Choices in Business Strategy
In this article we will be covering choices and related jargon such as, Resource-Based and Market-Based choices, different strategies, Decision support matrices and Financial Ratios.
Evaluation of choices for the future of a business really comes down to choosing among competing investments. The competing investments need to encapsulate the business purpose and objectives.
Resource based choices are concerning competencies, resources and capabilities in the firm. Try and encourage the sharing of resources of skills and if you are operating in different markets, make sure you create value for each one.
Market based choices concern the firms ability to remain competitive in it’s market. Appropriate choices need to be made to focus on the objectives. A focus strategy has narrow focus in the market. A differentiation Strategy concerns adding extra features that the customer is willing to pay for.. If you need to drive costs down through scale, you would adopt a Cost Leadership strategy.
Decision making should focus on the profitability of the product or service in it’s life-cycle rather than on per-transaction or per-period profitability. Remember that after sales services can contribute to a high percentage of revenue.
Decision support Matrices can be used to aid choices. From the basic BCG Matrix to the more advanced GE McKinsey matrix. Many people prefer the BCG matrix because it is simple and memorable.
Financial ratios are also an excellent guide for making strategic decisions, such as whether to seek a bank loan to buy a new piece of equipment or to finance an expansion through the company’s cash flow.
To do a break-even analysis, first divide your expenditures into fixed and variable costs. Fixed costs usually don’t change much from month to month: rent, utilities, office payrolls, insurance, etc. Variable costs change with different rates of production and sales. They can include supplies, sales commissions, advertising, and freight.
When figuring your break-even point, calculate fixed costs and variable costs as a percentage of sales. Say that at Joe’s Printing, fixed costs come to £10,000 a month. Variable costs, such as paper, sales commissions and shipping charges run about 50% of sales. In any given month, Joe’s Printing thus needs to sell £20,000 worth of printing to break even-(£20,000 in sales to offset 50% in variable costs and £10,000 in fixed costs).
It’s one thing to know your business is making money but another to know you’ll have enough cash to pay your bills. Even when business is good, companies can experience cash-flow problems. Often you can anticipate these problems by using liquidity ratios.
The most common liquidity ratio compares current assets to current liabilities. Current assets include cash and other resources that can typically be converted into cash within a year, such as accounts receivable, inventories and marketable securities. Current liabilities are obligations that come due within a year, such as accounts payable, interest payments, etc. To ensure liquidity, you should maintain a current-assets-to-current-liabilities ratio of 3:2. If £2,000 is going out in any given month and £2,000 is coming in, you should have another £1,000 of cash on hand, or easily accessible, in case you need it.
Don’t run into cash-flow problems because, customers are slow in paying their bills. Keep on top of collections.
Leverage Ratio gives a good indication of when to borrow money. Divide pre-tax net income by interest expense. Work in the potential increase in sales and interest through, say the purchase of new machinery. If the Leverage Ratio improves, it may be a good time to borrow.
If you ask a bank for a loan, they will want to see your debt to equity ratio. This is calculated by dividing your company’s total debt by tangible net worth. Some familiarity with financial ratios helps when applying for a loan. Loan officers are more likely to be impressed with a business owner who has command of the company’s financial situation.
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