Role of Financial Management Flashcards
What is the strategic role of financial management?
To effectively and efficiently ensure that a business sources and controls its funds so that it continues to operate, grows and is able to achieve its future financial goals and objectives
What are the five objectives of financial management?
Profitability
Growth
Efficiency
Liquidity
Solvency
The importance of profitability + McDonald’s example
Represents the return on the capital that owners have invested in a business
Gross profit (revenue-COGS) and net profit (gross profit-expenses) can be found in the income statement
Earnings before interest & tax (EBIT) is a more precise measure of profitability, because it measures the profit made directly from business operations
McDonald’s aimed for consistent operating margins in the mid-40% range (Overall net profit for the company before interest and tax)
In the first 6 months of 2020, this metric was 19%
The importance of growth + McDonald’s example
Refers to the size of the business compared to its competitors in the same market
A business that grows will increase its profitability in the long-term
Growth can be achieved by:
increasing the physical size of the business
increasing the value of business assets
increasing market share
Pre COVID-19, McDonald’s had the goal of increasing systemwide sales growth by 3% to 5%
Systemwide sales were down 13% worldwide for the first 6 months of 2020
The importance of efficiency + McDonald’s example
Refers to decreasing costs while increasing profits
Can be calculated using the an expense ratio (total expenses/total sales)
Another measure is the accounts receivable ratio (sales/average accounts receivable) which calculates how many days, on average, it takes customers to pay their invoices
Pre-COVID, McDonald’s aimed for return on incremental invested capital of 25% (the increase in income to the capital it invests)
2020 saw a significant reduction in both income and the amount of capital invested
The importance of liquidity + McDonald’s example
A measure of how quickly an asset may be converted into cash
Determines the ability of a business to pay short-term debts as they fall due
A business with low liquidity will find it difficult to pay creditors, but having too much cash saved is a waste of financial resources and loss of potential profits
Can be calculated using the liquidity ratio (current assets/current liabilities)
2020 saw McDonald’s suspend the program that was returning equity to shareholders
A US$1billion overdraft and $5.5 billion in issued notes led to the acquisition of US$6.5 billion in cash
The importance of solvency + McDonald’s example
The ability of a business to pay both short and long-term liabilities as they fall due
It is a measure of whether a business is financially stable
Gearing - how much debt finance the business has acquired to fund its operations compared to its use of equity finance
McDonald’s saw an increase in its level of debt due to COVID-19
Note common conflicts between short & long-term objectives
In the short term, costs may increase and profits decrease due to a policy of growth and expansion through the introduction of new technology
Environmental sustainability often conflicts with long-term goals of profit maximisation
Relationship between finance and operations
Finance must allocate adequate funds to operations to supply their product successfully
Finance needs to develop budgets and cost controls for operations, encouraging them to minimise expenses and work efficiently
Relationship between finance and marketing
Finance must allocate adequate funds to operations to supply their product successfully
Finance needs to develop budgets and cost controls for operations, encouraging them to minimise expenses and work efficiently
Relationship between finance and HR
Finance allocates HR funds to acquire, train, maintain & separate employees from businesses
