financial management

Financial management

The management of a company's investment and financing decisions, aimed at maximising the value of the company for its shareholders

Two major financial management decisions

(1) Which assets should the company invest in? (2) How should the company finance these investments?

Investment decisions

Decisions about which assets (financial or operating) the company should acquire; reflected on the asset side of the Statement of Financial Position

Financing decisions

Decisions about how the company raises the funds (equity or liabilities) to pay for its assets; reflected on the equity + liabilities side of the Statement of Financial Position

Financial assets

Investments such as equity shares, preference shares, debentures, bonds, and money market investments

Operating assets

Investments in current assets (working capital) and non-current assets used to run the business

Objective of financial management

To maximise the value of the company, i.e. to maximise shareholder value (share price), subject to long-term sustainability and optimum allocation of scarce resources

Decision rule for value creation

A company creates value when its Return on an investment is greater than its Cost of capital

Cost of capital

The return a firm theoretically must pay to its financiers to compensate them for the risk they undertake by investing their capital in the firm

Sole proprietor

A business owned and run by one person; low legal/regulatory requirements and low cost, but the owner has no limited liability (personal liability for business debts)

Partnership

A business owned by two or more people; each partner is taxed in their personal capacity (on a sliding scale) and generally has no limited liability

Private company (Pty) Ltd

A company form with limited liability that cannot be listed on the JSE; commonly used once outside investors are needed

Public company (Ltd)

A company form with limited liability that can be listed on the JSE, allowing capital to be raised from a large number of investors

Close corporation (CC)

A simpler juristic business form (no longer registrable, but existing ones continue) with limited liability, historically used by smaller businesses

Limited liability

A feature of company forms of business where an investor's potential loss is restricted to the amount they invested in the business

Company tax rate (South Africa)

27%

Prime lending rate

The base interest rate that affects the cost of borrowing for companies; currently 10.25%

Inflation

A sustained increase in the general level of prices for goods and services; South Africa's 2025 full-year inflation was 3.2%, close to the SARB's target of around 3%

Currency exchange rate impact

Exchange rates are highly volatile and affect the import/export of goods and services, so companies must factor in expected future exchange rate movements into investment and financing decisions

Profit maximisation vs value maximisation

Profit maximisation is usually linked to value maximisation, but they can conflict when profit is increased through accounting policy changes with no real economic substance (e.g. changing depreciation periods or inventory valuation methods) rather than genuine cash flow improvement

Economic Value Added (EVA)

A measure of value creation defined as: Operating income − (Invested capital × Cost of capital); a positive operating income can still coincide with a negative EVA if the return on invested capital is below the cost of capital

Why accounting profit is a poor measure of value

It depends on subjective accounting policies; ignores the time value of money; may not reflect actual cash flows; and does not include the cost of equity financing (only interest on debt is deducted, not the implied cost of equity)

Agency problem

The conflict of interest that arises because management (agents) may act to maximise their own benefit (e.g. remuneration, perks, job security) rather than to maximise shareholder wealth, since management often owns only a small proportion of a large company's equity

Mechanisms to align management and shareholder interests

Threat of takeover, management incentives (e.g. share options, performance bonuses), the board of directors' power to replace management, the market for managers, growth of institutional investor activism, and increasing corporate governance requirements

Inclusive capitalism

An approach to business that considers value creation for a broad base of stakeholders and society, not only shareholders

Multi-stakeholder approach

An approach to running a business that takes into account the interests of all stakeholder groups (e.g. shareholders, employees, customers, society), not only shareholders

Sustainable wealth creation

Creating value for the company and its stakeholders in a way that can be maintained over the long term, rather than through short-term or unsustainable means

The Six Capitals ( Framework)

The six types of capital used in the International Integrated Reporting Framework: financial, manufactured, intellectual, human, social & relationship, and natural capital

Triple context

Viewing business decisions within the combined context of the economy, society, and the environment

ESG

Environmental, Social, and Governance — a set of factors used to assess a company's sustainability and societal impact alongside its financial performance