unit 5 Flashcards
What are financial objectives?
Financial objectives are financial goals that a business wants to achieve. Businesses usually have specific targets in mind, not just profit maximisation, and a specific time period for completion
Who sets financial objectives?
Financial managers
What can financial objectives be based on to ensure that they are relevant?
Past financial data
What are the 3 types of financial objectives?
Revenue objectives
Cost objectives
Profit objectives
What is cash flow?
Cash flow is all the money flowing in and out of the business on a day to day basis
Why are cash flow objectives put in place?
To prevent cash flow problems
What does ROI stand for?
Return on investment
What does ROI measure?
Return on investment measures how efficient an investment is - it compares the return from a project to the amount of money that’s been invested
ROI formula
(ROI / Cost of investment) X 100
What are two internal factors that influence financial objectives?
The overall objectives of the business
- The status of the business
What are 5 external factors that influence financial objectives?
-The availability of finance
-Competitors
-The economy
-Shareholders
-Environmental and ethical influences
Explain the influence the economy has on financial objectives
In a period of economic boom, businesses can set ambitious profit targets. In a downturn, they have to set more restrained targets and they might set targets that minimise costs.
Percentage change in profit formula
(Current year’s profit - previous year’s profit) / previous year’s profit) X 100
What are the 3 types of profit?
-Gross profit
-Operating profit
-Profit for the year (net profit)
Gross profit formula
Gross profit = sales revenues - cost of sales
Operating profit formula
Operating profit = gross profit - operating expenses
Profit for the year formula
Profit for the year = operating profit - net finance costs - tax
Operating profit margin formula
(Operating profit / sales revenue) X 100
Net profit margin
(Net profit / sales revenue) X 100
gross profit margin
(Gross profit)
——————– X100
sales revenue
contribution per unit
selling price per unit - variable cost per unit
total contribution formula
-total revenue - TVC
-contribution per unit X num of units sold
Break even output formula
Fixed costs/contribution per unit
margin of safety formula
actual output - break even output
Give examples of cash inflows
-Sales revenue
-Payment from debtors (recievables)
-Sale of assets
-Owners’ capital invested
-Sources of finance
Give examples of cash outflows
Purchasing stock
Wages
Paying debts
Purchasing assets
main causes of cashflow problems
-low profits
-allowing customers too much credit and too long to pay
improving cash flow short term
-cut costs
-reduce current assets
-increase current liabilities
improving cash flow long term
-increasing equity finance
-increase long term liabilities
-reduce net outflow on fixed assets
debt factoring pros/cons
used if the business sells a lot on credit, you have a lot of debtors so you sell these debtors to a factoring company. They will give you 90% of the value.
Pros:
-business can focus on selling rather than collecting debts
-Receivables (amount owed by customers) are funded into cash quickly
Cons:
-customers may feel their relationship with the business has changed
-quite a high cost
Bank Overdraft pros and cons
when a business withdraws more cash from a bank account than it holds.
-short term finance
-used by startup businesses
-external finance
pros:
-quick and simple to organise
-flexible
-interest only paid on the amount borrowed under the family
cons:
-can be withdrawn at short notice
-higher interest rates than a bank loan
Retained profit
when a business uses historical profits from previous years to invest
-long term finance
-internal finance
-usually established business
Pros:
-flexibility
-business owners in control
-low cost
-no control/shares given up
-safe low risk approach
cons:
-may create conflict with shareholders
-no expertise added
-a drain on finance if loss-making
selling fixed assets
raising cash by selling assets
-usually long term finance
-internal finance
-usually established businesses
pros:
-not a form of debt so no no interest paid
-providing you can find a buyer its a quick form of cash
cons:
-only a finite amount of times
-risk you cant fins a buyer or its not a fair price
new shares issues
when a limited company issues shares in exchange for a payment
-long term finance
-external finance
-established businesses
pros:
-no interest
-if PLC -> stock exchange - opportunity to raise finance
cons:
-Give up shares in the business
-expected to pay dividends
bank loan
when a business borrows a sum of money and pays it back with interest over an agreed period of time.
-long term finance
-external finance
pros:
-no shares in the business need to be given up
-interest rates are lower than overdrafts
-greater certainty of funding
cons:
-harder to arrange
-no flexibility
-assets will be taken if you fail to repay
venture capital
a type of finance offered by V.C. fund to high risk high reward firms in exchange for a share of the business
-long term finance
-external finance
pros:
-makes expansion possible
-no repayment
-reduce personal risk
-V.C have expertise
cons:
-given up share of the business
-may lose control if more than 50% of share given up
Trade credit
when you buy raw materiel’s or components from suppliers today but pay later.
-short term finance
-external finance
pros:
-simple to arrange and maintain
-cheap form of short term finance
-no control is given up
cons:
-risk of spoiling relationship with supplier if credit terms are not met
-large fine if you pay late
What are the three types of budget?
income
expenditure
profit
Give 3 advantages of budgeting
-help achieve targets
-control income and expenditure
-assists managers to review their activities and make decisions
-motivate staff
-allocate resources
Give 3 drawbacks of budgets
-can cause resentment and rivalry if departments have to compete for money
-restrictive
-time-consuming to set and review the budget
-costs-there will always be unexpected costs
What are the two methods used to set budgets?
Zero-based budgeting and historical budgeting
Define varience
Variance is the difference between actual figures and budgeted figures
Give 3 external influences that cause variance
-competitor behaviour
-changes in the economy
-the cost of raw materials
Give 3 internal influences that cause variance
-improvements in efficiency
-overestimated/ underestimated budgets
-changes in selling price
Possible Causes of Adverse Variances
• Unexpected events lead to unbudgeted
costs
• Over-spends by budget holders
• Sales forecasts prove over-optimistic
• Market conditions (e.g. competitor actions) mean demand is lower than budget
Possible Causes of Favourable Variances
• Stronger demand than expected = higher actual revenue
• Selling prices increased higher than budget
• Cautious sales and cost assumptions (e.g. cost contingencies)
• Better than expected productivity or efficiency
Give 3 advantages of break-even analysis
-Easy to carry out
-Quick way to find out break-even output and margin of safety
-Forecasts how variations in sales will affect costs, revenue and profits
Give 3 disadvantages of break-even analysis
-Assumes that variable costs always rise steadily
-The analysis is for only one product and the majority of businesses sell a whole portfolio of products
-It only tells you how many units you need to sell and not how many you are actually going to sell
Key Benefits of Using Financial Objectives
-A focus for the entire business
-Important measure of success of failure for the business
-Reduce the risk of business failure
-Provide transparency for shareholders about their investment
-Help coordinate the different business functions
-Key context for making investment decisions
Cost Minimisation definition
Cost minimisation aims to achieve the most cost-effective way of delivering goods and services to the required level of quality
Key Benefits of Effective Cost Minimisation
-Lower unit costs (competitiveness)
-Higher gross profit margin (%)
-Higher operating profits
-Improved cash flow
-Higher return on investment
Possible Cash Flow Objectives
• Reduce borrowings to target level
• Minimise interest costs
• Reduce amounts held in inventories or owed by customers
• Reduce seasonal swings in cash flows
Two Common Investment Objectives
-Level of Capital Expenditure
Set at either an absolute amount (e.g. invest 5m per year) or as a percentage of revenues (e.g. 5% of revenues)
-Return on Investment (ROCE)
Usually set as a target % return, calculated by dividing operating profit by the amount of capital invested
Problems and Limitations of budgets
-Are only as good as the data being used
-Can lead to inflexibility in decision-making
-Need to be changed as circumstances change
-Take time to complete and manage
-Can result in short term decisions to keep within the budget
Favourable variances
• Actual figures are better than budgeted figure
• E.g. costs lower than expected
• E.g. revenue/profits higher than expected
Adverse variances
• Actual figure worse than budget figure
• E.g. costs higher than expected
• E.g. revenue/profits lower than expected
What is the Margin of Safety
Margin of Safety is the difference between: Actual Output (units) and Breakeven Output (units)
Profit equation
Profit =
Margin of Safety (units)
X
Contribution per Unit (E)
How to Improve the Margin of Safety?
-Increasing Contribution per Unit
• Raise selling prices
• Reduce variable costs per unit
-Lower the Breakeven Output
• Lower fixed costs
• Turn fixed costs into variable costs
-Increase Actual Output
• Sell more
Trade
Receivables (Debtors)
Amounts owed to a business by customers
Trade
Payables (Creditors)
Amounts owed by a business to suppliers & others
Receivables
Days
The average length of time taken by customers to pay amounts owed
Payables
Days
The average length of time taken by a business to pay amounts it owes
Receviable days equation
Receviables davs =
Trade receivables
————————- × 365
Revenue sales)
Payable days
Payables Days =
Trade payables
———————. × 365
Cost of sales
