A-Level Business Unit 5.1 (Year 1/AS AQA Slides)

Learning Outcomes

- Setting finacial objectives

- What you need to know:

  • the value of setting financial objectives
  • the distinction between cash flow and profit
  • revenue, costs and profit targets
  • the distinction between gross profit, operating profit and profit for the year
  • cash-flow targets
  • targets for investment levels
  • capital structure targets
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Financial Targets

- Financial target - a goal or objective to be pursued by the finance department

- They will be set by managers to help achieve the corporate objectives

- They must be SMART to be effective

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Understanding Financial Objectives

- Financial aims: broad goals for the finance department

- Financial objectives: specific SMART targets for the departments to achieve their aims

- Financial strategies: long-term/medium-term plans, devised at a senior management level; designed to achieve objectives

- Financial tactics: short-term financial measures adopted to meet needs of a short-term threat or opportunity

- Each department must achieve their aims and objectives to help achieve the overall company objectives

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Cash Flow

- Cash flow: the total amount of cash flowing into the business (inflows) minus all the cash leaving (outflows) of a business over a period of time

- Cash inflows: receipts of cash into the business such as those from customers from sales, loans taken out, rent charged, selling assests

- Cash outflows: payments of cash leaving the business such as for purchasing raw materials from suppliers, purchasing other goods or equipment, repaying loans and interest

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The Distinction Between Cash Flow and Profit

- Cash is the actual money held within a business in the short term that is able to use to pay debts

- Profit is the final result at the end of a financial period where the revenue is greater then the total costs

- So therefore a business may look profitable on its accout but may constanly struggle with low cash levels

- If a business is unable to pay its debts it is know as insolvent

- So even profitable businesses can fail because of poor cash flow and inability to pay their short term debts and firms with low profit may still survive with reasonable cash flow

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The Distinction Between Cash Flow and Profit

- Reasons for business to appear profitable but have poor cash flow and liquidity include:

  • a business that makes sales to customers on credit will paid at an agreed later date. therefore, the sale will count immediately as revenue but will not become a cash inflow until it has been recieved
  • likewise, payments for goods from suppliers will be shown as cost on the accounts but will not be a cash outflow until they are actually paid
  • purchased stock appears as an asset for the business but means cash is tied up in that form
  • payment for non-current assets will be cash outflow to the supplier when they are paid for but will not be shown as a cost on the income statement
  • non-current assets are counted as an asset on the balance sheetnot a cost to impact profit
  • depreciation would count as a cost but not a cash outflow
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Revenue, Costs and Profit Targets

- Targets in this area might include:

  • sales growth and maximisation - through better promotion, changing prices, etc
  • profit growth and maximisation - this can be done through charging higher prices, generating higher sales, minimising costs, etc
  • cost minimisation - for example, reducing raw materials costs, wage levels rent, etc. cost minimisation allows firms to maximise profit margins and to possibly reduce prices to pursue a cost leadership strategy
  • cost leadership - minimising costs to chargelow prices to differentiate the business and develop sustainable competitive advantage
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Cash Flow Objectives

- Examples of cash flow objectives might include:

  • maintaining a minimum closing monthly cash balance
  • improving inflows
  • minimising outflows
  • reducing the reliance on bank overdrafts to minimise high interest payments
  • spreading its cash inflows and outflows more evenly over the year
  • improving liquidity, for example, by holding less stock and improving credit terms with suppliers and customers
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ROCE Targets

- ROCE targets: profit is the ultimate measure of success and needs to be compared with the sixe of the business

- Capital emplyed: value of resources used by a business. It is an excellent guide to a firm'a size

- Profit targets are often expressed as a return on capital employed (ROCE)

- Targets in this area might include:

  • to improve on last year's ROCE
  • to be better than the average in their industry
  • to be better then rivals

- A firm may set less ambitious targets in periods of recession

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Capital Structure Targets

- The capital structure is how a firm finances its overall operations and growth by using different sources of funds

- Firms will have different attitudes about the level of debt they are willing to hold. They will also set targets about how much loan debt they will hold, how much of the firm's capital they will sell as shares to raise finance for growth and what level of retained profit they will be able to use

- Often shareholders/owners will have a say in the capital structure and will have different views on the level of risk they are willing to take

- The cost of finance will also influence firms decisions about their capital structure, for example, interest payments on loans

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Capital Structure Targets

  • a growing firm is more likely to have high debt to fund its expansion
  • gearing - the percentage of capital invested into the firm that has come from loans
  • firms may set targets about what level of gearing they are willing to have. above 50% is considered high capital gearing while below 25% is described as low capital gearing
  • different owners and managers will have different views on what level of gearing is acceptable
  • however many firms will still take out loans to fund their business even if it can be covered by retained profit, to help spread they costs over a longer period of time improving liquidity
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Other Financial Targets - Investment Levels

- Targets may be set on the level of spending on expansion and growth, aquiring capital equipment and non-current assets, for example, machinery, property and vehicles

- These targets will change depending on the financial position of the business, their profit levels, the spending of their rivals and the state of the economy

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Other Financial Targets - Shareholder Targets

- A business must satisfy its shareholders who may assess a firm's success in terms of the dividend they recieve. A high dividend is likely to link to high profits

- Targets in this areas may include:

  • high dividend per share - dividend is the payment made to share holders as part of the profit made
  •  high dividend yield - dividend paid compared to the market value of the share
  • increase the share prices - share prices rise as the company becomes more successful and people want to purchase its shares
  • high earnings per share - total profit dividend divided by number of share. it shows the profit made by each share and therefore is a good indicator of efficiency
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Reasons for Setting Financial Objectives

- Act as a focus for decision making and effort

- Can be used to measure success/failure of the department

- Will help to improve the co-ordination of staff by giving teams and departments a common purpose and direction

- Allows firms to improve efficiency and performance in the future by analysing the reasons for success or failure in different areas for example, varience anaylsis

- Allows sharehoilders to assess whether the business is going to provide a worthwhile investment

- Informs investors/owners of the company's future intentions

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Summary

- Financial targets are essential to ensure the department works towards achieving the overall corporate objectives

- They give the department motivation and help them to measure success

- They also help their stakeholders to know what the business is trying to achieve

- Firms will have different target dependant on their situation and external environment

- Cash flow may be more important in the short term, paricularly during difficult times but in the long term, all firms must make profit

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