Decision making to improve financial performance
Chapter 16
Setting financial objectives
It is common to contain a numerical element + timescale. This is set by
financial managers, but consistent throughout objectives.
They enable managers + owners to judge performance since it’s
conception. They are a valuable measure of performance as most are
judged on their financial attainments.
They identify aspects of performance causing problems early as possible.
Variances from objectives encourages corrective action.
They can be motivating, encouraging to work conscientiously or creatively,
thereby enhancing performance.
The distinction between cash flow and profit
Profit
A business can survive without profit for a short time if owners are patient
+ cash is managed carefully, but is essential in the long run for
shareholders.
Cash flow
The timing of payments and receipts. It is important in the short term, as
creditors must be paid.
Being profitable doesn’t mean holding large sums of cash. Because:
– Receivables may come later than payables.
– Expensive inventories e.g. a jeweller.
– Non-current assets may be profitable in the long term
A profitable business may be short of cash + unable to settle its bills. This
could lead to insolvency - major reason for failure.
Different measurements of profit
Profit is what remains from revenue once costs have been deducted.
Gross profit
– Revenue - cost of sales. Broad indication of the financial performance
without considering indirect costs or overheads.
,Operating profit
– Accounts for all earnings from regular trading activities + associated
costs. It excludes any activities that won’t be repeated in future. It also
excludes profit from joint ventures or non trading activities e.g.
investments. It doesn’t include certain expenditure e.g. interests or tax.
Profit of the year
– Considers income + costs from all sources. Managers can pay
dividends, retain or invest it.
Not all businesses record all 3 types Companies have stricter laws on
presenting financial info.
, Direct costs (cost of sales) are expenditure that can clearly be allocated to a
particular product or area of the business. Examples include raw materials and
components.
Indirect costs are expenditure that relates to all aspects of a business’s
activities, such as maintenance costs for buildings or senior managers’ salaries.
Financial objectives
Revenues objectives
Earning a certain amount over a financial period. Help to build a customer
base + become established. May be used more widely for growth. Products
with short life cycles seek to maximise revenues. Relevant for charities to
support their cause.
On a particular aspect
– Rather than the entire business e.g. advertising revenue
Aggressive revenue objective
– Requires revenue to grow at increasing rates over time.
Reducing prices first
– Before expecting an increase in revenue e.g. elastic products.
Revenue objectives don’t necessarily increase profits.
Cost objectives
Reducing costs
– By a given amount or % over time. In 2014 Aldi, Lidl placed pressure on
supermarkets to reduce prices.
Cost minimisation
– Can offer the lowest possible prices e.g. budget airlines. But it deprives
other functions.
Profit objectives
As a simple figure
– Based on previous years + expected changes.
As a % increase in profits
– Usually a yearly target with a % rise on the previous year.
As a profit margin
– This allows revenue to change, but profits must alter in line with it.
Risky if unexpected changes results in lower profits than predicted.
Resulting in falling share prices + nervous lenders.
Cash flow objectives
Especially if facing long cash cycles, cash has to be managed carefully.
Banks require a steady inflow of cash to engage in lending activities.
Chapter 16
Setting financial objectives
It is common to contain a numerical element + timescale. This is set by
financial managers, but consistent throughout objectives.
They enable managers + owners to judge performance since it’s
conception. They are a valuable measure of performance as most are
judged on their financial attainments.
They identify aspects of performance causing problems early as possible.
Variances from objectives encourages corrective action.
They can be motivating, encouraging to work conscientiously or creatively,
thereby enhancing performance.
The distinction between cash flow and profit
Profit
A business can survive without profit for a short time if owners are patient
+ cash is managed carefully, but is essential in the long run for
shareholders.
Cash flow
The timing of payments and receipts. It is important in the short term, as
creditors must be paid.
Being profitable doesn’t mean holding large sums of cash. Because:
– Receivables may come later than payables.
– Expensive inventories e.g. a jeweller.
– Non-current assets may be profitable in the long term
A profitable business may be short of cash + unable to settle its bills. This
could lead to insolvency - major reason for failure.
Different measurements of profit
Profit is what remains from revenue once costs have been deducted.
Gross profit
– Revenue - cost of sales. Broad indication of the financial performance
without considering indirect costs or overheads.
,Operating profit
– Accounts for all earnings from regular trading activities + associated
costs. It excludes any activities that won’t be repeated in future. It also
excludes profit from joint ventures or non trading activities e.g.
investments. It doesn’t include certain expenditure e.g. interests or tax.
Profit of the year
– Considers income + costs from all sources. Managers can pay
dividends, retain or invest it.
Not all businesses record all 3 types Companies have stricter laws on
presenting financial info.
, Direct costs (cost of sales) are expenditure that can clearly be allocated to a
particular product or area of the business. Examples include raw materials and
components.
Indirect costs are expenditure that relates to all aspects of a business’s
activities, such as maintenance costs for buildings or senior managers’ salaries.
Financial objectives
Revenues objectives
Earning a certain amount over a financial period. Help to build a customer
base + become established. May be used more widely for growth. Products
with short life cycles seek to maximise revenues. Relevant for charities to
support their cause.
On a particular aspect
– Rather than the entire business e.g. advertising revenue
Aggressive revenue objective
– Requires revenue to grow at increasing rates over time.
Reducing prices first
– Before expecting an increase in revenue e.g. elastic products.
Revenue objectives don’t necessarily increase profits.
Cost objectives
Reducing costs
– By a given amount or % over time. In 2014 Aldi, Lidl placed pressure on
supermarkets to reduce prices.
Cost minimisation
– Can offer the lowest possible prices e.g. budget airlines. But it deprives
other functions.
Profit objectives
As a simple figure
– Based on previous years + expected changes.
As a % increase in profits
– Usually a yearly target with a % rise on the previous year.
As a profit margin
– This allows revenue to change, but profits must alter in line with it.
Risky if unexpected changes results in lower profits than predicted.
Resulting in falling share prices + nervous lenders.
Cash flow objectives
Especially if facing long cash cycles, cash has to be managed carefully.
Banks require a steady inflow of cash to engage in lending activities.
