PAPER NO.8 FINANCIAL MANAGEMENT
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply financial management principles in practice.
8.0 LEARNING OUTCOMES
A candidate who passes this paper should be able to:
- Explain the nature and scope of financial management
- Describe the nature and functions of financial institutions and markets in the context of your country
- Appreciate the relevance and applications of the concept of time value of money
- Analyse the sources of finance for an organisation and evaluate various financing options
- Evaluate various investment decision scenarios available to an organisation a
- Evaluate the performance of a firm using financial tools
- Make appropriate capital structure decisions for a firm, Value financial assets and firms
- Make appropriate liquidity and dividend decisions for a firms
- Analyse and apply concepts in Islamic finance and Evaluate current developments in the field of finance
8.1 Overview of financial management
- Theoretical framework of financial management – The role and responsibilities of a finance manager towards shareholders, Employees, society, government and other stake holders.
- Goals of a firm and corporate strategy; financial and non-financial objectives, overlaps and conflicts among the objectives
- Agency theory, stakeholder’s theory and corporate governance
- Measuring managerial performance, compensation and incentives
- Ethical issues in financial management
8.2 The financing decision
- Nature and objectives of the financing decision
- Factors to consider when making financing decisions
- Sources of finances for enterprises; internally generated funds and the externally generated funds, long term sources (equity, debt, hybrids, lease finance, venture capital, business angel finance, private equity, asset securitisation and sale, Islamic finance and initial coin offerings), medium term sources such as medium term loans and hire purchase financing and short term sources of finance such as overdraft finance, trade credit, issue of commercial papers, accruals, deferred income; characteristics of each source of finance, pros and cons of the various sources of finance.
- Evaluation of financing options
- Methods of issuing ordinary shares – Public issue, private placement, bonus issue, employee stock option plans (ESOPS) and rights issues
8.3 Financial institutions and markets
- Overview of a financial system- Financial markets, financial institutions and financial instruments
- Nature and role of financial markets – primary and secondary securities market, money and the capital markets, over-the counter and organized market, derivatives market, mortgage market, forex market
- Nairobi securities exchange (NSE)-The role and functions of NSE, Securities exchange terminologies, Security exchange listing and cross border listing ,20 share and All Share Indices, Timing of investment at the securities exchange, Central depository system and automated trading system, De-Mutualisation of NSE.
- Stock market indices
- Central depository system and automated trading system
- Timing of investment at the securities exchange – Dow theory and Hatch system of timing
- The financial institutions and intermediaries: commercial banks, savings and loans associations and co-operative societies, foreign exchange bureaus, Unit trusts and mutual funds, insurance companies and pension firms, insurance agencies and brokerage firms, investment companies, investment banks and stock brokerage firms, micro-finance institutions and small and medium enterprises (SMEs)
- Regulation of financial markets; Central bank of Kenya (CBK) – The role of the Central bank and the Monetary policy of the central bank; Capital market authority and the Insurance regulatory authority
- Factors responsible for the rapid development of financial institutions and markets
- Risks facing financial institutions.
8.4 Time-value of money
- Concept of time value of money
- Relevance of the concept of time value of money in financial management
- Time value of money versus time preference of money
- Time line
- Real Verses nominal cash flows
- Compounding techniques- Compound interest, Future value (FV) of a single cash flow and series of cash flows; Compounding of annuity cash flows
- Discounting techniques – Present value (PV) of a future cash flow and series of future cash flows and Discounting of annuity cash flows
- Loan amortisation and sinking funds
8.5 Business/Financial asset Valuation models
- Concept of value; book value, going concern value, substitution value, replacement value, conversion value, liquidation value, intrinsic value and market value
- Reasons for valuing financial assets/business
- Theories on valuation of financial assets; fundamental theory, technical theory, random walk theory and the efficient market hypothesis
- Valuation of redeemable, irredeemable and convertible debentures/ corporate bonds
- Valuation of redeemable, Irredeemable and convertible preference shares
- Valuation of ordinary shares; net asset basis, price-earnings ratio basis, capitalisation of earnings basis, Gordon’s model, finite earnings growth model, Super-profit model, Walter’s model, discounted free cash flow, residual income model, Use of relative measures such as Economic Value added (EVA) and Market Value Added (MVA)
- Valuation of rights issues
- Valuation of unit trusts and mutual funds
- Valuation of private companies: income and market-based approaches
8.6 Introduction to capital structure decisions
- The meaning of capital structure and the factors to be taken into account when making capital structure decision.
- Cost of capital; Meaning of Cost of capital, Practical applications of cost of capital, Component costs of capital
- The firm’s overall cost of capital; Weighted average cost of capital (WACC), Weighted marginal cost of capital (WMCC) and factors influencing the firm’s Cost of capital.
- Leverage and Risk; Operating leverage and Operating risk, financial leverage and financial risk and Total leverage and total risk.
- Analysis of Operating profit (EBIT), Earning per share (EPS) at the point of indifference in the firm’s earnings; Determination of the range of firm’s Operating profit (EBIT) within which each financing option will be recommended.
8. 7 Introduction to Capital budgeting decisions
- The nature and importance of capital investment decisions
- Capital budgeting process
- Capital investment’s cash flows – initial cash outlay, terminal cash flows and annual net operating cash flows, incremental approach to cash flow estimation
- Capital investment appraisal techniques
- Non-discounted cash flow methods – payback period and accounting rate of return
- Discounted cash flow methods – net-present value, internal rate of return, profitability index, discounted payback period and modified internal rate of return (MIRR)
- Strengths and weaknesses of the investment appraisal techniques
- Expected relations among an investment’s NPV, company value and share price
- Capital investment options – timing option, strategic investment option, replacement option and abandonment option
- Problems/difficulties encountered when making capital investment decisions in reality
8.8 Financial statements analysis and forecasting
- scope of financial statement analysis, major financial statements and other information sources, financial statement analysis frame work and users of financial statements and their information needs
- Financial Statement analysis verses Business analysis
- Techniques of financial Statement analysis; Cross-Sectional analysis, Time series analysis and a combination of both techniques.
- Types of financial statement analysis
- Ratio analysis; nature of financial ratios, classification and calculation of financial ratios and limitation of financial ratios
- Common size statements – Vertical and horizontal analysis
- Financial forecasting; cash budgeting and percentage of sales method of forecasting
8.9 Working capital management
- Introduction and concepts of working capital
- Working capital versus working capital management
- Factors influencing working capital requirements of a firm
- Types of working capital
- Importance and objectives of working capital management
- Working capital operating cycle; the importance and computation of the working capital operating cycle
- Working capital financing policies: Aggressive, conservative and matching financing policy
- Determining the finance mix: basic approaches for determining an appropriate Working Capital finance mix; Hedging or matching approach, conservative approach, aggressive approach.
- Management of inventory: kinds of inventory, objectives of Inventory Management, Techniques of Inventory Management; stock levels, Economic Order Quantity (EOQ) and Just-In-Time(JIT).
- Cash Management; Motives of holding cash, techniques of managing cash, cash management models-Baumol model, Miller-Orr model and Orgler’s model
- Management of accounts receivable and accounts payable; assessing creditworthiness, collecting amounts owing, trade credit.
8.10 Dividend decision
- Meaning and significance of dividend policy
- Factors influencing dividend policy
- Forms of dividend: script dividend, cash dividend, stock dividend, bond dividend, property dividend
- Dividend theories; Bird in hand theory, Clientele effect theory, Information signalling theory, Walter’s model, Gordon Model, Tax differential theory, Modigliani and Miller dividend irrelevance theory
- Types of dividend policy: regular dividend policy, stable dividend policy, irregular dividend policy, zero dividend policy.
- The impact of dividend payout on share price
8.11 Introduction to portfolio analysis
- Introduction- Risk-return trade off/relationship, Distinction between risk free and risky assets
- Expected return, Standard deviation of returns and the Relative risk of an individual asset
- Expected return of a 2 asset-portfolio
- The Covariance and correlation coefficient of returns of assets.
- The actual portfolio risk of a 2-asset portfolio using the analytical and mathematical model and its interpretation.
8.12 Islamic finance
- Justification for Islamic Finance; history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
- Benefits and deficiencies of Islamic Finance
- Principles underlying Islamic finance: principle of not paying or charging interest, principle of not investing in forbidden items such as alcohol, pork, gambling or pornography; ethical investing; moral purchases
- The concept of interest (riba) and how returns are made by Islamic financial securities
- Sources of finance in Islamic financing
- Types of Islamic financial products:- sharia-compliant products: Islamic investment funds; takaful the Islamic version of insurance Islamic mortgage, murabahah,; Leasing – ijara; safekeeping – Wadiah; sukuk – islamic bonds and securitisation; sovereign – sukuk; Islamic investment funds; Joint venture – Musharaka, Islamic banking, Islamic contracts, Islamic treasury products and hedging products, Islamic equity funds; Islamic derivatives
- International standardisation/regulations of Islamic Finance: case for standardisation using religious and prudential guidance, National regulators, Islamic Financial Services Board
8.13 Personal financial management
- Financial Problems encountered in managing individual financial affairs
- Savings and investment considerations
- Personal risk management
- Cost of credit
- Financial Alterations-Retirements; Estate and Tax planning and family budgeting
8.14 Emerging issues and trends
- Globalization and growth of derivative markets and securitization.
- Block chain technology
- Cloud funding
- Digitization of financial transactions
- Behavioural finance
- Big data project finance
RECOMMENDED TEXT BOOKS
- Financial Management by I.M.Pandey 11th Edition
- Corporate finance theory and practice A. swath Damodaran
- Business finance theory and practice- 7th Edition by Eddie McLaney
- Principles of corporate finance by Braley R Myers