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2K views13 pagesChapter 2 Financial Management by Cabrera Compress
Uploaded by
Venus Charisse MabilingCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
CHAPTER
RELATIONSHIP OF FINANCIAL
OBJECTIVES TO
ORGANIZATIONAL STRATEGY
AND OBJECTIVES
Expected Learning Outcomes.
Alter studying Chapter 2, you should be able to:
1. Discuss the importance of objective setting in
a business enterprise.
2. Describe the primary financial objectives of a
business firm. ‘
3. Explain the responsibiliies of a Finance
Manager fo achieve the firm’s financial
objectives.
4. Understand the nature of environmental
(“green”) policies and their implications for
the management of the economy and firm.
ood CHAPTER 2
RELATIONSHIP OF
FINANCIAL OBJECTIVES TO
ORGANIZATIONAL STRATEGY AND
OTHER ORGANIZATIONAL OBJECTIVES
INTRODUCTION
‘Atone time or another, most people have had occasion to hire agents to take care
‘off specific matter In doing so, responsibilty is delegated to another person For
example, when suing for damages, individuals may represent themselves or may
hire a lawyer to plead their case in court. As an agent, the lawyer is given the
assignment io get the highest possible award. And s, itis with shareholders when
they delegate the task of running a fim toa financial manager who acts as an agent
of the company. Obviously, the goal isto achieve the highest value of an equity
share forthe firm's owners. But there are no standard rules that indicate which
course of action should-be followed by managers to achieve this. The ultimate
guideline is how investors perceive the actions of managers. A’ good way’ to
"metivate managers isto offer ther lucrative share options linked to performance.
inance permeates the entire business organization by providing guidance for the
firm's strategic (long-term) and day-to-day decisions. For long range planning and
Management control, a business firm establishes its overall objectives. Such
objectives are developed by the top management and they usually consist of
‘general statement or a series of statements in general terms stating what the
‘compariy expects io achieve.
‘Objective setting is thus, an important phase in the business enterprise since upon
comect cbjectives seiting will the entire structure of the strategies, policies and
plans of a company resi. Firms have numerous goals but not every goal can be
attained without causing conflict in reaching other goals. Conflicts often arise
bbocause of the firm's many constituents who include shareholders, managers,
‘employees, labor unions, customers, creditors, and suppliers. There are those who
claim thatthe firm's goal isto maximize sales or market share; others believe the
role of business isto provide quality products and service; still others feel that the di ihepe oee o
firm has a responsibly forthe welfare of solely at large. For example, he
objective may be stated in such broad tems as
‘+ tis the goal ofthe company tobe a leader in technology in the industry,
or '
+ Toachieve profits through a hih‘level manufactiring eTcieney, or
*# Toschieve high degree of customer saisection.
Fer the purpose though of measuring performance and degrée of control, itis
necessity to set objectives or goal in more preciseterms, The abjectves are usually
inquanitativeerms and ae set within atime frame. The setting of physica target
tobe accomplished within a set time period would provide the basis of conversion
of the targets into financial objectives,
‘STRATEGIC FINANCIAL MANAGEMENT
Strategic planning is long-range in scope and has its Focus onthe organization as
a whole. The concept is bused onan objective and comprehensive assessment of
the present situation ofthe organization and the setting up of targets to be schioved
in the context of an intelligent and knowledgeable anticipation of changes inthe
environment. The strategie financial planning. involves financial planning,
financial forecasting, provision of finance and formulation of finance polices
Which should lea the firm's survival and succes,
‘The responsibility of «finance manager isto provide a hasis and information for
strategic positioning of the firm in the industry. The firm's strategic financial
Planning should be able to meet the challenges and ‘competition, and it would lead
‘0 firm’s failure oF success,
The strategic Facil planing should enable the fem to judicious allocation of
funds, capitalization of relative ‘strengths, mitigation of weaknesses, early
identification of shifts in environment, counter possible actions of competitor,
reduction in financing coats, effective use of finds deployed, timely estimation of
‘funds requirement, identification of business and financial tisk, and so forth.
‘The strategic financial planning is likewise needed to counter the uncertait cand
imperfect market conditions and highly competitive business environment. While
framing fnaneal strategy, shareholders should be considered as one of te
Constituents of @ group of stakeholders, debenture holders, banks, financial
institutions, government, managers, employees, suppliers and customers. THE
strategie planing should concentrate’ on mulidmensinal objectives ike els Financial Objeives 19 Organizational Sete and.
profitability expansion growth, survival, leadership, business succes, positioning
Of the firm, reaching global markets and brand positioning. The financial policy
‘requires the deployient of firm's resources for achieving the corporate strategic
objestives. The financial policy should elign with the company’s strategic
planning It allows the firm in overcoming its weaknesses, enables the firm to
‘maximize the wilization of ts competencies and to direct the prospective business
‘opportunities and threats to its advantage. Therefore, the finance manager should
take the investment and finance decisions in consonance with the corporate
sirategy.
A company’s sirategic or business plan reflects how it plans to achieve its goals
‘and objectives. A plan's success depesds on an effective analysis of market
demand and supply. Specifically, a company must assess demand for its products
and services, and assess the supply of its inputs (both labor and capita). Te plan
include competitive analyses, opportunity assessments and consideration
Historical financial statements provide insight into the success of a company’s
strategic plen and arean important input ofthe planning process. These statements
highlight portions ofthe stategic plan that proved profitable and, thus, warrant
‘additional capital investment. They also reveal areas thet are less effective and
provide information ty help managers develop remedial ation.
‘Once strategic adjustments are planned and implemented, the resulting financial
‘statements provide input into the planning process fr the following year and this
rocess begins again. Understanding a company's strategic plan helps focus our
‘nalysis ofthe company’s short-term and long-term financial objectives by placing
them in proper context,
‘SHORT-TERM AND LONG-TERM FINANCIAL OBJECTIVES OF A
BUSINESS ORGANIZATION
Among are the primary financial objectives ofa firm ae the Following:
SHORT AND MEDIUM-TERM
‘* Maximization of rer on capital employed or reiurn on investment
= Growth in eamings per share and pricelearnings ratio. through
‘maximization of net income or profit and adoption of optimum level of
leverage mA
Minimization of fiance charges Chapter 2
© Efficient procurement and utilization of shortterm, medium-term, and
long-term funds
TLone-Term
= Growth in the market velue ofthe equity shares through maximization of
the firm's market share and sustained growth in dividend to shareholders
‘© Survival and sustained growth of the firm
‘There have been a number of different, well-developed viewpoints concerning
what the primary financial objectives of the business firm should be. The
‘competing viewpoints are:
‘©The owner's perspective which holds that the only appropriate goal is to
‘maximize shareholder or owner's wealth, and;
‘+ The stakeholders’ perspective which emphasizes social responsibility over
profitbilty (stakeholders include not only the owners and shereholders,
bout also include the business's customers, employees and local
commitments),
‘While strong arguments speak in favor of both perspectives, financial practt
and academics now tend to believe that the manager's primary responsibilty
should be to maximize shareholder’ wealth and give only secondary consieration
twother stakeholders’ welfare
‘Adam Smith, an 18% century economist was one of the first and well known
proponent ofthis viewpoint, He argued that, in capitalism, an individual pursuing,
hisown interest tends also to promote the good of his community. He also pointed
‘out that acting through competition and the free price system, only thove activities
‘most efficient and beneficial to society as a whole would survive in the long run.
‘Thus, those same activities would also profit the individual most, Owners of the
hire managers to work on their behalf, so the manager is morally, ethically.
land legally required to act inthe owners’ best interests. Any relationships between
the menager and other firm stakeholders are necessarily secondary tothe objective
that sharcholders give to their hired managers
The financial manager must have some goals or objestives to guide decision
involving the management of the firm's assets, liabilities and equity. Hence,
Priorities must be set to resolve conflicting goals. Relatonsip of Financ to Organizational Sraegy and... 19.
‘To reiterate, the primary financial goal ofthe firm i to maximize the wealth of
existing shareholders or overs. Therefore, the overriding premise of financial
‘management is that the Finn should be managed to enhance owner(s) well-being.
‘Sarebolder's weal depends on both the aividends paid end the market price of
the equity shares. Wealth is maximized by providing the sharcholders with the
{angetatanable combination of dividends per share and share prise appreciation
While his may at be pect meas of hele weal ti coir
‘The wealth maximization gol is advocated onthe following grounds:
‘+ considers the risk and time value of money
‘+ It consider all future cash flow, dividends and eamings per share
It suggests the regular and consistent: dividend. peyments 10 the
Shareholders
‘+The financial decisions are taken with a view to improve the capital
“appreciation ofthe share price
“Maximizaton of fr’s valve is flected in the marke price of share since
depends on sharcholer’s expectations reganting profitability, long-run
prospects, ming difference of retums, risk disibUton of resus of the
firm
(Cites of th wealth maximization objective however say that, this objective
narrow and ignores the concep of wealth maximization of society since society's
resources are used to the advantage only of a paticslar firm. The eptinal
Allocation ofthe society's resources should esat in capital formation and growth
‘ofthe economy which should ultimately lead tomaximizationaf economic welfare
ofthe society.
[RESPONSIBILITIES TO ACHIEVE THE FINANCIAL OBJECTIVES
Ivesring.
“The finance manager is responsible for determining how scarce resouress or funds
‘are committed to projects. The investing function deals with managing the firm's
‘asses, Because the firm has numerous alteraative uses of funds, the financial
‘manager strives to allocate fonds wisely within the frm, This ask requires both
the mix and type of assets to hold. The ater mix refers to the amount of pesos
invested in current and fixed asets chapter
“The investment decisions should aim at investments in assets only when they are
expected to eam a return greater than a minimum acceptable retum-wHich is also
called as hurdle rate. This minimum return should consider whether the money
ised from debt or equity meets the returns on investments made elsewhere on,
similar investments *
‘The following preas are examples of inv
‘4 Evaluation and selection of capital investment proposal
Determination of the total amount of funds that @ firm can commit for
westraent
©. Prioritization of investment alternatives
4d. Funds allecation and its rationing .
€ Determination of the levels of investments in working capital (ie
inventory, receivables, cash, marketable securities and its management)
£. Determination of fixed assets to be acquired
Asset replacement decisions
h
i
decisions of ¢ finance manager:
Purchase or lease decisions
Restructuring reorganization mergers and acqu
‘Securities analysis and portfolio management
FINANCING.
‘The finance manager is concerned with the ways in which the firm obtains and
‘manages the financing it needs to support its investments, The financing objective
asserts that the mix of debt and equity chosen to finance investments should
‘maximize the value of investments made. Financing decisions call for good
knowledge of costs of raising ands, procedures in hedging risk, different financial
instruments and obligation attached to them. In fund raising decisions, the finance
‘manager should keepin view how and where to raise the money, determination of|
the debt-equity mix, impact of interes, and inflation rates on the firm, and so forth.
‘The finance manager willbe involved inthe following finance decisions:
‘8. Determination ofthe financing pattern of short-ferm, medium-term and
long-term fands requirements
'b, Determination of the best capital structure or mixture of debt and equity
Financing Rel Financial Ojetvst Organizational Sratgy and. 14
«6. Procurement of funds trough the issuance of financial instruments such
1s equity shaves, preference shares, nds, longterm notes, and so ferh
4 Arrangement with bankers, suppliers, and creditors forts working capital,
‘medium-term and ther long-term funds requirement
Evaluation of alterative sources of finds
OreRATING
‘This third responsibilty area of the Finance manager concems working capital
‘management. The tem working capital refers to a fim short-term asset (Le,
inventory. receivobles, cash, and short-term invesimens) and. its shorterm
labiities (Le, accourds payable, shor-term loans). Managing te rmn's working
capital is-e day-to-day responsibilty tha enoures thatthe fem has sufficient
resowrees {0 continue its operations and avoid costly interuptions. This also
involves a numberof activities related to the fms receipts and disbursements of
cash
‘Some issues that may have tobe resolved in elation to managing a fiers working
capital are:
4. The level of cash, securities and inventory that shouldbe Kept on hand
b. The credit policy. should the firm sell on credit? If 50, what terms
should be extended?)
Source of short-term financing (ce. ifthe firm would borrow in the shor
‘erm, how and where should itbortow?)
4. Financing purchases of goods (ie, should the firm purchase its raw
‘materials or merchandise on cedit or should it borrow inthe short-term
fan pay cash?) z
ENVIRONMENTAL "GREEN" POLICIES AND THEIR IMPLICATIONS
FOR THE MANAGEMENT OF THE ECONOMY AND FIRM
Private propety rights cin promote prosperity nd cooperation and at the same
time prtet the enviroment, bt do ey pret he enronment sufient? In
recent years people have inresigly turned tothe government to achieve
‘ditional enrormetalinprovemens, Sometimes, peopl tune wo gonerrment
cause propery ight fled to hod posters assounable orth costs they were
imposing on others. In these “enter cost css", government may be abe to
improve acountabiity and prot rgts more eiceny by regulation In other no
tmees, people with ong, desires for various environmental amenities (for
a eee aces hiking tral nd wilderness lands) want the goveroment to
fore thers t help pay for hem
Courts help owners protect thei property against invasions by others, including
Saitten favor eases however itis dificult ~ if not impossible ~ to define,
bth and fully protect propery rights. This is particularly tue when there is
citer ange numberof polluter or large numberof people harmed by the
sariga ar both, In these lerge numbers of cases, high transaction costs
tusrine te effectiveness ofthe property rights ~ market exchange approach,
Forexample conser te air qualia large ety suchas Manila or Quezon City.
Millions ot people arc hermed when plltants ae put into the air. But millions of
opus contribstto te pollution asthey drive theircars. Proper ight alone
Siifbe unable to handle lrgesumber cose like this efficiently. More diect
Texolvons may generate a beter outome.
[Although government regulation is an alternative method of protecting the
fenvironment, the regulatory approach also has a number of deficiencies. First,
government regulation is often sought precisely because the harms are uncertain
land the source of the problem cannot be demonstrated, so relief from the courts
ficult obtain. But when the harms are uncertain, so ae the benefits of reducing
them Second, by is Very nature, regulation overrides or ignores the information
and incentives provided by market signals. Accountability of regulators forthe
Costs they impose is lacking, just as accountability for polluters is missing inthe
‘market sector when secure and tradable property rights are notin place. The tunnel
Vision of regulators, each assigned to oversee a small part of the economy, is not
propery constrained by readily observable cess. Third, regulation allows special
Interests to use political power to achieve objectives that may be quite different
from the environmental goals orginally announced. The global warming ise
illustrates all ofthese problems and the uncerairies that they generate.
Decal eso povrarint fet tat hey nnn etn maken an
Gay wo sakg pt wit ayy tre seep hun oe, Goma
ta pass pees Won eps a cei eee Same
prockctn grate an ete aie be cee ee
Governed ican nectar ca ae aaa oe
cei dean win via fom to pagar hoe ease ove
pect nian eflency whee vet san ene
vcrmental ais sel or Rae oer ae oat we Reialnship of Fharcal Obecine to Organisational Sraegy and ..__23
‘When i is dificult to assign and enforce private property rights, markets often
result in outcomes that ae inefficient. This soften the case when large numbers
_of people engage in actions that impose harm on others. Government regulation
has some premise but also poses some problems ofits own.
‘Gobel warming could exerts sizable advere impact on human welfre, but there
is considerable uncertainty about bth its use and the potential ais that might
be derived from regulations such as those f the Kyoto treaty. Global temperature
changes have ben seve prevcusly. We donot ow ta the eure warning
{sth ret of human activity. We do not even know whether on balare,
Mraming would exe an adverse impact. These unceainies increase the
‘rtvnea of edataton aan opon to regulation.
Market-lke schemes ean reduce the costs of reaching a chosen environment goal,
butthe programs provide litle help in choosing the right geal.
Government ownership of rational parks, as with other lands, has brought
troublesome rruts along with bereits, but tere scems tobe progress in moving,
closer to market solutions that provide beter information and incentives for
‘government managers.
Given that stock market lavestor emphasize flaancial results and the
maximization of sharholder value, one can wonder if it makes sense for a
company 1 be socially responsible. Can companies be socially responsible and
‘oriented toward sharcholder wealth atthe same time? Many businessmen think so
land so do most big business establishments that they have adopted welblaid
‘environmental-saving srategies that can observe such as recycling program,
pollution control, tee planting activities and s forth. The benefits come alle at
11d up. If an investor wants wealth
‘maximization, management that minimizes wastes might do th other litle
ight that make a company well-run and proftable 24 Cher 2
REVIEW QUESTIONS
Questions
1. Suppose you were the financial manager of a not-for-profit busines
sotfoxpiofit hospital). What kinds of goals do you think would (2
‘orroprate?
2. What kinds of conflicts confront the financial managers es an agent of
the firm? How ean a firm attract the best managers?
3. Does knowledge of financial theory and statistical approaches give a
‘manager all the answers in solving financial problems? Explain,
4. Evaluate the following statement: Managers should not focus on the
current stock value because doing so will lead to an overerphasis on
short-term profits atthe expense of long-term profits.
5. If & company’s board of directors wants management to maximize
sharcholders’ wealth, should the CEO's compensation be set as a fixed
amount, or should the compénsation depend on how well the firm
performs? Ifitis tobe based on performance, how should performance be
‘measured? Would it be easier to measure performance by the growth rate
in reported profits or the growth rate in the stock's intrinsic value? Which
‘would be the better performance measure? Why?
6. Should stockholder wealth maximization be thought of as a long-term or
short-term goal? For example, if one action increases a firm’s stock price
from a current level of 1,000 to 2,000 in 6 months and then to P3,000
in 5 years but another action keeps the stock at P1000 for several years but
then increases it toP4,000 in 5 years, which action would be berter? Think
‘of some specific corporate actions that have these general tendencies.
7. What are some actions that stockholders ‘can take to ensure that
‘management's and stockholders’ interests are aligned? Reltorhpof Finacial Objectives to Organzatonol Siratey and. 25
4 The president of Southern Tag Corporation (STC) made tis statement
inthe compary’s antl report: "ST's primary gal i o increase the
‘ale of our commen sockhlder's equity” Later inthe report, the
folowing announcements were made:
4 The company contributed P15 milion othe symphony orchestra.
The company is spending 50D million to open a new plant and
expand operations. No profits wil be produced by the operation for 4
‘years, so earnings wil be depressed during this period versus what
‘hey would have been had the decision been made not to expan.
& Thecompany holds abou half ofits assets in the frm of government
treasury bonds, and it keeps these funds available for ase in
tmergencies. In the fare, though, STC plans to shift its emergency
funds from treasury bonds to common stocks.
jcuss how STC's sckholders might view each ofthese actons and
the atone might aet the stock pice,
9. Miguel Enterprises recently made a lage investment to upgrade its
technology. While these improvements won't have much effect on
performance in the short run they are expected o reduce Future costs
‘Spnfianly. What effect wllthis investment have on Min Enterprises?
teaming pe share this year? What effet might this investment have en
the company’s inisic value and stock pice?
Mutipte Choice Questions
1. Which fhe lowing stemert ire?
2 Thehiger he prof os fm, te ihe the valu of ems
tured fein i eae
4 Stil epontiiy and ptt mexiiaion ar synonymous
& “Maxinaing the caming® ofthe frm te ray pal of
ean meager
4. "Tha ae soe sous problems with the Fac! goal of
maximizing the earnings of the firm. = 26 Chapter 2
‘orporate social responsibility is
2 Somtectvely enforced trough the controls envisioned by casi
the obligation to shareholders to earn a profit.
€. the duty toembrace service to the public interest
4. the obligation to serve long-term organizational interes
3. A common argument. agsinst corporate involvement in socaly
responsible behavior is that
4. Itencourages government intrusion in decision making,
b. asa legal person, a corporation is accountable for its conduct.
©. Ttereates goodwill.
4. in a competitive market, such behavior incurs costs that place
the company at a disadvantage.
4. Which ofthe following statements is false?
Because socially desirable goals can impede profitability in
‘many instances, managers should not try to operate under the
‘assumption of wealth maximization,
b. As finance emerged as a new field, much emphasis was placed
con mergers and acquisitions
© Timing is a particularly important consideration in financial
decisions
4. During the 1930s, the government assumed a much greater role
{in regulating the securities industry
5. Which of the following statements is false?
& In the mid 1950s, finance began to change to a more analytical,
