Stakeholder Theory in Business Management

FM Course Notes Summary

• The course covers financial management, focusing on the functions, environment, and management of working capital, investment appraisal, business finance, valuations, and risk management.
• The course is designed to help students become Finance Managers of businesses, responsible for investment, financing, and dividend decisions.
• Financial management involves acquiring and effectively utilizing financial resources to achieve organizational objectives. Profit maximization is not a sufficient objective, as other factors such as future prospects, dividend payouts, financing plans, and risk management are also crucial for investors.
• A better objective for profitability-focused companies is shareholder wealth maximization, which measures total shareholder return (dividend per share plus capital gain divided by initial share price).
• Key decisions in financial management include investment (in projects or takeovers or working capital), finance (debt level), and dividends (how returns are distributed to shareholders). The level of gearing depends on the business life-cycle, operating gearing, stability of revenue, and availability of security.
• The key objectives of financial management include wealth creation, generating cash, and providing an adequate return on investment, while considering accompanying risks and invested resources.
• Financial planning ensures adequate funding at the right time, managing short-term and long-term needs.
• Financial control is crucial for ensuring objectives are met by monitoring, assessing asset utilization (efficiency), and asset security.
• Financial decision-making involves investment, financing, and dividend policies. Finance must be raised, and alternative methods involve selling shares, borrowing from banks, or obtaining credit from suppliers. Decisions on profit retention or distribution to shareholders are also key.
• Financial management is closely linked to financial and management accounting. Financial accounting provides information about past events and is legally obligated, whereas management accounting helps manage day-to-day operations.
• Corporate objectives, such as return on investment, market share, growth, customer satisfaction, and quality, guide the creation of financial objectives.
• Shareholder wealth maximization, profit maximization, and earnings per share growth are examples of financial objectives used by organizations.
• Shareholder wealth maximization (share price) is vital. This is due to the theoretical value calculation of share price incorporating all future dividends. There may be short-term changes in share price for reasons outside the objective of maximizing profitability, such as profit increases and share price falls, suggesting that profit alone is not a sufficient or sufficient objective.
• Earnings per share (EPS) is calculated as profit after tax minus preferred dividends, divided by weighted average ordinary shares.
• Stakeholders have diverse objectives, including staff salaries, manager bonuses, shareholder wealth (high share price, dividend growth), banks minimizing risk, customer quality service, suppliers' liquidity, and government compliance.
• There's a potential conflict between stakeholder objectives. It's impossible for a company to entirely fulfill all stakeholder objectives due to conflict, and a compromise is often achieved.
• The agency problem arises where managers, acting as agents for owners, may not always prioritize shareholder wealth, leading to various management compensation schemes, like performance-related pay and share option schemes.
• Return on Capital Employed (accounting rate of return) is important, and should be higher than the borrowing rate, using operating profits divided by capital employed to show profitability. Return on Equity reflects how the company uses shareholder equity to generate earnings.
• Return on Equity (ROE) measures the profitability of shareholder investments, and high ROE typically signals a company performs effectively with the given equity.
• Dividend per share is directly related to dividends declared to shareholders, which, in the short-term, may hurt the company and its growth.
• The price-earnings (PE) ratio compares a company's share price to its earnings per share.
• Total shareholder return measures the aggregate return on investment over a specific period. This includes dividends per share plus capital gained, separated by the initial share price.
• Methods to encourage stakeholder objectives include managerial reward schemes, such as share options and performance-related pay, and regulatory requirements such as corporate governance codes of best practice and stock exchange rules.
• Non-profit organizations prioritize their missions (which often include socially desirable needs) over profit maximization.
• Value for money is essential, encompassing efficiency (maximizing output from resources), effectiveness (achievement of goals), and financial prudence.
• Measurement of non-financial objectives is possible through statistics relating to services/activities (e.g., client/user numbers).
• Financial management deals with long-term financing decisions, while financial accounting accounts for past company performance.
• Financial markets, like money and capital markets, facilitate the exchange of financial securities for purposes like raising capital and facilitating transactions. These are either direct through financial markets or indirect through financial intermediaries, including merchant banks, pension funds, and insurance companies.
• Euromarkets deal with offshore currency transactions, usually in large volumes, often with less regulation compared to domestic markets, which usually involves borrowers with high, credible credit ratings.
• Money markets concern short-term finance from borrowing/lending, while capital markets deal in long-term funds through stock, commodities, and bond markets. Securities are used to document transactions.
• Financial intermediaries, like banks, are important for facilitating transactions, transferring risks, and transforming the maturity of funds (making long-term funds available for short-term needs). Intermediaries also aggregate individual's relatively small sums into larger ones. These functions reduce transaction costs and credit risk.
• The concept of risk in relation to investment and returns is critical. Risk involves the variability of returns, which can be quantified, while uncertainty cannot.
• Sensitivity analysis quantifies the effect of variations in different factors on profitability measures.
• Probability analysis enables assigning probabilities of expected outcomes and estimates of expected values.
• Methods for managing currency risk include dealing in a company's home currency, matching transactions with payments, leading, lagging, forward exchange contracts, money market hedging, and asset/liability management.
• Methods for managing interest rate risk include matching and smoothing, asset and liability management, and forward rate agreements.
• Working capital is essential money needed for daily tasks, with current assets (cash, inventories, receivables) offset by current liabilities (overdraft, payables less than a year).
• Inventory management, accounts receivable management, payable management, cash management are critical in effective working capital management.
• The concept of overtrading in reference to capital issues means that companies are taking on too many risks. Overtrading issues may arise from problems with liquidity (financial ability) or a lack of sufficient capital to support the current level of business. Investment in working capital should not increase as fast as the increase of sales.
• There are different approaches to managing working capital, such as the conservative approach (higher levels of inventory and less risk, but potentially less profitable) and the aggressive approach (lower inventory and more risk, but potentially high profitability).
• Various techniques exist to manage inventory, including the Economic Order Quantity (EOQ) model and Just-in-Time (JIT) techniques.
• Managing receivables involves assessing creditworthiness, formulating credit policies, collecting overdue payments, offering early settlement discounts, and utilizing factoring or invoice discounting.
• Managing foreign receivables/payables involves using different methods, such as cash in advance, payment on shipment, or documentary letters of credit—the exporter agrees for a bank to secure the payment.
• Managing cash involves preparing cash flow forecasts, determining a company’s short-term funding needs to balance cash shortages with excess cash and its investment or lending options, and selecting from available sources.
• Different sources of long-term finance for companies include equity finance (via a rights issue, placing, or public offer), debt finance (loan, bonds, or debentures), lease finance, and venture capital.
• A creditor hierarchy dictates the order of payment when a company liquidates: those with fixed charges, then floating, then unsecured creditors, and lastly preference and ordinary shareholders.
• Methods for capital rationing when there isn't enough financial resources available involve profitability indexes (PI) for divisible projects.