Setting Financial Objectives Flashcards
1
Q
What are Profits?
A
Level of income a firm managers to gain. Also net gain.
2
Q
What are Fixed Costs?
A
Costs that don’t change with output.
3
Q
What are Variable Costs?
A
Costs that vary with output.
4
Q
What are Total Costs?
A
Fixed costs + Variable costs
5
Q
What are Financial Objectives and some Examples?
A
The monetary targets a business wants to achieve within a set period of time e.g. return on investment, capital structure, revenue, costs, profit, cashflows.
6
Q
What is Return On Investment (ROI)?
A
A measure of a business’ profitability and performance.
Return is how much money a business gets back.
Investment is how much capital is being used within the business.
-How effectively it is using the money tied up in the business to generate profit.
-Allows for comparison between alternative business opportunities.
7
Q
What is ROI Helpful for?
A
ROI targets will be set as a %
-Benchmark to industry standards
-Internal benchmarking
-External environment e.g. interest rate
8
Q
What is the Formula for ROI
A
operating profit / Capital invested x100
e.g 68000 / 400000 x 100, for every £1.00 invested in the business, £0.17 was generated that year
9
Q
What is an Income Statement?
A
The profit and loss on a business.
Example of a company account -> PLCs (has to be public) + LTDs have to produce these.
10
Q
What is Sales Revenue?
A
Money coming in from sales.
Quantity sold x Selling price
11
Q
What is Cost of Sales?
A
Costs directly linked to the production of the goods or services sold e.g raw materials (variable costs).
12
Q
What is Formula for Gross Profit?
A
Sales revenue - Cost of sales
13
Q
What are Expenses?
A
All other costs associated with the trading of the business e.g. salaries and marketing expenditure (fixed costs).
14
Q
What is the Formula for Operating Profit?
A
Gross profit - Expenses
15
Q
What is Interest and Taxation?
A
Interest paid on debt or received on positive balances. Less tax payable on profit.
16
Q
What is the Formula for Profit for the Year?
A
Operating profit - Interest and taxation
17
Q
What is Long Term Funding?
A
The amount of capital that has been invested in a business and will stay in a business for over a year. This is normally for the purchase of assets.
18
Q
What are the Two Sources of Long Term Funding?
A
-Equity i.e. capital invested by the shareholders of a company.
-Debt i.e. money from financial institutions.
19
Q
What is Capital Structure?
A
It refers to the relative ways in which the capital has been raised i.e. the ratio of equity to debt.
20
Q
What is meant by Long Term Funding that is debt is compulsory Interest Bearing?
A
-This means that regardless of profits
, interest and repayments have to be made to the financial institutions.
-This increases the degree of risk undertaken by the business especially if interest rates start to rise.
-Interest represent a cost to the business.
21
Q
Why might a business set a Capital Structure Objective?
A
To keep the proportion of long-term funding that is debt below a certain percentage.
22
Q
Why might cash and profits be different?
A
-Credit sales
-Bad debts
-Heavy stock holding
-Investment in fixed assets
-Seasonality
-Repayment of loans
23
Q
What is Cashflow?
A
The movement of money into and out of a business. It’s important for survival.
24
Q
What are the Internal Factors that affect Cashflow?
A
-Factors from within the business
-Corporate and functional objectives
-Characteristics of the firm
-Relationship between owners and directors
-Public or Private sector
25
What are the External Factors that affect Cashflow?
-Factors from outside the business
-Competitors
-Consumers
-Economic conditions
-External environment
26
What is Cashflow?
The movement of money into and out of a business in terms of their relative size and timings. It's important for survival.
27
What may be a specific Cashflow Target?
-Ensure all debts are received within 30 days.
-To maintain a cash balance of £25,000.
28
What is the Formula for Gearing?
Gearing = Debt/Total long-term funding (equity + debt) x100
-A business can be described as highly geared if the % is thought to be high as this increases the element of risk.
29
What are the Internal Influences of Financial Objectives?
-Current profitability levels
-Factors from within the business
-Corporate amd other functional objectives
-Characteristics of the firm
-Relationship between owners and directors
-Public or private sector
30
What are the External Influences of Financial Objectives?
-Economic climate (interest rates with borrowing)
-Competitors
-Consumers
-Factors from outside the business
-External environment
31
What are Budgets?
Forecasts or plans for the future finances of a business. These can be for the business as a whole or set for specific function e.g. a makreting budget.
e.g. income, expenditure, profit
32
What is a Variance?
The difference between the actual income, expenditure and profit and the figure that has been budgeted.
33
What is Variance Analysis?
The process of calulcating and interpreting these variances.
34
What is an Adverse Variance?
One that is bad for the business.
35
What is Favourable Variance?
One that is good for the business.
36
What is it important to fo once the Variance has been Identified?
-Identify the cause of the variance
-Consider the effect of the variance
-If appropriate look for a solution
37
What are the Causes of Variances?
-Ineffecient staff
-Unexpected costs e.g.changes in supplier, the economy
-Competitors
38
What are the Causes of Variances with Actions of Competitors?
-Lower prices
-Introduce a new product
-Close a store
39
What are the Causes of Variances with Actions of Suppliers?
-Change prices
-Offer a discount
40
What are the Causes of Variances with Changes in the Economy?
-Changes in interest rates
-Increase to minimum wage
41
What are the Causes of Variances with Internal Inefficiency?
-Poor management of a budget
-Demotivated sales team
42
What are the Causes of Variances with Internal Decision Making?
-Change suppliers
-Special promotions
43
What are the Strengths of Budgeting?
-Provides a quantifiable target against when actual outcomes can be measures e.g. are sales targets being achieved?, are managers keeping expenditure under control?, is the business operating efficiently to
achieve profit
-Informs decision making e.g. where can cuts be made or extra funds channeled?
-Motivates budget holders due to increased responsibility.
44
What are the Drawbacks of Budgeting?
-Potential for conflict e.g. lack of transparency, short term saving may be detrimental to long term objectives, may be too easy or too hard to achieve
-Maybe restrictive e.g. opportunities may be missed, innapropriate cost cuts
-Time consuimg to set and monitor
45
What is Breakeven?
The point at which is not making a profit or loss i.e. it is just breaking even.
Breakeven = Fixed costs/Contribution.
46
What is Contribution Per Unit?
The difference between selling price per unit and variable cost per unit i.e. how much is left to contribute. First to fixed costs and secondly to profit.
Contributuion (xunits gives total contribution) = Selling price - Variable costs.
47
What are the Strengths of Breakeven Analysis?
-Allows businesses to calculate the nu ber of sales needed before staring to make a profit and therefore to see if a venture is viable.
-Can calculate the level of profit or loss at different levels.
-Can predict the outcome of changing variables.
-An integral part of a business plan when seeking to secure finance.
-Aids decision making.
48
What are the Weaknesses of Breakeven Analysis?
-Is based on predicted costs and revenues.
-Even fixed costs can vary in reality, especially in the long run.
-Ignores changes in varibales costs or selling price as items are bought or sold in larger quantities.
-Only indicates the number of slales needed does not ensure actual sales will materialise.
49
What is the Margin of Safety?
How much actual output is above the breakeven level of output.
Margin of safety = Actual output level - Breakeven level of output.
50
What is Profitability?
Measures the financial performance of a business by comparing profits achieved to a second variable e.g. revenue.
51
What are Profitability Ratios?
-Gross profit margin
-Operating profit margin
-Profit for the year margin
-Return on investment
52
What is Gross Proft Margin?
A measure of a firm's profitability by looking at the relationship between gross profot and sales revenue.
Gross Profit Margin = Gross profit/Sales revenue x100
53
What is Operating Profit Margin?
A measure of a firm's profitability by looking at the relationship between net profit and sales revenue.
Operating Profit Margin = Operating profit/Sales revenue x100
54
What is Profit For The Year Margin?
A measure of a firm's profitability by looking at the relationship between profit for the tear and sales revenue.
Profit for the year margin = Profit for the year/Sales revenue x100
55
How can Profitability be Increased?
-Sell the same quantity at a high price.
-Sell more at the current price.
-Sell the same at the same price but reduce costs.
56
What are the Reasons for Seeking Finance?
-For a start up the busines might be raising sufficient capital to establish the business.
-For an established business to fund growth or implement a new strategy e.g. relocation.
57
When does Short Term Finance get Paid Back?
Within 12 months.
58
When does Long Term Finance get Paid Back?
After 12 months.
59
What is often a Major Aim of Growing Businesses?
Increased profitability.
60
What is an Overdraft*?
-A sum of money which has been borrowed. The amount may vary on a daily basis e.g. used for cashflow issues within the business.
-External source of finance.
-Short term.
61
What are the Advantages and Disadvantages of Overdrafts?
+Relatively easy to arrange.
+Interest only paid on the amount borrowed under the facility.
+Flexible as you only borrow what you need at the time.
+No charges for paying it off.
-Can be withdrawn at short notice.
-Interest change varies with changes in interest rate.
-Higher interest rate than a bank loan.
-Only available from a current bank account.
62
What is Share Issue* (Share Capital)?
-The sale of part of the business in return for an amount of money e.g. used for cashflow issues within the business.
-External source of finance and internal from current shareholders.
-Long Term.
63
What are the Advantages and Disadvantages of Share Issue?
+No new debt.
+Shared risk.
+Access to expertise.
+Enhanced reputation.
+Only have to pay dividends when making a prfoit and can choose how much.
-Diluted ownership.
-Reduced control of your business.
-Administration costs.
-You may have to offer a monthly or quarterly divident to investors.
-Potential risk of control for a PLC with a threat of hostile takeovers.
64
What is Retained Profit*?
-Finance obtained from within the business following successful trading e.g. used for investing in new equipment.
-Internal source of finance.
-Long term.
65
What are the Advantages and Disadvantages of Retained Profit?
+Very flexible - management control how they are reinvested , shareholders control the proportion retained.
+Do no dilute the ownership of the company.
+Avoids interest repayments.
-Danger of hoarding cash.
-Shareholders may get less dividends of the business as less profits because its being reinvested.
-Takes at least a year to get a year of finance report.
-Takes a while to get a return on investment.
66
What is Trade Credit?
-Goods obtained from a supplier which does not have to be paid for immediately e.g. used for finance for short term growth.
-External source.
-Short term.
67
What are the Advantages and Disadvantages of Trade Credit?
+Improved cash flow management as it allows businesses to acquire goods or services without immediate cash outflows.
+Flexibility in payment terms.
+Relationship building.
-Risk of late payment fees.
-Potential supply chain complications.
-Some suppliers may refuse credit to start ups.
-Expensive if payment date is missed.
68
What is Hire Purchase?
-A method of obtaining an asset in return for a series of monthly payment. Ownership of the asset does not transfer until the final repayment has been made e.g. used for hire of machinery.
-External source of finance.
-Medium-Long term.
69
What are the Advantages and Disadvantages of Hire Purchase?
+Flexible form of asset finance.
+Cashflow as businesses can spread the cost of equipment, allowing them to manage cashflow.
+Fixed interest.
+Easy to obtain.
-No ownership before the end of the contract term.
-More expensive than buying.
-Lower credit score = higher interest rates.
-Late repayments = damage to the credit score.
-Impractical as a very short term agreement.
70
What are Grants?
-Finance obtained for a specific purpose usually at no cost to the business. The money does not have to be paid back e.g. used to help gorw and develop a business.
-External source of finance.
-Long term.
71
What are the Advantages and Disadvantages of Grants?
+The money you receive doesn't have to be repaid.
+Allows for growth.
+No impact on business ownership.
-Restricted income.
-Often look for innovation and many give one-off grants only.
-High levels of competition for many funds.
-Might have to wait for period of time before reapplying.
72
What is a Loan?
-Finance obtained usually for a fixed period of time which has to be paid back e.g. used to start a business or expand a business further.
-External source of finance.
-Long term.
73
What are the Advantages and Disadvantages of Loans?
+Lower interest rate than a bank overdraft.
+Appropriate method of financing fixed assets.
+You keep full control of your company.
-Requires security (collateral)
-Interest paid on full amount outstanding.
-Harder to arrange.
-Time consuming to apply and there is no guarantee of success.
74
What is a Mortgage?
-Finance obtained to help with the purchase of property (type of loan) e.g. used to purchase property for the business.
-External source of finance.
-Long term.
75
What are the Advantages and Disadvantages of Mortgages?
+You continue to remain the legal owner of your property while you use the funds from the loan to fulfil your needs.
+Mortgage loans are easily approved since they are secured loans.
-You pay back more than you borrow.
-There may be fees and additional costs.
-Your home is at risk if you can't keep up with the repayments.
-Long term financial commitments.
76
What is a Lease?
-The right to use goods, in return for a monthly payment. The goods are not owned by the business e.g. used for machinery and other things needed for a short period of time.
-External sources of finance.
-Medium term.
77
What are the Advantages and Disadvantages of Leases?
+You don't have to pay the full cost of the asset up front and pay it over a fixed period of time (helps budgeting).
+You have access to a higher standard of equipment.
-You may have to put down a deposit or make some payments in advance.
-It can work out to be more expensive than if you buy the assets outright.
-Your business can be locked into flexible agreements which may be difficult to terminate.
78
What is a Debenture?
A long term secure long e.g. used for security on loans.
-External source of finance.
-Long term.
79
What are the Advantages and Disadvantages of Debentures?
+Debentures usually provide a fixed rate of interest for the lender.
+The use of debentures can encourage long term funding to grow a business.
+Control of the company by existing shareholders is not reduced.
-There is no flexibility in their obligationt o make interest payments on the debenture.
-By holding a debenture the lender loses their right to vote and take a share of company profits.
80
What is Factoring*?
-The sale of debt to a specialist firm who secures payment and charges commission for the service/ The provess of selling the debts owed to a business to a financial institution and the business receives funds immediately but at a reduced rate e.g. used to meet present and immediate cash needs.
-External source finance.
-Likely to be more short term.
81
What are the Advantages and Disadvantages of Factoring?
+Reduces reliance on debt by using immediate funding.
+Grant customers longer payment terms meaning the business can gain customers who require longer payment times.
+Provides flexibile financing.
-Expensive source of finance when invoices are numerous and smaller in amount.
-Higher interest rate.
-Involovement of third party which customers may not be comfortable with.
82
What is Sale of Assets?
-Selling of something that the business already owns e.g. used to create revenue in a business.
-Internal source of finance.
-Short term.
83
What are the Advantages and Disadvantages of Sale of Assets?
+The owner has the freedom to set sale prices for asstes as they desire.
+It allows the owner to remain in legal control of the business.
+Can provide quick finance.
-The business loses the tax benefits loses the tax benefits available to them through the lifetime capital gains exemption.
-Liabilities are likely to stay with the seller.
84
What is Business Angels?
-A small sum of capital invested from an individual e.g. used to finance a business, for growth and expansion.
-External source of finance.
-Short or Long term.
85
What are the Advantages and Disadvantages of Business Angels?
+No repayments or interest.
+Less risk.
-Takes longer to find suitable angel investor.
-Not suitable for investments below £10,000 or more than £500,000.
-Giving up share of your business.
86
What is Venture Capital*?
-Finance obtained from limited companies willing to invest in fast growing companies e.g. used to provide finance to start up a business.
-External source of finance.
-Long term.
87
What are the Advantages and Disadvantages of Venture Capital?
+Venture capitalists offer an opportunity for expansion and are helpful in building networks.
+Businesses can raise a large amount of capital.
+Venture capital is a source of guidance and expertise.
+Makes it easier to attrcat other sources of finance.
-Venture capitalists usually take a long time to make a decision.
-Finding investors can distract a business owner from their business.
-The founders ownership stake is reduced.
-The company is expected to grow rapidly.
-Long and complex process.
88
What is Crowd Funding*?
-Raising finance through a large number of people, who each cintribute a small amount usually via the internet e.g. used for companies to raise capital from a alarge group of investors.
-External source of finance.
-Mainly short term.
89
What are the Advantages and Disadvantages of Crowd Funding?
+A form of free marketing.
+Avoids business loan interest costs.
+Fast method of raising capital.
-Time commitment.
-May give up equity.
-Low succes rate.
-Your business idea may get swiped.
-Minimal professional guidance.
90
What are the Cash Inflows of Businesses?
-Cash sales.
-Payments from debtors.
-Owners capital invested.
-Sale of assets.
-Bank loan.
91
What are the Cash Outflows of Businesses?
-Purchasing stock.
-Paying wages.
-Paying debts - bank loans, creditors.
-Purchasing assets.
92
What is the Difference between Cashflow Forecast and Cashflow Statement?
-Cashflow forecast is predicted (new businesses).
-Cashflow statement is what actually happened (analyse financial performance).
93
What is the Net Cashflow Formula?
Net cashflow = Cash inflows - Cash outflows.
94
What is the Closing Balance Formula?
Closing balance = Opening balance + Net cashflow.
