Financial Management glossary

Profit and earnings per share (EPS), return on capital employed (ROCE) and return on investment (ROI) for a division; simple and familiar, but based on accounting profit, which managers can influence by policy choices, and which ignores risk and the cost of the capital tied up.

Taught in Overview of financial management

Pay:

• Fixed salary rewards nothing in particular.
• Annual bonuses tied to profit or EPS reward short-term accounting results and invite manipulation.
• Share options, share awards and employee share ownership plans (see Methods of issuing shares, in the chapter on financing) reward share price growth and align managers with shareholders, though options reward risk-taking and can be repriced when the price falls.
• Long-term incentive plans vesting over several years on total shareholder return or EVA targets are the current best practice.
• The Code requires a remuneration committee of non-executive directors to set executive pay and the shareholders to approve the policy.

Taught in Overview of financial management

Share price and total shareholder return (dividend plus capital gain over the period), and market value added (MVA), the excess of the firm's market value over the capital invested in it (see Valuing ordinary shares, in the chapter on valuation); the most direct measures of the shareholder objective, but affected by market movements the managers do not control.

Taught in Overview of financial management

Customer satisfaction, quality, innovation, employee development and market share, combined with the financial measures in a balanced scorecard, so that managers are not rewarded for a short-term financial result bought at the expense of the drivers of future value.

Taught in Overview of financial management

Residual income charges the division or firm for the capital it uses: profit less a capital charge at the required rate. Economic value added (EVA) is the same idea applied to the whole firm: net operating profit after tax less the weighted average cost of capital times the capital employed, adjusted to remove accounting distortions; a positive EVA means the managers created value above the cost of the funds they used.

Taught in Overview of financial management

To keep the firm solvent so that it can pay wages and provide secure employment, to fund fair remuneration, and to invest in the training and equipment that make their work productive.

Taught in Overview of financial management

To comply with company, tax, competition and sector law, to pay taxes when due and account for the taxes the firm collects as agent (PAYE, VAT), and to provide the returns and disclosures the regulators require.

Taught in Overview of financial management

To honour the firm's contracts, service its debt, and give the counterparties who extend it credit or rely on its products the information they need; a firm that cannot pay its creditors cannot serve its shareholders either.

Taught in Overview of financial management

To maximise the value of their investment, the return earned on the capital they supplied relative to the risk they bear, and to account to them honestly for how it has been used; the finance manager is their agent (see Agency, stakeholders and governance, below).

Taught in Overview of financial management

To conduct the firm's affairs responsibly: paying suppliers on time, not externalising costs onto the environment, and having regard to the community the firm operates in, which section 143 of the Companies Act, 2015 requires directors to consider.

Taught in Overview of financial management