FM: Financial management function and objectives

Answer: B. Financial management is concerned with the three key decisions — investment (which projects and assets to commit funds to), financing (how to raise the funds) and dividend (how much to return to shareholders) — all directed at maximising shareholder wealth. Option A describes financial accounting (external reporting), and option C describes bookkeeping; both are backward-looking record-keeping rather than forward-looking decision-making. Option D is tax compliance, a specialist administrative task. The defining feature of financial management is its forward-looking, decision-focused nature.

Answer: B. Financial management draws on the output of both accounting disciplines — financial accounting provides the reported position and performance, while management accounting supplies internal cost, budgeting and forecasting data — and uses that information to make decisions about the future. Option A is wrong: the accounting functions feed financial management, not vice versa. Options C and D describe financial accounting and bookkeeping respectively. The key distinction is that accounting largely records and reports, whereas financial management interprets and decides.

Answer: A. Accounting profit is open to manipulation through the choice of accounting policies (for example depreciation or inventory methods), is a single-period measure, and takes no account of the risk or the timing of returns. Shareholder wealth — reflected in the share price — is based on the present value of expected future cash flows, so it captures risk and the time value of money. Option B is simply untrue, option C is the reverse of reality (wealth depends on market values and expectations), and option D does not follow.

Answer: C. Financial management revolves around the investment decision (which long-term and short-term assets to invest in), the financing decision (the mix of equity and debt used to fund those investments) and the dividend decision (how much profit to distribute versus retain). These three decisions are interrelated — for example, a decision to retain earnings affects both financing and dividends. Option A lists operational functions, option B lists accounting activities, and option D lists management-accounting tasks, none of which is the financial-management triad.

Answer: C. Financial objectives (such as a target return on capital, gearing level or dividend policy) should be derived from, and support, the wider corporate objectives and strategy — they translate strategic aims into measurable financial targets. Option A wrongly isolates them from strategy, option B overstates the finance function's role (strategy is set by the whole board), and option D is incorrect because financial objectives guide a healthy business continuously, not only in distress.

Answer: A. EPS is built on accounting profit, so it inherits the weaknesses of profit-based measures: it can be flattered by accounting choices, it is a single-period figure, and it ignores the risk attaching to earnings and the timing of cash flows. A rising EPS does not necessarily raise the share price (option C is wrong) if achieved by, say, increasing financial risk. Option B is false — EPS is a standard listed-company metric — and option D is the opposite of the truth, since EPS is a for-profit, per-share measure.

Answer: B. Stakeholder conflict arises where one group's objective can only be met at the expense of another's. Higher wages for employees increase costs and so reduce the returns available to shareholders — a direct conflict. The other options describe shared or compatible interests: accurate records (A) suit both shareholders and the authorities, solvency (C) suits customers and suppliers alike, and long-term survival (D) is a common goal. Recognising genuine trade-offs, rather than aligned interests, is the heart of stakeholder analysis.

Answer: B. Agency theory examines the relationship in which shareholders (principals) delegate control to managers (agents). The agency problem is the risk that managers pursue their own interests — job security, perks, empire-building — rather than maximising shareholder wealth, because their goals are not perfectly aligned and shareholders cannot fully observe their actions. Option A describes one agency cost (monitoring) rather than the problem itself; options C and D relate to supplier and lender relationships, not the shareholder–manager agency relationship.

Answer: D. Share options that reward managers when the share price rises over time align managers' personal wealth with the long-term wealth of shareholders, encouraging decisions that build value. A fixed salary (A) gives no performance incentive, a guaranteed bonus (B) rewards managers regardless of outcomes, and rewarding short-term sales volume alone (C) can drive dysfunctional behaviour such as cutting prices or margins. Reward schemes work best when they tie managers' returns to the same long-term measures that matter to shareholders.

Answer: C. Corporate governance codes aim to reduce the agency problem by strengthening board oversight. Key recommendations include separating the chairman and chief-executive roles (so power is not concentrated in one individual) and appointing independent non-executive directors to provide objective challenge and to sit on audit and remuneration committees. Options A and D concentrate power and create conflicts of interest, and option B removes the very independence that governance codes seek to introduce.

Answer: A. ROCE = profit before interest and tax ÷ capital employed. Capital employed = equity + long-term debt = £2,400,000 + £600,000 = £3,000,000 (current liabilities are excluded). ROCE = £540,000 ÷ £3,000,000 = 18.0%. Option B (22.5%) divides by equity alone (£540,000 ÷ £2,400,000). Option C (15.0%) wrongly includes the £600,000 current liabilities in capital employed (£540,000 ÷ £3,600,000). Option D (12.0%) uses profit after tax or another profit figure rather than PBIT. ROCE measures the operating return generated on long-term capital.

Answer: B. Return on equity = profit after tax (the profit attributable to ordinary shareholders) ÷ ordinary shareholders' equity = £360,000 ÷ £2,400,000 = 15.0%. Option A (12.0%) divides the after-tax profit by a larger capital-employed figure that includes debt. Option C (22.5%) uses profit before interest and tax over equity. Option D (18.0%) is the ROCE-style measure (PBIT over total long-term capital). ROE focuses specifically on the return earned for the ordinary shareholders on the funds they have invested.

Answer: C. EPS = earnings attributable to ordinary shareholders ÷ number of ordinary shares. Earnings attributable to ordinary shareholders = profit after tax less preference dividends = £450,000 − £30,000 = £420,000. EPS = £420,000 ÷ 2,000,000 = £0.21 = 21.0p. Option A (22.5p) ignores the preference dividend (£450,000 ÷ 2,000,000). Option B (24.0p) uses an incorrect, smaller share count. Option D (14.0p) divides the correct earnings by the wrong number of shares (3,000,000). Preference dividends must always be deducted because they are not attributable to ordinary shareholders.

Answer: D. Total shareholder return = (capital gain + dividend) ÷ opening share price = ((£4.40 − £4.00) + £0.20) ÷ £4.00 = £0.60 ÷ £4.00 = 15.0%. Option A (5.0%) is the dividend yield only (£0.20 ÷ £4.00). Option B (10.0%) is the capital gain only (£0.40 ÷ £4.00). Option C (13.6%) wrongly divides the £0.60 total return by the closing price of £4.40 instead of the opening price. Total shareholder return combines both the income and the capital growth earned over the period, measured against the amount originally invested.

Answer: A. A not-for-profit organisation does not exist to enrich shareholders; instead its overriding aim is to meet the needs of its beneficiaries or service users as effectively as possible within the resources available — which makes value for money central. It still needs sound financial management to use limited funds well (so option B is wrong). It is not trying to maximise a surplus for its own sake (option C), and many NFPs do raise finance through grants, donations or borrowing (option D). Objectives are usually multiple and non-financial as well as financial.

Answer: B. The three Es of value for money are economy (acquiring resources of the right quality at the lowest cost — minimising input cost), efficiency (maximising the output achieved from a given input, i.e. the input–output relationship) and effectiveness (the extent to which the organisation's objectives are actually achieved — the output–outcome relationship). The other options mix in terms such as equity and earnings that are not part of the standard value-for-money framework. Distinguishing the three Es clearly is regularly required in not-for-profit questions.

Answer: D. A commercial company can fall back on profit as a clear, quantifiable bottom line. A not-for-profit organisation usually pursues multiple objectives whose outputs — for example the quality of healthcare or education provided — are non-financial and inherently difficult to quantify and compare. This is precisely why value-for-money analysis and surrogate performance indicators are used. Options A and B are simply untrue, and option C is the opposite of reality, since commercial performance is comparatively easy to measure.

Answer: C. Economy is concerned with minimising the cost of inputs while maintaining the required quality — buying the same supplies more cheaply is the textbook example. Efficiency (option B) would relate the inputs to the outputs produced (for example more patients treated per pound spent), and effectiveness (option A) concerns whether the organisation's underlying objectives are met. Equity (option D) is not one of the three Es. Obtaining the same quality at a lower price is purely an economy improvement.