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Paper F9: Financial Management MAP

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Paper F9: Financial Management MAP

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Type of presentation Chart Chart Chart Chart Chart Mnemonic Mnemonic Chart Chart Chart Chart Chart Mnemonic Chart Chart Mnemonic Mnemonic Chart/mnemonic Chart Mnemonic Title What is corporate finance? 3 main financial decisions Capital structure The financial management function Finance function within a large company/group The role of the Financial Controller The role of the Treasurer The scope of financial management + AddVance activities - introduction The scope of financial management activities - overview Cash flows between the firm and the financial markets The scope of financial management recap The financial management planning process The financial management process The financial management planning process - overview A firms liquidity cycle Benefits of centralised treasury management Disadvantages of centralised treasury management The principal financial objectives Stakeholder analysis for a typical company Concept of Principal-agency Theory (PAT) applied to shareholders and directors Difficulties associated with managing organisations with multiple objectives Reasons why maximising shareholders profits is not the same as maximising shareholders wealth The main Corporate Governance proposals
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Topic covered (briefly) Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial management function Financial objectives Financial objectives Financial objectives

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Mnemonic Mnemonic

Financial objectives Financial objectives

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Financial objectives

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Paper F9: Financial Management MAP

Electronic links - 2
Type of presentation Mnemonic Mnemonic Title Main focus of the LSEs Combined Code of Corporate Governance The distinctive characteristics of public services in the context of corporate governance Remuneration schemes for managers Value for Money (VFM) Measuring performance in a not-for-profit organisation Financial performance analysis - overview Financial performance analysis categories of ratios The RONA Pyramid Implications/issues of the ROI measure Measuring financial performance overview The FIVE main groupings for financial performance analysis The implications for the growth measures used by financial managers Reasons/benefits of financial ratio analysis Limitations of ratio analysis Information required for meaningful ratio analysis Combined analysis (Collection period) Overtrading Characteristics of overtrading Ratios/measures that can be used to indicate overtrading Parties who need to analyse corporate financial figures in addition to management Reasons why comparisons should be based on companies in the same industry or market sector Topic covered (briefly) Financial objectives Financial objectives Screen number

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Financial objectives Objectives in not-for-profit organisations Objectives in not-for-profit organisations Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis Financial ratio analysis

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Mnemonic

Financial ratio analysis

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Paper F9: Financial Management MAP

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Type of presentation Mnemonic Mnemonic Chart Mnemonic Chart Mnemonic Mnemonic Mnemonic Chart Chart Chart Mnemonic Mnemonic Title The difficulties involved in inter-firm comparison Macroeconomics The economic goals of government Main economic goals of most governments Main sources of inflation Sources of inflation Government policy : Full employment Examples of potential conflict within government economic policies The Bank of Englands (Central Bank) Repo rate of interest Economic objectives of Government Fiscal policies of central government Gilts The effects of a high PSBR (Public Sector Borrowing Requirement) on private sector businesses Factors that regulate the size of the Bank reserve requirement Characteristics of the perfectly competitive market Basis of monopoly power The effect of green policies on companies Ways that inflation can affect a company The central role of working capital management in financial management Topic covered (briefly) Financial ratio analysis Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Financial management environment Working capital management Screen number

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Type of presentation Mnemonic Title Potential conflict between functional managers and financial managers in working capital decisions Example of the need for working capital investment Working capital investment has a cost but there is no direct money return The constituents of Working capital management Sources of information available to help credit assessment Reasons for delays in invoicing Possible actions for dealing with slow payers Debtor management general factors Steps that a company could use to reduce bad debts Derivation of formula for calculating the average Accounts payable balance Offering discounts for early payment Receiving payments from overseas sales Managing payments from overseas customers The workings of an effective credit control department Factoring book debts Factoring book debts: Ups and Downs Benefits of factoring debts Overview on the management of accounts receivable Overview on the management of accounts receivable - 2 How risks of foreign trade (excluding foreign exchange risks) might be managed Terms of trade for overseas customers Topic covered (briefly) Working capital management Screen number

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Chart Chart Chart Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Chart Chart Chart Mnemonic Mnemonic Chart Chart Mnemonic Chart Chart Mnemonic

Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management

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Paper F9: Financial Management MAP

Electronic links - 5
Type of presentation Chart Chart Chart Mnemonic Mnemonic Chart Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Title Three main types of trade credit Control of trade credit Taking discount for early payment Advantages of using trade credit to finance working capital Factors that influence the amount of trade-credit period taken Levels of inventory The costs of holding inventory (stock) Costs of acquiring inventory (purchase order costs) Benefits of holding high levels of inventory (stock) Disadvantages of holding high levels of inventory (stocks) Ways a manufacturing company can use to reduce its average raw material inventory Characteristics of JIT systems The nature and characteristics of supply in JIT JIT. What is planned to be available just in time? Aims of Just-In-Time (JIT) Pre-requisites for a successful JIT system Advantages associated with JIT systems Toyota Production System (TPS) Examples of waste (non-value-adding activity and costs) The concept of pull production linked to just in time (JIT) Cash management Calculation of Cash conversion cycle period Releasing cash from working capital to deal with short-term cash deficits Topic covered (briefly) Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Screen number

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Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management

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Paper F9: Financial Management MAP

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Type of presentation Mnemonic Chart Chart Chart Chart Mnemonic Chart Chart Mnemonic Title Reasons for a company to hold liquid assets 6 Steps for cash budgeting Cash budgeting: Receipts and payments model Cash flow statement Baumol Cash Budget Model Potential problems associated with the Baumol model Miller-Orr Cash Budget Model Management of short-term surplus cash Factors to consider before investing surplus short-term funds on the money market Management of short-term deficit cash Reasons why there are cash problems (cash deficits) Overcoming short-term deficit cash Dynamics between short- and long-term interest rates Market segmentation theory 3 reasons why under normal economic conditions short-term interest rates are lower than long-term rates. Financing working capital: Three approaches Financing working capital 3 different financing policies for working capital The factors to consider before adopting an aggressive financing policy Balance between cash and short-term investments Explanations for the shape of the Normal Interest Yield Curve Financial instruments (paper) in the money markets Topic covered (briefly) Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management Screen number

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Working capital management Working capital management Working capital management Working capital management Working capital management Working capital management

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Working capital management Working capital management Working capital management Working capital management

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Paper F9: Financial Management MAP

Electronic links - 7
Type of presentation Mnemonic Chart Chart Mnemonic Mnemonic Chart Chart Chart Chart Chart Chart Mnemonic Chart Chart Chart Chart Title Financial instruments used in the money market The Bill of Exchange mechanism Letter of Credit The main organisations acting as financial intermediaries The main functions (roles) served by financial intermediaries in the market Organisations operating as financial intermediaries The role of financial intermediaries - 1 The role of financial intermediaries - 2 The role of financial intermediaries - 3 The role of financial intermediaries - 4 The role of financial intermediaries - 5 Ways that investors benefit from financial intermediation The financial markets Money The role of the Central Bank in the money market The London Stock Exchange (LSE) - 1 Topic covered (briefly) Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions Nature and role of financial markets and institutions
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Chart

The London Stock Exchange (LSE) - 2

Chart

The London Stock Exchange (LSE) - 3

Chart Chart

Risk/return trade-off - 1 Risk/return trade-off - 2

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Paper F9: Financial Management MAP

Electronic links - 8
Type of presentation Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Chart Chart Chart Chart Title Types of risks concerning financial and investment decisions Key factors in choosing sources of finance The relative merits of short-term debt compared with long-term debt The problems of using short-term debt sources compared with long-term debt Sources of short-term finance Bank investigation concerning a loan application Danger signs for a bank when assessing a bank loan application Factors that influence the rate of interest charged on a new bank loan The Sale and lease-back decision Public equity company raising long-term finance Ordinary shares and their characteristics 1 Ordinary shares and their characteristics 2 Ordinary shares and other things to know -1 Ordinary shares and other things to know -2 Ordinary shares and other things to know -3 Ordinary shares and other things to know -4 Factors affecting a share price Retained earnings compared with a new issue of equity Factors relating to a public issue of equity Rights issue - overview Rights issue - 1 Rights issue - 2
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Topic covered (briefly) Nature and role of financial markets and institutions Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance

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Chart Chart Chart Mnemonic Mnemonic Mnemonic Chart Chart Chart

Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance

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Paper F9: Financial Management MAP

Electronic links - 9
Type of presentation Chart Mnemonic Mnemonic Mnemonic Chart Chart Chart Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Mnemonic Title Rights issue - 3 Contents of a Prospectus for a Rights issue Benefits of a rights issue in a bull market The drawbacks of a rights issue Initial Public Offering (IPO) - 1 Initial Public Offering (IPO) - 2 Initial Public Offering (IPO) - 3 Advantages of getting listed on a stock exchange Disadvantages of getting listed on a stock exchange Methods for a company to obtain a listing on a stock exchange Costs of an issue on the stock exchange Ways investors use to assess a company that is making an initial public offer (IPO) Ways an unquoted company might restructure its balance sheet prior to the initial offer (IPO) Dividend policy the practical considerations The dividend decision - 1 The dividend decision - 2 The dividend decision - 3 The dividend decision - 4 The dividend decision - 5 Different dividend policies Reasons why dividend policy is important Main characteristics of bonds Bonds - 1 Bonds - 2 Bonds - 3 Different forms of corporate bond
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Topic covered (briefly) Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance

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Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance

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Type of presentation Chart Chart Chart Chart Mnemonic Mnemonic Mnemonic Mnemonic Title Internal sources of finance and dividend policy The influence of interest rates on the market value of bonds Convertible bonds The floor value of a convertible bond Factors relating to a public issue of corporate bonds Advantages of eurobonds Drawbacks in the eurobond market Factors that should be considered by a listed company when choosing between the issue of debt and an issue of equity Ways by which an unlisted company can obtain funds The financing of SMEs Reasons why SMEs gave difficulty in raising finance Source of funds for SMEs using UK as an example Problems faced by SMEs in respect of credit management Steps that could be taken by SMEs to minimise the effects of their poor credit management Purposes of venture capital The main financial markets The capital budgeting process The rolling capital budget system Seven steps involved in successfully evaluating and controlling a capital budget Component parts of a Business Case for an investment proposal Possible benefits of an investment project Topic covered (briefly) Business finance Business finance Business finance Business finance Business finance Business finance Business finance Business finance Screen number

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Mnemonic Chart Mnemonic Mnemonic Mnemonic Mnemonic

Business finance Business finance Business finance Business finance Business finance Business finance

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Business finance Business finance Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal

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Type of presentation Mnemonic Mnemonic Mnemonic Chart Mnemonic Mnemonic Mnemonic Mnemonic Title Main responsibilities of the Capital Expenditure Committee Relevant (or opportunity) costs that would affect the future cash flow of a project Costs which are not relevant when carrying out a DCF appraisal Capital investment appraisal techniques The main capital investment evaluation techniques and criteria Limitations of the payback period method of capital investment appraisal Advantages of the payback period method of capital investment appraisal Limitations of the Accountants Rate of Return (ARR) measure for evaluating capital investment proposals Strengths of the ARR measure Advantages of using discounted cash flow (DCFR) techniques for capital investment appraisal Data required to calculate the net present value (NPV) of an investment project Advantages of IRR over NPV Limitations of using the IRR measure for capital investment appraisal Advantages of NPV over other investment appraisal techniques General limitations of net present value (NPV) when applied to investment appraisal Steps taken to address the limitations of NPV analysis Capital investment appraisal applications Topic covered (briefly) Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Screen number

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Investment appraisal Investment appraisal

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Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal

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Investment appraisal Investment appraisal

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To manage a business well is to manage its future: and to manage the future is to manage information. Marion Harper

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Type of presentation Chart Chart Chart Mnemonic Mnemonic Mnemonic Mnemonic Title Effects of inflation on NPV NPV and risk Business and financial risks Factors contributing to business risk Factors contributing to financial risk Ways that risk can be managed in capital investment Problems of using the expected value approach when making investment decisions Limitations of sensitivity analysis The lease or borrow-to-buy decision Advantages of leasing assets Disadvantages of leasing assets Capital rationing: Overview Hard capital rationing: characteristics and reasons for Soft capital rationing: characteristics and reasons for Exploiting opportunities which are rejected because of capital rationing Limitations of using the Profitability index (PI) in a capital rationing situation Capital Replacement Theory - 1 Capital Replacement Theory - 2 The factors to consider in a replacement decision The process of capital budgeting and investment appraisal: overview Four different ways of valuing a company (or an equity share) Purpose of company or share valuation The main implications of the Efficient Market Hypothesis Different methods of valuing a company or its shares Topic covered (briefly) Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Screen number

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Mnemonic Chart Mnemonic Mnemonic Chart Mnemonic Mnemonic Mnemonic Mnemonic Chart Chart Mnemonic Chart Mnemonic Mnemonic Mnemonic Chart

Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Investment appraisal Business valuations Business valuations Business valuations Business valuations

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Type of presentation Mnemonic Mnemonic Chart Mnemonic Chart Chart Chart Mnemonic Mnemonic Mnemonic Mnemonic Chart Mnemonic Title Weaknesses of the dividend valuation model Assumptions underlying CAPM Systematic and unsystematic risk Limitations of using the beta factor Traditional gearing Traditional gearing ratios Managing foreign currency risk The uniqueness of the foreign exchange (FE) market Factors that affect a currencys supply and demand and thus its price Forecasting exchange rates Four ways of forecasting (estimating) future currency rates Four-way Equivalence Model Techniques available to help reduce foreign exchange risk involved in foreign trade or business The steps involved when using a money market hedge to cover foreign currency payments Advantages of using futures to hedge risks compared with a forward exchange contract Difficulties of using futures to hedge risks The reasons for using currency options Benefits of currency swaps Drawbacks of currency options Currency and interest rate management Pattern of interest rates Reasons why interest rates may be expected to fall Topic covered (briefly) Business valuations Cost of capital Cost of capital Cost of capital Cost of capital Cost of capital Cost of capital Risk management Risk management Risk management Risk management Risk management Risk management Screen number

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Risk management Risk management Risk management Risk management Risk management Risk management Risk management

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Financial performance analysis - overview


Start here and follow the numbers .
Financial Analysis

Appraisal/ evaluation

Management Investors Potential investors Creditors Other lenders Employees

Who needs to analyse? Overtrading Stakeholders

2
Danger of liquidation

Profit and Loss Account (Income statement) Balance Sheet Other data are also useful: Cash flow forecasts Industrial statistics Details of accountancy policies Post-balance sheet events Government statistics Inflation adjusted figures What data is used for the analysis?

8
Scope for improvement Control action required Financial problems

Internal/ external

Management action required

Main comparisons: Time series analysis (over different periods of time) Interfirm comparison Against objectives (budgets, etc.)

4
What basis of analysis?

5
What to measure?

6
How to measure? What to learn?

Comparisons

Criteria

Analytical techniques

Information

Five main areas of appraisal: Earnings - profitability - capital efficiency Growth Risk Control Shareholders investments
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Three main techniques: Common sizing (vertical analysis) Horizontal analysis Ratio analysis

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Start here and follow the arrows


FINANCIAL ANALYSIS

Financial performance analysis categories of ratios


EARNINGS MEASURES
RONA (Net profit x 100/net assets) NET MARGIN (Net profit x 100)/ sales revenue) NET ASSET TURNOVER (Profit x 100/net assets employed)

RISK MEASURES

Vertical analysis (Common-sizing)

GEARING
GEARING (Debt/equity value) (times) (There are other ways of calculating this ratio) INTEREST COVER (Profit before interest and tax/ interest payable)

Horizontal analysis (Side-by-side)

PROFITABILITY

Ratio analysis

Usually based on: Income statement 1 year Balance sheet Assets Performance is normally conducted by comparisons

GROSS MARGIN (Gross profit x 100/ sales revenue) OPERATING MARGIN (Profit before interest and tax x 100/ sales revenue) COST OF SALES PERCENTAGE (Cost of sales x 100/sales) COST MEASURES (Each element of cost x 100/sales)

LIQUIDITY
CURRENT RATIO (Current assets/current liabilities) (times) QUICK RATIO ((Current assets inventory)/ current liabilities)

CAPITAL EFFICIENCY
FIXED ASSET TURNOVER (Profit x 100/fixed assets employed) CURRENT ASSET TURNOVER (Profit x 100/current assets) INVENTORY TURNOVER THROUGH SALES (Profit x 100/inventory)

WORKING CAPITAL CONTROL MEASURES


INVENTORY TURNOVER ((Inventory value x 365)/purchases) (days) CREDITORS PAYMENT PERIOD (Accounts payable x 365/purchases) (days) DEBTORS COLLECTION PERIOD (Accounts receivable x 365/sales) (days)

Basis for performance comparisons: Time-series analysis (Trend analysis over periods) Cross-sectional analysis (inter-firm analysis) Budgets Other objectives Inter-unit/ division/ department Geographical

GROWTH MEASURES
EARNINGS-PER-SHARE GROWTH (%) SALES REVENUE GROWTH (%) DIVIDEND COVER (Profit after interest and tax/total dividend) (times) RETENTION % (1 (Dividends for the year x 100%/ profits after interest and tax)) DIVIDEND YIELD (Total dividend x 100/ earnings for ordinary shareholders)

INVESTORS RATIOS
DIVIDEND YIELD (Dividend per share x 100/ market price per share) PRICE EARNINGS RATIO (Market price per share/ earnings per share) DIVIDEND COVER (Earnings per share/ dividend per share) (times) EARNINGS YIELD (Earnings per share x 100/ Market price per share) RETURN ON EQUITY (Net profit x 100/ equity value (book or market value) NEXT CHART NEXT MNEMONIC

CRITERIA used for comparisons

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The RONA Pyramid


RETURN ON NET ASSETS Net profit/Net assets x 100 = %

Sub-analysis

Profit margin

Capital turnover (Activity) Sales/Net assets = times

Profit/Sales x 100 = %

Sub-analysis

Sub-analysis

Total cost/Sales x 100

Sales/Fixed assets = times

Sales/Current assets = times

Sub-analysis

Sub-analysis

Sub-analysis

Fixed costs/Sales x 100

Variable cost/Sales x 100

Rent/Sales x 100 Rates/Sales x 100 Deprec./Sales x 100 Insurance/Sales x 100 Etc.

= = = =

% % % %

Sales/Land value Sales/Property value Sales/Plant & Equip. value Sales/Vehicle values Sales/Fix. and Fittings Etc.

= = = = =

times times times times times

Material costs/Sales x 100 Labour costs/Sales x 100 Variable overhead/Sales x 100 Insurance/Sales x 100 Etc.

= = = =

% % % %

Sales/Inventory value Sales/Receivables Sales/Cash Etc.

= times = times = times

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Implications/issues of the ROI measure


The ROI ratio (sometimes called RONA [return on net assets] or ROCE [return on capital employed]) measures the overall effectiveness of management in generating profits with its available resources. It is a key, but rough, measure of performance. Although ROI shows the extent to which earnings are achieved on the investment in the business, the actual value is generally somewhat distorted. There are basically three ratios that evaluate the ROI. They are: net profit margin, net assets turnover, and return on equity. The implications/issues of the ROI measure are:

C O A S T

Companys cost of capital. Is the ROI high enough with regard to the company's marginal cost of capital (say the bank's overdraft rate)? Other companies/competitors/industrial norm. How does the ROI compare against other companies (competitors) or divisions (within the company)? Asset valuation. Are assets correctly valued? (The ROI ratio is overstated if the assets are under-valued.) Shareholders cost of capital. Consider the overall return. Is the ROI high enough with regard to shareholders' cost of capital? (The return the shareholders could earn elsewhere at the same level of risk.) Trend of the ROI. Is the trend satisfactory/unsatisfactory?

A company cant

COAST

along happily even when the ROI is high!

The very best financial presentation is one thats well thought out and anticipates any questions answering them in advance.

Nathan Collins Executive Vice President Valley National Bank CFO, August 1985

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5 criteria .
So
There are 5 main criteria for measuring financial performance 1. Earnings measures - principal measures, sub-analysed as: - profitability - capital efficiency 2. Growth measures 3. Risk measures - gearing - liquidity 4. Working capital control measures 5. Investors ratios

Measuring financial performance overview

And

3 techniques .

There are 3 techniques for measuring financial performance 1. Vertical analysis (Common-sizing) 2. Horizontal analysis (Side-by-side) 3. Ratio analysis

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The FIVE main groupings for financial performance analysis


There are many ratios that an analyst can use, depending on what he or she considers to be important relationships. For our purposes we will classify ratios into five groups:

Shareholders investment measures. The main measures are: - Dividend yield (Dividend per share/market price per share x 100). - Earnings per share (Earnings for ordinary shareholders/number of shares eligible for dividend). - Price earnings ratio (Market value per share/earnings per share). - Dividend cover (Earnings per share/dividend per share). - Earnings yield (Earnings per share/market price per share x 100). - Return on equity (Earnings for ordinary shareholders/equity (book or market) value x 100). Underlying control measures. The main measures are: - Inventory turnover (Inventory value x 365/purchases) (days). - Payables period (Payables value x 365/purchases) (days). - Receivables (Receivables value x 365/sales) (days). Risk measures. The main measures are: - Gearing (Debt/equity). (There are other ways of calculating this ratio.) - Interest cover (Profit before interest and tax/interest payable). - Current ratio (Current assets/current liabilities) - Quick ratio (sometimes called Acid test) (Current assets inventory value/current liabilities) Growth measures. The main measures are: - Earnings-per-share growth (%). - Sales revenue growth (%). - Dividend cover (as shown above) - Retention % (1 (dividends for year x 100/profits for ordinary shareholders). - Dividend yield (as shown above). Earnings measures. The main measures are: - ROI (or RONA or ROCE) (Net profit/net assets x 100). - Net margin (Net profit/sales revenue x 100). - Net asset turnover (Net profit x 100/net assets employed). (Operating profit may be used in place of net profit in all three of these ratios.)

A companys share price will consistently favourable.

SURGE ahead when these measures are

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The implications of the growth measures used by financial managers


R E
Retention percentage ratio. The retentions percentage is the inverse of the dividend cover (explained below) and provides much the same information. Earnings per share growth %. This is an important ratio for the present and prospective shareholders and management. The earnings per share represent the number of s earned on behalf of each outstanding share of equity capital. They are closely watched by the investing public and are considered an important indicator of corporate success. The value does not represent the amount of earnings actually distributed to shareholders. Growth (year by year) suggests strong corporate performance. Dividend cover ratio. The dividend cover indicates (a) the proportion of distributable profits for the year that is being retained by the company; and (b) the level of risk that the company will not be able to maintain the same dividend payments in future years, should earnings fall. A high dividend cover means that a high proportion of profits are being retained, which might indicate that the company is investing to achieve earnings growth in the future. Sales revenue growth %. The sales growth when measured against industry growth for the same period can provide useful information about the company's share of the market. Sales growth can also be used to evaluate the company's marketing, such as the effectiveness of an advertising campaign run during the period of report.

A company will usually keep out of the when these measures are strong.

REDS on the stock exchange board

Growth for the sake of growth is the ideology of the cancer cell. Edward Abbey

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Reasons/benefits of financial ratio analysis


Ratio analysis is widely used for analysing a company and is frequently employed by external stakeholders creditors, investors and financial institutions, as well as by senior management for internal performance appraisal. In more detail, the technique can help in the following ways:

I S

Identifies a moving picture of trends. A 'moving picture of the company', i.e. trends over a period of years can be analysed (time-series analysis). Segregates performance. It segregates performance into distinct groups such as: earnings, growth, control, risk and investment.

M A G I

Models and simulates. Ratios can be used for modelling and simulation purposes. Many large corporate finance models are based on ratios. Accounting software facilitates the quick production of ratios. Government statistics. Ratios allow a company to compare its performance against macroeconomic indices produced by government. Industrial norms. Ratios allow for comparison of the companys performance with other companies or the industry average, and hence for management to make judgement about the company's position in the competitive arena. Most inter-firm comparison schemes are based on ratios. Internal comparisons (between divisions/departments) are also made possible. Comparison with the budget for the same period. Management can use ratios to compare results with the budget covering the same period.

It

IS MAGIC

the way ratios can reveal a picture of performance results.

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Limitations of ratio analysis


The analytic approach used in ratio analysis must be used with circumspection and in conjunction with other analytical tools and techniques as it has a number of limitations. The limitations include the following:

O F T

Orientation that is historical. The approach is based on historical data and thus the ratios may not be a good guide to the future; Financial measures are used. Ratios are normally based exclusively on finance, and reflect only financial indicators of performance. There are, of course, non-financial implications associated with performance. Trading environments change over time. The changing value of money and differences in trading environments over time influence the ratios.

S A I D

Sub-optimal results might be encouraged. The use of ratios to measure performance may encourage sub-optimal behaviour by managers, e.g. short term manipulation of results. Accountancy practice influences the ratios. Differences in accounting practices adopted by companies over the treatment of fixed asset depreciation and revaluation, stock valuation, research and development expenditure, goodwill, write-off and profit recognition affect the ratios. Interpretation of change. Difficulties in deciding on a suitable yardstick and the interpretation of change, e.g. is a higher return on net assets (ROI) good or bad? Distortion can be a result. The quality of the analysis is determined by the quality of the accounting information upon which it is based (consider here the distortion that can result from 'creative accounting', such as 'window dressing' of financial statements to hide short-term fluctuations).

Its analysis.

OFT SAID

that too much emphasis is placed on only using ratio

The numbers tell you how your business is going, not why. Jonatghan P. Siegel Speech, McLean, Virginia, 12 September, 1987

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Information required for meaningful ratio analysis


For meaningful financial ratio analysis and other performance analysis the following information would be useful:

I F A C C A

Information and details concerning future plans of the company. Fixed assets. Details of fixed assets, with projected remaining lives and likely replacement costs.

Accounts adjusted to take account of inflation during the period under review. Cash flow forecasts. Current financial statements. Balance sheet [Statement of Affairs], Profit and Loss Statement [Income Statement] and Cash Flow Statement. Accountancy policy and changes to it. Details of the company's accounting policies and changes to any basis of accounting.

B A S E

Budgets and associated variances. Details of the company's budget plans with a schedule of variances. After balance sheet events (post-balance sheet). Details of any post-balance sheet events, and of any contingencies. Statistics provided within the industry. Statistics of the industry as a whole, and in particular financial and other ratios showing best, industry average and worst results. Economic indicators and other macro-environmental factors. Government statistics concerning inflation and interest levels and other economic indicators.

a question on what information is required for financial performance analysis to be meaningful then this is a useful list.

IF ACCA BASE

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Overtrading
Extending turnover too quickly Overtrading is a problem which arises from a firm extending its turnover at too rapid a rate. The ultimate result is a serious shortage of cash which means that wages, creditors and corporation tax cannot be met. A typical pattern of events A typical pattern of events commence when a firm takes on additional orders. This would then be followed by engaging additional workers or working overtime. At the same time, extra materials would be purchased on credit. If the working capital cycle is fairly long this means that although extra cash has to be paid out more or less immediately, additional revenue may not be forthcoming for a considerable period. This assumes that the additional production will be sold without delay, but in some circumstances the process may take the form of build up of stock. If this is the case, then the shortage of cash may necessitate an emergency sale at greatly reduced prices and this is likely to have adverse effects on profitability.

CHARACTERISTIC OF OVERTRADING The characteristics, or features of an overtrading situation include the following: The firm is under-capitalised (i.e. there are insufficient funds or credit lines). The firm is probably profitable. The firm has problems maintaining its asset base (non-current and current assets) with the level of its activities. Management may be focusing on sales (top line) at the expense of the costs (middle line) and profit (bottom line). The firms sales may be growing too fast and outstripping the available working capital. The firms quality is suffering (because of some of the points raised above). Inflation simply exacerbates the problems Over the period .

SYMPTONS OF OVERTRADING

Growth in sales. Growth in the volume of assets. Reduction in the firms liquidity. Increase in inventory turnover period (days). Increase in debtors assets (including the Accounts receivable collection period [days]). More use made of short-term credit (e.g. increase in Accounts payable payment period [days]). Increase in financial gearing. Quality problems Measures for assessing the extent of overtrading

An exam question that requires you to assess the extent of a firms overtrading position would need to present; Two or more years of financial data, and/or data concerning industrial/sector averages.

Key amounts, measure and ratios would be:


Increase in sales revenue (%) Gross margin (Gross profit x 100)/sales revenue) Increase in non-current assets ($) Non-current asset turnover ratio (Sales revenue x 100/ non-current assets employed) Total working capital ($) Inventory turnover through sales (Sales revenue/average inventory) Inventory turnover ((Inventory value x 365)/purchases) Payables period ((Payables value x 365)/purchases) Receivables collection period ((Receivables value x 365)/sales revenue) Reduction in liquidity (cash and bank overdraft levels) Current ratio (Current assets/current liabilities) Quick ratio (Current assets inventory value)/current liabilities) Financial gearing (Debt x 100/equity funds)

YEAR 1

YEAR 2 XX % XX % $XX XX % $XX XX times XX days XX days XX days $XX XX times XX times XX %

XX %

$XX XX times XX days XX days XX days $XX XX times XX times XX %

YOUR COMMENTS WOULD BE AN IMPORTANT PART OF AN EXAM ANSWER.


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Combined analysis
The most informative approach to ratio analysis is one that combines cross-sectional (inter-firm) and time-series analysis. A combined view permits assessment of the trend of behaviour of the ratio in relation to the trend for the industry. The diagram below depicts this type of approach using a company's average debtor collection period in the years 2006 to 2009.

Combined cross-sectional and time-series analysis of the average collection for the period 2006 - 2009

Fairy Nuff Engineering plc Average collection period (days) 70 60 50 40 30 20 10 0 2006 2007 2008 2009 Year 2010 1011 Industry average

Average collection period for Fairy Nuff Engineering plc

Theres few things as uncommon as common sense. Frank McKinney Hubbard, 1868 1930 American caricaturist and humorist

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Characteristics of overtrading
Overtrading is a problem which arises from extending turnover at too rapid a rate. The ultimate result is a serious shortage of cash which means that wages, creditors and corporation tax cannot be met. When a company is overtrading this is marked by large increases in sales which are not matched by increases in the asset base to support the greater level of activity. Working capital is used more intensively and there is little increase in the level of fixed assets. Expansion is financed by short term credit, and stock and debtor turnover can slow as the company tries to secure additional sales on the basis of improved credit terms and as it tries to manufacture ahead of demand. When analysing the situation shown on a Balance Sheet/Income Statement it is very important to watch for signs of overtrading. Some of the more important of these signs are summarised below.

S A L

Sales growing too fast. Very rapid growth in sale turnover. The Growth of sales ratio would be a useful indicator. Asset maintenance. Inventories may increase more proportionately than the increase in sales turnover with a deterioration in Inventory turnover ratios. Rapid growth in the volume of current assets and possibly fixed assets. Consider here the Asset turnover ratio. Liquidity problems. Increased significance of credit in financing along with the growth in assets. This may show in slower payment of payables and a bank overdraft which is close to its limit. Similarly, a comparison of the period of credit being taken by the company with the norm for the particular industry will be a guide. Look to see if there has been an increase in the Payables turnover ratio. Also, look for any sudden upward or downward swing in cash figures, or the appearance of new items such as short-term loans. The Current ratio and Quick ratio would indicate the liquidity problem. Excessive inflation causing capital replacement problems. Sales focus to the exclusion of other factors. Management focusing on sales (advertising expenditure, generous credit terms, price reductions, etc.) possibly at the expense of profits and cash flow. The Gross profit margin is an important indicator of sales to costs.

E S

Undercapitalisation. This often occurs because of a growth in the rate of borrowing so that the proportion of borrowing in relation to the assets owned by shareholders is excessive. Reductions in the current and quick ratios, possibly leading to a liquid deficit. The Gearing ratio and Cash Flow would be used here. Profitable, but! Total profit, gross and/or net, begins to diminish

A companys might be overtrading.

SALES may be UP but its cash could be seriously down.

It

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Ratios/measures that can be used to indicate overtrading


When a company is overtrading this is marked by large increases in sales which are not matched by increases in the asset base to support the greater level of activity. Working capital is used more intensively and there is little increase in the level of fixed assets. Expansion is financed by short term credit, and inventory and debtor turnover can slow as the company tries to secure additional sales on the basis of improved credit terms and as it tries to manufacture ahead of demand. To carry out a meaningful appraisal two or more years of data are required including industry/sector statistics. Signs that a company may be overtrading include the following:

G I A N T

Gross margin. (Gross profit/sales revenue x 100). Increase in bank overdraft $. (Current level previous level). Asset turnover ratio (particularly fixed asset turnover) (Gross profit/fixed assets employed x 100) Net working capital size. (Current assets Current liabilities). (Current compared with previous). Turnover of inventory through sales. (Sales revenue/inventory) (times)

C A R

Current ratio. (Current assets/current liabilities) (times) Acid test (often called Quick ratio). Now (Current assets inventory/current liabilities) (times). Reduction in liquidity ($). (Bank + cash overdraft) (current compared with previous).

T R I P S

Turnover of inventory in days. (Inventory value x 365/purchases or cost of goods sold) (days). Receivables payment days. (Receivables value x 365/sales) (days). Increase in fixed assets %. (Current fixed asset value previous fixed asset value/previous fixed asset value x 100) Payments days. (Payables x 365/purchases) (days). Sales revenue increase%. (Current sales previous sales/previous sales x 100).

GIANT CAR TRIPS dont have anything to do with overtrading, but the
mnemonic does give you a list of 13 ratios or other measures than can be used to assess whether a company is overtrading.

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Parties who need to analyse corporate financial figures in addition to management


Financial analysis is an evaluation of both the company's past financial performance and its prospects for the future. Typically, it involves an analysis of the company's financial statements and its flow of funds. Financial statement analysis involves the calculation of ratios and also uses other ways of measuring. The analysis of a firm's financial statements is of interest to a number of different groups including present and prospective shareholders, creditors, and the firm's own employees.

S C

Shareholders - current. The present shareholders are interested in the current and future level of risk, liquidity, activity, debt and return (profitability). These are the dimensions which influence share price. Creditors. The firm's creditors, such as the bank, are primarily interested in the short-term liquidity of the firm and its ability to service its debts over the long run. Present creditors want to assure themselves that the firm is liquid and that it will be able to make scheduled interest and principal payments. Prospective creditors are concerned with determining whether the firm can support the additional debt that would result if they extended credit to the firm. Other lenders, such as customers who pay forward on a contract would want to assess the financial stability of the company. Potential investors. In the same way as the companys present shareholders, prospective shareholders are interested in the current and future level of risk, liquidity, activity, debt and return (profitability). For this reason, the business advisory group is also interested in carrying out performance analysis. Employees. Employees (present, past with pension, and potential)), like the shareholders, are concerned with all aspects of the firm's financial situation. Employee representatives (such as trade unions) would need to evaluate the companys position with regard to negotiating pay rises (pay increments).

O P

There is a big of different people who have an interest in the financial standing and performance of a company

SCOPE

EVER ONWARD EVER ONWARD Thats the spirit that brought us fame! Were big, but bigger we will be. We cant fail for all to see, That to serve humanity has been our aim. Our products are now known in every zone. Our reputation sparkles like a gem. Weve fought our way through, and new Fields were sure to conquer too. Forever onward IBM. IBM Company Song

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Reasons why comparisons should be based on companies in the same industry or market sector
Comparison of the companys performance with that of other companies operating in the same industry or market sector is a significant part of performance assessment. By carrying out inter-firm assessment management is able to (i) compare operating and financial performances and identify strengths and weaknesses in the organisation; (ii) contrast strategic structures and detect threats and opportunities, product-market gaps, competitive moves and market movements; (iii) plot take-over bids, or alternatively plan defensive measures to avert possible take-over strikes by other companies; (iv) assess the company's worth (or the disposal worth of divisions) and (v) view the company through the eyes of interested parties, e.g., the capital market, trade unions, employees and creditors. Methods of conducting inter-firm comparisons include: (i) subscription to a formal scheme; (ii) informal and internal research (which uses data provided by the relevant trade association and central government); and (iii) benchmarking exercises. It is centrally accepted that comparisons should be made with companies operating in the same industry or sector for the following reasons.

Working capital. Different industries have different working capital requirements. For example, the retail sector will have a much lower level of debtors than the manufacturing sector due to the different levels of inventory. Similarly, manufacturing concerns generally require a much greater investment in inventory than do service providers. Applicable for the investor group. Investors often group in sectors, and therefore the internal comparison will be similar to the comparisons made by the companys investors. Fixed costs level. Different industries have different levels of fixed costs. For example, the fixed costs of service providers are generally a lot lower than for companies involved in heavy engineering. Earnings volatility. There will be different levels of earnings volatility in different industries and market sectors influenced by seasonal fluctuations and cyclical changes. For example, the furniture retail sector is more influenced by the business cycle (say a downturn in the economy) than the food retail sector. Risk. Leading from the last point, business risk is also different between industries making it impossible to compare important performance indicators.

A F E

Without inter-firm (or inter-sectional) comparison within the same industry or market sector the exercise of financial performance analysis is

WAFER

thin.

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The difficulties involved in inter-firm comparison.


The comparison of financial information (such as ratios) from one firm to another, even in the same industry, involves a number of difficulties, particularly in the following.

I D E A S

Inventory valuation. vary.

The method of accounting for inventory (FIFO, average cost, etc.) may

Depreciation. Depreciation calculations and rates may differ. Expenses. When comparison of different items of expense is possible, then there might be inconsistency in the classification of costs under the main headings of operating costs, marketing costs and administration costs, etc. and also in the method of apportioning common costs. Asset valuation. Where historical values are used the asset-based ratios will vary according to the average age of the assets held which would be different company by company. Several ways of valuing work in progress and finished goods. The cost content of work in progress and finished goods inventory may differ. Some companies will include a share of administration costs, others will cut off at factory cost or include direct costs only.

A number of trade associations or federations have prepared manuals of standard practices in accounting for their members (which are in additional to the GAAP standards) and these help to make reported results more suitable for comparative analysis.

Financial managers need on how to make the necessary corrections for distortions caused by lack of uniformity in the way that financial information is reported by different companies.

IDEAS

A problem well stated is a problem half solved. Charles F. Kettering

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Macroeconomics
Macroeconomics This involves the study of the entire economy. (For accountancy students, the specific areas are anticipated government/central bank economic policy; and economic events and influences which affect decisions of financial/treasury managers, mainly changes, and anticipated changes in the rates of interest, inflation and currency exchange rates.) Macroeconomic policy The conduct of government/central bank policy in such a way as to influence the performance and behaviour of the national economy as a whole. Macroeconomic models and the forecasts they provide are used by both governments and large companies to assist in the development and evaluation of economic policy and business strategy. Macroeconomics then is a branch of Economics that deals with the performance, structure, and behaviour of the economy as a whole. Macroeconomists seek to understand the determinants of aggregate trends in the economy with particular focus on the following:

N A T I O N A L

National income (Gross National Product, etc.), projections and targets. Aggregate unemployment and regional unemployment and causes of. Trends in foreign exchange rates, causes and lessons learned, etc. Interest rates and their effect on the economy. Outward investment, trends and implications. Net trade figures (exports less imports). Accrued government debt and current public sector borrowing requirements. Level of inflation, causes and implications.

Macroeconomics has a

NATIONAL prospective.

Reference: Wikipedia
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The economic goals of government

Eradicate extreme poverty

Increase/ maintain economic growth

Avoid extreme economic fluctuations

ECONOMIC OBJECTIVES OF UK GOVERNMENT

Sustain a healthy (controlled) balance of payments

Maintain price stability Achieve full employment

He slept beneath the moon, He basked beneath the sun, He lived a life of going-to-do, And died with nothing done. James Albery, 1839 1889 English playwright Epitaph for himself

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Main economic goals of most governments


The main economic aims of government (and the central bank which usually acts as an independent agency) are sixfold:

F I G

Full employment. Government aims to reduce the number of involuntary unemployed people to an acceptable
level, or the creation of more jobs. (It is possible to create more jobs without reducing unemployment, e.g. by more school leavers entering the jobs market than new jobs being created.)

Inflation control and price stability. Government have a continuous policy of containing the rate of national
inflation at an acceptable level.

Growth of gross national product. Economic growth happens when there is an expansion in national income (gross national product) in relation to the size of the population. Measures of national income and output are used in economics to estimate the value of goods and services produced in an economy. They use a system of national accounts (or national accounting) first developed in the 1940s. Some of the more common measures are Gross National Product (GNP), Gross Domestic Product (GDP) and Net National Income (NNI). There are at least two or three different ways of calculating these numbers. The expenditure approach determines aggregate demand (or Gross National Expenditure), by summing consumption, investment, government expenditure and net exports. On the other hand, the income approach can be seen as the summation of wages, rents, interest, profits, non-income charges, and net foreign income earned. Healthy, controlled balance of payments. When the balance of visible (trading) and invisibles (investment
income) are combined they form what is effectively the nation's current balance of payments. The capital account The flow of investment and capital flows provide (the concept of) a capital account. (ii) Interaction of the two flows The two sets of flows are likely to move in the same direction, e.g. a balance of payments surplus would be taken as a sign of economic strength by other countries and attract capital; a deficit as a sign of weakness with money moving out of the currency. Government/Central Bank policy to counteract these tendencies (i) The Central Bank might raise interest rates in an attempt to counteract the fall in the value of the home currency. (ii) Convincing overseas financiers/merchants that the Government is taking effective action to reverse a weak economy. (iii) Maintaining controls over the moment of money owned by its own nationals. (An unlikely policy in most countries, but it can happen.) (i)

Trim the economy reduce the economic fluctuations. Unmanaged economies tend to grow in cyclical fashion - periods of recession followed by recovery, then boom. Problems with this economic tendency are: (i) In recession there are unemployed assets and lost output. (ii) In boom the economy is in danger of overheating leading to an increase in demand-inflation, with a consequent loss of international competitiveness of the nation state. The Bank of England (BOE) (or central bank of most national economies) intervenes to avoid the economy overheating with two main policy instruments (i) By increasing the BOE's 'repo' rate of interest (ii) By taking money out of the economy Share wealth and reduce extreme poverty. Government policy attempts to eradicate extreme poverty by
redistributing factor incomes - normally by transferring funds from profits, rents, interest and wages into social services payments, such as unemployment benefits, family aid and so on. The policy is usually achieved by taxation policy e.g., corporate tax, value-added tax (VAT) and personal direct taxes.

The Government country.

FIGHTS hard to improve economic conditions in the

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Main sources of inflation


Demand inflation occurs when demand and purchasing power outstrips (exceeds) the rate of output (supply). Options for government to reduce demand include: increasing taxation (corporate, VAT, direct taxes) - to cut consumer spending, lowering government expenditure (and lower government borrowing) with the aim of using the multiplier effect to spread out in reverse. increasing interest rates (Bank of England policy). Expected effect inflation occurs because of an anticipation that inflation will occur within current wages bargaining and price adjustments. For example, employees negotiating an annual wage settlement who anticipate an increase in inflation during the year ahead would consequently demand a higher rate of wage increase to compensate for this future inflation. In this respect, inflation becomes a self-fulfilling prophesy. Options for government to reduce the self fulfilling influences include: pursuing clear policies which indicate its intention to contain/reduce rates of inflation, not practising 'U-turn' economic policy. Demand inflation

Costs rise because of a shortage of factors of supply. Money is such a factor, but there are others, particularly labour. A shortage of labour tends to cause an increase in the level of wages. Options for government to increase the factors of supply include: de-regulating labour markets (e.g. reducing the power of trade unions to impose 'closed shops'), encouraging greater productivity, applying controls over wages and price rises (prices and incomes policy) encourage immigrant labour

Expectations effect inflation Source of inflation

Cost inflation

Money-supply inflation

Imported inflation

Money supply inflation results from an over expansion of the money supply. (A simplistic explanation of the 'Monetarists' position on the relationship between money supply and the rate of inflation, is that inflation is caused by money supply growth - 'too much money chasing too few goods'.) Options for government/Central Bank to reduce the rate of money supply growth include: cutting the public sector borrowing requirement (PSBR), funding the PSBR by borrowing from the non-bank private sector (which would pull money from other corporate and private investments), control or reduction of bank lending, using interest rates to deter money supply growth (e.g. the higher the rate of interest the less attractive investments become; less money would be borrowed and thus 'created').
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Imported inflation is a consequence of prices rising because of the weakening (softening) value of the country's foreign exchange rate against other trading currencies. The result of this is that imports cost more.. Options for government to counter-balance foreign exchange disadvantages include: appreciation or depreciation of the domestic currency rate (rare), the Central Bank raising interest rates to counteract fall in currency value, trying to achieve a balance of trade (imports and exports).

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Sources of inflation
A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase. Rising prices inflation - reduces the value of money. Monetary policy is directed at achieving this objective and providing a framework for noninflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price of money - the interest rate, In May 1997 the Government gave the Bank of England independence to set monetary policy by deciding the level of interest rates ('repo rates') to meet the Government's inflation target - currently 2% (August 2007). Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy. Price stability is a precondition for achieving a wider economic goal of sustainable growth and employment. High inflation can be damaging to the functioning of the economy. Low inflation can help foster sustainable long-term economic growth. Financial managers need to be aware of: - the probable level of future inflation, and - the effects on their organisation of likely government (central bank) policies to deal with rising inflation. There are five types (or sources) of inflation, some of which overlap, which might lead the government (central bank) to pursue deflationary policy:

Money supply inflation. Money supply inflation results from an over expansion of the money supply. (A simplistic explanation of the 'Monetarists' position on the relationship between money supply and the rate of inflation, is that inflation is caused by money supply growth - 'too much money chasing too few goods.) Options for government (central bank) to reduce the rate of money supply growth include: - cutting the public sector borrowing requirement (PSBR), - funding the PSBR by borrowing from the non-bank private sector (which would pull money from other corporate and private investments), - control or reduction of bank lending, - using interest rates to deter money supply growth (e.g. the higher the rate of interest the less attractive investments become; less money would be borrowed and thus 'created').

Expectations effect inflation. Expected effect inflation occurs because of an anticipation that inflation will
occur within current wages bargaining and price adjustments. For example, employees negotiating an annual wage settlement who anticipate an increase in inflation during the year ahead would consequently demand a higher rate of wage increase to compensate for this future inflation. In this respect, inflation becomes a self-fulfilling prophesy. Options for government to reduce the self fulfilling influences include: - pursuing clear policies which indicate its intention to contain/reduce rates of inflation, - not practising 'U-turn' economic policy.

Demand inflation. Demand inflation occurs when demand and purchasing power outstrips (exceeds) the rate of
output. Options for government to reduce demand include: - increasing taxation (corporate, VAT, direct taxes) - to cut consumer spending, - lowering government expenditure (and lower government borrowing) with the aim of using the multiplier effect to spread out in reverse. - increasing interest rates (central bank policy, perhaps).

Imported inflation. Imported inflation is a consequence of prices rising because of the weakening (softening)
value of the country's foreign exchange rate against other trading currencies. The result of this is that imports cost more. Options for government to counter-balance foreign exchange disadvantages include: - appreciation or depreciation of the domestic currency rate (rare), - the central bank raising interest rates to counteract fall in currency value, - trying to achieve a balance of trade (imports and exports).

Cost inflation. Costs rises because of a shortage of factors of supply. Money is such a factor, but there are others,
particularly labour. A shortage of labour tends to cause an increase in the level of wages. Options for government to increase the factors of supply include: - de-regulating labour markets (e.g. reducing the power of trade unions to impose 'closed shops'), - encouraging greater productivity, - applying controls over wages and price rises (prices and incomes policy). - encourage immigrant labour.

MEDIC, may

have no word association with inflation but high levels of inflation are unhealthy for an economy..

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Government policy: Full employment


The Government aims to reduce the number of involuntary unemployed people to an acceptable level, or the creation of more jobs. (It is possible to create more jobs without reducing unemployment, eg by more school leavers entering the jobs market than new jobs being created.)

G E T S T H E M

Growth in private sector. Encouraging growth in the private sector. Encouraging training in job skills. Training grants to employers in selected regional areas. Spending money directly on jobs, e.g. employing more civil servants.

Trade union closed shops agreements disallowed or discouraged. Higher education and university places made available. Encouraging labour mobility. Minimum wage legislation. Careful balancing of minimum-wage legislation.

Memory jog: Government policy

GETS THEM,

(people) into work.

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We hope that you have found this sample download interesting and helpful. We anticipate that the full version will be of some help in your studies towards your ACCA exams. If you enjoy these Mnemonics and Charts, then perhaps you might also enjoy the Questions and Answer practice papers, or the Full Exam Study Textbooks, or even the Case Studies we also have. Please feel free to browse our other products and purchase the full version here Good Luck in your Exams!

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