Understanding Financial Objectives
Profit- The surplus of revenues over total costs at the end of the trading period.
Cash Flow- The movement of cash into and out of a business over a given period of time.
Return on capital employed- The net profits of a business expressed as a value of capital employed.
- A goal or target persued by the finance department within an organisation.
- Likely to contain a numerical element and specific timescale.
- Set by managers who are responsible for the finance of the business
- Cost minimisation
- ROCE targets
- Cash flow targets
- Shareholders' returns
Cash Flow Targets
Cash flow is the money flowing into and out of a business
Many businesses get into difficulties due to a lack of cash flow, rather than a lack of profitability.
- Maintaining a minimum closing balance each month
- Reducing bank overdraft by a certain sum by the end of the year
- Creating a more even spread of sales revenue
- Spreading its costs more evenly
- Raising certain levels of cash
- Setting contingency fund levels.
A strategy that entails seeking to reduce all costs of production that a business incurs as part of its trading activities to the lowest possible level. These types of targets should be used with caution as cheaper raw materials may lead to inferior quality.
Benefits the business in two ways:
- Can keep the price the same and benefit from higher profit margins
- Can use the cost reduction and reduce its selling price which could attract more customers.
- Reducing wage cost per unit
- Relocating the business to the least cost site
- Improving the efficiency of production by reducing variable costs
- Lowering levels of production
Capital employed measures the value of the resources used by the business and is a guide to the size of the business. Profit targets are often expressed as return on capital employed.
(Operating Profit / Capital Employed) x 100
- To achieve ROCE that exceeds previous years by a certain percentage
- Recieve an ROCE percentage that compare favourable to the average percentage achieved in the UK
- Achieve a level of ROCE that exceeds competitors
These are the returns on current share price and any associated dividends that are due in the near future. Business must satisfy the needs of its owners, many shareholders assess a business in terms of dividends they recieve. However they may have other objectives that need to be considered.
- A high dividend per share
- A high dividend yield
- Increasing the share price
- High earnings per share
Reasons for setting financial objectives
- Act as a focus to decision making and effort
- Provide a yardstick against which success or failuer can be measured
- Improves coordination and efficiency
- Allows shareholders to assess whether the business is a worthwhile investment
- Enables outside organisations to confirm the financial viability of the business
- Corporate objectives
- Nature of the product sold-e.g. if the demand for a product is sensitive to price, managers may wish to implement strategies of cost minimisation.
- The attitudes and aspirations of the business' senior managers-if the managers hold large numbers of shares then increasing shareholders value might be an attractive financial objective.
- Finance available
- Resources Available
- PESTLE (political, ethical, social, technological, legislation and environmental)
- Actions of competitors
- Market factors- if the market for the businesses products is expanding, it may lead managers to set more expansive financial objectives such as higher rate s of shareholder returns.
- Availability of exernal finance; if a business is experiencing difficulty in raising capital, financial objectives are more likely to centre on profits and profitability.