1) Financial Management FUnction Flashcards
- What is financial management concerned with?
Management account and financial accounting are both concerned with resource usage to meet targets- however MA deals in short time scales and FM is concerned with the longer term
Financial management is concerned with the long-term raising of finance and the allocation and control of resources; it involves targets, or objectives, that are generally long-term by nature, whilst management accounting usually operates within a 12-month time horizon.
- What do you need to think of when making a financing decision?
- Sources of Finance
- Cost of Capital
- Capital Structure
- Risk
- What do you need to think of when making a investment decision?
Investment appraisal
Working capital management
Risk
What is investment appraisal
Investment appraisal considers the long-term plans of the business and identifies the right projects to adopt to ensure financial objectives are met. The projects undertaken will nearly always involve the purchase of non-current assets at the start of the process.
What is working capital management
Working capital management is concerned with the management of liquidity – ensuring debts are collected, inventory levels are kept at the minimum level compatible with efficient production, cash balances are invested appropriately and payables are paid on a timely basis
- What do you need to think of when making a dividend decision?
The decision on the level of dividends to be paid can affect the value of the business as a whole as well the ability of the business to raise further finance in the future.
- business valuation
* efficient markets
Describe the layout of corporate strategy, corporate and financial opjectives
Mission> Broad based goal > Detailed objectives/ targets which are broken into Commercial, Finance and strategy objectives. Each of these them have corporate, business and operational targets
- What is the difference between strategy and financial objectives?
- objectives/targets define what the organization is trying to achieve. Strategy considers how to go about it. Strategy is developed in response to the need to achieve objectives
- Almost all strategies developed by the business will have financial implications and the financial manager has a key role to play in helping business strategies succeed.
- What is the difference between commercial and financial objectives?
The distinction between ‘commercial’ and ‘financial’ objectives is to emphasise that not all objectives can be expressed in financial terms and that some objectives derive from commercial marketplace considerations.
- What is a operational strategy
- Operational strategy concerns how the different functional areas within a strategic business unit plan their operations to satisfy the corporate and business strategies being followed.
- In this syllabus, we are most interested in the decisions facing the finance function. These day-to-day decisions include all aspects of working capital management.
- What are the types of financial objectives for a business other than
hareholder wealth maximisation is a fundamental principle of financial management
- Shareholder wealth maximisation
- Profit maximisation
- Growth
- Market share
- Social responsibilities
What are the risks of adopting profit maximisation objective?
- Long run vs short run
- Quality risk of earnings
- Cash
what is long run vs short run issue?
In any business, it is possible to boost short-term profits at the expense of long-term profits. For example, discretionary spending on training, advertising, maintenance and research and development (R&D) may be cut.
will improve reported profits in the short-term but damage the long-term prospects of the business. The stock exchange will normally see through such a tactic and share prices will fall.
what is quality (risk) of earnings issue?
A business may increase its reported profits by taking a high level of risk. However, the risk may endanger the returns available to shareholders. The stock exchange will then generally regard these earnings as being of a poor quality and the more risk-averse shareholders may sell. Once again the share price could fall.
what is cash issue?
Accounting profits are just a paper figure. Dividends are paid with cash. Investors will therefore consider cash flow as well as profit
Whats is EPS and the formula for earnings per share
it is a measure of profitability, not wealth generation
profit after tax and preference share dividends divided by the number of shares in issue
What is maximising
maximising – seeking the maximum level of returns, even though this might involve exposure to risk and much higher management workloads.
What is satisficing
finding a merely adequate outcome, holding returns at a satisfactory level, avoiding risky ventures and reducing workloads.
What are the three types of stakeholder
Internal
Connected
External
who are the connected stakeholders
equity investors (ordinary shareholders)
customers
suppliers
finance providers (debt holders/bankers)
competitors
who are the internal stakeholders
company employees
company managers/director
who are the external stakeholders
the government
the community at large
pressure groups
regulators.
What is the agency theory
Agency relationships occur when one party, the principal, employs another party, the agent, to perform a task on their behalf. In particular, directors (agents) act on behalf of shareholders (principals).
However, the objectives of principals and agents may not coincide so requires goal congruence
What are some examples of directors making corporate decisions in their own intereests?
Remuneration Empire building Creative accounting Off balance sheet finance Takeover bids Unethical activities
What is empire building
The high level of corporate takeover activity in the 1980s led to many chief executives believing that building as large a group as possible was a valid aim in itself, an objective described as empire building. Executives gained prestige from successful bids and from being in charge of large conglomerates, but the returns to shareholders were often disappointing.
What is creative accounting
The directors are responsible for selecting the accounting policies to be used by their company, subject to accounting standards and the opinion of the auditors.
Examples of such techniques are:
capitalising expenses on the statement of financial position (e.g. development expenditure, advertising expenditure),
not depreciating non-current assets,
maximising the value of intangibles on the balance sheet (e.g. putting a value to brands),
recognising revenue on long-term contracts at the earliest possible time,
and other forms of off-balance sheet financing (see below).
What is off balance sheet financing
One example is the use of quasi-subsidiaries into which financial liabilities are moved so that they don’t appear in the parent company’s balance sheet. The introduction of FRS 5 aimed to restrict off-balance sheet finance, for example by requiring quasi-subsidiaries to be consolidated into the group accounts. The collapse of Enron in the US in late 2001 put the spotlight on the various forms of off-balance-sheet finance used, and further scrutiny and regulation is inevitable.
What is attitudes against takeover bids
Boards of directors often spend considerable amounts of time and money attempting to defend their companies against takeover bids, even when it appears that the takeover would be in the best interests of the target company’s shareholders. These directors are accused of trying to protect their own jobs, fearing that they will be retired if their company is taken over.
what are unethical activities
Examples are trading with countries ruled by dictatorships, testing products on animals, emitting pollution or carrying out espionage against competitors.
What should the characteristics of manager rewards be
The schemes should:
be clearly defined, impossible to manipulate and easy to monitor
link rewards to changes in shareholder wealth
match managers’ time horizons to shareholders’ time horizons
encourage managers to adopt the same attitudes to risk as shareholders.
Common types of reward schemes
Remuneration links
executive share option schemes (ESOP)
Common types of reward schemes
– minimum profit levels
– economic value added (EVA)
– revenue grow
What is economic value added
EVA is a measure of the increase in the value of shareholder wealth in the period. Schemes such as these are therefore designed to more closely align the interests of the employee and the shareholder.
A potential disadvantage is that calculating the bonus may be complex.
How does linking to revenue growth work
Growth of the business and higher production levels can lead to economies of scale, which in turn can help the business compete more successfully on price.
However, revenue growth could be achieved at the expense of profitability, e.g. by reducing selling prices or by selecting high revenue product lines, which may not necessarily be the most profitable. Maximising revenue is therefore unlikely to maximise shareholder wealth.
What are the criticisms of Executive share option scheme
When directors exercise their share options, they tend to sell the shares almost immediately to cash in on their profit.
If the share price falls when options have been awarded, and the options go ‘underwater’ and have no value, they cannot act as an incentive.
If a company issues large quantities of share options, there could be some risk of excessive dilution of the equity interests of the existing shareholders
Directors may distort reported profits (creative accounting) to protect the share price and the value of their share options.
What are the requirements for non executive directors
– important presence on the board
– must give obligation to spend sufficient time with the company
– should be independent.
– at least half the board to be independent NEDs (don’t take part in running the business)
What are the requirements for executive directors
- separation of chairman and chief executive officer (CEO)
– submit for re-election
– clear disclosure of financial rewards - all directors should submit themselves for re-election at least every 3 years
How do you measure the achievement of corporate objectives?
This is commonly done via ratio analysis. Ratio analysis compares and quantifies relationships between financial variables.
Ratio analysis can be grouped into four main categories: Profitability and return Debt and gearing Liquidity Investor
What are the objectives of not for profit in general
To raise as much money as possible
effectively spend it
The primary objective of not-for-profit organisations (NFPs or NPOs) is to benefit prescribed groups of people. As with any organisation, NFPs will use a mixture of financial and non-financial objectives.
However, with NFPs the non-financial objectives are often more important and more complex
Why are not for profit objectives complex
Most key objectives are very difficult to quantify, especially in financial terms, e.g. quality of care given to patients in a hospital.
Multiple and conflicting objectives are more common in NFPs, e.g. quality of patient care versus number of patients treated.
not for profit objectives are influenced by?
wide range of stakeholders
high level of interest from stakeholder groups
significant degree of involvement from funding bodies and sponsors
little or no financial input from the ultimate recipients of the service
funding often provided as a series of advances rather than as a lump sum
projects typically have a longer-term planning horizon
may be subject to government influence/government macroeconomic policy.
What is value for money
VFM is achieving the desired level and quality of service at the most economical cost
Value for money relates to economy (value for money on inputs to the organisation),
efficiency (vfm on converting inputs to outputs)
and effectiveness (vfm on the outputs).
What are the three E’s
Economy
Efficiency
Effectiveness
What is effectiveness (vfm on the outputs- achieving targets)
effectiveness relates to the overall objectives of the organisation being achieved. It is a measure of outputs
Whether outputs are achieved that match the predetermined objectives.
i.e. services/facilities e.g. number of pupils taught
% achieving key stage targets
e.g. Customer satisfaction rating is an ‘effectiveness’ target (D
Effectiveness can only be measured with respect to the organisations objectives
What is Efficiency (vfm on converting inputs to outputs- e.g. costs and cost control)
efficiency is about effective resource utilisation (such as decreasing waste levels)
Ratio of outputs to inputs – achieving a high level of output in relation to the resources put in (input driven) or providing a particular level of service at reasonable input cost (output driven)
Maximising the useful output from a given level of resources, or minimising the inputs required to produce the required level of output.
This is the measure of outputs over inputs
i. e. resource utilisation- e.g. average class size, cost per pupil
e. g. Efficiency targets aim to make the most efficient use of the resources available.
What is Economy (value for money on inputs to the organisation)
Economy relates to keeping costs down without sacrificing quality,
Minimising the costs of inputs required to achieve a defined level of output. Economy is being effective and efficient at the lowest possible cost.
Acquiring resources of appropriate quality and quantity at the lowest cost.
e. g. by adopting commercial purchasing techniques
e. g. Paying rates for staff of appropriate levels of qualification is an ‘economy’ target (B).
What is input driven efficiency
Input driven efficiency- try to provide as much of a service as possible with strictly limited resources and few opportunities to generate further income sources. This would include services such as library provision.
What is output driven efficiency
the obligation is to provide the service at a reasonable cost and is known as ‘output-driven’ efficiency. there is a statutory obligation to provide a particular standard of service, for example prison services, which cannot be significantly reduced or withdrawn.
key financial objectives for NFPs will be to:
raise as large a sum as possible
spend funds as effectively as possible.
Targets may then be set for different aspects of each accounting period’s finances such as:
total to be raised in grants and voluntary income maximum percentage of this total that fund-raising expenses represents
amounts to be spent on specified projects or in particular areas
maximum permitted administration costs
meeting budgets
breaking even in the long run.
What are the key decisions that financial manager faces in a company?
Investment decision
Dividend decision
Financing decision
Financial management aims to ensure that the money is available to finance profitable projects and to select those projects that the company should undertake. Once profits have been made the decision then needs to be made about how much to distribute to the owners and how much to re-invest for the future. Income decisions are really sub-divisions of the investment decision. Appraisal decisions would be sub-divisions of the investment decision and budget decisions would be performed by management accountant
What are the key decisions that financial manager faces in a company?
Investment decision
Dividend decision
Financing decision
Financial management aims to ensure that the money is available to finance profitable projects and to select those projects that the company should undertake. Once profits have been made the decision then needs to be made about how much to distribute to the owners and how much to re-invest for the future. Income decisions are really sub-divisions of the investment decision. Appraisal decisions would be sub-divisions of the investment decision and budget decisions would be performed by management accountant
What is the dividend payout ratio?
.. The dividend payout ratio compares the dividend to the profit before the dividend
The dividend payout ratio is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company. It is the percentage of earnings paid to shareholders in dividends. The amount that is not paid to shareholders is retained by the company
formula= Dividends paid / Net income
Compare and contrast the financial objectives of a stock exchange listed company such as Bar Co and the financial objectives of a not-for-profit organisation such as a large charity
A key financial objective for a stock exchange listed company is to maximise the wealth of shareholders. This objective is usually replaced by the objective of maximising the company’s share price, since maximising the market value of the company represents the maximum capital gain over a given period. The need for dividends can be met by recognising that share prices can be seen as the sum of the present values of future dividends. Maximising the company’s share price is the same as maximising the equity market value of the company, since equity market value (market capitalisation) is equal to number of issued shares multiplied by share price.
Maximising equity market value can be achieved by maximising net corporate cash income and the expected growth in that income, while minimising the corporate cost of capital. Listed companies therefore have maximising net cash income as a key financial objective.
Not-for-profit (NFP) organisations seek to provide services to the public and this requires cash income. Maximising net cash income is therefore a key financial objective for NFP organisations as well as listed companies. A large charity seeks to raise as much funds as possible in order to achieve its charitable objectives, which are non-financial in nature.
Both listed companies and NFP organisations need to control the use of cash within a given financial period, and both types of organisations therefore use budgets. Another key financial objective for both organisations is therefore to keep spending within budget.
The objective of value for money (VFM) is often identified in connection with NFP organisations. This objective refers to a focus on economy, efficiency and effectiveness. These three terms can be linked to input (economy refers to securing resources as economically as possible), process (resources need to be employed efficiently within the organisation) and output (the effective use of resources in achieving the organisation’s objectives
Described in these terms, it is clear that a listed company also seeks to achieve value for money in its business operations. There is a difference in emphasis, however, which merits careful consideration. A listed company has a profit motive, and so VFM for a listed company can be related to performance measures linked to output, e.g. maximising the equity market value of the company. An NFP organisation has service-related outputs that are difficult to measure in quantitative terms and so it focuses on performance measures linked to input, e.g. minimising the input cost for a given level of output.
Both listed companies and NFP organisations can use a variety of accounting ratios in the context of financial objectives. For example, both types of organisation may use a target return on capital employed, or a target level of income per employee, or a target current ratio.
Comparing and contrasting the financial objectives of a stock exchange listed company and a not-for-profit organisation, therefore, shows that while significant differences can be found, there is a considerable amount of common ground in terms of financial objectives.
