A Level Business Studies - Financial Objectives

Types of Financial Objectives

Making a business’s finances can be hard. There are many different financial objectives. It might be necessary to balance the conflicting needs of these aims to achieve a better overall performance. Businesses need to keep good levels of cash to make payments e.g wages. Some potentially profitable but risky decisions may need to be constrained.

1.       Revenue Objectives

2.       Cost Objectives

3.       Profit Objectives

4.       Cash Flow Objectives

5.       Investment Objectives (including return on investment objectives)

6.       Objectives relating to debt

Benefits of setting financial objectives

·         Vary per specific objective

·         They act as a focus for decision making and effort

·         Allow for comparisons

·         Provide a yardstick so success and failure can be measured against

·         Improves efficiency – look at reasons for success/failure

·         Shareholders assess whether business will be a good investment

·         Outside organisations e.g suppliers and customers can confirm the financial viability of a business

It can be difficult to set these objectives - why?

·         Realistic objectives for new activities can be hard to set

·         External changes are beyond the control of the business but may affect the ability to achieve an objective

·         Difficult to measure accurately

·         Can be impossible to determine why something is success/failure

·         Responsibility for achievement of objectives may rest with the finance department, but the actual performance will be dependent on the performance of all departments.

·         Some objectives may conflict with others, both financial and non-financial.

Difference between cash flow and profit

Cash inflows are the receipts of cash, typically from sales of goods, payments from debtors, loans received, rent charged, sale of assets and interest received.

Cash outflows are payments of cash, typically from the purchase of goods, payments to creditors, loans repaid or given, rental payments, purchase of assets and interest payments made.

Net cash flow is the sum of cash inflows to an organisation minus the sum of cash outflows, over a period.

Profitable firms can be short of cash because:

·         If the firm has built up its inventory levels, its wealth will lie in assets rather than cash. These inventories may not be saleable in the short term.

·         If the firm’s sales are on credit, its wealth will be in debtors (receivables) rather than cash. The firm may have agreed with its debtors that they don’t need to pay for a certain time. Although this helps marketing, it may damage cash flow.

·         If the firm has used its profit to pay dividends to shareholders or repay long-term loans, it may be short of cash.

·         If a firm has purchased fixed assets (factory, IT system) this will have involved a large outflow of cash, but in the accounts the ‘cost’ of the fixed assets is spread over several years. In the year they are purchased, the recorded ‘costs’ will be much lower than the actual loss of cash, leading to a potential crisis.

A business must make profit to survive. Repeatedly making losses will find it hard to acquire cash, as sales revenue will be lower than expenditure – creditors and investors will be iffy about giving the firm credit or loans, or buy shares. This could lead to liquidation – where the business must sell its assets to make the payments. Liquidity is the ability to convert an asset into cash without loss or delay.

Cash Flow objectives

Many businesses get into hard times by having a lack of cash flow rather than a lack of profitability. It is vital businesses make cash flow objectives to ensure that they are able to keep operating.

Examples:

·         Maintaining a minimum closing monthly cash balance. e.g a minimum cash balance of £10,000 would be a sensible objective for a small newsagent.

·         Reducing the bank overdraft by a certain sum by the end of the year. Overdraft will be needed to support everyday expenses which can be high in the opening few months. A permanent bank overdraft is not advisable – reducing overdraft would be appropriate. e.g paying off the bank overdraft by a certain date.

·         Creating a more even spread of sales revenue. e.g Mars Ltd introducing the Mars Ice Cream because sales of chocolate fall in the summer months. They are less likely to be short of cash in the summer.

·         Spreading costs more evenly. A business may pay utility bills (gas, electric) monthly rather than quarterly or more.

·         Achieving a certain level of liquid, non-cash items. Many businesses set an objective of holding certain assets, such as short-term investments or stock. If the business does run low on cash, it can turn these assets into cash quickly.

·         Raising certain levels of cash at a point in time. If the business knows through its forecasts that it needs a higher level of cash at a certain time, it may set an objective of raising these levels. e.g building stock levels for Christmas.

·     

    Setting contingency fund levels. Most businesses set an objective for a contingency fund, which is an emergency source of finance that can be used if unexpected difficulties occur.

External/Internal influences on financial objectives

External

Political factors – guided towards the wishes of the shareholders. Greater openness has led to expectations on businesses to serve the needs of other stakeholders including customers, workforce, etc.

Economic factors – if there is a recession, customers will purchase fewer products which means there are lower sales and profit targets will be set. For business selling luxury products, targets will be lower. Selling staple foods - limited effect.

Social factors – people expect access to a business 24/7 is possible. This change in expectations makes it hard for a business to set targets that involve lower costs, but at the same time it opens up opportunities for targeting greater revenue and creating new ways of generating income.

Technological factors – improvements. One benefit is that financial targets can be monitored more closely and regularly, meaning aims can be modified in light of changing circumstances.

Legal factors – can modify objectives. For example, in the motor industry, updates in environmental laws covering both the manufacturing process and end product, have increased costs to make a car.

Environmental factors – environmental awareness is growing among consumers. Pressure groups have an impact on objectives too. Supplies and raw materials from environmentally friendly sources is a common aim nowadays as firms want to minimise their carbon footprint.

Market factors – demand can change. Related to the life cycle for that type of product. When a product reches maturity, high levels of profit will become the main financial objective.

Competitors’ actions – prices of utilities (gas, electricity) have increased because suppliers can take advantage of limited levels of competition. They can target and achieve high levels of profit.

Suppliers – Co-op is is one of the UK’s major farmers and supplies its shops with food products, mostly from dairy farms. It has provided them with a regular supply, but it is not among the cheapest and is more expensive than farm produce from other countries. It has affected the Co-op’s ability to set and achieve high profit targets.

Internal

Business objectives – overall aims are a key influence on departments e.g finance. The finance department must ensure its objectives are in line with the corporate objectives. Example: Aldi is aiming to increase customer numbers and get customers to spend more with each visit. This required the finance department to set objectives focused on higher profit margins and a wider range of products.

Finance – ‘money makes money’. A good financial situation is more likely to achieve high profits and cash flow. It can fund investment into items like research and development, new technology and marketing campaigns which may improve overall financial performance. A business can also set more challenging objectives. High levels of profit achieved by Microsoft have enabled it to spend more on making new software so it can be ahead of competition. These high profits enable Microsoft to diversify into other areas of potential – computer consoles.

Human resources – achieving objectives depends on effort and skills of the workforce. Good planning can recruitment and training policies can mean a business can increase its profitability by increasing the workforce’s efficiency. However, needs of the workforce and objectives can conflict. Cost minimisation means workers may resist measures that might endanger their jobs.

Operational factors – finance department relies on other departments to reach goals. If operations are efficient, a firm will be able to produce goods of high quality and low cost. This leads to good sales revenue and high profit margins.

Available resources – over time, a business will build up a strong resource base and will be able to target and achieve a strong financial performance. Resources could be premises, brand names or workforce quality.

Nature of the product – success is heavily influenced by products and services. Successful business happened to be in the right place at the right time, like mobile phone networks. However, as the market reaches maturity, EE & Vodafone have needed to be more innovative and make extension strategies to reach their financial objectives.