Financial Strategies and Accounts
- Created by: DemiStanley
- Created on: 11-12-15 12:04
Financial Objectives
"The monetary targets a business wants to achieve in a given time period"
These could include:
- Cash-flow targets - Objectives designed to achieve a specific net cash balance at the end of the month, year, or specific trading period
- Cost-minimisation targets - Objectives focused on actions that can be taken to minimise fixed and/or variable costs
- ROCE targets - A minimum acceptable percentage for the money the business gets back compared to how much money is being used in the business
- Shareholders' return targets - A minimum acceptable level of financial rewards in return for shareholders' investment
Influences on Financial Objectives
Internal
- Corporate and Functional Objectives - Will have to contribute towards achieving corporate objectives. Will be influenced by functional objectives
- The characteristics of the firm - Capital of labour intensive? Low cost or highly differentiated
- Relationship between owners and directors - Within a plc these can be the same or different. The power of individual shareholders
External
- Competitors - Leader or follower? Degree and relative power of competition? Actions and reactions
- Consumers - Degree of loyalty, changing tastes
- Economic conditions - Stable or unstable? Economic growth or decline? Optimistic or pessimistic?
- External environment - Political, social and technological change
Balance Sheets
"A formal financial document that summarises the net worth of a business at a given point in time"
It is important to understand:
- Depreciation - The accounting process of spreading the cost of non-current assets. Ensures the value is a fair reflection of the actual value. Annual depreciation appears as an expense in the income statement
- Working capital - Measures a firm's liquidity. Current assets - current liabilities
Balance Sheet Headings
- Non-current assets - long term or fixed assets owned
- Inventories - value of stock held
- Receivables - cash owed from credit sales
- Cash & cash equivalents - cash in hand or in the bank
- Total current assets - current assets added together
- Current liabilities - money owed to be repaid in the short term
- Net current liabilities - total current assets - current liabilities
- Non-current liabilities - long term debts
- Net assets - net worth of a business' assets and liabilities
- Share capital - money raised from the sale of shares
- Reserves & retained earnings - cumulative profits kept in the business
- Total equity - value of shareholders' funds
Income Statements
"A formal financial document that summarises a business' trading activities and expenses to show whether the business has made a profit or a loss"
It is important to understand:
- Profit utilisation - How the profit after tax is used - will break down the profit to show:
- % paid in dividends to shareholders
- % reinvested in the business
Will depend on both long term and short term financial objectives - Profit quality - The substantiability in the profit figure - will break down the profit to show:
- % from normal trading activities
- % from non-standard trading activities
Income Statement Headings
- Revenue - selling price x quantity sold
- Cost of sales - direct costs relating to a quantity sold
- Gross profit - profit after cost of sales has been deducted
- Expenses - other costs incurred
- Operating profit - profit after all other expenses have been deducted
- Finance income - money from investments
- Finance costs - costs incurred through debts
- Profit before tax - profit after adjustments for profits from joint ventures or investments
- Taxation - tax deducted as a % of profit before tax
- Profit for the year - profit after tax has been deducted
Comparisons
Inter-firm
- Looking at the performance of one firm against another
- May be comparing performance against competitors or similar sized businesses
- Can help inform ROCE targets
- May lead to benchmarking of performance against a market leader
Intra-firm
- Looking at the performance of different operations within the same firm
- May be comparing branches, product lines, profit centres or geographical areas
- Can help inform ROCE targets
- Can help identify best practice within a business
Using Financial Data Pros & Cons
Pros
- Plc accounts are audited and should therefore be accurate
- Provides detailed qualitative data
- Ease of comparison between firms and within the firm
- Facilitates ratio analysis for meaningful interpretation
Cons
- Does not consider qualitative factors
- Potential for some manipulation
- Need to be considered in the context of corporate and functional objectives
Ratio Analysis
"A comparison of two or more pieces of data taken from the financial records of a business"
Used to measure the following financial indicators:
- Profitability
- Liquidity
- Financial Efficiency
- Gearing
- Shareholders' Returns
Profitability Ratios
ROCE
- Measures how efficiently a business is using capital employed to generate profits
- (Operating profit/[total equity + non-current liabilities]) x 100
Gross Profit Margin
- (Gross profit/sales revenue) x 100
Net Profit Margin
- (Net profit/sales revenue) x 100
Financial Efficiency Ratios
Asset Turnover
- Considers the relationship between assets and revenue
- Revenue / net assets
Stock Turnover
- Cost of sales / average stock held
Debtor Days
- (Trade debtors / revenue) x 365
Creditor Days
- (Trade payables / cost of sales) x 365
Liquidity Ratios
Current Ratio
- Current assets / current liabilities
Acid Test Ratio
- (Current assets-stocks) / current liabilities
Gearing
This focuses on the long-term stability of the business.
(Long term liabilities / capital employed) x 100
Shareholder Ratios
Dividend per share
- Total dividends paid / number of ordinary shares in issue
Dividend yeild
- (Dividend per share [p] / share price [p]) x 100
Disadvantages of Ratio Analysis
- Ratios deal mainly in numbers so ignore qualitative factors
- Ratios look mainly at the past and not the future
- Ratios are most useful when looked at over a long period of time or against comparable businesses
- Financial information can be made to look more attractive, and therefore may not be representative of the truth
Internal Sources of Finance
- Retained earnings - This is when a business keeps some of their net profit. These can be spent in the business or kept in a bank account.
- They are a cheap source of finance
- They are flexible
- They do not dilute the ownership of the company.
If too much of the earnings are retained, shareholders may become upset - Reduction in working capital - This is where companies collect money from their debtors, but this has to be sustainable to become a long-term source of finance
- Disposal of assets / sale & leaseback - This is where a business sells their assets in order to create a one-off cash inflow. It is unlikely to be a long-term solution to a lack of finance.
Sale and leaseback is a specialist method of selling fixed assets and then leasing them back from the new owner. This is a one-off way of raising cash as it can only be done once
External Sources of Finance
- Selling shares - Two options are available when selling shares:
- Flotation (issue of new shares) - this is a costly way of raising finance which involves a percentage of a company being on the stock market for the first time.This is only usually an option with a business worth £25-50 million. This means that the shareholder base of the business becomes much wider, and management therefore liquidates
- Rights issue or open offer - This is fairly common, and involves a company offering new shares to existing customers. These shares will often be offered at a discount price. - Loan capital - There are 3 main ways of raising loan capital:
- Bank overdrafts
- Bank loans
- Debentures - These are a long-term soure of finance which is issued by the company. Interest payments must be made by the company
Cost Minimisation
"Aims to achieve the most cost-effective way of delivering goods and services to the required level of quality"
Popular sources of cost-minimisation include:
- Eliminating waste and avoiding duplication
- Simplifying processes and procedures
- Outsourcnig non-core activities
- Negotiating better pricing with suppliers
- Improving communication
- Pruning product ranges and customer accounts to eliminate unprofitable business
- Using the most effective methods of training and recruitment
- Introducing flexible working that benefits both employer and employee
- Aggressive control over non-essential overheads
Being too aggressive with cost-minimisation can have disadvantages:
- Can be left with insufficient capacity to handle increase in demand
- Cost reductions could annoy departments if not properly communicated
Profit Centres
"A separately identifiable part of a business for which it is possible to identify revenues and costs"
E.g.
- Individual shops in a retail chain
- Local branches in a regional or nationwide distribution business
- A geographical region
- A team or individual
Profit Centres Pros & Cons
Advantages
- Provides insight into where profit is earned in a complex business
- Supports budgetary control at a detailed level
- Can improve motivation of those responsible for the profit centre
- Comparisons can be made between profit centres
- Improves decision making at a local level
- Finance can be allocated more efficiently
Disadvantages
- Can be time consuming to set up & monitor
- Difficulties allocating costs & revenues
- May lead to conflict & competition rather than cooperation
- Potentially de-motivating if targets are too tough
- Profit centres may persue their own objectives rather than those of the broader business
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