7. Financial Objectives and Constraints

7. Financial Objectives and Constraints

1. F.O outline what the business wishes to achieve in financial terms during a certain period of time. Constraints are the internal and external factors that affect the firm's ability to achieve these objectives.

2. Types of Financial Objective

   • Ownership vs Management
     • Small business usually the same. Large company such as a plc, owners (shareholders) and management (directors) differ.
     • Shareholders want return on investment
     • Directors may want growth/ diversification/ satisficing (ticking along). Also may want achievable and not challenging targets (due to bonuses)
   • Short Term vs Long Term
     • Some business goals (growth/diversification) will need investment -> reduction in short term profits with the hope of increasing returns in future.
     • If in difficulty, need to focus on survival so increasing profitability will be a definite short-term goal.
   • Stakeholders vs Shareholders
     • Profit may cause conflict
       • Rise of interest in environment -> costs increased -> profit reduced. However, huge savings i.e. limiting waste
       • Some firms (i.e. supermarkets) drive down prices of their suppliers to the lowest possible level -> increase profits. Need to ensure balance between keeping costs low and maintaining quality. Tough bargaining -> unacceptable welfare conditions -> backfire (poor reputation)
       • Taxation -> deliberately reduce profit to pay less tax, vice versa. Can do this by charging differential prices between subsidiaries in different countries
       • Public image: spend money on charitable concerns or sponsorship -> reduce profit, but may get return on investment through creating a better brand image or good public relations
   • Profit is a Major Objective
     • Most companies more specific in defining their financial objectives: increase gross/ net profit, use ROCE.
     • Firms that have a high gross profit margin -> easier to finance high spending on research and development, marketing or investing in assets. Better control of costs -> more profitable. Generate high profits -> content shareholders.
   • Revenue Targets
     • Directors may set overall aim i.e. increase revenue by 10%. This approach is important for early stages of growth
   • Cash Flow Targets
     • All business need healthy cash flow.
     • Short of cash -> trouble with day-to-day management of liabilities-> hard to pay creditors -> miss opportunities to develop-> order refused if insufficient cash
     • Too high cash reserves -> missing out on opportunities to use cash to generate business
     • 'Right' level will depend on nature of business
   • Cost Minimisation
     • Lowering costs -> increase profitability
     • May be necessary when times are hard
   • Return on Capital Employed (ROCE)
     • Measure of how well the company is using its assets to create profit. Calculated by taking net profit/ operating as a percentage of capital employed
     • Capital employed = long term finance
     • Want highest and important that ROCE is higher than the rate of interest paying on borrowed funds
   • Shareholder Returns
     • Expressed in terms of the dividend payments that will be given to shareholders or in terms of maintaining or adding value to the share price
     • Gain from investment: increase in value of shares -> higher capital return. Income through dividends

3. How are Financial Objectives set?

   • Determined by taking into account the overall company aims, internal position and external business environment. They express the financial aspects of the overall company plan.
     • Internal aspects: what the business is currently doing, what resources are available
       • This has to be put into the perspective of the external environment -> will affect how easy it is to carry out plans
   • What makes a good financial objective? (SMART)
     • Specific: clearly defined so all staff know and understand them
       • Measurable: possible to see if target has been achieved
         • Achievable: to set one that is impossible -> demoralising for staff, can create poor shareholder and public confidence
           • Realistic: make good business sense
             • Timebound: usually relate to financial year, can also look further into the future

4. Internal and External Influences on Financial Objectives

   • Internal Constraints
     • Financial: pursuit of higher profit might be constrained by lack of cash flow, especially at a time of rising/ booming demand
     • Labour Force: Any business activity requires cooperation of the workforce, important that the business has the manpower with the necessary skills
     • Type of Business: New/ young business may set unrealistic targets because of inexperience or difficulty assessing new market. Large/ more established find it easier. PLC's more constrained in their objectives as will have to satisfy shareholders + management
     • Operational: close to full capacity -> fewer opportunities for improving profit-ability of the business, unless has confidence and resources to increase capacity i.e. moving
   • External Constraints
     • Competitive environment: plans can be affected by competitors reaction and behaviour. i.e. plan to increase profit margins by increasing price may be destroyed if competitors reduce their prices/ advertising this
     • Economic Environment: Booming economy will help businesses improve sales, BUT high interest rates would reduce customers disposable income, therefore spending/ financial targets may not be met -> own-brands will do better than branded goods
     • Government: Objectives can be limited by regulatory