ACCA Paper F9: Notes

Notes
ACCA Paper F9
Financial Management
For exams in December 2009
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ExPress Notes
ACCA F9 Financial Management
Contents
About ExPress Notes 3
1. Financial Management Function 7
2. Working Capital Management 10
3. Investment Appraisal 18
4. Business Finance 36
5. Cost of Capital 42
6. Business Valuations 50
7. Risk Management 55
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Chapter 1
Financial Management Function

KEY KNOWLEDGE
The Nature and Purpose of Financial Management

The main purpose of financial strategy is to ensure that financial resources are available to
the organization in support of its overall corporate objectives, which include financial
objectives.
Management accounting is a set of tools and disciplines measuring corporate performance

and to facilitate decision-making; it is designed and implemented in coordination with the
company’s strategy.
Financial accounting is concerned with maintaining the records of the transactions of the
firm and preparing financial statements for the benefit of shareholders (and other external
audiences) in conformity with established accounting standards.
KEY KNOWLEDGE
Financial Objectives and the Relationship with Corporate

Strategy

In pursuing its financial objectives, the firm must ensure that those objectives are congruent
– i.e. consistent – with its overall corporate strategy.
KEY KNOWLEDGE
Stakeholders and Impact on Corporate Objectives

Stakeholder groups
 Shareholders: As owners of the business, they rank supreme, as reflected in US/UK

models of corporate governance;
 Lenders: Important if the business relies heavily on providers of loan capital (banks,
bondholders);
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 Directors: The executive directors or senior management of the business is central since
they have “hands-on” power and can serve their own interests (giving rise to agency
risk);
 Employees: Often referred to as a company’s “most valuable asset”; they must be

motivated and adequately compensated;
 Customers: No customers, no business! How influential they are or how carefully

management needs to listen to their concerns depends on the type of business activity
and the competitive environment;
 Suppliers: Good and reliable suppliers can be critical to corporate success.
 Government: They have two major interests: (a) they receive revenue via taxes and (b)
benefit indirectly when firms create employment. Environmental and other regulatory
concerns are also within the scope of the government’s interest;
 Public: The general public, its opinions and ability to exert pressure through lobby
groups are all relevant factor for businesses that pollute, are involved in nuclear power,
or carry out other activities that may be controversial (e.g. abortion clinics).
Conflicting stakeholder interests
Conflicting interests can exist between various stakeholder groups.
Management must examine the degrees of stakeholder influence and actively manage the
relationship with relevant stakeholders.
Agency theory
Agency theory addresses the risk that management will not act in the best interest of the
shareholders, but will make decisions that will serve its own interests.
Examples of self-serving management behavior could include: (a) artificially boosting

corporate profits in the short-term in order to earn bonuses; (b) paying too much to acquire
another company for reasons of prestige or in order to “build empires”; (c) rejecting
opportunities, such as takeover bids, or restructuring initiatives, that might jeopardize their
positions (an orientation to maintain the “status quo”).
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Influencing managerial behavior
In order to cause managers to behave in a way consistent with stakeholder interests,

rewards and bonus schemes need to be carefully designed. This can be seen as the
“internal” dimension to corporate governance. The other dimension -- “external” – comes in
the form of regulation.
KEY KNOWLEDGE
Financial and Other Objectives in Non‐for‐Profit

Organisations

Profit and Not-for-profit organisations
Profit-seeking organizations exist ultimately to create wealth for their owners.
Non-profit (or not-for-profit) organizations are created to accomplish a pre-defined mission,

such as the delivery of a service; they are expected to do so in an economical manner.
KEY KNOWLEDGE
Financial Management Environment

1. The economic environment for business
The general economic environment, and in particular the influence of governments –

through its monetary and fiscal policies – has a far-reaching impact on most businesses.
2. The nature and role of financial markets and institutions
Financial markets and institutions have achieved such a degree of global integration that
shocks in one part – as shown with the onset of the financial crisis in 2008 – can have
systematic implications across all markets.
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Chapter 2
Working Capital Management

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The Big Picture
1. The nature, elements and importance of working capital
This is a core function of management which has day-to-day implications.
Working capital definition: Current assets – Current liabilities
This is an accounting definition. The discussion and analysis of working capital management
focuses on the “operating” elements of current assets and liabilities:
 Cash
 Inventory
 Receivables
 Payables
2. Management of inventories, accounts receivables, accounts payable and cash
These elements are linked through the Cash conversion cycle, also known as the Cash
Operating Cycle.
Raw materials
received
Receipt of
cash
Payment to supplier
Sale of goods Conversion into

finished goods
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The above diagram shows the operating cash flows for a typical manufacturing company
converting raw materials into finished goods for sale. The company needs its own cash to
pay the supplier and can only recover this from the sale of the finished goods.
The cash invested in inventories and receivables represents a cost to the company. This is
most directly obvious in opportunity cost terms: the cash could be earning interest, reducing
interest-bearing debt, or ultimately find its way into shareholders’ pockets as a dividend
payment.
The presence of payables indicates that cash payments (outflows) are delayed; this is
beneficial to the company as long as it is not overdue on its payments, as late payment
could lead to penalties or damage to the company’s reputation (creditworthiness).
Managing the individual parts of working capital means managing the “whole picture” in an
optimal way; doing this well can give a firm a significant competitive advantage over its
competitors.
Ratio Analysis
Liquidity ratios
The relationship between current assets and current liabilities is used as a measure of
liquidity in the firm:
Current ratio = Current assets

Current liabilities
Quick ratio = Current assets - Inventories

Current liabilities
Turnover ratios
(1) Trade debtors (receivables)
Trade Debtors x 365

Sales
(2) Inventory turnover
Inventory x 365
COGS
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(3) Trade creditors (payables)
Trade Payables x 365

COGS
Economic Order Quantity (EOQ)
Within a company, there is a natural temptation to accumulate buffer stocks (raw materials
and semi-finished goods) so that production is never interrupted.
Similarly, in order to avoid stock-outs, sales managers will insist on maintaining a plentiful
level of finished goods. All of this costs money.
The EOQ is a method which seeks to minimize the costs associated with holding inventory.
To determine the total costs, the following data is required:
Q = order quantity
D = quantity of product demanded annually
P = purchase cost for one unit
C = fixed cost per order (not incl. the purchase price)
H = cost of holding one unit for one year
The total cost function is as follows:
Total cost = Purchase cost + Ordering cost + Holding cost
which can be expressed algebraically as follows:
TC = PxD + C x D/Q + H x Q/2
It is this total cost function which must be minimized.
Recognizing that:
 PD does not vary;

 Ordering costs rise the more frequently one places (during the year); and
 Holding costs rise the fewer times one places orders (due to larger quantities being
ordered each time),
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1. Financial Management Function 7

2. Working Capital Management 10

Components of an effective study system

 The ExPress notes for that paper

Your stage in These ExPress ExP ExP ACCA online

Our ExPress notes fit into our portfolio of materials as follows:

Notes Notes Notes

To maximise your chances of success in the exam we recommend you visit

Financial Management Function

Management accounting is a set of tools and disciplines measuring corporate performance

 Shareholders: As owners of the business, they rank supreme, as reflected in US/UK

 Employees: Often referred to as a company’s “most valuable asset”; they must be

 Customers: No customers, no business! How influential they are or how carefully

 Suppliers: Good and reliable suppliers can be critical to corporate success.

Conflicting stakeholder interests

Conflicting interests can exist between various stakeholder groups.

Examples of self-serving management behavior could include: (a) artificially boosting

In order to cause managers to behave in a way consistent with stakeholder interests,

Profit-seeking organizations exist ultimately to create wealth for their owners.

Non-profit (or not-for-profit) organizations are created to accomplish a pre-defined mission,

The general economic environment, and in particular the influence of governments –

2. The nature and role of financial markets and institutions

Working Capital Management

1. The nature, elements and importance of working capital

This is a core function of management which has day-to-day implications.

Working capital definition: Current assets – Current liabilities

2. Management of inventories, accounts receivables, accounts payable and cash

Sale of goods Conversion into

Current ratio = Current assets

Quick ratio = Current assets - Inventories

(1) Trade debtors (receivables)

Trade Debtors x 365

(2) Inventory turnover

Trade Payables x 365

Economic Order Quantity (EOQ)

To determine the total costs, the following data is required:

D = quantity of product demanded annually

P = purchase cost for one unit

C = fixed cost per order (not incl. the purchase price)

H = cost of holding one unit for one year

The total cost function is as follows:

Total cost = Purchase cost + Ordering cost + Holding cost

which can be expressed algebraically as follows:

TC = PxD + C x D/Q + H x Q/2

It is this total cost function which must be minimized.

 PD does not vary;

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