11.1PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

ACCOUNTINGACCOUNTINGFinancial and Organisational Financial and Organisational

Decision MakingDecision Making

Chapter 11

Accounting and financial management

Slides written by Sandra Porritt

designed by Tony Van Eekelen

11.2

Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Learning ObjectivesLearning Objectives

• In this chapter you will be introduced to – the objectives of the organisation– possible measurable substitutes for the

maximisation of owners’ wealth– the reasons why management may have

different goals from those of the organisation

11.3

Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Learning ObjectivesLearning Objectives

– possible incentives for management to persue the goals of the organisation

– the types of risk

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

– a formula for share-price calculation

– the role of financial management in relation to:

• financial decisions

• managing working capital

• dividend policy decisions

Learning ObjectivesLearning Objectives

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

IntroductionIntroduction

– OBJECTIVES

• Maximise wealth of the owners– via maximisation of share price

• Role of financial management– management of risk and return

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

To maximise profitTo maximise profit

• Profit– how do we define profit

• Does the accounting method change profit

• Does profit measure risk

• Reported profit only reports historic events

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

How is owners’ wealth How is owners’ wealth maximised?maximised?

• Actively trading share-market– share price indicates the markets assessment

• Without shares traded– organisations need to set goals, efficiency and

performance (world best practice)

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The efficient market hypothesisThe efficient market hypothesis

• information is reflected in prices

• investors in shares will assess the new information

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Additional organisation Additional organisation objectivesobjectives

• maximisation of efficiency and performance

• other interest groups such as customers, suppliers and employees

• overall performance aided by these interest groups

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Organisation versus management Organisation versus management objectivesobjectives

• separation of ownership and control gives maagers opportunity to persue their own objectives

potential conflict of interest has been limited by the threat of takeovers, cost of obtaining external finance, and management compensation plans

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Cost of obtaining external Cost of obtaining external financefinance

• poor management is reflected in the cost of finance

• debt - loans only available at high rates of interest

• equity - shares may need to be sold at a low price to induce new shareholders - dilutes proportion of existing shareholders

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Management compensation plansManagement compensation plans

• managers income is linked to the organisations performance

• motivation for managers comes from share schemes - creating a direct link

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The influence of risk and return The influence of risk and return on share priceson share prices

• business risk

• financial risk

• management risk

11.14

Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Business riskBusiness risk

– affected by factors such as the industry and the type of product and service

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Financial riskFinancial risk

• choice of debt or equity – failure to pay interest may lead to

liquidation– failure to pay dividends will cause a

decline in its share price

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Quality of managementQuality of management

• effectiveness of asset and liability management

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Rates of returnRates of return

• realised rates of return

• expected rates of return

• required rates of return

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The management of risk and The management of risk and returnreturn

• The higher the expected return, the higher the share price

• The higher the expected risk the lower the price of the share

• Managers appraise the risk-return trade-off

• Maximum return at an acceptable risk level

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The role of financial The role of financial managementmanagement

• How the organisation is financed

• How much dividend should be paid

• Which projects or activities should the organisation undertake

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

FINANCIAL MANAGEMENT AND FINANCIAL MANAGEMENT AND THE BALANCE SHEETTHE BALANCE SHEET

• The financing decision– necessary funds at minium cost, suitable

sources with the risk of such financing assessed

• Cost of finance– the price of time– the price of risk– the maturity structure

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

continuedcontinued

• Level of debt– use of debt is called leverage – debt is only a fixed rate of return– the organisation needs to earn more than it

costs for the borrowed funds

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Sources of financeSources of finance

• Short term - Debt– commercial paper– overdraft– factoring, trade credit

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

continuedcontinued

• Long term - Debt– lease

– mortgage

– debentures

– unsecured notes

• Long term - Equity– convertible notes

– preference shares

– ordinary shares

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Other factors influencing the choice Other factors influencing the choice of financeof finance

• Volume of funds required

• Transaction fees ie: legal/bank/ stamp duty

• Restrictive conditions

• How permanent is the source of funds

• Prevailing conditions in the capital market

• Tax effects

• Anticipated growth of the organisation

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Managing current assetsManaging current assets

• Cash and marketable securities

• Accounts receivable

• Inventory

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Financial management and the Financial management and the profit and loss statementprofit and loss statement

• financial mnager has a direct influence on the cost of finance, which may substantially affect profitability

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Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Dividend policyDividend policy

• portion of profit distributed to owners– dividends inrease share price?– dividends do not affect share price?– policy on dividends also has a clientele effect– information is also signalled to the market by

policy

11.28

Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Dividend imputationDividend imputation

• introduced in Australia in 1981 removes double tax

• now dividends are only taxed once

11.29

Chapter 11: Accounting and financial management

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

SummarySummary

• Interaction of risk and return• The balance between these two factors

determines success