5.1 Setting financial objectives

Question 1

define: financial objective

Answer 1

goals or targets that relate to the business’s intentions with cash.

Question 2

define: cash flow

Answer 2

the difference between cash receipts and cash payments.

Question 3

Why is a positive cash flow important for a business?

Answer 3

cash receipts should be greater than cash payments to enable a business to pay their day to day bills. It is necessary for short term survival.

Question 4

define: profit

Answer 4

revenue - total costs

Question 5

Why is profit important for a business?

Answer 5

It is the reward to the owners who will be shareholders expecting a reasonable dividend and the value of their shares to rise. Failure to earn a profit means a loss of share value and shareholders will sell their shares. This means that the business may be taken over in the longer term. It is an important source of funds for investment in new machinery, new technology and market research.

Question 6

what are the 3 types of profit?

Answer 6

1. Gross profit
2. Operating profit
3. Net profit (profit for the year)

Question 7

define: direct costs

Answer 7

spending that can be clearly allocated to a particular product or area of the business -> fuel + raw materials

Question 8

define: indirect costs

Answer 8

spending that relates to all aspects of a business’s activities -> building maintenance costs + salaries

Question 9

define: remaining costs

Answer 9

interest paid and received by the firm as well as profits on taxation

Question 10

formula for revenue:

Answer 10

Revenue = Price x Quantity sold

Question 11

formula for gross profit:

Answer 11

Revenue - Direct costs (COGS) = Gross profit

Question 12

formula for operating profit:

Answer 12

Gross profit - Indirect costs = Operating profit

Question 13

formula for Net profit (profit for the year):

Answer 13

Operating - remaining costs = Profit for the year (Net profit)

Question 14

types of financial objectives?

Answer 14

1. Revenue
2. Costs
3. Profit objectives

Question 15

Revenue objectives:

Answer 15

earning a certain amount of revenue over a financial period.
May be used:

• Throughout the business that aim to grow
• Build a customer base and establish themselves in market
• Maximise revenue - short lifecycle
• Relate to a specific aspect of the business - online sales
• Aggressive revenue objectives increasing from £4 mill to £4.5m to £5.3m
• Reducing price/increasing price - risky?
• Doesn’t necessarily increase profits why?

Question 16

Cost objectives: (2 types)

Answer 16

1. Cost minimisation (reducing costs)
2. To maintain profit margins (by reducing costs)
   e. g. cost per unit being reduced by 10%

Question 17

Profit objectives:

Answer 17

• Can relate to previous years and any expected changes in the future
  e. g. profits increasing from £3m to £3.5m per year

Question 18

define: investment

Answer 18

the purchase of assets that will remain with the business over the long term- known as non-current assets

Investment objectives are also called capital expenditure.

Question 19

investment + returns:

Answer 19

By undertaking a level of capital expenditure the business will increase:

• its size
• its value
• its ability to supply products to its customers.

A business may set itself an objective of lowering its capital expenditure to reduce the amount it has borrowed -> considers that its debts are too high/ look to pay off loan debt.
Capital investment expenditure objectives can be difficult to achieve principally because the business may encounter problems in raising sufficient capital to fund its planned investment programme.

Question 20

It may be easier to raise capital for investment if:

Answer 20

• The business hasn’t borrowed excessive amounts already, reassuring lenders that it will be able to repay any borrowings
• The business is purchasing non current assets (property) that will retain value and could be sold if necessary to repay a loan
• The business is a company and sell additional shares to raise funds

Question 21

what is an alternative way of setting financial objectives for investment?

Answer 21

is to set a target for the return on an investment.

Return on investment = operating profit/capital invested x 100

Question 22

define: capital structures (2 types)

Answer 22

the balance of this finance in terms of how much is equity (or share capital) and how much is is in the form of debt.

1. Borrow funds- pay interest
2. They can choose to sell shares- pay more dividends, lose control

Capital structure is the balance between these two types of capital, loan capital and share capital.

Question 23

What affects capital structure objectives:

Answer 23

1. Interest rates
2. Capital structure optimisation objectives - aims to minimise the cost of raising capital for the company without affecting overall value
3. Inflation
4. Income

Question 24

influences of financial objectives:

Answer 24

• Competitive environment
• Overall business objective
• Economic environment
• Technological environment
• Senior managers
• Political and legal environment
• Nature of product