1) Financial Management FUnction

Question 1

1. What is financial management concerned with?

Answer 1

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.

Question 2

2. What do you need to think of when making a financing decision?

Answer 2

• Sources of Finance
• Cost of Capital
• Capital Structure
• Risk

Question 3

3. What do you need to think of when making a investment decision?

Answer 3

Investment appraisal
Working capital management
Risk

Question 4

What is investment appraisal

Answer 4

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.

Question 5

What is working capital management

Answer 5

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

Question 6

4. 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.

Answer 6

• business valuation

* efficient markets

Question 7

Describe the layout of corporate strategy, corporate and financial opjectives

Answer 7

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

Question 8

5. What is the difference between strategy and financial objectives?

Answer 8

• 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.

Question 9

5. What is the difference between commercial and financial objectives?

Answer 9

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.

Question 10

10. What is a operational strategy

Answer 10

• 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.

Question 11

12. What are the types of financial objectives for a business other than

hareholder wealth maximisation is a fundamental principle of financial management

Answer 11

• Shareholder wealth maximisation
• Profit maximisation
• Growth
• Market share
• Social responsibilities

Question 12

What are the risks of adopting profit maximisation objective?

Answer 12

• Long run vs short run
• Quality risk of earnings
• Cash

Question 13

what is long run vs short run issue?

Answer 13

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.

Question 14

what is quality (risk) of earnings issue?

Answer 14

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.

Question 15

what is cash issue?

Answer 15

Accounting profits are just a paper figure. Dividends are paid with cash. Investors will therefore consider cash flow as well as profit

Question 16

Whats is EPS and the formula for earnings per share

Answer 16

it is a measure of profitability, not wealth generation

profit after tax and preference share dividends divided by the number of shares in issue

Question 17

What is maximising

Answer 17

maximising – seeking the maximum level of returns, even though this might involve exposure to risk and much higher management workloads.

Question 18

What is satisficing

Answer 18

finding a merely adequate outcome, holding returns at a satisfactory level, avoiding risky ventures and reducing workloads.

Question 19

What are the three types of stakeholder

Answer 19

Internal
Connected
External

Question 20

who are the connected stakeholders

Answer 20

equity investors (ordinary shareholders)
 customers
 suppliers
finance providers (debt holders/bankers)
 competitors

Question 21

who are the internal stakeholders

Answer 21

 company employees

 company managers/director

Question 22

who are the external stakeholders

Answer 22

 the government
the community at large
 pressure groups
 regulators.

Question 23

What is the agency theory

Answer 23

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

Question 24

What are some examples of directors making corporate decisions in their own intereests?

Answer 24

Remuneration
Empire building
Creative accounting
Off balance sheet finance
Takeover bids
Unethical activities

Question 25

What is empire building

Answer 25

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.

Question 26

What is creative accounting

Answer 26

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).

Question 27

What is off balance sheet financing

Answer 27

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.

Question 28

What is attitudes against takeover bids

Answer 28

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.

Question 29

what are unethical activities

Answer 29

Examples are trading with countries ruled by dictatorships, testing products on animals, emitting pollution or carrying out espionage against competitors.

Question 30

What should the characteristics of manager rewards be

Answer 30

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.

Question 31

Common types of reward schemes

Answer 31

Remuneration links

executive share option schemes (ESOP)

Question 32

Common types of reward schemes

Answer 32

– minimum profit levels
– economic value added (EVA)
– revenue grow

Question 33

What is economic value added

Answer 33

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.

Question 34

How does linking to revenue growth work

Answer 34

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.

Question 35

What are the criticisms of Executive share option scheme

Answer 35

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.

Question 36

What are the requirements for non executive directors

Answer 36

– 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)

Question 37

What are the requirements for executive directors

Answer 37

• 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

Question 38

How do you measure the achievement of corporate objectives?

Answer 38

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

Question 39

What are the objectives of not for profit in general

Answer 39

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

Question 40

Why are not for profit objectives complex

Answer 40

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.

Question 41

not for profit objectives are influenced by?

Answer 41

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.

Question 42

What is value for money

Answer 42

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).

Question 43

What are the three E’s

Answer 43

Economy
Efficiency
Effectiveness

Question 44

What is effectiveness (vfm on the outputs- achieving targets)

Answer 44

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

Question 45

What is Efficiency (vfm on converting inputs to outputs- e.g. costs and cost control)

Answer 45

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.

Question 46

What is Economy (value for money on inputs to the organisation)

Answer 46

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).

Question 47

What is input driven efficiency

Answer 47

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.

Question 48

What is output driven efficiency

Answer 48

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.

Question 49

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:

Answer 49

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.

Question 50

What are the key decisions that financial manager faces in a company?

Answer 50

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

Question 51

What are the key decisions that financial manager faces in a company?

Answer 51

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

Question 52

What is the dividend payout ratio?

Answer 52

.. 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

Question 53

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

Answer 53

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.