3.5 Decision Making for Financial Performance

3.5 Decision Making for Financial Performance

1. Why set financial objectives?

   • A focus for the entire business
   • Important measure of success or failure of the business
   • Reduce the risk of business failure
   • Helps to coordinate different business functions
     • For example, ensuring that increasing profits could mean that budgets are stricter in finance and production wishes to spend less on suppliers

2. Profit and Cash Flow

   • Profit is the difference between total revenues and total costs over a period
   • Cash flow is the difference between total cash inflows and total cash outflows over a period
     • How does cash flow differ from profit?
       • Timing differences
         • Sales to customers made on credit
         • Payments to suppliers
       • How fixed assets are accounted for
         • Payment for any fixed assets is counted as cash outflow
         • The cost of the fixed asset is treated as an asset not a cost
       • Cash flows arising from the way the business is financed
         • Inflows from shareholders, bank loans
         • Repayments of amounts loaned
         • Payments of dividends
   • Profits are the main source of funds for an established business. Revenues eventually turn into cash inflows. Costs eventually turn into cash outflows.

3. KEY TERMS

   • REVENUE
     • Revenue (sales) during the period
   • COST OF SALES
     • Direct costs of generating revenues, such as cost of raw materials, components, direct costs of labour production
   • GROSS PROFIT
     • Revenue minus cost of sales
     • % of profit made from every £1
   • ADMIN EXPENSES
     • Operating costs and expenses that are not directly relating to the production of goods or services. Includes distribution costs and overheads that incur
   • OPERATING PROFIT
     • Gross profit minus expenses
   • FINANCE EXPENSES
     • Interest paid on bank loans, useful for shareholders to see how much is lost to funding
   • TAXATION
     • Estimate of the amount of corporation tax that is likely to be payable on the profits for the period
   • PROFIT OF THE YEAR
     • The amount of profit left after tax has been accounted for

4. Influences on Financial Objectives

   • Internal
     • Business Ownership
       • Nature of the ownership - venture capital investor would choose a different approach than a long-standing family ownership
     • Size and status of the business
     • Other functional objectives
   • External