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Key Principles of Financial Managements

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You have recently been appointed as the senior management accountant in a large listed company, XYZ plc which has divisions in a number of countries and trades globally.

You have examined the financial management procedures of XYZ plc and have had discussions with the board of directors of the company. In doing so you have identified the following key areas which need to be addressed:

1. There is little understanding of the role and nature of financial management amongst the other directors and senior managers and you feel that this limits their ability to make sound decisions regarding shareholder wealth maximisation.

2. There appears to be no strategy behind the management of the sources of capital in the company and little understanding of the need to manage the cost of capital.

3. Large projects seem to be undertaken with little or no formal investment appraisal.

You are required to produce a report to the board of directors explaining the key principles and concepts in the above areas and discuss models and techniques by which the company may improve performance.

The report should include critical evaluation of the models and concepts proposed outlining their merits and limitations. You may incorporate logical assumptions with regard to the company and use numerical examples to illustrate the models and concepts that you propose to adopt.

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Solution Preview

This report would assess the importance of financial management in a company and outline the different principles and concepts related to evaluating large projects before investing in them. The report would also highlight the importance of using different sources of capital and managing cost of capital.

Finance is a very crucial area for any firm. Financial management seeks to plan for the future such that a personal or business entity has a positive flow of cash (Damodaran, 2002). The process of financial management may also include identifying and trying to work around the various risks to which a particular project may be exposed. Financial planning aims to boost the levels of resources at their disposal, while also functioning on money invested in them from external investors. Another goal companies have is to provide shareholders with sufficient amounts of returns on their investments (Broadbent & Cullen, 2003).

It is vital for the firm to give special attention to investment decisions as these decisions influence the firm's growth in the long run, affect the risk of the firm, involve commitment of large amount of funds, irreversible or reversible at substantial loss, among the most difficult decisions to make (Pandey, 2004). Financial decision-making is an important part of the modern day financial management process. The particular entities involved in financial management also need to be able to take the financial decisions that are intended to benefit them in the long run and achieve their financial aims, which are the basic premise of financial management (Damodaran, 2002).

Capital investment should not be made on an ad hoc basic, but should link into the organization existing and planning investment programme. This investment programme should in turn be driven by the company's long term strategy. One of the most important long term decisions for any business relates to investment. Investment is the purchase or creation of assets with the objective of making gains in the future. Typically investment involves using financial resources to purchase a machine, building or other asset, which will then yield returns to an organization a period of time. The steps involved in the evaluation of an investment are estimation of cash flows, estimation of the required rate of return and application of a decision rule for making the choice (Damodaran, 2002).

Key considerations in making investment decisions are: what is the scale of the investment - can the company afford it? How long will it be before the investment starts to yield returns? How long will it take to pay back the investment? What are the expected profits from the investment? And could the money that is being ploughed into the investment yield higher returns elsewhere? (Pandey, 2004).

Company can choose from a number of investment criteria which are net present value, internal rate of return, profitability index, payback period, discounted payback period and accounting rate of return. (Neale and McElroy, 2004)

Net present value is discounted cash flow technique that explicitly recognizes the time value ...

Solution Summary

This solution of 1,980 words explains the key concepts of financial management, ranging from roles of financial managements, strategy of managing sources of capital and the importance of formal investment appraisals.