- Created by: pink_butterfly
- Created on: 25-03-21 20:01
Unit 5: Chapter 16: Setting Financial Objectives
Financial objectives are goals or targets that the finance function in a business works to pursue. These objectives often contain a specific numerical element and timescale too, being consistent with other functional objectives and contributing to achieving the business’s corporate objectives.
Remember: business functions are finance, marketing, operations, HR.
Setting financial objectives is beneficial for many reasons: current performance can be compared with performance in the beginning, so you don’t run out of cash as a new business. Secondly, your financial position, especially if you’re established, impacts ability to get loans, share price, etc. Thirdly, businesses are judged on financial attainments by shareholders therefore you ought to work to maximise your performance. Additionally, they help you find problems early (e.g. your costs are too high). Lastly, objectives in general are motivating for all employees.
Cash flow and profit are different. Profit is made if revenue is higher than total costs. Cash flow is relating to timing of payments and receipts.
Profit isn’t important short-term but it is in long-term, it goes oppositely for cash flow.
A business may be greatly profitable yet be without large sums of cash or enough generally. Firstly, because customers may have several months’ credit to pay for an order. Secondly, business may have lots of expensive stock (e.g. jewellery) held which can only become cash once bought. Thirdly, business may need to initially pay lots for assets which is expensive short-term.
So a business may become short on cash, unable to settle bills leading to insolvency so trading stops. A cash crisis is a major cause for failure.
There are multiple ways to measure profit. These are gross profit, operating profit and profit for the year.
Gross profit is revenue minus cost of sales. It gives a broad indication of financial performance without taking into account other costs (e.g. indirect costs, overheads).
Operating profit means profit made in total from trading activities before any account is taken of how the business is financed, excluding tax.
Profit for the year takes into account a wider range of expenditures and incomes, including tax.
Business revenue minus direct costs (cost of sales - fuel, raw materials) gives gross profit. This is broad, ignores some costs. Subtract this from indirect costs (rent, salaries, security) gives operating profit. This is a fair performance measure, excluding non-trading activities and makes allowance for interest and tax. This is the profit for the year.
Financial objectives contribute toward overall / corporate objectives. These may be revenue objectives, cost objectives or profit objectives. Remember CPR - Cost, Profit, Revenue.
Revenue objectives are used more widely by businesses aiming to grow. Short-life cycle products may do so to maximise short-term selling opportunities. Charities may also have these objectives. In price elastic situations, these objectives are based on a business reducing its prices so you get more demand/sales. In price inelastic situations, these objectives may be based on increasing…