Choosing Appropriate Objectives
When you consider your strategic objectives and your annual business plan, you will want to define the objectives in financial terms (as well as marketing, quality and people terms). If a key objective is to make money, then one of your targets must define return on capital. If you are in manufacturing, then you are likely to have an investment in capital that is high compared to sales turnover (and, consequently, a low asset turnover).
You will probably want to set a target for return on equity. If you are in business to create a job for yourself, or because you do not want to work for someone else, you are unlikely to be discouraged by a low return on your investment. It probably makes more sense for you to monitor the return on capital employed, which clearly must be greater than the cost of your loan. Achieving this will provide you with good ammunition when you negotiate with potential lenders or investors. Achieving your desired return on capital employed (RoCE) is a long term, or strategic, objective.
In setting financial objectives, you are committing yourself to perform to a certain standard. Monitoring the ratios suggested is straightforward if you have a computerised accounting package - though identifying what corrective action to take if the actual results differ from the targets may not be so clear.
Simply setting targets is insufficient by itself. You will also need to prepare financial forecasts to show how you might achieve those targets and within what timescale. You might decide, for example, to set a target of 15% return on capital employed by the end of the third year from now. However, that might require an annual increase of gross profit margin which, in turn, might require an annual increase in sales of, say, 20%.