Question

Different types of businesses can have different business objectives. For each of the following objectives, give an example of a business that might have that objective, and explain your answer. (3 marks each; 9 marks total)

Objective 1: Maximisation of sales revenue

Objective 2: Maximisation of profit

Objective 3: Maximisation of return on capital employed

Answer 1

I)

Revenue maximisation

Revenue maximisation is a theoretical objective of a firm which attempts to sell at a price which achieves the greatest sales revenue. This would occur at the point where the extra revenue from selling the last marginal unit (i.e. the marginal revenue, MR, equals zero). If marginal revenue is positive, an extra unit sold must add to total revenue and revenue maximisation will not have been reached. Only when marginal revenue is zero will total revenue have been maximised.

Sales maximisation

Firms often seek to increase their market share – even if it means less profit. This could occur for various reasons:

• Increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run.
• Managers prefer to work for bigger companies as it leads to greater prestige and higher salaries.
• Increasing market share may force rivals out of business. E.g. the growth of supermarkets have lead to the demise of many local shops. Some firms may actually engage in predatory pricing which involves making a loss to force a rival out of business.

2) Maximisation of profit

The objective of Profit maximisation is to reduce risk and uncertainty factors in business decisions and operations. It acts like a benchmark of operational efficiency, survival and well being of the business organisations as it reflects the business decisions and policies.

1. Profitability of the firm is an important indicator of its financial stability as well as economic well being.
2. It leads to proper and efficient channelisation and utilisation of surplus funds for productive business operations and other economic activities.
3. Increased profits promote socio-economic welfare of various stakeholders associated with the firm. It helps shareholders wealth maximisation increased incentives and benefits to employees, better improved products to customers and employment generation.
4. Retained profit act as major source of long term finance for the company. It can be utilised for fixed asset acquisition expansion and modernisation of firms obviating the need for outside funds.
5. PM helps the firms to sustain in the competitive market, with increased profits the firm can sustain growth and development amongst severe completion through product development, market development, and gaining market share.
6. Strengthens foundation of sound decision making and hence solves issues in the organisation through optimum utilisation of funds for business expansion as well as increased returns to share holders.
7. When company earns more profit the entry of new shareholders is not required which leads to full control of the company with existing shareholders.

3) Maximisation of return on capital employed

Because it is a measurement of profitability, a company can improve its ROCE through the same processes that it undertakes to improve its overall profitability. The most obvious place to start is by reducing costs or increasing sales. Monitoring areas that may be racking up excessive or inefficient costs is an important part of operational efficiency.

Another action that can improve the ROCE ratio is selling off unprofitable or unnecessary assets. For example, a company would do well to sell a piece of machinery that has outlived its useful life. Selling the outdated machinery would lower the company’s total asset base and thus improve the company’s ROCE since removing unused or unnecessary assets allows for less capital to be employed to facilitate the same amount of production.

Paying off debt, thereby reducing liabilities, can also improve the ROCE ratio. Another step a company can take in the area of financing is to restructure existing debt, refinancing at lower interest rates or with more attractive repayment terms.

A key area to overall operational inefficiency that may be improved upon is inventory management. Proper inventory management can often be a very effective means of improving a company's overall financial performance. Proper monitoring, organization, and coordination of ordering inventory can significantly improve a company's cash flow and available working capital. This allows the company to reinvest more capital back into the company on a regular basis, which enables it to grow and increase its market base.