5.1 Setting financial objectives

Question 1

Benefits of setting financial objectives

Answer 1

• 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

Question 2

Difference between cash flow and profit

Answer 2

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

Question 3

Reasons for cash flow problems:

Answer 3

• Holding large amounts of stock
• Having sales on long credit periods
• Using cash to purchase fixed assets

Question 4

Gross profit calculation

Answer 4

Gross profit = Sales revenue - Direct costs of production

Question 5

Operating profit calculation

Answer 5

Operating profit = Sales revenue - All costs of production
OR
Operating profit = Gross profit - expenses

Question 6

Profit for the year calculation

Answer 6

Profit for the year = Operating profit + other income - other expenditure

Question 7

Revenue objectives

Answer 7

• 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

Question 8

Cost objectives

Answer 8

• 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

Question 9

Profit objectives

Answer 9

• Particular figure, percentage increase in profit
• Profit maximisation

Question 10

Cash flow objectives

Answer 10

• 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

Question 11

Capital expenditure

Answer 11

The money used to purchase, upgrade or improve the life of long-term assets.

Question 12

Investment objectives

Answer 12

• Business growth
• Business growth = requires an increase in capital expenditure

Question 13

Return on investment calculation

Answer 13

Profit/ Capital invested x 100

Question 14

Equity

Answer 14

The money a business raises through the issue of shares.

Question 15

Borrowing

Answer 15

The money a business raises through loan capital.

Question 16

What is the capital structure of a business?

Answer 16

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

Question 17

Why should businesses consider the proportion of borrowing to equity? (high borrowing)

Answer 17

• 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

Question 18

Gearing ratio calculation

Answer 18

Loan capital/ Total capital x 100

Question 19

Total capital equation

Answer 19

Loan capital + equity

Question 20

External influences on financial objectives and decisions

Answer 20

• 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

Question 21

Internal influences on financial objectives and decisions

Answer 21

• 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