setting financial objectives

• benefits for setting 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
• The Difference between Profit and Cash Flow

  Profit - The difference between total revenues and total costs over a period

  Cash Flow - The difference between total cash inflows and total cash outflows over a period
• cash flow differs from profit in the following ways

  • Timing differences

  • The way fixed assets are accounted for

  • Cash flows arising from the way the business is financed
• Cost of sales

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

  The difference between revenue and cost of sales. A simple but very useful measure of how much profit is generated from every £1 of revenue before overheads and other expenses are taken into account. Is used to calculate the gross profit margin (%)
• Administration expenses

  Operating costs and expenses that are not directly related to producing the goods or services are recorded here. Includes distribution costs (e.g. marketing, transport) and the wide range of administrative expenses or overheads that a business incurs
• Operating profit

  A key measure of profit. Operating profit records how much profit has been made in total from the trading activities of the business before account is taken of how the business is financed.
• Finance expenses

  Interest paid on bank and other borrowings, less interest income received on cash balances. A useful figure for shareholders to assess how much profit is being used up by the funding structure of the business
• Taxation

  An estimate of the amount of corporation tax that is likely to be payable on the profits for the period.
• Profit for the year

  The amount of profit that is left after the tax has been accounted for. Shareholders then decide how much of this is paid out to them in dividends and how much is left in the business (“retained profits”)
• Revenue Objectives

  Revenue growth (percentage or value)

  Sales maximisation

  Market share
• Cost Minimisation

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

  • Lower unit costs (competitiveness)

  • Higher gross profit margin

  • Higher operating profits

  • Improved cash flow

  • Higher return on investment
• 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

  • Net cash flow as a percentage of net profit
• Investment Objectives

  • 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
• 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

  Return on Investment - Usually set as a target % return, calculated by dividing operating profit by the amount of capital invested
• Capital Structure

  two main types of capital in a business
• Equity

  Represents amounts invested by the owners of the business: it comprises:

  -SHARE CAPITAL

  -RETAINED PROFITS
• Debt

  Represents long-term finance provided to the business by external parties: it comprises

  -LONG-TERM BANK LOANS

  -OTHER LONG-TERM DEBT
• Reasons for higher equity in the capital structure

  – Where there is greater business risk (e.g. a startup)

  – Where more flexibility required (e.g. don’t have to pay dividends)
• Reasons why high levels of debt can be an objective

  – Where interest rates are very low = debt is cheap to finance

  – Where profits and cash flows are strong; so debt can be repaid easily
• internal influences on financial objectives

  Business ownership

  Size and status of the business

  Other functional objectives
• external influences on financial objectives

  Economic conditions

  Competitors

  Social and political change