Setting Financial Objectives Notes Flashcards
What are financial objectives
Financial objectives can be described as goals or targets that relate to the business’s financial objectives.
Financial objectives will be consistent with other functional objectives and also contribute to the achievement of the business’s corporate objectives.
Positive cash flow is important to a business because?
Cash receipts need to exceed cash payments so that the business has the cash to pay its bills when they fall due e.g. pay shop rents, employees’ wages and raw materials.
Negative cash flow means that a business has to borrow to pay its bills which means extra cost through interest payments and therefore lower profits.
For a business to survive in the short term it is essential that it has the cash to pay its bills when they fall due.
What is profit
Profit is the difference between total revenue and costs and expenses
Profit is made by businesses buying and selling the goods in which they trade
Why is profit important
It is the reward to the owners who will be shareholders expecting a reasonable dividend and the value of their shares to rise. Failure to earn a profit means a loss of share value and shareholders will sell their shares. This means that the business may be taken over in the longer term
It is an important source of funds for investment in new machinery, new technology and market research.
Profit is important in the financial management of a business because?
Businesses that make a loss will find it very difficult to borrow funds from banks to finance their expansion.
For a business to survive and expand in the longer term it must make a profit.
If a business is profitable will it have large amounts of cash
A common misconception is that if a business is profitable it must have sufficient cash for its needs.
However, this is not always the case because profit and cash are not the same things.
There are three types of profit?
Gross profit
Operating profit
Profit for the year (net profit)
How do we calculate revenue
To begin calculating we need to know what revenue is:
Revenue = Price x Qty sold
How do we calculate gross profit
Revenue - Direct costs (COGS) = Gross profit
Direct costs is spending that can be clearly allocated to a particular product or area of the business includes fuel and raw materials
How do we calculate operating profit
Gross profit - Indirect costs = Operating profit
Indirect costs are spending that relates to all aspects of a business’s activities includes building maintenance costs and salaries
How do we calculate net profit
Operating - remaining costs = Profit for the year (Net profit)
Remaining costs include interest paid and received by the firm as well as profits on taxation
What are fixed costs
rent
business rates
insurance premiums
loan repayments
What are variable costs
Shopfloor wages
Raw materials
Component costs
Fuel and power
How do you work out total costs
Variable Costs + Fixed Costs = Total costs
You also can have _________ costs which are a combination of fixed and variable costs
Transport costs renting and insurance costs are fixed but fuel and drivers wages are variable
semi-variable
How do you work out profit
Total Revenue - Total Costs = Profit
What are Revenue objectives
Revenue objectives - earning a certain amount of revenue over a financial period.
May be used:
Throughout the business that aims to grow
Build a customer base and establish themselves in market
Maximise revenue - short lifecycle
Relate to a specific aspect of the business - online sales
Aggressive revenue objectives increasing from £4 mill to £4.5 mill to £5.3 mill
Reducing price/increasing price
Cost objectives - there are two types:
Reducing costs or cost minimisation
Reducing costs to maintain profit margins
What are Profit objectives
xxxxxxxx
Why is cash important?
Without cash any business is unable to meet its financial commitments they have - which means they would cease to continue trading. Especially true of businesses that face long cash cycles.
`What are cash cycles
Cash cycles is the time that elapses between the outflow of cash and the receipt (inflow) of cash.
What are Investment objectives
Businesses set goals for the level of investment they wish to undertake over specific future periods.
Investment entails the purchase of assets that will remain with the business over the long term and for at least a period of one year, these are known as non-current assets.
Investment objectives are also called capital expenditure.
Capital expenditure objectives
A business may seek to achieve a certain level of capital expenditure over a financial year.
By undertaking a level of capital expenditure the business will increase its size, its value and its ability to supply products to its customers.
A business may set itself an objective of lowering its capital expenditure to reduce the amount it has borrowed if it considers that its debts are too high and look to pay off loan debt.
It may be easier to raise capital for investment if:
The business hasn’t borrowed excessive amounts already, reassuring lenders that it will be able to repay any borrowings
The business is purchasing non current assets (property) that will retain value and could be sold if necessary to repay a loan
The business is a company and sell additional shares to raise funds
An alternative way of setting financial objectives for investment is?
An alternative way of setting financial objectives for investment is to set a target for the return on an investment.
Return on investment = operating profit/capital invested x 100
Return on investment = operating profit/capital invested x 100
Negatives of this formula?
Many investments are long-term projects and it may be too simplistic to make a judgement against and objective over a single year.
Some investments are designed to produce returns over many years and may not meet the percentage return that is the objective for some time.
What is capital structure?
Decisions made by managers in relation to the business’s capital structure can be important in both the short and long term.
There are two types:
LOAN CAPITAL = Borrow funds - pay interest
SHARE CAPITAL = They can choose to sell shares - pay more dividends, lose control
Capital structure is the balance between these two types of capital, loan capital and share capital.
What is gearing?
Low gearing is lots of share capital
High gearing is lots of loan capital
What affects capital structure objectives?
Interest rates
Inflation
Income
Capital structure optimisation objectives - aims to minimise the cost of raising capital for the company without affecting overall value.
Internal Influences on financial objectives
Overall business objective - financial objective must assist the business in achieving its overall or corporate objectives such as growth
Nature of product - determined by cash flow cycles or price sensitivity
Senior managers - if they hold shares then they may look at profit objectives or they may seek recognition that accompanies the successful achievement of growth
External Influences on financial objectives
Competitive environment - actions of competitors
Economic environment - implications for consumer spending and borrowing
Technological environment - rapidly changing technology
Political and legal environment - EU and changes - national minimum wage etc
