Financial management function Learning objectives ‘On completion of this chapter, you should be able to: The nature and purpose of financial management + Explain the nature and purpose of financial management. + Explain the relationship between financial management and financial and management accounting. Financial objectives and the relationship with corporate strategy + Discuss the relationship between financial objectives, corporate objectives and eompnrnte strategy, + Identify and describe a variety of financial objectives, including: shareholder wealth maximisation, profit maximisation, earnings per share growth, Stakeholders and impact on corporate objectives + Identify the range of stakeholders and their objectives. + Discuss the possible conflict between stakeholder objectives. + Discuss the role of management in meeting stakeholder objectives, including the application of agency theory, + Describe and apply ways of measuring achievement of corporate objectives including: ratio analysis (using appropriate ratios such as ROCE, ROE, EPS ‘and DPS) and changes in dividends and share prices as part of total shareholder return. + Explain ways to encourage the achievement of stakeholder objectives, Including: managerial reward schemes (such as share options and performance-related pay), regulatory requirements such as corporate governance codes of best practice and stack exchange listing regulations. Financial and other objectives in not-for-profit organisations + Discuss the impact of not-for-profit (NFP) status on financial and other objectives, + Discuss the nature and importance of value for money as an objective in NFP organisations. + Discuss ways of measuring the achievement of objectives in NFP organisations Syllabus reference Ata) At(b) A2(0) Aa(b) A3(o) A3(b) A3(e) A3(d) Aaa(e) AN(a) As(b) AMO)Exam context This chapter covers Section A of the syllabus (the financial management function). This is an important chapter that is commonly exomined in Section of the exam and could also feature in a Section B mini case study scenario question. Part of a Section C exam question could examine some of the themes of this chapter, but these areas will not be the main focus of Section C question, This chapter also sets out the main themes of financial management; these will be covered in later chapters. 2 Financil Menagement (FM) @prpChapter overview Financial management function Definition Framework for maximising shareholder wealth Total shareholder return (18%) Investmont decision Maximisation of ‘Financing decision shareholder wealth | | Dind don ws | Rak management Other Not-for-profi stakeholders organisations Interna stakeholders Prof ratos Volue for money | | Connected stolaholdrs Dob ratios | | External stakeholders Lgutay ratios | | Non-financiol Shoreholderotios performance mecsures @ sep 1: rand menagement funtion Encouraging shareholder wealth maximisation | ‘Agency theory Incentive schomas Corporate governance: Financial management ‘compored to management and financial accounting Different from ‘management ‘eccounting Different from financial ‘accounting a14.3 Purpose of financial management Definition of financial management Financial management: The acquisition and deployment of financial resources to achieve key objectives. We can analyse this definition by breaking it dawn into its separate ports. Acquisition of financial resources ‘This involves obtaining suitable sources of finance and is a financing decision. In selecting sources of finance, risk will be a consideration since some sources of finance create risk for a business (eg variable rate bank loan may expose a company to the risk of interest rate increases). Deployment of financial resources ‘This involves using a business's financial resources effectively and can Involve deciding whether or Not to invest in projects (the investment decision), and whether or not to return surplus cash to shareholders (the dividend decision). When making investments, risk will again be a consideration. Key financial objectives — profits Profit maximisation is often assumed to be the main financial objective of « businass. In fact this is not the assumption made in financial management and, in reality, shareholders often express disappointment in a company's porformance even when profits are rising; this suggests that profit is not sufficient as a financial objective. Activity 1: Financial abjectives 8B Co has just released its financial results for the year and its profits before tax increased by 38% over the previous year. This was due largely to a doubling of sales in South-East Asia. However, the share price in B Co fell by almost 20% immediately after the profit announcement. Which of the following is the LEAST likely explanation for the fall in share price? © Soles in South-East Asio had been expected to increase by more than 100%. (© The depreciation charge was higher due to a change in accounting policy. © The level of B Co's business risk has increased over the year. (© Dolays in the launch of new products are expected in the coming yoar. Profit, as a financial objective, has a number of drawbacks: (@) Itis historie and is not future-oriented: it therefore does not measure the future potential of acompany (©) It does not measure liquidity or risk: both are Important commercial issues (©) Itcan be manipulated eg by the use of accounting policies However, profit and profit-based ratios such as earnings per share will continue to be monitored by investors as thay are evidence of the returns that have actually been achieved by a company. 4+ Financial Management EM) @prpx 1 Earnings per shore (EPS): Profits distributable to shoreholders/Number of ordinary shares Distributable profits will be after interest, tax and preference dividends. Other profit-based ratios (euch os return on capital employed) are covered later in the chapter. Key financial objectives - shareholder wealth maximisation For a for-profit company, maximisation of shareholder wealth is assumed to be the main financial objective, although profit-based objectives are still important. The wealth of the shareholders in a company comes from: + Dividends received + Market value of the shares The market value of shares will depend on the forecast future cash flows of the company, and the perceived risk of these cash flows, These forecasts will result from a financial analysis of tho impact of a firm's long-term business plane, io its eorporate strategy. The ability of a firm to ereate wealth for shareholders is measured by total shareholder return (TR). ‘Total shareholder return: Dividend + change in share price/Share price at the start of the year Illustration 1: TSR [A shareholder purchased 1,000 shares in SUG Co on January 20X1 at a market price of $2.50 per share. On 31 December 20X! the shares had a market value of $2.82 per share, The dividend paid during 20X! was $0.28 per share. Calculate total shareholder return. 6 Solution 2H] % Copital gain during the year is $2.82 - $2.50 = $0.32 The total shareholder return is: ($0.28 + $0.32)/$2.50 = 0.24 or 24% This is made up of the capital gain of $0.32/$2.50 = 0.128 or 12.8% ‘and the dividend return or dividend yield of $0.28/82.50 = 0.112 oF 11.2% Exam focus point Students often forget to use the start of year share price ae the denominator when calouloting the total shareholder return. The start of the period share price needs to be used, as the return being calculated is the return on the share price paid at the start of the period, @ BPP {:Financial management function 5Eg Activity 2: Calculation of financial objectives Magneto ple has objectives to improve earnings per share (EPS) and dividends per share (DPS) by 10% per year. Profits before Interest and tax Interest Tox Profits after interest and tex Preference idends Dividends Retained earnings No. of ordinary shares issued (millions) (Ordinary share price at the ond of the year 1 What is the current year earnings per ordinary share? © 145 cents © 14.3 cents © SZcents © 5.3cents 2 What ie the growth in the dividend por ordinary ohare? 0 O% © 8.0% © 8.6% © 78% 3 What is the total shareholder return in the current year? © 11.6% © 10.6% © 98% © 1.8% Solution Lost year Sm 22,300 3,000 5,790 13,510 200 7986 5324 100,000 $4.70 per share Current year $m 23,726 3,000 6.218 14,508 200 8,585 5,723 400,000 $5.16 per share 6 Financial Management (EM)wl Essential reading ‘See Chapter 1 Section 1 of the Essential reading for further discussian of financial management ‘and financial ratios. The Essential reading is avallable as an Appendix of the digital edition of the Course Book. 2 A framework for maximising shareholder wealth Videos can be viewed by accessing your ebook version on VitalSource. Financial management is based on a framework of decisions that are designed to maximise shareholder wealth, (reser doco) dan Fikaragonert) 2.1. Investment decision Fitstly, and most importantly, the investment decision eg in projects) analyses proposed investments to ensure they are beneficial to the investor and manimise sharsholder wealth; this Is mainly covered in Chapters 3, 5, 6, 7,8 and 13. Investments ore olso eructal in helping a firm to achieve key corporate objectives such as market share and quality, and in achieving financial objectives such as improving earnings per share, 2.2 Financing decision Financing decisions mainly focus on how much debt a firm should use, and a key aim is to minimise the cost of capital. This area is focused on in Chapters 4, 9, 10, 1 and 12, 2.3 Dividend decision The dividend decision considers how much to pay out to shareholders. It is determined by how much a firm has decided to spend on investments (the Investment decision) and how much of the finance needed for this it has decided to raise externally (the finance decision) and is a good example of the Interrelationship between these key decisions. The dividend decision is covered in Chapter 10. 2.4 Risk management Risk needs to be considered in determining what type of finance to raise, how to invest it and whether to pay a dividend. Risk matters to shareholders and therefore needs to be carefully managed. Risk management is mainly covered in Chapters 14 and 15. @spp 1: Financial management fun3 Encouraging shareholder wealth maximisa' 3.1 Corporate and financial objectives 3.11 Corporate strategy and objectives Corporate strategy Is a long-term plan for how an organisation intends to compete, and which markets it intends to compete in. Corporate objectives are the overall cims of an organisation that should result from the successful implementation ofits corporate strategy. Some corporate objectives, such as shareholder wealth maximisation and profit maximisation, have already been considered. Other corporate objectives reflect the existence of other groups with @ powerful interest in how a company is being run (stakeholders). The fellowing tables gives some examples of such objectivos. level of market share will often be critical in order to be | competitive. | This might include environmental concerns such as pollution and sustainability, and also treatment of employees and suppliers. Survival | Ezpocially non economic recession, the short-term survival of a | company is italy to be In the best interest of shareholders. 3.1.2. Relationship to financial objectives From a financtal management perspective, itis argued that corporate objectives should normally only be pursued in support of c long-run objective to maximise shareholder wealth, Ae such, there are come potential conflicts to be aware of, Market share | An overly aggressive approach to chasing sales can create | pressure on profit if prices are cut in order to do this. Liquidity problems may also arise (se0 section on overtrading in section 2 of Chapter 3) Expenditure on achieving these goals may be in line with | ochieving shareholder wealth maximisation. However, if excessive | spending on achieving this cbjective compromises the competitiveness of a company, then there may be a conflict that needs to be managed. In the longer term, it may be better for a company to close down or sell-out to another company and to cease to exist as an entity: | this would release funds back to shareholders to invest ina more | productive way. The ability of a company to manage the potential conflict between corporate and financial objectives will depend on the actions of its managers (see section 3.2) and the effectiveness of its corporate governance processes (see section 3.3).3.2 Agency theory Agency relationship: A description of the relationship betwoon business owners (og ELS shareholders) ond those acting as agents on their behalf (eg managers), expressing the idea that managers act as agents for the owners, using delegated powers to run the company in the owners’ best interests, Ino for-profit company, the ordinary shareholders (equity shareholders) are the owners of the company to whom the board of directors is accountable, the actual powers of shareholders tend tobe restricted, except in companies where the shareholders are also the directors, The day-to~ day running of a company is the responsibility of management. Managers can therefore be sald to be acting as the agents of shareholders. However, monagers (unless they have a significant equity stake in a business) may not behave in ‘a way that is likely to maximise shareholder wealth. The danger that managers may not act in the best interest of owners (eg shareholders) is referred to os the agency problem. Maximisation of short-term profits at the ‘expence of long-term profite (chort-termiem) For example, by cutting back on investments = to eneure short-term profit targets ora mot ‘end te ensure profit-related bonuses are paid Minimise dividend payments To free up funds to use within the business Neglect risk management There is often a greater focus on profit Remuneration may be set at excessively generous levels, that damage shareholder wealth Boost their own pay and perks Agency problems can be addressed by monitoring the actions of manogement (corporate governance) or by the use of incentive schemes. 3.3 Corporate governance In many countries, including the UK, the corporate governance regulations have been doveloped to monitor the actions of management. © corporate governance: The ues nd proses by whch the bebavour oom erected Hee are some common fetures, which ore patof the ltng requirement or mojr stock exchanges such as the London Stock Exchange: + Separate MD and chairman (to reduce the | power of a single individual) + Significant % of the board consisting of non-executive directors (NEDs ~ part-time directors who moniter the actions of executives) + NEDs should be independent (three-year contract, no share options) @spp Remuneration committee + Pay and ince! set by NEDs Audit committee + Monitors risk management processes + NEDs only Nomination committee + Choice of new directors by NEDs |: Financial management function — 93.3.1 Other stock exchange regulations In addition, other stock exchange requirements increase the serutiny of directors by shareholders; for example: + The regular publication of financial accounts (including information on future strategy and risk management policies) + Regular updates to the stock exchange on trading performance. Activity 3: Corporate governance The following statements have been made about corporate governance. (Sound aystems of carparate gavernanne involve the establishment of risk management and ternal control procedures for the organisation. (2) Good corporate governance requires the organisation to always act in an ethically acceptable manner even if that is contrary to the law. (@) Anon-executive director should not be paid for his services to the organisation in order to keep him independent. Which of these statements is/are correct? © ond @) only © (,@and@ © only © @only Incentive schemes Goal congruence: The alignment between the objectives of agents acting within an organisation and the objectives of the organisation as a whole. Goal congruence may be better achieved and the ‘agency problem’ better dealt with by offering organisational rewards (more pay and promotion) for the achievement of certain levels of performance. Examples of such remuneration incentives are: (©) Performance-related pay (PRP) Pay or bonuses are usually related to the size of profits, but other performance indicators may be used. PRP may create problems if rewards are based on short-term profits because this may encourage managers to focus on short-term profits at the expense of long-term profits. It may be better to award pay on a broader range of targets (Including for example, {otal shareholder return and key non-financial measures). Cash or share awards may be given for achieving good performance. (©) Shore options Ina share option scheme, selacted employees are given a number of share options, each of which gives the holder the right after a certain date to subscribe tar shares in the company at «@ fixed price, The value of an option will increase if the company is successful and its share goes up, So, manogers now have an interest that aligns with shareholders (ie a higher share price). However, itis debatable whether share options are really motivational because some managers may feel that there are more powerful forces than their own performance that rive share prices and that these ore largely beyond their control (eg market sentiment). 10 Finoncil Management M) @ seruA 4ad 4.2 4.3 Needs of other stakeholders lerests ore affected by the activities of a firm. Stakeholders: Groups or individuals whose ‘Types of stakeholder Stokeholders can be classified os: (©) Internal ~ staff, managers (6) Connected ~ finance providers (shareholders, banks), customers, suppliers (©) External - government, trade unions, pressure groups Shareholders are normally the most important stokeholder group, but the interests of other stakeholders are often important too. difficulty in meeting stokeholder needs is that there is often « conflict between stakeholder objectives, eg there is a short-term conflict between achieving profit for shareholders and delivering pay rises to stoff, Resolving this conflict will equire the development of acceptable compromises, eg poy rises could be linked to productivity gains. Examples of stakeholder conflict Between different shareholder groups Some shareholders might have a preference for short-term dividends, others for long-term capital gain (requiring more cash to be reinvested, cnd less to be paid as 0 dividend). Shareholders and staff/customers/suppliers Pursuit of short-term profits may lead to difficult relationships with other stakeholders. For ‘example, relationships with suppliers and customers may be disrupted by demands for changes to the terms of trade. Employees may be made redundant in a drive to reduce costs. ‘These policies may aid short-term profits, but at the expense of damaging lona-term relationships ‘and consequently damaging shareholder value in the long term. Shareholders and external stakeholders The Impact of «company's settles may impact eeverely ons environment eg nls, pollution, Managers and shareholders ‘This has been discussed earlier, in section 3.2 (agency theory). Non-financial performance measures ‘To ensure that the interests of other stakeholder groups are not neglected, non-financial measures can be Used in addition to financial measures. Here are some examples: (©) Staff ~ staff turnover (percentage of staff leaving during a year) (©) Customers - liquidity ratios, complaints, market share (©) Suppliers - payables (creditor) days Financial performance measures Financial ratios are normally spit into four categories; each type is likely to be of interest to different stakeholders (note that these ratios need to be learnt): (©) Profital (©) Debt ratios - important to banks (©). Liquidity ratios — important to suppliers and customers (@) Shareholder investor ratios ~ important to shareholders lity ratios ~ important to assess managerial performance Q@erp 1iFhranolmenogementfunetion #143d 43.2 4.3.3 [Link] Profitability ratios Profitability ratios include: Return on capital employed (ROCE) = (Profit from operations/Capital employed) % Profit from operations = before interest and tox Capital employed = equity plus long-term debt (or total assets less current liabilities) ‘This is an important ratio because you cannot assess profits or profit growth properly without relating them to the amount of funds (the capital) employed in making the profits. ROE (return on equity) = Profits after interest and tax/Shareholders funds Another measure of the firm's overall performance is return on equity. This compares net profit, after interest and tax with the equity that shareholders have invested in the frm, Debt ratios Debt ratios include: Gearing = Book value of debt/Book value of equity (lternatively this could be calculated as debt/(debt + equity) and could use book or market values, so read the question carefully) Debt ratios are concemed with how much the company owes in relation to its size and whether I Is getting into heavier debt or Improving Its situation. The main debt and gearing ratios are covered in Chapter 12 The interest cover or coverage ratio is « measure of the affordability of interest payments. oft from operations/interest {As a general guide, an interest coverage ratio of less than three times is considered! low, indicating that profitability is too low given the gearing of the company. However, a better benchmark would be the industry average interest cover, and this is often given ina question. Interest cover Liquidity ratios Liquidity rotios include: Currant ratio = Current assets/Current liabilities Acid Test ratio = Current assets (less inventory)/Current liabilities ‘A company should have enough current assets that give a promise of ‘cash to come’ to meet its commitments to pay its current abilities. Superficially, a current ratio in excess of 1 implies that the organisation has enough cash and near-cash assets to satisfy its immediate liabilities. Componies are unable to convert all their current assets into cash very quickly. In some businesses where inventory turnover is slow, most inventories are not very liquid assets. For this reason, we coleulate an additional liquidity ratio, known as the quick ratio or acid test rati Shareholder investor ratios Shareholder i Dividend yiold = (Dividend per share/Market price per share) * 100 Earnings per share (EPS) = Profits distributable to ordinary shareholders/Number of ordinary shares issued) Price/earnings (P/E) ratio = Market price per share/EPS The value of the P/E ratio reflects the markot's eppraisal of the share's future prospects - the more highly regarded a company, the higher will be its share price and its P/E ratio. wvestor ratios include: 12 Financial Management FM) @ sppy 4: Calculation of financial objectives fS> Acti 7 ‘Summary financial information for Robertson pl is given below, covering the last two years. Previous year Current yeor $000 $000 Turnover 43,800 48,000 Cost of soles 16,600 18,200 Solaries and wages 12,600 12900 Other costs 5900 7900 Profit before interest and tax 8,700 9500 Interest 4,200 1,000 Tox 2400 2,800 Profit after interest and tax 5,100 5,700 Dividends payable 2,000 2,200 Shareholders’ funds 22,600 25,700 Long-term debt 11,900 9,000 Number of shares in issue (000) 9,000 9.000 P/E ratio (average for year) Robertson ple 170 180 Required Review Robertson's performance bu calculating ROCE, interest cover and total shareholder return. Solution ww Essential reading See Chapter 1 section 2 of the Essential reading for further discussion of stakeholders and ratio analysis, The Essential reading is available as an Appendix of the digital edition of the Course Book.51 Not-for-profit organisations Value for money Value for money: This can be defined as getting the best possible combination of services from the least resources, which moans maximising the benefits for the lowest possible cost. Many organisations are not for profit. In this case their key objective willbe to ensure that the organisation is getting good value for money. Value for money Value for money involves measuring economy, efficiency and effectiveness. (©) Economy - purchase of inputs of appropriate quality at minimum cost (b) Efficiency — use of these inputs to maximise output (© Effectiveness — use of these inputs to achieve its goals (quality, speed of response) ‘The existence of not-for-profit organisations means that we need to recognise that financial management is not chvays cbout shareholder wealth maximisation. Essential reading ‘See Chapter 1 section 3 of the Essential reading for further discussion of this area. ‘The Essential reading is available as an Appendix of the digital edition of the Course Book. Activity 5: Objectives Which of the following otatomente ie true? © The agency problem is not important for a public sector organisation because there are no. shareholders. Maximisation of shareholder wealth is the primary objective of financial management. ° © Value for money is not relevant to 0 for-profit company. © The agency problem means that shareholder wealth is not being maximised. 6 Fenced Mogae FM) @srr6 Financial management compared to management and financial accounting From your earlier studies you will be aware of the key functions of management ond financial ‘accounting. These are recapped and contrasted in the following table. Details the performance of an organisation cover a defined period. Limited companies must, by law, prepore financial accounts Format of published financial accounts is sat by law and accounting standards. Most financial accounting information Is of monetary nature. Financial accounts present an essentially historic picture of past operations. jid management to control activities ‘and to help in decision making. There is no legal requirement to prepare manugerrient aecounts The format of management accounts is entirely at management discretion. Management accounts incorporate non- ‘monetary measures. Management aecounts are both a historical record and a future planning tool. Having introduced the scope of financial management, we ean identify some differences between financial management and management accounting because financial management is: + externally focused (analysis is focused on what is best for shareholders) + concerned with longer-term decision-making issues. Also, we can say that financial management differs from financial accounting because itis: + Forward looking + Useful at providing information that is directly used for decision making + Has no set format. Activity 6: Financial management Mount Co is planning to move into @ new foreign market. This will involve aoquiring a new: warehouse, organising new suppliers and a new distribution network. Which of the following aspects of the responsibility of financial management? © Recording the acqui ition of new non-current assets west ment in Country A would you expect to be the Mount Co's financial statements. © Producing regulor profit forecasts for the new operation in Country A, © Managing the exchange rate risk faced by the new operation © Choosing the new suppliers that will be used |:Financlal management function 15,Chapter summary 16 Financial management function Definition “The acquisition and deployment Investment decision Wane tesco oie fegobioctnes rough ret? ' ( Tota share {Ovdend + capita gain (ro) {thor roe at star of prea i ( Dividend decision 19 projects generate o nigh renee eee Financing decision How best to raise finance? Maximisation of shareholdar ee = = 14 out or reinvest ‘As measured by TSR ‘ 1 Fiske menogemont A gonerel concern for a shareholders Profit hosed measures ore alo relevent Other Not-for-profit stakeholders organisations Internal stakeholders Profit ratios Value for money Employees, ROCE, ROE Economy. sficiency, management 7 effectiveness | Debt ratios Conected stakeholders Financia gearing, Customers supplier, interest cover bank, shoroheldore 1 ' Liguatty ratios Exteral stakeholders Gyrent ratio, qulerato Pablo, government, 1 pressure groupe 1 ‘Shareholder ratios U + PIE rato, TSR, Non-financial Ghidond yeh performance measures. EPS, dividend yd Useful for monitoring solebolders Financial Management (FM) Encouraging shareholder wealth maximisation 1 osncy theory Iwanagers goaismay not be ‘gned with ownere ' Incentive schemes: May help address the agency problem (options and performance-related pay) ' Corporate governance Especially the use of Independent non-executive iroctore Financial management ‘compared to ‘management and financial accounting 1 Different from ‘monogement ‘accounting Lenger-term and external focus Different from financial ‘accounting + Forward looking, no sotformot + Directly used for decision makingKnowledge diagnostic 1. Financial management Financial management concerns the cequisition and deployment of financial resources to achieve kay objectives to maximise shareholder wealth; this can be measured by total shareholder return for a for-profit company, 2, Framework for maximising shareholder wealth. ‘The investment decision is the key mechanism for increasing shareholder wealth, the other key dlecisions include the financing, dividend and risk management decisions. 8, Agency issues Corporate governance regulations and incentive schemes are used to combat the agency problem. 4, Ratio analysis ‘To assess the impact of decisions on shareholders and other stakeholders, itis important to monitor profit, debt, liquidity and shareholder ratios. These ratios need to be learnt. 5. Value for money Economy ~ purchase of inputs of appropriate quality at minimum cost Efficiency ~ use of these inputs to maximise output Effectiveness — use of these inputs to achieve its goals (quality, speed of response) @ sep IeFereat management fureion 47Further study guidance Question practice Now try the following from the Further question practice bank (available in the digital edition of the Course Book): Section A questions 1,02, 08 18 Financial Management M) @ sppActivity answers 4: Financial objectives ‘The correct answer is: The depreciation charge was higher due to @ change in accounting policy The share price will fall ft + expected future returns falls or + ifrisk rises. This is the case with the other options. Activity 2: Calculation of financial objectives 1 The correct answer is: 14.3 cents Earnings after preference dividends divided by the number of shores. $14,808m/100,00 14.3 cents 2 The correct answer is: 75% Dividend per share has increased from 8 cents per share to 8.6 cents, a 75% increase. 3 The correct answer is: 11.65% Scents Dividend per share Increase in share price (516 - 470) = 46 cents [As a percentage of the opening share price this is (8.6 + 46)/470 = 1.6%. Activity 3: Corporate governance The correct answer i: (I) only Sound corporate governunve Uues not inviuue breaking Ure low und u norexeuutive uineeior Gun expect to be paid for their services but not in such a way that impairs their independence (eg in shares or share options) Activity 4: Calculation of financial objectives ‘The question does not tell us what the share price has been over the period, but it does provide the price/earnings (P/E) ratio. We ean derive the share price at the time of the announcement of the results by multilying the EPS of the company by its P/E ratio which shows the share price os ‘a multiplo of its EPS: Interest cover ——_-8,700/1,200 = 7.25 '9{500/1,000 = 9.5 ROCE 8,700/33.900 = 25.7% 9,500/34,700 = 274% Share price 17x 5,100/9,000 = 9.63, 48 x 5,700/9,000 = 11.40 Total shareholder (0.244 dividend + 1.77 increase in share return price)/9.63 start of year share price = 21% + The debt level does not appear to be a problem, as interest cover is high. + The P/E ratio, which is influenced by perceived growth potential, has improved. + Total shareholder return looks impressive, although we would need to know the shareholders! expected return (covered in Chapter 11) to be sure of this. @spp t:Financal management function 19Activity 5: Objectives The correct answer maximised. The agency problem means that shareholder wealth is not being If there is an agency problem, it means that the agents of the shareholders (eg managers) are not acting in the best interest of shareholders. Notes on incorrect answers: The agency problem also refers to managers not working in the best interest of the organisation; this can also happen in the public sector. Maximisation of shareholder wealth is the primary objective of financial management ~ # bbut only for profit-secking companies, not true for not-for-profit companies. Value tor money is relevant to a tor-protit company; even though the term is more commonly, associated with not-for profit companies Activity 6: Financial management The correct answer is: Managing the exchange rate risk faced by the new operation Risk management is a key function of financial management, and exchange rate risks likely to be ‘an issue here. Notes on incorrect answers: Recording the acquisition of new non-current assets in the financial statements is the responsibility of the financial accounting function. Producing regular profit forecasts for the new operation in Country A is « management ‘accounting role. Financial management may be involved in the terms of trade that will be used with new suppliers, but not the choice of suppliers (this will be managed by a purchasing department). 20. Financll Management EM) @sep