Financial management

Question 1

What is a financial objective?

Answer 1

A goal/target pursued by the finance department within an organisation, they are specific, focused aims or goals of the finance and accounting function within an organisation.

Question 2

What are the financial objectives?

Answer 2

Increasing revenue
Reducing costs
Profit
Cash flow
Investment levels (increasing)
Capital structure

Question 3

What are the reasons for setting financial objectives?

Answer 3

Judge the performance of the enterprise from when it was first established.
Acts as a focus for decision-making.
Identifies aspects of performance that are causing problems at the earliest stage.
Improve efficiency
Allows shareholders to assess whether the business is going to provide a worthwhile investment.
Enables outside organisations (suppliers and customers) to confirm the financial viability of a business.

Question 4

What is cash flow?

Answer 4

The amount of money flowing into and out of the business over a period of time.

Question 5

What are cash inflows?

Answer 5

Receipts of cash from sales, interest received.

Question 6

What are examples of cash outflows?

Answer 6

Payments of cash for purchases of products, payments to suppliers (creditors) repayment of loans, purchase of assets, payment of rent, and interest payments.

Question 7

How do you calculate net cash flow?

Answer 7

Total cash inflows - Total cash outflows

Question 8

How do you calculate profit?

Answer 8

Total revenue - Total costs

Question 9

What is the difference between profit and cash flow?

Answer 9

Profit is essential to the long-term survival of the business whereas cash is the lifeblood of the business. Businesses will have to ensure that they keep an eye on their liquidity (how quickly you make money from it) as well as their profitability.

Question 10

How can a business be profitable but cash poor?

Answer 10

If it has spent a lot of money buying stock that has not yet been sold.
If it has sold a lot of good on credit so they have not yet been paid.
If it has had to repay a loan or pay dividends to their shareholders.
If it has purchased new (non-current) assets such as premises of new ICT equipment.

Question 11

What is gross profit and how can it be calculated?

Answer 11

Cost of sales covers the direct costs of providing the goods e.g. materials/labour.
Revenue - Cost of sales (unit costs, variable costs)

Question 12

What is operating profit and how can it be calcualted?

Answer 12

Profit which is generated from trading (the normal activities of the business). Exceptional expenses are not included in the calculation. It does not include tax on profits/paying interest on loans.
Excludes any income/costs that incurred by activities that are unlikely to be repeated in future financial years.
Gross profit - Costs of goods and services sold. (overheads- fixed costs)

Question 13

How is net profit calculated?

Answer 13

Operating profit - Tax, interest, dividends etc.

Question 14

What are the revenue objectives?

Answer 14

Sales maximisation (focused on maximising sales volume/sales value).
Target a specific increase in sales revenue.
Exceeding the sales of a competitor.

Question 15

What are the cost objectives?

Answer 15

Cost minimisation (achieving the lowest possible unit cost).
A business that reduces unit costs can be beneficial in 2 ways:
if it keeps its price the same it will benefit from a higher profit margin
if it can use its cost reduction to reduce the selling price of its product and so attract more customers.

Question 16

What are profit objectives and what does it depend on?

Answer 16

Most firms aim to make a profit. Is £100,000 a good profit?
It depends…
for a local corner shop, it is fantastic but for shell, it would be poor therefore to make it more meaningful you need to compare the size of the business.

Question 17

What is the difference between profit and profitability?

Answer 17

Profit is absolute value whereas profitability is relative to the size of the business/volume of its sales.

Question 18

What are cash flow objectives?

Answer 18

Maintaining a minimum closing monthly cash balance e.g. minimum cash balance of £10,000.
Reducing the bank overdraft by a certain sum by the end of the year.
Creating a more even spread of sales revenue (important for firms with seasonal sales).
Spreading costs more evenly.
Achieving a certain level of liquid, non-cash items.
Raising levels of cash at certain times.
Setting contingency levels.

Question 19

What is the return on investment objective?

Answer 19

Investment = spending on items that are purchased by firms because they help them produce goods and services e.g. capital goods such as machinery, delivery vehicles, and factories.
Return on investment = measure of the efficiency of an investment in financial terms it is used to compare the financial returns of alternative investments.

Question 20

How is return on investment calculated?

Answer 20

Return on investment / Cost of the investment x100
Or
Financial gains from the investment - Costs of the investment

Question 21

What are the factors influencing investment decisions and objectives?

Answer 21

Expected return on investment
Interest rates
Expected demand
Levels of technological change
Availability of finance
Business confidence
Attitude to risk
Level of spare capacity
Nature of production
Competitors actions

Question 22

What is the capital structure objective?

Answer 22

Debt capital = borrowed funds e.g. bank loans or debentures.
Equity capital = capital provided by the shareholders who will receive dividends paid depending on the profit earned by the business and some of the profit will be retained by the business.

Question 23

What are the external influencers on financial objectives and decisions?

Answer 23

Political factors
Economic factors
Social factors
Technological change
Legal factors
Environmental factors
Market factors
Competitors actions and performance
Suppliers

Question 24

What are the internal influencers on financial objectives and decisions?

Answer 24

Business objectives
Finance
Human resources
Operational factors
Available resources
Nature of the product

Question 25

What are the benefits of financial objectives?

Answer 25

Focus for decision-making Improve business efficiency Provides a means of judging performance Improves coordination by providing departments with a common purpose Allows shareholders to assess whether the business is going to provide a worthwhile investment Enable outside organisations such as suppliers and customers to confirm the financial viability of a business

Question 26

What are the drawbacks of financial objectives?

Answer 26

Can be difficult to set realistic objectives, particularly for new activities. External changes, such as increased competition may be outside of the control of a business. Certain objectives may be difficult to measure accurately. Some financial objectives may conflict with other objectives. Reasons for success and failure may be impossible to determine.

Question 27

What are non-current assets?

Answer 27

Items that a business owns and which it expects to retain for one year or longer.

Question 28

What is capital expenditure?

Answer 28

Spending undertaken by businesses to purchase non-current assets such as vehicles and property.

Question 29

What are investment objectives?

Answer 29

Most businesses make investments to a greater or lesser degree. Like any investment, the aim is usually to earn at least an acceptable return on those investments. They include: Capital expenditure on items such as product machinery, IT systems, buildings, etc. Purchase of other businesses (takeovers or brands) Investment is intended to help generate a return (profits) over more than a year.

Question 30

What are the problems in achieving capital expenditure objectives?

Answer 30

Difficult to achieve due to problems in raising sufficient capital to fund its planned investment. It may be easier to raise capital if: The business has not borrowed excessive amounts already, reassuring lenders that it will be able to repay any borrowings. The business is purchasing non-current assets (such as property) that will retain value and could be sold if necessary to repay a loan. The business is a company and can sell additional shares to raise funds.

Question 31

What is a budget?

Answer 31

An estimation of income and expenses over a specified period of time.

Question 32

What are income budgets?

Answer 32

Shows the planned income over a period of time. Revenue from product sales- linked closely to marketing targets. Should investigate at product level. Any other sources of income e.g. rent.

Question 33

What are expenditure budgets?

Answer 33

Shows the planned expenditure over a period of time. Spending on raw materials, labour, marketing, administration, rent, capital costs, etc. Particularly important for business start-ups to deal with specific start-up costs e.g. premises, equipment, vehicles etc.

Question 34

What are profit budgets?

Answer 34

Shows the planned profit for the business over a period of time. Depends on the income and expenditure budgets.

Question 35

What is the process of setting budgets?

Answer 35

Setting objectives Carry out market research Carry out research into costs Complete the sales (income budget) Construct the expenditure budget Create an overall profit budget Draw up divisional or departmental budgets Summarise the detailed budgets in the master budget

Question 36

What are the methods of setting budgets?

Answer 36

Budgeting according to company objectives (the more ambitious the objectives the higher the budget required). Budgeting according to competitors spending. Setting a budget as a % of sales revenue. Zero-based budgeting e.g. Olympics. Budgeting based on last year's allocation (e.g. inflationary increase).

Question 37

What are the reasons for setting budgets?

Answer 37

To gain financial support To ensure the business does not overspend To establish priorities To encourage and motivate staff To assign responsibility To improve efficiency

Question 38

What are the problems with setting budgets?

Answer 38

Managers may not have enough information There may be problems gathering information There may be unforeseen changes Inflation is not easy to predict Can be time consuming Budgets should not be imposed

Question 39

What are sources of finance?

Answer 39

Various sources that are available to managers from inside and outside of the business.

Question 40

What is the definition of internal sources of finance?

Answer 40

Already exists in a business and requires a decision about how to use it.

Question 41

What are external sources of finance?

Answer 41

Funds that are injected from outside the business e.g. a bank loan.

Question 42

What is short-term finance?

Answer 42

Needed for a limited period of time (less than a year to pay bills and keep suppliers happy).

Question 43

What is long-term finance?

Answer 43

Needed over a longer period of time.

Question 44

What are retained profits?

Answer 44

Businesses use profits from the current trading year of profits from previous trading years.

Question 45

What are sale of assets?

Answer 45

Businesses sell assets they no longer need.

Question 46

What is a bank loan?

Answer 46

Money provided to a business to start up however they need to return the payment in the form of interest charges.

Question 47

What is an overdraft?

Answer 47

When a business is allowed to spend more than it holds in its current bank account (agreed limited).

Question 48

What is venture capital?

Answer 48

Funds given to businesses which are in a high risk in the form of share and loan capital.

Question 49

What is share capital?

Answer 49

Finance invested into a company as a result of the sale of shares in the business.

Question 50

What is budgetary control?

Answer 50

Using budgeting to monitor and review the actual outcomes in comparison with the budgeted figures (target). This is referred to as variance analysis.

Question 51

What is adverse?

Answer 51

Worse than budgeted

Question 52

What is favourable?

Answer 52

Better than budgeted

Question 53

What is a cash flow forecast?

Answer 53

A prediction of what money goes in and out. Helps you predict when you have a liquidity problem. Cash flow problems are the main reasons businesses fail. Regular and reliable cash flow forecasting can address many of the business's problems.

Question 54

Why is cash flow so important?

Answer 54

Gives management and other stakeholders of the business advanced warning of cash that may run out (shortfall). Will the business have enough cash to pay its suppliers? Important part of financial control for investors as it gives assurance to how the business is managing their money properly.

Question 55

What are examples of cash inflow?

Answer 55

Cash sales (revenue) Receipts from trade debtors (customers bought on credit- buy now pay later) Sale of fixed assets Interest on bank balances Grants Loans from the bank

Question 56

What are examples of cash outflows?

Answer 56

Payment to suppliers Wages and salaries Payments for fixed assets Tax on profits Interest on loans and overdrafts Dividends paid to shareholders Repayment of loans

Question 57

What is the opening balance?

Answer 57

The cash at the beginning of the period.

Question 58

How is the closing balance calculated?

Answer 58

Opening balance + net cash flow

Question 59

What is a cash flow cycle?

Answer 59

The pattern of inflows and outflows of cash within a business.

Question 60

What is a cash flow problem?

Answer 60

When a business does not have enough cash to be able to pay its liabilities.

Question 61

What are the main causes of cash flow problems?

Answer 61

Low profits or (worse assets) Too much production capacity Too much stock Allowing customers too much credit Overtrading- growing too fast Unexpected changes in the business (technology) Seasonal demand

Question 62

How can cash flow be improved?

Answer 62

Find new sources of inflows- try to sell more, borrow money or sell assets. Delay outflows- it could delay paying bills as long as possible. Spaced-up cash inflows- could put pressure on customers to pay their bills earlier. Reduce stock levels. Cheaper suppliers.

Question 63

What is break-even?

Answer 63

When the level of output by TR=TC.

Question 64

How is contribution calculated?

Answer 64

Revenue- Variable costs

Question 65

Why do we use break-even analysis?

Answer 65

Helps decide if the business will be viable and profitable. Helps decide the level of output and sales necessary to generate a profit. The results can be used to help support the businesses application for a loan. To assess the impact of changes in the level of production on the profitability of the business. To assess the effects of different prices and levels of costs on the potential profitability of the business. The point at which neither a profit nor loss is made known as the break-even point.

Question 66

What are the strengths of break-even analysis?

Answer 66

The business can see how long it will take to make a profit. Helps others see the practicality of a business proposition of investing. Illustrates the importance of keeping fixed costs to a minimum (high fixed costs= higher break-even analysis). Calculations are quick and easy- quick estimates.

Question 67

What are the limitations of break-even analysis?

Answer 67

Unrealistic assumption= products are not sold at the same price of different levels of output, fixed costs do vary when output changes. Sales are unlikely to be the same as output= there may be some build-up of stocks or wasted output too. Variable costs do not always stay the same. Most businesses sell more than one product so the break-even for the business becomes harder to calculate. Break-even analysis should be seen as a planning aid rather than a decision-making tool.

Question 68

How is the break-even point calculated?

Answer 68

Fixed costs/ selling price per unit- variable cost per unit Fixed costs/contribution per unit

Question 69

What is gross profit and how is it calcualted?

Answer 69

Revenue - Cost of sales Money a company makes after paying for the things it needs to make and sell its products/services. Shows how well a company uses labour and suppliers to make things. Doesn't include fixed costs. Important because it helps us see how efficiently a company is using its resources.

Question 70

What is profit from operations and how can it be caculated?

Answer 70

Money a company makes from its main business activities; it is the money left over after paying expenses. Important because it shows if a company is making more money than it spends on its core operations. Positive operating profit doesn't guarantee future profitability other factors, like debt and other large costs, can still affect a company's overall financial health. Sales revenue - (cost of sales + overheads)

Question 71

What is profit for the year and how can it be calculated?

Answer 71

Total sales (revenues) less total costs. If revenue is greater than the costs, the business makes a profit. But if the costs are greater than the revenue, the business makes a loss. Profit margin tell us how much profit a business makes for each £ of sales. Businesses can improve their profit by making good financial decisions and analysing their financial performance. Sales revenue - (cost of sales + overheads + finance costs)

Question 72

What is gross profit margin and how can it be calculated?

Answer 72

Measures gross profit as a % of sales (turnover) Ration measures how efficiently the business is transforming raw materials into products. Gross profit/revenue x100

Question 73

What is operating profit margin and how can it be calculated?

Answer 73

Measures operating profit as a % of sales (turnover) Ration measures how efficiently the business is making a profit from the resources that it is using for its trading activities. Operating profit/sales revenue x100

Question 74

What is profit of the year margin and how can it be calculated?

Answer 74

Measures profit that is available for shareholders as a % of sales (turnover). Ratio measures how much the shareholders may benefit directly from the financial performance of the business. Profit of the year/sales revenue x100

Question 75

What is ratio analysis?

Answer 75

Involves the comparison of financial data to gain insights into business performance. Helps to answer key questions such as: Why is one business more profitable than another? What returns are being earned in investment in a business? Is a business able to stay solvent? (can they pay their debts?) How effectively is a business using its assets?

Question 76

What are the factors influencing the choice of source of finance?

Answer 76

The amount of personal finance available The legal structures of the business Past history and future prospects The business's profitability Assets owned by the business The amount of finance needed How risky the business is judged to be

Question 77

When choosing a source of finance why do the factors matter?

Answer 77

The legal structures of the business matter because only private and public limited companies can sell shares and offer investors limited liability. The profitability of the business because a business must be profitable if they are borrowing money so they can make the repayments and pay interest. The amount of finance needed by the business because some sources of finance can raise larger amounts, such as Bank Loans and share issues. Trade credit is normally only used for smaller amounts. How risky the business is judged to be matters because a Bank may charge a very high interest rate on a loan if the business is judged as risky, for instance if they are new.

Question 78

What are the sources of finance?

Answer 78

Business objectives Profits and profitability Capital intensity Cash flow forecasting Shares and shareholders

Question 79

What has to be considered when choosing the right source of finance?

Answer 79

How much? Enough v not too much, safety buffer. When? All at once, Drip feed/as needed. Challenges: keeping control, staying afloat.

Question 80

What are examples of internal sources of finance?

Answer 80

Retained profits Working capital Asset disposals

Question 81

What are examples of external sources of finance?

Answer 81

Issue shares Bank loan/overdraft Debentures Venture capital Suppliers

Question 82

What is the most significant source of finance for an established profitable business?

Answer 82

Retained profits

Question 83

What are the main benefits of retained profits?

Answer 83

Cheap (though not free): the "cost" of retained profits is the opportunity cost for shareholders of leaving profits in the business. Very flexible: management control how they are reinvested, shareholders control the proportion retained. Do not dilute the ownership of the company: unlike the issue of new share capital.

Question 84

What are the drawbacks of retained profits?

Answer 84

Danger of hoarding cash. Shareholders may prefer dividends if the business is not achieving sufficiently high returns on investment. High profits and cash flows would suggest the business could afford debt (higher gearing).

Question 85

What is debt factoring?

Answer 85

An external, short-term source of finance for a business. With debt factoring, a business can raise cash by selling their outstanding sales invoices (receivables) to a third party (a factoring company) at a discount.

Question 86

What are the benefits of debt factoring?

Answer 86

Receivables (amount owned by customers) are turned into cash quickly. Business can focus on selling rather than collecting debts. The facility is practically limitless and therefore suits a fast-growing business. There is no security required- unlike a loan or overdraft.

Question 87

What are the drawbacks of debt factoring?

Answer 87

Quite a high cost- the charge made by the factoring company. Customers may feel their relationship with the business has changed.

Question 88

What is share capital?

Answer 88

Both private and public companies can raise finance by selling new shares in the company. There are 2 main options open to a publicly-quoted company i.e. a company whose shares are quoted and traded on a recognised stock change. Flotation- new issue of shares. A stock market flotation is a costly way of raising new capital which involves selling a % of a company's on a stock market for the first time. Right issues or open offer- common way for a company to raise fresh capital.

Question 89

What are the benefits of share issues?

Answer 89

Able to raise substantial funds if the business has good prospects. Broader base of shareholders. Equity rather than debt= lower risk finance structure.

Question 90

What are the drawbacks of share issues?

Answer 90

Can be costly and time-consuming (particularly flotations). Existing shareholders' holdings may be diluted. Equity has a cost of capital that is higher than debt.

Question 91

What are bank loans and what are benefits and drawbacks?

Answer 91

Long-term finance Loan provided over a fixed period Rate of interest either fixed or variable Timing and amount of repayments are set Start-up provide some security for the loan Good for financing investment in fixed assets Generally at a lower rate of interest than a bank overdraft However they don't provide much flexibility

Question 92

What are bank overdrafts?

Answer 92

Short-term finance, widely used by businesses of all sizes. Really a loan facility- the bank lets the business "owe it money" when the bank balance goes below 0, in return for charging a high rate of interest. Flexible source of finance, in the sense that it is only used when needed. Excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems (e.g. a major customer fails to pay on time).

Question 93

What is venture capitalists?

Answer 93

Form of "risk capital". Capital that is invested in a project (in this case- a business) where there is a substantial element of risk relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher "rate of return" to compensate him for his risk. Specialist investors in private companies. Often back management in private companies. Manage investment funds designed to achieve high rate of returns.

Question 94

What is crowdfunding?

Answer 94

Alternative method of raising equity finance for a business, project or idea. An entrepreneur or business can attract a "crowd" of investors- each of whom takes a small stake by contributing towards an online fundraising target.