UNIT 6: - Finance function and financial management environment
1. The nature and purpose of financial management
2. -Relationship with FA & MA
3. The relationship b/w corporate strategy and corporate and financial objectives
, 4. Financial objectives
Shareholder wealth maximization: - Shareholder wealth come from Dividend and share price
growth.
Total shareholder return: - TSR measures how much return (profit) a shareholder got from owning a
share in one year.
REFER EXCEL FOR QUESTION (QUESTION 1)
Justification for maximising shareholders wealth: (Easier to raise finance- Encourages companies to
satisfy customers- Encourages companies to satisfy customers- Directors have a legal duty)
Criticisms of focusing only on shareholder wealth: (It ignores market imperfections- It ignores social
needs- It ignores other stakeholders)
Profit Maximization: - Companies are supposed to aim to make their shareholders richer. In
theory, this means increasing the total value of the company’s shares. But in real life, this is tricky
because:
Theoretical Goal Maximising Shareholder Wealth: - For public companies share prices are increased by
overall stock market—For private companies there’s no share price to track.
Why Profit Isn’t Always a Good Proxy for Shareholder Wealth: - Cash matters more than accounting
profit- short term thinking- Risk of fraud or manipulation- Accounting ignores some costs like interest on debt
Earnings per share: - tells investors how much profit is allocated to each ordinary share. There
are ways to boost EPS
,Share consolidation (reverse stock split): - The company reduces the number of shares by combining
several existing shares into one. Profit stays the same, but fewer shares mean higher EPS. Example:
Share buyback: The company uses cash to buy back its own shares and cancels them. Company Y
has. Example:
REFER EXCEL FOR QUESTION (QUESTION 2)
5. Stakeholder objectives and conflicts
Internal: employees, managers/directors
Connected: shareholders, customers, suppliers, banks, competitors
External: government, community, regulators, pressure groups
STAKEHOLDER WHAT THEY WANT
Shareholders (equity Make money from their investment (dividends + share price growth) because they
investors) take the financial risk.
Managers/Directors Often want to increase their own pay and job security; could focus on short-term
profits or long-term growth.
Employees Good wages, bonuses, job security, safe working conditions.
Customers Good products/services at fair prices.
Suppliers Timely payments and long-term contracts.
Banks/Finance providers Confidence the company can pay back loans with interest.
Government Companies obey laws, pay taxes, create jobs, and help the economy.
Community Companies act responsibly, protect the environment, and contribute to social
welfare.
Conflicts between stakeholders: - Goals of stakeholders might clash
Criticism: - Some people argue that only shareholders take real financial risk, so making them
wealthy should remain the main goal. Still, companies are increasingly aware they operate within a
society and have responsibilities beyond just profit.
Agency Theory: - explains situations where one person (the principal) hires another person (the
agent) to do a job for them.
Conflict: - Shareholders own the company, but managers control it day-to-day. Shareholders rely on
managers to make decisions that increase shareholder wealth. Managers may instead: Maximise
their own pay or bonuses or pursue personal goals
Examples of agency problems: - Remuneration- Empire building- Creative accounting – Unethical activities-
Off balance sheet finance (Enron collapse 2001)
Managerial reward scheme: - The main goal is to align the interests of managers and
shareholders, so managers make choices that increase the value of the company.
Common Types of Reward Schemes: Pay linked to minimum profit levels- Pay linked to Economic Value
Added (EVA)- Pay linked to revenue growth- Executive Share Option Schemes (ESOPs)
6. Measuring achievement of corporate objectives
, comparing different financial numbers from the company’s accounts to understand its performance.
Profitability & Return Ratios: Show how much profit the company makes. Example: Profit margin,
return on capital employed (ROCE).
Debt & Gearing Ratios: Show how much of the company is financed by debt. Example: Debt-to-
equity ratio.
Liquidity Ratios: Show whether the company can pay its short-term bills. Example: Current ratio,
quick ratio.
Investor Ratios: Show information useful for shareholders or potential investors. Example: Earnings
per share (EPS), price/earnings ratio (P/E).
7. Not-for-profit organisations
These organisations do not exist to make money, unlike normal businesses. Their main purpose is to
provide a service or benefit to certain people or to society.
Non-financial objectives are usually more important. They are also harder to measure.
Difference from business: - Many different stakeholders- Stakeholders have strong and sometimes
conflicting interests- Funding bodies (donors, government) influence decisions- Users of the service often pay
little or nothing- Funding is often given in small amounts over time, not all at once - Long-term planning is
common- Government influence is often strong.
ideally, they should try to maximize the difference between: Benefits provided to society − Cost of
running the service
8. Macroeconomic policy
Governments use macroeconomic policies to achieve certain big goals for the whole country. These
goals include: Full employment- Economic growth- Fair distribution of wealth- Price stability (low inflation)-
Healthy balance of payments (import less than export)
Monetary policy: - Monetary policy is when a government or central bank (like the Bank of England,
the European Central Bank, or the Federal Reserve) takes actions to control money and interest rates
in order to achieve economic goals such as low inflation, economic stability, and growth.
Availability of finance: Controlling supply (When the central bank restricts lending credit
restrictions, small businesses find it hard to borrow money). Increasing interest rates (Higher
interest rates mean investors want higher returns. If companies can’t provide these returns,
their share price may fall.)
Cost of finance: Controlling supply (If the central bank reduces the amount banks can lend, there
is less money available. When supply is low, the cost of borrowing increases, making businesses
less likely to expand.) Increasing interest rates (When interest rates rise, borrowing becomes
expensive. Shareholders expect higher returns. If companies fail to deliver, share prices may
drop).
Level of Consumer Demand: Controlling supply (If businesses find it difficult to raise money, they
can’t invest or expand, they spend less, causing demand to fall) Increasing interest rates (Saving
1. The nature and purpose of financial management
2. -Relationship with FA & MA
3. The relationship b/w corporate strategy and corporate and financial objectives
, 4. Financial objectives
Shareholder wealth maximization: - Shareholder wealth come from Dividend and share price
growth.
Total shareholder return: - TSR measures how much return (profit) a shareholder got from owning a
share in one year.
REFER EXCEL FOR QUESTION (QUESTION 1)
Justification for maximising shareholders wealth: (Easier to raise finance- Encourages companies to
satisfy customers- Encourages companies to satisfy customers- Directors have a legal duty)
Criticisms of focusing only on shareholder wealth: (It ignores market imperfections- It ignores social
needs- It ignores other stakeholders)
Profit Maximization: - Companies are supposed to aim to make their shareholders richer. In
theory, this means increasing the total value of the company’s shares. But in real life, this is tricky
because:
Theoretical Goal Maximising Shareholder Wealth: - For public companies share prices are increased by
overall stock market—For private companies there’s no share price to track.
Why Profit Isn’t Always a Good Proxy for Shareholder Wealth: - Cash matters more than accounting
profit- short term thinking- Risk of fraud or manipulation- Accounting ignores some costs like interest on debt
Earnings per share: - tells investors how much profit is allocated to each ordinary share. There
are ways to boost EPS
,Share consolidation (reverse stock split): - The company reduces the number of shares by combining
several existing shares into one. Profit stays the same, but fewer shares mean higher EPS. Example:
Share buyback: The company uses cash to buy back its own shares and cancels them. Company Y
has. Example:
REFER EXCEL FOR QUESTION (QUESTION 2)
5. Stakeholder objectives and conflicts
Internal: employees, managers/directors
Connected: shareholders, customers, suppliers, banks, competitors
External: government, community, regulators, pressure groups
STAKEHOLDER WHAT THEY WANT
Shareholders (equity Make money from their investment (dividends + share price growth) because they
investors) take the financial risk.
Managers/Directors Often want to increase their own pay and job security; could focus on short-term
profits or long-term growth.
Employees Good wages, bonuses, job security, safe working conditions.
Customers Good products/services at fair prices.
Suppliers Timely payments and long-term contracts.
Banks/Finance providers Confidence the company can pay back loans with interest.
Government Companies obey laws, pay taxes, create jobs, and help the economy.
Community Companies act responsibly, protect the environment, and contribute to social
welfare.
Conflicts between stakeholders: - Goals of stakeholders might clash
Criticism: - Some people argue that only shareholders take real financial risk, so making them
wealthy should remain the main goal. Still, companies are increasingly aware they operate within a
society and have responsibilities beyond just profit.
Agency Theory: - explains situations where one person (the principal) hires another person (the
agent) to do a job for them.
Conflict: - Shareholders own the company, but managers control it day-to-day. Shareholders rely on
managers to make decisions that increase shareholder wealth. Managers may instead: Maximise
their own pay or bonuses or pursue personal goals
Examples of agency problems: - Remuneration- Empire building- Creative accounting – Unethical activities-
Off balance sheet finance (Enron collapse 2001)
Managerial reward scheme: - The main goal is to align the interests of managers and
shareholders, so managers make choices that increase the value of the company.
Common Types of Reward Schemes: Pay linked to minimum profit levels- Pay linked to Economic Value
Added (EVA)- Pay linked to revenue growth- Executive Share Option Schemes (ESOPs)
6. Measuring achievement of corporate objectives
, comparing different financial numbers from the company’s accounts to understand its performance.
Profitability & Return Ratios: Show how much profit the company makes. Example: Profit margin,
return on capital employed (ROCE).
Debt & Gearing Ratios: Show how much of the company is financed by debt. Example: Debt-to-
equity ratio.
Liquidity Ratios: Show whether the company can pay its short-term bills. Example: Current ratio,
quick ratio.
Investor Ratios: Show information useful for shareholders or potential investors. Example: Earnings
per share (EPS), price/earnings ratio (P/E).
7. Not-for-profit organisations
These organisations do not exist to make money, unlike normal businesses. Their main purpose is to
provide a service or benefit to certain people or to society.
Non-financial objectives are usually more important. They are also harder to measure.
Difference from business: - Many different stakeholders- Stakeholders have strong and sometimes
conflicting interests- Funding bodies (donors, government) influence decisions- Users of the service often pay
little or nothing- Funding is often given in small amounts over time, not all at once - Long-term planning is
common- Government influence is often strong.
ideally, they should try to maximize the difference between: Benefits provided to society − Cost of
running the service
8. Macroeconomic policy
Governments use macroeconomic policies to achieve certain big goals for the whole country. These
goals include: Full employment- Economic growth- Fair distribution of wealth- Price stability (low inflation)-
Healthy balance of payments (import less than export)
Monetary policy: - Monetary policy is when a government or central bank (like the Bank of England,
the European Central Bank, or the Federal Reserve) takes actions to control money and interest rates
in order to achieve economic goals such as low inflation, economic stability, and growth.
Availability of finance: Controlling supply (When the central bank restricts lending credit
restrictions, small businesses find it hard to borrow money). Increasing interest rates (Higher
interest rates mean investors want higher returns. If companies can’t provide these returns,
their share price may fall.)
Cost of finance: Controlling supply (If the central bank reduces the amount banks can lend, there
is less money available. When supply is low, the cost of borrowing increases, making businesses
less likely to expand.) Increasing interest rates (When interest rates rise, borrowing becomes
expensive. Shareholders expect higher returns. If companies fail to deliver, share prices may
drop).
Level of Consumer Demand: Controlling supply (If businesses find it difficult to raise money, they
can’t invest or expand, they spend less, causing demand to fall) Increasing interest rates (Saving
