Financial
Management
Function
Financial Management
● Financial management is concerned with the efficient
acquisition of both short- and long-term financial
resources
● and efficient deployment (investment) of these
resources
● to ensure the objectives of the enterprise are achieved.
Decisions
● investment – both long-term investment in non-current
assets and short term investment in working capital;
● finance – from what sources should funds be raised?
● dividends – how should cash funds be allocated to
shareholders and how will the value of the business be
affected by this?
Objectives and strategies
Objectives/targets define what the organisation is trying to
achieve.
Strategy considers how to go about it.
Objectives can be Financial and non-financial (commercial)
Levels of Business - Corporate, Business, and operational
Objectives
Financial Commercial
Shareholder Wealth Market Share
Maximisation
Social responsibilities
Profit Maximisation
Earnings per share growth Employee welfare
Financial ratios
Shareholder wealth Maximisation
Most companies are owned by shareholders and originally set up
to make money for those shareholders. The primary objective of
most companies is thus to maximise shareholder wealth. This
could involve increasing the share price and/or dividend pay-out.
It ignores other stakeholder interests.
Total shareholder return
Profit Maximisation - Drawbacks
Long-run versus short-run issues: In any business, it is possible to
boost short-term profits at the expense of long-term profits.
(management myopia)
Quality (risk) of earnings: A business may increase its reported
profits by taking a high level of risk. However, the risk may
endanger the returns available to shareholders.
Excessive pressure to maximise profits leads to data manipulation
(Fraudulent financial reporting)
Cash: Accounting profits are just a paper figure (can be
manipulated). Dividends are paid with cash. Investors will therefore
consider cash flow as well as profit
Earnings per share growth
Stakeholders
A stakeholder group is one with a vested interest in the
company.
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.
Stakeholder objectives and Conflicts
Shareholder - Want to maximize their wealth
Directors - Remuneration, Power
Suppliers - Prompt payment
Customers - Quality goods on time
Banks - Interest and minimize default risk
Employees - Reward and employment security
Government - Tax and employment
Community at large - CSR, pollution control,
Maximising versus Satisficing
A company may aim at either maximising or satisficing
objectives.
● Maximising involves seeking the best possible outcome.
● Satisficing involves finding an adequate outcome.
Agency Relationship
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).
The problem arises when agent acting in their own selfish
interests rather than pursuing the objectives of the principal.
Other principal - agent relationships:
(Directors - Employees, Loan creditors - Shareholders)
How to reduce agency problems?
Finding ways to reduce the problems of the agency relationship
and ensure that managers take decisions which are consistent
with the objectives of shareholders is a key issue - Goal
congruence
● Managerial reward Scheme
● Good Corporate Governance - (may be a Stock market listing
requirement in most countries)
If Agency problems is minimised shareholder wealth will be
maximised.
Types of Reward Scheme
● Performance related Pay based on
– based on profit levels (problems of profit)
– additional shareholder wealth
– revenue growth (chances of manipulation)
● executive share option schemes (ESOP).
● Long-term incentive plans (LTIPs) – paying a bonus to directors
if the company's performance over several years is good when
benchmarked against competitors.
ESOP
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.
Corporate Governance Codes
Corporate governance − the system by which companies are directed and controlled.
● Every company should be headed by an effective board Consisting of both EDs and
NEDs
● The board should have a balance of executive and independent non-executive
directors.
● There should be a clear division of responsibilities at the head of the company
between running the board (chairman) and running the business (CEO); no single
individual should dominate.
● All directors should be required to submit themselves for re-election on a regular
basis.
● No ED should be involved in setting his own remuneration. (remuneration committee
consisting of NEDs should)
● Maintain solid internal control systems. (to prevent fraud/error)
Monitoring
One form of monitoring is auditing the financial statements of a
company to confirm the quality and validity of the information
provided to stakeholders.
Not for profit Organisation
● The primary objective of not-for-profit organisations (NFPs or NPOs) is not to
make money but 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
● However, they are often constrained by having multiple stakeholders with
potentially conflicting objectives.
Value for Money and 3E’s
VFM can be defined as ‘achieving the desired level and
quality of service at the most economical cost’.
Economy: securing resources as economically as possible,
that is minimising the input costs of the organisation
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.
Management Accounting
Management accounting is concerned Financial Accounting
with providing information for the Financial accounting is concerned with
more day-to-day functions of control the production of financial statements
and decision-making. This will involve for external users.
budgeting, cost accounting, variance
analysis, and evaluation of alternative Strict format
uses of short-term resources.
financial
No strict format
Past
Financial and non financial
Required by law
Past and future
No legal requirement
