CIMA F3 Syllabus A. Financial policy decisions - Purpose of Financial Management - Notes ^{1 / 12}

Financial objectives

Profit maximisation is often assumed, incorrectly, to be the main objective of a business.

Reasons why profit is not a sufficient objective:

1. Investors care about the future

2. Investors care about the dividend

3. Investors care about financing plans

4. Investors care about risk management

For a profit-making company, a better objective is the maximisation of shareholder wealth;

this can be measured as total shareholder return (the dividend per share plus capital gain divided by initial share price)

Key decisions:

1. Investment 

   (in projects or takeovers or working capital) need to be analysed to ensure that they are beneficial to the investor.

   Investments can help a firm maintain strong future cash flows by the achievement of key corporate objectives 

   e.g. market share, quality.

2. Finance

   mainly focus on how much debt a firm is planning to use.

   The level of gearing that is appropriate for a business depends on a number of practical issues:

   Life cycle - A new, growing business will find it difficult to forecast cash flows with any certainty so high levels of gearing are unwise.

   Operating gearing- If fixed costs are a high proportion of total costs then cash flows will be volatile; so high gearing is not sensible.

   Stability of revenue- If operating in a highly dynamic business environment then high gearing is not sensible.

   Security- If unable to offer security then debt will be difficult and expensive to obtain.

3. Dividends

   how returns should be given to shareholders

4. Risk management

   mainly involve management of exchange rate and interest rate risk and project management issues.

Key Objectives of Financial Management

Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:

• Create wealth for the business

• Generate cash, and

• Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested