Ch 1 Flashcards
Definition of Mission
Fundamental objective(s) of entity, expressed in general terms
Definition of Mission Statement
Published statement, apparently of entity’s fundamentl objective(s)
May or may not summarize true mission of entity
Definition of “hierarchy of objectives”
Arrangement of entity obj into number of different levels: higher levels general; lower more specific.
Levels may be mission / goals / targets OR strat obj / tactical obj / operational obj
Different Types of Entity
For-profit = primary objective to make profit, thus satisfy sh/h
NFP = usually have other non-fin primary objectives
Incorporated entity (aka company or corp) = legally separate from owners
Unincorported = not so - thus owner personally bears risk (partnership, sole trader)
Quoted = shares quoted / listed on a stock exchange
Unquoted = not so
Private sector entity = owned by privated investors
Public sector entity = owned by government
OTHER
Charity = type of NFP - centters on philanthropic goals and social wellbeing
Association / Union = group of individuals grouping together to accomplish a purpose (e.g. trade union, professional assoc)
Primary Strategic Objective of For-Profit Entity
Long-term goal of maximization of sh/h wealth
Primary Strategic Goal of public sector bodies, charities, trade unions, associations
Benefits for a prescribed group of people
(Secondary objective to raise maximum funds and utilize efficiently to maximize benefit - since services depend on funds available)
Objectives of Incorporated vs Unincorporated Entity
Incorporated = likely several owners, thus greater potential st/h conflict regarding objectives vs unincorporated
Objectives of quoted vs unquoted companies
Quoted = higher scrutiny from investors and market in general vs unquoted
Due to scrutiny, arguably important for quoted company to set appropriate non-fin objectives re. relationship with env and staff
Objectives of Charities
raise money for a specific cause, and spend in most effecitve way
some however are setting up retail outlets to generate trading profits - taking risks to increase returns - once regarded as inappropriate but now commonplace
Definition of Stakeholders
persons and entities that have an interested in the org’s strategy
include sh/h, customers, staff, local community
Example of for-profit entity balancing st/h needs
Setting an objective of achieving maximum profit consistent with balancing needs of various st/h
e.g. achieving a satisfactory return whilst (for example) establishing competitive employment T&C and avoiding env pollution
Agency Theory
a hypothesis attempting to explain elements of org behavior through understanding relationships between principals (sh/h) and agents (those tasked with running the entity on their behalf)
conflict may arise when agents pursue self-interest of those of principals
in practice, ordinary shares are diversely held and opportunities to assess whether mgrs are acting in their best interest are somewhat limited
Considerations when determining the financial objectives of a For-Profit Entity
EQUITY INVESTORS
they provide the risk finance – to attract funds, the company is competing with risk-free investment opps (e.g. govt bonds) – thus sh/h require returns (dividends and future share price increases)
FINANCE PROVIDERS
primary interest = ability to generate s/t and l/t CF and thus repay debts
RISK EXPOSURE
certain risks (FX/interest rate) can be managed through hedging – thus sh/h and entities can determine how much risk they are willing to take for a particular return
however, some risk is not addressed in finance theory – e.g. activity of competitors, recruitment of senior personnel
directors should thus set risk policies according to an agreed risk appetite reflecting that of the sh/h
Example specific financial objectives of for-profit entities
Profitability = e.g. annual 10% increase in earnings or EPS
Dividends = e.g. annual 5% increase
Cash Generation = e.g. annual 10% improvement in operating CF
Gearing = e.g. maximum ratio of 40% [debt to (debt plus equity)]
Financial Performance Indicator
Return to investors
Capital appreciation on shares (difference between P1 and P0 / end and start of year) + dividends
even with no dividends, capital appreciation of shares is important
{ P1 – P0 + Dividend } div P0
Financial Performance Indicator
Cash Generation
Poor liquidity = greater threat to survival than poor profitability
Cash generation vital to ensure investment in future ventures
Otherwise growth must be funded with high levels of borrowing
Financial Performance Indicator
Value Added
Measure of Performance
Defined as revenues less cost of purchased materials and services
Represents value added to entity’s products by its own efforts
Main issue is comparability (across and within industries)
Financial Performance Indicator
Profitability
Rate at which profits are generated
ADV
well-known and accepted
readily understood
comparable (provided consistency of calculation across time)
DISADV
does not explain why one business sector has more favorable prospects
insufficient insight into dynamics and balance of entity’s BUs
remote from the actions which create value, thus can only be managed directly in very small orgs
the input to the measure may vary substantially between orgs
Financial Performance Indicator
Return on Assets (ROA)
dividing annual profits by average net book value of assets
thus subject to distortions of using profits > CF (deprec, inv reval, write-offs)
also ignores time value of money – only minor concern if inflation is low
Financial Performance Indicator
Market Share
often seen as an objective for the comp in its own right – but must be judged in context of other measures such as profitability and shareholder value
unlike other measures, takes quality into account – assuming that dissatisfied customers will drive red’n in share
growing share is a l/t goal of entities to maximize outlets for prods/svcs and minimize competition
Financial Performance Indicator
Competitive Position
comparing our position to theirs – managers making decisions need to know by whom, by how much, and why they are gaining or losing ground
no single measure is useful – an array is needed to establish competitive position – the main challenge is gathering data from competitors for comparison
Stakeholder Issues in For-Profit Companies
(which may drive non-financial objectives)
EMPLOYEES – returns (salaries), job security, working conditions
MANAGERS/DIRECTORS – well-placed to prioritize their own needs - l/t goals (max sales, defence against takeovers) and s/t (profit margins leading to bigger bonuses)
SUPPLIERS – s/t prompt payment and l/t desire for regular business – importance of their needs depends on # of suppliers and relative size
GOVERNMENT – political desire to inc exports / dec imports while monitoring competition - financial desire to maximize tax revenues
COMMUNITY – including legal and social resp, pollution control, employee welfare
ENVIRONMENTAL – awareness of pollution and other issues
CUSTOMER PRESSURE – demanding ethical and responsible behavior - often conflicting with sh/h objective of wealth maximization
CUSTOMER SATISFACTION - failing here results in lost market share and eventual liquidation
Example non-financial objectives for for-profit entity
HUMAN (relationship with staff)
increasing training provision, reducing turnover
INTELLECTUAL (intangible assets, e.g. brand / reputation)
improving brand recognition
NATURAL (responsibility to environment)
reduction of pollution, increased recycling
SOCIAL (responsibility to community)
ensure 50% of employees live within 5km of office
RELATIONSHIP (towards key st/h - e.g. suppliers and customers)
pledge l/t contracts to suppliers and pay on time => improved relationships
Objectives and Stakeholders for NFPs
NFPs will also have a range of fin and non-fin objectives and will have multiple st/h groups to satisfy
varying views on “ideal” NFP objectives and what success looks like - e.g. hospitals saving lives vs having shorter waiting lists
defining measurable objectives is the major challenge in determining how to run NFPs (especially in public sector) effectively
Overview of Financial Objectives in Public Sector Orgs
Quoted company objective is max sh/h wealth, measurable through share price and dividends
Public sector org is run in interests of society of whole, thus we should try to measure the gap between costs of operation (easily measured) and benefits provided (incredibly difficult)
benefits are intangible / impossible to quantify – govt orgs use low discount rate and/or attempt to quantify non-fin benefits in standard NPV – but overall very tricky
Regulation in the Public Sector
Regulation to ensure public are not victims of monopoly that these orgs enjoy
eg. capping of sales prices, taxing of super profits, or limit on permitted profit levels
Public Sector Objectives
Cash Generation
historically, public sector growth entirely funded by govt
now, government has imposed cash limits, and public sectors orgs are turning to capital markets for funds, thus beginning to face the same choices as for-profit entities
Public Sector Objectives
Value Added
value added to an entity’s products by its own effort
problem = comparability with other industries or entities in same industry
public sector entities (e.g. health) are publishing information on their own value-add
Value for Money Diagram
