5.1 Decision making to improve financial performance

Question 1

What are financial objectives?

What are they consistent with?

Answer 1

Financial objectives- a companys financial needs/ targets or goals for the future.

Consistent with other functional objectives and also contribute to the achievement of the businesses corporate objectives.

Question 2

What are the advantages of setting financial objectives?

Answer 2

• They may act as a measurer of performance.
• They provide targets which can be a focus for decision-making.
• Potential investors or creditors may be able to assess the viability ( ability to survive/ live successfully) of the business.

Question 3

What is cash flow?

What three forms can cash flow be?

Answer 3

Cash flow= the difference between the actual amount of money a business receives (inflows) and the actual amount it pays out (outflows).

Positive, neutral, negative

Question 4

What is profit?

Answer 4

Profit= The difference between all sales revenue ( even if payment has not yet been recieved) and expenditure.

Question 5

A positive cash flow is important to a business because…..?

Answer 5

• Cash receipts need to exceed cash payments so that the business has the cash to pay its bills when they fall e.g. shop rents, employees wages, and raw materials.
• A negative cash flow means that a business has to borrow money to pay bills- which results in extra costs 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.

Question 6

What can cause cash flow problems?

Answer 6

• Holding large amounts of inventory (stock).
• Having sales on long credit periods.
• Using cash to purchase fixed assets.

Question 7

What is Gross profit and how is it calculated?

Answer 7

• Gross profit- the difference between a businesses sales revenue and the direct costs of production such as raw materials and direct labour.

Gross profit= sales revenue- direct costs of production (cost of sales)

(Direct costs- spending that can be clearly allocated to a particular product/ area of a business that includes fuel and raw materials)

Question 8

What is operating profit?

How do you calculate it? (there are two ways)

Answer 8

• Operating profit= the difference between gross profit and the indirect costs of production or expenses such as marketing and salaries.

OP= sales revenue- all costs of production

OP= Gross profit- expenses (indirect costs)

(Indirect costs- spending that relates to all aspects of a businesses activities- includes building maintenance costs and salaries)

Question 9

A business is likely to set targets in terms of revenue, costs and profit.

REVENUE - what is it essential for?

Answer 9

A knowledge of business revenue is essential and is the starting point for creating a budget!

The objective set might depend on the type of market a business is operating in and the state of the economy!

Question 10

Business objective- cost

What does this involve?

Answer 10

Businesses operate in a highly competitive environment and as a result- face a increasing pressure on costs.

• Cost minimisation is therefore a important business objective!
• It involves trying to achieve the lowest possible unit costs !
• A business might set a objective of reducing costs by a certain percentage or target a specific area of the business that is seen to be underperforming!

Question 11

PROFIT- business targets!

Specific objectives for profit?

What is the formula for profit?

Answer 11

This might be a particular figure/ percentage increase or set in terms of a profit margin!

Profit= revenue - costs

Question 12

Cash flow objectives?

Answer 12

• Targets for monthly closing balances.
• Reduction of bank borrowings to a target level.
• Reduction of seasonality in sales.
• Targets for achieving payment from customers.
• Extension of the businesses credit period to pay its suppliers.

Question 13

What is the equation for net profit, (profit of the year) ?

Answer 13

Net profit= OP- remaining costs (tax / interest)

(Remaining costs- include interest and recieved by the firm as well as taxation on profits)

Question 14

Why is profit important for the financial management of a business?

Answer 14

• It is a reward to the owners- who are the shareholders, expecting a reasonable dividend- hoping the value of their shares will rise!
• Failure of a profit- means a loss of share value- shareholders will sell their shares. Therefore the business may be taken over in the long term!
• It is an important source of funds for investment in new machinery, technology and market research!

Question 15

What are fixed costs?

Give some examples..

Answer 15

Costs that do not vary with output.

e.g. rent, business rates, insurance premiums, loan repayments.

Question 16

What are variable costs?

Answer 16

Costs that vary with output!

e.g. shop floor wages, raw materials, component costs, fuel and power!

Question 17

What is the equation for total costs?

Answer 17

Variable costs+ fixed costs= total costs

Question 18

What are semi-variable costs?

Answer 18

A combination of fixed costs+ variable costs!!

Question 19

What are the two types of cost objectives?

Answer 19

• Reducing costs/ cost minimisation.
• Reducing costs to maintain profit margins.

Question 20

What is capital expenditure?

Answer 20

The money spent on fixed assets e.g. buildings and equipment, and represents long-term investment into a business

Question 21

What will objectives for investment depend on?

Answer 21

• The overall corporate objectives of the business.
• The type of business it is.
• The state of the economy.
• The market the business is operating in.

Question 22

What will occur if a business undertakes a level of capital expenditure?

Why may a business choose to set an objective to lower its capital expenditure?

Answer 22

• The business can increase its size, its value and its ability to supply products to its customers!
• To reduce the amount it has borrowed if it considers that its debts are too high, and look to pay off loan debt!

Question 23

Why may capital expenditure objectives be difficult to achieve?

Answer 23

The business may encounter problems in raising sufficient capital to fund its planned investment programme!

Question 24

How may it be easier for a business to raise capital investment?

Answer 24

• 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 aditional shares to raise funds!

Question 25

How do you calculate the return of an investment?

Answer 25

ROI= (operating profit/ capital invested ) x 100

Question 26

What does the capital structure of a business refer to?

Answer 26

It refers to the long term capital (finance) of a business.

Long- term capital is made up of equity (share capital) and borrowing (loan capital).

Question 27

Why is the proportion of borrowing to equity an important consideration for a business?

Answer 27

The higher the borrowing, the greater the interest repayment!

High interest payments could put a business at risk if profits should fall for any reason!

Question 28

A business may set targets in terms of the proportion of long-term capital that it debt!

How can this be measured?

Answer 28

Gearing ratio= (loan capital/ total capital) x 100

Question 29

What affects capital structure objectives?

Answer 29

• Interest rates
• Inflation
• Income

Question 30

What do capital structure optimisation objectives aim to do??

Answer 30

Aim- to minimise the cost of raising capital for the company without affecting overall value!!

Question 31

What are the internal influences on financial objectives?

Answer 31

• Corporate objectives (overall business objective).
• 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 recongition that accompanies successful achievement of growth!
• Resources available- ability to achieve financial targets may be limited by the resources available, such as the availability of skilled labour and the money available to finance the targets set!
• Operational factors- The ability to achieve financial targets will be limited in the short term by the physical capacity of a business!!

Question 32

External influences on financial objectives!!

Answer 32

• Competitor actions
• Market forces
• Economic factors
• Political factors
• Technology

Question 33

External influences- financial objectives/decisions

COMPETITOR ACTIONS

Answer 33

• Businesses operate within a competitve environment- and therefore financial objectives may be affected by the actions of competitors.
• This might be due to competitors launching a new marketing campaign, price cuts or the development of new products/ services.

Question 34

EXTERNAL INFLUENCES

Market forces?

Why are they important?

Answer 34

Market and fashion change over time, and unless a business can lead or keep up with the changes, financial targets may be missed!!

Question 35

EXTERNAL INFLUENCES

Economic factors?

Answer 35

• Changes in the economy, such as the recession of 2008, are likely to result in financial targets being missed- whereas increasing growth may lead to better performance.
• Changes in interest rates can also impact on performance, illustrating the need for all businesses to review targets in the light of any changes in the economy!

Question 36

EXTERNAL INFLUENCES

Political factors?

Give an example.

Answer 36

• Changes of government and legislation can have an impact.
• E.g. An increase in the minimum wage or the introduction of new health and safety legislation will incur additional costs- which if not passed onto the consumer, will impact on financial targets!

Question 37

EXTERNAL INFLUENCES

Technology?

What impact will introducing technology have in the long term and short term??

Answer 37

• Changes in technology may impact in a number of ways such as facilitating quicker and easier monitoring of financial data.
• The introduction of new technology- may in the long term lead to greater efficiency and improved performance. But it likely to have a significant cost in the short term!

Question 38

What is the formula for total capital?

Answer 38

Total capital= loan capital + equity

Question 39

INTERNAL INFLUENCES on financial objectives or decisions.

Corporate objectives?

Answer 39

• Any financial targets need to be linked to the overall corporate objectives.
• E.g. an economic growth might lead to improved financial performance in the long term, but in the short term to decline in performance as more money is being used for financial growth.

Question 40

INTERNAL INFLUENCES- on business objectives.

Resources available?

Answer 40

The ability to achieve financial targets may be limited by resources available- such as the availability of skilled labour and the money available to finance the targets set!

Question 41

INTERNAL INFLUENCES- on business financial objectives and decisions.

Operational factors?

Answer 41

The ability to achieve financial targets will be limited in the short term by the physical capacity (the maximum output a business can produce with its available resources in a given period) of a business.

Question 42

What are cash cycles?

Answer 42

The time that elapses between the (outflow) of cash and the recepit (inflow) of cash.

Question 43

What are non-current assets?

Answer 43

Assets that will remain with the business over the long term and for atleast a year!