A listed company says its aim is to make its owners richer. A charity says it exists to help people. A local government says it serves residents. Each one has a purpose, and each one must turn that purpose into targets, plans and money. Strategic financial management is the work of doing that.
It sits between the big strategy of the organisation and the day-to-day finance, and it decides how much money to raise, where to put it, and how much to pay out.
This is the first topic in Strategic Financial Management (SFM). It covers the meaning of strategy and financial strategy, corporate objectives, the case for and against shareholder wealth maximisation, how to measure objectives, non-financial objectives, the three decisions of the financial manager and the role of the Chief Financial Officer (CFO). The next topic covers the treasury function.
The past papers test this topic often, usually as part of a scenario.
In 30 seconds
Strategy is the long-term direction and scope of an organisation. Financial strategy is the part of it that deals with money. For a company the primary objective is usually to maximise the wealth of its shareholders, measured as the market value of the company. But it must be pursued within the limits set by other stakeholders.
Because wealth is hard to turn into targets, companies use profit growth, growth in earnings per share (EPS), return on capital employed (ROCE) and total shareholder return (TSR), and none is perfect alone. Non-financial objectives (employees, customers, society) limit the financial ones. The financial manager advises on three decisions: investment, financing and dividends. Non-profit bodies have a non-financial primary objective with a financial constraint.
Key terms in plain English
| Term | What it means |
|---|---|
| Strategy | The long-term direction and scope of an organisation, and the use of resources to reach its goals |
| Financial strategy | The part of corporate strategy that covers money: how much to raise, where to invest and what to pay out |
| Primary corporate objective | The main aim of the organisation, which other targets support |
| Shareholder wealth | The dividends shareholders receive plus the rise in the share price |
| Return on capital employed (ROCE) | Profit before interest and tax divided by capital employed |
| Earnings per share (EPS) | Profit after tax and preference dividends divided by the number of ordinary shares |
| Total shareholder return (TSR) | The rise in share price plus dividends, as a percentage of the opening price |
| Stakeholder | Anyone with an interest in what the organisation does |
Syllabus check
This topic is in syllabus area A, which carries 10% of the marks. It covers:
- A1: the role of the senior finance executive, including the CFO as strategic partner and the idea of a chief value officer (CVO);
- A2: financial strategy, including performance appraisal using ratios and trends and the link to distribution policy.
CAMA 2020 and this topic
The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria.
| Section | What it says | Link to this topic |
|---|---|---|
| s. 305 | A director is in a fiduciary relationship with the company and must act with utmost good faith, in the best interests of the company, and have regard to employees as well as members | Wealth maximisation must be pursued within directors’ duties |
| s. 308 | A director must use the care, diligence and skill of a reasonably prudent director | Financial strategy advice must meet this standard |
| s. 377(1) and s. 378 | Directors prepare statements that follow IFRS and give a true and fair view | The ratios used to measure objectives come from these statements |
| s. 404(7) | The audit committee reviews policies and internal control | It can review how performance targets are set and measured |
Strategy and financial management
There is no single definition of strategy. Chandler stressed long-term goals and the resources needed to reach them. Drucker spoke of a pattern of activities that adapts the organisation to a changing environment. Johnson, Scholes and Whittington defined it as the direction and scope of an organisation over the long term, which gains advantage in a changing environment through its resources and skills, to meet stakeholder expectations.
All three say the same thing: a strategy is a set of organised activities with a purpose, over the long term, in a changing environment.
Financial management is planning and controlling the financial affairs of an organisation so it reaches its objectives. It covers how much finance is needed, where it should come from (debt or equity, long or short term), how to handle cash surpluses and deficits, how much to pay out as dividends, and how to protect against financial risk.
Strategic financial management is the same on a bigger scale and a longer time frame, covering objectives, resources, analysis of data and major financial decisions. Financial strategy is part of corporate strategy, and business plans always contain financial plans.
Corporate objectives
Every organisation has a purpose and should have a primary objective within it. For a company it is to maximise the wealth of its owners. For a state body it may be a standard of public service. For a charity it is its charitable purpose. When the main objective is not financial there is still a financial constraint, such as giving the best service with the money available.
The process runs in five steps: identify the corporate objective (usually financial); set targets for it; develop strategies to reach the targets; turn strategies into action plans; and monitor performance.
Shareholder wealth maximisation
Shareholder wealth rises with dividends and a higher share price, so it is taken as the market value of the company. Surveys show that most chief executives see raising market value as their main duty, and most financial models test a decision by its effect on value. The objective also has limits, because it benefits one group.
A company cannot pursue it by acts that another stakeholder prohibits, for example money laundering.
The practical problems are:
- which time period to use
- how to split a target between dividends and share price
- that share prices move with market mood and not only with the performance of the company
It is accepted as a basis for planning but is hard to turn into targets, so other financial objectives are used as stand-ins.
Profit and earnings per share
Profit maximisation is simple and easy to understand. Its problem is the time period. Short-term profit can be raised by harming the long term, for example by not replacing old equipment or by turning down projects that lose money at first. Managers lean to the short term because bonuses depend on annual targets and many do not expect to stay long.
Profit can also rise just because more capital is raised, while profit per share falls.
Growth in EPS fixes the last point. EPS growth should lead to more dividends or more retained profit to reinvest. But EPS can be raised by borrowing, because interest is tax-deductible. Higher gearing adds financial risk, so the share price can fall even when EPS rises.
| Stated objective | Link to wealth maximisation |
|---|---|
| Maximise profits | Allows bigger dividends and use of good investment opportunities, which should raise market value |
| Raise EPS every year | Gives a positive market view and more demand for the shares, which raises market value |
Measuring objectives
Objectives are tested with ratios, compared over time, with similar companies and with industry averages.
- ROCE = profit before interest and tax ÷ capital employed (share capital and reserves plus long-term debt and preference shares). Use the average of opening and closing capital where possible. It is a before-tax measure.
- Return on shareholder capital (ROSC) = profit after tax and preference dividend ÷ shareholders’ capital. It is an after-tax measure and so is not comparable with ROCE.
- EPS = profit attributable to ordinary shareholders ÷ weighted average number of shares. Dividend per share matters to investors who want income.
- TSR = (closing price − opening price + dividends) ÷ opening price.
Non-financial objectives
Companies also have non-financial objectives that limit the financial ones:
- the welfare of employees
- the welfare of management (high pay and perks reduce profit)
- a service to the public
- duties to customers (quality, honest dealing, after-sales care)
- duties to suppliers (fair terms and prompt payment)
- the welfare of society (reducing pollution, local sponsorship)
Others are growth, diversification and leadership in research.
These do not cancel the financial objective, but they show that the simple theory is too simple, and sometimes the financial objective has to give way.
The financial manager and the CFO
Much of the work of the senior financial manager is advice. The three fundamental decisions are:
- Investment: which investments to take with the capital available.
- Financing: how to raise finance at the lowest cost of capital.
- Dividend: how much profit to distribute and how much to keep for reinvestment.
Further duties are communicating financial policy to internal and external stakeholders, financial planning and control, and managing risk. The syllabus also asks about the CFO as a strategic partner to the chief executive (financial leadership, performance, risk, cost, technology, stakeholder relations and compliance) and the change from CFO to chief value officer. The syllabus does not define the second term.
Research by BDO and the Association of Chartered Certified Accountants (ACCA) in 2023 describes it as the CFO’s role widening from financial stewardship to creating value for several stakeholders, where value can be financial, environmental, social and ethical. The title is still debated and many CFOs already do the work. In an answer, describe a CFO whose main job is to create and show value, not only to report results.
The rules in more depth
Why wealth is measured by market value
Market value is the price at which the owners could sell, and it reflects the expected future cash flows and their risk. That is why investment appraisal later in this course tests projects by their effect on value.
Why a single measure is not enough
Each measure has a blind spot. Profit ignores risk and time. EPS ignores gearing. ROCE, an accounting measure, depends on accounting policies and ignores the cost of capital. TSR depends on the share market. A good answer uses several measures and compares them with the cost of capital.
Why a return below the cost of equity destroys value
Shareholders need a return that pays for the risk they take. If the TSR is below the cost of equity, the company did not earn enough for them, even if the figure looks healthy.
Effect on analysis
When you appraise a company in the exam, state its stated objective first, then test each target with a calculation, then say which targets were met and what that means for shareholders.
Worked examples
Example 1: ratios. A company had profit before tax of ₦210,000 after interest of ₦30,000, and tax of ₦65,000. It has 200,000 shares of ₦1. Capital employed was ₦1,000,000 at the start and ₦1,400,000 at the end. Shareholders’ capital was ₦800,000 at the start and ₦900,000 at the end. The share price was ₦840 at the start and ₦900 at the end, and dividends were ₦45 a share.
- Profit before interest and tax.
210,000 + 30,000 = ₦240,000.
Average capital employed = (1,000,000 + 1,400,000) ÷ 2 = ₦1,200,000.
ROCE = 240,000 ÷ 1,200,000 = 20.0%. - Profit after tax.
210,000 − 65,000 = ₦145,000.
Average shareholders’ capital = (800,000 + 900,000) ÷ 2 = ₦850,000.
ROSC = 145,000 ÷ 850,000 = 17.06%. - EPS = 145,000 ÷ 200,000 = ₦0.725 (72.5 kobo).
- TSR = (900 − 840 + 45) ÷ 840 = 105 ÷ 840 = 12.5%.
Example 2: testing stated objectives. TAXIM Plc has 12 million shares and no debt. It aims for growth in profit before interest and tax (PBIT) of 4% a year, growth in EPS of 3.5% a year and TSR of 5% a year. Its cost of equity is 12%. PBIT was ₦17.1m, ₦17.7m and ₦18.3m in 2019 to 2021.
Profit after tax was ₦12.0m, ₦12.4m and ₦12.8m. Dividends were ₦4.8m, ₦5.1m and ₦5.1m. Equity market value was ₦54.0m, ₦55.2m and ₦56.4m.
- PBIT growth:
2020: 17.7 ÷ 17.1 − 1 = 3.5%.
2021: 18.3 ÷ 17.7 − 1 = 3.4%.
The 4% target is not met. - EPS: ₦1.000, ₦1.033 and ₦1.067. Growth is 3.3% in 2020 and 3.2% in 2021. The 3.5% target is not met.
- TSR:
2020: (55.2 − 54.0 + 5.1) ÷ 54.0 = 11.7%.
2021: (56.4 − 55.2 + 5.1) ÷ 55.2 = 11.4%.
The 5% target is met. - But the TSR is below the 12% cost of equity, so shareholders earned less than they required. The company met its stated target and still did not create value.
Example 3: a share option. A chief executive is given 500,000 options to buy shares at ₦7, the market price on the award date, exercisable after three years. Three years later the share price is ₦10.
- Gain per share.
10 − 7 = ₦3. - Total gain.
500,000 × ₦3 = ₦1,500,000. - The executive gains only if the share price rises, which lines up their interest with the shareholders’.
How to score full marks
- State the primary objective of the organisation first, and its constraint.
- Apply the theory to the facts. A private company has no quoted price, so wealth is hard to value. A local government has no shareholders.
- Test each target with a calculation and say met or not met.
- Compare returns with the cost of equity.
- Weigh stakeholders and say which group has most power.
- Finish with a recommendation, such as a balanced set of objectives.
Common mistakes in the exam
- Writing about shareholder wealth for a local government or charity.
- Giving a generic list of objectives with no link to the scenario.
- Using book values and not market values.
- Ignoring the time period when judging profit objectives.
- Praising EPS growth without checking gearing.
- Calling a company successful because it met its own target, without checking the cost of equity.
Quick revision
- Strategy is long term. Financial strategy is part of corporate strategy.
- Primary objective of a company: maximise shareholder wealth (market value), within stakeholder limits.
- Stand-ins: profit, EPS growth, ROCE, TSR. None is perfect alone.
- Non-financial objectives limit financial ones.
- Three decisions: investment, financing, dividend.
- CAMA 2020: ss. 305, 308, 377(1), 378, 404(7).
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. The primary objective of a company is usually to:
- Maximise sales
- Maximise shareholder wealth
- Minimise tax
- Maximise staff numbers
Show the answer
B. Measured as the market value of the company.
Question 2. A main problem with profit maximisation as an objective is:
- It is hard to understand
- The time period
- It ignores sales
- It is illegal
Show the answer
B. Short-term profit can harm the long term.
Question 3. EPS can rise while the share price falls because of:
- Higher gearing and risk
- Lower sales
- Lower tax
- More dividends
Show the answer
A. Borrowing raises EPS but adds risk.
Question 4. ROCE uses profit:
- After tax
- Before interest and tax
- After dividends
- Before depreciation
Show the answer
B. It is a before-tax measure.
Question 5. TSR is:
- Dividends divided by profit
- Price rise plus dividends over opening price
- Profit over assets
- Sales growth
Show the answer
B. It is the total return to shareholders.
Question 6. The three decisions of the financial manager are:
- Buying, selling, holding
- Investment, financing, dividend
- Audit, tax, payroll
- Plan, do, check
Show the answer
B. Advice on these is a main duty.
Question 7. A non-profit body usually has:
- No objective
- A non-financial objective with a financial constraint
- A profit target only
- No stakeholders
Show the answer
B. For example the best service with the funds available.
Question 8. A TSR below the cost of equity means:
- Value was created
- Shareholders earned less than they required
- Nothing
- Dividends were too high
Show the answer
B. The return did not pay for the risk.
Question 9. Long-term incentives for executives are usually:
- Cash only
- Share awards or options
- Salary rises
- Loans
Show the answer
B. They link pay to the share price.
Question 10. Which section of CAMA 2020 requires the statements to follow IFRS?
- Section 378
- Section 400
- Section 405
- Section 409
Show the answer
A. The ratios come from those statements.
Written questions
Question 11 (10 marks). (a) Explain why the primary objective of a company is shareholder wealth maximisation, and the problems of using it as a target. (5 marks) (b) State the three decisions on which a financial manager advises, and explain the role of the CFO as a strategic partner. (5 marks)
Question 12 (20 marks). Delta Plc has 20 million shares and no debt. Its objectives are growth in profit before interest and tax of 5% a year, growth in EPS of 4% a year and a total shareholder return of 8% a year. Its cost of equity is 11%. Data (₦m): 2022: PBIT 44.0, profit after tax 30.0, dividends 12.0, equity market value 300. 2023: PBIT 46.1, profit after tax 31.2, dividends 12.5, equity market value 312.
2024: PBIT 48.2, profit after tax 32.2, dividends 13.0, equity market value 322. (a) Analyse the extent to which Delta met each objective in 2023 and 2024. (12 marks) (b) Comment on whether shareholders gained. (3 marks) (c) Explain why profit and EPS objectives can conflict with each other. (5 marks)
Question 13 (10 marks). The board of Eko Plc will give its managing director 400,000 share options at ₦5, exercisable after three years. (a) Describe the usual parts of an executive pay package. (4 marks) (b) Calculate the gain if the share price is ₦8.50 at exercise. (2 marks) (c) Discuss two limits of share options in aligning managers with shareholders. (4 marks)
Model answers
Show the model answer to Question 11
(a) Objective (5 marks). The owners provide the risk capital, so the main aim is to maximise their wealth, taken as the market value of the company. (2) Wealth rises with dividends and the share price. (1) Problems: the time period; splitting the target between dividends and price; and share prices move with market mood. (2)
(b) Decisions and the CFO (5 marks). Investment, financing and dividend decisions. (2) The CFO advises the board and the chief executive on strategy, performance, risk, cost, technology and compliance, as a partner and not only a reporter of results. (3)
Show the model answer to Question 12
(a) Objectives (12 marks).
- PBIT growth: 2023: 46.1 ÷ 44.0 − 1 = 4.8%
- 2024: 48.2 ÷ 46.1 − 1 = 4.6%.
- The 5% target is not met in either year. (3)
- EPS: ₦1.50, ₦1.56 and ₦1.61.
- Growth is 4.0% in 2023 (met) and 3.2% in 2024 (not met). (4.5)
- TSR: 2023: (312 − 300 + 12.5) ÷ 300 = 8.2% (met).
- 2024: (322 − 312 + 13.0) ÷ 312 = 7.4% (not met, against 8%). (4.5)
(b) Shareholders (3 marks). The TSR of 8.2% and 7.4% is below the 11% cost of equity, so shareholders earned less than they required in both years, even though the 2023 targets were met. (3)
(c) Conflict (5 marks). Profit can rise by raising and investing more capital while profit per share falls. (1.5) EPS can be raised by borrowing, with tax relief on interest. (1.5) Higher gearing adds risk and may reduce the share price. (1) Managers may cut long-term spending to lift short-term figures. (1)
Show the model answer to Question 13
(a) Package (4 marks). A basic salary with pension. (1.5) Annual performance incentives, usually cash bonuses linked to profit, EPS or TSR targets. (1.5) Long-term incentives, usually share awards or options over about three years. (1)
(b) Gain (2 marks). (8.50 − 5.00) × 400,000 = ₦1,400,000. (2)
(c) Limits (4 marks). The share price depends on the market as well as on management, so managers may be rewarded for market rises or punished for falls they did not cause. (2) Options can encourage short-term focus or risk taking to lift the price before exercise, and they give no downside risk to the holder. (2)
Pathfinder on Corporate objectives and financial strategy
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
A chairman proposes to raise EPS by paying creditors late, postponing capital spending and freezing pay. You report on the effect on the share price and stakeholders, then give four ways to encourage managers to meet stakeholder aims. See the rules on objectives and the worked examples.
Revise first: Corporate objectives
Q5 gives three years of figures and asks how far three objectives were met, then four ways to encourage managers. Q6 asks for the validity of a company statement on dividends, shareholders, overseas costs and tax havens. Worked example 2 shows the layout.
Revise first: Worked examples
Source: ICAN Pathfinder, Strategic Financial Management. Diets covered: November Diet, 2022 (Q7); May Diet, 2023 (Q5 and Q6); an earlier Pathfinder diet (private and public sector objectives).
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