The Role of the Financial Manager: Solutions
Activity 1 - Question 1.1Purpose: The purpose of this activity is to identify and discuss one (1) of the responsibilities of a financial manager in more detail.Question 1.1 Excess or idle assets are not being used by the business and are not generating any returns through use. The business is paying some form of “cost of capital” on the asset, represented by the money tied up in the asset which can only be realised by selling it (as the business is not using it to generate any cash flows). One (1) of the key objectives of the financial manager is to maximise shareholder wealth. In order to achieve this, the financial manager needs to only invest in assets that is likely to earn a return greater than the “cost of capital”. Therefore, the financial manager should choose to dispose of assets that do not meet this requirement. Should the financial manager choose to dispose of these assets, the cash proceeds from the sale could be used in more productive ways through investment (in assets or projects that will be used to generate cash flows) or by paying off borrowings. Either approach will enhance the return on capital employed of the entire business and result in the more effective use of the business’ assets.Activity 2 - Question 1.2Purpose: The purpose of this activity is to reflect on the different stakeholders that a financial manager has to consider when making business decisions. Comment: This activity is designed to make you realise that financial managers do not act in isolation, and that all of their decisions have an impact on both internal and external stakeholders, and ultimately on the business itself.Question 1.2Shareholders provide one (1) form of capital to the business. Their objective is for their wealth (represented by the share price) to be maximised. The frequency of cash flows in the form of dividends as well as long-term share price appreciation will influence whether shareholders will buy/ sell shares in the company.Share price movements are in turn influenced by the market’s perception of how the business is managed, so major decisions made by the financial manager will have an impact on the perceptions of the market, giving rise to a movement in the share price. (ii) Creditors provide goods and services to the firm. Generally, they will have the same business objectives as the business and will want to be paid in a prompt manner, whilst still maintaining the trading relationship with the business. The financial manager’s role here is to preserve this business relationship, ensuring that the credit terms negotiated are beneficial to the business. (iii) Long-term credit providers are usually banks who provide the business with the other form of capital. Their objective is to ensure that the business makes the scheduled loan capital and interest repayments. The financial manager’s role here is to negotiate loan capital and interest rates that are favourable to both parties, and ensure that the business has sufficient funds to meet its debt-servicing requirements (so that there are no defaults on the loan). Not having defaults on payments and maintaining a good relationship, will allow the financial manager to negotiate better rates/ payment terms with the bank in future. (iv) Employees of the business seek to maximise their remuneration and continuity of employment. The financial manager needs to ensure that employees are remunerated appropriately and on a timely basis. If employees feel they are unfarily remunerated, they may become less productive, look for employment elsewhere or even engage in strike action. Activity 3 – Question 1.3 Purpose: The purpose of this activity is to distinguish between an entrepreneur and a financial manager and the roles they play in a business. Commentary: This activity is designed in order for you to realise that entrepreneurs often act as the financial managers of their businesses, if the business is very small. The larger a business becomes, the more the need for the financial function to be separated from the overall management function.Question 1.3 An entrepreneur is a person whose objective is to find new and innovative ways of doing something through inventing and selling a new product or service. They are inventors and are willing to take risks in exploiting opportunities. In most cases an entrepreneur is the owner of the business he/ she created, and might not necessarily be formally educated in business and finance. The smaller the entrepreneur’s business, the more involved they will be in the “financial management” aspects of their business. The bigger their business, the greater the likelihood that they will employ financial managers to manage the business on their behalf. In summary, “entrepreneurs” start up their own businesses, whereas a financial manager manages a business on behalf of somebody else.Activity 4 – Question 1.4 Purpose: The purpose of this activity is to identify the role that performance-related incentives play in motivating financial managers to act in a certain mentary: This activity is designed to encourage you to look at both sides of an argument, and to identify both the positive and negative aspects of linking a financial manager’s performance to his or her remuneration.Question 1.4 (i) Bonuses: Many organisations use performance-related bonus schemes to incentivise management. For example, a financial manager might be entitled to a maximum 20% bonus, of which 10% will be related to personal performance (evaluated and assessed using employee appraisals) and 10% will be related to the overall performance of the business. Share schemes: Many listed companies will give employees the option of participating in a share scheme. Employees are granted a number of share options entitling them to subscribe to a given number of shares in the company after a certain date at a fixed price (this is usually set at a value that will be lower than the current share price). Share schemes serve to align the financial manager’s personal objectives with that of other shareholders i.e. shareholder wealth maximisation.(ii) Advantages of performance-related reward schemes:Motivates employees to improve their performance levels;May attract strong candidates to the organisation and improve employee loyalty;By aligning organisational key performance indicators to employee rewards, employees know what sort of performance will generate a strong business performance;It fosters a culture of continuous improvement throughout the organisation;Schemes based on shares encourage employees to focus on the long-term interests of the organisation by engaging in activities that will increase the business’ market value.(iii) Disadvantages of performance-related reward schemes:It may encourage dysfunctional behaviour – to make bonuses more achievable, many managers may lower budgets and standards;Managers may be more willing to take on projects with an unacceptably high level of risk in the hope of achieving high returns – this could be to the detriment of the business as a whole;Schemes with a long-term focus may put managers off as they are too long-term;Performance objectives of an individual might not provide an indication of what the individual has actually achieved and their assessment is still subjective;Individual performance objectives may be to the detriment of team work;The high level of output required by performance objectives might come at the expense of quality.Once staff members have met the required performance level to qualify for their bonuses, motivation levels might drop, as no marginal benefit may be available to them beyond reaching this target. ................
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