Financial Management in
Southern Africa
6th edition
Johan Marx, Cecilia de Swardt, Marius Pretorius,
Wesley Rosslyn-Smith, Mapolo Belina Morake
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Financial Management in Southern Africa 6e
Maskew Miller Learning (Pty) Ltd
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Contents
Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii
Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .viii
Part 1
Fundamentals of financial management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter 1
The financial goals of a firm. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2
Vision, mission and organisational culture of a firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.3
Business model and strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
1.4
Business strategies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
1.5
Forms of business organisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
1.6
Financial goals: Long-term goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.7
Financial goals: Short-term goals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.8
Functions of a CFO. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
1.9
Competencies required of a CFO of a company listed on the JSE. . . . . . . . . . . . . . . . . . . 18
1.10 Fundamental principles of financial management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
1.11 Overview of the book. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
1.12 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Chapter 2
Financial markets, institutions and securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.2
Flow of funds in an economic system. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.3
Economic environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2.4
Financial markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
2.5
Forms of long-term financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
2.6
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Chapter 3
Understanding financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.2
Users of financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
3.3International Financial Reporting Standards (IFRS) and Generally Accepted
Accounting Principles (GAAP) ������������������������������������������������������������������������������������������� 45
3.4
Classification of financial information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
3.5
Recording changes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
3.6
Summarising. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
3.7
Cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
3.8
Auditors’ report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
3.9
Directors’ report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
3.10 Financial management and accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
3.11 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Chapter 4
Analysing financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
4.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
4.2
Types of comparison. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
4.3
Financial ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
4.4
Profitability ratios. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
4.5
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
4.6
Measures of activity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
4.7
Measures of debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
4.8
Securities market ratios. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
4.9
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
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Chapter 5
Chapter 6
Chapter 7
Chapter 8
Business and financial planning. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
5.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
5.2
Formulating strategies, objectives and goals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
5.3
Risk identification and assessment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
5.4
Operational planning. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
5.5
Budgeting process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
5.6
Responsibility centres. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
5.7
Principles of budgeting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
5.8
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Risk and return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
6.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
6.2
Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
6.3
Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
6.4
Sources of risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
6.5
Measuring risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
6.6
Portfolio risks and return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
6.7
Diversifiable and non-diversifiable risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
6.8
Linking risk and return: Capital asset pricing model (CAPM). . . . . . . . . . . . . . . . . . . . . . 120
6.9
Efficient market hypothesis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
6.10 Arbitrage pricing model (APM). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
6.11 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
The time value of money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
7.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
7.2
Future value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138
7.3
Comparing future value and present value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
7.4
Present value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147
7.5
Variations of future- and present-value techniques. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
7.6
Role of time value of money in financial management. . . . . . . . . . . . . . . . . . . . . . . . . . . 160
7.7
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
Valuation of shares and debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
8.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
8.2
Basic valuation model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
8.3
Valuation of debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
8.4
Valuation of ordinary shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172
8.5
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178
Part 2: Short-term financial management: The management of working capital . . . . . . . . . . . . . . . . . . . . . . . . . 183
Chapter 9
Net working capital and cash flow management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
9.1
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
9.2
Working capital financing policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186
9.3
Sources of short-term financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
9.4
Unsecured sources of short-term financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191
9.5
Management of cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
9.6
Cash and near-cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
9.7
The cost of cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
9.8
The cash flow cycle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
9.9
Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
Chapter 10 The management of accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
10.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
10.2 Establishment of a credit policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
10.3 Follow up on delinquent accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238
10.4 Monitoring control of accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242
10.5 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
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Chapter 11
The management of inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
11.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
11.2 Inventory as an investment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
11.3 Classification of inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
11.4 Inventory valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252
11.5 ABC method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256
11.6 Cost of inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257
11.7 Quantity discounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264
11.8 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265
11.9 Seasonal demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266
11.10 Inventory control systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266
11.11 Monitoring inventory balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
11.12 Preventing inventory losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268
11.13 Alternatives to holding inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
11.14 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Part 3: Long-term financial management: Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275
Chapter 12 Capital budgeting and cash flow principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
12.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
12.2 Capital expenditure motives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
12.3 The capital budgeting process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278
12.4 Project types. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
12.5 Cash flow types. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280
12.6 Relevant cash flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282
12.7 Calculating the initial investment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
12.8 Operating cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286
12.9 Terminal cash flow. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
12.10 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288
Chapter 13 Capital budgeting techniques. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293
13.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293
13.2 Approaches to decision making. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293
13.3 Capital budgeting techniques. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294
13.4 Using a financial calculator. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302
13.5 Comparing techniques. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303
13.6 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305
Chapter 14 Risk adjustments and other refinements to capital budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
14.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
14.2 Approaches to dealing with risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
14.3 Risk adjustment techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315
14.4 Capital budgeting refinements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320
14.5 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325
Part 4: Long-term financial management: Financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327
Chapter 15 The cost of capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329
15.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329
15.2 Assumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329
15.3 Component costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331
15.4 The financing weights (proportions). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337
15.5 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343
Chapter 16 Leverage and capital structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349
16.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349
16.2 Understanding cost behaviour. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350
16.3 Breakeven analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352
16.4 Leverage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356
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Chapter 17
Chapter 18
Chapter 19
16.5 Financial leverage and return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357
16.6 The firm’s capital structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 360
16.7 Financial leverage and return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 362
16.8 Other important considerations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368
16.9 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372
Leasing and convertible securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379
17.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379
17.2 Leasing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380
17.3 Convertible securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388
17.4 Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389
17.5 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393
Dividend policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395
18.1 Fundamentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395
18.2 Forms of dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396
18.3 Factors influencing dividend policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 399
18.4 Contractual constraints. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401
18.5 Dividend policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402
18.6 The relationship between dividend policy and share prices. . . . . . . . . . . . . . . . . . . . . . . 403
18.7 South African research regarding dividends (since 1991). . . . . . . . . . . . . . . . . . . . . . . . 404
18.8 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405
Business rescue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411
19.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411
19.2 Turnaround intervention. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411
19.3 Investigation of the firm’s affairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416
19.4 Chapter review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 428
Solutions to self-test, multiple-choice, integrated questions and critical-thinking exercises . . . . . . . . . . . . . . . . . . . . . . 430
Appendix A: Interest tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480
Table A – Future-value interest factors for R1 compounded at k % for n periods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480
Table B – Future-value interest factors for a R1 annuity compounded at k % for n periods. . . . . . . . . . . . . . . . . . . . . . 481
Table C – Present value interest factors for R1 discounted at k % for n periods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482
Table D – Present-value interest factors for a R1 annuity discounted at k % for n periods. . . . . . . . . . . . . . . . . . . . . . . 483
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484
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Overview
In tough economic times, effective financial management is crucial for the sustainability and profitability of
any business. Now in its sixth edition, Financial Management in Southern Africa provides a concise and up-todate explanation of financial management in the context of Southern Africa.
The book is aimed primarily at undergraduate students of Financial Management, as well as Engineering
students. Students will benefit from the many insights, practical hints and tips which inform sound financial
decision making. It provides comprehensive discussions of how broader issues such as economic conditions
affect the management of working capital, investments and financing.
The sixth edition of Financial Management in Southern Africa offers the reader:
• a user-friendly book in managerial finance for the undergraduate student written from an African
perspective and using South African examples
• visual integration of fundamental concepts in the form of a chapter infographic that gives an overview of
the core framework of each chapter
• extensive use of graphs, tables and mind maps to illustrate and support content
• more than 30 thought-provoking critical-thinking questions to challenge students’ understanding of key
principles, while an expanded bank of self-test questions (approximately 200 multiple-choice, integrated
long questions and short questions) at the end of each chapter provides self-assessment opportunities
• approximately 50 activity boxes to challenge students to apply their knowledge in real-life situations and
to anticipate various management challenges that they may face in practice
• more than 320 key terms assisting students to understand core theory, while approximately 170 examples
provide essential information on key financial management theory and practice
• a larger, user-friendly design and layout encourages an understanding of the fundamental concepts and
techniques of financial management
• lecturer support material, including PowerPoint® slides of the key concepts in the book and an extensive
test bank of assessment questions.
This edition may be used with the Using Financial Calculators for Time-Value-of-Money Calculations, a useful
resource for anyone studying or working in the field of Financial Management.
About the authors
• Professor Johan Marx is a professor in the Department of Finance, Risk Management and Banking at the
•
•
•
•
University of South Africa.
Cecilia de Swardt taught risk management and insurance at the University of South Africa. She
is now retired.
Professor Marius Pretorius is a professor in the Department of Business Management at the
University of Pretoria.
Doctor Wesley Rosslyn-Smith is a senior lecturer in the Department of Business Management at the
University of Pretoria.
Mapolo Belina Morake is a lecturer in the Department of Accountancy at the Vaal University of Technology.
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Preface
Financial Management is one of the key functional areas of the management sciences. Management is both
the art and science of how to succeed in business by formulating and implementing a plausible vision of the
future, an appropriate business model and competitive strategy, supported by the functions of supply chain,
operations, marketing, human resources, ICT and risk management. A scientific approach to management
eliminates guesswork and reduces the risk of failure – and unfortunately business failure seriously impacts
the lives of employees, customers and shareholders (such as the members of pension funds) negatively.
During times of economic growth a firm could expect increased profitability, improved cash flow, more
investment and expansion opportunities, as well as a relatively low cost of capital due to improved business
conditions and reduced risk. However, during economic recessions and times of economic policy uncertainty
created by politicians, firms face the opposite circumstances, which results in the firm having to resort to
austerity measures and finding ways to reduce operating expenses including the retrenchment of employees.
Therefore, economic conditions and policy certainty influence the financial capability of a firm and the finances
of a firm is an enabler of a growth strategy; under circumstances of rapid growth, the finances of a firm could
be a constraint to any proposed strategy. The management of the firm has the responsibility of leading and
governing the firm in a responsible and sustainable fashion under any economic conditions. The successful
management team has to understand the operating environment of the firm and adapt as the plausible future
scenarios unfold. Innovation, sound corporate governance and risk management require constant attention.
Over the long term the firm has to ensure its sustainability by being environmentally sustainable, socially
equitable and economically viable. This requires sound corporate governance so that each member of senior
management has clearly defined roles, responsibilities and boundaries.
Over the short term the marketing management team of a firm has to ensure revenue is maximised, while
all the managers have to limit expenses to the essential and remain within their budget limitations. However,
the finance department needs to ensure suppliers and creditors are paid only once amounts are actually due,
while the debtors department has to ensure outstanding amounts are collected as soon as possible. This way
cash flow is managed.
Financial management is about financial decision making and planning. With the statement of financial
position in mind, the financial manager has to consider which assets will add value to the firm, which have
to be replaced and how these need to be financed. These are referred to as the investment and financing
decisions. And bearing in mind the statement of financial performance, revenue needs to always exceed
expenses. All these decisions need to be future orientated, aligned to the business model and support the
firm’s strategy.
Despite all efforts to manage a firm in a sustainable fashion, some firms do run into financial difficulties.
These may be as a result of changes in government policies and regulations, pandemics, consumer preferences,
new competitors, new technologies, and changes in the suppliers’ terms and conditions of selling to the firm.
Even environmental factors (such as climate change) may influence the sustainability of food producers and
retailers. Management has to attempt turnaround strategies once a firm is under threat, but should these fail,
a firm may have to revert to business rescue.
Financial Management in Southern Africa covers the above and several other fundamental aspects needed in
order to manage a firm successfully. The structure of the book is as follows:
Part 1: Fundamentals of financial management
•
•
•
•
•
•
•
•
Chapter 1: The financial goals of a firm
Chapter 2: Financial markets, institutions and securities
Chapter 3: Understanding financial statements
Chapter 4: Analysing financial statements
Chapter 5: Business and financial planning
Chapter 6: Risk and return
Chapter 7: The time value of money
Chapter 8: Valuation of shares and debentures
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Preface
ix
Part 2: Short-term financial management: The management of working capital
• Chapter 9: Net working capital and cash flow management
• Chapter 10: The management of accounts receivable
• Chapter 11: The management of inventory
Part 3: Long-term financial management: Investments
• Chapter 12: Capital budgeting and cash flow principles
• Chapter 13: Capital budgeting techniques
• Chapter 14: Risk adjustments and other refinements to capital budgeting
Part 4: Long-term financial management: Financing
•
•
•
•
•
Chapter 15: The cost of capital
Chapter 16: Leverage and capital structure
Chapter 17: Leasing and convertible securities
Chapter 18: Dividend policy
Chapter 19: Business rescue
We trust that the sixth edition of Financial Management in Southern Africa will prove to be a useful text
and reference book. The authors welcome any comments and suggestions that could enhance the book.
Johan Marx
Department of Finance, Risk Management and Banking
University of South Africa
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PART I
Fundamentals of financial management
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
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The financial goals of a firm
Financial markets, institutions and securities
Understanding financial statements
Analysing financial statements
Business and financial planning
Risk and return
The time value of money
Valuation of shares and debentures
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2
PART 1 Fundamentals of financial management
OVERVIEW
The financial goals of a firm
Cost leadership
Strategies
Differentiation
Focus
Sole proprietorship
Partnership
Business forms
Co-operatives
Companies
Long-term goals
Earning more than the
required return
Keeping cost
of capital low
The financial
goals of a firm
Profitability
Short-term goals
Liquidity
Solvency
Making investment
decisions
Making financial
decisions
Functions of
a financial manager
Ensuring profitability
Ensuring positive
cash flow
Ensuring solvency
Cost-benefit
Fundamental
principles
Risk-return
Time value of money
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CHAPTER 1 The financial goals of a firm
3
CHAPTER 1
The financial goals of a firm
Learning outcomes
After studying this chapter, you should be able to:
• describe the reasons for the existence of business firms
• explain the need for a vision, mission and organisational culture of a firm
• explain the role of the business model and strategy in managing a firm
• evaluate the various forms of business organisation
• distinguish between the long-term and short-term financial goals of a firm
• relate the functions of a financial manager to the long- and short-term financial goals of a firm
• describe the competencies of a chief financial officer (CFO)
• apply the fundamental principles of financial management.
1.1 Introduction
For every human need, problem or want, there is an opportunity to serve by providing a product or service to
satisfy the need or want or solve the problem. Opportunities for ethical entrepreneurs abound in South Africa.
Business firms exist because they satisfy a human need by providing a product or service. Usually these are
products or services that government departments are not able, nor willing, to provide because they do not have
the expertise or the required financial resources. Government departments exist primarily in order to prepare and
implement legislation and regulations aimed at promoting the public interest, and providing and maintaining
infrastructure (such as roads, airports, ports, electricity, water and sanitisation). Government departments should
provide services only if the business sector does not provide them because such services are not profitable or not
allowed by legislation. Examples of government services are crime prevention by means of policing and border
control; arranging elections and paying social benefits, such as disability grants and old-age pensions.
Human needs may be broadly classified as physiological needs, safety needs, social needs, esteem needs
and self-actualisation needs (Maslow, 1970). The higher-order needs can only be satisfied once the lowerlevel needs have been satisfied. The physiological needs include air, food, drink, clothing, shelter and sleep.
The safety needs include protection, security, order, law and stability. The social needs include the need for
communication, affection, belonging and relationships with family, friends and work colleagues. The esteem
needs include achievement, status, responsibility and reputation. Self-actualisation needs refer to needs for
personal growth (studying) and fulfilment.
These needs could be presented as follows:
Figure 1.1 The hierarchy of human needs
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4
PART 1 Fundamentals of financial management
Activity 1.1
Problems and challenges are opportunities to serve humanity and to improve matters. Some opportunities
are supposed to be the responsibility of politicians, for example, water, electricity and waste disposal by
municipalities. What opportunities exist in your area that could possibly become profitable businesses?
Because consumers have such a wide variety of needs, different incomes and spending patterns, as well as
preferences, businesses must understand their customers well in order to best meet their needs. A firm that
succeeds in satisfying people’s needs will experience customer loyalty, an increase in sales and expansion over
time. However, consumer demands are dynamic and change frequently.
Example 1.1
Apple Incorporated came up with the iPod
and iPhone, which allowed consumers to
buy their music from the iTunes store directly
from their Apple devices over the internet
and to pay by credit card, without having to
leave their offices or homes. Their customers
are now also able to buy only the songs they
like, and not the entire album, when they only
like one or two songs. This innovation, as
well as the Android equivalent, Spotify, and
the streaming of music and movies, became
a major threat to CD and DVD retailers, who
have largely closed down.
1.2 Vision, mission and organisational culture of a firm
Future studies offer alternative visions of what the future could look like. A facilitator may be used during
the strategic planning sessions of the board of directors to design alternative, long-term futures – futures
that are possible, probable and preferable. More than ever before, boards of directors need to consider
resilience, sustainability and their responsibility in re-imagining the use of scarce resources and protecting
the environment, while improving the quality of life of people. Decision making and setting strategy will
have to improve to ensure success instead of failure, responsible investment instead of wasteful expenditure,
and reducing pollution instead of worsening climate change. All of these require a different mindset and
innovation by asking how else? who else? how differently? compared to the status quo.
Definition
Sustainability is the ability of a firm to endure over time because it is environmentally bearable, socially equitable
and economically (financially) viable.
Trends in the social, political, technological and economic forces shaping the future need to be analysed in
arriving at plausible futures. The role of demographics and population growth rates, climate change, energy
shortages, inflation and the role of technology in limiting inflation need to be considered. This is a challenging
exercise for the leadership of the firm amid increasing volatility, complexity, uncertainty and ambiguity.
Thinking about the future creates foresight, which is vital in designing a better world. Top management
needs to realise and appreciate that there is never just ‘one future’, but multiple futures to consider. Once
top management has clarity about its vision for the firm’s preferred future, it needs to capture it in its
vision statement.
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Vision
A firm’s vision is usually determined by the board of directors of a firm under the leadership of its chairperson
and the chief executive officer (CEO) and captured in its vision statement. The vision statement is a brief
description of what the firm should look like in the future, which sets the direction for the firm’s planning and
implementation of its strategy. However, the vision of a firm must not be a pipe dream of the chairperson
and CEO of a company. The vision must be formulated based on the art and science of future studies.
Definition
Leadership is the ability of an individual or group to inspire others to be effective and efficient in achieving a
long-term vision through responsible investment, innovation and taking initiative.
Definition
Vision statement is a brief description of what the firm should look like in the future, which sets the direction for
the firm’s planning and implementation of its strategy.
Definition
Strategy is a plan of action designed to achieve a long-term goal, aim or objective.
Mission statement
The reason for the existence of a business also needs to be described in its mission statement. A mission
statement justifies the reason for a firm’s existence and provides stakeholders with a clear indication of the
core business of the firm.
Definition
Mission statement, in the business context, defines what line of business a firm is in, why it exists or what
purpose it serves.
Organisational culture
A firm that wishes to succeed needs to establish a healthy organisational culture. This is important
because there is a correlation between organisational culture and the performance of firms. A healthy
organisational culture enables organisations to adapt and thrive on change, while unhealthy cultures lead to
underperformance of firms and ultimately their demise (Dewar, 2018).
Definition
Organisational culture refers to the common set of behaviours, mindsets and beliefs that shape how people
work and interact, which determines employee engagement, productivity and company success.
The following characteristics can be found in a healthy organisational culture:
• Employees align themselves with the firm’s vision, mission and goals.
• There is open communication between employers and employees.
• Elite employees are successfully recruited and retained.
• A healthy culture can be cultivated by aligning a company’s culture with its values.
• Top management demonstrates and practices the values and culture (lead by example).
• Management recognises and rewards employee contributions.
• It intentionally considers culture during the recruitment and appointment of new staff members.
• It emphasises professional development and learning (Masterclass, 2022).
Organisational culture is a strong enough force in any organisation that it can prevent a strategy from
being fully realised, and, according to Guley and Reznik (2019), culture eats strategy for breakfast and
transformation for lunch.
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1.3 Business model and strategy
Starting up and managing a firm requires a solid business model. A business model focuses on the value
proposition for the customer and the business. Customers need value for money and a product or service that
will meet their needs or solve one of their problems at an affordable price. The firm, on the other hand, needs
to be able to provide the product or service at a price that will generate adequate profit and cash flows needed
to sustain the firm. From a marketing perspective, the business model requires that the firm must have
clarity about which market segments to serve, which channels to use and how customer relationships will be
managed. From an operational point of view, the firm has to decide what key activities need to be performed,
what key partnerships to enter into, and what key resources are needed. From a financial point of view, the
business model must take the firm’s cost structure and revenues, as well as cash flow, into account; in other
words, to ensure the firm will be profitable and be able to maintain liquidity.
Definition
A business model is a conceptual structure of the core aspects that needs to ensure the viability and financial
sustainability of a firm. It considers the value proposition, the key activities, key partnerships, key resources,
customer segments and how customer relationships and channels of communication will be used, the cost
structure of the firm, and how revenue and cash flows will be generated.
Definition
Partnership is a form of business organisation where two (maximum twenty), partners jointly invest in a firm.
They share the risk, but also have to share the profit with one another.
Figure 1.2 shows a more detailed presentation of the above-mentioned components of the business model:
Key
partnerships
Key activities
Customer relationships
Value proposition
Key resources
Channels
Cost structure
Revenue and cash flow streams
Customer
segments
Figure 1.2 The business model
A firm operates within the parameters of an industry with the associated threat of competition. According
to Porter (1980), the operating environment contains five main competitive forces, namely rivalry within an
industry, the bargaining power of suppliers, the bargaining power of clients, the threat of new entrants, and
the threat of new technology. This is illustrated in Figure 1.3 below.
Definition
Competitive forces occur in environments where there is rivalry among firms within each industry, threats of new
entrants and new technologies, and both suppliers and clients who have bargaining power.
Threat of new entrants
Bargaining power
of suppliers
Rivalry within an industry
THE FIRM
Bargaining power
of clients
Threat of new technology
Figure 1.3 Competitive forces
Source: Marx, J., Ngwenya, M.S. & Grebe, G.P. 2020. Finance for non-financial managers (ital). 3rd revised ed. Pretoria: Van Schaik.
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A firm also operates within the confines of the national economy and other legal constraints, such as the
statutes (laws) of the country.
The economy expands and contracts as economic activity increases or decreases. Periods of rapid growth
are followed by periods of economic decline.
Periods of economic growth are characterised in the following ways:
• Interest rates decline.
• Consumers are optimistic about the future as their disposable income increases.
• They buy more goods and services (especially on credit).
• Government is able to reduce taxes and more businesses open up.
• Job opportunities increase.
• Firms experience increases in both cash and credit sales, as well as profits.
• There are also increases in the number of building projects for shopping malls, industrial parks and
residential homes.
However, during periods of economic decline, the following happens:
• Interest rates start increasing.
• Consumers become pessimistic about their future.
• People lose their jobs.
• The government has to increase taxes.
• Consumers postpone any purchases for as long as possible because their disposable income is declining.
• Firms experience a decline in sales and profitability and bad debt increases.
Should there be two quarters in succession that economic growth (measured by gross domestic product or
GDP) declines, then economists refer to it as a recession.
Successfully managing a firm in a competitive environment requires a strategy that will provide a
sustainable competitive advantage. This can be achieved by means of one of three generic strategies, namely:
• cost leadership
• differentiation
• focus strategy.
Definition
Profitability is the extent to which revenue from sales exceeds the cost of goods sold, operating expenses,
interest and taxes.
Cost leadership
A cost leadership strategy means a firm manufactures or buys and sells standard products at low cost to
the broad market at the lowest possible price. Such a firm must be able to do so at a lower price than its
competitors because the consumer is cost-conscious or price sensitive. Firms that follow such a strategy must
have economies of scale. Economies of scale are the advantages that big firms have over smaller ones because
they can spread their fixed costs over a larger number of units. Big firms also need to be well experienced
and invest heavily in equipment that will enable them to produce at a low cost per unit. The big investment
in equipment also discourages new competitors from entering the same market. The firm must also keep
its costs within reasonable limits by exercising a degree of control over its supply chain by pressurising
suppliers for lower prices or quantity discounts, by using just-in-time to avoid carrying inventory themselves,
or by using backward integration. Examples of firms using a cost leadership strategy include McDonald’s,
Amazon and BIC pens.
Differentiation
A differentiation strategy means the firm provides a product different from the standard product by adding
some unique features and qualities, but charges a price higher than other suppliers. Clearly, this can only
be successful if customers are not price sensitive. Alternatively, a differentiation strategy may be employed
if the market is saturated or customers have specific needs that are not fully met by other suppliers.
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The firm then has to ensure it has features that are difficult to copy and needs to use trademarks, copyright
and patents effectively. Examples of firms that use differentiation strategies are Nike and Canterbury.
Focus
The focus strategy requires that a firm uses either its cost leadership strategy or its differentiation strategy in
only a few target markets with specialised needs. With a focus strategy, a firm should target markets where
substitutes are unlikely, and competition is weak in order to earn an above-average return on investment. An
example would be the no-name brands of some retailers.
Activity 1.2
Use Google to find the website of any of the companies listed on the Johannesburg Stock Exchange (JSE).
Find a copy of their latest annual report and see if you can find their mission statement and more details
about their strategy.
Managing the growth of the firm
Since consumer needs become satisfied at some stage (except for food, drink and clothing), any product has
a typical life cycle.
This could be illustrated as follows:
Sales
Saturation
Maturity
Decline
Growth
Introduction
R&D
Time
Figure 1.4 A typical life cycle of products
A firm may similarly grow over time. Such growth may take place either organically, or by means of mergers
and acquisitions (M&A).
Organic growth would involve the firm increasing its operations due to an increase in market share. This
is known as market penetration and would involve starting up more facilities (for example, more factories or
more retail stores). Market share is the percentage of sales achieved in a market by each of the firms involved.
An example might be Capitec Bank, which achieved a market share of 20% of all revenue generated from
services provided by South African banks.
Alternatively, a firm could grow by taking over other firms (acquisitions) or by merging with similar firms
in order to increase its market share as a result of removing a competitor.
Other ways of achieving growth are by means of market expansion, product expansion or diversification.
Market expansion involves marketing the firm’s products in new markets. Another option would be to
increase its product line(s) by introducing more products or services – this is also known as product expansion.
A riskier strategy would be to introduce new products to new markets, also known as diversification.
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It is riskier because the management might not fully appreciate the characteristics of such new products or
services, such as how these have to be transported and stored, or the management may not fully understand
the needs of the consumers in these new markets and how price sensitive they are, or not.
The management of a firm thus must be very aware of events in their operating environment.
Operating environment of the firm
No firm operates in a vacuum. Instead, it operates, as a
producer or retailer of goods or services.
Some firms market to the end consumer (such as
Pick n Pay), whilst others market to other business
firms in what is known as Business to Business (B2B)
marketing. Examples of B2B would be Xerox, which
rents out their copiers to other firms, and suppliers of
components to vehicle manufacturers – say, Bridgestone
supplying a vehicle manufacturer with tyres.
As mentioned earlier, all firms operate within legal
constraints and are subject to a variety of laws. These
range from the Basic Conditions of Employment Act
(Act 75 of 1997), to the Occupational Health and
Safety Act (Act 85 of 1993), the Companies Act (Act 71
of 2008), the Competition Act (Act 89 of 1998), the
Broad-based Black Economic Empowerment Act Figure 1.5 Supplying a vehicle manufacturer with tyres
(Act 53 of 2003) and the Tax Administration Act (Act 28 of 2011), to name but a few. South Africa had 557
national statutes by November 2022. The cost of compliance with legislation in South Africa is substantial
and discourages investors from starting new businesses in South Africa. Many firms prefer to locate in
neighbouring countries such as Botswana and Namibia.
From a financial point of view, the financial institutions and markets in the operating environment are
significant. Financial institutions lend money to firms needing finance and provide investment services to
those who have surplus funds available.
A financial institution may be defined simply as the intermediary or agent who channels funds from the
savings of investors to invest in either financial assets (such as shares or bonds) or real assets (such as office
blocks or industrial parks).
Financial institutions include banks, insurance companies, pension funds, stockbrokers and investment
companies.
Definition
Companies are legal or juristic persons brought into being by complying with the Companies Act (Act 71 of
2008). Companies are financed by selling shares to investors (such as retirement funds) and borrowing the
balance of the finance needed. There are two types of companies namely, private companies and public
companies.
Financial markets provide a forum in which suppliers of funds and borrowers of funds may directly negotiate
and transact their business with one another. The two key financial markets are the money market and the
capital market. In both markets, there is a primary and a secondary sector. The primary sector deals only in
new securities (such as shares, and bonds issued for the first time). The secondary market trades only existing
securities (for example the shares of companies that have been listed on the JSE for some time).
The financial market is not necessarily a physical place. Essentially it involves buyers and sellers who
contact one another in order to do business (buy and sell), either telephonically or via the internet. Financial
institutions participate in the financial markets on behalf of lenders and borrowers.
Financial markets are divided into two main categories, namely:
• the money market
• the capital market.
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Money market
The money market deals only in short-term funds, also referred to as marketable securities, with a maturity
or life span of three years or less. The South African Reserve Bank acts as the lender of last resort in
the money market.
Capital market
The capital market, on the other hand, deals in long-term funds, from three years and longer. In practice,
funds flow back and forth between the two markets. Some institutions even serve both markets.
A significant feature of the South African capital market is the Johannesburg Stock Exchange (JSE).
The basic functions of the JSE include the following:
• raising finance for public companies listed or wishing to list on the JSE by facilitating the trading of the
company’s shares
• providing a market for listed securities
• affording protection to investors by enforcing the rules and regulations of the Stock Exchanges Control Act
(Act 40 of 2001).
Figure 1.6 The offices of the Johannesburg Stock Exchange (JSE)
While the banking sector may be regarded as the primary source of funds for the money market, the following
financial institutions may similarly be regarded as primary sources of funds for the capital market:
• short- and long-term insurers (for example Santam and Old Mutual respectively)
• pension and provident funds (for example the Government Employees Pension Fund (GEPF))
• collective investment schemes (sometimes also called unit trusts)
• the Public Investment Commission (PIC)
• the JSE (as mentioned earlier).
From the above, you can see that the financial markets facilitate the trading of funds between the suppliers
and borrowers of funds. The significance of this is that their actions influence the cost of financing, such as
interest rates. This has important implications for firms using loans to partially finance the firm. (This will
be discussed in greater detail in Chapter 15 The cost of capital.)
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Ensuring sustainability – governance, internal control and risk management
Sustainability is the ability to endure and involves the environmental, economic (financial) and social aspects
of a firm. This is illustrated in Figure 1.7.
Sustainability requires that the firm must be socially equitable, environmentally bearable and economically
(financially) viable. This is also known as the so-called triple bottom line, meaning the management of a
firm must care for people (customers and employees), the planet and profit. One should not be used at the
expense of the other, but need to be managed in a responsible and ethical manner. Sustainability, therefore,
requires sound governance and risk management.
Definition
Governance is the way responsibilities and roles are allocated to the top management of a firm, including the
chairperson of the board, the board, sub-committees of the board, chief executives, the audit committee and
non-executive directors.
PEOPLE
Social variables dealing with
community, education, equity,
social resources, health, wellbeing and quality of life
BEARABLE
PLANET
Environmental variables
relating to natural resources,
water and air quality, energy
conservation, and land use
EQUITABLE
Environmental variables
relating to natural
SUSTAINABLE
resources, water and
air quality, energy
conservation, and land PROFIT
use
Economic variables
VIABLE
dealing with the bottom
line, cash flow
Figure 1.7 The key elements of sustainability
Source: https://www.smartkarma.com/home/daily-briefs/brief-multi-strategy-sustainability-esg-frameworks-sdgs-unsustainable-development-goals-and-more/
In a small firm, the owner is also the manager of such a firm. The owner-manager will pursue the goal of wealth
maximisation and act in their own best interest in order to protect the capital they invested as best possible.
However, in larger firms, such as public companies, ownership is spread over a number of shareholders.
The dispersion of ownership means that employees and managers have to act on behalf of owners.
The managers may not necessarily act in the best interests of the shareholders, creating a possibility of
conflict of interest between the principal (the owners or shareholders) and the agents (managers).
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Such a conflict is called an agency problem. Directors who fail to discharge their duties may face prosecution
and be declared delinquent directors in terms of section 162 of the Companies Act of 2008. A director found
guilty of gross negligence, wilful misconduct or breach of trust in relation to the performance of their director’s
duties, or a director who uses their position to gain an advantage for themself or for another person, other
than the company or a wholly-owned subsidiary of the company; or knowingly causes harm to the company
or a subsidiary of the company, could be declared delinquent. Companies may also claim damages from any
delinquent director for losses incurred by the company as a result of such a director’s conduct (Levenstein, 2013).
Definition
Agency problem is the separation between managers and owners, resulting in costs to control the behaviour of
managers, yet providing benefits and incentives so that managers act the way shareholders expect them to act.
The agency problem results in costs, such as the cost of lost business opportunities if directors are too riskaverse, the cost of benefits and incentives payable to directors and managers, and the cost of preventative
measures, such as monitoring management actions and auditing financial statements. The agency problem
requires that firms clearly define the roles of management and implement an incentive scheme to ensure that
goals are achieved. Sound governance remains the key to ensuring a sustainable business.
Governance is the way responsibilities and roles are allocated to the top management of a firm, including
the chairperson of the board, the board of directors, sub-committees of the board, chief executives, audit
committee and non-executive directors. These roles are described by the King report (visit the website of the
Institute of Directors (IOD) for more details at https://www.iodsa.co.za/ ).
The top management of a firm consists of the chairperson of the board of directors, a chief executive officer
(CEO), the chief operations officer (COO), the chief information officer (CIO), and the chief financial officer
(CFO). These executive officers report to a board of directors, who have been elected by the shareholders of
the firm at the annual general meeting (AGM) to represent their interests and ensure the firm is managed in
a responsible and sustainable manner.
The board of directors normally include a few non-executive directors (NEDs). The role of the nonexecutive directors is to provide general counsel, and additional perspective and to serve in some of the
various sub-committees of the board, for example, the remuneration and benefits committee, the risk
management committee and the audit committee. The NEDs are not involved in the day-to-day management
of the firm like the CEO, COO, CIO, CFO and managers at the middle and operational levels of the firm. The
contribution a non-executive director brings is independence, impartiality, experience, specialised knowledge
and personal qualities (IOD, 2022). Personal qualities could include aspects such as competitive intelligence,
ethics, values and norms.
All firms must have internal controls in place, consisting of preventative, detective and corrective
controls. Internal controls are the rules, procedures and mechanisms to promote accountability, prevent
fraud and corruption, and ensure the integrity of their financial and accounting information. Such internal
control needs to assist in achieving the goals and objectives of the firm, help protect the assets of the firm,
promote effective and efficient operations and ensure compliance with laws and regulations. One of the
key preventative controls of any firm is managing the risk of the firm. During the process of planning a
strategy, the management must consider the risks (both opportunities and threats) they shall face during the
implementation of their strategy.
Risk management requires that:
• risks be identified and analysed
• possible ways of mitigation be formulated
• decisions be made as to whether the residual risks will be treated, tolerated, the financial consequences
transferred (by means of outsourcing or insurance) or terminated.
The top management must decide about the firm’s risk appetite. According to Perrin (2009) risk appetite is ‘the
amount of total risk exposure that an organisation is willing to accept or retain based on risk–reward trade-offs:
• reflective of strategy, risk strategies and stakeholder expectations
• set and endorsed by the board of directors through discussions with management’.
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1.4 Business strategies
From a financial management perspective, the key to financial success and sustainability is to have sufficient
financing. The saying ‘you need money to make money’ remains true.
In a small business, the owner(s) may use their hard-earned savings to partially finance the firm, along
with loans or leasing arrangements they have entered. The owner’s or owners’ contribution is referred to as
owners’ equity. Normally, owners’ equity is not sufficient, and a part of the total finance has to be obtained by
borrowing funds. Borrowed funds (loans) must be repaid by means of regular instalments. These instalments
consist of interest and capital payments. Should the business firm not be able to repay these instalments,
and should turnaround strategies and business rescue plans not succeed, the firm becomes economically
unsustainable and could be declared insolvent.
Not all businesses will grow from being small businesses to corporate businesses. Some types of firms
remain small businesses from their inception to their termination. Examples of these may be found in the
services industry, for example, hairdressers, spaza shops and spas. Some may grow should they decide to
franchise their operations.
Franchising is an arrangement where one party (the franchiser) grants another party (the franchisee) the
right to use its trademark or trade name, as well as certain business systems and processes, to produce and
market a good or service according to certain specifications. The franchisee usually pays a one-time franchise
fee plus a percentage of sales revenue as royalty, and gains:
1. immediate name recognition
2. tried and tested products
3. standard building design and décor
4. detailed techniques in running and promoting the business
5. training of employees
6. ongoing help in promoting and upgrading of the products.
However, some types of firms need to operate as corporate firms from the outset. Examples are in the mining,
manufacturing and transport industries. An example is the Gautrain, which is a so-called public-private
partnership (PPP) because it is operated by private companies in conjunction with government departments,
such as the Gauteng Provincial Government.
The type of business and the amount of financing plays a significant role in deciding what form of business
organisation needs to be used.
1.5 Forms of business organisation
In-depth knowledge of the forms of business organisation may be gained by studying commercial and
company law. This section will only briefly describe the forms of business organisation.
One thing common to all forms of business organisation is the accounting perspective. Any business is
regarded as an accounting entity separate from its owner(s). This will be explained in greater detail in Chapter 3.
A firm may be organised as a sole proprietorship, partnership, co-operative or company. However, the form
of organisation may change depending on changes in the environment or its business model. Some firms may
start as a sole proprietorship, but may have to become a partnership or company depending on their growth over
time, their need for certain expertise or financing required. Some firms listed on a stock exchange may decide to
delist from the exchange if the cost of administration and compliance with regulations becomes too cumbersome.
Takeovers and mergers may also lead to changes in business names and their form of business organisation.
Definition
Sole proprietorship is a firm owned by one person who accepts all the risk, but may also enjoy all the profit.
Definition
Co-operative is a form of business organisation consisting of at least five persons pooling their resources to
pursue their common interest in community development and to become more self-reliant.
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Sole proprietorship
The sole proprietorship is sometimes also referred to as the ‘one-person business’ or ‘sole trader’.
In the case of a sole proprietorship, one person accepts all the risk. However, the owners and management
of a business enterprise are not necessarily the same people. In some cases, the magnitude of the business
requires the appointment of managers to act on behalf of the owners. It may also require the involvement of
partners who are prepared to contribute some of the financing. The legal relationship between the various
partners to the business firm may be achieved by setting up some form of business organisation.
Some of the advantages of a sole proprietorship are that the owner has full control over the firm and the
strategy employed and has all the profit for themself. It is relatively easy and cheap to set up the firm, and no
memorandum of incorporation (MOI), reservation of name and formal registration with the Companies and
Intellectual Properties Commission of SA (a unit of the Department of Trade & Industry (DTI) are required
as is the case for companies.
Some of the disadvantages are that the owner is solely responsible for the management of the firm and
they must have good technical, marketing, labour relations and human resource management, administrative
and financial management skills themself. Very few individuals have all these skills. The owner of a sole
proprietorship is fully liable for all of the debts of the business and could therefore lose all of their personal
assets (home, furniture, vehicle and cash) in the event of the business failing. The business is not a separate
tax entity, and the owner pays tax on the profits of the business, even if they do not receive these profits in
cash. The life of the firm is only as long as the life of the owner, in other words, there is no continuity once
the owner steps down or passes on.
Partnership
The form of business organisation in which more than one owner is involved may be either a partnership
or a company.
In a partnership, the business is owned by two or more people who have a private agreement between
themselves as to how the business should be run. A partnership is restricted to a maximum of 20 people,
except in the case of certain professions, such as architects, attorneys, notaries and conveyancers, accountants
and professional engineers.
They share the profits and losses (or liabilities) of the firm. Ideally, the contribution of each of the partners
should be complementary, whether it is technical know-how, capital or equipment that the other partner does
not possess. A written partnership agreement is advisable, especially if one considers that the partners will
not live forever and friendships do change over time – once the partnership needs to dissolve, a partnership
agreement will assist in dissolving the firm amicably. An advantage of a partnership is that it requires less
administration at the establishment than a company.
Some of the disadvantages are that a partnership is not a separate legal entity. It cannot sue or be sued,
and the partners are jointly and severally liable for all the debts of the partnership business. Partners are also
liable for income tax on their share of the profit of the partnership business. There is a lack of continuity,
because the partnership is terminated on the death or insolvency of any one of the partners, and a new
partnership must be formed.
Co-operatives
A co-operative may be established once a formation meeting of at least five persons has been held in
order to agree on the establishment of such a co-operative to pursue their common interest in community
development. In South Africa, co-operatives are encouraged among disadvantaged, marginalised and
vulnerable communities with limited resources in order to assist them in becoming more self-reliant.
Co-operatives are registered by the Companies and Intellectual Properties Commission of SA (CIPC).
A co-operative must have a constitution that spells out the rules of how the co-operative will be structured
and managed, including membership, the AGM, the board of directors and other managerial rules.
A co-operative yields a surplus (similar to profits in other forms of business organisation) and the members
of the co-operative may share in the surpluses, if any. Co-operatives are treated the same as companies when
it comes to taxes.
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Companies
Companies are legal or juristic persons brought into being by complying with enabling legislation, that is,
the Companies Act (Act 71 of 2008). There are two types of companies – private companies and public
companies. The information on companies has been updated to accommodate the changes made in the
Companies Amendment Act 3 of 2011.
For a company, a memorandum of incorporation (MOI), reservation of name and formal registration with
the Companies and Intellectual Properties Commission of SA (CIPC) are required.
Private companies are identifiable to outsiders by the words ‘(Proprietary) Limited’ following the name of
the company – more commonly abbreviated to ‘(Pty) Ltd’.
Public companies are identifiable to outsiders by the word ‘Limited’ following the name of the company –
more commonly abbreviated to ‘Ltd’. Note that not all public companies are listed on the Johannesburg Stock
Exchange (JSE). While it is necessary for a company to be a public company to obtain a listing, it must, in
addition, comply with the listing requirements of the JSE.
Activity 1.3
Visit the website of the JSE at www.jse.co.za and see if you can find the requirements in order to be listed on
the stock exchange.
The essential differences between private and public companies are that a private company may have from
one to fifty shareholders, whereas the minimum for a public company is seven shareholders, and there is
no maximum. Furthermore, a private company must have at least one director, and a public company a
minimum of two.
Another important difference between private and public companies is that the private company’s articles
(part of its founding documents which set rules and restrictions for the legal conduct of the company) must
restrict the transferability of its shares. This means that the private company must prohibit any offer to the
public at large inviting them to subscribe to any shares of the company.
The right to the transfer of shares in a public company is not restricted, and the public may be invited
to subscribe to the shares of the company. The reporting requirements of private and public companies are
also different. The financial statements of a private company need only be made available to shareholders
and directors, or people determined by them, for example managers in the firm or bank managers. A public
company is obliged to lodge a certified copy of its annual financial statements with the Registrar of
Companies. It must also send its members (shareholders) half-yearly interim reports and audited annual
financial statements.
There are other differences, but a full discussion of them falls beyond the scope of this chapter.
The main advantage of a limited liability company is that it sets a legal limit to the liability of its members
(shareholders). This limited liability may be reduced by personal guarantees for certain debts of the company.
Another advantage is continuity, because the shares may be transferred to other investors should a shareholder
wish to discontinue their involvement with the company, without the company being affected by the change
in ownership of the shares. The company is taxed separately from the shareholders (the owners). At the time
of writing, companies’ profits were taxed at 27%. However, tax rates may be adjusted by the Minister of
Finance on an annual basis during their budget speech, if necessary.
The administrative procedure is more complex than in other forms of ownership, which leads to higher costs.
Since the size, organisational structures and forms of business organisation vary, it is not possible to
describe the role of a financial manager in a manner that would be universally applicable to all firms. However,
if the role of financial management is assessed from the viewpoint of the financial goals of the business firm,
a few common aspects should become evident.
Activity 1.4
If you wanted to start a firm in your suburb in order to serve the community with a product or service, what
form of business organisation would you need to use? Why?
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PART 1 Fundamentals of financial management
1.6 Financial goals: Long-term goals
The medium-term to long-term financial goal should be to increase the value of the firm, by increasing
the wealth of the owners. This may be done by investing in assets that will add value to the firm, keeping
the firm’s cost of capital as low as possible, but balancing the environmental, social and economic
sustainability of the firm.
Investing in assets
A firm must invest in both non-current assets and current assets.
Non-current assets include buildings, equipment, and vehicles. No firm can operate without such assets,
which are used until they need to be replaced, and hence are classified as non-current assets. Sometimes they
are also called fixed assets. The cost of using such assets cannot be charged against the income of the firm in one
year and need to be charged as depreciation against the revenue over their useful life.
A firm also needs current assets, such as cash and stock. Some firms must sell their goods on credit, and
debtors (accounts receivable) then also become a current asset. These assets are for operational purposes
and the firm must use such assets productively to achieve an acceptable return to remain financially viable
(sustainability).
Keeping cost of capital low
A firm can only remain financially sustainable if it controls its expenditure.
The cost for using borrowed funds is interest. Any loan is a debt (liability) that requires that the loan be
paid off over the period agreed to between the firm and the creditor, along with interest.
Ordinary shareholders equally need to be compensated with dividends on their investment.
Since a firm uses both debt and equity finance, it has to keep both these costs under control by attempting
to keep them as low as possible.
1.7 Financial goals: Short-term goals
The short-term financial goal should be to ensure the profitability, liquidity and solvency of the firm. (Short
term is regarded as periods of up to 12 months. Medium term may be regarded as periods ranging between 12
to 24 months, while long term is regarded as periods of three years and longer.)
Definition
Liquidity is the ability of the firm to satisfy (pay) its debts (liabilities) as they become due for settlement.
Definition
Solvency is the extent to which assets exceed liabilities.
Profitability
Profitability is the firm’s ability to generate revenues in excess of total costs using the firm’s assets productively.
It may be achieved by marketing products or services to include a sufficient profit margin with the support
of promotion at competitive prices to appropriate target markets through appropriate distribution channels.
Liquidity
Liquidity is the firm’s ability to satisfy its short-term obligations as they become due. Management may
achieve the short-term financial goal of liquidity by:
• accelerating cash flows from accounts receivable (debtors)
• delaying cash flows by paying creditors (accounts payable) as late as possible without damaging the firm’s
credit record and relations with suppliers
• not over-investing in inventory (stock) and by stocking a range of products that is in demand and will
turn over rapidly.
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Solvency
Solvency is the extent to which the firm’s assets exceed its liabilities. Solvency differs from liquidity. Liquidity
relates to the settlement of short-term liabilities, while solvency relates to the excess of total assets over
total liabilities.
Some believe that the owners’ objective is to maximise profit, while others believe it is to maximise
wealth. From a financial management point of view, the goal is to maximise the shareholders’ wealth.
Wealth maximisation is preferred to profit maximisation for several reasons. The following three reasons are
generally agreed on:
1. Shareholders expect to receive a return in the form of periodic cash dividend payments and of increases
in the value of their shares (in the case of a company). The market price of a company’s shares reflects a
perceived value of expected future dividends, as well as of actual current dividends. If a shareholder in
a company wishes to sell the shares, he or she will have to do so at or near the prevailing market price.
Since it is the market price of the share that reflects an owner’s (shareholder’s) wealth in a firm at any
time, the financial manager’s goal should be to maximise the market price of the shares, and thus the
shareholder’s wealth.
2. Profit maximisation is a short‑term approach, while wealth maximisation is based on long‑term prospects.
A firm wishing to maximise profits could use low-quality materials in products while making a strong
sales effort to market its product or services at a price that yields a high profit per unit. This short‑term
strategy could result in high profits for a short while, but sales might decline significantly once clients
discover the poor quality of the product or service. An example of this can be seen in Example 1.2.
3. Profit maximisation does not take risk into consideration, whereas differences in risk receive high priority
when evaluating alternative investments in the case of a wealth‑maximisation approach. A basic premise
of financial management is that there is a trade‑off between risk and return: shareholders expect to receive
higher returns from higher risk investments, and vice versa. Financial managers should therefore consider
risk from their respective viewpoints when evaluating potential investments.
Example 1.2
JM Construction (Pty) Ltd may
have won a state tender in order to
construct 500 homes in the Bakubung
area near Rustenburg. A government
official is insisting on getting a bribe
of R200 000. The owner of the
construction firm decides to paint the
houses with only one coat of paint
in order to save R300 000. Will this
building contractor survive for long?
If not, why not?
1.8 Functions of a CFO
A CFO’s function may be evaluated in terms of the firm’s financial goals. They have the following
primary functions:
Making investment decisions
In making investment decisions, the CFO must determine the cost-effectiveness of the assets on the firm’s
balance sheet. The CFO must attempt to maintain certain optimal levels of each type of current asset (cash,
stock and accounts receivable) and also decide which are the best non-current assets (for example buildings,
equipment and vehicles) to acquire and know when existing non-current assets may require maintenance,
modification or replacement.
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PART 1 Fundamentals of financial management
Making financing decisions
Making financing decisions concerns the right‑hand side of the balance sheet. Two major decisions must be
made about the firm’s financial structure, namely:
• the most appropriate mix of short‑term and long‑term financing
• determining which individual short‑term or long‑term sources of financing are best at a given point.
Some of these decisions are dictated by necessity, but some require an in‑depth analysis of the available
alternatives, their cost and their long‑term implications as part of financial planning. The key financing
decision is always to keep the cost of capital as low as possible.
Ensuring profitability
Profitability is the extent to which the revenue from sales exceeds the expenses of the firm, including the cost
of goods sold, operating expenses, interest paid and taxes. It is therefore crucial that the marketing department
achieve the greatest possible sales for the firm, and that the management accounting department manage
expenses in a conservative fashion by ensuring that all expenditure is controlled and limited to the essential.
Ensuring positive cash flow
The treasury department must attempt at all times to ensure cash inflow exceeds cash outflow, or that the
timing of cash outflows occur at a time when the firm is expecting cash inflows that will occur prior to such cash
outflows. The use of a cash budget to estimate these cash inflows and outflows is an essential tool in this regard.
Ensuring solvency
Solvency is the extent to which the value of the firm’s assets exceeds the debts (liabilities) of a firm. A firm
that succeeds in maintaining its profitability and liquidity need not be concerned about its solvency. However,
once profitability suffers and liquidity requires that the firm borrow more funds until its liabilities start
exceeding the assets, solvency becomes a concern because debtors may start insisting on the repayment of
debts due to them or even apply to the court for the firm to be declared insolvent, which could mean the
end of the firm.
1.9 Competencies required of a CFO of a company listed on the JSE
Competency is a combination of knowledge, skills, values, attitude and attributes. The following are some of
the core competencies a CFO must have:
Knowledge
The Companies Act (Act 71 of 2008) requires that the CFO of a listed company in South Africa must be a
chartered accountant (CA). To become a chartered accountant, you need to complete a BCompt degree, a
Hons BCompt degree, the Certificate in the Theory of Accounting (CTA), complete a learnership programme
over a two-year period, and pass the two final professional examinations administered by the South African
Institute of Chartered Accountants (SAICA).
Skills
A CFO must have good mathematical skills, interpersonal skills, communication skills, negotiation and
computer skills. In addition, they need to possess analytical and problem-solving skills, strategic thinking, as
well as risk management, time management and organisational skills.
Values
A CFO must be professional, have integrity, be highly responsible, trustworthy and objective. They must
respect the confidentiality of information they work with. A CFO should not be compromised by bias, conflict
of interest, or undue influence by others, in other words a CFO must not display any interest in corruption,
fraud or theft. A CFO found guilty of being a delinquent director may be stripped of their designation as a
chartered accountant (CA) and face prosecution by the National Prosecution Authority (NPA).
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Attitude
A CFO must be disciplined and needs to have a good work ethic, be committed, adaptable to new technologies
and be self-motivated.
Attributes
A CFO needs to have extensive experience and business acumen in order to assist in sound decision making.
1.10 Fundamental principles of financial management
The management of a firm’s assets is not exclusively in the hands of a CFO. The other functional departments,
especially the procurement and marketing departments, play a significant role in determining inventory
(stock) levels, for example. It is important for the procurement, marketing and financial departments to
co‑operate to ensure that optimum inventory levels are maintained. Inventory represents an investment of a
portion of the firm’s available funds and should be managed judiciously.
All functional departments in the business firm, such as procurement, operations and marketing devote
their energy to the achievement of the firm’s goals. Since most business decisions are measured in financial
terms, people in all the functional departments are, to a greater or lesser extent, involved in the financial
decision making of the firm. It is therefore important for them to have an understanding of the following
principles of financial management and apply them vigorously.
Cost–benefit
Decision making, which is based on the cost of resources only, will not necessarily lead to the most economic
utilisation of resources. Sound financial decision making requires making an analysis of the total cost and the
total benefits. As far as possible, the benefits should be greater than the cost of any decision.
The cost–benefit principle may be used by means of the following steps:
• Obtain clarity about the objective to be attained.
• Identify alternative ways in which the objective may be attained.
• Calculate the cost and benefits of each of the alternatives.
• Determine the effectiveness of the benefits of each alternative.
• Decide on a criterion or standard to be used against which the acceptability of an alternative may be weighed.
• Take a decision about the most appropriate course of action. This step may have to be preceded by
consultation in situations where there is enough time available to do so and where certain members of
staff have relevant expertise, or if they will be affected by or involved in the implementation of a decision.
Definition
Cost–benefit principle requires that the cost (disadvantages) and the benefits (profit) are determined in any
decision in order to decide if it is worth proceeding.
Risk–return
Risk is an inseparable characteristic of any decision. Risk is the probability that the actual result of a decision
may deviate from the planned end result with an associated financial loss or waste of funds. Risk differs from
uncertainty in that in the case of the latter there is no probability or measure of the chances that an event will
take place, whereas risk is measurable by means of probabilities.
Similar to the cost–benefit principle, the risk–return principle is a trade-off between risk and return. The
higher the risk is, the higher the required rate of return will be. As far as possible the return should exceed
the risk involved in any business decision. Risk should also be minimised or managed.
Definition
Risk–return principle is the greater the risk, the greater the required rate of return.
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PART 1 Fundamentals of financial management
Time value of money
The time-value-of-money principle means a person could increase the value of an amount of money by
earning interest. If, however, the amount is invested in inventory, equipment or vehicles for example, then
the amount cannot earn interest. This ties up with the previous two principles. From a cost–benefit point of
view the investor will have to earn a greater return on the investment in inventory, equipment and vehicles
than on the best alternative type of investment. From a risk–return point of view, the return must compensate
adequately for the risk incurred.
The time-value-of-money principle also invokes the concept of opportunity cost. If a person were to invest
R5 000 000 in a business firm, then they would forfeit the opportunity of earning interest on that amount,
because they could have invested the amount in, say, a fixed deposit to earn 10% interest and earn this return
with less risk involved.
Definition
Time value of money is an amount invested that could earn interest and, if invested long enough, start earning
interest on interest (also known as compounding), and earn the investor a future value greater than the initial
investment.
Business rescue
Should a firm become unsustainable and insolvent, the assets of the firm may be repossessed through a
court order and sold (liquidated) by the creditors (the persons or organisations to whom the money is owed)
in order for them to recover as much as possible of the amount of the loan. This will result in the loss of
owners’ equity.
The owners of a business firm not only run the risk of losing their money, but also incur an opportunity
cost when investing in the firm or practice. The owners could have earned interest (say 8 per cent per annum)
on the amount invested in the business firm. The owners must therefore receive compensation for this
opportunity cost and the risk they are accepting.
A firm may apply to the court for business rescue in terms of Chapter 6 of the Companies Act. The firm
could be assisted by a business rescue practitioner to return to sustainability. This will be explained in greater
detail in Chapter 19.
1.11 Overview of the book
In view of the description of the role of financial management and the fact that the firm’s CFO must report
the financial performance and financial position of the firm by means of financial statements, this book will
explain financial management accordingly by:
• explaining the fundamentals of financial management in Part 1 of the book. This includes an explanation of
how financial statements are compiled and analysed; how financial planning may be done; how to assess
risk and return; how time value of money influences financial decision making; and what valuation entails.
• explaining the management of cash flow in Part 2 of the book. Here attention is devoted to cash management,
the management of accounts receivable and the management of stock. These current assets must be
financed by current liabilities (short-term funds), and/or by long-term funds (equity or debt). As such,
these aspects interact as part of the net working capital reported in the statement of financial
position of a firm.
• explaining how investment decisions need to be evaluated in Part 3 of the book. The focus is on non-current
assets (real assets) and the approval of any investment decision results in additional assets in the firm’s
statement of financial position.
• explaining financing decisions in Part 4 of the book. Any decision to proceed with an investment has an
influence on the amount and cost of finance.
• devoting Part 5 to business rescue and the options available to a firm under such circumstances. Since not all
plans and strategies are executed perfectly, and since not all directors and managers always act in the best
interest of a firm, the business could face serious challenges that may require business rescue.
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1.12 Chapter review
Summary
This chapter explained:
• the reasons for the existence of business firms
• the role of a vision, mission and organisational culture of a firm
• the role of the business model and strategy
• the typical life cycle of a product
• the various forms of business organisation
• the long-term and short-term financial goals of a firm
• the functions of a chief financial officer (CFO) relating to the long- and short-term financial goals of a firm
• the competencies of a chief financial officer (CFO)
• the fundamental principles of financial management.
Self-test questions
1. Which of the following statements are correct?
a. The mission statement must be formulated before the vision can be determined.
b. Ideally the vision needs to be determined after doing scenario planning about the future.
c. The budgeting process does not need to consider the vision and mission.
d. Environmental considerations must be an integral part of the planning process.
e. Financial planning is a summary of the budgets of the procurement, marketing, HR and
finance departments.
2. Organisational culture can be enhanced by:
a. aligning a company’s culture with its values
b. top management practises what it preaches
c. incorporating organisational culture into the recruitment process
d. encouraging professional development and learning
e. all of the above
3. Internal controls are needed to:
a. enable fraud and corruption
b. transform the integrity of the financial and accounting information
c. disable the goals and objectives of the firm
d. help protect the assets of the firm
e. promote ineffective and inefficient operations
4. The financial goal of the firm is to maximise shareholders’ wealth by:
a. maximising return
b. optimising solvency
c. balancing environmental, social and economic sustainability
d. optimising liquidity
e. internal control
5. Which of the following statements is/are correct?
(i) Profitability is the firm’s ability to generate cash sales.
(ii) Solvency is the extent to which the firm’s assets exceed its liabilities.
(iii) Liquidity is the firm’s ability to satisfy its short-term obligations as they become due.
a. (i)
b. (ii)
c. (ii) and (iii)
d. (i) and (iii)
e. none of the above
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PART 1 Fundamentals of financial management
6. How many of the following statements are correct?
(i) Financial management and accounting are not synonymous.
(ii) Accounting uses a cash flow basis.
(iii) Financial management emphasises cash inflow and outflow.
(iv) The receipt of funds sooner as opposed to later is preferred.
a. none
b. one
c. two
d. three
e. four
7. Financial management is based on the following principles:
a. cost of resources
b. risk–return
c. the time value of money
d. b and c above
e. none of the above
8. The cost–benefit principle means that:
a. decisions based on cost only will yield the best benefits
b. the greater the costs, the greater the benefits
c. clarity about the objective to be attained is vital
d. benefits should outweigh costs
e. c and d above
9. The risk–return principle states that:
a. every business decision may result in either a profit or a loss
b. the higher the risk, the higher the required rate of return
c. risk and uncertainty are synonyms
d. the higher the risk, the higher the actual rate of return
e. a and b above
10.According to the time-value-of-money principle:
a. there is an opportunity cost involved in waiting to receive an amount of money
b. money should always be invested to earn a return
c. cash flow received later as opposed to earlier is in order
d. a and b above
e. a, b and c above
11.The capital market consists of the:
a. supply and demand for short-term funds
b. supply and demand for long-term funds
c. Johannesburg Stock Exchange (JSE) only
d. primary market only
e. SA Reserve Bank
12.The agency problem refers to:
a. inefficient advertising agencies
b. auditing fees only
c. industrial espionage
d. managers who do not focus on wealth creation like shareholders would
e. the cost of implementing EVA
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Critical-thinking exercises
1. Are the long- and short-term goals of a listed company different from those of a small business?
2. Are the fundamental principles of financial management the same regardless of the type of business firm?
3. Would the functions of a CFO or financial manager be the same in a government department as in a
privately owned firm?
4. The portfolio of responsibilities of CFOs are evolving as the complexity of firms increase. What
competencies should the chief financial officer (CFO) of a listed firm have in future, say five years from now?
Further readings
Adams, W.M. 2006. The Future of Sustainability: Re-thinking Environment and Development in the Twenty-first
Century. Report of the IUCN Renowned Thinkers Meeting, 29–31 January 2006. Available: https://www.
globalnature.org/bausteine.net/f/6379/iucn_future_of_sustanability.pdf?fd=2 Viewed 8 April 2022.
BMW Group Plant Rosslyn. 2022. Available: http://www.bmwplant.co.za Viewed 8 April 2022.
Corporate Finance Institute (CFI). 2022. What is a mission statement? Available: https://corporatefinanceinstitute.
com/resources/knowledge/strategy/mission-statement/ Viewed 11 April 2022.
Dewar, C. 2018. Culture: 4 keys to why it matters. San Francisco: McKinsey. Available: https://www.mckinsey.com/
business-functions/people-and-organizational-performance/our-insights/the-organization-blog/culture-4keys-to-why-it-matters Viewed 12 April 2022.
Gitman, L.J. 2014. Principles of managerial finance – global and Southern African perspectives. 2nd ed.
Cape Town: Pearson.
Guley, G. & Reznik, T. 2019. Culture eats strategy for breakfast and transformation for lunch. Available: https://
journal.jabian.com/culture-eats-strategy-for-breakfast-and-transformation-for-lunch/ Viewed 12 April 2022.
Institute of Directors (IOD). 2022. King IV report. Available: https://www.iodsa.co.za/page/king-iv
Viewed 11 April 2022.
Institute of Directors (IOD). 2018. The role of the non-executive director. What is the role of the Non-Executive
Director? | Institute of Directors | IoD Viewed 12 April 2022.
Levenstein, E. 2013. The delinquent director: no tolerance for errant directors? Johannesburg: Werksmans Attorneys.
Available: https://www.werksmans.com/wp- content/uploads/2018/10/160_JN5493-Werksmans-Brief_
The-Delinquent-Director1.pdf Viewed 11 April 2022.
Marx, J., Ngwenya, M.S. & Grebe, G.P. 2020. Finance for non-financial managers. 3rd revised ed.
Pretoria: Van Schaik.
Maslow, A.H. (1970). Motivation and personality. 2nd ed. New York: Harper & Row.
Masterclass. 2022. Organisational culture: how to create a healthy organisational culture. Available: https://
www.masterclass.com/articles/organizational-culture-guide#4-types-of-organizational-culture
Viewed 12 April 2022.
Perrin, T. 2009. What’s Your Risk Appetite? Available: https://www.rims.org/.../RIMS_Exploring_Risk_Appetite_
Risk_Tolerance_0412.pdf Viewed 18 May 2016.
Porter, M.E. 1980. Porter generic strategies. New York: Free Press.
Spencer, A.R. & Nevid, J.S. 2020. Psychology and the challenges of life: adjustment and growth. 14th ed.
New Jersey: Wiley.
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PART 1 Fundamentals of financial management
OVERVIEW
Financial markets, institutions and securities
GDP
Flow of funds
in an economic
system
Economic
environment
Financial
markets,
institutions and
securities
Interest rates
Inflation
Budget deficit
Balance of
payments
Exchange rates
Unemployment
rates
Money market
Financial
markets
Capital market
Debt
Forms of longterm financing
Debentures
and bonds
Ordinary shares
Equity
Retained
earnings
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