ChapterTope

Ch1 Financial management and financial opbjective

I-The nature and purpose of financial management
II-Financial objectives and the relationship with corporate strategy
1-Strategy
2-Corporate objectives
3-Financial objectives
3.1-Shareholder wealth
maximization
3.2-Profit maximization
3.3.-Earnings per share growth

Exercis (EPS,Dividend Yield,Capital Gain)

7-Other financial targets

8-Non-financial objectives

Exercise finance and non finance

III-stakeholders

IV-Measuring the achievement of corporate objectives

1-Measuring financial
performance
2-Profitability and return: the return on capital employed
3-Evaluating the ROCE
4-Secondary ratios
5-Return on equity
6-Gross profit margin, net profit margin and profit analysis
7-Debt and gearing ratios
8-Liquidity ratios:
9-Shareholders’ cash and working capital
investment
rations
10-The dividend yield
11-Earning per share: EPS
Exercise
Total Hours
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Chapter1- Financial Management objective (Page3-22) New(page 4-

I-The nature and purpose of financial management (Page:05)

Summary
Financial Accounting Provides externally -used information
Historic pictures of Past operations

Management Accounting Provides internally -used information

Used and aid management to record plan and control
activities and help the decision making process.

Financial Management Financial planning-making sure funds available.

Financial control- objectives being met and assets being
used effeciency.

Financial management decision Investing to maximize company's value

Financing taking more credit, profit retention, issuing
Dividend.

1- What is financial management (Page:05)

Financial management can be defined as the management of
the finances of an organisation in order to achieve the financial objectives of the organisation

1.2 Financial planning (Page:05)

The financial manager will need to plan to ensure that enough funding is available
at the right time to meet the needs of the organisation for short-, medium- and long-term capital.

1.3 Financial control (Page:05)

The financial manager may compare data on actual performance with forecast performance.
Forecast data will have been prepared in the light of past performance (historical data)
modified to reflect expected future changes. Future changes may include the effects of economic de

1.4 Financial management decisions(Page:05)

The financial manager makes decisions relating to investment, financing and dividends.
The management of risk must also be considered.

1.5 Management accounting, financial accounting and financial management(Page:06)

II- Financial objectives and the relationship with corporate strategy (Page:07)

Summary
Strategy
is a course of action to achieve an objective.

Corporate Objective
Corporate Objectives are relevant for the organization as a whole,relating
to key factors for business success.

Financial objectives Non financial objectives

- shareholder wealth maximization. - Welfare of employees
- Profit maximization. - Welfare of management
- Earning per share growth. - Welfare of Society

2.1-Strategy (Page:07)
Strategy may be defined as a course of action, including the specification of resources required
achieve
- Strategy can be objective.
a specific short term or long term, depending on the time horizon of the objective it is int
achieve.

2.2 Corporate objectives (Page:07)

Corporate objectives are relevant for the organisation as a whole, relating to key factors for busine
Objectives 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
- Industrial relations
- Added value

2.3 Financial objectives (Page:08)

The usual assumption in financial management for the private sector is that
the primary financial objective of the company is to maximise shareholders' wealth

2.3.1 Shareholder wealth maximisation

The wealth of the shareholders in a company comes from:

- Dividends received
- Market value of the shares

A shareholder's return on investment is obtained in the form of:

- Dividends received
- Capital gains from increases in the market value of their shares

Total Shareholder Return(TSR) = (P1- P0+D1)/P0

Capital Gain =(P1-P0)/P0

Dividend Yield = D1/Po

Notice (Page:09)
(a)-Business Risk : related to Sales and Operating Cost Risk
(b)- Financial Risk : Related to Net income and Operating cash Flow to external fund.

2.3.2 Profit maximisation (Page:09)

measures of financial achievement include:

(i) Accounting return on capital employed
(ii) Earnings per share
(iii) Yields on investment, eg dividend yield as a percentage of stock market value

2.3.3 Earnings per share growth (Page:10)

A company must be able to sustain its earnings in order to pay dividends and reinvest in the busin
so as to achieve future growth. Investors also look for growth in the EPS from one year to the nex

EPS = Profit distributed to oridary shoareholders/Weighted number of ordinary shares.

2.3.4 Other financial targets (Page:12)

- A restriction on the company's level of gearing
 - A target for profit retentions.
- A target for operating profitability

2.3.5 Example: Financial targets (Page:12)

2.4 Non-financial objectives (Page :13)

(a) The welfare of employees

(b) The welfare of management

(c) The provision of a service

(d) The fulfilment of responsibilities towards customers

(e) The fulfilment of responsibilities towards suppliers

(f) The welfare of society as a whole

III-Stakeholders (Page:14)

Summary
Stakeholders Stakeholders' objectives
are group whose interest are directly - Ordinary shareholders want to
affected by activities of organization. maximize their wealth.
- Suppliers want to paid full amounts
- Banks want to receive interest and minize
Internal Mangers default(credit) risk.
Employees - Employees watnt to maximize rewards and
External Government ensure employement continuity.
Local communities - Manager watnt to maximize their rewards.
Pressure groups - Government watnt to sustained economic
Connected Shareholders growth and high level of employeement.
Bankers
Customers
 Supplies

Stakeholders are individuals or groups who are affected by the activities of the firm
-Internal : :(employees and managers
- External :local communities, pressure groups, government
- Connected : :shareholders, customers and suppliers

IV-Measuring the achievement of corporate objectives (Page:17)

Performance measurement is a part of the system of financial control of an enterprise as well as bein

Summary

Return to shareholders Dividend

Capital Gain form increase in market value.
Profitabily
Return on capital employed(or ROI) = Profit Margin x Asset Turnover
ROCE

PBIT/Capital employed = PBIT/Sales Revenue x Sale revenue/Capital emp

Return on equity = Profit available to ordinary shareholders/Shareholder's equity.

Dividend Yield = (Dividend per share/Market price per share(at beginning/when buying) x
Capital Gain Yield = (P1 - Po )/Po
Price earning ratio = Market price of share/EPS
Dividend cover = Profit available to ordinary shareholders/Actual dividend.
Earning per share = Profit available to ordinary shareholders/Weighted average number of ordina

4.1 Measuring financial performance (Page:17)

A common means of doing this is through ratio analysis,

4.2 The broad categories of ratios (Page:18)

Ratios can be grouped into the following four categories
-Profitability and return
 -Debt and gearin
-Liquidity
- Shareholders' investment ratios ('stock market ratios')

4.3 Ratio pyramids (Page:18)

4.4 Profitability (Page:18)

profit before interest and tax (PBIT)
Sales-Expense-Depreci =PBIT

4.4.1 Profitability and return: the return on capital employed (Page:19)

e return on capital employed (ROCE), also called return on investment (ROI).

Return on capital employed = PBIT/Capital Employed

Capital employed = Shareholders' funds plus long-term liabilities

or
= Total assets less current liabilities

4.4.3 Secondary ratio (Page:19)

What does a company's ROCE(or ROI) tell us? What should we be looking for? There are three c

ROCE = PBIT/Capital Employed

ROCE = PBIT/Sales Revnue x Sales Revnue/Capital Employed

Profit margin x asset turnover = ROCE

- Profit Margin = PBIT/Sales Revnues

- Asset Turnover = Sales Revnues/Capital employed

4.4.4 Return on equity (Page:19)

Another measure of the firm's overall performance is return on equity. This compares net profit af

Return on equity =Earnings attributable to ordinary shareholders/Shareholders' equity

 4.4.5 Gross profit margin, the net profit margin and profit analysis (Page:20)

Profit Margin = Sales - Cost of sales

Net Profit = Profit Margin - Expense - Depre - Interest - Tax

4.5 Debt and gearing ratios (Page:20)

The main
- Debt debt are
ratios andconcerned
gearing ratios
withare
howcovered
muchin Chapter
the 15. owes in relation to its size and w
company

- Financial gearing (often simply referred to as 'gearing') is the

amount of debt finance a company uses relative to its equity finance.

Gearing Ratio = Book value of debt/ Book value of equity

4.6 Liquidity ratios: cash and working capital

The main liquidity ratios will be described in Chapter 4.

4.7 Shareholders' investment ratios (Page:21)

ndicators such as dividend yield, EPS, P/E ratio and dividend cover can be used to assess investor r

4.7.1 The dividend yield (Page:21)

Dividend yield =Dividend per share/Ex-div market price per share.

4.7.2 Earnings per share (EPS) (Page:22)

Earnings per share = Profit distributable to ordinary shareholders/Weighted average number

Let
a)- Profit distributable to ordinary shares = Net income - Preferred Dividend.
b)- Weighted average number of ordinary shares = Weighted average common share outstanding

4.7.3 The price earnings ratio (Page:22)

Price earnings ratio = Market price of share/EPS

 4.7.4 Example: Price earnings ratio (Page:22)

V- Encouraging the achievement of stakeholder (Page:24)

5.1 Managerial reward schemes (Page:24)
5.2 Regulatory requirements (Page:25)

VI-Not for profit organisations (Page:27)

n and control

and assets being

ny's value
profit retention, issuing shares.

of the organisation

and long-term capital.

cast performance.
orical data)
he effects of economic development.

nd dividends.

gement(Page:06)
 on of resources required, to
n of the objective it is intended to

to key factors for business success.

e typically as follows.
ers' wealth

external fund.

arket value

and reinvest in the business

from one year to the next.

r of ordinary shares.
lders want to

paid full amounts

eive interest and minize

to maximize rewards and

t continuity.
maximize their rewards.
t to sustained economic
el of employeement.
enterprise as well as being important to investors.

market value.

et Turnover

ale revenue/Capital employed

areholder's equity.

inning/when buying) x 100

verage number of ordinary shares.

ng for? There are three comparisons that can be made.

his compares net profit after tax with the equity that shareholders have invested in the firm.

Shareholders' equity
Page:20)

elation to its size and whether it is getting

into heavier Debt or i

used to assess investor returns

eighted average number of ordinary shares

mmon share outstanding.

nto heavier Debt or improving its situation.
Ex1-Garica Inc, owns and operates restaurants throughout the southestern United States.
Garica Inc declared dividends over the 7 years shown below.
Each year there was 20,000 preferred stock cummulative,2%, $80 par and 90,000 of common Stock
Calculate the dividends and per share amounts for the preferred and common stock

Year 2006 2007 2008 2009 2010 2011 2012

Total dividends 18,000 36,000 54,000 72,000 90,000 108,000 126,00

P/S's equity 1600000 1600000 1600000 1600000 1600000 1600000 1600000

P/S's Dividend 2% 32000 32000 32000 32000 32000 32000 32000
Paid to P/S 18000 22000 32000 32000
P/S in arrear 14000 10000 0
Paid to C/S 0 0 12,000 30000
in Arrrear 14000 10000 0
Remaing 10000
ed States.

000 of common Stock at $4 par.

Last year ABC Co made profits before tax of $2,628,000. Tax amounted to $788,000.
ABC Co's share capital was $2,000,000 (2,000,000 shares of $1) and $4,000,000 6% preference shares.
What was the earnings per share (EPS) for the year? (insert your answer to two decimal places)

Asnser
EPS = (Net income - Preferred stocks'dividend)/Weighted average ordinary shares.

Profit before tax 2,628,000.00

Less Tax 788,000.00
Profit after tax 1,840,000.00
Less Preferrence shares'dividend 240,000.00
Profit available for ordinary share 1,600,000.00
Number of Common Stock or Ordinanry shares 2,000,000.00
EPS 0.80

Working
1/- Preferred stock 4,000,000.00
Preferred stock's dividend 6% 240,000.00

2/- Share capital/Common stock/Stock's Equity 2,000,000.00

Price per share 1
Number of Common Stock or Ordinanry shares 2,000,000.00
Which of the following statements describes the main objective of financial management?
 Efficient acquisition and deployment of financial resources to ensure achievement of objectives
 Providing information to management for day to day functions of control and decision making
 Providing information to external users about the historical results of the organisation
 Maximisation of shareholder wealth

Answer
No (4)
A company has recently declared a dividend of 12c per share.
The share price is $3.72 cum div and earnings for the most recent year were 60c per share. What is the P/E ratio

Answer
hare. What is the P/E ratio
The following information relates to a company:

Year 0 1 2 3
Earnings per share (cents) 30 31.8 33.9 35.7
Dividends per share (cents) 13 13.2 13.3 15
Share price at start of year ($) 1.95 1.98 2.01 2.25
Which of the following statements is correct?
– The dividend payout ratio is greater than 40% in every year in the period
– Mean growth in dividends per share over the period is 4%
– Total shareholder return for the third year is 26%
– Mean growth in earnings per share over the period is 6% per year Correct

0.3 0.318 0.339 357

0.018 0.021 356.661

(1+g)t = 35.7/30

Pt=
Which of the following is LEAST likely to fall within financial management?
— The dividend payment to shareholders is increased
— Funds are raised to finance an investment project.
— Surplus assets are sold off
— Non-executive directors are appointed to the remuneration committee.

Answer
PT Co has just paid a dividend of 15 cents per share and its share price one year ago was $3.00 per share. The total s
What is the current share price? (to two decimal places)

Answer

Shareholder returne = (P1- P0 + D1)/P0

P1 ?
P0 =3
Dividend =0.15
Shareholder return =25%
as $3.00 per share. The total shareholder return for the year was 25%.
Which of the following does NOT form part of the objectives of a corporate governance best practice framework?
Separation of chairperson and CEO roles
Establishment of audit, nomination and remuneration committees
Minimisation of risk Correct
Employment of non-executive directors
est practice framework?
Are the following statements true or false?

1/- Maximising market share is an example of a financial objective.

2/- Shareholder wealth maximisation is the primary financial objective for a company listed on a stock exchange.
3/-Financial objectives should be quantitative so that their achievement can be measured
 1 0

d on a stock exchange.
A school decides to have larger classes, and examination results suffer as a result. In terms of the 'value for money' f
Economy has increased but efficiency has decreased
Efficiency has increased but effectiveness has decreased.
Economy has increased but effectiveness has decreased.
s of the 'value for money' framework, which of the following statements is true?