Financial management Flashcards
What is a financial objective?
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.
What are the financial objectives?
Increasing revenue
Reducing costs
Profit
Cash flow
Investment levels (increasing)
Capital structure
What are the reasons for setting financial objectives?
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.
What is cash flow?
The amount of money flowing into and out of the business over a period of time.
What are cash inflows?
Receipts of cash from sales, interest received.
What are examples of cash outflows?
Payments of cash for purchases of products, payments to suppliers (creditors) repayment of loans, purchase of assets, payment of rent, and interest payments.
How do you calculate net cash flow?
Total cash inflows - Total cash outflows
How do you calculate profit?
Total revenue - Total costs
What is the difference between profit and cash flow?
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.
How can a business be profitable but cash poor?
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.
What is gross profit and how can it be calculated?
Cost of sales covers the direct costs of providing the goods e.g. materials/labour.
Revenue - Cost of sales (unit costs, variable costs)
What is operating profit and how can it be calcualted?
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)
How is net profit calculated?
Operating profit - Tax, interest, dividends etc.
What are the revenue objectives?
Sales maximisation (focused on maximising sales volume/sales value).
Target a specific increase in sales revenue.
Exceeding the sales of a competitor.
What are the cost objectives?
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.
What are profit objectives and what does it depend on?
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.
What is the difference between profit and profitability?
Profit is absolute value whereas profitability is relative to the size of the business/volume of its sales.
What are cash flow objectives?
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.
What is the return on investment objective?
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.
How is return on investment calculated?
Return on investment / Cost of the investment x100
Or
Financial gains from the investment - Costs of the investment
What are the factors influencing investment decisions and objectives?
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
What is the capital structure objective?
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.
What are the external influencers on financial objectives and decisions?
Political factors
Economic factors
Social factors
Technological change
Legal factors
Environmental factors
Market factors
Competitors actions and performance
Suppliers
What are the internal influencers on financial objectives and decisions?
Business objectives
Finance
Human resources
Operational factors
Available resources
Nature of the product
What are the benefits of financial objectives?
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
What are the drawbacks of financial objectives?
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.
What are non-current assets?
Items that a business owns and which it expects to retain for one year or longer.
What is capital expenditure?
Spending undertaken by businesses to purchase non-current assets such as vehicles and property.
What are investment objectives?
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.
What are the problems in achieving capital expenditure objectives?
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.
What is a budget?
An estimation of income and expenses over a specified period of time.
What are income budgets?
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.
What are expenditure budgets?
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.
What are profit budgets?
Shows the planned profit for the business over a period of time.
Depends on the income and expenditure budgets.
What is the process of setting budgets?
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
What are the methods of setting budgets?
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).
What are the reasons for setting budgets?
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
