INTRODUCTION TO FINANCIAL MANAGEMENT

EVALUATION OF FINANCIAL PERFORMANCE

Finance revolves around MONEY

Functions of MONEY:MONEY is what MONEY DOES MONEY is a MEDIUM OF EXCHANGE (it is a means of payment for goods and services)

MONEY is the LIFEBLOOD of a BUSINESS(a business cannot exist without MONEY!)

MONEY is a MEASURE OF RELATIVE VALUE(it is a Unit of Account)

MONEY is a STANDARD FOR DEFERRED PAYMENTS(enabling credit transactions)MONEY is a STORE OF VALUE(it can be held as an ASSET)

MONEY has TWO (2) sides (Heads and Tails?)

CAPITAL and REVENUECAPITAL consists of all the resources of an ENTREPRISE that will produce REVENUE (or INCOME)There can be NO REVENUE without CAPITALThe bigger the CAPITAL the bigger the potential for INCOMEThe FATTER THE COW: the FATTER THE PURSE!

A business NEEDS Money before it can spend it!

SOURCES OF FUNDS

A business gets Money from EQUITY and/or DEBTEQUITY funds come from SHAREHOLDERS orReinvested PROFITS or RESERVESDEBT is sourced from External BORROWINGS

The Financial Manager must decide how to get money to GROW the CAPITAL of the business

This is the FINANCIAL DECISION!

CLASSIFICATION OF SHARES

Shares can be Ordinary, Preferred or DeferredPreference Shares can be CUMULATIVE orNon-cumulative

EQUITY FUNDS are LONG TERM sources of funds

Preference Shares can be REDEEMABLERedeemable Preference Shares are often classified as aHYBRID Source of FundsShares can be PREFERRED or DEFERRED as toDividends and/or Return of Capital on Winding Up

Preference Shares can be PARTICIPTATING orNon-participating as to dividends and/or Return of Capital on Winding Up

CLASSIFICATION OF BORROWINGS

BORROWINGS can be either SHORT TERM or LONG TERMSome examples of Short Term Borrowings are:Trade Credit, Factoring, Overdraft, Accommodation Bills

Convertible Notes are another example of HYBRID FINANCE

Some examples of Long Term Borrowings are:Debentures, Unsecured Notes, Mortgage Debentures, Inter Company Notes, Financial Leases

After the FINANCE DECISION come the INVESTMENT DECISION and the OPERATING (or DIVIDEND) DECISIONThe INVESTMENT DECISION is about deciding how money is spent on CAPITAL

The OPERATING (or DIVIDEND) DECISION is about deciding how money is spent on REVENUE

EVALUATING FINANCIAL PERFORMANCEFINANCE is the SCIENCE of MANAGING MONEYThere are also TWO (2) dimensions to Finance:RETURN and RISKThe higher the risk of OWNERS loosing money, the greater the return that BUSINESS OWNERS will demand!

So, how could the performance of Financial Managers’ be measured?

In a Modern Corporation there is a clear separation of business ownership and management

In a Modern Corporation, Managers are appointed to look after the interests of owners (shareholders) : Managers are the AGENTS of Shareholders (PRINCIPALS)

POSSIBLE METHODS FOR EVALUATIING FINANCIAL PERFORMANCE

Maximising Corporate Income?

Minimising Corporate Costs?

Maximising Corporate Profit?Maximising Corporate Cash?

Maximising Financial Manager’s Remuneration?

Minimising Company Tax?

ALL OF THESE METHODS HAVE SERIOUS FAULTS AS MEASURES OF FINANCIAL PERFORMANCE!NONE take into account the degree of Financial Risk!NONE take into account the size of each owners interest in the business!

PROFIT is too ambigiuous to be used as a measure!INCOME, COSTS and TAX each have too narrow a focus AND CONFLICTING PURPOSE in their contribution to PROFITS!

Directors have the power to set their own salaries SUCH THATThe power of GREED often ensures that Managers SELF INTEREST dominates over SHAREHOLDERS INTERESTS!

ALL are measured in money terms over TIME, BUT do not take into account the Time Value of MONEY!

BEST UNIFYING MEASURE OF CORPORATE FINANCIAL PERFORMANCE

Since Managers are appointed to look after SHAREHOLDERS INTERESTS, why not let SHAREHOLDERS themselves rate the FINANCIAL PERFORMANCE of Managers?

If SHAREHOLDERS feel their returns are not worth the risk, they will SELL their investments and SHARE PRICES will FALLConversely, if SHAREHOLDERS are happy with the risk/return profile, they will buy an investment MARKET FORCES will push SHARE PRICES UP!

Let the STOCK MARKET rate the Financial Performance of a Corporation

BEST UNIFYING MEASURE OF CORPORATE FINANCIAL PERFORMANCETherefore MAXIMISATION of SHAREHOLDER WEALTH is generally accepted as the best unifying measure of a MANAGER’s FINANCIAL PERFORMANCE!

MARKET CAPITALISATION =Number of Issued Shares x Market Price per ShareOf the above two (2) variables, Issued Shares are relatively stable BUT Share Prices fluctuate every instance of time, therefore SHAREHOLDER WEALTH MAXIMISATION is synonymous with SHARE PRICE MAXIMISATION

Since EQUITY belongs to SHAREHOLDERS, this is measured by MARKET CAPITALISATION of the Firm’s EQUITY

Although SHARE PRICE MAXIMISATION overcomes all the disadvantages of other measures, it is the BEST but NOT PERFECT measure!