The financial management function

Question 1

Financial management is concerned with

Answer 1

the efficient acquisition and
deployment of both short- and long-term financial resources, to ensure the
objectives of the enterprise are achieved

Question 2

Corporate strategy concerns

Answer 2

the decisions made by senior
management about matters such as the particular business the
company is in, whether new markets should be entered or
whether to withdraw from current markets. Such decisions can
often have important financial implications. If, for example, a
decision is taken to enter a new market, an existing company in
that market could be bought, or a new company be started from
scratch

Question 3

Business strategy concerns

Answer 3

the decisions to be made by the
separate strategic business units within the group. Each unit will
try to maximise its competitive position within its chosen market.
This may involve for example choosing whether to compete on
quality or cost

Question 4

Operational strategy concerns

Answer 4

how the different functional areas
within a strategic business unit plan their operations to satisfy the
corporate and business strategies being followed. We are, in this
syllabus, most interested in the decisions facing the finance
function. These day-to-day decisions include all aspects of
working capital management

Question 5

satisficing –

Answer 5

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

Question 6

Agency relationships occur when

Answer 6

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)

Question 7

Managerial reward schemes

Answer 7

Common types of reward schemes include:
 remuneration linked to:
– minimum profit levels
– economic value added (EVA)
– revenue growth
 executive share option schemes (ESOP).

Question 8

Remuneration linked to economic value added (EVA)

Answer 8

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 9

Remuneration linked to minimum profit levels

Answer 9

This scheme would be easy to set up and monitor.
Disadvantages are that the scheme may lead to managers taking
decisions that would result in profits being earned in the short-term at
the expense of long-term profitability. It could also lead to managers
underachieving, i.e. relaxing as soon as the minimum is achieved. The
scheme might also tempt managers to use creative accounting to boost
the profit figure.

Question 10

Remuneration linked to revenue growth

Answer 10

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 11

An executive share option scheme (ESOP)

Answer 11

This scheme has the advantage that it will encourage managers to
maximise the value of the shares of the company, i.e. the wealth of the
shareholders. When an executive is awarded share options, the theory
is that it is in their interests for the share price to rise, so they will do
whatever possible to improve the share price. Their interests will be
best served by working towards a goal that is also in the interests of the
shareholders.
Such schemes are normally set up over a relatively long period,
thereby encouraging managers to make decisions to invest in positive
return projects, which should result in an increase in the price of the
company shares. However, efficient managers may be penalised at
times when share prices in general are falling

Question 12

Ratio analysis can be grouped into four main categories

Answer 12

 Profitability and return
 Debt and gearing
 Liquidity
 Investor

Question 13

Economy:

Efficiency:

Effectiveness:

Answer 13

Minimising the costs of inputs required to achieve a defined
level of output.

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)

Whether outputs are achieved that match the
predetermined objectives