3.5 Decision Making To Improve Financial Performance Flashcards
What are financial objectives?
Financial objectives are financial goals that a business wants to achieve. Businesses usually have specific targets in mind, not just profit maximisation, and a specific time period for completion
Who sets financial objectives?
Financial managers
What can financial objectives be based on to ensure that they are relevant?
Past financial data
What are the 3 types of financial objectives?
- Revenue objectives
- Cost objectives
- Profit objectives
What is cash flow?
Cash flow is all the money flowing in and out of the business on a day to day basis
Why are cash flow objectives put in place?
To prevent cash flow problems
What does ROI stand for?
Return on investment
What does ROI measure?
Return on investment measures how efficient an investment is - it compares the return from a project to the amount of money that’s been invested
ROI formula
(ROI / Cost of investment) X 100
What does capital structure refer to?
Capital structure refers to the way a business raises capital to purchase assets
What combination makes up capital structure?
Capital structure is a combination of debt capital and equity capital
What are two internal factors that influence financial objectives?
- The overall objectives of the business
- The status of the business
What are 5 external factors that influence financial objectives?
- The availability of finance
- Competitors
- The economy
- Shareholders
- Environmental and ethical influences
Explain the influence the economy has on financial objectives
In a period of economic boom, businesses can set ambitious profit targets. In a downturn, they have to set more restrained targets and they might set targets that minimise costs.
Percentage change in profit formula
(Current year’s profit - previous year’s profit) / previous year’s profit) X 100
What are the 3 types of profit?
- Gross profit
- Operating profit
- Profit for the year (net profit)
Gross profit formula
Gross profit = sales revenues - cost of sales
Operating profit formula
Operating profit = gross profit - operating expenses
Profit for the year formula
Profit for the year = operating profit - net finance costs - tax
Gross profit margin formula
(Gross profit / sales revenue) X 100
Operating profit margin formula
(Operating profit / sales revenue) X 100
Net profit margin
(Net profit / sales revenue) X 100
Give examples of cash inflows
- Sales revenue
- Payment from debtors (recievables)
- Sale of assets
- Owners’ capital invested
- Sources of finance
What is the difference between credit sales and cash sales?
Cash sales appear in the month of sale and credit sales usually appear in the month after
Give examples of cash outflows
- Purchasing stock
- Wages
- Paying debts
- Purchasing assets
What is the difference cash payments and credit payments?
Cash payments appear in the month of purchase and credit purchases appear in the month of cash outflow
What 2 things is the length of the cash flow cycle dependent on?
- The type of product - this determines the length of time it’s takes to produce and how long it’s held in stock
- Credit payments
Give 6 ways that businesses can improve cash flow
1) Overdrafts
2) Hold less stock, so less cash is tied up in stock
3) Try to reduce the time between paying suppliers and getting money from customers
4) Credit controllers keep debtors in control
5) Debt factoring
6) Sale and leaseback
What are cash flow forecasts?
Cash flow forecasts show the amount of money that managers expect to flow into the business and flow out of the business over a period of time in the future
Why isn’t cash forecasting always accurate? (Think about the two main reasons)
- Cash flow forecasts can be based on false assumptions about what’s going to happen
- Business environment can suddenly change and costs and demand can change rapidly
Give two reasons why a cash flow forecast is useful to someone setting up their own small business
- They can use it to support themselves when applying for loans and sources of finance
- It can give them an idea of when they will have large payment months (e.g when bills are paid quarterly or yearly)
What is a budget?
A budget is a financial plan for the future
What are the three types of budget?
- income
- expenditure
- profit
What are budget holders?
Budget holders are people responsible for spending or generating the money for each budget.
For example, the budget holder of the expenditure budget for marketing could be the head of the marketing department
Give 3 advantages of budgeting
- help achieve targets
- control income and expenditure
- assists managers to review their activities and make decisions