Financial Objectives

Front 1

What are financial objectives?

Back 1

A specific goal or target relating to the financial performance, resources and structure of a business.

Front 2

Benefits of financial objectives

Back 2

Focus for the entire business to track financial trends.

Important measure of success / failure for the business.

Reduce risk of business failure.

Transparency for shareholders so they know what they're investing into.

Coordinate different business functions such as setting budgets they have to abide by.

Context for making investment decisions - can they afford it? Is it worth it?

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Proft

Back 3

The difference between total revenues and total costs over a period.

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Cash flow

Back 4

The difference between total cash outflows and total cash outflows over a period - normally short term.

Front 5

How is profit closely linked to cash flow?

Back 5

Profits are main source of funds for an established business.

Revenues from sales eventually turn into cash inflows.

Variable and fixed costs eventually turn into cash outflows.

Front 6

Gross profit formula

Back 6

Sales - variable costs

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Net profit formula

Back 7

Gross profit - fixed costs

Front 8

Operating profit for the year formula

Back 8

Net profit - tax

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Net cash flow formula

Back 9

Cash inflows - cash outflows

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Timing differences between cash flow and profit

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Sales to customers may be paid on credit (paid at a later date - delaying inflow).

Payments to suppliers (which could also be paid on credit).

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Asset

Back 11

Something you own with value such as machinery.

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Fixed assets differences between cash flow and profit

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Payment for fixed assets are cash outflows.

Costs of fixed assets are treated as assets - not costs.

Depreciation is charged as cost when value of fixed assets is reduced.

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Financial sources differences between cash flow and profit

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Inflows from shareholders, bank loans, factoring, etc.

Repayments of amounts loaned.

Payment of dividends.

These inflows and outflows are NOT factored in profits.

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Customer buys goods for £50,000 on 60 days credit

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Sales of £50,000 are recognised immediately to profit.

Cash inflow of £50,000 recognised when customer actually pays.

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Marketing campaign costing £10,000 ordered from marketing agency

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Cost of £10,000 included in marketing costs.

Cash outflow of £10,000 recognised when marketing agency is paid.

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New factory machinery purchased for £150,000

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No effect to profit. Value of £150,000 added to value of fixed assets.

Cash outflow of £150,000 paid to supplier of machinery.

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Depreciation charge of £100,000 to reflect factory use of fixed assets

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Depreciation of £100,000 included as a cost in terms of profit.

No effect on cash flow.

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Gross profit

Back 18

Calculates sales and cost of sales. Tells the profitability of a product and how profitable operations are. Doesn't factor expenses.

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Operating profit

Back 19

Gross profit minus expenses. Always less than gross profit.

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Profit for the year

Back 20

Tax paid from net profit. Shows amount left for reinvestment.

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Revenue

Back 21

Sales during a period

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Cost of sales

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Direct costs of generating revenues go into "cost of sales". Includes cost of raw materials, components, goods bought for resale and the direct labour costs of production.

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Administration expenses

Back 23

Operating costs and expenses that are not directly related to producing the goods or services are recorded here.

Includes distribution costs such as transport.

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Operating profit explanation

Back 24

Records how much profit has been made in total from trading activities of the business before account is taken of how the business is financed.

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Finance expenses

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Interest paid on borrowings minus interest income received on cash balances. Useful figure for shareholders to assess how much profit is being used up by the funding structure of the business.

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Taxation

Back 26

Estimate of the amount of corporation tax that is likely to be payable on profits for the period.

Front 27

Profit for the year explanation

Back 27

The amount of profit left after tax has been accounted for. Shareholders decide how much of this is paid out to them in dividends and how much is left in the business ("retained profits").

Front 28

Revenue growth objective example

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Aim to grow total revenues by 10%.

Reach £1million in sales during the year.

Front 29

Sales maximisation objective example

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Aim to maximise total sales, regardless of whether those sales are profitable.

Front 30

Market share objective example

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Grow market share to 20%.

Front 31

Cost minimisation

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Aims to achieve most cost-effective way of delivering goods and services to the required level of quality.

Front 32

Benefits of effective cost minimisation

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Lower unit costs - competitiveness

Higher gross profit margin

Higher operating profits

Improved cash flow

Higher return on investment

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Specific level of profit example objective

Back 33

Achieve an operating profit of £1m.

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Rate of probability profit example objective

Back 34

Achieve operating profit margin of 10% of revenues

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Profit maximisation example objective

Back 35

Maximise total profit for the year

Front 36

Exceed industry or market profit margins example objective

Back 36

Achieve higher gross or operating profit margins than key competitors.

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What does strong cash flow help businesses to achieve?

Back 37

Other financial objectives by providing extra financial resources.

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Possible cash flow objectives

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Reduce borrowings to target level.

Minimise interest costs.

Reduce amounts held in inventories or owed by customers.

Reduce seasonal swings in cash flows.

Net cash flow as a % of profit, e.g - 90% of operating profit.

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What is business investment?

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Capital expenditure on items such as product machinery, IT systems and buildings.

Can also be the purchase of other businesses or brands.

Investment intended to generate a return over more than a year.

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Level of capital expenditure investment objectives

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Set at an absolute amount or as a percentage of revenues.

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Return on investment objectives

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Usually set as a target % return. Calculated by dividing operating profit by amount of capital invested.

Front 42

What is the capital structure of a business?

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Represents the finance provided to it to enable it to operate over the long term.

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2 parts to the capital structure

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Equity and debt

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Equity

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Amounts invested by the owners of the business such as share capital and retained profits.

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Debt

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Finance provided to the business by external parties such as bank loans and other long term debts.

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The Debt / Equity Ratio

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Percentage of a business' capital made up from equity and debt.

Debt

---------- x100

Equity

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Reasons for higher equity in capital structures

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Where there is greater business risk such as in a start up.

Where more flexibility is required such as in a case where you don't have to pay dividends.

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Reasons why high levels of debt can be an objective

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When interest rates are low, debt is very cheap to finance.

When profits and cash flows are strong so debt can be repaid easily.

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Internal influences on financial objectives

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Business ownership

Size and status of the business

Other functional objectives

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Business ownership

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Nature of the business ownership has a significant impact on financial objectives. Venture capital investor would have a different approach to a long standing family ownership.

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Size and status of the business

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Start ups and smaller businesses tend to focus on survival, break even and cash flow objectives. Quoted multinational businesses are more focused on growing shareholder value.

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Other functional objectives

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Nearly all other functional objectives have a financial dimension which often brings the financial department into conflict with other functions.

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External influences on financial objectives

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Economic conditions

Competitors

Social and political change

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Economic conditions

Back 54

Demonstrated by the Credit Crunch which forced many businesses to reappraise their financial objectives in favour of cost minimisation and maximising cash inflows and balances.

Changes in interest and exchange rates have the potential to threaten the achievement of financial targets.

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Competitors

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Directly affects the achievability of financial objectives. For example, cost minimisation may be essential if a competitor is able to grow market share because it's more efficient.

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Social and political change

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Often an indirect impact. Legislation on environmental emissions for example may force a business to increase investment in some areas, but cut costs in others.