3.5.1 Setting financial objectives Flashcards
(41 cards)
What are financial objectives?
a specific goal or target relating to financial performance
What can financial objectives be based on?
- Revenue
- Costs
- Profit
- Cash flow
- Investment levels
- Capital structure
- Return on investment
- Debt as a proportion of long term funding
What are benefits of setting financial objectives?
- Provides a focus for the business as a whole
- Focus for decision making and effort
- Can measure success and failure
- Reduces the risk of business failure (particularly prudent cash flow objectives)
- Improved coordination (of the different business functions) and efficiency
- Information for shareholders – priorities of management
- Allows external stakeholders to confirm financial viability
- Provides a target to help make investment decisions
What are difficulties of setting financial objectives?
- Not always realistic
- External changes
- Difficulty in measuring
- May conflict with other objectives
- Responsibility may lie with finance department, when it is a whole business priority
What is Return on Investment (ROI)?
this is the measure of efficiency of an investment in financial terms, used to compare the financial returns of alternative investments
How do you calculate ROI as a percentage?
= return on investment / cost of investment x 100 (return on investment = financial gains from the investment – cost of investments)
What can firms consider from ROI?
From the returns on investments, firms should be able to consider financial returns, trends in financial performance, changing levels in return
What is the equation for profit?
Profit = revenue – total costs
What is cash flow?
Cash Flow = the money flowing in and out of the business on a day to day basis. This is essential to prevent a firm from becoming insolvent (when a business can no longer pay its debts off)
What is Net Cash flow?
this is the money left over when a business takes its outflows from its inflows
What are main cash inflows?
- Money invested by business owners
- Loan from the bank
- Income from sales
What are main outflows?
- Wages and training
- Raw materials
- Advertising
- Rent, mortgage, and bills
- Taxes
- Interest on loans
- Maintenance and repair
What is gross profit?
this shows how efficiently a business converts raw materials into finished goods and how much value they add
How do you calculate gross profit?
GP = revenue – cost of sales
How do you calculate operating profit (net profit)?
Operating Profit (Net Profit) = gross profit – expenses
What is profit for the year?
this is the profit available to shareholders and it includes the sale of assets, interest payments, and tax
What are examples of revenue objectives?
- Sales maximisation – volume/value
- Targeting a specific increase in sales revenue
- Exceeding the sales of a competitor
- Revenue growth (% or value)
- Market share
What are examples of cost objectives?
- Cost minimisation – this could be in terms of unit cost which are then further linked to efficiency, labour productivity, and capacity utilisation
- Productivity – in terms of unit per worker and capacity utilisation
What are examples of profit objectives?
- Specific level of profit (in absolute terms)
- Rate of profitability (as a % of revenues)
- Profit maximisation
- Exceed industry or market profit margins
Give reasons as to why cash flow is important.
- It can be used to support an application for sources of finance
- If a business does not have enough cash available to pay its bills it could fail
- A business that is not able to pay its suppliers will probably not receive any more supplies
- It may be unable to pay its workers, which will at the very least cause demotivation, and encourage them to leave, at worst
- It is the main cause of failure of small businesses
- The principle of timing, managing when money flows in and when it flows out is vital
What can firms gain from setting cash flow objectives?
- Maintain a minimum closing monthly balance
- Reduce bank overdraft by a certain amount by the end of the year
- Create a more even spread of sales revenue
- Spread costs more evenly
- Setting contingency fund levels
What are examples of cash flow objectives?
- Maximum level of debt (the absolute amount, rather than the gearing ratio)
- Amount of cash tied up in working capital (inventories, receivables)
- Cash flow to profit %
What are advantages of cash flow forecasts?
- Identify problems in advance
- Guide to appropriate action
- Make sure there is sufficient cash to make payments
- Evidence for financial support
- Avoids failure
- Identifies if they are holding too much cash
