3.5.1 Decision making to improve financial performance

Question 1

Define a financial objective.

Answer 1

The specific, focused aim or goals of the finance and accounting function or department within an organisation.

Question 2

Outline the main types of financial objectives.

Answer 2

Revenue.

Cost.

Profit.

Cash flow.

Objectives for investment (capital expenditure) levels.

Capital structure objectives.

Return on investment objectives.

Objectives relating to debts as a proportion of long-term funding.

Question 3

Outline the benefits of setting financial objectives.

Answer 3

Focus for decision making and effort.

Baseline for success of failure.

Improve co-ordination.

Improve efficiency.

Allow shareholders to asses whether the business is going to provide a worthwhile investment.

Enable outside organisations to confirm the financial viability of a business.

Question 4

Outline the difficulties of using financial objectives in this way.

Answer 4

Difficult to be realistic.

Cannot control external change.

Can be difficult to measure.

Reasons for success and failure difficult to measure.

responsibility for achievement rests with the finance department but performance is on all of them.

Financial objectives may conflict with others.

Question 5

What is the formula for return on investment?

Answer 5

financial gains from the investment / cost of the investment * 100

Question 6

Define investment.

Answer 6

Items that are purchased by firms because they help them to produce goods are services. Aka capital goods. Machinery, delivery vehicles etc.

Question 7

Define return on investment.

Answer 7

A measure of the efficiency of an investment in financial terms, used to compare the financial returns of alternative investments.

Question 8

What can return on investment enable a business to recognise?

Answer 8

Relative financial returns on different investments.

Trends in financial performances.

Changing levels of return.

Question 9

What is the formula to calculate debts as a proportion of long term funding?

Answer 9

Debts / long term funding * 100.

Question 10

Define debts.

Answer 10

money owed by an individual or organisation to another.

Question 11

Define long term funding.

Answer 11

Money provided to a business which does not require repayments within a year.

Question 12

Outline the problems that debts bring.

Answer 12

Interest payments on the debts must be paid regularly, in accordance with the schedule agreed with the bank.

The full amount of the loan must be repaid by an agreed date.

Question 13

What can the problems of debt lead to?

Answer 13

Cash flow problems.

Question 14

What are cash inflows?

Answer 14

The receipts of cash, typically arising from sales of products etc.

Question 15

What are cash outflows?

Answer 15

The payments of cash, typically arising from the purchase of products etc.

Question 16

What is net cash flow?

Answer 16

The sum of cash inflow into an organisation minus the sum of cash outflows, over a period of time.

Question 17

Define profit.

Answer 17

The difference between the total revenue of a business and its total costs. Profit = total revenue - total costs.

Question 18

Why some examples as to why profitable firms might be short of cash?

Answer 18

Built up inventory levels - wealth is lying in assets rather than cash.

If sales are on credit, it’s wealth will be in the debtors (receivables) rather than cash. Will damage cash flow etc.

Question 19

Define cash flow.

Answer 19

The amount of money flowing in an out of the business over a period of time.

Question 20

What can difficulty acquiring cash lead to?

Answer 20

Continually recording losses can make it difficult to find cash, sales revenue will be lower than expenditure, creditors and investors will be reluctant to give the firm credit, loans or buy shares.

Question 21

What can the hesitance of investors buying shares or providing loans lead to?

Answer 21

Liquidation.

Question 22

Define liquidation.

Answer 22

The firm will be forced to close because it must sell its assets in order to make cash payments.

Question 23

Define liquidity.

Answer 23

The ability to convert an asset into cash without loss or delay.

Question 24

Outline the equation for gross profit.

Answer 24

Revenue - cost of sales.

Question 25

What does the cost of sales consist of?

Answer 25

Items of expenditure directly related to the provision of the businesses products e.g. wages to shop floor workers and raw materials.

Question 26

What does gross profit show?

Answer 26

How efficiently a business is converting raw materials into finished products.

Question 27

Why can gross profit be limited as a measure of performance?

Answer 27

As overheads (administrative expenditure) are excluded from the calculation.

Question 28

Define overheads.

Answer 28

The ongoing business expenses not directly attributed to creating a product or service.

Question 29

Define operating profit.

Answer 29

Profit made from trading.

Question 30

What is the formula for operating profit?

Answer 30

Gross profit - administrative expenses.

Question 31

Define profit for the year.

Answer 31

Profit available to the owners.

Question 32

What does profit for the year include?

Answer 32

All revenue, including non-trading revenue such as expenditure, sale of assets and taxation.

Question 33

Outline ways to calculate the measures of profit.

Answer 33

Revenue.

Cost of sales.

Gross profit.

Administrative expenses.

Operating profit.

Net finance and one off-items.

Taxation.

Profit for year.

Question 34

Outline revenue objectives.

Answer 34

Sales maximisation.

Targeting a specific increase in sales revenue.

Exceeding the sales of a competitor.

Question 35

Outline some examples as to how businesses will rely on their marketing mix to achieve the revenue objectives.

Answer 35

Lowering prices, leading to an increase in demand and then sales volume.

If aware of the PED for its products - increase sales revenue (by lowering the price if demand is elastic or the opposite etc).

Question 36

Outline cost objectives.

Answer 36

Cost minimisation - means achieving the lowest possible unit costs.

Question 37

How can a business benefit from low unit costs?

Answer 37

Keep prices the same but benefit from a higher profit margin.

Use cost reduction to reduce the selling price of its final product which will attract more customers.

Question 38

Outline some examples of cost minimisation objectives.

Answer 38

Achieving a certain cost reduction in the purchase of raw materials.

Reducing wage costs per unit.

Lowering levels of wastage.

Question 39

Why must we be wary of cost reduction in purchasing raw materials.

Answer 39

Might lead to lower quality.

Question 40

What will profit objectives apply to?

Answer 40

Gross profit, operating profit and profit for the year.

Question 41

Outline some profit objectives.

Answer 41

Usually take a similar for to revenue objectives:

Profit maximisation.

Targeting a specific increase in profit.

Exceeding the profit of close competitors.

Question 42

What is the problem with setting profit objectives?

Answer 42

Difficult to tell when they have been achieved.

Can conflict with other corporate objectives, such as fair treatment.

Question 43

Outline some cash flow objectives:

Answer 43

Maintaining a minimum closing monthly cash balance.

Reduce the bank overdraft by a certain sum by the end of the year.

Creating a more even spread of sales revenue.

Question 44

Define depreciation.

Answer 44

The fall in revenue of an asset over time, Reflecting the wear and tear of the asset as it become older, the reduction in its economic use or its obsolescence.

Question 45

Define obsolescence.

Answer 45

When an asset is still functioning but is no longer considered useful because it is out of date.

Question 46

What are the two types of investment?

Answer 46

Replacement capital/investment - intended to replace depreciated assets.

New investment - expenditure on new capital goods increasing capacity to produce.

Question 47

Outline the factors influencing investment decisions and objectives.

Answer 47

Expected return on investments.

Interest rates.

Expected demand.

Levels of technological change.

Availability of finance.

Business confidence.

Attitude to risk.

etc.

Question 48

How are businesses funded?

Answer 48

A combination of debt capital and equity capital.

Question 49

Outline debt capital.

Answer 49

Consists of borrowed funds. Used when external sources provide funding in exchange for regular fixed interest payments and an agreed repayment date.

Question 50

Define equity capital.

Answer 50

Provided by shareholders who receive dividends and agree some of them can be retained within the business.

Question 51

What two factor s should be taken into consideration when deciding on its ideal capital structure and therefore its objective?

Answer 51

Match their capital structure to the timings of cash flow.

balance the costs of their financing with the level of risk involved.

Question 52

Outline the external factors influencing financial objectives.

Answer 52

Economic factors. 
Social factors.
Technological change. 
legal factors. 
environmental factors. 
Market factors. 
Competitors actions and performance. 
Suppliers.

Question 53

Outline the internal influences on financial objectives.

Answer 53

Business objectives. 
Finance. 
Human resources. 
Operational factors. 
Available resources. 
Nature of the product.