AQA A level business 3.5

Financial objectives

the specific goals set in relation to the management of an organisation's monetary resources that will enable a company to achieve its corporate objectives

Value of Financial Objectives X2

• it sets a clear targets = allow for decisions to be made about resource allocation

• it secures external finance e.g. bank loan or investment

Return on Investment

• a financial metric used to evaluate the profitability of an investment relative to its cost.

• measures the ratio of the net profit or gain generated from an investment to the initial investment cost, expressed as a percentage

• (Net Profit / Initial Investment) × 100

Investment appraisal

Process that managers use to compare the costs of an investment to the expected revenues it will accrue

Gearing

Measure of risk as more debt that has been used to fund the business = More vulnerable to changes in interest rate

Cash flow

The movement of money into and out of a business over a period of time

Profit

The excess amount of money made by a company when its total revenue exceeds its total costs

Loss

The difference between total costs and revenues when costs outweigh revenue

Gross profit

The difference between sales revenue and cost of goods sold

Operating profit

The difference between sales revenues , cost of goods and other operating costs (fixed)

Profit for the year

The amount of profit left over at the end of the year by subtracting non current liabilities (e.g. tax) from operating profit

Revenue objectives

Goals relating to the level of income (amount to be received) from sales

Cost objectives

goals relating to the expenditure (amount to be spent) for production

Profit objectives

goals relating to the amount of profit to be achieved

Cash flow objectives

goals relating to the ability of an organisation to fund its day to day operations

Investment objectives

goals relating to the amount to be invested in corporate development strategies (i.e. the purchase of new equipment)

Factors Determining Investment Levels X2

Market conditions
Competitors actions

Capital structure objectives

goals relating to the extent the business is financed internally, or by debt

Capital employed

Long term funding

Capital employed includes x4

• shares

• capital (financial assets)

• debt/loan capital

• retained profits

Share

• represents ownership in a corporation.

• when purchased they become shareholders

• entitling them to certain rights and benefits, including voting rights, dividends

Capital

refers to the financial resources, assets, or wealth owned or controlled by businesses used to generate income

Debt/loan capital

• this is one way to fund capital expenditure

• often comes from banks in the form of loans and mortgage and needs to be rapid

Debt capital repayment

• refers to the process of returning borrowed funds, along with any accrued interest, to creditors or lenders according to the terms of a loan agreement

• crucial for maintaining financial health, credibility and reliability

Internal influence on financial decisions and objectives X2

Corporate objectives - growth? Consolidation(strategic goal of streamlining and integrating various aspects of a business's operations)?
Marketing - diversification and growth vs survival

External influences on financial decisions and objectives X2

Competitors: the competitiveness of the industry determines cost and revenue
Economic: Changes in the interest rate has a huge effect on a businesses debt / customer confidence affects revenue

Types of Budgets

• expenditure,

• revenue

• profit

Revenue budget

• is a financial plan that outlines expected revenues or income for a specific period

• facilitate decision-making, cash flow management, and strategic planning by providing insights into expected revenue streams and identifying areas for growth or improvement

Revenue budget value

Informed by past data seasonality and market research
can be used to generate a cash flow forecast

Expenditure budget

• is a financial plan that outlines projected spending or expenses for a specific period

• provide a framework for managing expenses, controlling costs, and ensuring that spending remains within planned limits

Expenditure budget value

• set expenditure targets for different cost centres within the business

  • e.g. marketing/regional area

• informed by past data and predicted sales)

• can be used to generate cash flow forecast

Profit budget

• a financial plan that outlines projected revenues, expenses, and anticipated profits for a specific period

• plays crucial role in financial planning, performance management, and decision-making for businesses

profit budget process

Set objectives for budget → Carry out the market research → calculate revenue/expenditure budget → calculate profit budget → set targets → review budgets against objectives

Variance analysis

Process of comparing the budget to the actual financial performance of the business

variance

when there is a difference between the budgeted figure and the one actually achieved

Favourable variances

occurs when actual results exceed budgeted or expected results, indicating that performance is better than anticipated.

Adverse variances

• occurs when actual results fall below budgeted or expected results, indicating that performance is worse than anticipated

• signals potential challenges, inefficiencies, or missed targets in achieving financial goals

• prompt organizations to investigate underlying causes, take corrective actions, to improve performance

Reasons for cash flow forecast

• To ensure business has sufficient capital to operate (pay wages/suppliers)

• To identify potential cash flow problems in advance (overall have enough liquidity to survive)

Cash inflow

• refers to money entering a business from sales, investments, or financing activities, boosting the cash balance.

• Sources: Sales revenue, customer payments, interest/dividends earned, asset sales, loans/capital injections.

• Importance: Essential for liquidity, funding operations, growth, and meeting financial obligations.

• Management: Monitor sources, manage receivables, minimize delays, maximize returns for financial stability.

Cash outflow

• the movement of cash out of a business or entity, representing expenditures or payments made for various purposes

• including operating expenses, investments, debt repayment,

Opening balance

The amount of money left at the end of the previous period to the start of the next period

Closing balance

In a cash flow forecast the amount of money/cash left at the end of the period

Increase cash inflow x2

• Increase/reducing selling price:

  • Depends on accurate PED data. How will consumers react?

• Increase marketing: will incur costs

Improving cash outflow x2

• Reduce stock level: business may not be able to meet unexpected changes in demand

• Reduce raw material cost: Impact on quality

Value of budgeting x2

• Provide a clear target for the company teams and individuals

• Motivational for staff (goal setting and performance measurement)

• Cash Flow Management (especially for business where liquidity is important: start-up + fast growing{prevents overtrading} )

Budgeting problems x2

Unforeseen changes in the external environment e.g. competitors actions
Time consuming and expensive - opportunity cost

Costs

The expenses the business incurs in order to operate

start-up cost

Are one off or infrequently occurring expenditure items that are required at the set up stage of the business

Running cost

Are the day to day costs incurred in order for the business to operate

Fixed cost

Cost towards the business which stay the same regardless of output e.g. rent/salaries/ interest payments

Variable cost

Costs to a business which change relating to the output e.g. materials/wages/distribution costs

Total cost

All of the costs associated with provision of a good or service, including variable cost and fixed cost

Break even output

The number of units a business needs to sell so that it makes neither a profit nor a loss

Break even output importance x2

Analyse if business is viable
help set selling price

Margin of safety

The difference between the number of forecasted sales and business break even output

Total contribution

The difference between the total revenue and total variable cost

Total contribution Importance x1

Allow business to asses if a product is contributing to paying fixed cost and adding to profit

Break even analysis pros x2

• used to asses impact of change in price/cost

• help to set sales targets

Break even analysis cons x2

Does not take into account unforeseen changes
Assumes constant returns (no discount to customer/from suppliers)

Gross profit margin

Measure of how effective a business is at controlling its variable cost of production

Operating profit margin

Measure of how efficiently a business is controlling its fixed cost of production

Receivables

• sales business has made but is waiting for

• recorded as revenue on the income sheet/but not as cash inflow

Payables

• represent the amounts owed by a business to its suppliers, vendors, or creditors for goods purchased or services received on credit

• recorded as cost on income sheet, however NOT outflow as money has not left yet

Financial decisions e.g. Budget

• setting and reviewing targets

• Cash flow forecasts

• arranging finance

data for finance decisions value x2

• informed decision-making: data provides valuable insights and information that enable businesses to make informed decisions based on evidence rather than speculation.

• risk management: helps businesses assess and mitigate risks associated with financial decisions by identifying potential pitfalls, uncertainties, and adverse outcomes (HIDO do they have a person with skill to analyse data)

Data for finance decisions limits x2

• Unforeseen changes may occur

• Quantitative targets may not take qualitative data into account e.g. staff morale /trends in society

Sources of finanaces depends on X2

• use of finance long term vs short term

• amount required and level of perceived risk

Internal sources of finance

generated within the business, or by their current owners

External sources of finance

are obtained from outside the business

Sources of finance short term used (revenue expenditure)…

used to pay for running costs, like stock / wages etc

Sources of finance long term used (revenue expenditure)…

used to fund the purchase of assets, like machinery / property etc

Debt factoring

Process of selling the right to collect sales made on credit to another business

Debt factor type x2

Short term
external

Debt factoring uses

Most businesses would only use in an emergency to cover urgent costs

Debt factoring pros x2

• Provides cash in the short term

• Reduced risk of bad debts (affect on cashflow)

Debt factoring Cons X2

• May only receive 80% of sale value

• financial institution to retain about 5% of the value of the invoice to cover its costs in debt collection

• Reputational damage if customers are chased to payment by factoring company

Overdraft

Arrangement with a bank to overspend on a current account up to a set limit

Overdraft type X2

Short term
external

Overdraft uses X2

Cover seasonal changes in demand
Cover short term short falls in cash i.e. awaiting payment from a customer

Overdraft Pros X2

Helps to deal with seasonal fluctuations in demand
Enables a business to respond to unforeseen changes in demand

Retained profits

funds that a business has reinvested after previous trading

Retained profits types X2

Short or long term
Internal

Retained profits uses X2

Can be used for any purposes
·Most common use is investment in new capital

Retained profits pros X2

Quickly and easily accessible
No interest or dividend payments, therefore a cheap option

Retained profits Cons X2

Reduces availability of dividends to shareholders
Opportunity cost

Share capital

Equity invested by shareholders in return for a share of the profits and part ownership of the company

Share capital types X2

Long term
External

Share capital use X1

Fund investment

Share capital pros x3

• Limited liability encourages potential investors

• May benefit from additional expertise

• Investment is permanent

Share capital Cons x2

• Possible short - term focus of shareholders

• Loss of control

Loans

Funds that need to be repaid with interest, usually over a fixed period. I.e. 3 - 5 years

Loan types X2

Long term
External

Loans uses X2

• Often use to buy machinery

• A mortgage is a long term loan use to purchase property

Loan pro X3

• Can be relatively quick and easy to secure i.e. quicker than selling shares ( HIDO if the business has a good financial history)

• Loan are specific to the business i.e. value and duration of time

• No loss of ownership

Loan con X2

Relatively inflexible (strict payment schedules)
Interest payments

Venture capital

Money invested into a business that may be considered high risk to other lenders by an organisation or individual

Venture capital type X2

Long term
external

Venture capital uses X2

Used to finance expansion of small to medium sized enterprises
The providers of venture capital often also provide service and experience

Venture capital Pro X2

Useful for companies that cannot find investment from other sources
sources of advice and support from experienced business managers

Venture capital Cons X2

Partial loss of ownership
Potential for excessive control and conflict