Financial Managers Corporation

Financial managers have a plethora of duties. You may be running your company well and selling effectively, but managers always have to bear in mind that perhaps they should have been doing something different which is more profitable. How is the choice among competing courses of action made in a world of uncertainty? A financial manager takes all available information on projected future cash flows and subjects them to rigorous evaluation; a company might have the choice of revamping an existing product or launching a new product which is a close substitute, and the projected cash flows both in and out are totally different while the risks associated with each are also different. A financial manager's job is to provide a quantitative solution to such problems, and this takes the company a long way towards deciding on the most appropriate course of action.

In a global corporation, the financial manager's job is even more challenging. Desai(2008) notes that the finance function in this setting needs to wrestle with complications such as profit repatriation policies, ''currency, tax and country risks'' as well as strategically position the company to benefit from potential arbitrage opportunities.

Making episodic financial decisions in the form of capital budgeting, capital structure and financing decisions is a truly important function within a company but is somewhat misleading about the day-to-day activities of financial managers. There is another set of actions regularly undertaken by financial managers that is as important and often claims more of a typical financial manager's time. This is the management of the company's working capital. This ''double duty'' (Jackson, 2008:67) aspect of financial manager's job is important to any organisation - big or small - and as Jackson rightly posits: ''being able to respond to sudden economic shifts without losing sight of long-term objectives is one of the hallmarks of a successful [chief financial officer] (CFO)''(p 67).

But the CFO model is a relatively new concept (Zorn, 2004) and there are many organizations without dedicated financial managers or CFOs. My various companies, being small businesses, have no dedicated financial manager and this is true of many small and medium size businesses (SMEs). The double duty is, nevertheless, carried out. To stay in business I have to monitor the day-to-day financial situation of my companies as well as keep focus on their long-term strategic objectives. Vecchio (2007:320) observes that when high personal financial stakes are involved, it is not uncommon to find founders predisposed to seek greater personal control. This is perhaps the behaviour exhibited by most founders of SMEs. Note that agency problems (Jensen and Meckling 1976) are comparatively reduced as a result but raising capital comes at relatively unfavourable terms.

In summary, financial managers face three main challenges: financing, capital budgeting, and risk management. Capital budgeting, capital structure and financing-dividend decisions deal with assets, product lines and capital sources that can be expected to persist at least some years. This is not the case with working capital items, whose very nature is that they are much shorter-term assets and financings.

Financial managers must help their companies steer the economy's shoals as well as keep ''jittery'' shareholders happy. (Because of the residual nature of their claim, the shareholders of a company will experience the corporate investment NPV as their increase in wealth.) To successfully perform all these duties financial managers need to be familiar with the various ways of financing their companies' operations and the various sources of financing available.

Sources of finance available to a UK-listed company

The sources can be conveniently categorised as internal and external (Laureate Online Education 2007; Ross et al. 2008; Koubouros 2008). Internal sources of finance are the remit of the directors and managers of the business; external sources, on the other hand, do require the compliance of ‘outsiders' e.g. potential shareholders. Flexibility and relative speed of arriving at a decision makes internal sources of finance more appealing.

Within each category, sources of finance may further be categorised as 'short-term' and 'long-term'. Although the distinction between short-term and long-term sources of finance is by no means a settled matter, it is generally accepted that ''short-term sources of finance are due for repayment within one year'' (Laureate Online Education 2007:425); long-term sources, on the other hand, typically provide finance for at least more than one year. We shall concern ourselves only with long-term sources in this discourse.

Retained profits/earnings

Retained profit is the main long-term source of internal finance for most businesses not just listed companies(Laureate Online Education 2007; Ross et al. 2008; Koubouros 2008). Reinvesting profits is a useful way of raising capital from ordinary shareholders and is the most used long-term source of internal finance because unlike, say new share or rights issues, there are no issue costs and the amount raised is certain. Ergo, in terms of value of funds raised, it is most appealing. Retaining profits also does not affect the control structure of the business.

Note that the ordinary shareholders would expect a return rate from the earnings reinvested that is equivalent to what they would have received had the funds(i.e. dividends) been invested in another opportunity with the same level of risk. Ergo, retained earnings are not a free source of finance to a business.

UK-listed companies typically retain profits to fund future expansion and most typically have a payout ratio of not more than 50%. Some clienteles (in particular ''fat cats'') prefer the profits to be retained rather than be distributed in the form of dividends and research(see for example DeAngelo and DeAngelo 2006 ) indicates that dividend/retention policies firms adopt may attract or drive away potential investors.

Long-term sources of external finance

Main ones, in descending order of riskiness, are (Laureate Online Education 2007):

ordinary shares;

preference shares;

loans (secured/unsecured loans);

leases;

hire-purchase agreements

Ordinary/common shares

This is the company's risk capital. As mentioned earlier, claims on cash flows are residual and therefore rate of return expectations are comparatively higher. This form of finance is appealing when is it is attractive to avoid paying dividend. Note that avoidance of dividend payment may have a negative effect on the company's share price.

In the UK tax system, dividend payment isn't tax deductible but loan interest payments are and this means borrowing can be less expensive.

Preference shares

Their holders have priority over common shareholders but like ordinary shareholders dividend payments aren't tax deductible.

Loans

Unlike shares, interest payments are tax deductible. They (e.g. term loans offered by banks and other financial institutions) may be cheap to set up and contract terms may also be tailored to suit particular business situations. For example, the charge may floating or fixed; the loan may be convertible or callable; funds may be drawn only as and when required, and interest payment, in this scenario, is due only on sums actually drawn. (Note that convertible bonds are a mechanism to merge the interests of bondholders and shareholders.)

In addition to domestic markets, there is a truly international capital market from which companies can borrow. In this market, long-term funds are usually called 'eurobonds' - unsecured loan stocks. There is often slightly lower borrowing rate in Eurobond markets than in comparable domestic loans, due to lower regulatory costs.

Leases

Current accounting disclosure requirements and changes in tax law make finance leases not as tax-efficient (or a vehicle for concealing the actual financial situation from investors) as they once were. One important aspect of leasing is that large cash outflows can be avoided and this is perhaps why many airline companies use finance leasing as a means of acquire new aircrafts.

Sale-and-lease-back arrangements are useful for businesses and many UK businesses(e.g. Sainsbury, Tescos, Boots, hotel chains) are at it (Financial Times, 2004). A good number of businesses indulge in order to concentrate on their core operations or areas of competence.

Hire purchase agreements

Quite similar to finance leases in that they allow the holder to avoid incurring a huge initial capital outlay if they bought the asset outright. Unlike a finance lease, the holder will eventually become the legal owner of the asset.

Source most used and why

This will depend on the life-cycle stage of the company. At listing (or just after listing) ordinary shares and preference shares are the most used. At expansion, profit retentions are the most used source for reasons already given above. At rescue/distress situations a combination of profit retention (if any), rights issue, management buy-in/buy-out are most used. Private equity/venture capitalist or business angels may have an enormous impact in management buy-in/buy-out situations.

Conclusion

We have looked at the principal duties of finance managers and gone through a number sources of financing for a project. We still have not given a rigorous, quantitative formulation of what a finance manager should do faced with a decision as to whether to use debt, equity or combination of debt and equity. We have noted repeatedly, as do others(Koubouros 2008;Ross et al. 2008; Business Link 2008; BVCA 2008), that the principal decision determinants are cost and flexibility/accessibility. There isn't, however, at this time, an all-encompassing process or template that all financing managers can use. A lot is understood now about capital structure decisions than when Modigliani and Miller (1958) did their groundbreaking work. But there is probably just as much to be discovered about this most challenging of financial decisions, particularly in the application of the theory to actual decisions taken by financing managers.

References

Business Link, (2008) ''Equity finance'' [online] Available from: http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1073864776 (Accessed: 30 August 2008)

BVCA (The British Private Equity and Venture Capital Association) (2008) ''Why private equity is good for Britain' [online] Available from: http://www.bvca.co.uk/ (Accessed: 30 August 2008)

DeAngelo, H.,DeAngelo, L. (2006) ''The irrelevance of the MM dividend irrelevance theorem'', Journal of Financial Economics Feb2006, Vol. 79 Issue 2, p293-315

Desai, M. A. (2008) ''The Finance Function in a Global Corporation'', Harvard Business Review, July-August 2008

Financial Times, (2004) ''Travelodge to raise ￡400m via sale and leaseback'', Financial Times, 12 July 2004

Jackson, H. (2008) ''America's Best CFOs'', Institutional Investor-International Edition Mar2008, Vol. 33 Issue 3, p67-74

Koubouros, M. (2008) Business Finance Week 2 Lecture Notes, Laureate Online Education

Laureate Online Education (2007) ‘Managing Resources', First Edition, Pearson Custom Publishing.

Modigliani, F. and Miller, M. (1958) 'The Cost of Capital, Corporation Finance and the Theory of Investment', American Economic Review, 48 (June), 261-97

Vecchio, R. P. (2007) Organizational Behaviour: Core Concepts, 6^th Edn, Thomson-SouthWestern

Zorn, D. M. (2004) ''Here a Chief, There a Chief: The Rise of the CFO in the American Firm'', American Sociological Review pp. 345-364

We provide a professional essay writing service that thousands of our customers use as an effective way of improving their grades, improving their research and saving them lots of time.