3.5.1 Setting financial objectives

Question 1

1 What is investment

Answer 1

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

Question 2

1 What is Return on investment (ROI)

Answer 2

measure of efficiency of an investment in financial terms, used to compare the financial returns of alternative investments

Question 3

1 What are Non-current assets?

Answer 3

items a business owns that are expected to be retained for one year or longer

Question 4

1 What is capital expenditure

Answer 4

spending undertaken by a business to purchase non-current assets such as a vehicle and property. another term for investment

Question 5

1 What is Capital Structure?

Answer 5

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

Question 6

1 What are investment objectives

Answer 6

most businesses make investments to earn an acceptable return on them
Capital expenditure on items such as product machinery, IT systems, buildings etc
Can also be the purchase of other businesses (takeovers) or brands
Investment is intended to help generate a return (profit) over more than one year

Question 7

1 What are two common investment objectives

Answer 7

Level of capital expenditure​ - Set at either an absolute amount (e.g. investment $5m per year) or as a percentage of revenues (e.g. 5% of revenues)​
Return on investment​ - Usually set as a target % return, calculates by dividing operating profit by the amount of capital invested.​

Question 8

1 How do you calculate return on investment?

Answer 8

ROI = (Operating profit/capital invested) x 100

Question 9

1 What are the two types of capital expenditure?

Answer 9

Replacement capital
New investment

Question 10

1 What is Replacement capital?

Answer 10

This investment is intended to replace assets that have depreciated (worn out). Replacement capital is not, therefore is not stock!

Question 11

1 What is new Investment

Answer 11

This is expenditure on new capital goods that enables a business to increase its capacity to produce.

Question 12

1 Why would a business set itself lower capital expenditure targets?

Answer 12

Reduce the amount it has borrowed if it considers that its debts are too high. In this case. Management may divert funds that would have been invested into buying non-current assets to repaying loans. Reduce the interest payments that the company is liable to pay and increase profits in the long term.

Question 13

1 What does ROI depend on?

Answer 13

targets, debts, loans etc

Question 14

1 What is Expected return on investment

Answer 14

businesses will only invest in projects if the expected returns are satisfactory​

Question 15

1 What is Interest rates

Answer 15

rise in interest rates increase cost of borrowing money, therefore business may decide that a certain project is not financially worthwhile.

Question 16

1 What is Expected demand

Answer 16

If expected demand for its products is high, then business is more likely to undertake capital expenditure because this will enable it to increase capacity to produce.

Question 17

1 What is Availability of finance

Answer 17

if unable to get access to sufficient fiancé to fund new equipment, then it will need to cut back on it capital expenditure.

Question 18

1 What is Business confidence

Answer 18

spending on capital equipment depend on what businesses expect to happen in the future e.g. boom in economy.

Question 19

1 What is Level of spare capacity

Answer 19

If the business has high levels of spare capacity, it will not need to spend on investment in new equipment.

Question 20

1 What are the factors influencing investment decisions and objectives

Answer 20

Expected return on investment
Interest rates
Expected demand
Availability of finance
Business confidence
Attitude to risk​
Level of spare capacity
Competitors’ actions

Question 21

1 What is Capital Structure?

Answer 21

Businesses are funded by a combination of debt capital and equity capital. These are the long term finance which forms the foundation for the business.​

Question 22

1 What is Equity

Answer 22

Represents amounts invested by the owners of the business: it comprises:​
Share capital​
Retained profits

Question 23

1 What is Debt

Answer 23

Represents long-term finance provided to the business by external parties: it comprises:​
Long-term bank loans​
Other long-term debt (e.g. debentures)

Question 24

1 Reasons for higher equity in the capital structure

Answer 24

Where there is greater business risk (e.g. a start-up)​
Where more flexibility required (e.g. don’t have to pay dividends)

Question 25

1 Reasons why high levels of debt can be an objective

Answer 25

Where interest rates are very low = debt is cheap to finance​ Where profits and cash flows are strong; so debt can be repaid easily.

Question 26

1 How do you record revenue, costs and profit to measure achievement of objectives?

Answer 26

Financial Statements Income statement Balance sheets

Question 27

1 What are some revenue objectives?

Answer 27

Revenue growth (percentage or value)​ Sales maximisation (maximising sales volume or sales value – revenue)​ Market share​

Question 28

1 What is a revenue growth objective

Answer 28

Aiming to grow total revenues by 10%​ Reach £1million in sales during a year

Question 29

1 What is a Sales maximisation objectives?

Answer 29

Aim to maximise total sales – regardless of whether those sales are profitable

Question 30

1 What is a market share objective?

Answer 30

Grow market share to 20% (will involve faster revenue growth than market competitors)

Question 31

1 How do you achieve revenue objectives?

Answer 31

Rely on the marketing mix Lowering price will lead to an increase in the quantity demanded, sales volume will rise Promotion can also help to achieve this objective.​ If aware of the price elasticity of demand it might be able to increase sales revenue

Question 32

1 What are benefits of cost minimisation objectives

Answer 32

lower unit costs (competitiveness)​ higher gross profit margin​ higher operating profits​ improved cash flow​ higher return on investment

Question 33

1 What are some cost minimisation objectives

Answer 33

Cost reduction in the purchase of raw materials​ Reducing wage cost​ Lower levels of wastage​ Relocating​ Improving efficiency of production​

Question 34

1 How do you cost reduction in the purchase of raw materials?

Answer 34

Use cheaper suppliers overseas, such as China.

Question 35

1 How do you reduce wage costs?

Answer 35

Improving productivity of labour or reducing the level of overtime payments.

Question 36

1 How do you lower levels of wastage?

Answer 36

Saves costs by reducing the usage of raw materials or the number of finished products that are discarded.

Question 37

1 How do you relocate well?

Answer 37

Unit cost should be reduced if a business relocates to a place where wages and rents are lower.

Question 38

1 How do you improve efficiency of production

Answer 38

Introduce new technology and just-in-time methods of production in order to reduce variable cost per unit​

Question 39

1 What is a cost minimisation objective?

Answer 39

Achieving the lowest possible unit costs. ​ Aims to achieve the most cost-effective way of delivering goods and services to the required level of quality.​

Question 40

1 How can businesses reduce their unit costs?

Answer 40

Keep its price the same and benefit from a higher profit margin​ Use cost reduction to reduce the selling price of its finished product and so attract more customers.

Question 41

1 What are some profit objectives

Answer 41

Specific level of profit (in absolute terms)​ Rate of profitability (as a% of revenues)​ Profit maximisation ​ Exceed industry or market profit margins​

Question 42

1 What is the problem with Profit objectives

Answer 42

Profit maximisation is a difficult target to set because it is hard to know if it has been achieved Can conflict with other corporate objectives, such as fair treatment of workers and suppliers Focus on an objective to increase profit in comparison to previous years

Question 43

2 what are financial objectives

Answer 43

a goal or target set by the finance department in an organisation

Question 44

2 what is revenue

Answer 44

price x quantity total values of sales generated

Question 45

2 what is fixed costs

Answer 45

costs paid by a business to do with the running of a firm that do not change with output

Question 46

2 what are variable costs

Answer 46

costs paid by a business to create goods, they do change with output

Question 47

2 what is profit

Answer 47

the difference between total revenue and total costs

Question 48

2 what is cash flow

Answer 48

the movement of cash in and out of a business over time

Question 49

2 how are cash flow and profit linked

Answer 49

profit is main source of a funds for an established business revenues eventually turn into cash inflows costs eventually turn into cash outflows

Question 50

2 how do cash flows arise from different areas of the business?

Answer 50

inflows from shareholders repayments of amounts loaned payments of dividends

Question 51

2 what is the time difference of profit to cash flow

Answer 51

sales to customer made on credit and payment to suppliers

Question 52

2 what is the fixed assets differences for cash flow and profit

Answer 52

payment for a fixed asset - cash outflow cost of fixed assets are assets depreciation is charged as cost when the value of fixed assets is reduced

Question 53

2 what is the profit equation

Answer 53

sales - variable costs - total costs = net profit

Question 54

2 what is the cash flow equation

Answer 54

cash inflows - cash outflows = net cash flow

Question 55

2 what happens to profit and cash flow when customer buys $50,000 on 60 days credit

Answer 55

profit- £50,000 sales recognised immediately cash flow- cash inflow of £50,000 when customer actually pays

Question 56

2 what happens to profit and cash flow when marketing campaign costing £10,000 ordered

Answer 56

profit- cost of £10,000 included in marketing costs cash flow- cash outflow of £10,000 when company is paid

Question 57

2 benefits of financial objectives?

Answer 57

focus of the business important success measure reduce risk of failure provide transparency for shareholders about the investment help co-ordinate business functions key context for making investment decisions

Question 58

2 what are some financial objectives?

Answer 58

revenue cost minimisation profit cash flow investment