AQA Business finance powerpoint GCSEs last

finance

1. Investment and calculations In this presentation we will look at: The reasons why businesses invest How to calculate the average rate of return for an investment How to interpret break-even charts and the value of break-even analysis to a business

2. Key words Productivity The quantity of goods or services produced by an employee over a period of time, such as one year Investment Takes place when a business buys an asset, such as a factory, in the hope of making a profit from its use The average rate of return (ARR) Compares the average yearly profit from an investment with the cost of the investment and is stated as a percentage Break-even The level of production at which a business’s total costs and revenue from sales are equal Break even chart Shows a business’s costs and revenues and the level of production needed to break-even The margin of safety Measures the amount by which a business’s current level of production exceeds its break-even level of output

3. Basic financial terms Land and buildings where businesses decide to expand production or retailers decide to open new stores to increase sales, e.g. Aldi’s expansion of UK stores will cost £300m. Machinery and vehicles in order to increase productivity as new technology becomes more efficient, meaning investment will cut costs, improve competitiveness and make more profit. New products as businesses need to remain competitive by innovating through investment to keep ahead of rivals, e.g. new iPhones are released every 12 months. Aldi

4. The average rate of return The average rate of return (ARR) compares the average yearly profit from an investment with the cost of the investment and is stated as a percentage. For example, if a new delivery van costs £20,000 but increases a business’s profits by £3,000 ARR can be calculated as follows: The calculation of ARR from an investment project needs the average yearly profits calculated first. See the diagram which shows how to calculate the ARR for this project. ARR = × 100 ARR = × 100 = 15%  

5. Interpreting an ARR calculation The higher figure for an ARR calculation, the better rate of return on the investment. Managers can then choose between a range of different projects based on the one that gives them the best ARR, assuming profits are the only factor that influence the decision. However, calculations are predictions and therefore not always accurate. Figures such as forecast profits may be over optimistic.

6. Break even analysis Break-even is the level of production at which a business’s total costs and revenue from sales are equal. The table shows the different scenarios that can be calculated. Break even charts show a business’s costs and revenues and the level of production needed to break-even. If total revenues are greater than total costs … … the business will make a profit. If total revenues are less than total costs … … the business will make a loss. But if total revenues equal total costs … … the business will break-even.

7. Break even chart Look at the break even chart for Viv Burns’ business. Fixed costs do not change regardless of the level of production. In Viv’s case the straight and horizontal line shows £7,500. Variable costs rise and fall dependant on the level or production, e.g. when Viv produces 500 paper weights look at the chart – what are the variable costs? Total costs are the total of fixed and variable costs, e.g. production of 1,000 paper weights means Viv’s total costs each year are £17,500. Total revenue is also called revenue from sales and calculated by multiplying the level of output by the selling price of the product, e.g. at 500 paperweights the revenue would be £12,500.

8. The level of break-even output Break-even output occurs when the total costs of production equal the revenue from sales. In a break-even chart this occurs when the level of production at which the total costs line intersects the total revenue line, i.e. 500 paperweights. Levels of output below break-even mean the productions costs will be greater than the total revenue and the business will make a loss. Levels of output above break-even mean higher levels of production with total revenue higher than total costs meaning the business will make profit.

9. The margin of safety The margin of safety measures the amount by which a business’s current level of production exceeds its break-even level of output. For example if Viv produced and sold 750 paperweights in a year her business would make a profit with the margin of safety being 250 paperweights. That is the break-even amount of 500 less the 750 sold. The higher the margin of safety the less risks the business has of making a loss.

10. Advantages of break even analysis Break-even charts help managers see the effects of any changes in costs with a rise in cost needing an increase in output and vice versa. Margin of safety will also reduce. Charts show the effects of changes in prices with a rise in price reducing the break-even output and increasing the margin of safety. Banks are more likely to agree to a loan if the business can provide evidence of good future financial planning as evidence of being able to repay.

11. Disadvantages of break-even analysis Break-even analysis assumes that a business sells all it produces which is unrealistic. If the manager can show market research to support the sales and production figures this negate this issue. Many businesses operate in markets where costs change frequently making break-even charts inaccurate – e.g. exchange rates for the pound have fluctuated in 2016/17 so that raw material costs are changing regularly.

12. Summary questions Write down or discuss the answers to these questions. What is average rate of return? How can average rate of return help a business? What is break even? What is a break even chart? What is one advantage of break-even analysis? If a business’s break-even was 300 and it actually sold 500 products, what would the margin of safety be?

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