3.1.2 Objectives financial management

Question 1

What is the overall objective of financial management?

Answer 1

The overall objective of financial management is to maximise the returns on the funds that the owners have invested in the business and to help to achieve goals such as profits and growth.

Question 2

What are the five main objectives of financial management?

Answer 2

• Profitability
• Growth
• Efficiency
• Liquidity
• Solvency

Question 3

What is Profitability?

Answer 3

Profitability is the ability to make a financial return from business activities.

Question 4

How can Profit be calculated?

Answer 4

Profit can be calculated as the difference between revenue and expenses.

Question 5

If expenses are greater than a sale in a business what has happened?

Answer 5

The business has made a loss

Question 6

If sales revenue is greater than expenses in a business what has happened?

Answer 6

The business has made a profit.

Question 7

What is Profitiability a driving force of?

Answer 7

Profitability is the main driving purpose for running most businesses.

Question 8

Why do business owners expect a profit over the long term?

Answer 8

Business owners expect for a profit over the long term as this is critical to business survival, investors return on capital and the growth of the business.

Question 9

If a business is not profitable how will this affect investors?

Answer 9

Investors have an expectation that the business will be profitable. If this expectation is not met, many investors will reconsider their continued investment in the business.

Question 10

What is growth in financial management?

Answer 10

Growth is the increase in the size and value of a business over time.

Question 11

What opportunities does growth provide a business?

Answer 11

Growth provides a business with the opportunity to expand, produce a wider range, access additional resources, including a more extensive variety of specialist skills and innovations, and help consolidate the position of the business in the market in terms of its competitors and market share.

Question 12

In what ways can Growth be achieved?

Answer 12

Growth can be achieved both internally (Within the business) and externally (from other businesses).

Question 13

How can internal expansion be achieved?

Answer 13

Internal expansion can be achieved through increases in demand for a product, Improved productivity and new market opportunities, such as advances in technology.

Question 14

How is external expansion achieved?

Answer 14

External Expansion is achieved by purchasing other businesses, or by the mergers or acquisitions (such as the 2008 Westpac and ST George bank merger)

Question 15

What is the purpose of growth?

Answer 15

The purpose of growth is to increase profits and return on capital.

Question 16

Why must a business monitor it’s growth?

Answer 16

A business must monitor their level of growth so that they are achieving sustainable levels of growth. Too much growth too fast can cause cash flow problems, but careful cash flow management can avoid serious liquidity and solvency concerns.

Question 17

What is Efficiency in financial management and what does it involve?

Answer 17

Efficiency is generating the maximum returns for the minimum costs. It involves increasing the amount of output with the same number of inputs or maintaining current levels of output with fewer inputs.

Question 18

What is Efficiency directly linked to?

Answer 18

Efficiency is directly linked to the costs of producing goods and services and the quantity produced by the business.

Question 19

How can a business be more efficient?

Answer 19

Improving efficiency can involve both lowering the costs of production (inputs) such as wages, materials and marketing and increasing the amount of production (outputs). This creates the potential for greater responsibility by either increasing sales revenue or reducing expense.

Question 20

What is Liquidity?

Answer 20

Liquidity refers to the ease with which asset can be converted into cash. Importantly in business, liquidity refers to the ability of a business to meet it’ short-term debt.

Question 21

What is Short Term Debt also referred to as?

Answer 21

Short term debt is also referred to as current Liabilities.

Question 22

What are current liabilities?

Answer 22

Current Liabilities include bank overdrafts and money owed to suppliers (accounts payable). These liabilities must be paid within a year. The short term assets of a business are required to pay short term debt.

Question 23

What are short term assets referred to as?

Answer 23

Short term assets are referred to as current assets.

Question 24

What are Current assets?

Answer 24

Current assets include cash, stock (inventory) and money owed by debtors (accounts receivable) that can be converted into cash quickly and easily within the year.

Question 25

What does Liquidity relate to?

Answer 25

Liquidity relates to both the working capital and cash flow position of the business.

Question 26

What is working capital?

Answer 26

Working capital is the number of funds required by a business to meet its short-term debt.

Question 27

How is working capital calculated?

Answer 27

Working capital is calculated as the difference between current assets and current liabilities. That is working capital = current assets- current liabilities.

Question 28

What does cash flow relate to?

Answer 28

Cash flow relates to the availability of short-term funds to meet the short- term debts. The ability of a business to properly manage cash flow and working capital is vital to the success of the business.

Question 29

What does solvency refer to?

Answer 29

Solvency refers to the extent to which the current assets of a business exceed its current liabilities.

Question 30

What does it mean for a business to be solvent?

Answer 30

It means that if current assets exceed current liabilities then the business is able to meet its short term debt commitments and the business is described as solvent. There is also a long term view of solvency which refers to the ability of a business to meet its long term- fixed expenses and to pursue the goals of long term growth and expansion.

Question 31

What is an example of a business being solvent?

Answer 31

The concept of solvency means that a business is able to pay off its debts as they become payable. An example of this would be where a business receives its quarterly electricity bill for $1200. If the bill Is payable in 30 days then the business must have the current assets available in 30 days’ time to pay that debt.

Question 32

What is the key for cash flow solvency?

Answer 32

The key to solvency for a business is cash flow. Cash flow refers to the movement of cash into and out of a business.

Question 33

How does a business become insolvent?

Answer 33

If a business has borrowed too much and debt repayments exceed the ability of the business to generate cash from sales, the business will soon become insolvent and will cease trading.

Question 34

What are short term financial objectives?

Answer 34

Short-term financial objectives are mainly concerned with managing cash flow and ensuring that the balance between current assets and current liabilities is positive for the business. In this way the business is able to pay off its debt obligations when they fall due and therefore remain solvent

Question 35

What are long term financial objectives of a business?

Answer 35

Long-term financial objectives are mainly concerned with growing the business.

Question 36

What do long term financial objectives require?

Answer 36

Long term financial objectives require capital investment and the managers or owners of the business will need to decide how to finance this investment.

Question 37

What are the main ways to finance investment?

Answer 37

The main ways of financing investment are to borrow the money from financial institutions (debt financing) or to offer shares in the business to outsiders who then become part owners of the business (equity financing)

Question 38

What is a potential conflict between the long term-term objective of growth and expansion and the short term objective of managing cash flow and repaying debt?

Answer 38

Borrowing funds means that the business will need to make regular repayments of the principal and interest on the money that has been borrowed. This means that the business has to generate the cash flow to make the regular payments. As the business expands, it may expand its output and generate the additional cash flow but the growth output may not be immediate.

Question 39

What is a potential conflict between managers and shareholders when it comes to long term and short term financial objectives?

Answer 39

Managers may prefer to prioritise the goal of having enough cash flow for the business to operate. This means that managers may be unwilling to undertake certain activities with a high degree of risk. On the other hand, shareholders may be willing for the business to take more risks, especially with investment projects. If they do not pay off they can sell their shares and purchase equity in another business.