CIMA OFFICIAL REVISION CARDS STRATEGIC LEVEL SUBJECT F3 Financial Strategy FINANCIAL STRATEGY Published by: Kaplan Publishing UK Unit The Business Centre, Molly Millars Lane, Wokingham, Berkshire RG41 2QZ Copyright © 2017 Kaplan Financial Limited All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publisher Acknowledgements The CIMA Publishing trademark is reproduced with kind permission of CIMA Notice The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties Please consult your appropriate professional adviser as necessary Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 978-1-78415-949-8 Printed and bound in Great Britain Financial STRATEGY How to use Revision Cards The concept •• Revision Cards are a new and different way of learning, based upon research into learning styles and effective recall •• The cards are in full colour and have text supported by a range of images, making them far more effective for visual learners and easier to remember •• Unlike a bound text, Revision Cards can be rearranged and reorganised to appeal to kinaesthetic learners who prefer to learn by doing •• B eing small enough to carry around means that you can take them anywhere This gives the opportunity to keep going over what you need to learn and so helps with recall •• The content has been reduced down to the most important areas, making it far easier to digest and identify the relationships between key topics •• Revision Cards, however you learn, whoever you are, wherever you are Financial STRATEGY How to use them Revision Cards are a pack of approximately 52 cards, slightly bigger than traditional playing cards but still very easy to carry and so convenient to use when travelling or moving around They can be used during the tuition period or at revision They are broken up into sections •• An overview of the entire subject in a mind map form (orange) •• A mind map of each specific topic (blue) •• Content for each topic presented so that it is memorable (green) Each one is a different colour, allowing you to sort them in many ways •• Perhaps you want to get a more detailed feel for each topic, why not take all the green cards out of the pack and use those •• You could create your own mind maps using the blue cards to explore how different topics fit together •• And if there are some topics that you understand, take those out of the pack, leaving yourself only the ones you need to concentrate on There are just so many ways you can use them Financial STRATEGY Contents Objectives and Development of Financial Strategy Integrated Reporting Hedge Accounting Financing – Equity and Debt Finance Capital Structure Dividend Policy Financial Performance Measurement Financial and Strategic Implications of Mergers and Acquisitions Business Valuation 10 Pricing and Post-transaction Issues Financial STRATEGY Core areas of the syllabus The syllabus comprises of: A Formulation of financial strategy 25% B Financing and dividend decisions 35% C Corporate finance 40% Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to mykaplanreporting@kaplan.com with full details, or follow the link to the feedback form in MyKaplan Our Quality Co-ordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions overview financial strategy RevisionCards Financial STRATEGY Strategic aspects Capital structure Financing and dividend decisions (30%) Corporate finance (40%) Financial Strategy Pricing / post transaction issues Business valuation Equity finance Dividend policy Development of financial strategy Debt finance CHOICES CHOICE S CHOICES Objectives ca$h Hedge accounting Formulation of financial strategy (25%) Integrated reporting Objectives and development of financial strategy financial strategy RevisionCards Financial STRATEGY – Objectives and development of financial strategy Profit making Different types of entity Not for profit ca$h Objectives and development of financial strategy Investment decision Dividend decision CHOICES CHOICES CHOICES 10 Three interlinked decisions Financing decision Financial STRATEGY – Objectives and development of financial strategy Objectives: Profit making v not-for-profit organisations Profit making organisations: Not-for-profit organisations: A company (profit making organisation) has shareholder wealth maximisation as its primary objective The primary objective is to provide an acceptable level of service to its key stakeholders Financial objectives will tend to focus on costs, and the efficient, effective and economic use of resources The needs of other stakeholders need to be considered too, since dissatisfied stakeholders in the short term may lead to an erosion of shareholder wealth in the long term 11 Financial STRATEGY – Objectives and development of financial strategy •• Organisations set objectives which will satisfy key stakeholders, such as: −− Shareholders – require returns (dividends and / or capital growth) −− Employees / managers – require job security and pay increases −− Customers – require good quality products / services and reasonable prices −− Suppliers / Lenders – require payment when due −− Government – require taxes to be paid and laws to be followed −− Local community – require considerate / responsible behaviour 12 •• The impact of external, economic forces (such as interest rates, inflation, exchange rates) needs to be considered before objectives can be set •• Conflicts will often arise between different stakeholder groups (e.g shareholders requiring dividends and employees requiring pay rises) Financial STRATEGY – Objectives and development of financial strategy Performance appraisal The most readily available source of information is the published accounts, but these have the following limitations: •• fi gures are historic records, not forward looking Investors (shareholders and lenders) will often appraise the performance of an entity, to assess whether it represents a good investment 13 •• t he accruals concept means that the income statement will not relate to the entity’s cash position •• fi nancial information might not give a full picture of the entity’s position Financial STRATEGY – Objectives and development of financial strategy Profitability ratios •• Operating profit margin = (Profit before interest and tax (PBIT) / Turnover) x 100% •• Gross profit margin = (Gross profit / Turnover) x 100% Return on Capital Employed (ROCE) and Return on Equity (ROE): ROCE = (Operating profit / Capital employed) x 100% ROE = (Profit after tax (PAT) / Equity value) x 100% This measures the underlying performance of the business before considering financing This measures the return which relates to the shareholders Capital employed = total funds (debt and equity) invested in the business 14 Note that ROE is post tax and ROCE is pre tax, so the ratios are not directly comparable Financial STRATEGY – Objectives and development of financial strategy Financial gearing ratios Financial gearing can be analysed by looking at the balance sheet (statement of financial position) or the income statement The risk is that if gearing is too high, the entity will not be able to afford to service its debts Balance sheet (statement of financial position) Financial gearing can be measured as either: Debt value / Equity value, or Debt value / (Value of equity +debt) •• Market values should be used if possible, or use book values if working from financial accounts 15 Income statement Key measure: Interest cover = Profit before interest and tax (PBIT) / Interest (Finance charges) •• A high ratio indicates low risk Financial STRATEGY – Objectives and development of financial strategy Stock market ratios For quoted companies, stock market ratios will give a market driven measure of performance P/E ratio Dividend cover Dividend yield Share price / EPS EPS/Dividend per share (DPS) DPS/Share price A high P/E ratio indicates that the market has confidence in the company High dividend cover will reassure investors that dividend levels are likely to be maintained even if profits fall A basic measure of yield to shareholders Note that: •• EPS (earnings per share) = (Profit after tax and preference dividends) / No of shares •• A better measure of shareholder return (taking account of capital gains as well as dividends, would be [(closing share price – opening share price) + dividend] / opening share price 16 Financial STRATEGY – Objectives and development of financial strategy Investment decision v Financing decision v Dividend decision CHOICES CHOICES CHOICES Investment decision – what projects should be undertaken? Financing decision – how should the necessary funds be raised? Dividend decision – how much cash should be paid out to shareholders? Links between these decisions When deciding which investments to undertake, the firm needs to decide how finance will be raised If large amounts of finance are available, this will enable the firm to undertake more / better investments 17 If investments generate lots of cash, this will enable the firm to pay large dividends If more equity finance is raised, higher cash levels will be needed for dividends to satisfy the shareholders Financial STRATEGY – Objectives and development of financial strategy Forecasting exchange rates Terminology: GBP is STRENGTHENING / APPRECIATING means that GBP1 is worth MORE foreign currency GBP is WEAKENING / DEPRECIATING means that GBP1 is worth LESS foreign currency e.g GBP1 = US$1.60 in year GBP1 = US$1.70 in year The GBP has strengthened (and the US$ has weakened) e.g GBP1 = US$1.60 in year GBP1 = US$1.50 in year The GBP has weakened (and the US$ has strengthened) 18 Financial STRATEGY – Objectives and development of financial strategy Forecasting exchange rates Interest Rate Parity: Expectations theory: The forward rate can be predicted if we know the interest rate differential between the two countries The future exchange rate can be predicted if we know the interest rate differential between the two countries Forward rate (A$/B$) = Spot rate (A$/B$) x 1+ B$ interest rate 1+ A$ interest rate Future rate (A$/B$) = Spot rate (A$/B$) x 1+ B$ interest rate 1+ A$ interest rate Note on CIMA notation: Exchange rates will always be quoted in the format A$/ B$2.5, which means there are 2.5B$ to each 1A$ 19 RevisionCards ... editions overview financial strategy RevisionCards Financial STRATEGY Strategic aspects Capital structure Financing and dividend decisions (30%) Corporate finance (40%) Financial Strategy Pricing... reporting Objectives and development of financial strategy financial strategy RevisionCards Financial STRATEGY – Objectives and development of financial strategy Profit making Different types of entity... comparable Financial STRATEGY – Objectives and development of financial strategy Financial gearing ratios Financial gearing can be analysed by looking at the balance sheet (statement of financial