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Managing finances has always been part of managing of managing organizations, but finance first appeared as an academic discipline in early 1990s.
Financial management is able to be defined as the process of making optimal use of financial and real or physical resources to increase the value of the firm. This highlights that the efficient use of resources in order to raise the wealth of the business.
The term strategic financial management is able to be defined as the identification of the possible strategies that capable of maximizing value of business, the allocation of scarce capital resources among the competing opportunities and the implementation and monitoring of the chosen strategies so as to achieve stated objectives. Under the strategic financial management it is discussed financial goals.
The primary financial goal is to maximize the shareholder wealth. While growth of assets and earnings and maximization of profits sometimes served as acceptable goals in the past, today's professional financial managers hold the maximization of the firms' total value to be the objective of all decision making. The concept is more commonly expressed as the maximization of the shareholder wealth.
Wealth is measured by market value of business's stock which depends on expectations about the business's profitability in the future. Maximizing shareholder wealth means making financing and investment decisions for both the long run and the short run that maximizes the market value of the stock.
There are other secondary financial goals. They are intended to achieve particular level in earnings per share, dividend per share, return per equity, return per assets and debt to equity etc.
Importance of Costs in their pricing strategy
Costs are one of most important aspect of financial management. Costs are the money or wealth incurred in order to take returns in future from the businesses. There are many types of costs involved all throughout the business process. These costs vary with the type of the industry, type of products; types of inputs used and so on.
These costs are always burden for the business as it always taking negative values in financial accounts. Finally it leads to the bad financial performances. The cost can have multiple impact of the business as it has many dimension especially time dimension. As cost is always deal with capital, there is capital cost which is most considered when making investment decisions. So there are few sources of cost of capital such as cost of ordinary share capital, cost of preference share capital and cost of debt capital (Atrill, and McLaney, (2002.)
All these types of costs have direct impact of performance of the business. Thus the cost plays a vital role in the business success. The costing is the process of putting the number value for the incurred costs while pricing is done in order to determine value for each and every element. These processes are very important as earlier mentioned as both are directly also indirectly impacted on the overall financial performance and financial viability of the company. So the both processes should be well designed and should be thoroughly addressed the each and every aspects which has financial dimension.
Potential for the use of activity-based costing (ABC) and to recommend processes that could enable them to manage cost reduction and related management processes.
Activity-Based Costing (ABC) is a technique of allocating costs to products and services. It is generally used as a instrument for planning and control. It was developed as an approach to address problems associated with the traditional cost management systems, which tend to have the inability to accurately determine actual production and service costs, or provide useful information for operating decisions.
Activity based costing (ABC) assigns manufacturing overhead costs to products or services in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing (ABC) first assigns costs to the activities that are the real cause of the overhead. It is then assigning the cost of those activities only to the products that are actually demanding the activities.
Activity based costing (ABC) is able to recognize that the special engineering, special testing, machine setups, and others are activities that cause costs; they cause the company to consume resources. Under Activity Based Costing (ABC), the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities. Activity based costing (ABC) has grown in importance in recent decades because of the following reasons.
(1) Manufacturing overhead costs have increased significantly,
(2) The manufacturing overhead costs are not longer correlate with the productive machine hours or direct labor hours.
(3) The diversity of products and the diversity in customers' demands have grown, and
(4) Some products are produced in large batches, while others are produced in small batches.
Uses of Activity Based Costing (ABC)
It is be of assistances to identify the inefficient products, departments and activities
It assists to allocate more resources on profitable products, departments and activities
It helps to control the costs at an individual level and on a departmental level
It helps to find the unnecessary costs
It helps to fixing the price of a product or service scientifically
Creation of a master budget
Master budget is very important in terms of achieving business goals efficiently and effectively. The master budget is a summary of organization's plans which sets specific targets for sales, production, distribution and financing activities. It is generally culminating in a cash budget, a budgeted income statement, and a budgeted balance sheet. In a nut shell, this budget corresponds to a comprehensive expression of management's plans for future and how these plans are to be accomplished.
It generally consists of a number of breaks up but interdependent budgets. One budget may be essential before the other can be commenced. More one budget estimate affects other budget estimates because the figures of one budget are as a rule used in the preparation of other budget. This is the reason why these budgets are called interdependent budgets.
Making justifiable decisions about the viability of the projects
Use of Net Present Value to make decisions
NPV rule is choosing a project if it costs less than the PV of its cash flows. More generally: take a project if its Net Present Value is positive.
According to the results of net present value calculations for two projects, first project of building a new health centre yield 674,000 while building a new sports centre yield net present value of 474,000 pounds.
Considering both these values it is better to build new health centre as its net present value (674,000) is higher than the net present value of building of sports centre of which net present value is 474,000. For building of sports centre, investors would have to invest 674 more (a total of 1774, 000) to get the cash flows of 536, 159, 285, 318 and 477 at an interest rate of 12%. Therefore the project has a value of 123 for investors.
Acceptable rule; accept the project if NPV>0; reject if NPV<0 but may accept if the NPV=0
Merits of the Net Present Value are; It recognizes the time value of money; net
present value solely depends on the forecasted cash flows; the additive property.
Demerits of NPV are difficult to ascertain the cash flow, difficulty in deciding the discount rate of cost of capital and not suitable in ranking projects.
Use of Internal Rate of Rate calculation to make decisions
IRR rule for selecting a project is; choose a project if and only if IRR > Cost of Capital. According to the results, results shows that internal rate of return is less than to zero in building a sports center project while internal rate of return is 33% in building a health center project. Therefore it is better to build a health center than sports center.
Internal Rate of Rate calculation for building of sports center
Merits of the Internal Rate of Return are it considers time value of money, considers all cash flows occurring over the life time and considers with the stakeholders' wealth maximization objectives.
Internal Rate of Rate calculation for building of health centre
Use of Pay Back Periods to make decisions
Payback period is the period taken by the projects to bridge the cost incurred by making profit by projects itself.
Acceptable rule is; firms compare the calculated payback with the standard or target payback set by the management. If the calculated payback is less than the target payback the project would be accepted. If not it would be rejected. According to the calculations for the first project payback period is four years but for second project it is more than 5years according to our calculations.
Merits of the Payback period,
Simple to understand and easy to calculate, a company can have favorable short run effects on EPFs by setting up a shorter target payback period, the riskiness of the project could be tackled by having a shorter target payback period and early recovery of the investment gives an insight into the liquidity of the project.
It fails to capture the cash inflows earned after the payback period; it is not an appropriate method of measuring the profitability of an investment project as it does not consider all cash inflows yielded by the project; it fails to take into account the pattern of the cash inflows; it is unable in determining the target payback period and it is not consistent with the objectives of maximizing the market value of the firms' shares.
Other appropriate and relevant financial information for use in the process of making the strategic decisions on investment
Here we can use the "profitability Index" of the project, in order to evaluate the decision alternatives. This is again time adjusted method of evaluating the investment proposals. This is also called the cost benefit analysis. It is the ratio of the present value of the cash inflows at the required rate of return to the initial cash outflow of the investment.
Profitability index = Present value of cash inflow/ initial cash outlay
Acceptance rule; accept if PI>1; reject if PI<1 and may accept if PI=0. If PI is greater than one, then the project will have positive net present value.
Factors will need to be taken into account when making recommendations based on a post-audit appraisal on the appropriateness of an investment project decisions
Projects are intended to make profits over time, by achieving the goals set for each year while ensuring the come true of overall organization mission and vision. So when the recommendations made based on a post audit appraisal for investment project decisions. The firms' investment decisions would generally include expansion, acquisition, modernization or replacement of the long term assets. The nature of the investment decisions will fall into the following categories; whether or not to undertake an investment, when there are alternative choices for an investment, selecting which of the mutually exclusive investments to undertake; when capital for spending is in short supply, deciding which investments to undertake with the money that is available.
To make sound decisions some factors have to be considered in order to make better decision making.
The project viability
Project long term financial yielding ability
Project's out come on the presence of financial crisis and so on
Financial management is one of key aspect which is directly affecting to the achievement of business goals. Thus thorough understanding of each and every financial management aspects is important in order to sustain the business.
The financial performance evaluation, evaluation of financial viability and accordingly adjust the budget is normal procedure while comply with the master budget. However financial discipline is the most important thing in achieving the success of the business.