Chapter 2; Nature, Purpose & Scope of Financial accounting aspects of a company's relationship

Management with its funding source.

2. Another group of experts believes that money is
Any company's financial health is crucial. Finances, like
all in finance. Since all business transactions,
most other resources, are, however, finite. Wants, on
whether directly or indirectly, include cash,
the other hand, are often limitless. As a result, it is
finance is concerned with everything the
important for a company to effectively control its
company does.
finances. It is important for any company to invest the
3. The third and most commonly held viewpoint is
funds it receives in such a way that the investment
that financial management encompasses both
yields a higher return than the cost of capital. Financial
the acquisition and effective use of funds. In the
management, in a nutshell;
case of a manufacturing company, for example,
 Endeavours to reduce the cost of finance financial managers must ensure that funds are
 Ensures sufficient availability of funds sufficient for the installation of the
 Deals with the planning, organizing, and manufacturing plant and machinery. It must
controlling of financial activities like the also ensure that earnings are sufficient to cover
procurement and utilization of funds the costs and risks faced by the company.

Definitions of Financial Management Many companies can easily raise capital in a

developed market. The real issue, however, is
“Financial management is the activity concerned with maximizing capital use through successful financial
planning, raising, controlling and administering of funds planning and control.
used in the business.” – Guthman and Dougal
Furthermore, the company must ensure that it
“Financial management is that area of business handles activities such as allocating funds, handling
management devoted to a judicious use of capital and a them, investing them, controlling expenses,
careful selection of the source of capital in order to predicting financial needs, preparing income and
enable a spending unit to move in the direction of calculating returns on investment, evaluating
reaching the goals.” – J.F. Brandley working capital, and so on.
“Financial management is the operational activity of a
business that is responsible for obtaining and effectively
utilizing the funds necessary for efficient operations.”
Massie

Nature, Significance, and Scope of Financial

Management

Any company's financial management is a natural part

of its operation. To procure physical resources, carry
out manufacturing activities and other business
operations, pay compensation to vendors, and so on,
Core Financial Management Decisions
every company requires funds. There are several
financial accounting theories: Managers of companies make the following decisions in
order to reduce the costs of obtaining finance and to
1. Some experts believe that Financial
use it in the most efficient way possible:
Management is all about getting a company the
money it needs on the most attractive terms  Investment Decisions
possible while keeping its goals in mind. As a  Financing Decisions
result, this strategy is mainly concerned with  Dividend Decisions
the acquisition of assets, which can include
instruments, institutions, and fundraising
activities. It also looks after the legal and
Investment Decisions: Managers must determine the CHAPTER 3: RELATIONSHIP of FINANCIAL OBJECTIVES
amount of investment available from existing funds, to ORG STRATEGY & OTHER ORG OBJECTIVES
both long- and short-term. There are two kinds of them:
Financial Objectives and Organizational Strategy
 Capital Budgeting, also known as Long-term
investment decisions, imply committing funds
for a long time, similar to fixed assets. These
decisions are normally irreversible and involve
those involving the purchase of a building
and/or property, the acquisition of new
plants/machinery or the replacement of old
ones, and so on. These choices influence a
company's financial goals and results.
 Working capital management, also known as
short-term investment decisions, refers to
committing funds for a short period of time,
such as current assets. These decisions include
cash, bank deposits, and other short-term
investments, as well as inventory investment.
They have a direct impact on a company's
liquidity and profitability.

Financing Decisions: Managers must also make

decisions on raising funds from long-term (Capital
Structure) and short-term sources (called Working
Capital). There are two kinds of them:

 Financial Planning Decisions that include

estimating the origins and applications of funds. Shareholder Wealth Maximization
It entails anticipating a company's financial
I. Most companies are owned by shareholders and
needs in order to ensure that sufficient funds
originally set up to make money for those shareholders.
are available. The primary goal of financial
The primary objective of most companies is thus to
planning is to prepare ahead of time to ensure
maximise shareholder wealth. (This could involve
that funds are available when needed.
increasing the share price and/or dividend payout.)
 Capital Structure Decisions that include locating
funding sources. They also include decisions on II. Shareholder wealth maximisation is a fundamental
whether to raise funds from external sources principle of financial management. Many other
such as selling shares, bonds, or borrowing from objectives are also suggested for companies including:
banks, or from internal sources such as retained
A. profit maximization
earnings.
B. growth
Dividend Decisions: These are decisions over how much C. market share
of a company's earnings will be paid as dividends. D. social responsibilities
Shareholders often seek a higher dividend, while
One issue that the financial manager faces is meeting
management prefers to keep income for operational
the goals of many stakeholders at the same time.
purposes. As a result, this is a difficult managerial
Reducing salaries, for example, will increase profits and
decision.
please shareholders, but it is unlikely to satisfy workers.
As a result, a distinction between maximising and
satisfying must be made in practice.

A. Maximising – seeking the best possible outcome

 because they have a stake or an interest in what
happens.
B. Satisficing – finding a merely adequate
outcome. It's common to divide stakeholders into groups, each
with its own set of priorities and concerns. The
following are the most common types of stakeholder
Objectives in Not-For-Profit Organizations
groups in an organization:
Not-for-profit organisations include charities, state
Internal:
health services, and police forces, which are run for the
purpose of providing a service rather than profit. A. Directors
Despite the importance of good financial management B. Employees
in these organisations it is not possible to set financial C. Connected:
goals in the same way as businesses do. As a result,
Shareholders
these organizations place a premium on value for
money, or trying to get the most benefits for the least A. Leaders
amount of money. B. Customers
C. Suppliers
Value for money is described as obtaining the best
D. Labour union
possible combination of services by using the fewest
resources possible, i.e., maximizing benefits at the External:
lowest possible cost. This is commonly understood to
necessitate the use of economy, effectiveness and A. Government
efficiency. B. Society as a whole

To achieve a certain amount of outputs, the economy Goal incongruence between stakeholders
must obtain the required quantity and quality of inputs For example, bondholders seek a steady stream of
at the lowest possible cost. For example, the economy income in the form of interest and the assurance that
in which a school purchases equipment can be their principal will be repaid. Shareholders, on the other
calculated by comparing real costs to budgets, previous hand, seek rising dividends and, as a result, rising stock
year's costs, government/local authority requirements, prices. Risky projects are avoided by the former, while
or other schools' spending. risky projects are welcomed by the latter because the
The degree to which stated objectives/goals are met is higher the risk, the higher the return. This exemplifies
referred to as effectiveness. The proportion of students the goal inconsistency between bondholders and
who go on to higher or further education, for example, stockholders.
may be used to assess the efficacy of a school's goal of Agency Problem The conflict of interests between
producing quality teaching. different stakeholders of a corporation, such as
The relationship between inputs and outputs is known shareholders and bondholders or employees and
as efficiency. The efficiency in which a school's IT shareholders, is referred to as an agency issue. They can
laboratory is used, for example, may be calculated in appear in a variety of ways.
terms of the percentage of the school week that it is Moral hazard – A boss has a vested interest in reaping
used. the rewards of his or her job. All of the perks that come
Stakeholders with status, such as a company vehicle, use of a
company plane, lunches, and so on, are included.
While a private sector corporation's theoretical goal
may be to increase its shareholders' wealth, other Effort level – Managers could put in less effort than if
individuals and organizations are interested in what the they were the company's owners. In a large
company does and may be able to influence its corporation, the issue would occur at both the middle
corporate goals. Stakeholders are people who are and senior management levels.
interested in a company's operations or success
Earnings retention – Rather than earnings, the size of C. Where there is (or may be) a conflict of interest
the business is also used to determine the remuneration between executive directors and the company's
of directors and senior managers. Rather than paying best interests, independent non-executive
out dividends, management is more likely to want to directors may also make decisions. Non-
reinvest profits in order to grow the business. executive officers, for example, may be in
charge of remuneration arrangements for
Risk aversion - Executive directors and senior managers
executive directors and other senior managers.
typically receive the majority of their profits from the
D. The possibility of a hostile takeover. If a
organization for which they work. As a result, they care
company is poorly run, the stock price would be
about the company's stability because it will secure
low in comparison to its future value. When the
their job and future earnings. This may indicate that
stock price is poor, competing management
management is risk averse and unable to invest in
teams are more likely to launch a hostile
higher-risk ventures.
takeover. In most cases, the current
Time horizon - Shareholders are concerned about their management will be dismissed. As a result,
company's long-term financial prospects because the managers are compelled to optimize share
value of their shares is based on long-term assumptions. prices.
Managers, on the other hand, could be only concerned
Incentive Schemes
with the short term. This is partly due to the fact that
they may be paid annual bonuses based on short-term A remuneration package for executive directors or
results, and partly due to the fact that they may not senior managers may have a variety of structures, but
plan to stay with the organization for more than a few most remuneration packages have at least three
years. components.

Agency costs include direct and indirect costs. A basic salary – it needs to be high enough to attract
and retain individuals with the required skills and talent.
Direct costs include remuneration and audit fees.
Annual performance incentives – The performance
Indirect costs include the cost of lost opportunity
target might be stated as profit or earnings growth, EPS
because of agency problems.
growth, achieving a profit target, etc. Some managers
Reducing the agency problem might also have a non-financial performance target.

Several methods of reducing the agency problem have Long-term performance incentives – Which are linked
been suggested. These include: in some way to share price growth. Long term
incentives are usually provided in the form of share
A. Creating a compensation plan for executive awards or share options of the company.
directors and senior managers that encourages
them to behave in the best interests of the Corporate Governance
company's shareholders. Offering managers
The collection of procedures, customs, rules, laws, and
share options, for example, is one way to
institutions that regulate how a corporation (or
motivate them to behave in ways that maximize
company) is guided, managed, or regulated is known as
shareholder capital. Managers will be enticed to
corporate governance. The relationships between the
make choices that are likely to result in higher
stakeholders and the purposes for which the company
share prices (such as investing in projects with
is regulated are discussed in corporate governance.
positive net present values), as this will increase
their share option incentives. A. There are a number of key elements in
B. Having a sufficient number of qualified non- corporate governance:
executive directors on the board. They are not B. Risk management and mitigation is a central
full-time workers and do not hold any executive theme in all conceptions of good governance,
positions in the company. They have the ability whether specifically specified or implicitly.
to behave in the shareholders' best interests. C. Most concepts are based on the idea that good
organizational frameworks and management
 practice within set best practice guidelines L. The board should maintain a regular dialogue
improve overall efficiency. with shareholders, particularly institutional
D. From the perspective of all stakeholder groups shareholders. The annual general meeting is a
affected, good governance provides a basis for significant forum for communication.
an organization to execute its policy in an M. Annual reports must convey a fair and balanced
ethical and efficient way, as well as protections view of the organisation. This might include
against the misuse of physical or intellectual whether the organisation has complied with
capital. governance regulations and codes, and give
E. Good governance necessitates not only the specific disclosures about the board, internal
application of externally defined laws, but also control reviews, going concern status and
the ability to apply both the spirit and the letter relations with stakeholders.
of the law.
F. Accountability is generally a major theme in all
governance frameworks.

Corporate governance codes of good practice generally

cover the following areas:

A. The board should be responsible for taking

major policy and strategic decisions.
B. Directors should have a mix of skills and their
performance should be assessed regularly.
C. Appointments should be conducted by formal
procedures administered by a nomination
committee (or selection committee).
D. Division of responsibilities at the head of an
organisation is most simply achieved by
separating the roles of chairman and chief
executive.
E. Independent non-executive directors have a key
role in governance.
F. Their number and status should mean that their
views carry significant weight.
G. Directors' remuneration should be set by a
remuneration committee consisting of
independent non-executive directors.
H. Remuneration should be dependent upon
organisation and individual performance.
I. Accounts should disclose remuneration policy
and (in detail) the packages of individual
directors.
J. Boards should regularly review risk
management and internal control, and carry out
a wider review annually, the results of which
should be disclosed in the accounts.
K. Audit committees of independent non-
executive directors should liaise with external
auditors, supervise internal audit, and review
the annual accounts and internal controls.