INTRODUCTION TO FINANCIAL MANAGEMENT

FUNCTIONS OF THE FINANCIAL MANAGER

Financial Management is that part of the total management functions which is

concerned with the effective and efficient raising and use (or utilization) of funds.
In short the functions of a financial manager is to manage finances.

Investment of funds in assets. e.g. Cash will reflect the liquidity position of the firm
and hence determine its size, its profits from operations. (i.e. PROFITABILITY).

THE FIRM’S OBJECTIVES (Management)

The most commonly presumed objectives of any given firm from management point
of view are:
1. Maximization of Shareholder’s funds/wealth
2. Adequate return. (i.e. the maximization of profit in relation to investment).
3. Return on Equity (ROE).

OBJECTIVES OF A BUSINESS (ENTITY)

(a) Growth -
(b) Risk of reduction – Management tries to avoid risky undertakings preference for
profit. They differentiate between High/Low risk investments. E.g. Govt. Bonds,
shares in the Mining Company etc.
(c) Personal Aspirations – may affect the business. e.g. Professional managers may
tend to improve there own salary, career prospects or security, which may mean a
desire for quick results which will stand to the immediate credit of the managers
involved as against the more usual but longer term profit – making objectives.
(d) Social Objectives:-
Some organizations are concerned about the improvement of working conditions for
good rates of pay for their employees. E.g. provision of wholesome product for their
customers.
(e) Efficiency – Some enterprises such as charities of public services have as a
fundamental objective of the provision of the required services which is not
supplied in the market place. A suitable management objective for them is the
provision of the service at minimum cost.
(f) Orderly liquidation – once the firm goes into liquidation, management have the
objective to see to it that business continues to run until its demise so as to
balance the conflicts of interests of employees, shareholders, and customers and
to full fill contractual obligations. E.g. to pay creditors and debenture holders and
to bring a tidy conclusion to all outstanding matters.

SUMMARY:
 (i) The Financial Manager’s function can be analyzed as being to ensure that
finance is available at the right time and at least (i.e. lowest) cost and that
funds are used in the most profitable and efficient ways.

 (ii) The effective discharge of this function requires the Financial

Manager to have a good knowledge of Financial Accounting, Management
Accounting, Law, Economics, Quantitative Methods and Taxation.

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WHAT ARE THE MAJOR FUNCTIONS OF THE FINANCIAL MANAGER?

The functions of the Finance Manager involves three major decisions, these are:
i) They must make Investment decisions.
(ii) Financial decisions and
(iii) Dividend decisions.

Each of these decisions are considered in relation to the objectives of the firm.

1. INVESTMENT DECISIONS:

This the most important of the three decisions. Capital Investment – forms a major
aspect of this decision and involves the allocation of capital to investment proposals
whose benefits are to be realized in the future. Because the future benefits are not
known with certainty investment proposals necessarily involve risk. Consequently
they should be evaluated in relation to their expected return and risk.

In addition to selecting new investments, a firm must manage its existing assets
efficiently. Financial Managers have varying degrees of operating responsibility for
existing assets, they are more concerned with the management of Current Assets than
with Fixed Assets.

2. FINANCING DECISIONS:

The Financial Manager is concerned with determining the best Financing Mix or
Capital Structure. Cost of debt is one part of a company's capital structure, which also
includes the cost of equity. Capital structure deals with how a firm finances its overall
operations and growth through different sources of funds, which may include debt
such as bonds or loans, among other types. The Finance Manager’s concern is with
exploring the implications of variations in the capital structure on the valuation of
the firm.

3. DIVIDEND DECISIONS:

The dividend decisions include the percentage of earnings paid to

stockholders/shareholders in cash dividends, the stability of absolute dividends.
The dividend pay-out ratio determines the amount of earnings retained in the firm and
must be evaluated in the light of the objective of Maximizing Shareholders wealth.

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THE ROLE OF FINANCIAL MANAGEMENT

1. Translation of plans into financial terms.

2. Financial evaluation of the business plans
3. Raising of funds for the plan.
4. Implementing and controlling the plan.
5. Reporting to the interested parties as to the financial outcomes of the plan
implemented.

ORGANIZATION OF FINANCE FUNCTION:

(a) Finance Director- He is responsible for:

(i) Setting of broad Financial Strategies.
(ii) Major Capital Expenditure decisions
(iii) Micro- and Macro- economic interpretations.
(iv) Government economic and fiscal policies. i.e. implications.
(v) Dividend Decisions.

(b) Chief Accountant- He is responsible for:

(i) Preparation of Financial Reports
(ii) Management Information System (MIS)
(iii) Preparation and Control of Budgets
(iv) Pricing policy
(v) Capital Investment Appraisal
(vi) Management of Working Capital

(c). Treasurer- He/she is responsible for:

(i) Relationship with shareholders and Financial Institutions.
(ii) Finance and Credit Sourcing
(iii) Cash Management.
(iv) Foreign Exchange Management
(v) Corporate Financial Planning.

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INTRODUCTION TO COSTING AND MANAGEMENT ACCOUNTING

The American Accounting Association defines accounting as the process of identifying,

measuring, and communicating economic information to permit informed judgments and
decisions by the users of the information.
In other words accounting is concerned with providing both financial and non-
financial information that will help decision makers to make good decisions. An
understanding of accounting therefore requires an understanding of the decision making
process and an awareness of the users of the accounting information: namely:
 Management
 Owners as investors
 Employees
 Lenders
 Suppliers and other trade creditors
 Customers
 Governments and their agencies
 Public interest
 Financial Analysts

Management

Many would argue that the foremost users of accounting information about an
organization must be those who manage the business on a day-to-basis. This group is
referred to in broad terms as management, which is a collective term for all those persons
who have collective responsibilities for making judgments and decisions within the
organization. Because they have close involvement with the business, they have access to
a wide range of information (much of which might be confidential within the
organization) and will seek those aspects of information which are most relevant to their
particular judgments and decisions.
Owners as investors

Where the owners are the managers, as is the case for a sole trader or partnership, they
have no problem in gaining access to information and will select information for their
own needs on matters of judgment and decisions. Where the ownership is separate from
the management of the business, as is the case with a limited liability company, the
owners are more appropriately viewed as investors who entrust their money to the
company and expect something in return, usually dividend and a growth in the value of
their investment as the company prospers. Providing money to fund a business is a risk
act to take and the investors are concerned with the risk inherent in, and return provided
by their investments. They need information to help them whether they should buy hold
or sell.

Employees

Employees and their representatives are interested in information about the stability and
profitability of their employers. They are also interested in the information that helps
them to assess the ability of the entity to provide remuneration, retirement benefits and
employment opportunities. Employees continue to be interested in their employer after
they have retired from work because in many cases the employer provides pension funds.

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Lenders

Lenders are interested in the information that enables them to determine whether their
loans, and the related interest rates will be paid when due.
Loan creditors provide information on a long-term basis. They will wish to assess the
economic stability and vulnerability of the borrower. They are partially concerned with
the risk of default and its consequences.
Suppliers and other creditors

Suppliers of goods and services (also called trade creditors) are interested in information
that will enable them to decide whether to sell to the entity and to determine whether the
amount owed to them will be paid when due.

Customers
Customers have interest in information about the continuance of an entity, especially
when they have a long-term involvement with, or are dependant upon the entity. In
particular customers need information concerning the present and future supply of goods
and services offered price and other product details and conditions of sale. Much of this
information may be obtained from sales literature or from sales staff of the enterprise, or
from trade and consumer journals.

Governments and their agencies

Governments and their agencies are interested in allocation of resources and, therefore in
the activities of entities. They also require information in order to regulate the activities
of entities, assess taxation and provide a basis for national income and economic
statistics.

Public interest

Enterprises affect members of the public in a variety of ways. For example enterprises
may make a substantial contribution to the local economy providing employment and
using local suppliers. Financial statements may assist the public by providing information
about the trend and recent developments in the prosperity of the entity and the range of its
activities.
A strong element of public interest has been aroused in recent years by environmental
issues and the impact of companies on the environment. There are costs imposed on
others when a company pollutes a river or discharges harmful gases in the air.

Financial Analysts (or Journalists)

These are business specialists who analyze business trends and advise prospective
investors on appropriate sectors of the country’s economy in which they could invest in.

An examination of the various users of accounting information indicates that they can be
divided into two categories:

1. Internal parties within the organization

2. External parties such as shareholders, creditors and regulatory agencies etc. outside
the organization.

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It is possible to distinguish between two branches of accounting that reflect internal and
external users of accounting information.

Management accounting
Is concerned with the provision of information to people within the organization to help
them make better decisions and improve the efficiency and effectiveness of existing
operations, whereas financial accounting is concerned with the provision of information
to external parties outside the organization.

Differences: Management Accounting and Financial Accounting

The major differences between management accounting and financial accounting are:

 Legal requirements. There is a statutory requirement for public limited

companies to produce annual financial accounts regardless whether or not
management regards this information as useful. Management accounting, by
contrast, is entirely optional and information should be produced only if it is
considered that the benefits from the use of information by departments exceed
the cost of collecting it.
 Focus on individual parts or segments of the business. Financial accounting
reports describe the whole of the business whereas management accounting
focuses on small parts of the organization, for example the cost and profitability
of products, services, customers and activities. In addition, management
accounting information measures the economic performance of decentralized
operating units, such as divisions and departments.
 Generally accepted accounting policies. Financial accounting must be prepared
to conform to the legal requirements and the generally accepted accounting
principles established by the regulatory bodies such as the financial accounting
standard board (FASB) in the USA and the accounting standards board (ASB) in
the UK. These requirements are essential to ensure uniformity and consistence
that is needed for external financial statements. Outside users need assurance that
external statements are prepared according to the generally accepted accounting
principles so that the inter-company and historical comparisons are possible. In
contrast management is not required to adhere to the generally accepted
accounting principles when providing managerial information for internal
purposes. Instead the focus is on serving management’s needs and providing
information that is useful to managers relating to their decision –making, planning
and control functions.

 Time dimension. Financial accounting reports what happened in the past in an

organization, whereas management accounting is concerned with future
information as well as past information. Decisions are concerned with future
events and management therefore requires details of expected future costs and
revenues.
 Report frequency. A detailed set of financial accounts is published annually and
less detailed accounts are published semi-annually. Management requires
information quickly if it is to act on it. Consequently management accounting
reports on various activities and may be prepared at daily, weekly or monthly
intervals.

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Home work

Discuss the qualities of good accounting information.

(a) relevance
(b) comprehensibility/understandability
(c) reliability
(d) completeness
(e) objectivity
(f) timeliness
(g) comparability
(h) accuracy

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 THE DECISION MAKING PROCESS

Because information produced by management accountants must be judged in the light of

its effect on the outcome of decisions, a necessary precedent to understanding of
management accounting is an understanding of the decision- making process.

FIGURE 1.1 the decision-making, planning and control process

1. Identify objectives

2. Search for alternative courses of action

Planning
Process 3. Gather data about alternative

4. Select alternative courses of action

5. Implement the decisions

Control 6. Compare actual and planned outcomes

Process
7. Respond to divergences from plan

Figure 1.1 presents a diagram of a decision-making model. The first five stages represent
the decision-making or the planning process. Planning involves making choices between
alternative and is primarily a decision making activity. The final two stages represent the
control process, which is the process of measuring and correcting actual performance to
ensure that the alternatives that are chosen and the plans for implementing them are
carried out.
Let us now consider each of the elements of the decision-making and control process.

Identifying Objectives

Before good decisions can be made there must be some guiding aim or direction that will
enable the decision-makers to assess the desirability of favoring one course of action over
another. Hence, the first stage in the decision making-making process should be to
specify the goals or objectives of the organization.

Considerable controversies exist as to what the objectives of firms are or should be.
Economic theory normally assumes that firms seek to maximize profit for the owners of
the firm (the ordinary share holders in a limited company) or precisely, the maximization
of the shareholders wealth. Various arguments have been used to support the profit
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maximization objective. There is legal argument that the ordinary shareholders are the
owners of the firm, which therefore should be run for their benefit by a trustee manager.
Another argument supporting the profit objective is that the profit maximization leads to
the maximization of overall economic welfare. That is by doing the best for yourself, you
are unconsciously doing the best for society. More over it seems a reasonable belief that
the interest of firms will be better served by a larger profit than by a smaller profit, so that
maximization is at least a useful approximation.

The Search for Alternative Courses of Action

The second stage in the decision-making model is a search for a range of possible courses
of action (or strategies) that might enable the objectives to be achieved. If the
management of accompany concern rates entirely on its present product range and
markets, and market shares and cash flows are allowed to decline, there is a danger that a
company will be unable to generate sufficient cash flows to survive in the future. To
maximize future cash flows, it is essential that management identifies potential
opportunities and threats in its current environment and takes specific steps immediately
so the organization will not be taken by surprise by any developments which may occur
in the future. In particular the organization should take one or of the following courses of
action:

1. Developing new product for sale in existing markets

2. Developing new products for new markets.
3. Developing new markets for existing products.
The search for alternative courses of action involves the acquisition of information
concerning future opportunities and environments; t is the most difficult and important
stage of the decision-making process. Ideally firms should consider all alternative courses
of action, but in practice they only consider a few alternatives.

Gather Data about Alternatives

When potential areas of activity are identified, management should assess the potential
growth rate of activities, the ability of the company establish market shares, and the cash
flow for each alternative activity for various states of nature. Because decision problems
exist in an uncertain environment, t is necessary to consider certain factors that are
outside the decision-maker’s control, which may occur for each alternative course of
action. These uncontrollable factors are called states of nature. Some examples of
possible states of nature are economic boom, high inflation, recession, the strength of
competition and so on.
The course of action selected by a firm using the information presented above may be for
the long-run or short run and the organization will commit its resources according to
plan.

Select Appropriate Alternative Courses of Action

In practice, decision-making involves choosing between competing alternative courses of

action and selecting the alternative that best satisfies the objectives of an organization.
Assuming that our objective is to maximize future net cash inflows, the alternative
selected should be based on the comparison of the differences between the cash flows.
Consequently, an incremental analysis of the net cash benefits for each alternative should
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be applied. The alternatives are ranked in terms of net cash benefits, and those showing
the greatest benefits are chosen subject to taking into account any qualitative factors.

Implementation of the Decisions

Once alternative course of action has been selected, they should be implemented as part
of the budgeting process. The budget is a financial plan for implementing the various
decisions that management has made. The budgets for all of the various decisions are
expressed in terms of cash inflows and outflows, and sales revenue and expenses. These
budgets are merged together a single unifying statements of the organization’s
expectation for future periods. This statement is called master budget. The master
budget consists of a budgeted profit and loss account, cash statement and balance sheet.
the budgeting process communicates to everyone in the organization the part that they are
expected to play in implementing management’s decision.

Comparing Actual and Planned Outcomes and Responding To Divergences from

Plan

The final stages in the process outlined in figure 1, 1 of comparing actual and planned
outcomes and responses to divergences from plan represents the firms control process.
The managerial function of control consists of the management, reporting and
subsequent correction of performance in an attempt to ensure that the organization’s
objectives are achieved. In other words the objectives of the control process are to ensure
that the work is done so as to fulfill the original intentions.

To monitor performance, the accountant produces performance reports and presents

them to the appropriate managers who are responsible for various decisions. Performance
reports consisting of a comparison of actual outcomes (actual costs and revenue) and
planned outcomes (budgeted costs and revenue) should be issued at regular intervals.

Performance reports provide feed back information by comparing planned and actual
outcomes. Effective control requires that corrective action is taken so that actual
outcomes conform to planned outcomes. the process of taking corrective action so that
the actual outcomes conforms to planned outcomes, or the modification of the
comparisons that actual outcomes do not conform to planned outcomes.

Prepared by: J. Lubemba.

Senior Consultant (Accounting and Finance)
NIPA,

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