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.