Objectives of Financial Management Flashcards
What does a ‘strategic plan’ refer to?
A long-term plan (5-10 yrs) for a business that outlines its future direction
What are the objectives of financial management?
Profitability
Growth
Efficiency
Liquidity
Solvency
Define profitability
The earnings of the business after expenses have been paid
How is profitability measured?
Net Profit
Where can profitability be found on financial statements?
Gross Profit (Income Statement)
Net Profit (Income Statement)
Earnings Before Interest & Tax (Income Statement)
What is gross profit?
Sales revenue minus cost of goods sold (wholesale costs and transport costs)
What is net profit?
The final amount of revenue remaining after all expenses have been paid?
Why is EBIT (earnings before interest & tax) a more precise measure of profitability than net profit?
Because it measures the profit made directly from the operations of the business
Why is profitability desireable?
Because it is the function of a business - to make a return for the investment of its owner
(And because capitalism, duh)
Define growth
The size of the business compared to competitors in the same market
Why is growth desireable?
A business that grows will increase its size and therefore its profitability in the long-term
How can growth be achieved?
Increasing the physical size of the business
Increasing market share through business expansion
Increasing the value of the assets in the business
Define efficiency
The achievement of maximum output with the minimum level of inputs
Why is efficiency desireable?
When a business decreases its costs, it increases its profit
How can efficiency be measured?
An expense ratio (total expenses/total sales)
The business’s ability to collect its accounts receivables (accounts receivables turnover ratio)
Define liquidity
A measure of how quickly a current asset can be converted into cash
What are current assets?
Assets expected to be used, sold or converted into cash within 12 months
They include cash at the bank, accounts receivable and stock
Why is liquidity important?
It determines the ability of a business to pay short term debts (current liabilities) as they fall due
What are current liabilities?
Debts that are due to be repaid within 12 months
What is the danger of a business with low liquidity?
If it cannot pay its short term debts, as business may:
- Have its facilities disconnected
- Find suppliers do not wish to trade with it
- Its credit rating will fall
What is the danger to a business of having too high liquidity?
If a financial manager decides to keep a lot of cash in the business bank account, they will be wasting financial resources and losing potential profits
Define solvency
The ability of a business to pay both short and long term liabilities as they fall due
Why is solvency important?
It is a measure of whether a business is financially stable
What does gearing refer to?
How much debt finance the business has acquired to fund its operations compared to its use of equity finance
