FIA-Paper FFM
Foundations in Financial
Management
For exams in 2015
theexpgroup.com
Notes
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 2 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Contents
About ExPress Notes
1. Cash receipts and payments 7
2. Cash balances 12
3. Working capital management 17
4. Credit granting 23
5. Debt collection 26
6. Sources of finance 29
7. Short-term decisions 37
8. Capital investments 44
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 3 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
START
About ExPress Notes
We are very pleased that you have downloaded a copy of our ExPress notes for this paper.
We expect that you are keen to get on with the job in hand, so we will keep the introduction
brief.
First, we would like to draw your attention to the terms and conditions of usage. It’s a condition of printing these notes that you agree to the terms and conditions of usage.
These are available to view at www.theexpgroup.com. Essentially, we want to help people
get through their exams. If you are a student for the ACCA exams and you are using these
notes for yourself only, you will have no problems complying with our fair use policy.
You will however need to get our written permission in advance if you want to use these
notes as part of a training programme that you are delivering.
WARNING! These notes are not designed to cover everything in the syllabus!
They are designed to help you assimilate and understand the most important areas for the
exam as quickly as possible. If you study from these notes only, you will not have covered
everything that is in the ACCA syllabus and study guide for this paper.
Components of an effective study system
On ExP classroom courses, we provide people with the following learning materials:
The ExPress notes for that paper
The ExP recommended course notes / essential text or the ExPedite classroom
course notes where we have published our own course notes for that paper
The ExP recommended exam kit for that paper.
In addition, we will recommend a study text / complete text from one of the ACCA
official publishers, but we do not necessarily give this as part of a classroom course,
as we think that it can sometimes slow people down and reduce the time that they
are able to spend practising past questions.
ExP classroom course students will also have access to various online support materials,
including:
The unique ExP & Me e-portal, which amongst other things allows “view again” of the classroom course that was actually attended.
ExPand, our online learning tool and questions and answers database DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 4 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Everybody in the World has free access to ACCA’s own database of past exam questions, answers, syllabus, study guide and examiner’s commentaries on past sittings. This can be an invaluable resource. You can find links to the most useful pages of the ACCA database
that are relevant to your study on ExPand at www.theexpgroup.com.
How to get the most from these ExPress notes
For people on a classroom course, this is how we recommend that you use the suite of
learning materials that we provide. This depends where you are in terms of your exam
preparation for each paper.
Your stage in study for
each paper
These ExPress notes
ExP recommended
course notes, or ExPedite notes
ExP recommended
exam kit
ACCA online past exams
Prior to study, e.g.
deciding which optional papers to take
Skim through the ExPress notes
to get a feel for what’s in the syllabus, the
“size” of the paper and how much it appeals to you.
Don’t use yet Don’t use yet Have a quick look at the two
most recent real ACCA exam papers to get a
feel for examiner’s style.
At the start of
the learning phase
Work through
each chapter of the ExPress notes in detail before
you then work through your course notes.
Don’t try to feel that you have to understand
everything – just get an idea for
what you are about to study.
Don’t make any annotations on the ExPress notes at this stage.
Work through in
detail. Review each chapter after class at least once.
Make sure that you understand each area reasonably
well, but also make sure that you can recall key
definitions, concepts,
approaches to exam questions, mnemonics, etc.
Nobody passes an
exam by what they have studied – we pass exams by
being efficient in being able to prove what we know. In
other words, you need to have effectively input the
knowledge and be effective in the
output of what you know. Exam practice is key to
this.
Try to do at least one past exam
question on the learning phase for each major chapter.
Don’t use at
this stage.
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 5 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Your stage in study for each paper
These ExPress notes
ExP recommended course notes, or
ExPedite notes
ExP recommended exam kit
ACCA online past exams
Practice phase Work through the ExPress notes again, this time
annotating to explain bits that you think are easy
and be brave enough to cross out the bits that
you are confident you’ll remember without reviewing
them.
Avoid reading through your notes again. Try
to focus on doing past exam questions first and
then go back to your course notes/ ExPress notes if
there’s something in an answer that you don’t understand.
This is your most important tool at this stage. You
should aim to have worked through and
understood at least two or three questions on each
major area of the syllabus. You pass real exams by
passing mock exams. Don’t be tempted to fall
into “passive” revision at this
stage (e.g. reading notes or listening to CDs).
Passive revision tends to be a waste of time.
Download the two most recent real exam
questions and answers.
Read through the
technical articles written by the examiner.
Read through the two most recent examiner’s reports in detail. Read through some other older
ones. Try to see if there are any
recurring criticism he/ she makes. You must avoid
these!
The night before the real
exam
Read through the ExPress
notes in full. Highlight the bits
that you think are important but you think you are most
likely to forget.
Unless there are specific bits that
you feel you must revise, avoid
looking at your course notes. Give up on any areas
that you still don’t understand. It’s too late now.
Don’t touch it! Do a final review of the two most
recent examiner’s reports for the paper you will be taking tomorrow.
At the door of the exam room
before you go in.
Read quickly through the full
set of ExPress notes, focusing on
areas you’ve highlighted, key workings,
approaches to exam questions, etc.
Avoid looking at them in detail,
especially if the notes are very big.
It will scare you.
Leave at home. Leave at home.
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 6 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Our ExPress notes fit into our portfolio of materials as follows:
Notes
Notes
Notes
Provide a base
understanding of the most important areas of the
syllabus only.
Provide a
comprehensive coverage of the syllabus and
accompany our face to face
professional exam courses
Provide detailed
coverage of particular technical areas and are used
on our Professional Development and
Executive Programmes.
To maximise your chances of success in the exam we recommend you visit
www.theexpgroup.com where you will be able to access additional free resources to help
you in your studies.
START About The ExP Group
Born with a desire to be the leading supplier of business training services, the ExP Group
delivers courses through either one of its permanent centres or onsite at a variety of
locations around the world. Our clients range from multinational household corporate
names, through local companies to individuals furthering themselves through studying for
one of the various professional exams or professional development courses.
As well as courses for ACCA and other professional qualifications, our portfolio of
expertise covers all areas of financial training ranging from introductory financial awareness
courses for non financial staff to high level corporate finance and banking courses for senior executives.
Our expert team has worked with many different audiences around the world ranging from
graduate recruits through to senior board level positions.
Full details about us can be found at www.theexpgroup.com and for any specific enquiries
please contact us at [email protected].
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 7 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Chapter 1
Cash Receipts and Payments
KEY KNOWLEDGE
Cash and Cash Flow
Cash comprises both cash and bank deposits payable on demand and also cash equivalents
which are defined as “short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value”. The amount of cash held by a business at a point in time is found in the balance sheet
under “current assets”.
Cash flow refers to the movement of cash in and out of a business over a period of time.
This information is found in a statement of cash flows, which is a primary financial
statement. Such a statement is useful in that it is structured to show the extent to which a
company is able to generate net cash from its operating activities and how such net cash is
used in investing and/or financing activities.
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 8 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Examples of cash receipts and payments include:
Operating: cash flow from trading activities, e.g. cash received from customers, cash
paid to suppliers and to employees;
Financing: Cash paid on interest;
Taxation: Actual cash paid during the year;
Investing: Cash flows on purchase or sale of non-current assets;
Financing: Cash flows on raising or redeeming long-term finance, such as shares or
debentures; dividends can also be included here.
Cash flow accounting
The relationship between cash flow accounting and accounting for income and expenditure
lies in the use of accruals and decisions as to the capitalisation of expenditures. Cash flow
accounting dispenses with the “matching” principle in financial accounting.
As the cash flow statement is derived from the income statement and the balance sheet,
adjustments need to be made to remove the effects of accrual accounting so that the cash
movements can be made more transparent.
Importance of cash flow management
Planning, tracking and collecting cash are all important because cash PAYS THE BILLS.
The failure to pay bills puts a company in danger of bankruptcy.
What begins as a condition of illiquidity can evolve into insolvency.
Cash flow is vital to going concern and commercial success, regardless of profitability.
Having enough cash on hand is therefore critical in being able to settle obligations when
they fall due (both planned and unforeseen); however, holding too much cash in a business
is costly. There is a trade-off between liquidity and profitability.
Determining the “optimal” amount of cash to hold becomes the challenge facing managers. Cash management functions are typically handled by treasury, and include:
Collecting cash from customers (as soon as possible);
Disbursing cash to suppliers (as late as practically possible);
Investing short-term cash surpluses in low-risk interest-bearing investments (such as
Treasury bills) in order to generate additional income for the company;
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 9 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
KEY KNOWLEDGE
Cash budgets
A cash budget is an estimate of the receipt and payments of cash in and out of the business
for a defined future period based on existing conditions and operating assumptions.
By understanding the nature and timing of cash receipts and expenditures, management is
better able to influence them and plan/budget for the future. The purpose is to ensure that
the company has sufficient cash on-hand to avoid missing disbursements when they fall
due.
There are statistical techniques which assist management in planning cash levels.
Cash budget/forecast
Businesses should develop their cash budget/forecast formats in a way which best reflects
the type of business conducted and transactions generated. Such tools serve as a
mechanism for monitoring and control.
KEY KNOWLEDGE
Cash forecasting
A cash forecast format/structure is shown below, in this case covering 6 months. Both
operating and non-operating cash flows are included.
The bottom of the table shows opening and closing cash balances.
Cash Budget Jan Feb Mar Apr May June
$ $ $ $ $ $
Receipts
Credit sales
Cash sales
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 10 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Equipment disposal
Total
Payments
Materials
Labour
Variable Overheads
Fixed Costs
Equipment acquisition
Overdraft Interest
Current account interest
Income tax
Total
Net cash m-o-m variance
Cash balance at month-end
Completing the table above requires forecast assumptions relating to volume of
production/sales as well as prices and costs.
EXAMPLE
Unit Selling Price (on credit) $/unit payment terms given to credit customers:
Unit Selling Price (cash) $/unit discount granted to cash customers
Unit Variable Cost:
Material $/unit payment terms taken from suppliers:
Labour $/unit paid in the month
Overheads $/unit
Fixed Costs $/month
< Actual Forecast > Sales/Production volumes Nov Dec Jan Feb Mar Apr May June Total
actuals/forecast
Production (units)
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 11 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Credit sales (units)
Cash sales (units)
Capex forecast New equipment acquisition
Old equipment sale
Inventory levels required +/- planned
Bank interest at % pa Bank interest at % pa
KEY KNOWLEDGE
Sensitivity of variables
Preparing cash forecasts requires assumptions, and assumptions are exposed to uncertainty.
This means that the actual amount of cash received or disbursed may vary from that budgeted.
Budgeting processes therefore include the testing of assumptions for sensitivity. If, for example, wage levels rise by 10% (instead of 5%), then what effect will this have on the
level of cash? Same question with regard to materials (and overheads and prices, etc.).
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 12 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Chapter 2
Cash Balances
KEY KNOWLEDGE
Investing and financing
Cash surpluses and deficits occur as a result in timing differences between the receipt of
cash and the necessity to settle obligations punctually. If a deficit results, then the company
should have overdraft faciltities in place with a bank.
If deficits prove to be longer-term in nature, then the company should consider short-term
borrowing, or possibly, longer-term forms of finance if the deficit is expected to persist.
In the event of surpluses, these can be invested (e.g. T-bills mentioned earlier); other types
of investments include:
Bank deposits DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 13 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
Money- market deposits
Certificates of deposit
Government bonds
Local authority stock
KEY KNOWLEDGE
Optimum liquidity levels
Cash management models Holding too much cash is sub-optimal. A business with permanently excessive balances (not
required for operating purposes) should be paid out to shareholders.
Two techniques for monitoring the optimal level of cash are discussed below.
Baumol model
This model was developed several decades ago. One can think of:
cash as inventory;
selling marketable securities transactions as ordering costs;
Interest rate, representing the opportunity cost of holding cash
By determining the following:
N = the total annual amount of cash required
F = the cost of each securities transaction (sale)
i = the annual interest rate obtainable on the investment in securities
then
Z = the amount of cash that needs to be raised per transaction
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 14 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
The optimal level of Z = √2NF / i
The main drawback of the Baumol method is that it makes the simplified (and unrealistic)
assumption that cash disbursements are constant and predictable.
Miller-Orr
A second method addresses the issue of optimal cash balances and attempts to improve on
the drawback of the Baumol model.
Miller-Orr is based on statistically tracking the variability of net daily cash flows; this is
denoted as
V = Variability of net daily cash flows (variance or sigma squared)
The other variables are:
F = Cost of each securities transaction;
k = Interest rate per day on marketable securities; and
LL = Lower cash limit, which needs to be established by management
Based on the above, the cash balance return point (R) is
________ R = 3√3xFxV/4k + LL
The level R is the cash balance which must be restored when either the upper limit (UL) or
lower limit (LL) have been reached.
Once R is known, then the upper cash limit, or UL, is calculated thus:
UL = 3 R – 2(LL)
DEM
O PAG
ES -
FREE
FUL
L SE
T AT
WW
W.T
HEEX
PGRO
UP.C
OM
ExPress Notes FIA – Foundations of Financial Management
Page | 15 © 2015 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
KEY KNOWLEDGE
Working capital needs and funding strategies
The level of working capital required in a business depends on the industry it operates in,
the length of its working capital cycle and the range of funding options open to it. Retaining
flexibility is a key requirement. While overdraft financing is expensive, it does permit
spontaneous drawdowns and rapid repayments.
Funding strategies are guided by the following considerations:
Temporary cash shortages can be funded short-term, while
Permanent shortages should be funded long-term
The “matching principle” can be applied to the assets being financed:
Fixed assets are generally funded long-term, along with the permanent portion of
current assets (e.g. buffer stocks);
Current assets of a fluctuating nature can rely on short-term finance (e.g. seasonal
upswings in inventories / receivables)
Cash surpluses, on the other hand, can be dealt with based on whether they are:
Short-term: in this case they may be invested in short-term, low-risk, liquid
investments (e.g. Treasury bills or marketable securities);
Long-term: Make acquisitions; Reduce debt; Pay extraordinary dividend, etc.
KEY KNOWLEDGE
Liquidity ratios
The relationship between current assets and current liabilities is used as a measure of
liquidity in the firm:
Current ratio = Current assets Current liabilities DE
MO P
AGES
- FR
EE F
ULL
SET
AT W
WW
.THE
EXPG
ROUP
.COM