Understanding Financial Objectives Flashcards
Define a financial objective?
A financial goal that a business wants to achieve. Businesses usually have specific targets in mind, and a specific period of time to achieve them in. E.g. a business might have an objective to increase its profits by 10% within three years.
What is the formula for ROCE? (Return on capital employed)
(Gross profit / Capital employed) * 100
What is ROCE?
ROCE (Return on capital employed) measures how efficiently the business is running - it tells you how much money the business has made compared to how much money’s been put into the business.
What is an ideal ROCE figure?
A ROCE of about 20-30% is good, so if a business’ ROCE is lower than that, it might aim to increase it.
How might a business improve cash flow?
Business can improve their cash flow by getting debtors to pay them promptly and using debt factoring if payments to the business are taking a long time. Holding less stock and not taking more orders than the business can fulfil also improves cash flow.
What should businesses try to avoid when minimising costs?
Businesses have to be careful that cutting costs doesn’t reduce the quality of their products or services - otherwise sales might drop, and they’d end up with lower profits instead of higher profits.
How might a limited company or PLC aim to increase returns for their shareholders?
Businesses usually pay out around a third of their net profit to shareholders as dividends. To increase dividends, they can either pay out a bigger percentage of the net profit as dividends (but this means there is less money to reinvest in the business) or increase profits.
What is profit margin?
A business’ profit margin is the proportion of revenue from each sale that is profit. E.g. if a bottle of shampoo costs £1.20 to produce and sells for £3.50, the business makes a profit of £2.30 (66%) on each bottle sold.
How might a business increase its profit margin?
Businesses can increase their profit margins by either increasing their prices or reducing their costs. Most businesses try to keep their costs as low as possible in order to benefit from large profit margins without putting their prices up (since this is likely to reduce demand for their products.)
Why is minimising costs important for businesses in a competitive market?
Minimising costs is particularly important for businesses operating in very competitive markets. They’re forced to keep their prices low in order to compete, so the only way for them to increase their profits is by cutting costs.
How might a business cut costs?
Businesses can cut the average cost of making a product by producing in large quantities so they they can benefit economies of scale. Other ways of cutting costs include switching to cheaper suppliers (or negotiating cheaper deals with existing suppliers), cutting staffing levels or taking in less experienced staff who don’t need to be paid as much.
Does cutting costs result in a direct increase of profits?
No - cutting costs doesn’t always mean that a business’ profits will increase. If cutting costs reduces the quality of the company’s products or services, it could end up causing a fall in profits. E.g. a good company might change to a cheaper type of packaging to cut costs, but if the new packaging is prone to leaking, the company’s reputation could suffer and sales will probably fall.
When making decisions about which raw materials to use, which supplier to use, which to staff to employ etc, do businesses only look at cost?
No - businesses don’t just look at the cost. They also consider other issues depending on the company’s aims, culture, etc. E.g. a health food company that prides itself on having knowledgeable staff to advise customers won’t want to reduce costs by cutting back on staff training, because this would go against its basic aims and principles.
What internal factors could influence financial objectives?
The overall objectives of the business. E.g. a company with strong environmental standpoint might be more interested in minimising its carbon footprint than in maximising its profits.
The status of the business. New businesses might set ambitious targets for revenue because they’re try to grow quickly and establish themselves in the marketplace. Established companies might be satisfied with smaller increases in revenue if they’re not actively trying to grow.
Employees. E.g. if a business has a high turnover of sales staff, an objective to dramatically increase revenue might be unrealistic because well-trained, experienced staff are needed to encourage customers to spend more.
What external factors could influence financial objectives?
The availability of finance. Cash flow targets might depend on how easy or difficult it is for the business to get credit.
Competitors. If new competitors enter the market, or demand for existing competitors’ products increase (due to a marketing promotion or price reduction, etc) a business might set an objective to cut costs in order to be more competitive.
The economy. In a period of economic boom, businesses can set ambitious ROCE and profit targets. In a downturn, they have to set more restrained targets, and they might also set to minimise costs.
Shareholders. Shareholders usually want the best possible return on their investment - this might put pressure on businesses to set objectives to increase profits or dividends.
