What is financial management?
Financial management can be defined as the
management of the finances of an organization in
order to achieve the financial objective of the
organization.
Financial manager will need to plan to ensure that
enough funding is available at the right time to
meet the needs of the organization for short,
medium and long-term capital.
The control function of the financial manager
becomes relevant for funding which has been
raised.
Financial management decisions
The financial manager makes decisions relating to
investment, financing and dividends.
The management of risk must also be considered.
Financial management is also concerned with
management of short-term funds and with
how funds can be raised over the long term.
Dividend decision: how much of its profits
should the company pay out as dividends and how
much should it retain for investment to provide for
future growth and new investment opportunities?
Corporate objectives
Objective should relate to the key factors for
business success, which are typically as follows
Profitability (return on investment)
Market share
Growth
Cash flow
Customer satisfaction
The quality of the firm’s products
Measuring the achievement of corporate objectives
It has been suggested that the financial objective for a
company might be stated as maximization of shareholder
wealth, or possibly in terms of profitability and earnings
per share, or growth in profits.
Financial objectives are commonly measured using ration
analysis. Financial ratio can be used to make comparisons:
Comparisons over a number of years.
Comparisons with the similar ratios of other, similar
companies for the same period.
Comparisons with ‘industry average’ ratios.
The return on capital employed (ROCE)
Profit-making companies should try to make a profit that is
large enough in relation to the amount of money or capital
invested n the business.
The most important portability ratio is return on capital
employed or ROCE
The capital employed is the share capital and reserves, plus
long-term debt capital such as bank loans, bond and loan
stock.
Interest charges on bank loans were $30,000. Dividend payments to
shareholders were $45,000. Sales during the year were $5,800,000.
Required:
Calculate the return on capital employed for year 1
ROCE of Sting Company
Return on equity
Return on equity measures the return on investment that
the shareholders of the company have made.
Earnings per share and dividend per share
The earnings per share (EPS) is a measure of the profit
after taxation (and preference share dividend, if any) per
equity share, during the course of a financial year.
The EPS might be
A historical EPS, which is the company’s financial statements
A forward-looking EPS, which is the EPS that the company will
expect to achieve in the future, usually in the next financial year.
Dividend per share may be important for shareholders
who are seeking income from shares rather than capital
growth.
The company may have a dividend policy which aims for
steady growth of dividend per share.
Earnings per share and dividend per share
Using the figures in the previous example:
EPS = profit after tax/Number of ordinary shares
= $135,000 / 200,000 = 67.5c per share
Dividend per share = 45,000 / 200,000 = 22.5c per
share
Corporate governance
A more extensive approach to reducing the agency
problem and trying to ensure that companies are
managed in the best interests of shareholders is to
apply rules or guidelines of ‘best practice’ in
corporate governance.
Corporate governance is a term that is used to
describe the way in which a company is ‘governed’ on
behalf of its owners by the board of directors.
Elements of good corporate governance
Remuneration and management reward schemes are
one aspect of corporate governance.
The board of directors: the board’s responsibilities
and the composition of the board
Financial reporting and the independence of the
external auditors
Directors’ remuneration
Internal control and risk management
Question