3.5 Finance

• What is a financial objective?


  A specific goal or target relating to financial performance
• What can financial objectives be based on?


  • Revenue
  • Costs
  • Profit
  • Cash flow
  • Investment levels
  • Capital structure
  • Return on investment
  • Debt as a proportion of long-term funding
• What are the benefits of setting financial objectives?


  • Provides focus for the business
  • Guides decision making and effort
  • Measures success and failure
  • Reduces risk of business failure
  • Improves coordination and efficiency
  • Informs shareholders of management priorities
  • Confirms financial viability for stakeholders
  • Aids in making investment decisions
• What are the difficulties of setting financial objectives?


  • May not be realistic
  • External changes can impact objectives
  • Difficulty in measuring success
  • Potential conflicts with other objectives
  • Responsibility may lie solely with the finance department
• What does Return on Investment (ROI) measure?


  The efficiency of an investment in financial terms
• How is ROI calculated?


  ROI = (return on investment / cost of investment) x 100
• What is the difference between profit and cash flow?


  Profit is revenue minus total costs, while cash flow is the money flowing in and out of the business.
• What is Net Cash Flow?


  The money left over when outflows are subtracted from inflows
• What are the main cash inflows for a business?


  • Money invested by business owners
  • Loans from the bank
  • Income from sales
• What are the main cash outflows for a business?


  • Wages and training
  • Raw materials
  • Advertising
  • Rent, mortgage, and bills
  • Taxes
  • Interest on loans
  • Maintenance and repair
• What does Gross Profit indicate?


  It shows how efficiently a business converts raw materials into finished goods.
• How is Gross Profit calculated?


  Gross Profit = revenue - cost of sales
• What is Operating Profit also known as?


  Net Profit
• How is Operating Profit calculated?


  Operating Profit = gross profit - expenses
• What does Profit for the Year include?


  It includes the profit available to shareholders, including asset sales, interest payments, and tax.
• What are the objectives related to revenue?

  • Sales maximization (volume/value)
  • Targeting specific increases in sales revenue
  • Exceeding competitor sales
  • Revenue growth (percentage or value)
  • Market share
• What are the objectives related to costs?

  • Cost minimization (linked to efficiency)
  • Productivity (units per worker)
  • Capacity utilization
• What are the objectives related to profit?


  • Specific level of profit (absolute terms)
  • Rate of profitability (percentage of revenues)
  • Profit maximization
  • Exceeding industry profit margins
• Why is cash flow important?


  • Supports applications for finance
  • Prevents business failure due to inability to pay bills
  • Ensures suppliers continue to provide goods
  • Maintains employee motivation
  • Main cause of failure for small businesses
  • Timing of cash flows is vital
• What are some cash flow objectives?


  • Maintain a minimum closing monthly balance
  • Reduce bank overdraft by a certain amount
  • Create a more even spread of sales revenue
  • Spread costs more evenly
  • Set contingency fund levels
• What are the advantages of cash flow forecasts?


  • Identify problems in advance
  • Guide appropriate action
  • Ensure sufficient cash for payments
  • Provide evidence for financial support
  • Avoid business failure
  • Identify excess cash holdings
• What are the causes of cash flow problems?

  • Poor management
  • Business losses (outflows > inflows)
  • Long customer payment terms
  • Over-optimistic forecasting
• What are investment objectives?


  • Replacement capital/investment
  • New investment for increased capacity
  • Level of capital expenditure (absolute or percentage of revenues)
  • Return on investment target percentage
• What does capital structure refer to?


  • The balance of finance in terms of equity and debt
  • How a business is funded in the long term
• What are capital structure objectives?


  • Gearing ratio (percentage of finance from debt)
  • Debt/equity ratio (proportion of finance from debt and equity)
• What are internal influences on financial objectives?


  • Business ownership
  • Size and status of the business
  • Other functional objectives
• What are external influences on financial objectives?


  • Economic conditions
  • Competitors
  • Social and political change
• What are budgets?


  • Future financial targets/plans set by businesses
• What are the types of budgeting?


  • Income (revenue) budget
  • Expenditure (cost) budget
  • Profit budget
• What does cash flow forecasting involve?


  • Opening balance
  • Net cash flow
  • Closing balance
• What is the process of setting budgets?


  1. Setting objectives
  2. Market research
  3. Complete income budget
  4. Complete expenditure budget
  5. Complete profit budget
  6. Complete departmental budget
  7. Summarize in master budget
• Why do businesses use budgeting?


  • Control income and expenditure
  • Establish priorities and set numerical targets
  • Provide direction and coordination
  • Assign responsibilities to budget holders
  • Communicate targets to employees
  • Motivate staff
  • Improve efficiency
  • Monitor performance
• What are the advantages of budgeting?


  • Helps secure financial support
  • Prevents overspending
  • Establishes priorities and targets
  • Motivates staff
  • Assigns departmental responsibilities
  • Improves efficiency
• What are the disadvantages of budgeting?


  • Dependent on data accuracy
  • Needs adjustments as circumstances change
  • Time-consuming process
  • Unexpected costs may arise
  • Difficulty in collecting information
  • Managers may lack budgeting experience
  • Inflation impacts
• What is Variance Analysis?


  It compares the expected budget to the actual figures.
• What can variance be classified as?


  Positive (favorable) or negative (adverse)