ACCA AFM Syllabus A. Role Of The Senior Financial Adviser - Purpose of Financial Management - Notes ^{1 / 2}

Financial objectives

Profit maximisation is often assumed, incorrectly, to be the main objective of a business.

Reasons why profit is not a sufficient objective:

1. Investors care about the future

2. Investors care about the dividend

3. Investors care about financing plans

4. Investors care about risk management

For a profit-making company, a better objective is the maximisation of shareholder wealth;

this can be measured as total shareholder return (dividend yield + capital gain or the dividend per share plus capital gain divided by initial share price)

Key decisions:

1. Investment 

   (in projects or takeovers or working capital) need to be analysed to ensure that they are beneficial to the investor.

   Investments can help a firm maintain strong future cash flows by the achievement of key corporate objectives 

   e.g. market share, quality.

2. Finance

   mainly focus on how much debt a firm is planning to use.

   The level of gearing that is appropriate for a business depends on a number of practical issues:

   Life cycle - A new, growing business will find it difficult to forecast cash flows with any certainty so high levels of gearing are unwise.

   Operating gearing- If fixed costs are a high proportion of total costs then cash flows will be volatile; so high gearing is not sensible.

   Stability of revenue- If operating in a highly dynamic business environment then high gearing is not sensible.

   Security- If unable to offer security then debt will be difficult and expensive to obtain.

3. Dividends

   how returns should be given to shareholders

4. Risk management

   mainly involve management of exchange rate and interest rate risk and project management issues.

Key Objectives of Financial Management

Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:

• Create wealth for the business

• Generate cash, and

• Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested

3 key elements to the process of financial management

1. Financial Planning

   Management need to ensure that enough funding is available at the right time to meet the needs of the business. 

   In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.

   In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.

2. Financial Control

   Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. 

   Financial control addresses questions such as:

   • Are assets being used efficiently?
   • Are the businesses assets secure?
   • Do management act in the best interest of shareholders and in accordance with business rules?

3. Financial Decision-making

   The key aspects of financial decision-making relate to investment, financing and dividends:

   • Investments must be financed in some way – however there are always financing alternatives that can be considered. 

   For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers

   • A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. 

   If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further