Chapter 1 - Strategic Objectives Flashcards
What is value for money?
- Performance of an activity in such a manner as to achieve economy, efficiency and effectiveness
- Used to appraise not for profit org’s
What are primary objectives (profit making org’s)?
- Long-term objectives
* Often financial
What are secondary objectives (profit making org’s) ?
- Lower priority objectives (stepping stone) to achieving primary objectives
What are primary objectives (not for profit org’s)
- Grouped under effectiveness (high quality, high take up of service or timeliness)
- Are usually non-financial
What are secondary objectives (not for profit org’s)?
- Can be grouped under:
1. Economy (purchase of inputs of appropriate quality at minimum cost)
2. Efficiency (using inputs to maximize outputs or operating within budget) - Will often be financial
Reasons why profit is not a sufficient objective?
Investors care about:
- The future
- Dividends
- Financing plans
- Risk management
Maximization of shareholder wealth can be measured as:
Total shareholder return (dividend yield + capital gain)
Total shareholder return:
- Increase in share price plus dividends received during the year
- Reflects the fact that both share price growth and dividends are important to investors
Earnings per share formula:
(Profits distributable to ordinary shareholders (profit after tax,interest and pref.dividends )
/
(Number of ordinary shares)
Share price formula:
P/E ratio x EPS
Total shareholder return as a % formula:
(Dividend per share + Capital gain) / (Share price at the start of the year) ×10 * Capital gain = current year share price – prev. share price
Other financial objectives:
- Profit-based ratios such as EPS and ratios measuring risk is still important as secondary financial objectives, because if profit targets are missed, shareholder wealth maximisation is unlikely to be achieved.
Profit based ratios:
- EPS
* Return on shareholders funds (equity)
EPS formula:
(Profits distributable to ordinary shareholders)
/
(Number of ordinary shares)
Return on shareholders funds (equity) formula:
Earnings
/
shareholders funds
- If shareholder funds are not given in question:
Shareholder funds = ordinary shares + reserves (book value)
Ratios measuring financial risk:
- Gearing
* Interest cover
Gearing Ratio formula:
Debt / Equity
OR
Debt / Debt + Equity
- Equity = shareholders funds
Interest cover formula:
PBIT / interest
Earnings growth / dividend growth analysis allows:
- Analysis of growth of earnings or dividends can allow investors to make assessments about the company’s performance
Growth formula:
g = n √((Latest dividend) / (Earliest dividend) -1) n = growth periods
Sensitivity of objectives to economic and business variables - exchange rates:
- Exchange rates = change in exchange rates can impact the selling prices and hence the profitability ratios which could cause earnings objectives to not be met.
Sensitivity of objectives to economic and business variables - interest rates:
- Interest rate parity theory suggests that the forward rate of exchange can be found by adjusting the spot rate of exchange to reflect the differences in interest rates between two countries.
- The difference in interest rates should offset the difference between the spot exchange rate and the forward exchange rate over the same period
Interest Rate Parity Formula:
FO = SO × ([1+r var])/([1+r base])
FO = Forward rate of exchange
SO = Spot rate of exchange
R var = Interest rate of variable currency
R base = interest rate of base currency (exchange rate expressed as 1)
Why use non-financial objectives?
- Non-fin objectives do not negate the importance of financial objectives, but instead highlights the importance of companies having targets other than maximising shareholder wealth
Non-financial objectives can be determined using:
- The balanced scorecard
* The capitals of integrated reporting
The balanced scorecard perspectives includes:
The balanced scorecard:
- Improved innovation and learning
- Improved business processes
- Improved customer relationships
- Improved financial performance
- In addition, it can be argued for both business and ethical reasons, broader social and environmental objectives should be set, measured and monitored.
Traditional reporting vs. integrated reporting:
- Traditional financial reporting focuses on annual financial performance and how it fits with an entity’s aim to create shareholder wealth over the long term
- Traditional financial reporting does not relate to:
1. An entity’s overall business model
2. How it is achieving its aims over time
3. How other stakeholders are impacted by the focus of creation of wealth - Integrated reporting encourages businesses to focus on:
1. The value creators within their business
2. With a view of the longer-term success of a business
3. Rather than the short-term focus on results that arises from other types of reporting
The aim of integrated reporting:
It explains how a business creates value over time and the nature and quality of the org’s relationships with its stakeholders
Integrated reporting involves:
- Reporting on sustainability/ environmental issues which may help to enhance the importance with which these issues are treated.
- Integrated reporting is designed to make visible the capitals on which the org depends and how these capitals are used to create value in the short, medium and long term.
The capitals:
- Financial
- Intellectual
- Social & relationship
- Human
- Manufactured
- Natural
Financial capital:
- Source of funds available to entity such as share capital and loans.
- Financial objectives = TSR, EPS & Gearing
Intellectual capital:
- Entity’s formal R&D and less formal knowledge that is gathered, used and managed by the entity.
- Objectives = attracting high caliber employees and brand recognition
Social & relationship capital:
- Relationships within an entity and with external stakeholders
- Objectives = paying suppliers on time & improving customer service
Human Capital:
- Entity’s management & employees and their skills developed through education, training and experience.
- Objectives = Staff retention and increasing number of training days
Manufactured Capital:
- Equipment & tools used in entity’s production process.
* Objectives = increasing capital budget
Natural capital:
- Renewable and non-renewable environmental resources and processes.
- Objectives = increased recycling and reduced carbon footprint
Why use non-financial reporting?
- Non-financial reporting enables entities to be more transparent in communicating non-financial elements of their business to their stakeholders.
- Non-financial reporting can provide tremendous advantages for the entity’s reputation and positive stakeholder engagement
Global Reporting Initiative Standards Principles:
- Materiality
- Stakeholder inclusiveness
- Completeness
- Sustainability context
Sustainability reporting integrates:
- Environmental
- Social
- And economic performance data and measures (including the economic element of sustainability such as wages, taxes and core financial statistics)
Sustainability Reporting - The global reporting initiative
- Develop and disseminate globally applicable GRI standards on sustainability reporting for voluntary use by org’s.
Core values of a sustainable business:
- Economic viability
- Environmental responsibility
- Social accountability
Environmental reporting:
- Aim is the disclosure of an org’s corporate environmental responsibilities and effects of its activities on its environment.
- External reporting of social and environmental issues is now seen as a key part of orgs dialogue with its stakeholders
Aim of Social reporting:
- Aim is to measure and disclose the social impact of a businesses’ activities
Social measures can include:
- Philanthropic donations
- Employee satisfaction levels and remuneration issues
- Community support
- Stakeholder consultation info
