obtained, which may be affected by inaccurate interest rate predictions.

• Review

  • Investment appraisal is the quantitative assessment of the viability of an investment proposal. It establsihes whether a particular business venture is worth pursueing or profitable, as well as assisting businesses in making comparisons with other investment projects. Investment appraisal techniques include payback period, average rate of return and net present value

  • Payback period looks at how long a business will take to recover its principle investment or initial cash outlay from its net cash flows. It is simple to calculate and useful method in rapidly changing industries. However does not consider he cash earned after the payback period and ignores the overall profitability of an investment project

  • Average rate of return assess the profitability per annum generated by a project

3.9 Budgets (HL only)

A budget is a quantitative fnancial plan that estimates revenue and expenditure over a specified future time period. Budgets can be prepared for individuals, for governments, or for any type of organization. Budgets help in setting targets and are aligned with the main objectives ofthe organization. They enable the effcient allocation of resources within the specifed time period.

• Cost and Profit Centre (HL)

  Cost centre are part of the business where cost are incured and recorded. Cost centers can help managers collect and use data effectively. eg. electricity, wages, advertising, insurance and among other costs. Businesses can be divided into cost centres in some of the following ways:

  By department - eg, finance, production, marketing, and HR

  By product - business can produce several products could ensure that each product are cost centers.

  By geographical location - businesses such as KFC or Coca Cola company are located in different parts of the world. Each of the geographic areas that they are located in could be cost centres.

  Profit centre are part or section of a business where both costs and revenues are identified and recorded. This allows the business to calculate how much profit each centre makes.