ACCA Applied Skills · Financial Management
The Nature and Purpose of Financial Management for ACCA FM
Financial management is the planning and control of a business's finance to meet its objectives. It covers three decisions: investment, financing and dividends. For a company the main objective is to maximise shareholder wealth. You solve questions by naming the objective, spotting conflicts between parties, and recommending actions that fit.
What this chapter covers
This opening chapter of Financial Management (FM) explains what a finance function does and what it is trying to achieve. It sets out the three key decisions: investment (which projects to accept), financing (how to pay for them) and dividend (how much profit to return to owners). It then defines the objective that guides all three: maximising shareholder wealth.
The chapter also looks at what goes wrong. Managers run the company but shareholders own it, so their interests can differ. This is the agency problem. You will study how it arises, how it is reduced, and how other stakeholders such as lenders, employees and government may pull in other directions. You then meet organisations with different aims, namely not-for-profit bodies, where success is judged by value for money (economy, efficiency and effectiveness). The chapter closes with corporate governance and ethics.
There is little calculation here, but the chapter underpins the whole paper. Investment appraisal, cost of capital, working capital and risk management all assume a goal of increasing shareholder wealth. When a later question asks you to advise whether a project or financing choice is sensible, your reasoning comes from this chapter. It is mostly tested through objective test questions and through the discussion parts of the constructed response questions.
Every exam in FM is 100 marks, and 60 of them are objective test questions that are marked all or nothing. Questions on objectives, agency, value for money and governance are often short and wordy, so a precise grasp of definitions wins marks quickly. The same ideas also give you the structure for written answers in Section C, where you must comment on whether a decision supports shareholders. It is a light chapter to learn, and it improves your discussion marks across the paper.
The nature and purpose of financial management: topics in the order to study them
- 1Nature and Purpose of Financial ManagementStart here to learn the three decisions and the role of the finance function, which everything else builds on.
- 2Financial Objectives and Shareholder Wealth MaximisationOnce you know the decisions, learn the goal they serve and how it is measured, for example through dividends and share price.
- 3Agency Problem and Stakeholder ConflictsThis follows naturally, because conflicts appear when managers and other groups do not share the shareholder wealth goal.
- 4Not-for-Profit Organisations and Value for MoneyStudy this next to see how objectives change when profit is not the aim, and compare it with the company case.
- 5Corporate Governance and Ethical IssuesFinish with the controls and principles used to manage agency conflicts and to keep decisions ethical.
How to prepare The nature and purpose of financial management
This chapter is theory, so you learn it by being able to define, explain and apply. Aim for short, accurate answers you can give from memory.
- Write the three financial management decisions in your own words and give one example of each.
- Learn the shareholder wealth objective, including why profit maximisation alone is a weaker goal (it ignores timing, risk and cash).
- List the causes of the agency problem and the ways to reduce it, such as managerial reward schemes linked to performance, monitoring and governance rules. Note the drawbacks of each.
- Learn the three Es of value for money (economy, efficiency, effectiveness) and practise placing an example under the right one.
- Make a short list of governance and ethical principles, then link each to the risk it controls.
- Practise objective test questions on each topic, then write a six-line answer to a scenario asking you to comment on a manager's or company's decision.
- Review wrong answers and note whether the error was a definition, a misread scenario or a mix-up of terms.
Common mistakes in The nature and purpose of financial management
Treating profit maximisation and shareholder wealth maximisation as the same thing
Fix: Remember that wealth maximisation considers cash, timing and risk. Profit can be raised in the short term in ways that reduce long-term value.
Mixing up economy, efficiency and effectiveness
Fix: Ask: is it about lower cost of inputs (economy), output for each unit of input (efficiency), or meeting the stated aim (effectiveness)?
Describing the agency problem but not saying who is the agent and who is the principal
Fix: State the relationship first: managers are agents, shareholders are principals. Then give the conflict and a remedy.
Suggesting that performance-related pay fully solves agency conflict
Fix: Give the benefit and the weakness, for example that targets may be manipulated or may promote short-term decisions.
Giving generic answers in Section C discussion parts
Fix: Use the facts given. Name the company's decision, state which stakeholder is affected and explain the effect on shareholder wealth.
Assuming all organisations aim to maximise profit
Fix: Check the type of organisation first. For public sector and charities, judge success by value for money and service objectives.
Last-day revision: The nature and purpose of financial management
- Three decisions: investment, financing and dividend.
- Main objective of a company: maximise shareholder wealth.
- Shareholder wealth is increased through dividends and share price growth.
- Profit maximisation can ignore risk, timing of returns and cash flow.
- Agency problem: managers (agents) may not act in the interests of shareholders (principals).
- Ways to reduce agency conflict: performance-linked pay, monitoring, audit and governance codes.
- Performance-linked rewards can still encourage short-term or risky behaviour.
- Stakeholders include lenders, employees, customers, suppliers, government and the community.
- Not-for-profit bodies usually have non-financial objectives and often work with limited funds.
- Value for money = economy, efficiency and effectiveness.
- Economy is lower input cost, efficiency is output per input, effectiveness is achieving the objective.
- Good governance supports accountability, transparency and ethical conduct.
The nature and purpose of financial management practice questions
- Zenith plc has 10 million shares in issue. At the start of the year the share price was $4.00. During the year the company paid a total divi…
- A company's managers are rewarded with a bonus based on this year's reported profit. Which behaviour is this scheme most likely to encourage…
- Which of the following is the most effective way to align the interests of managers with those of shareholders?
- Which of the following remuneration arrangements for directors is MOST likely to help align directors' interests with those of shareholders …
- Which of the following is a corporate governance mechanism intended to reduce the agency problem?
- Which of the following best describes the agency problem in a listed company?
- Which of the following is generally regarded as the primary financial objective of a profit-seeking company in financial management theory?
- In the context of the financial management function, which of the following best describes the agency problem between a company's shareholde…
The nature and purpose of financial management in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
The nature and purpose of financial management: frequently asked questions
Is this chapter worth studying if it has no calculations?
Yes. Objective test questions on definitions and concepts are quick marks if you know the terms exactly. The chapter also gives you the reasoning for discussion answers in Section C.
What is the main objective of financial management in a company?
The usual objective is to maximise shareholder wealth. This is achieved by making investment, financing and dividend decisions that increase the value of the company to its owners.
What is the agency problem in simple terms?
It is the risk that managers, who run the business, act in their own interests instead of those of the shareholders who own it. Monitoring, rewards linked to performance and good governance are used to reduce it.
How do I answer questions on not-for-profit organisations?
Identify the organisation's aims, which are usually not about profit. Then judge performance using value for money: economy, efficiency and effectiveness, with examples from the scenario.
How should I revise this chapter on my phone?
Use short flashcards for definitions and lists, then attempt a few objective questions on each topic. Keep a note of the terms you confuse and review them just before the exam.