A. Financial policy decisions Flashcards
What is a mission?
fundamental objectives of an entity expressed in general terms
What is a mission statement?
published statement, apparently of the entity’s fundamental objs.
what are the hierarchy of objectives?
arrangement of the objectives of an entity into a number of different levels, with the higher levels bing more general and the lower levels more specific
how will the mission and objectives differ?
the type of entity ( for profit vs not for profit)
the needs of the entity’s different stakeholders
what is an incorporated entity?
legally a separate entity from its owners
what is a stakeholder
have an interest in the strategy of an entity
what is agency theory?
principal (e.g. shareholders) and agents (e.g. employees) have conflict of interest and want to promote own self interest instead of that of principals
-managers handle day-to-day
what needs to be considered when deciding the financial objectives for a for-profit entity?
equity investors
finance providers
risk exposure
what are some examples of specific financial objectives of for-profit entities?
profitability, dividends, cash generation, gearing, market share
what is the annual return to investors?
return from ownership of shares in a profit-making entity. capital appreciation on the shared plus dividends received during the year.
reflects the fact that both share price growth and dividends are important to investors
what are some defects on RoA?
distorting factors for interpretation and comparison purposes e.g. depreciation policy
ignores time value of money
what are some examples of NFPI?
SIN HR
social
intellectual
natural
human
relationship
what are some stakeholder issues for non-financial objectives of for-profit entities?
company employees, managers, suppliers, employees, community, customer pressure
what are the main objectives for NFP entities?
benefit prescribed groups
raise the maximum possible funds each year and VFM
how are public sector companies regulated?
natural monopolies
price cap
taxing large profits
limits on profit
what are some specific objectives of public sector entitites?
budgetary compliance cash generation value added profitability RoA market share competitive position risk exposure
what are the 3 elements of VFM?
economy: min cost for inputs-spending less
efficiency: max input to output-spend well
effectiveness: intended vs actual outcome-spend wisely
Effectiveness – Achieving the end goal of making people well e.g. recovery rates or operation success rates.
Efficiency – Operating as productively as possible e.g. reducing time taken for an operation by using new procedures, or using technology to reduce staff numbers.
Economy – Operating as cheaply as possible – e.g. purchasing equipment and drugs in bulk with other hospitals to keep costs down.
what is the fourth element of VFM?
equity:available to reach all people, different levels of service-spend fairly
what is a VFM audit/stufdy?
investigation into whether proper arrangements have been made for securing economy, efficiency and effectiveness in the use of resources
uses mix of quantitative and qualitative methods
what are the real world difficulties of VFM?
will only focus on effectiveness or economy and efficiency e.g. better service but more expensive
what are the financial implications of international expansion?
impact on the financial statements:currency, consolidation, exchange rates -translation risk
impact on the cost of capital:international investments will often be more risky to an entity than its normal domestic investments
what is translation risk?
value of assets will fluctuate but does not impact actual cash flows of the business
what are the 3 main financial performance ratios?
profitability ratios
lender ratios
investor ratios
profitability ratios?
GPM: want high OPM:want high net profit:want high ebitda or EBB ROCE ROE
why does EBITDA as a measure make sense?
removes depreciation and amortisation that are determined by management
misunderstood because sometimes seen as a cash flow measurement
what is ROE?
indication of how well company is performing in relation to its shareholders
are ROE and ROCE directly comparable?
ROCE: based on operating profit(pre tax)
ROE: based on net profit(post tax)
what can ROCE be broken up into?
ROCE=OPM x AT
what can lower ROCE be attributed to?
generating a lower profit margin on the sales which have been achieved (lower OPM)
generating lower sales from the company’s capital (lower asset turnover)
what is the CIMA definition of gearing?
the relationship between an entity’s borrowings, which include both prior charge capital and long-term debt, and its shareholders’ funds
what are the 2 main measures of gearing?
capital gearing
interest cover
what does debt include in gearing calculation?
redeemable preference shares, bank borrowings and bonds
what does equity include in gearing calculation?
ordinary and irredeemable preference shares
what is the book value of equity?
ordinary share capital + reserves
what is the market value of equity?
number of shares x share price
what does interest cover ratio show?
determine the vulnerability of interest payment to a drop in porfit
what do investors use instead of PBIT in the interest cover equation?
EBITDA as it is a better approximation of cash generated by the business
what is the debt ratio?
LT debt against total assets
what are the investor ratios?
P/E ratio
dividend cover
dividend yield
what is the market price per share?
ex-dividend market price
what does ex-dividend mean?
that in buying a share today, the investor will not participate in the forthcoming dividend payment
how can ex-div be calculated from cum-div?
ex-div= cum div- div per share
why can EPS be manipulated?
historical figure
can be manipulated by changing accounting policies, merges, acquisitions
future earnings should be of more concern for investors
what is the dividend-payout rate?
the cash effect of payment of dividends is measured by the dividend-payout rate
what are the effects of an increase in interest rates?
spending falls asset values fall:inverse relationship between bonds and ir foreign funds attracted to country exchange rate rises:inflow of funds inflation falls
how can higher interest rates affect the rate of inflation?
inflation falls because:
- less demand so lower prices
- new borrowing deferred so demand falls
- the higher exchange rate will raise export prices and thereby threaten sales which pressures producers
what is inflation?
rising prices
shows cost of living in general terms
why is low inflation beneficial for the economy?
fairly stable prices
prospect of higher profits
what are the drawbacks of of an inflation rate between 0-3%?
higher unemployment
what are the drawbacks of 5+% inflation/accelerating rates?
distorts consumer behaviour:bring purchases forward
redistributes income:fixed income have less power
affects wage bargainers
undermines business confidence: wide fluctuations
weakens the country’s competitive position
redistributes wealth:borrower gaining at the expense of llender
what is the interest rate parity thoery?
shows that the forward rate of exchange can be found by adjusting the spot rate of exchange to reflect the differential in interest rates between the two countries
what are the limitations of published accounts figures for ratio analysis?
historical records, not forward looking
SPL is prepared using accruals concept, difficult to calculate cash position
only contain financial information
what is the GRI?
Global Reporting Initiative
What is the GRI’s Sustainability Reporting Standards?
suggest the entities should report performance indicators so that users can monitor their performance from three key perspectives:
economic
environmental
social
what are the 2 parts of the GRI Standards?
the Universal Standards and the Topic Specific Standards
What are the 3 Universal Standards?
GRI 101- Foundation
GRI 102- General Disclosures
GRI 103-Management Approach
how do entities assess which topics are material and what should be included in the Standards?
according to the reporting principles
What is GRI 101?
Foundation
contains the Reporting Principles for report content and quality
gives guidance on how to decide which topics are material and how to layout and present the sustainability report
What is GRI 102?
General Disclosures
disclose contextual details of the org (size, location, supply chains, key markets, ethical principles, governance policies, key risks and stakeholder engagement
What is GRI 103?
Management Approach
disclose which topics are deemed to be material, why they are material and an overview of how management control and assess the impact on these areas
what are the 4 principles for Defining Report Content?
stakeholder inclusiveness
sustainability context
materiality
completeness
what are the 6 principles for Defining Report Quality?
Balance:positive and negative Comparability:consistently reported and presented Accuracy:accurate and detailed Timeliness Clarity:understandable and accessible Reliability
BTRACC
what are the Topic Specific Standards of the GRI Standards?
modular
org selects standards specific to their material topics
split into sections
what are the 3 sections of the Topic Specific Standards?
Economic 200 series
Environmental 300 series
Social 400 series
must report on all these
what happens in exceptional cases if it is not possible to disclose certain requires information on the GRI Standards?
- identify the information that has been omitted
- explain the reasons why the information has been omitted
e.g. confidentiality or legal constraint or information not available (should outline steps taken to find it)
what happens if there is a large number of omitted disclosures?
may invalidate ability to claim that its sustainability report has been prepared ‘in accordance’ with he Standards
what are some examples of Economic Topic Specific Standards?
economic performance
market presence
indirect economic impacts
procurement practices
what are some examples of Environmental Topic Specific Standards?
materials energy biodiversity emissions products and services supplier environmental assessment
what are some examples of Social Topic Specific Standards?
employment e.g. staff and policies training and education diversity and equal opportunity investment freedom of association and collective bargaining assessment of operations local communities public policy customer health and safety customer privacy
what is the International Integrated reporting Council?
create a more holistic and balanced view of the company being reported upon, bringing together material aspects such as strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates
how are the sustainability reporting e.g. GRI Standards and integrated reporting linked?
GRI form important part of integrated reporting
what are the 3 fundamental concepts of integrated reporting?
value creation for the organisation and for others
the capitals (FHM SIN)
the value creation process
what is the relevance of the capitals?
all entities depend on forms of capitals
try to maximise all in long run
they are stocks of value that change through the activities and outputs of the entity
what are the guiding principles?
underpin the preparation of an integrated report, informing the content f=of the report and how information is presented
what are the content elements?
key categories of information required to be included in an integrated report under the Framework, presented as a series of questions rather than a prescriptive list of disclosures
what are the 7 guiding principles?
Strategic focus and future orientation Connectivity of information Stakeholders relationships Materiality Conciseness Reliability and completeness Consistency and comparability
what are the 8 content elements?
organisational overview and external environment governance business model risks and opportunities strategy and resource allocation performance outlook basis of preparation and presentation
BROGPSOB
what are the SDGs?
UN Sustainability Development Goals
when were the SDGs developed?
Sept 2015 UN adopted 15 year plan to end extreme poverty, fight inequality and protect planet
what were the 17 SDGs?
- no poverty
- zero hunger
- good health and well being
- quality education
- gender equality
- clean water and sanitation
- affordable and clean energy
- decent work and economic growth
- industry, innovation and infrastructure
- reduced inequalities
- sustainable cities and communities
- responsible consumption and production
- climate action
- life below water
- life on land
16.peace and justice strong institutions
17 partnerships for the goals
How can additional non-financial information be reported ?
GRI
what does capitalism rely on?
the efficient allocation of capital to deliver returns to investors over the short, medium and long term
why has the western model of capitalism been questioned following 2007 banking crisis?
dependence on short term financial factors over other forms of capital and longer time scales
what does the GRI encourage organisations to do?
disclose extra information when communicating with key stakeholders
what is the most accepted framework for reporting sustainability?
GRI’s Sustainability Reporting Standards June
what are materiality considerations?
materiality placed at the centre of the GRI Standards
focus heavily on material issues
must identify material sustainability issues and explain their impact
what is social and relationship capital?
institutions and the relationships within and between communities, groups of stakeholders and other networks
what are human capitals?
people’s competencies, capabilities and experience
what are the intellectual capitals?
organisational, knowledge-based intangibles including IP, organisational capital
what are the primary reasons for including capitals in the Framework?
-part of the theoretical underpinning for the concept of value creation
as a guideline for ensuring organisations consider all the forms of capital they use or affect
where is extra information usually presented?
as part of the entity’s management commentary
what is the purpose of the Management Commentary (MC)?
provides context within which to interpret the financial position, financial performance and cash flows of an entity, explain objectives and strategies, help evaluate an entity’s prospects and its general risks
where to find framework for MC?
IFRS Practice Statement on MC provides broad, non-binding framework for the presentation of management commentary that accompanies financial statements that have been prepared in accordance with the IFRS
-principles
-qualitative characteristics
elements necessary for inclusion
what is the framework for presentation of the MC?
- provide management’s perspective of the entity’s performance, position and progress
- should supplement and complement information presented in the financial statements
- it should have an orientation to the future
- it should possess the qualitative characteristics of relevance and faithful representation as described in the IASB’s Conceptual Framework for Financial Reporting
due to the voluntary nature of non-financial disclosures, what does their impact and effectiveness depend on?
relevance, reliability and comparability
what are some long term benefits to supporting and adopting the SGDs?
- improved reputation with customers for being socially responsible
- a healthier and more skilled workforce
- greater growth opportunities in developing countries as their economy strengthens, giving the population more disposable income
- continued supply of raw materials from a sustainable source, helping to secure the long term future of the business
- reduced risks of regulatory breaches and bad publicity
links between SCGs and IR?
both require organisations to consider how the external environment impacts value creation
How are SDGs used in the Vodafone Sustainable Business Report?
overview of sustainable business strategy
Focus on five UN SDGs:
- SDG4: Quality education:enable young people to develop digital skills e.g. School programmes in Egypt and Africa
- SDG5 Gender equality:women with access to life-changing services and leadership positions
- SDG 8 Decent work and economic growth: youth unemployment, work experience
- SDG 9 Industry, innovation and infrastructure
- SDG 13 Climate action:GHG emissions, 2.1 tons of CO2 saved
report allows reader of report to see at a glance which of the UN SDGs are most important from Samsung’s POV
what is strategy?
a course of action, including the specification of resources required to achieve a specific objective
what is financial strategy?
the aspect of strategy which falls within the scope of financial management, which will include decisions on investment, financing and dividends
what is strategic financial management?
the identification of the possible strategies capable of maximising an entity’s net present value, the allocation of scarce capital resources among the competing opportunities and the implementation and monitoring of the chosen strategy so as to achieve stated objectives
what are 3 key decisions in financial strategy that are closely interlinked?
investment, financing and dividends
what is the investment decision?
what projects should be undertaken i.e. how to make the most of money
understand short, medium and long term capital requirements for fixed assets and working capital
what factors is a potential investment likely to affect?
the liquidity of the company
the reported profit and earnings
the variability of cash flows and earnings
what is the financing decision?
how should funds be raised?
- internal funding e.g. dividend policy and tax implications
- external funds e.g. equity and debt finance, gearing
- extent to which working capital should be financed by long term finance and short term credit
what are some options for financing decision?
rights issue:reinvest stock market:give up control overdraft:short term finance new bank loan: good long term debenture: listed companies
what is the optimum level of cash to hold?
trade off (too much vs too little)
flexibility
expectations of shareholders
what is the downside of too little cash?
subject to liquidity problems and possible liquidition
what are the downsides to too much cash?
opportunity cost and leave entity vulnerable to a takeover bid
what are the benefits of matching characteristics of investment and financing?
matching: where profile of the entity’s financing matches the profile of the assets being funded
e. g. maturity of bond with disposal of asset
what are the 2 elements of the dividend decision?
amount to be paid out
the amount to be retained to support the growth of the entity
how are all 3 decisions interlinked?
investment decisions cant be made without financing
dividends represent the payment of returns on the investment back to the shareholders. the risk and how it was financed
debt finance can be cheap but requires interest payment to be made out of project earnings
what are some examples of interrelationships?
- investment decision to undertake a profitable project, financed by raising new debt or equity finance, may impact several important investor and lender rations such as EPS, earnings yield and interest cover
- financing requirements available for payment of dividends are determined based on the overall consideration of the forecast future cash flows arising from investment decisions business strategy and forecast business and economic variables
- a change in dividend policy can have an immediate impact on some investor ratios such as dividend cover and dividend yield
what are some major external influences on financial strategy?
- good investor relations
- limited access to sources of finance, either due to weak creditworthiness or lack of liquidity in the banking sector and capital markets
- gearing level
- debt covenants
- government influence
- regulatory bodies
- major economic influences e..g. interest rates, growth in GDP, inflation rates
- accounting concepts
what are some government influences on financial strategy?
- employment policy
- regional policy
- taxation policy
- legislation
what are some legislations that financial managers must have a proper understanding of?
Companies Acts, health and safety regulation, laws relating to consumer protection and consumer rights, laws relating to contract and agency, employment taw and laws relating to protection of the environment and promoting competition
what are some regulators of listed companies?
Stock Exchange regulations
Oftel (telecoms)
Ofcom(media
Ofwat (water)
what are the 3 headings the objectives of a regulatory body must be classified under?
- promotion of competition
- promotion of customers from monopoly power
- promotion of social and macroeconomic objectives
how does domestic tax implications affect financial strategy?
any profits taxable
debt interest tax deductible
-tax savings for new investments
dividends will be taxed under income tax
share price rise due to good investments taxed under capital gains tax rules
how does international tax implications affect financial strategy?
where is the head office?
multinational companies often attracted to set up their operations in a low tax economy
transfer pricing policy
royalties and management charges monitored
what must a borrower prepare when seeking finance from a lender?
a business plan
what does the business plan include?
- the purpose, amount and duration of the borrowing
- detailed cash flow forecasts
- an explanation of how the borrower is proposing to repay the borrowing
what does the assessment of the creditworthiness by the lender include?
- analysis of business plan
- assessment of business prospects
- security available
- credit rating
- other borrowings/covenants
how are gearing ratios interpreted?
SOFP:high proportion of debt finance is seen as risky, compare to previous years and industry
SOPL:interest cover ratio less than 1 indicates that the entity is having trouble servicing its debt finance, higher above 1, the easier it is to pay interest so less risky
what are the 2 biggest credit rating agendies?
Moody’s and Standard and Poor’s
what do credit rating agencies focus on when setting credit ratings?
- plans and forecasts of the company
- the strength and trends in the industry in which the company operated and the company’s competitive position within that industry
- country risks-the political and regulatory risks
- the quality of the management team
- corporate attitude to risk taking
- financial position
- financial ratios
- any parental support such as guarantees
how often are credit ratings updated?
constantly and regularly
Which ratings are known as junk/high risk?
Ba, B, Cs and below for Moody’s
BB, B and below for S&P
what is the link between credit ratings and interest rates?
high risk and low credit rating means higher interest charged
