Management Accounting - Financial Strategy

PUBLISHING

CIMA'S Official Leorning System

Strategic Level

Management Accounting Financial Strategy

John Ogilvie

ELSEVIER

AMSTERDAM BOSTON HEIDELBERG PARIS SAN DIEGO SAN FRANCISCO

LONDON NEW YORK SINGAPORE SYDNEY

OXFORD TOKYO

Contents

The CIMA Learning System

xi

Acknowledgements

xi

How to use your CIMA Learning System

xi

Guide to the Icons used within this Text

xii

Study technique

xiii

Management Accounting - Financial Strategy Syllabus

xv

Formulae

xxi

1 Formulation of Financial Strategy

1

Learning Outcomes

3

1.1 Introduction

3

1.2 Objectives of profit-making entities

4

1.2.1 Financial objectives

4

1.2.2 Stakeholders

5

1.2.3 Non-financial.objectives

6

1.2.4 Agency theory

6

1.2.5 Shareholder value analysis

7

1.3 Objectives of not-for-profit entities

8

1.3.1 Value for money

10

1.4 Public and private - similarities and differences

11

1.5 Assessing attainment offinancialobjectives

11

1.5.1 Financial performance indicators

12

1.5.2 Non-financial performance indicators

13

1.6 The three key decisions offinancialmanagement

14

1.6.1 Investment decisions

14

1.6.2 Financing decisions

14

1.6.3 Dividend decisions

15

1.7 Policies for distribution of earnings

15

1.7.1 Practical dividend policies

16

1.7.2 Theory of dividend irrelevance

18

1.7.3 Scrip dividends

20

1.7.4 Share repurchases

20

1.8 The impact of internal and external constraints on financial strategy

21

1.8.1 Internal constraints

21

1.8.2 External constraints

21

1.9 Government influence

22

1.9.1 Market failure

22

1.10 Developing financial strategy in the context of regulatory requirements 23

1.10.1 Corporate governance

23

1.10.2 Regulatory bodies

24

1.10.3 The impact of regulation on business combinations

26

in

iv MANAGEMENT ACCOUNTING - FINANCIAL STRATEGY P9

?

1.11 Major economic influences

28

?

1.11.1 Interest rates

28

O

1.11.2 Term structure of interest rates

29

u

1.11.3 Inflation

32

1.11.4 Exchange rates

32

1.12 Modelling and forecasting cashflowsandfinancialstatements

33

1.12.1 Forecasting cash

flows

33

1.12.2 Forecasting financial statements

34

1.12.3 Sensitivity analysis

40

1.13 Current and emerging issues in

financial.reporting

40

1.13.1 IFRS 1firsttime adoption of IFRS

41

1.13.2 IFRS 2 share-based payment

41

1.13.3 Reporting environmental issues

43

1.13.4 Reporting of social issues

44

1.13.5 Inclusion of forecasts in the annual report

46

1.13.6 Reporting of human capital

47

1.14 Summary

47

Readings

49

Revision Questions

53

Solutions to Revision Questions

55

2 Financial Management

6i

Learning Outcomes

63

2.1 Introduction

63

2.2 Thefinancefunction

63

2.2.1 Financial control

64

2.2.2 Evaluating key success factors in the management

of the finance function

64

2.2.3 Relationships with stakeholders

65

2.2.4 Outsourcing and shared service centres

65

2.3 The treasury function

66

2.3.1 The role of the treasury function

66

2.3.2 Cost centre or profit centre

67

2.3.3 Advantages of a specialised central treasury function

68

2.4 Financial markets

68

2.4.1 Money market

68

2.4.2 Capital or securities market

69

2.4.3 The foreign exchange market

69

2.4.4 Derivatives markets

69

2.5 Share price volatility

70

2.5.1 Technical analysis or chartism

70

2.5.2 Fundamental analysis

70

2.5.3 Random Walk theory

70

2.6 The efficient market hypothesis

71

2.6.1 Weak form

71

2.6.2 Semi-strong form

71

MANAGEMENT ACCOUNTING - FINANCIAL STRATEGY v

2.6.3 Strong form 2.6.4 Implications of EMH forfinancialmanagers 2.7 Investor ratios 2.7.1 Market price per share 2.7.2 Earnings per share 2.7.3 The price/earnings ratio 2.7.4 Earnings yield 2.7.5 Dividend-payout rate 2.7.6 Dividend yield 2.7.7 Dividend cover 2.7.8 Book value per share 2.8 Working capital management strategies 2.8.1 The investment decision 2.8.2 Thefinancingdecision 2.8.3 Liquidity ratios 2.8.4 The operating cycle 2.9 Overtrading 2.9.1 Symptoms of overtrading 2.9.2 Preventing overtrading 2.10 Multinational working capital management 2.11 Summary

Revision Questions

Solutions to Revision Questions

72 Q 72 Z 73 Z 73 ?? 73 74 74 74 75 75 76 11 77 78 79 80 82 83 83 84 84

85

87

3 Sources of Long-term Finance

93

Learning Outcome

95

3.1 Introduction

95

3.2 Shareholders' funds

95

3.2.1 Ordinary shares

95

3.2.2 Preference shares

96

3.2.3 Reserves

97

3.3 Raising share capital

97

3.3.1 Stock market listing

97

3.3.2 Methods of obtaining a

flotation

98

3.3.3 Rights issues

99

3.3.4 Bonus issues

105

3.3.5 Share splits

105

3.4 Debt

finance

105

3.4.1 Bonds

105

3.4.2 Debt yields

106

3.4.3 Convertible bonds

108

3.4.4 Warrants

110

3.5 Medium-term

financing

110

3.5.1 Term loans

110

3.5.2 Mezzanine

finance

111

3.5.3 The lender's assessment of creditworthiness

111

v i MANAGEMENT ACCOUNTING - FINANCIAL STRATEGY P9

?

3.5.4 Leasing

\??

3.5.5 Lease-or-buy decisions

?

3.5.6 Factoring

u

3.6 Financing of small profit-making entities

3.6.1 Venture capital

3.6.2 Business 'angels'

3.6.3 Government assistance

3.7 Summary

Readings

Revision Questions

Solutions to Revision Questions

4 Capital Structure and Cost of Capital

Learning Outcomes 4.1 Introduction 4.2 Gearing

4.2.1 Measuring gearing 4.2.2 Classification of debt and equity 4.2.3 Interest cover 4.2.4 Leverage 4.3 Cost of capital 4.3.1 Cost of equity 4.3.2 Cost of debt 4.3.3 Cost of preference shares 4.4 Weighted average cost of capital 4.4.1 Assumptions in the use of WACC 4.5 Marginal cost of capital 4.6 The traditional theory of gearing 4.7 Modigliani and Miller's theories of gearing 4.7.1 Limitations of MM theory 4.8 Cost of capital and adjusted cost of capital 4.8.1 Adj usted present value 4.8.2 Adjusted cost of capital-Modigliani and Miller 4.9 Risk and reward 4.10 Portfolio theory 4.10.1 Systematic risk and unsystematic risk 4.11 The capital asset pricing model 4.11.1 Measuring beta values 4.11.2 The security market line 4.12 Using the CAPM as an investment tool 4.13 MM, CAPM and geared betas 4.13.1 Ungearing Beta 4.13.2 Geared equity beta 4.14 Use of CAPM in investment appraisal 4.14.1 Limitations of CAPM 4.15 Arbitrage pricing model 4.16 Summary

Revision Questions

Solutions to Revision Questions

112 113 120 122 123 124 124 125

127

131

137

147

149 149 150 150 152 154 155 155 156 160 162 163 164 165 166 168 172 173 173 175 175 177 180 181 182 184 185 187 187 189 190 191 191 192

195

201

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