Management Accounting – Financial Strategy (FLFS)

Syllabus overview

This syllabus explores financial management from domestic and international perspectives.It builds on material covered in the Finance and Management Accounting Decision Making papers at Intermediate level.

The risk management section of the paper introduces entirely new material not seen in previous papers.The other three sections of the syllabus represent developments of material introduced in earlier papers, including knowledge of ratio analysis, WACC and other financial management techniques and knowledge.The ability to identify and analyse appropriate performance measures and ratios underpins this syllabus.

Aims

This syllabus aims to test the student’s ability to:

  • evaluate and interpret the financial implications of strategies;

  • calculate, evaluate and recommend the value of an organisation;

  • interpret the risks facing an organisation and recommend risk-management strategies;

  • evaluate advanced investment proposals.

Assessment

There will be a written paper of three hours. Section A will contain a compulsory question worth 50 marks, based upon a scenario. Section B will contain a choice of questions, normally two from four.

All learning outcomes may be tested in each section.

Formulae will be given as required.

Learning outcomes and syllabus content

13(i) The formulation and achievement of financial objectives and strategy – 25%

Learning outcomes

On completion of their studies students should be able to:

  • identify appropriate actions for improving financial performance;

  • evaluate the attainment of financial and non-financial objectives;

  • analyse and interpret company accounts and available information of relevant stakeholders;

  • identify and interpret the impact of internal and external constraints on financial strategy (for example funding, regulatory bodies, investor relations, strategy, and economic factors).

Syllabus content

  • Financial and non-financial objectives; planning, evaluating and controlling an organisation’s objectives; evaluating the effect of actual or forecast changes in major economic forces on both the setting and achievement of objectives.

  • The impact of financial obligations on achieving financial objectives (for example redeemable debt, earn out arrangements, potential liabilities, long term commitments including Public / Private partnerships, such as the Private Finance Initiative in the UK).

  • The impact of regulation on developing strategy (for example, regulation by competition authorities, pricing and services agencies such as OFTEL, OFWAT and takeover regulation). Note: Detailed knowledge of the City Code for Takeovers and Mergers will not be tested.

  • Domestic and international working capital management strategies. Note: Detailed testing of stock management models will not be set, since these were covered in the Finance paper.

  • Forecast financial statements (profit and loss account, balance sheet and cash flow) based on expected changes in base data or previous forecasts (for example changes in inflation, volume, margins and probabilities and expected values). (Note: presentation of these statements need not be in published account format.) Detailed testing of cash management models will not be set, since these were covered in the IFIN syllabus.

  • Policies for distribution of earnings: for example, dividends, share repurchase.Note: theory of dividend irrelevance will not be tested.

13(ii) Business valuations – 25%

Learning outcomes

On completion of their studies students should be able to:

  • calculate values of organisations of different types, for example, service, capital-intensive;

  • assess and evaluate the strengths and weaknesses of the various methods of valuing a business;

  • identify and calculate the value of intangible assets in an organisation (including intellectual capital);

  • identify and evaluate the financial and strategic implications of proposals for mergers, acquisitions, demergers and divestments;

  • compare, contrast and recommend settlement methods and terms;

  • evaluate post-merger value enhancement strategies and calculate post merger values of companies;

  • evaluate exit strategies for major investors.

Syllabus content

  • Various methods for valuing a business (for example asset basis; earnings bases, such as P/E multiples, earnings yield; cash flow valuation bases such as discounted cash flow, dividend yield, dividend growth model; and other valuation bases such as earn out arrangements or super profits methods). (Note: the bases for valuing assets include historic, replacement and realisable asset.)

  • The efficient-market hypothesis (EMH) and its application to business valuations.

  • Approaches of the various valuation bases to the issue of new equity, including the valuation of the company prior to flotation.

  • Cost of capital as required in the valuation process.

  • The impact of changing capital structures on the market value of a company will be tested using the formula Vg = Vu + TB. (An understanding of the principles of Modigliani and Miller’s theory of gearing with and without tax will be expected, but no proof of their theory will be examined (by which we mean arbitrage).

  • The different forms of intellectual capital and the methods of valuation.

  • The priorities of different stakeholders in the merger or company valuation process.

  • The reasons for acquisitions (for example, synergistic benefits, removing competition).

  • Different payment methods (for example, cash, shares, convertibles, earn-out arrangements).

  • The integration process following a takeover, for example transferring management, merging systems and the impact of the merger on post-merger values.

  • Post-merger value enhancement strategies.

  • The function/role of management buyouts, providers of private equity and venture capitalists.

  • Exit strategies for major investors, for example flotation of company (if currently unlisted), sale of shares on a stock exchange (if listed), private sale of shareholding to a third party.

13(iii) Risk management – 25%

Learning outcomes

On completion of their studies students should be able to:

  • identify the sources of risk facing a company;

  • interpret the financial impact of the various risks facing an organisation and evaluate risk management strategies;

  • demonstrate how and when to convert fixed to floating rate interest;

  • calculate the impact of differential national inflation rates on forecasting exchange rates;

  • explain exchange rate theory.

Syllabus content

  • Management of risk: transaction, translation, economic, political/cultural and commercial risks, including fraud.

  • The principle of diversifying risk (no numerical calculations required).

  • Interest rate parity, purchasing power parity and the Fisher effect.

  • Forward contracts and money market hedges. Numerical questions will be set including the need to be able to use cross-rates.

  • Currency futures and options, including tick values. Numerical questions including tick values but ignoring basis risk will be set. The Black–Scholes option pricing model will not be tested numerically – however, an understanding of the variables, which will influence the value of an option, should be appreciated.

  • Internal hedging techniques for example netting and matching.

  • Currency swaps. Calculations to illustrate a currency swap may be set

  • Management of interest rate risk, including the use of forward rate agreements, futures and interest rate guarantees; interest options and the use of interest rate swaps. (Note: caps, collars and floors are included in interest rate options.)

  • Calculations may be required to illustrate all these interest rate management techniques.

13(iv) Advanced investment appraisal – 25%

Learning outcomes

On completion of their studies students should be able to:

  • evaluate investment proposals (domestic and international);
  • recommend methods of funding investments;
  • interpret the impact of changing exchange rates and inflation rates on the investment;
  • calculate and interpret real options (abandonment, follow-on, deferment);
  • calculate the tax shield of debt finance on an investment;
  • identify and describe procedures for the control of international investments;
  • recommend investment decisions when capital is rationed.

Syllabus content

  • Net present value and internal rate of return calculated by either converting the foreign currency cash flows into sterling and discounting at an appropriate sterling discount rate, or discounting the cash flows in the host country’s currency using an adjusted discount rate.

  • Capital asset pricing model (CAPM). The ability to gear and ungear betas will be tested. Candidates will not be asked to calculate a beta value from raw data using regression or other methods.

  • Sources of long-term finance, including the benefits of finance drawn from the foreign environment, for example Euro currency and Eurodebt markets.

  • Adjusted present value (APV). The two-step method of APV will be tested for debt introduced permanently and debt in place for the duration of the project.

  • Risk adjustment using the certainty equivalent method when given a risk-free rate and certainty equivalent values.

  • Capital investment real options by which we mean the option to make follow-on investment, the option to abandon and the option to wait.

  • The effect of taxation, including differential tax rates and double tax relief.

  • The effect of restrictions on remittances.

  • Post completion audit and other controls of investments in long term domestic and international capital projects; procedural controls and project management.

  • Single-period capital rationing for divisible and non-divisible projects.Mulllti-period capital rationing will not be tested.