Setting financial objectives

Question 1

What is a financial objective?

Answer 1

A financial objective is a goal or target pursued by the finance department (or function) within an organisation

Question 2

What is profit?

Answer 2

Revenue > Expenditure

A business can survive without making a profit for a short period of time, but it is essential in the long run

Question 3

What is cash flow?

Answer 3

Timing of payments and receipts

Important in short term, businesses must pay creditors.

Question 4

What is an income statement?

Answer 4

Income statements record a business’s sales revenue over a trading period and all relevant costs incurred as well as the business’s profit or loss

Question 5

What is gross profit?

Answer 5

Gross profit is income received from sales minus the costs of goods and services sold

Question 6

What are direct costs?

Answer 6

Direct costs are expenditure that can clearly be allocated to a particular product or area of the business. Examples include raw materials and components

Question 7

What are indirect costs?

Answer 7

Indirect costs are expenditure that relates to all aspects of a business’s activities, such as maintenance costs for buildings or senior managers’ salaries

Question 8

What is operating profit?

Answer 8

Operating profit is the financial surplus arising from a business’s normal trading activities and before taxation

Question 9

What is profit for the year?

Answer 9

Profit for the year is a measure of a business’s profits that takes into account a wider range of expenditures and incomes including taxation

Question 10

What are objectives?

Answer 10

Objectives are medium to long-term goals established to coordinate the business

Question 11

What are revenues?

Answer 11

Revenues are the earnings or income generated by a firm as a result of its trading activities

Question 12

What financial objectives are there?

Answer 12

Revenue Objectives
- aim to grow
- demand sensitive to price

Cost Objectives
- cost minimisation
- fixed or variable

Profit Objectives
- simple figure
- percentage increase
- percentage compared to sales

Cash flow objectives

Investment objectives

Capital structure objectives

Question 13

What is investment?

Answer 13

Investment is the purchase of assets such as property, vehicles and machinery that will be used for a considerable time by the business

Question 14

What are non-current assets?

Answer 14

Non-current assets are items that a business owns and which it expects to retain for one year or longer. Examples include property and vehicles

Question 15

What is capital expenditure?

Answer 15

Capital expenditure is spending undertaken by businesses to purchase non-current assets such as vehicles and property. It is another term for investment.

Question 16

What factors can make it easier for businesses to raise capital for investment?

Answer 16

• If business has not already borrowed excessive amounts
• Purchasing non-current assets that will retain value and could be resold
• Business is a company and can sell additional shares to raise funds

Question 17

What is capital structure?

Answer 17

Capital structure refers to the way in which a business has raised the capital it requires to purchase its assets

Question 18

What are the internal factors that have an influence on financial objectives and decisions?

Answer 18

Overall objectives of the business
- must assist business in achieving its corporate (overall) objectives
- profit maximisation = cost minimisation

Nature of the product that is sold
- cash flow?

Objectives of the business’s senior managers
- shareholders = increase share price

Question 19

What are the external factors that have an influence on financial objectives and decisions?

Answer 19

The competitive environment
- investment

The economic environment
- profits & cash flow

The technological environment
- profit & investment

The political and legal environment
- cost minimisation

Question 20

What is variance analysis?

Answer 20

Variance analysis is the process of investigating any differences between forecast data and actual figures

Question 21

What is a favourable variance?

Answer 21

A favourable variance exists when the difference between the actual and budgeted figures will result in the business enjoying higher profits than shown in the budget.

Causes:
- wage rises lower than expected
- economic boom leads to higher sales
- rising value of pound makes imports cheaper

Question 22

What is an adverse variance?

Answer 22

An adverse variance occurs when the difference between the figures in the budget and the actual figures will lead to the firm’s profits being lower than planned.

Causes:
- competitors introduce new products
- government increases business rates
- fuel prices increase as price of oil rises

Question 23

Why may managers use break-even analysis?

Answer 23

• To help decide whether the business idea will be profitable and whether it is viable
• Help decide the level of output and sales necessary to generate a profit
• Results of break-even analysis can be used to support loan application
• Assess impact of changes in the level of production
• Assess the impacts of different prices and levels of costs

Question 24

What is contribution?

Answer 24

Contribution is the difference between revenue and variable costs

Question 25

Contribution formula?

Answer 25

Contribution = revenue - variable costs

Question 26

Contribution per unit formula?

Answer 26

Contribution per unit = selling price of one unit of output - variable cost of producing that one unit

Question 27

What information is required to calculate break-even point?

Answer 27

• Selling price of product
• Variable cost of producing a single unit of the product
• Fixed costs associated with the product

Question 28

Break-even output formula?

Answer 28

Break-even output = fixed costs/contribution per unit

Question 29

What is the margin of safety?

Answer 29

The margin of safety measures the amount by which a business’s current level of output exceeds break-even output

Question 30

What is profitability?

Answer 30

Profitability is a measure of financial performance that compares a business’s profits to some other factors such as revenue