Presentation on theme: "EVALUATION OF FINANCIAL PERFORMANCE Finance revolves around MONEY Functions of MONEY: MONEY is what MONEY DOES MONEY is a MEDIUM OF EXCHANGE (it is a."— Presentation transcript:
EVALUATION OF FINANCIAL PERFORMANCE
Finance revolves around MONEY Functions of MONEY: MONEY is what MONEY DOES MONEY is a MEDIUM OF EXCHANGE (it is a means of payment for goods and services) MONEY is the LIFEBLOOD of a BUSINESS (a business cannot exist without MONEY!) MONEY is a MEASURE OF RELATIVE VALUE (it is a Unit of Account) MONEY is a STANDARD FOR DEFERRED PAYMENTS (enabling credit transactions) MONEY is a STORE OF VALUE (it can be held as an ASSET)
MONEY has TWO (2) sides (Heads and Tails?) CAPITAL and REVENUE CAPITAL consists of all the resources of an ENTREPRISE that will produce REVENUE (or INCOME) There can be NO REVENUE without CAPITAL The bigger the CAPITAL the bigger the potential for INCOME The FATTER THE COW: the FATTER THE PURSE!
A business NEEDS Money before it can spend it! SOURCES OF FUNDS A business gets Money from EQUITY and/or DEBT EQUITY funds come from SHAREHOLDERS or Reinvested PROFITS or RESERVES DEBT is sourced from External BORROWINGS The Financial Manager must decide how to get money to GROW the CAPITAL of the business This is the FINANCIAL DECISION!
CLASSIFICATION OF SHARES Shares can be Ordinary, Preferred or Deferred Preference Shares can be CUMULATIVE or Non-cumulative EQUITY FUNDS are LONG TERM sources of funds Preference Shares can be REDEEMABLE Redeemable Preference Shares are often classified as a HYBRID Source of Funds Shares can be PREFERRED or DEFERRED as to Dividends and/or Return of Capital on Winding Up Preference Shares can be PARTICIPTATING or Non-participating as to dividends and/or Return of Capital on Winding Up
CLASSIFICATION OF BORROWINGS BORROWINGS can be either SHORT TERM or LONG TERM Some examples of Short Term Borrowings are: Trade Credit, Factoring, Overdraft, Accommodation Bills Convertible Notes are another example of HYBRID FINANCE Some examples of Long Term Borrowings are: Debentures, Unsecured Notes, Mortgage Debentures, Inter Company Notes, Financial Leases
After the FINANCE DECISION come the INVESTMENT DECISION and the OPERATING (or DIVIDEND) DECISION The INVESTMENT DECISION is about deciding how money is spent on CAPITAL The OPERATING (or DIVIDEND) DECISION is about deciding how money is spent on REVENUE
EVALUATING FINANCIAL PERFORMANCE FINANCE is the SCIENCE of MANAGING MONEY There are also TWO (2) dimensions to Finance: RETURN and RISK The higher the risk of OWNERS loosing money, the greater the return that BUSINESS OWNERS will demand! So, how could the performance of Financial Managers be measured? In a Modern Corporation there is a clear separation of business ownership and management In a Modern Corporation, Managers are appointed to look after the interests of owners (shareholders) : Managers are the AGENTS of Shareholders (PRINCIPALS)
POSSIBLE METHODS FOR EVALUATIING FINANCIAL PERFORMANCE Maximising Corporate Income? Minimising Corporate Costs? Maximising Corporate Profit? Maximising Corporate Cash? Maximising Financial Managers Remuneration? Minimising Company Tax?
ALL OF THESE METHODS HAVE SERIOUS FAULTS AS MEASURES OF FINANCIAL PERFORMANCE! NONE take into account the degree of Financial Risk! NONE take into account the size of each owners interest in the business! PROFIT is too ambigiuous to be used as a measure! INCOME, COSTS and TAX each have too narrow a focus AND CONFLICTING PURPOSE in their contribution to PROFITS! Directors have the power to set their own salaries SUCH THAT The power of GREED often ensures that Managers SELF INTEREST dominates over SHAREHOLDERS INTERESTS! ALL are measured in money terms over TIME, BUT do not take into account the Time Value of MONEY!
BEST UNIFYING MEASURE OF CORPORATE FINANCIAL PERFORMANCE Since Managers are appointed to look after SHAREHOLDERS INTERESTS, why not let SHAREHOLDERS themselves rate the FINANCIAL PERFORMANCE of Managers? If SHAREHOLDERS feel their returns are not worth the risk, they will SELL their investments and SHARE PRICES will FALL Conversely, if SHAREHOLDERS are happy with the risk/return profile, they will buy an investment MARKET FORCES will push SHARE PRICES UP! Let the STOCK MARKET rate the Financial Performance of a Corporation
BEST UNIFYING MEASURE OF CORPORATE FINANCIAL PERFORMANCE Therefore MAXIMISATION of SHAREHOLDER WEALTH is generally accepted as the best unifying measure of a MANAGERs FINANCIAL PERFORMANCE! MARKET CAPITALISATION = Number of Issued Shares x Market Price per Share Of the above two (2) variables, Issued Shares are relatively stable BUT Share Prices fluctuate every instance of time, therefore SHAREHOLDER WEALTH MAXIMISATION is synonymous with SHARE PRICE MAXIMISATION Since EQUITY belongs to SHAREHOLDERS, this is measured by MARKET CAPITALISATION of the Firms EQUITY Although SHARE PRICE MAXIMISATION overcomes all the disadvantages of other measures, it is the BEST but NOT PERFECT measure!