Purpose of Financial Management
- Acquisition of financial resources
- Deployment of financial resources
- Profit maximisation
o Historic and not future orientated
o Doesn’t measure liquidity or risk
o Can be manipulated
o Earnings Per Share = Profits Distributable to Shareholders/Number of Ordinary
Shares
▪ Distributable profits is after interest, tax, preference dividends
- Shareholder wealth maximisation
o Derived from dividends and market value of share
o Total Shareholder Return = Dividend + Change in Share Price/Share Price at the
start of the year
- Growth
- Market Share
- Social responsibilities
Framework for Maximising Shareholder Wealth
- Investment decision
- Financing decision
o Minimise cost of capital
o How much debt to use
- Dividend decision
- Risk management
o Type of finance
o How to invest it
o Raise dividends or not
Encouraging Shareholder Maximisation
- Agency theory: agents using delegated powers to run company in the owners’ best
interests
- Agency problem
o Short-termism at the expense of long term profits
o Minimise dividend payments
o Neglect risk management
o Excessive remuneration
- Corporate Governance
o Separate MD and Chairman
o Board consist of NEDs
o NEDs are independent
o Remuneration committee
o Audit committee
, o Nomination committee
o Regular publication of financial accounts
- Incentive Schemes – goal congruence
o Performance related pay
o Share options
Stakeholders
- Internal
- External (government, trade unions, pressure groups)
- Connected (finance providers, customers, suppliers)
Financial Performance Measures
- Profitability Ratios
o ROCE = PBIT/Equity+Long-term Debt
o ROE = Profits after interest and tax/shareholders funds
- Debt Ratios
o Gearing = debt/debt+equity
o Interest cover = PBIT/Interest
- Liquidity Ratios
o Current ratio
o Acid Test ratio
- Shareholder Investor Ratios
o Dividend Yield = dividend per share/market price per share x 100
o EPS = profits distributable/number of ordinary shares
o P/E = Market price per share/EPS
▪ Higher P/E value, higher regarded company
Not for Profit Organisations
- Value for Money
o Economy – minimum cost
o Efficiency – maximise output
o Effectiveness – achieve goals
Macroeconomics Policies
- Economic growth
- Control price inflation
- Full employment
- Balance of payments stability
o Imports exceed exports – deficit
▪ Manipulate exchange rate to switch spending towards exports
- Expansionary macroeconomics
o Stimulate growth
o Need for new jobs
- Acquisition of financial resources
- Deployment of financial resources
- Profit maximisation
o Historic and not future orientated
o Doesn’t measure liquidity or risk
o Can be manipulated
o Earnings Per Share = Profits Distributable to Shareholders/Number of Ordinary
Shares
▪ Distributable profits is after interest, tax, preference dividends
- Shareholder wealth maximisation
o Derived from dividends and market value of share
o Total Shareholder Return = Dividend + Change in Share Price/Share Price at the
start of the year
- Growth
- Market Share
- Social responsibilities
Framework for Maximising Shareholder Wealth
- Investment decision
- Financing decision
o Minimise cost of capital
o How much debt to use
- Dividend decision
- Risk management
o Type of finance
o How to invest it
o Raise dividends or not
Encouraging Shareholder Maximisation
- Agency theory: agents using delegated powers to run company in the owners’ best
interests
- Agency problem
o Short-termism at the expense of long term profits
o Minimise dividend payments
o Neglect risk management
o Excessive remuneration
- Corporate Governance
o Separate MD and Chairman
o Board consist of NEDs
o NEDs are independent
o Remuneration committee
o Audit committee
, o Nomination committee
o Regular publication of financial accounts
- Incentive Schemes – goal congruence
o Performance related pay
o Share options
Stakeholders
- Internal
- External (government, trade unions, pressure groups)
- Connected (finance providers, customers, suppliers)
Financial Performance Measures
- Profitability Ratios
o ROCE = PBIT/Equity+Long-term Debt
o ROE = Profits after interest and tax/shareholders funds
- Debt Ratios
o Gearing = debt/debt+equity
o Interest cover = PBIT/Interest
- Liquidity Ratios
o Current ratio
o Acid Test ratio
- Shareholder Investor Ratios
o Dividend Yield = dividend per share/market price per share x 100
o EPS = profits distributable/number of ordinary shares
o P/E = Market price per share/EPS
▪ Higher P/E value, higher regarded company
Not for Profit Organisations
- Value for Money
o Economy – minimum cost
o Efficiency – maximise output
o Effectiveness – achieve goals
Macroeconomics Policies
- Economic growth
- Control price inflation
- Full employment
- Balance of payments stability
o Imports exceed exports – deficit
▪ Manipulate exchange rate to switch spending towards exports
- Expansionary macroeconomics
o Stimulate growth
o Need for new jobs
