ACCA Financial Management Study set
The nature and purpose of financial management -: Financial management is
concerned with the efficient acquisition and deployment of both short- and long-term
financial resources, to ensure the objectives of the enterprise are achieved
Management accounting -: Concerned with providing information for the more day-to-
day functions of control and decision making
Financial accounting -: Concerned with providing information about the historical
results of past plans and decisions
Corporate strategy -: Concerns 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
Business strategy -: Concerns 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
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. Interested in the decisions facing the finance function. These day-to-day
decisions include all aspects of working capital management
Financial objectives -: - Shareholder wealth maximisation
- Profit maximisation
- Growth
- Market share
- Social responsibilities
Stakeholder objectives and conflicts -: A stakeholder group is one with a vested
interest in the company
Typical stakeholders for an organisation would include:
Internal
- company employees
- company managers/directors
Connected
- equity investors (ordinary shareholders)
,- customers
- suppliers
- finance providers (debt holders/bankers)
- competitors
External
- the government
- the community at large
- pressure groups
- regulators
Managerial reward schemes -: One way to help ensure that managers take decisions
which are consistent with the objectives of shareholders is to introduce carefully
designed remuneration
packages. 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 include:
Remuneration linked to:
- minimum profit levels
- economic value added (EVA)
- revenue growth
Executive share option schemes (ESOP)
Corporate governance codes -: The director/shareholder conflict has also been
addressed by the requirements of a number of corporate governance codes. The
following key areas relate to this conflict
Non-executive directors (NEDs)
- 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
Executive directors
- separation of chairman and chief executive officer (CEO)
- submit for re-election
- clear disclosure of financial rewards
Value for money (VFM) and the 3 Es -: VFM can be defined as 'achieving the desired
level and quality of service at the most economical cost'
,The 3 Es:
Economy: Minimising the costs of inputs required to achieve a defined level of output
Efficiency: 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)
Effectiveness: Whether outputs are achieved that match the predetermined objectives
ROCE (return on capital employed) -: This is also known as accounting rate of return
(ARR)
ROCE = (Average annual profits before interest and tax / Initial capital costs) x 100
or ROCE = (Average annual profits before interest and tax / Average capital investment)
x 100
Average capital investment =
(Initial investment + scrap value) / 2
Decision rule:
If the expected ROCE for
the investment is greater than the target or hurdle rate (as decided by management)
then the project should be accepted
Advantages and disadvantages of ROCE -: Advantages include:
- simplicity
- links with other accounting measures
Disadvantages include:
- no account is taken of project life
- no account is taken of timing of cash flows
- it varies depending on accounting policies
- it may ignore working capital
- it does not measure absolute gain
- there is no definitive investment signal
Accounting profits and cash flows -: In capital investment appraisal it is more
appropriate to evaluate future cash flows than accounting profits, because:
- profits cannot be spent
- profits are subjective
- cash is required to pay dividends
Cash flows and relevant costs -: For all methods of investment appraisal, with the
exception of ROCE, only relevant cash flows should be considered.
, These are:
- future
- incremental
- cash-based
- opportunity costs
Ignore:
- sunk costs
- committed costs
- non-cash items
- allocated cost
Payback method of appraisal -: The payback period is the time a project will take to
pay back the money spent on it. It is based on expected cash flows and provides a
measure of liquidity
Decision rule:
- only select projects that pay back within the specified time period
- choose between options on the
basis of the fastest payback
Payback period = initial investment / annual cash flow
Advantages and disadvantages of payback -: Advantages include:
- simple
- useful in certain situations:
> in rapidly changing technology
> improving investment conditions
- favours quick return:
> helps company growth
> minimises risk
> maximises liquidity
- it uses cash flows, not accounting profit
Disadvantages include:
- ignores returns after the payback period
- ignores the timings of the cash flows
- subjective - no definitive investment signal
- ignores project profitability
Time value of money -: Money received today is worth more than the same sum
received in the future, i.e. it has a time value
This occurs for three reasons:
- potential for earning interest/cost of finance
- impact of inflation
- effect of risk
The nature and purpose of financial management -: Financial management is
concerned with the efficient acquisition and deployment of both short- and long-term
financial resources, to ensure the objectives of the enterprise are achieved
Management accounting -: Concerned with providing information for the more day-to-
day functions of control and decision making
Financial accounting -: Concerned with providing information about the historical
results of past plans and decisions
Corporate strategy -: Concerns 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
Business strategy -: Concerns 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
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. Interested in the decisions facing the finance function. These day-to-day
decisions include all aspects of working capital management
Financial objectives -: - Shareholder wealth maximisation
- Profit maximisation
- Growth
- Market share
- Social responsibilities
Stakeholder objectives and conflicts -: A stakeholder group is one with a vested
interest in the company
Typical stakeholders for an organisation would include:
Internal
- company employees
- company managers/directors
Connected
- equity investors (ordinary shareholders)
,- customers
- suppliers
- finance providers (debt holders/bankers)
- competitors
External
- the government
- the community at large
- pressure groups
- regulators
Managerial reward schemes -: One way to help ensure that managers take decisions
which are consistent with the objectives of shareholders is to introduce carefully
designed remuneration
packages. 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 include:
Remuneration linked to:
- minimum profit levels
- economic value added (EVA)
- revenue growth
Executive share option schemes (ESOP)
Corporate governance codes -: The director/shareholder conflict has also been
addressed by the requirements of a number of corporate governance codes. The
following key areas relate to this conflict
Non-executive directors (NEDs)
- 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
Executive directors
- separation of chairman and chief executive officer (CEO)
- submit for re-election
- clear disclosure of financial rewards
Value for money (VFM) and the 3 Es -: VFM can be defined as 'achieving the desired
level and quality of service at the most economical cost'
,The 3 Es:
Economy: Minimising the costs of inputs required to achieve a defined level of output
Efficiency: 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)
Effectiveness: Whether outputs are achieved that match the predetermined objectives
ROCE (return on capital employed) -: This is also known as accounting rate of return
(ARR)
ROCE = (Average annual profits before interest and tax / Initial capital costs) x 100
or ROCE = (Average annual profits before interest and tax / Average capital investment)
x 100
Average capital investment =
(Initial investment + scrap value) / 2
Decision rule:
If the expected ROCE for
the investment is greater than the target or hurdle rate (as decided by management)
then the project should be accepted
Advantages and disadvantages of ROCE -: Advantages include:
- simplicity
- links with other accounting measures
Disadvantages include:
- no account is taken of project life
- no account is taken of timing of cash flows
- it varies depending on accounting policies
- it may ignore working capital
- it does not measure absolute gain
- there is no definitive investment signal
Accounting profits and cash flows -: In capital investment appraisal it is more
appropriate to evaluate future cash flows than accounting profits, because:
- profits cannot be spent
- profits are subjective
- cash is required to pay dividends
Cash flows and relevant costs -: For all methods of investment appraisal, with the
exception of ROCE, only relevant cash flows should be considered.
, These are:
- future
- incremental
- cash-based
- opportunity costs
Ignore:
- sunk costs
- committed costs
- non-cash items
- allocated cost
Payback method of appraisal -: The payback period is the time a project will take to
pay back the money spent on it. It is based on expected cash flows and provides a
measure of liquidity
Decision rule:
- only select projects that pay back within the specified time period
- choose between options on the
basis of the fastest payback
Payback period = initial investment / annual cash flow
Advantages and disadvantages of payback -: Advantages include:
- simple
- useful in certain situations:
> in rapidly changing technology
> improving investment conditions
- favours quick return:
> helps company growth
> minimises risk
> maximises liquidity
- it uses cash flows, not accounting profit
Disadvantages include:
- ignores returns after the payback period
- ignores the timings of the cash flows
- subjective - no definitive investment signal
- ignores project profitability
Time value of money -: Money received today is worth more than the same sum
received in the future, i.e. it has a time value
This occurs for three reasons:
- potential for earning interest/cost of finance
- impact of inflation
- effect of risk
