3.5.1 Flashcards
What are financial objectives?
the most important objectives in a business. This is because without sufficient financial security the business will cease to trade. Financial objectives, such as profit maximisation, are also the incentive for which many businesses are run.
Importance of financial objectives:
- Poor financial management is a key reason why a business might fail
-The level of long-term debt in a business increases risk. A business may set objectives to reduce the proportion of long-term funding that is debt - Financial objectives are easier to manage than other functional objectives, often with a numerical element and timescale
- Financial measures determine the success of all other functional areas such as marketing, operations and human resources.
- Financial measures such as profitability and shareholder value are two of the key reasons why people invest in businesses.
What is the difference between cash flow and profit?
Profit is measured over a given period of time.
Cash flow considers the timing of payments and receipts - a profitable business can still run out of cash
the profit hierarchy
- revenue - direct costs e.g. materials are taken away from revenue
- gross profit - indirect costs e.g. salaries and overheads are taken away from profit
- operating profit - other incomes such as interest are taken into account and taxation to be applied to the business profit also referred to as net profit = profit for the year
What are cost objectives?
lowering costs may be important where a business is trying to improve efficiency. Cost is also an important factor in a recession or where a business competes on price.
What are revenue objectives?
this is earnings generated by a business from its trading activity.
Setting revenue objectives helps drive a business’s ambition to grow.
Increased revenue indicates the popularity of a particular product. Also suitable where profit is less important, for example a charity.
What are profit objectives?
profit objectives are clear to understand and one of the key performance indicators of a business. Profits are often shared with all stakeholders and as such are the indicator that most businesses will be judged against. Even though the business may be performing well, shareholders and the public may judge a business as underperforming if profits have fallen.
Internal influences on financial objectives
- Corporate objectives - all functional objectives will flow from these
- Nature of the product - a product with a short life-cycle may dictate that sales revenue is an important financial objective to set
- Other functions - if the business sets operational objectives to improve efficiency, financial objectives around reducing costs may be appropriate.
External influences on financial objectives
- Technological - new technology may determine how a business invests. It may also create opportunities to cut costs and increase revenues.
- Economic environment
- a business may set lower profit objectives if indicators suggest the market is shrinking - The competitive environment - businesses will naturally set objectives that will allow them to compete. For example, aggressive investment targets.
What are capital structure objectives?
Capital structure is the balance between capital from borrowing (loan capital) and the capital from selling shares (share capital) in the company.
Some businesses will want to balance these two sources.
example of capital from borrowing balancing with capital from selling shares
- low gearing
- danger of losing control of the business
- high dividend payments to shareholders
VS - high gearing
- may be at risk of increasing interest payments
- difficult to find further lending
Investment and return objectives
A business may set a target for capital investment over the year. This will support a strategy of growth. Similarly, a business may set an objective to reduce capital over the year in order to reduce debt.
Investment objectives may also refer to the
returns received on the investment. This may be calculated as the operating profit as a percentage of the investment.
What are cash flow objectives?
A business will fail if it is unable to meet its financial obligations and pay bills. For this reason, some businesses will set specific objectives to help manage cash flow. Businesses with long cash cycles will find it more challenging to manage cash flow.
Specific cash flow objectives might include:
- maintaining a specific level of cash reserves
- extending payment periods to suppliers
- shortening payment periods from customers.
