Assessing Financial Position & Performance (AQA A Level Business): Flashcards

A growth-focused business keeps a large proportion of profit for reinvestment, so it pays lower dividends in the short term. A mature business with limited growth opportunities may pay out a higher proportion of profit as dividends.

A business facing cash flow difficulties may cut or suspend its dividend to prioritise solvency over shareholder income.

False.

Cutting the dividend in a downturn may be a sensible decision to preserve cash in difficult conditions. It is not necessarily a sign of fundamental weakness.

They should be measured against the business's objectives, the performance of competitors, the financial plan and the wider business environment.

True.

A growth-focused business may accept lower margins in the short term because it is investing heavily in marketing, new staff or expansion.

The cost of ethical sourcing, fair wages or sustainable production is priced into its profit expectations.

It suggests the business has greater pricing power, more efficient production or a better product mix than its rivals.

Competitors may operate in different market segments, and larger rivals may benefit from economies of scale. Accounting policies, such as the treatment of depreciation, can also vary.

An adverse variance occurs when actual profit is lower than planned and requires investigation.

The problem lies in overhead costs rather than production efficiency.

False.

Start-ups typically report lower margins because of the costs of building brand awareness, attracting customers and investing in equipment. This is not necessarily a concern if the trend is improving.

Some business models are inherently low-margin, such as supermarkets, while others, such as luxury goods and software, are inherently high-margin.

Events such as a large asset sale, an exceptional legal cost or restructuring expenses will not recur. Removing them gives a clearer picture of business performance.

It means the business's costs have grown faster than its revenue.

False.

If costs have risen across the whole industry, a lower profit figure could actually represent excellent management.

Return on capital employed (RoCE) measures how efficiently a business generates profit from the long-term capital invested in it.

False.

If RoCE falls short of the business's own target, it is an adverse variance, even if the figure is above the industry average.

They require far more capital to generate each pound of profit. Manufacturing, property and utilities are capital-intensive, while software and consulting are asset-light.

It may indicate that capital employed is growing faster than operating profit. This can happen through acquisitions or new sites opening.

True.

Capital employed rises sharply after a major investment, so RoCE typically falls until the investment has had time to generate its full return.

If RoCE is lower than the interest rate paid on debt, the capital invested is not covering its financing costs. This is a serious concern regardless of what competitors achieve.

Return on investment (RoI) evaluates the financial return generated by a specific investment decision, such as new equipment, a marketing campaign or a new location.

It is a threshold set before an investment is made, below which the investment would not be considered worthwhile.

The RoI is £540,000 ÷ £1,800,000 × 100 = 30%.

It can compare RoI against external benchmarks, such as the return available from a savings account.

False.

A higher-than-forecast RoI may mean the original projections were too conservative, or that market conditions were more favourable than expected.

An RoI calculation cannot capture non-financial benefits, such as improved product quality, better staff conditions or a stronger brand.

False.

A higher RoI is expected from riskier investments. The same 15% return from a well-established, low-risk process improvement is arguably more valuable.

The business must ask whether the investment was the best available use of the capital. An RoI of 10% may be acceptable, or it may mean a better opportunity was missed elsewhere.

Cash flow is the movement of money into and out of a business over time.

False.

A business focused on rapid expansion may deliberately accept periods of negative net cash flow as it invests ahead of revenue growth.

It suggests an internal problem, such as slower inventory turnover, poor credit control or higher fixed costs.

It may reflect stronger sales or lower costs. However, it may also mean that planned investment has been delayed.

Seasonal businesses often have negative cash flow outside peak trading, which is manageable if they have planned for it with appropriate reserves or credit facilities.

Liquidity measures a business's ability to meet its short-term obligations using its short-term assets.

The benchmark for the current ratio is 2:1 and for the acid test ratio is 1:1. These should be interpreted carefully rather than applied rigidly.

False.

A large supermarket can operate sustainably below 1:1. It collects cash from customers almost immediately but takes 30–60 days to pay suppliers.

The business may be sitting on cash that could be used more productively. This suggests overly cautious financial management.

Manufacturers tend to show higher current ratios than service businesses, which may hold very little inventory.

Gearing measures the proportion of a business's capital that is funded by long-term debt.

The stability and predictability of their income streams makes debt more manageable.

The business may be borrowing more than planned, or it may have made losses that have reduced the value of its equity.

True.

A business comfortably repaying debt at 2% may face serious pressure if rates rise to 6%.

The break-even output is the minimum level of sales a business must achieve to cover all of its costs.

The margin of safety is the difference between actual (or forecast) output and break-even output. It shows how far sales can fall before the business makes a loss.

It is likely to have invested heavily in premises and equipment to support expansion. It accepts greater financial risk in exchange for this investment.

Actual sales are below break-even, so the business must act urgently to reduce costs or increase revenue.

True.

It is more exposed to falling demand and less able to compete on price without making a loss. Rivals that break even at lower output have a cost advantage.

Comparing break-even output with the output forecast in the business plan shows whether the plan is viable.

False.

A low margin of safety is common in the early stages of trading, as fixed costs are incurred before revenue increases. It is not a problem provided the sales growth trend is positive.

This is normal and manageable provided peak-season profits are sufficient to cover off-season losses.

A budget variance is the difference between a budgeted figure and the actual outcome.

It may reflect a deliberate strategic decision, such as spending more on marketing or quality than budgeted to pursue a growth objective.

False.

A favourable revenue variance may indicate that the original budget was too conservative, rather than that performance has been exceptional.

It suggests the variance reflects the business environment rather than poor management.

If the assumptions in the original budget were unrealistic, the variance reflects a planning problem as much as a performance problem.

In large, complex organisations some variance is inevitable. The key is whether variances are within acceptable levels and whether the business can respond quickly to significant ones.