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ACCA Paper F9

ACCA Paper F9. Financial Management. Core areas of the syllabus. Financial management function Financial management environment Working capital management Investment appraisal Business finance Cost of capital Business valuations Risk management. Format of the exam.

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ACCA Paper F9

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  1. ACCA Paper F9 Financial Management

  2. Core areas of the syllabus Financial management function Financial management environment Working capital management Investment appraisal Business finance Cost of capital Business valuations Risk management

  3. Format of the exam Four compulsory questions 25 marks each Balance of calculative and discursive elements in questions

  4. The financial management function

  5. The financial management function • (1) Raising finance • (2) Investing funds raised – this includes • allocating funds and • controlling investments • (3) Dividend policy – returning gains to shareholders

  6. Corporate strategy and objectives

  7. Corporate stakeholders

  8. Agency theory Agency relationships occur when one party, the principal, employs another party, the agent, to perform a task on their behalf Objectives of principals and agents may not coincide Problem of goal congruence

  9. Not for profit organisations

  10. Value for money • Effectiveness • A measure of outputs • e.g. number of pupils taught • Efficiency • A measure of outputs over inputs • e.g. Average class size • Economy • Being effective and efficient at the lowest possible cost

  11. System analysis

  12. Investment appraisal ROCE Payback Net present value Internal rate of return

  13. ROCE

  14. Payback

  15. Payback

  16. The time value of money • Money received today is worth more than the same sum received in the future because of: • The potential for earning interest • The impact of inflation • The effect of risk

  17. Compounding • Compounding calculates the future value of a given sum of money F = P (1 + r)n where F = future value after n periods P = present or initial value r = rate of interest per period n = number of periods

  18. Discounting Discounting is the conversion of future cash flows to their present value

  19. Annuities and perpetuities An annuity is a constant annual cash flow for a number of years

  20. Annuities and perpetuities An perpetuity is an annual cash flow that occurs for ever

  21. Annuities and perpetuities

  22. Relevant cash flows • Only consider future, incremental cash flows • Ignore: • ‘sunk costs’ • Committed costs • Depreciation • Interest & dividend payments • Include opportunity costs

  23. Net present value • All future cash flows are discounted to their present value and then added • A positive result indicates the project should be accepted • A negative result and the project should be rejected

  24. Internal rate of return The rate of interest (discount) at which the NPV = 0

  25. Internal rate of return

  26. NPV with inflation

  27. Real and money rates

  28. Taxation • Two tax effects to consider: • Tax payments on operating profits • Tax benefit from capital allowances and a possible tax payment from a balancing charge on asset disposal

  29. Writing down allowances

  30. Pro Forma NPV calculation

  31. Working capital in NPV questions Working capital is treated as an investment at the start of the project Any increases during the project are treated as a relevant cash outflow At the end of the project the working capital is ‘released’ – an inflow The working capital requirement may be given as a % of (usually) sales

  32. Lease versus buy decision • Compare the present value cost of leasing with the present value cost of borrowing to buy • Leasing cash flows: • Rental payments (usually in advance) • Tax relief on the rental payments • Buying cash flows: • Asset purchase • Writing down allowances

  33. Replacement decisions Used when the assets of a project need replacing periodically Choose the option with the lowest equivalent annual cost The optimum replacement cycle is that period which has the lowest EAC

  34. Capital rationing Insufficient funds to undertake all positive NPV projects Mutually exclusive projects – choose the project with the highest NPV Divisible projects – calculate the profitability index Indivisible projects – trial and error

  35. Risk in investment appraisal • Risk = probabilities of different outcomes can be estimated • Expected values p = probability of each outcome x = the cash flow from each outcome • Payback used in addition to NPV • Risk adjusted discount rates

  36. Uncertainty in investment appraisal Uncertainty = probabilities of different outcomes cannot be estimated Sensitivity analysis Minimum payback period Assess the worst possible situation Obtain a range by assessing the best and worst possible situations

  37. Sensitivity analysis Calculate how much one input value must change before the decision changes (say from accept to reject) The smaller the margin the more sensitive is the decision to the factor being considered

  38. Working capital • The capital available for conducting the day-to-day operations of the business • All aspects of both current assets and current liabilities need to be managed to: • Minimise the risk of insolvency • Maximise the return on assets

  39. Cash operating cycle

  40. Cash operating cycle • The length of the cycle = Inventory days + Receivable days – Payables days • The amount of cash required to fund the operating cycle will increase as either: • The cycle gets longer • The level of activity or sales increases

  41. Cash operating cycle • Reduce cycle time by: • Improving production efficiency • Improving finished goods and / or raw material inventory turnover • Improving receivable collection and payables payment periods

  42. Working capital ratios

  43. Working capital ratios

  44. Managing inventory

  45. Economic order quantity Where: Co = cost per order D = annual demand Ch = cost of holding one unit for one year Q = quantity ordered

  46. Inventory management systems • Bin systems • Action taken if inventory falls outside a preset maximum and minimum • Periodic review • Inventory levels reviewed at fixed intervals • Just in time • Aims for elimination of inventory • Finished goods made to order • Raw material inventory is delivered to point of use when needed

  47. Accounts receivable Have a credit policy Assess credit worthiness Control credit limits Invoice promptly and collect overdue debts Follow up procedures Monitoring the credit system Offer discounts

  48. Prompt payment discounts

  49. Debt factoring

  50. Debt factoring

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