Strategic Financial Management
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Overview of the objectives of strategic financial management
What is financial management?
ÐThat part of management accounting concerned with setting financial objectives, planning and acquiring the optimum finance to meet them, and seeing that fixed and working capital are effectively managed. (CIMA).
Two fundamental questions:
1. What investments should a firm make?
Long term investments are referred to as Ðcapital investment projects
e.g. build a new supermarket or factory.
2. How should the firm pay for those investments?
Sources of finance, i.e. where should the money come from?
e.g. Should the supermarket or factory be financed by borrowing money from the bank?
Diagrammatic overview of a public limited company
Stakeholder:
A party with an interest in an organisation (Arnold, p.7)
Learning activity:
1) Who are the main stakeholders in Tesco plc?
2) Who are the most important ones and why?
The primary objective of strategic financial management
A company should make investment and financing decisions with the aim of maximising shareholder wealth.
Other possible financial objectives:
Maximise profits
Maximise sales
Survival
Social responsibility
Agency theory
“Theory of the relationship between a principal, e.g. a shareholder, and an agent of the principal, e.g., the companys manager.” (BMA, p.995)
Key issues:
Divergence of ownership and control
The goals of the managers (agents) differ from those of the shareholders (principals)
What will managers wish to maximise?
The risk attitude of managers may differ from that of the shareholders
Asymmetry of information
Agency costs: “The direct and indirect costs of attempting to ensure that agents act in the best interest of principals as well as the loss resulting from failure to get them to act this way.” (Arnold, p.983)
Sources of Finance
Internal v external sources
Internal
Funds available from within the company.
1. Cash generated by a company which is not needed to meet operating costs, interest payments, tax liabilities, cash dividends or fixed asset replacement..
This source is a direct result of the DIVIDEND DECISION, i.e. if directors reduce the size of the dividend paid to shareholders this increases the amount of retained earnings.
2. ÐSavings generated by more efficient management of working capital e.g. if a business can reduce its stock level, this releases funds to invest elsewhere.
External
Funds obtained from providers of finance outside the company.
Fundamental decisions:
Equity or debt?
Short-term v long-term?
Short-term = up to 1 year
Long-term = greater than one year
Ordinary share (or equity share) capital
ÐShares that entitle the holders to the remaining divisible profits (and, in a liquidation, the assets) after prior interests, e.g. creditorsÐ have been satisfied. (CIMA).
N.B. Normally, the capital invested by ordinary shareholders is not repaid (by the company).
Debt capital/loan capital/borrowed capital
1. Money which is loaned to a business enterpriseÐ… on which interest is payable at a rate which does not depend on the amount of profit made by the enterprise (French).
2. Capital used to finance an organisation that is subject to payment of interest over the life of the loan, at the end of which the loan is normally repaid e.g. mortgage debentures which are secured on the specific assets of the organisation.
Fundamentals of accounting and accounting statements
Financial accounting
1. The periodic external accounting reporting function, statutorily required for shareholders.
2. The classification and recording of the monetary transactions of an entity in accordance with established concepts, principles, accounting standards and legal requirements and their presentation, by means of profit and loss accounts, balance sheets and cash flow statements, during and at the end of an accounting period
(CIMA).
Fundamental accounting concepts
The broad basic assumptions which underlie the periodic financial accounts of business enterprises. The four following fundamental concepts are regarded as having general acceptability:
Going concern: the enterprise will continue in operational existence for the foreseeable future.
Accruals: Revenue and costs are accrued (that is recognised as they are earned or incurred, not as money is received or paid), matched with one another….provided that where the accruals concept is inconsistent with the prudence concept the latter prevails. Revenues and profits dealt with in the profit and loss account are matched with the associated costs and expenses by