FINANCIAL STRATEGY

CHAPTER 1

STRATEGIC FINANCIAL OBJECTIVES

 Learning outcomes

A1 Advise on strategic financial objectives

a) Analyse different types of organisations and their
objectives;
b) Advise on financial objectives; and
c) Advise on non-financial objectives (also covered in chapter
2)

Footnote Strategic Financial Objectives 2

 Topics to be covered

1. Profit and not for profit organisations

2. Quoted and unquoted companies
3. Private and public sector organisations
4. Value for money, maximising shareholder wealth
5. Earnings and dividend growth
6. Impact of economic conditions on objectives

Footnote Strategic Financial Objectives 3

 1 Overview
• Types of entities
• Incorporated and unincorporated
• Companies versus sole traders
• For-profit and not-for-profit
• Profit making versus charity
• Quoted and unquoted
• Listed on a stock exchange versus unlisted
• Private sector and public sector
• Private shareholders versus government entities (i.e. SOE’s)
• Stakeholders
• Objectives – financial and non-financial

Footnote Strategic Financial Objectives 4

 2 Mission and objectives

• The mission and objectives of entities may differ, depending on:

• The type of entity; and
• The needs of the entity’s stakeholders.

Footnote Strategic Financial Objectives 5

 3 Objectives of entities

• Maximisation of shareholder wealth is often assumed to be the primary /

main objective of a for-profit entity.
• Not-for-profit entities are not run to make a profit, but to provide a
service.
• There may, however, be other objectives (financial and non-financial) that
are also important.
• Spend some time thinking about objectives for organisations from a
practical perspective.

Footnote Strategic Financial Objectives 6

 4 Objectives & stakeholders

• Stakeholders are those persons and entities that have an interest in the
strategy of an entity. Stakeholders normally include:
• Shareholders;
• Customers;
• Staff; and
• The local community.
(CIMA Official Terminology)
• Entities often have many, sometimes conflicting objectives.

Footnote Strategic Financial Objectives 7

 4 Objectives & stakeholders

Local Communities
Pressure Groups External
Government
Connected
Shareholders
Customers
Suppliers
Internal
Bankers

Managers
Employees

Footnote Strategic Financial Objectives 8

 4 Objectives & stakeholders

• The various stakeholders have different interests, namely:

• Shareholders – wealth maximisation
• Suppliers – paid amount owed in full by due date
• Lenders – repayment of capital and interest
• Employees – continuity of employment & salary
• Government – economic growth, employment
levels and taxes due
• Customers – continuous trading relationship
• General Public – pollution and social
responsibility, etc.

Footnote Strategic Financial Objectives 9

 4 Objectives & stakeholders

• A possible conflict can arise when ownership is separated from the

day-to-day management.
• Agency relationship / theory
• Relationship between management and shareholders. Management act as
agents for the shareholders (principals) and should run the organisation in the
shareholders’ best interests.
• Agency problem
• A conflict may exist between the actions undertaken by agents in furtherance
of their own self-interest, and those required to promote the interests of the
principals.

Footnote Strategic Financial Objectives 10

 4 Objectives & stakeholders

• Goal congruence
• In a control system, the state which leads individuals or groups to take actions
which are in their self-interest and also in the best interest of the entity.
(CIMA Official Terminology)
• Goal congruence can often be achieved by offering management and
staff incentives (i.e. performance related pay, share options or
bonuses).

Footnote Strategic Financial Objectives 11

 5 For-profit entities

• Maximisation of shareholder wealth is often assumed to be the primary /

main objective of a for-profit entity.
• However, this objective needs to be balanced with other objectives,
depending on the stakeholder groups.
• For-profit entities will have a mix of financial and non-financial
objectives.

Footnote Strategic Financial Objectives 12

 5 For-profit entities

Strategy
Financial Non-financial
Objectives Objectives
 Wealth  Customer
maximisation; satisfaction;
 Increase  Welfare of
earnings per employees;
share.  Welfare of society.

Footnote Strategic Financial Objectives 13

 6 Not-for profit entities

• Not-for-profit entities include:

• Trade unions (i.e. Cosatu);
• Professional bodies (i.e. CIMA and SAICA);
• Charities (i.e. SPCA and Child Welfare);
• Religious organisations; and
• Sports clubs.
• The objectives of a not-for-profit organisation should be the same as a
profit maximising organisation, except for the use of the profit (or
surplus).
• Not-for profit entities include public sector entities.

Footnote Strategic Financial Objectives 14

 6 Not-for profit entities
• Not-for-profit organisations make use of the 3 “E’s”. The 3 “E’s” refers
to:
• Economy (doing things as cheaply as possible);
• Efficiency (relating to productivity); and
• Effectiveness (relating to doing things right).
• This is often referred to as ‘value for money’ (VFM).
• A 4th “E” is sometimes included, known as Equity.
• The 3 “E’s” can also be found in many organisations within the private
sector.

Footnote Strategic Financial Objectives 15

 6 Not-for profit entities

• Similarities and differences exist between the public (government

departments) and private sector.
• Financial management is applicable to the not-for-profit sector and very
applicable to the public sector (government departments).
• It is impossible to determine whether or not value has been
maximised (for any sector, including the private sector).

Footnote Strategic Financial Objectives 16

 6 Not-for profit entities
• Financial management in government departments is different from
commercial companies (i.e. private sector) due to Government
departments:
• Not focusing on generating a profit;
• Not facing commercial pressure of competition;
• Relying on politicians to make decisions; and
• Raising finance in different ways (i.e. taxes, government borrowing, etc.).
• A different framework is needed for planning and control for
government departments.

Footnote Strategic Financial Objectives 17

 7 International operations

• The objectives of an entity trading internationally will be similar to an

entity based in just one country. However, there are some additional
considerations:
• Competition;
• Country specific factors (i.e. natural resources or labour availability);
• Customer benefits;
• Economies of scale;
• Risk management; and
• Impact on cost of capital.
• The main purpose of international expansion should be to maximise
shareholder wealth.

Footnote Strategic Financial Objectives 18

8 Financial performance
• You may be required to use ratio analysis to determine
whether an entity has met its financial objectives.
• Ratios can be grouped into the following categories:
o Profitability and return ratios;
o Lender ratios;
o Liquidity ratios; and
o Investor ratios.
• Please note that the following ratios can also be
calculated in slightly different ways. This will depend on
the industry, as well as how you justify to amend the ratio.

Footnote Strategic Financial Objectives 19

9 Profitability ratios
• Return on capital employed is calculated as:
PBIT X 100
Capital employed
• Return on equity (ROE) is calculated as:
(Net) profit X 100
Shareholders funds
• Return on assets (ROA) is calculated as:
Operating profit X 100
Total assets
• PBIT = operating profit; PAIT = (net) profit
Footnote Strategic Financial Objectives 20
9 Profitability ratios
• Gross profit margin (or %) is calculated as:
Revenue – cost of sales X 100
Revenue

Gross profit X 100

Revenue
• Gross profit mark-up is calculated as:
Revenue – cost of sales X 100
Cost of sales

Gross profit X 100

Cost of sales
Footnote Strategic Financial Objectives 21
9 Profitability ratios
• Operating profit margin (or %) is calculated as:

Operating profit X 100

Revenue

• Net profit margin (or %) is calculated as:

(Net) profit X 100

Revenue

Footnote Strategic Financial Objectives 22

9 Profitability ratios
• Asset turnover is calculated as:
Revenue
Total assets less current liabilities (or CE)
• Non-current asset turnover is calculated as:
Revenue
Non-current assets excluding investments
• Inventory turnover is calculated as:
Cost of sales
Average inventories

Footnote Strategic Financial Objectives 23

10 Lender ratios
• Debt ratio is calculated as:

Current and non-current liabilities X 100

Current and non-current assets
• A debt ratio of > 50% is considered high
• Debt/equity ratio is calculated as:

Interest bearing (net) debts X 100

Shareholders’ funds
• A debt/equity ratio of > 100% is considered high
• Debt/equity is also known as gearing ratio and can be
calculated in a number of different ways.
Footnote Strategic Financial Objectives 24
10 Lender ratios
• Using relatively more debt in the capital structure is
known as leverage (or gearing).
• Operating gearing can be calculated as:

Contribution X 100
PBIT
• Interest cover is calculated as:
Profit before interest and tax
Interest expense
• Interest expense is also known as finance costs.

Footnote Strategic Financial Objectives 25

Liquidity ratios
• Liquidity of an entity is measured by examining the
relationship between current assets and current liabilities.
• Current ratio is calculated as:
Current assets
Current liabilities
• Quick ratio is calculated as:
Current assets - inventories
Current liabilities

Footnote Strategic Financial Objectives 26

Liquidity ratios
• The working capital cycle comprises cash, receivables,
inventories and payables.
• Inventory days is calculated as:

Average inventories X 365 (or 12 if months)

Cost of sales
• Inventory days is the inverse of the inventory turnover
ratio (the same applies to receivables days and payables
days).
• You can calculate averages (if the information is
available).

Footnote Strategic Financial Objectives 27

Liquidity ratios
• Receivables days is calculated as:
Average receivables X 365 (or 12 if months)
Credit revenue
• Payables days is calculated as:
Average payables X 365 (or 12 if months)
Credit purchases
• The total length of the working capital cycle is inventory
days plus the receivables days less the payables days.
• If credit purchases are not available use COS.

Footnote Strategic Financial Objectives 28

11 Investor ratios
• P/E ratio is calculated as:
Market price per share (MPS)
Earnings per share (EPS)
• The P/E ratio indicates the amount investors are willing to
pay for each rand of earnings. It is an indicator of investor
confidence.
• Earnings yield is the inverse of the P/E ratio
• Earnings per share (EPS) is calculated as:
Profit attributable to ordinary shareholders
Weighted number of ordinary shares in issue

Footnote Strategic Financial Objectives 29

11 Investor ratios
• Dividend pay-out rate is calculated as:
Cash dividend per share (DPS)
Earnings per share (EPS)
• Dividend yield is calculated as:
Dividend per share (DPS)
Market price per share (MPS)
• Dividend cover is calculated as:
Earnings per share (EPS)
Dividend per share (DPS)

Footnote Strategic Financial Objectives 30

12 Sensitivities to economic influences

• Economic influences consist of:

• Inflation;
• Interest rates; and
• Exchange rates.

• Understanding the impact of the above economic influences on financial

strategy is a key focus area.
• [Students MUST be able to apply the above influences and impact of each
to a scenario provided in a test or exam].

Footnote Strategic Financial Objectives 31

12 Sensitivities to economic influences
• Changes in interest rates affect economies in many ways. An increase
in interest rates may have the following consequences:
• Spending falls;
• Asset values fall (because of the inverse relationship);
• Attraction of foreign funds;
• Exchange rate increases;
• Move to switch investments into interest bearing instruments; and
• Inflation falls, etc.

Footnote Strategic Financial Objectives 32

12 Sensitivities to economic influences
• Inflation is defined as “rising prices” and indicates the cost of living in
general terms.
• A low inflation rate may be beneficial to an economy.
• Inflation can affect the profitability of a company in the following ways:
• Inflation will affect prices of goods and services, especially input prices;
• Inflation may require regular price reviews;

Footnote Strategic Financial Objectives 33

12 Sensitivities to economic influences
• Inflation can affect the profitability of a company in the following ways
(continued):
• High inflation may result in high levels of uncertainty;
• Inflation may result in cash flow pressures;
• Companies may increase inventory levels to combat higher prices (i.e. bring
purchases forward); and
• Higher inventory levels may result in increased storage costs (and possible
obsolescence).

Footnote Strategic Financial Objectives 34

12 Sensitivities to economic influences
• Interest rate parity theory:
• The impact of interest rates on the expected exchange rate is provided by the
interest rate parity theory.
• Interest rate parity formula:
• F0 = S0 x (1 + r var)
(1 + r base)

• A change in economic variables such as interest rates, exchange rates and

inflation can have an impact on an entity’s ability to meet its objectives.

Footnote Strategic Financial Objectives 35

 13 Limitations of ratio analysis
• The limitations of ratio analysis include:
o Availability of comparable information;
o Use of historical information;
o Ratios are not definitive;
o Need for careful interpretation;
o Manipulation (estimation and judgment);
o Monetary expression;
o Simplification and aggregation; and
o Need for other information.

Footnote Strategic Financial Objectives 36

QUESTIONS?