Teaching guide: Decision making to improve financial performance (podcast)
These podcast teaching guides cover topics from our AS and A-level Business specifications. You can download them below.
Podcast 5: Decision making to improve financial performance
This podcast covers the specifications’ fifth subject area, ‘Decision making to improve financial performance’. It covers: Setting financial objectives; Analysing financial performance; and Making financial decisions: sources of finance.
Please note we've changed the heading of this subject area to 'Financial management'. To find out more, read our summary of changes.
Transcript
Hello and welcome to the AQA AS and A-level Business podcast, supporting your teaching of our new specifications available for first teaching September 2015.
We believe that our holistic approach to the study of business equips students with the academic as well as the practical skills they need to succeed – and helps students of today develop the fundamental skills needed by the business leaders of tomorrow.
This podcast is the fifth of six, and covers the fifth subject area of the new specifications, ‘Decision making to improve financial performance’ in which we cover the following topics:
* Setting financial objectives
* Analysing financial performance; and
* Making financial decisions: sources of finance.
Topic one: Setting financial objectives
In this topic we consider the financial decisions made by managers. Throughout this topic students should consider factors that influence the decision made, including ethical and environmental issues. A potentially profitable project may not be ethically acceptable to the owners: for example launching a new tobacco product.
Students must also appreciate how financial decisions are interrelated with the other functions. For example decisions to cut costs may affect the nature of the service provided and therefore the success of marketing activities.
Students should also be aware of how changes in technology affect financial decision-making – for example, businesses can now raise funds by inviting investors to contribute online which provides a new way of accessing funds. Once again, the decision making cycle provides a useful framework for this part of the specification.
As is the case in other business areas, managers need to be clear what their financial objectives are. Achieving a given amount of profit may be a common target but managers are also likely to consider the initial outlay made to calculate the return on investment: the concept of rate of return is an important one.
Students should also be clear on the difference between cash and profit. At any moment in time businesses need to have enough cash to pay outstanding bills and to buy essential inputs. This means that at times cash may be more significant than profit: a business may be prepared to sell items at a lower price if it receives payment quickly rather than charging more and having to wait. On the other hand, a discount for cash payment improves cash flow but may reduce profits.
The following paragraph is based on an old version of the specification. It is only relevant to A-level exams in 2024.
Managers may also set targets for investment in different parts of their business and will want to monitor their capital structure: for example, if they end up with too much debt this might bring very high interest costs. On the other hand if borrowing costs are low, a business may choose to increase borrowing relative to other forms of funding.
When studying financial objectives students should consider what influences these targets. For example, when starting out a business may accept that the first years are likely to achieve low profits – or even be loss making. Similarly if the external environment is unfavourable, perhaps because the economy is doing badly or there are many new competitors, this might put a downward pressure on profits. Students should always focus on the context to interpret the financial data effectively.
Topic two: Analysing financial performance
Having set financial objectives, managers need to analyse the position of the business and take appropriate decisions. This may include setting financial budgets. Students should understand the value of budgets both in terms of setting targets and planning, but also in terms of analysing and reviewing performance.
They should also be able to construct and interpret breakeven charts. They should be able to analyse the impact of changes in costs and revenues in terms of contribution, profits and the margin of safety. They should also appreciate the difference between profit and profitability. What seems like a high level of profit may actually represent a low return.
It is also expected that students will understand that there are different forms of profit and that by analysing these it may be possible to gain an insight into the cost structure of the business and how best to improve performance. If profits are falling is it due to an increase in interest repayments, operating costs or overheads? An understanding of what is affecting the profits will enable better decisions to be made. Are costs rising due to too many levels of management or because the material costs are too high?
A final aspect of this section is the management of cash. Students should understand why the timings of cash inflows and outflows are so crucial to a business and understand the potential problems if inflows happen much later than outflows.
Topic three: Making financial decisions: sources of finance
Having analysed the financial performance of the business managers will need to make decisions, including those around how to raise finance. Students should be able to compare and contrast the difference between raising funds internally and externally. Is it better to take out loans or to issue shares? Is debt factoring a suitable solution to the financial problems of the business?
The answer will depend on factors such as:
* is it short or long term finance that is required?
* what will it be used for and how much return can it generate ?
* what is the interest rate on borrowing?
* are there willing investors?
* are the existing owners willing to sacrifice some of their control?
Another aspect of financial decision making relates to improving cash flow and profits. Students need to be aware of the range of options open to the manager and then be able to weigh up the advantages and disadvantages of each option in any given situation.
Some scenarios to consider include:
* delaying payments to suppliers may improve cash flow, but may lose their goodwill and future cooperation. How important are they to the business?
* increasing loans may increase debt and borrowing, but how high are the interest rates?
* selling shares may be a good option provided there are potential buyers – but are the existing shareholders comfortable bringing in new investors?
Numbers without context do not tell much of a story but by examining trends, making comparisons and understanding what the context is and what the objectives are enable better analysis and evaluation.
Thank you for listening to this AQA business podcast. You can find information on the specifications and the resources available to support your teaching of them on the AQA website: just visit aqa.org.uk/business