3.5.1 Setting financial objectives Flashcards
1 What is investment
the purchase of assets such as property, vehicles, machinery that will be used for a considerable time by a business
1 What is Return on investment (ROI)
measure of efficiency of an investment in financial terms, used to compare the financial returns of alternative investments
1 What are Non-current assets?
items a business owns that are expected to be retained for one year or longer
1 What is capital expenditure
spending undertaken by a business to purchase non-current assets such as a vehicle and property. another term for investment
1 What is Capital Structure?
refers to the way in which a business has raised the capital it requires to purchase its assets
1 What are investment objectives
most businesses make investments to earn an acceptable return on them
Capital expenditure on items such as product machinery, IT systems, buildings etc
Can also be the purchase of other businesses (takeovers) or brands
Investment is intended to help generate a return (profit) over more than one year
1 What are two common investment objectives
Level of capital expenditure - Set at either an absolute amount (e.g. investment $5m per year) or as a percentage of revenues (e.g. 5% of revenues)
Return on investment - Usually set as a target % return, calculates by dividing operating profit by the amount of capital invested.
1 How do you calculate return on investment?
ROI = (Operating profit/capital invested) x 100
1 What are the two types of capital expenditure?
Replacement capital
New investment
1 What is Replacement capital?
This investment is intended to replace assets that have depreciated (worn out). Replacement capital is not, therefore is not stock!
1 What is new Investment
This is expenditure on new capital goods that enables a business to increase its capacity to produce.
1 Why would a business set itself lower capital expenditure targets?
Reduce the amount it has borrowed if it considers that its debts are too high. In this case. Management may divert funds that would have been invested into buying non-current assets to repaying loans. Reduce the interest payments that the company is liable to pay and increase profits in the long term.
1 What does ROI depend on?
targets, debts, loans etc
1 What is Expected return on investment
businesses will only invest in projects if the expected returns are satisfactory
1 What is Interest rates
rise in interest rates increase cost of borrowing money, therefore business may decide that a certain project is not financially worthwhile.
1 What is Expected demand
If expected demand for its products is high, then business is more likely to undertake capital expenditure because this will enable it to increase capacity to produce.
1 What is Availability of finance
if unable to get access to sufficient fiancé to fund new equipment, then it will need to cut back on it capital expenditure.
1 What is Business confidence
spending on capital equipment depend on what businesses expect to happen in the future e.g. boom in economy.
1 What is Level of spare capacity
If the business has high levels of spare capacity, it will not need to spend on investment in new equipment.
1 What are the factors influencing investment decisions and objectives
Expected return on investment
Interest rates
Expected demand
Availability of finance
Business confidence
Attitude to risk
Level of spare capacity
Competitors’ actions
1 What is Capital Structure?
Businesses are funded by a combination of debt capital and equity capital. These are the long term finance which forms the foundation for the business.
1 What is Equity
Represents amounts invested by the owners of the business: it comprises:
Share capital
Retained profits
1 What is Debt
Represents long-term finance provided to the business by external parties: it comprises:
Long-term bank loans
Other long-term debt (e.g. debentures)
1 Reasons for higher equity in the capital structure
Where there is greater business risk (e.g. a start-up)
Where more flexibility required (e.g. don’t have to pay dividends)
1 Reasons why high levels of debt can be an objective
Where interest rates are very low = debt is cheap to finance
Where profits and cash flows are strong; so debt can be repaid easily.
1 How do you record revenue, costs and profit to measure achievement of objectives?
Financial Statements
Income statement
Balance sheets
1 What are some revenue objectives?
Revenue growth (percentage or value)
Sales maximisation (maximising sales volume or sales value – revenue)
Market share
1 What is a revenue growth objective
Aiming to grow total revenues by 10%
Reach £1million in sales during a year
1 What is a Sales maximisation objectives?
Aim to maximise total sales – regardless of whether those sales are profitable
1 What is a market share objective?
Grow market share to 20% (will involve faster revenue growth than market competitors)
1 How do you achieve revenue objectives?
Rely on the marketing mix
Lowering price will lead to an increase in the quantity demanded, sales volume will rise
Promotion can also help to achieve this objective.
If aware of the price elasticity of demand it might be able to increase sales revenue
1 What are benefits of cost minimisation objectives
lower unit costs (competitiveness)
higher gross profit margin
higher operating profits
improved cash flow
higher return on investment
1 What are some cost minimisation objectives
Cost reduction in the purchase of raw materials
Reducing wage cost
Lower levels of wastage
Relocating
Improving efficiency of production
1 How do you cost reduction in the purchase of raw materials?
Use cheaper suppliers overseas, such as China.
1 How do you reduce wage costs?
Improving productivity of labour or reducing the level of overtime payments.
1 How do you lower levels of wastage?
Saves costs by reducing the usage of raw materials or the number of finished products that are discarded.
1 How do you relocate well?
Unit cost should be reduced if a business relocates to a place where wages and rents are lower.
1 How do you improve efficiency of production
Introduce new technology and just-in-time methods of production in order to reduce variable cost per unit
1 What is a cost minimisation objective?
Achieving the lowest possible unit costs.
Aims to achieve the most cost-effective way of delivering goods and services to the required level of quality.
1 How can businesses reduce their unit costs?
Keep its price the same and benefit from a higher profit margin
Use cost reduction to reduce the selling price of its finished product and so attract more customers.
1 What are some profit objectives
Specific level of profit (in absolute terms)
Rate of profitability (as a% of revenues)
Profit maximisation
Exceed industry or market profit margins
1 What is the problem with Profit objectives
Profit maximisation is a difficult target to set because it is hard to know if it has been achieved
Can conflict with other corporate objectives, such as fair treatment of workers and suppliers
Focus on an objective to increase profit in comparison to previous years
2 what are financial objectives
a goal or target set by the finance department in an organisation
2 what is revenue
price x quantity
total values of sales generated
2 what is fixed costs
costs paid by a business to do with the running of a firm that do not change with output
2 what are variable costs
costs paid by a business to create goods, they do change with output
2 what is profit
the difference between total revenue and total costs
2 what is cash flow
the movement of cash in and out of a business over time
2 how are cash flow and profit linked
profit is main source of a funds for an established business
revenues eventually turn into cash inflows
costs eventually turn into cash outflows
2 how do cash flows arise from different areas of the business?
inflows from shareholders
repayments of amounts loaned
payments of dividends
2 what is the time difference of profit to cash flow
sales to customer made on credit
and payment to suppliers
2 what is the fixed assets differences for cash flow and profit
payment for a fixed asset - cash outflow
cost of fixed assets are assets
depreciation is charged as cost when the value of fixed assets is reduced
2 what is the profit equation
sales - variable costs - total costs = net profit
2 what is the cash flow equation
cash inflows - cash outflows = net cash flow
2 what happens to profit and cash flow when customer buys $50,000 on 60 days credit
profit- £50,000 sales recognised immediately
cash flow- cash inflow of £50,000 when customer actually pays
2 what happens to profit and cash flow when marketing campaign costing £10,000 ordered
profit- cost of £10,000 included in marketing costs
cash flow- cash outflow of £10,000 when company is paid
2 benefits of financial objectives?
focus of the business
important success measure
reduce risk of failure
provide transparency for shareholders about the investment
help co-ordinate business functions
key context for making investment decisions
2 what are some financial objectives?
revenue
cost minimisation
profit
cash flow
investment
