5.1 Setting financial objectives Flashcards
Benefits of setting financial objectives
- Act as a measure of performance
- Provide targets which can be a focus for decision-making
- Potential investors or creditors may be able to assess the viability of the business
Difference between cash flow and profit
Cash flow is the difference between the actual amount a money receives and the actual amount it pays out.
Profit is the difference between all sales revenue and expenditure
Reasons for cash flow problems:
- Holding large amounts of stock
- Having sales on long credit periods
- Using cash to purchase fixed assets
Gross profit calculation
Gross profit = Sales revenue - Direct costs of production
Operating profit calculation
Operating profit = Sales revenue - All costs of production
OR
Operating profit = Gross profit - expenses
Profit for the year calculation
Profit for the year = Operating profit + other income - other expenditure
Revenue objectives
- Business may create a budgeted revenue target
- Budgeted revenue might be based on the objective of increasing revenue by 5% per annum
- Objective set might depend on the type of market a business is operating in
Cost objectives
- Increasing pressure on costs due to highly competitive environment
- Cost minimisation (business objective)
- Business may set an objective of reducing costs by a certain percentage
Profit objectives
- Particular figure, percentage increase in profit
- Profit maximisation
Cash flow objectives
- Targets for monthly closing balances
- Reduction of bank borrowings to a target level
- Reduction of seasonality in sales
- Targets for achieving payment from customers
- Extension of the business’s credit period to pay suppliers
Capital expenditure
The money used to purchase, upgrade or improve the life of long-term assets.
Investment objectives
- Business growth
- Business growth = requires an increase in capital expenditure
Return on investment calculation
Profit/ Capital invested x 100
Equity
The money a business raises through the issue of shares.
Borrowing
The money a business raises through loan capital.
What is the capital structure of a business?
Refers to the long-term capital (finance) of a business.
- Long-term capital is made up of of equity (share capital) and borrowing (loan capital)
- Business should consider the proportion of borrowing to equity
Why should businesses consider the proportion of borrowing to equity? (high borrowing)
- Higher the borrowing, the greater the interest payment
- High interest payments put businesses at risk if profit falls for any reason
- Rise in interest rates would significantly impact profits
- Gearing ratio measures proportion of long-term capital that is in debt
Gearing ratio calculation
Loan capital/ Total capital x 100
Total capital equation
Loan capital + equity
External influences on financial objectives and decisions
- Competitor actions: Price cuts, development of new products, New marketing campaigns
- Market forces: Market and fashion changes
- Economic factors: Changes in the economy, recession, changes in interest rates
- Political factors: Change of government and legislation
- Technology: Changes in technology, introduction of new technology
Internal influences on financial objectives and decisions
- Corporate objectives: Financial targets needs to be linked to corporate objectives
- Resources available: The ability to achieve financial targets may be limited by resources available
- Operational factors: Ability to achieve financial targets will be limited in the short term by the physical capacity of the business
