Week 1 Flashcards
(27 cards)
What is Financial Management
Three key decision areas
FM 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.
Investment - ensure finance is used efficiently and effectively to generate return through investment appraisals e.g purchase of NCA
Working Capital Management - liquidity
Financing - a business needs finance - identifying the most appropriate source - taking into account the requirement and demands of investors.
Dividend - if profitable and generate cash - should the business return to SH and how much or retain and invest further.
Differences between the roles of Management Accountant, Financial Accountant and Finance Manager
Management Accountant
- Provide information on the day to day activities/decisions made by the business
- Produce budgets, variance analyses, management accounts
- Role is to help managers make short term decisions, evaluate the effects of those decisions and control business in the short term
Financial Accountant
- Not directly involved in the day to day planning, controlling & decision making
- Produce reports and provide information about historical results of past plans
- Ensure that the business follows accounting principles: reporting, depn, accs & pp
- Purpose is to keep SH and other stakeholders informed of the overall financial position of the business
Financial Managers
- Concerned with the long term e.g raising of finance and ensuring that appropriate resources are used to manage it
- Three key decision areas are: investment, dividend, financing*
The main aim of a business is to maximise shareholder wealth - but how do we do this.. the company must understand how the shareholders perceive wealth
Profit Maximisation
- a business with profits should have cash to pay dividends and see share price grow but this is not always the case –> accounting profits are just paper figures, dividends are paid with cash and therefore investors will consider CF too.
- however, it is possible for a robust SP to exist with low profits if SH’s have confidence
EPS
- often used to see if the company is growing and is a calc of share of profits to shareholders after interest and tax. –> in theory, if SP is growing, happy SH, but again only a measure of profitability and open to same critisicms as profit maximisation.
- doesn’t represent income to shareholder but shareholders share of the income according to accounting formula
NPV
- only taking on projects with a positive NPV should achieve maximisation of SH wealth
- the NPV represents the value added and therefore directly correlates with maximising SH wealth and is main tool used by managers
Examples of different Stakeholders
Internal
* employees & managers/directors
Connected
- shareholders
- customers & suppliers
- competitors
External
- the government
- community
- regulators
Stakeholder Conflict
Professor Charles Handy argues that maximisation of SH wealth cannot be the single overall objective and account must be taken of broader economic and social responsibilities.
Examples
- if focus on SH and upset customers by raising prices to generate profit, could lose custom, profits by failing to meet expecations
- if try to save costs by not awarding pay increases, staff will be demotivated –> lower quality or leave –> business will have to spend on recruiting staff
- Government want profits because of tax which aligns with SH but will also want the company to invest in regulations e.g H&S, minimum wage and must think of the community as a whole.
What is agency theory and what are the problems associated?
often used to understand the relationships between the pricipal and the agent.
Agency relationships occur when one party, the principal, employs another party, the agent, to perform a task on their behalf. directros (agents) shareholders (principals).
e.g employees are also the agents to maangers.
in most of these relationships, conflict will arise. the problem lies when once the agent has been appointed, they are able to act in their own interests rather than pursuing the objectives of the principal.
Examples of Agency Theory
The divorce of Ownership & Control
*the most important conflict between SH and Managers –>mgmt are in the place to make decisions to maximise their own wealth/hapiness over SH
Off-Blanace-Sheet Finance
- refers to ways of financing assets where the method of funding is not recorded on the BS
- EG Enron - use of quasi-subsidiaries whereby liabilities are moved so they dont appear on parent company’s BS lead to the collapse of Enron –> intro of FRS5 aimed to restrict this
Creative Accounting
*directors are responsible for selecting the accounting policies they use - can flatter their accounts and artificially boost share price. e.g capitalising expenses such as repairs and depreciating over a number of years.
Remuneration
*recession 2008-2009 lead to companies reporting reduced profits and laying off staff. many took governemnt assistance but were still paying their top executives highly.
Attempts to prevent agency theory
Introducing carefully designed remuneration packages:
Linked to minimum profit levels: (easy to set up & monitor)
- may lead to mgmt making decisions that result in short term profits at the expense of long term profits
- mgmt may relax when minimum target is reached
Linked to EVA
*a measure of the increase in value of SH wealth in a period
+closely alligns the interests of SHs and mgmt
but - calculating the bonus might be complex
An executive share price option scheme (ESOP)
+encourage mgmt to maximise the value of shares of the company –> awarding share options should encourage them to make decisions that will cause the price to rise –> inline with owners
+normally set up over a long period of time –> encouraging managers to invest in positive return projects –> SP increase
- when SO are exercised, directors tend to sell to cash in on profit, unless offered more their interest in SP might end
- if SP falls when options are awareded, they will not act as an incentive
- offering too much could dilute the SP, suggested that companies should recognise cost in P&L
- directors may distort reported profits to protect the SP
Corporate Governance codes linked to Agency Thoery and the divorce of ownership and control
NEDs
- atleast half of the board should be independent
- must give obligation to spend sufficient time with the compnay
- important presence on the board as they can act as a form of control because they are independent and provide advice
Executive Directors
- separation of chairman and cheif executive officer
- must submit for re-election
- must be clear disclosure of financial rewards
Not for Profits -performance measures of value for money
essential as public funded
VFM can be defined as ‘achieving the desired level and qaulity of service at the most economincal cost’.
Performance measures have been developed to evaluate each functioning aspect of the organisation in turning inputs into outputs and evalutating if these are meeting the desired targets
Economy
*acquiring resources of appropriate qualitiy and qauntity at the lowest cost - these purchases should be fit for purpose and meet predetermined standards.
Efficiency
*maximising the output from a given level of resources (input driven) or minimising the inputs required for a required level of output (output driven).
Effectiveness
- ensuring that the output from any given activity is achieving the desired result
- e.g building something economincally and efficiently doesnt always mean that it will meet the stated objectives and be effective.
What is Macroeconomic Policy?
What are its objectives?
Macroeconomic policy is the management of the economy by government to influence the performance and behaviour of the economy as a whole
objectives:
- Economic Growth - high –> improving living standards
- Inflation - low and stable –> price stability
- Unemployment - low –> full and stable employment
- Balance of payments (imports & exports) - Equal –> ratio of imports to exports
Conflict between Macroeconomic objectives
The simultaneour achievement of all macroeconomic objectives is extremely difficult, two examples are:
Full employment vs Price Stability
- It is sugested that inflation and employment are inversely related.
- The achievment of full employment may therefore lead to excessive inflation through an excess level of aggregate demand in the economy (more money, buy more, low supply pushes up prices)
Economic Growth vs Balance of Payments
*Rapid economic growth may have damaging consequences for the BOP in the short term, since rapidly rising incomes may lead to rising level of imports.
Policy objectives may conflict, governments will have to consider trade-offs between objectives.
Instruments of macroeconomic policy
Maintain stable aggregate demand –> helps businesses plan:
investment, employment and output
or. . influence costs through
* Monetary policy - interest rates
* Fiscal policy - taxation
* Exchange rates
Aggregate Demand
as an instrument of Macroeconomic Policy and its effect on business planning
AD is the total demand for goods and services in the economy. National income is the AD that has been satisified by the provision of goods and services.
The broad thrust of MP is to influence the level of AD in the economy - it is central to the determination of the level of unemployment and rate of inflation.
Changes in AD will affect all businesses and effective
business planning is reliant on the business:
- prediciting the impact of the MP in the short to medium term
- prediciting the concequences for sales growth
the more stable the government policy is, the easier it is for a business to plan investment, employment and future output.
Effects of changes in other instruments of MP on business planning
(NOT AD)
What are they?
Exchange rates
MP may involve changes in exchange rates - this might raise the domestic price of imported goods and lead to a rise in home countries production costs.
Taxation
Fiscal policy - changes in tax rates or structure of taxation will affect businesses e.g change in NIC could increase labour costs. changes in indirect tax will either need to be absorbed or passed on to customer
Interest rates
Monetary Policy - changes in interest rates, directly affect firms in two ways:
*Costs of debts will change - especially for highly geard companies
*The viability of investments will be affected - cost harder to predict
What is Monetary Policy?
Monetary Policy is concerned with influencing the overall monetary conditions in the economy, in particular:
- the volume of money in circulation (supply)
- the price of money (interest rates)
Two problems with the use of Monetary Policy
The objective is to influence some important variable in the economy e.g level of demand, rate of inflation or exchange rate for the currency.
The Choice of Targets
*To target either the volume of money - the stock of money is believed to have important effects on the volume of expenditure in the economy - in turn might affect the level of output or level of prices e.g if harder to lend because bank reserves are higher, people will spend less vise versa
*Target the price of money - if the government wants to influence the amount of money held in the economy or the demand for credit they may attempt to infleunce interest rates. e.g high interest rates will mean people save more and spend less, vise versa.
Effects on Interest Rates
Controlling the level of interest rates is easier than controlling stock but the effects are less certain:
Investment may be affected more than consumption - rate of interest is the main costs of investment by businesseses but consumption by individuals are not generally financed through credit, therefore less affected by changes
therefore - economic growth and international competitiveness could be serious long term effects
Effects can be uneven - the demand for consumer goods bought on credit eg goods for houses are most effected, this type of policy will iduce instability in some sectors.
What is interest rate smoothing and why is it used
A policy of some central banks to move official interest rates in sequence of relatively small steps in the same direction, rather than waiting until making a single larger change
Reasons:
- Economic - to avoid instability and need to reverse policy
- Political - higher rates are broken to the electorate gently.
Impact of Monetary Policy on availability of finance, cost of finance and level of exchange rates
Availability of Finance -
Credit restrictions will make it difficult for small or medium sized or new firms to raise finance and will impact financial decisions to expand.
Cost of Finance -
Any restrictions on credit will increasse the cost of borrowing, making investment projects less worthwhile and discourage expansion - share prices may fall
Level of exchange rates -
MP which increases the level of domestic interest rates will likely raise exchange rates - FMs must considedr methods of hedging exchange rate risk and the effect of changes in ERs on their position as importers and exporters
Impact of Monetary Policy on Inflation and Business cash flows and profits
MP often used to control inflation - makes business decisions harder - timing of purchases and borrowing etc becomes critical.
The effect depends on the form of inflation and the nature of of the markets in which the company operates.
Demand-pull - occurs when excess aggregate monetary demand enables companies to raise prices and expand profit margins
Cost-push - occurs when production costs increase, independent of state of demand. initally affects profits but extent depends on the businesses ability to pass on cost increases.
Cost push will always result in a negative effect on cash flow but demand pull wont always be positive unless cost plus mark up
- excess demand may lead to companies expanding output, increasing their costs, companies pass on increased costs as higher prices however in most cases inflation will reduce profits and cash flow in the long run.
What is Fiscal Policy
Fiscal policy is where the government uses changes in government spending, taxation and government borriwng to manipulate the economy
e.g if the government chooses to increase spending to try and stimulate the economy it must either be financed through increasing taxes or by borrowing more.
Three Budget Positions in Fiscal Policy
A balanced budget - Expenditure matches income
A Deficit Budget - Expenditure exceeds income, deficit funded by borrowing
A Surplus Budget - Income exceeds expenditure, surplus can be used to pay back public debt
Problems of Fiscal Policy
Crowding Out
FP can lead to ‘financial crowding out’ whereby government borrowing leads to a fall in private investment.
Increased borrowing leads to higher interest rates by creating a greater demand for money.
The private sector who is sensitive to IRs will then reduce investment due to lower rate of return, this is the investment that is crowded out.
The reduced investment counteracts the economy boosting benefits of governemnt spending.
Incentives
All taxes have some effect. Some can be useful eg controlling the pattern of consumption - high excise duties on alcohol or tobacco.
However, raising NIC would increase the costs of labor and probably reduce employment.
Income tax would reduce incentive to work.
Government Intervention and Regulation as a more specific measure to regulate business
Competition Policy
Look at this further!!!!
It’s not the governments place to set prices for goods and services provided by businesses but in markets such as monopolies, where there is no competition and business is a price maker rather than taker.
Can lead to: economic inefficiency (no incentive to reduce costs if people will pay higher price) price discrimination (charging different prices to different customers)
