ACCA Applied Skills · Financial Management

Financial objectives and relationship with corporate strategy: formula sheet

Full chapter guide

Key formulas

The three key decisions: Investment decision + Financing decision + Dividend decision; Learn the three names and a one-line meaning of each. They are interlinked, not separate.
Primary financial objective of a company: Maximise shareholder wealth = dividends received + increase in share price; Shareholder return over a period is dividends plus capital gain, usually measured against the opening share price.
Total shareholder return (TSR): TSR = (P₁ − P₀ + D₁) ÷ P₀; P₀ is the opening share price, P₁ the closing price, D₁ the dividend for the period.
Link between decisions and value: Value is created when project return > cost of capital; A project adds wealth only if it earns more than the return investors require for its risk.
Total shareholder return (TSR): TSR = (P₁ − P₀ + D₁) ÷ P₀; P₀ is the opening share price, P₁ the closing price, D₁ the dividend in the period. The result is a percentage for the period.
Capital gain (as a percentage): Capital gain % = (P₁ − P₀) ÷ P₀; Add the dividend yield (D₁ ÷ P₀) to get TSR.
Dividend yield: Dividend yield = D₁ ÷ P₀; Use the price at the start of the period for TSR.
Shareholder wealth over several years: Wealth = Σ dividends received + change in share price; A discounted view values the share as the present value of future dividends at the cost of equity.
Earnings per share: EPS = profit after tax and preference dividends ÷ number of ordinary shares; A common financial objective target, but it can be manipulated and ignores risk.
Agency relationship: Principal (shareholders) → appoints → Agent (managers); The agent should act in the principal's interest. Conflict arises when the agent's own goals differ.
Goal congruence: Manager's goals = shareholders' goals (wealth maximisation); Achieved by monitoring and by incentives. Never fully achieved.
Agency costs: Agency costs = monitoring costs + incentive costs + residual loss; Residual loss is the value still lost because managers' decisions are not perfectly aligned.
Share option value to manager: Gain per option = market price at exercise − exercise price (if positive); The option is worthless if the market price is at or below the exercise price on exercise.
ROCE: ROCE = PBIT ÷ capital employed × 100%; Capital employed = total assets − current liabilities = equity + non-current liabilities. PBIT is profit before interest and tax. State your definition if the question does not give one.
Operating profit margin: Operating margin = PBIT ÷ revenue × 100%; Gross margin uses gross profit ÷ revenue in the same way.
Asset turnover: Asset turnover = revenue ÷ capital employed; Answer in times. Use the same capital employed as in ROCE.
ROCE breakdown: ROCE = operating margin × asset turnover; Use it to explain why ROCE moved.
Earnings per share: EPS = (profit after tax − preference dividends) ÷ weighted average number of ordinary shares; Earnings must be attributable to ordinary shareholders. EPS growth = (this year's EPS ÷ last year's EPS) − 1.
Dividend cover: Dividend cover = earnings attributable to ordinary shareholders ÷ ordinary dividends = EPS ÷ DPS; Answer in times. A higher figure means more profit is kept in the business.
Gearing: Gearing = debt ÷ equity, or debt ÷ (debt + equity); Both definitions are used. Choose one, state it and use it for every year. Follow any definition given in the question.
Interest cover: Interest cover = PBIT ÷ finance costs; Answer in times. A low figure means profit gives little protection against interest costs.
Economy: Economy = spending the minimum on inputs of appropriate quality; Looks at input cost only. Example measure: cost per unit of supplies bought compared with a benchmark.
Efficiency: Efficiency = outputs ÷ inputs (or output per unit of resource); Example: patients treated per nurse hour, or cost per case handled. Compare with past periods or similar bodies.
Effectiveness: Effectiveness = actual outcome achieved compared with the objective set; Example: percentage of students passing, or reduction in waiting time against target. Needs a defined objective.
Value for money: VFM = economy + efficiency + effectiveness; A conceptual sum, not a calculation. Good VFM needs all three together.
Earnings per share (EPS): EPS = Profit after tax and preference dividends ÷ Number of ordinary shares; Common target for growth. It can be manipulated by accounting choices or by buying back shares, so it is not the same as wealth creation.
Return on capital employed (ROCE): ROCE = Profit before interest and tax ÷ (Total assets − Current liabilities) × 100%; Compare with the target return and the cost of capital. Use the definition given in the question.
Gearing (debt to equity): Gearing = Debt ÷ Equity (or Debt ÷ (Debt + Equity)); State which definition you use. Lenders often set a maximum level as a covenant.
Interest cover: Interest cover = Profit before interest and tax ÷ Interest expense; Shows how safely the company can pay interest. A target minimum acts as a constraint on borrowing.
Total shareholder return: TSR = (Closing share price − Opening share price + Dividends) ÷ Opening share price; Measures what the shareholder actually gains, linking strategy to wealth.

Quick revision

The three key finance decisions are investment, financing and dividend.
The primary objective of a listed company is to maximise shareholder wealth.
Shareholder wealth increases through dividends and share price growth, which together make total shareholder return.
Profit maximisation is not the same as wealth maximisation, as it ignores risk, timing and cash flow.
Other objectives include survival, growth, market share and social responsibility, and they can conflict with each other.
The agency problem arises when managers pursue their own interests rather than those of shareholders.
Remedies include performance-linked pay, share options, monitoring, and good corporate governance.
Return on capital employed = operating profit ÷ capital employed.
Interest cover = operating profit ÷ finance costs, and gearing shows the financial risk from debt.
Value for money means economy, efficiency and effectiveness.
Not-for-profit organisations have objectives such as service quality and cost control, not profit.
Financial objectives should support the corporate strategy and be measurable.

Common mistakes

Saying the objective is to maximise profit. Fix: State shareholder wealth maximisation. Explain that profit ignores risk, timing of cash flows and retained funds.
Mixing up the investment and financing decisions. Fix: Ask: is the money being spent (investment) or raised (financing)? Label each part separately.
Dividing by the closing share price instead of the opening price. Fix: The return is earned on the amount invested at the start. Always divide by P₀.
Leaving out the dividend and using only the capital gain. Fix: TSR always has two parts: capital gain and dividend. Check the question for dividends.
Treating shareholders and stakeholders as the same thing. Fix: Remember shareholders are one subset of stakeholders. Name the other groups separately and state their different aims.
Listing stakeholders without stating their objectives or conflicts. Fix: For every group, write what it wants and link it to a fact in the scenario.
Treating managers and shareholders as having the same goals. Fix: Always state the manager's own goal first, then show why it conflicts.
Listing remedies without linking them to the scenario. Fix: Match each remedy to a symptom in the question and explain how it changes behaviour.
Using profit after interest or after tax in ROCE. Fix: ROCE uses PBIT, because capital employed includes debt and debt providers are paid from this profit.
Forgetting to deduct preference dividends in EPS. Fix: Deduct preference dividends first. Then divide by the weighted average number of ordinary shares.

Exam tips

Always name the decision before explaining it. Markers look for the exact terms: investment, financing and dividend.
In written answers, use facts from the scenario. Generic lists score poorly.
Check the organisation type. A charity or public body needs value for money, not shareholder wealth.
Objective test questions on this topic often test a definition or classification. Read all four options before choosing, as marking is all or nothing.
Add one linking sentence between decisions. It is a cheap way to show higher-level understanding.
In OT questions, always check whether the dividend is given. If so, TSR needs it.
Remember the denominator is the opening price. Examiners often build a wrong option on closing price.
In written answers, use the words timing, risk and cash. They are the core of the profit versus wealth argument.