A financial objective is a specific goal or target of relating to the financial performance, resources and structure of a business
Value of setting financial objectives
The key benefits of setting financial objectives include:
- Providing a focus for the entire business
- A measure of success of failure for the business
- Reduced risk of business failure (particularly prudent cash flow objectives)
- Help coordinate the different business functions (all of which require finance)
- Provide target to help make investment decisions (investment appraisal)
- Indicate to stakeholders (e.g. shareholders) what the priorities of the management are
Main types of financial objective
These can be summarised as follows:
Revenue Objectives
Most businesses set revenue objectives. Amongst the most common are revenue objectives relating to:
- Revenue growth (% or value)
- Sales maximisation
- Market share
Cost objectives
Cost minimisation is a common cost objective - particularly in relation to controlling the fixed costs of a business and, therefore, the break-even output.
A business might also set objectives relating to unit costs and link these to targeted efficiency measures such as labour productivity and/or capacity utilisation.
Profit objectives
Most people assume that businesses aim to maximise their profits, so profit objectives are likely to be a key part of the overall corporate objectives for a business. Different types of profit objective include:
- Specific level of profit (in absolute terms)
- Rate of profitability (as a % of revenues)
- Profit maximisation
- Exceed Industry or Market profit margins
Cash flow objectives
A timeless quote states that, in business:
Revenue is vanity
Profit is sanity
, but Cash is KING
Which neatly highlights the important of setting cash flow objectives. With adequate cash flow a business is more likely to be able achieve other financial objectives by providing extra financial resources.
Typical cash flow objectives might include those relating to:
- Maximum level of debt 9the absolutely amount, rather than the gearing ratio)
- Amount of cash tied up in working capital (inventories, receivables)
- Cash flow to profit %
Capital structure objectives
The capital structure of a business refers to the balance of its finance in terms of how much is equity (or share capital) and how much is is in the form of debt. The two key capital structure objectives tend to be:
- Gearing ratio (the percentage of total business finance that is provided by debt)
- Debt / equity ratio (the proportion of business finance provided by debt and equity)
Return on investment objectives
Financial objectives relating to the return that businesses make on their investment tend to be of two types:
- Objectives relating to the level of capital expenditure - at either an absolute amount (e.g. invest £5m per year) or as a percentage of revenues (e.g. 5% of revenues)
- Objectives relating to the return on Investment - usually set as a target % return, calculated by dividing operating profit by the amount of capital invested.
