What are some potential conflicts between short-term and long-term financial objectives?

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The first thing we need to understand in order to answer this question is exactly what short-term and long-term financial objectives are. Examples of short-term goals could include paying a web designer to upgrade your company’s website, paying for a marketing campaign to advertise a product that you are selling or hiring a new employee to enable the team to take on more work and bring in new clients. Examples of long-term financial goals would be ensuring the long-term viability and liquidity of the company and ensuring maximum gains for shareholders.

A conflict between these goals could occur if shareholders were hesitant to pay for an upgrade to the company’s website, as this expense would eat into the company’s profits for that year. It is easy for shareholders to be shortsighted in this regard. However, not having a website that is user-friendly, secure, and responsive will mean that your website quickly becomes less trusted and less browsed than those of your up-to-date competitors.

The conflict here could therefore be between the shareholders, who were hesitant to pay the money for the website upgrade and the marketing manager, who would be the first to see the damage that is caused by the old-fashioned website.

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The principal conflict between long-term and short-term financial objectives for any business is whether to realize profits or reinvest them to build the business. In the case of a small business, this may be a simple decision of how much the owner decides to pay themself. An emphasis on short-term profit would lead to the owner taking the maximum possible income each year, whereas a long-term perspective would motivate them to build the business using as much of that money as possible.

In a larger, publicly-traded company, the decision is similar, though the dividends the company pays to shareholders, rather that the board's remuneration, will usually be the most important short-term factor. It is well-known that some large and ultimately successful companies, particularly in the digital economy, do not make any profits for many years, since they are concentrating entirely on long-term financial objectives. This is famously true of Amazon, which was founded in 1994 and publicly traded in 1997 but made no profits at all until 2001. Even then, Amazon did not pay dividends, but invested the money in building the business as quickly as possible and gaining market share. Examples like Amazon make it easier for executives to argue for this type of long-term strategy, but it is still unusual to find investors who are willing to wait for years before realizing any profits.

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One of the most significant conflicts between short-term and long-term financial objectives arises due to differences in expected results. In certain situations, short-term results brought about by the short-term financial objectives may make it difficult to achieve some long-term financial objectives.

For instance, a short-term financial objective would be to increase profits through outsourcing or renting certain functions, like warehousing; however, such an objective would conflict with a long-term objective of shareholder wealth maximization because the warehousing facility will not be owned as an asset by the company and remains a perpetual cost. Thus, while the company pursues profitability, it may lose an opportunity to increase company wealth in the future.

Environmental volatility increases with time and may present an opportunity for conflict between short-term and long-term financial objectives. The ability to predict risk diminishes with time, and the situation presents a challenge in how the business chooses to finance its operations. For instance, a loan taken to finance short-term objectives may appear lucrative at that particular moment, but the same may present challenges in the long-term when payments are due. The challenges may arise due to the unpredictable nature of the value of money and legislative policies, among other environmental factors.

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The question of short versus long term results is very important in business, and in fact, emphasis on quarterly earnings may well have contributed to the current economic downturn. Much of the long term profitability of business depends on investment in human and physical capital and also in research and development. Many of these things cost money and take a long time to pay off.

A simple example might be the choice of how to finance a physical plant. You could lease a property, buy an existing property that might have older and more inefficient technology, or have one custom built to suit your business. Leasing (or other forms of outsourcing) are least expensive over the short term, but often most expensive over the long term because you don't build equity in the property.

For a drug company, investing in research that can result in new drugs is very expensive -- and it might take years to get useful results. Thus it is a strategy bad in the short term but can make the company billions in the long term. Producing copycat generics is a low risk profitable short term strategy, but in the long term a company following it will have very low profit margins.

Thus an objective to have a good quarterly report can undermine long term profitability and growth.

 

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