ACCA Paper F9 Mnemonics Revision (Sample Download)

Paper F9: Financial Management

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ACCA Paper F9 – Financial Management – Mnemonics and Charts

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Type of presentation

Title Topic covered (briefly) Screen number

Chart What is corporate finance? Financial management function 42Chart 3 main financial decisions Financial management function 43Chart Capital structure Financial management function 44Chart The financial management function Financial management function 45Chart Finance function within a large

company/groupFinancial management function 46

Mnemonic The role of the Financial Controller Financial management function 47Mnemonic The role of the Treasurer Financial management function 48

Chart The scope of financial management +AddVance activities - introduction

Financial management function 49

Chart The scope of financial management activities - overview


Chart Cash flows between the firm and the financial markets


Chart The scope of financial management -recap


Chart The financial management planning process


Mnemonic The financial management process Financial management function 54

Chart The financial management planning process - overview


Chart A firm’s liquidity cycle Financial management function 56Mnemonic Benefits of centralised treasury

managementFinancial management function 57

Mnemonic Disadvantages of centralised treasury management


Chart/mnemonic The principal financial objectives Financial objectives 59Chart Stakeholder analysis for a typical

companyFinancial objectives 60

Mnemonic Concept of ‘Principal-agency Theory’ (PAT) applied to shareholders and directors

Financial objectives 61

Mnemonic Difficulties associated with managing organisations with multiple objectives


Mnemonic Reasons why maximising shareholders’ profits is not the same as maximising shareholders’ wealth


Mnemonic The main Corporate Governance proposals


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Mnemonic Main focus of the LSE’s ‘Combined Code of Corporate Governance’


Mnemonic The distinctive characteristics of public services in the context of corporate governance


Mnemonic Remuneration schemes for managers Financial objectives 67Chart Value for Money (VFM) Objectives in not-for-profit

organisations68

Chart Measuring performance in a not-for-profit organisation

Objectives in not-for-profit organisations

69

Chart Financial performance analysis - overview Financial ratio analysis 70Chart Financial performance analysis –

categories of ratiosFinancial ratio analysis 71

Chart The RONA Pyramid Financial ratio analysis 72Mnemonic Implications/issues of the ROI measure Financial ratio analysis 73

Chart Measuring financial performance -overview

Financial ratio analysis 74

Mnemonic The FIVE main groupings for financial performance analysis


Mnemonic The implications for the growth measures used by financial managers


Mnemonic Reasons/benefits of financial ratio analysis


Mnemonic Limitations of ratio analysis Financial ratio analysis 78Mnemonic Information required for meaningful ratio

analysisFinancial ratio analysis 79

Chart Combined analysis (Collection period) Financial ratio analysis 80Chart Overtrading Financial ratio analysis 81

Mnemonic Characteristics of overtrading Financial ratio analysis 82Mnemonic Ratios/measures that can be used to

indicate overtradingFinancial ratio analysis 83

Mnemonic Parties who need to analyse corporate financial figures in addition to management


Mnemonic Reasons why comparisons should be based on companies in the same industry or market sector


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Mnemonic The difficulties involved in inter-firm comparison


Mnemonic Macroeconomics Financial management environment

87

Chart The economic goals of government Financial management environment

88

Mnemonic Main economic goals of most governments

Financial management environment

89

Chart Main sources of inflation Financial management environment

90

Mnemonic Sources of inflation Financial management environment

91

Mnemonic Government policy : Full employment Financial management environment

92

Mnemonic Examples of potential conflict within government economic policies


93

Chart The Bank of England’s (Central Bank) ‘Repo’ rate of interest


94

Chart Economic objectives of Government Financial management environment

95

Chart Fiscal policies of central government Financial management environment

96

Mnemonic Gilts Financial management environment

97

Mnemonic The effects of a high PSBR (Public Sector Borrowing Requirement) on private sector businesses


98

Mnemonic Factors that regulate the size of the ‘Bank reserve requirement’


99

Mnemonic Characteristics of the ‘perfectly competitive market’


100

Mnemonic Basis of monopoly power Financial management environment

101

Mnemonic The effect of ‘green policies’ on companies


102

Mnemonic Ways that inflation can affect a company Financial management environment

103

Mnemonic The central role of working capital management in financial management

Working capital management 104


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Mnemonic Potential conflict between functional managers and financial managers in working capital decisions


Chart Example of the need for working capital investment


Chart Working capital investment has a cost but there is no direct money return


Chart The constituents of ‘Working capital management’


Mnemonic Sources of information available to help credit assessment


Mnemonic Reasons for delays in invoicing Working capital management 110Mnemonic Possible actions for dealing with slow

payersWorking capital management 111

Mnemonic Debtor management – general factors Working capital management 112

Mnemonic Steps that a company could use to reduce bad debts


Chart Derivation of formula for calculating the average ‘Accounts payable’ balance


Chart Offering discounts for early payment Working capital management 115Chart Receiving payments from overseas sales Working capital management 116

Mnemonic Managing payments from overseas customers


Mnemonic The workings of an effective credit control department


Chart Factoring book debts Working capital management 119Chart Factoring book debts: Ups and Downs Working capital management 120

Mnemonic Benefits of factoring debts Working capital management 121Chart Overview on the management of accounts

receivableWorking capital management 122

Chart Overview on the management of accounts receivable - 2


Mnemonic How risks of foreign trade (excluding foreign exchange risks) might be managed


Mnemonic Terms of trade for overseas customers Working capital management 125


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Chart Three main types of trade credit Working capital management 126Chart Control of trade credit Working capital management 127Chart Taking discount for early payment Working capital management 128

Mnemonic Advantages of using trade credit to finance working capital


Mnemonic Factors that influence the amount of trade-credit period taken


Chart Levels of inventory Working capital management 131Mnemonic The costs of holding inventory (stock) Working capital management 132Mnemonic Costs of acquiring inventory (purchase

order costs)Working capital management 133

Mnemonic Benefits of holding high levels of inventory (stock)


Mnemonic Disadvantages of holding high levels of inventory (stocks)


Mnemonic Ways a manufacturing company can use to reduce its average raw material inventory


Chart Characteristics of JIT systems Working capital management 137Mnemonic The nature and characteristics of supply

in JITWorking capital management 138

Mnemonic JIT. What is planned to be available just in time?


Mnemonic Aims of Just-In-Time (JIT) Working capital management 140Mnemonic Pre-requisites for a successful JIT system Working capital management 141Mnemonic Advantages associated with JIT systems Working capital management 142Mnemonic Toyota Production System (TPS) Working capital management 143Mnemonic Examples of waste (non-value-adding

activity and costs)Working capital management 144

Chart The concept of ‘pull production’ linked to ‘just in time (JIT)’


Chart Cash management Working capital management 146Chart Calculation of ‘Cash conversion cycle

period’Working capital management 147

Mnemonic Releasing cash from working capital to deal with short-term cash deficits



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Mnemonic Reasons for a company to hold liquid assets


Chart 6 Steps for cash budgeting Working capital management 150Chart Cash budgeting: Receipts and payments

modelWorking capital management 151

Chart Cash flow statement Working capital management 152Chart Baumol Cash Budget Model Working capital management 153

Mnemonic Potential problems associated with the Baumol model


Chart Miller-Orr Cash Budget Model Working capital management 155Chart Management of short-term surplus cash Working capital management 156

Mnemonic Factors to consider before investing surplus short-term funds on the money market


Chart Management of short-term deficit cash Working capital management 158Mnemonic Reasons why there are cash problems

(cash deficits)Working capital management 159

Mnemonic Overcoming short-term deficit cash Working capital management 160Chart Dynamics between short- and long-term

interest ratesWorking capital management 161

Chart Market segmentation theory Working capital management 162Mnemonic 3 reasons why under normal economic

conditions short-term interest rates are lower than long-term rates.


Chart Financing working capital: Three approaches


Chart Financing working capital Working capital management 165Mnemonic 3 different financing policies for working

capitalWorking capital management 166

Mnemonic The factors to consider before adopting an ‘aggressive financing policy’


Mnemonic Balance between cash and short-term investments


Mnemonic Explanations for the shape of the ‘Normal Interest Yield Curve’


Chart Financial instruments (‘paper’) in the money markets



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Mnemonic Financial instruments used in the money market

Nature and role of financial markets and institutions

171

Chart The Bill of Exchange mechanism Nature and role of financial markets and institutions

172

Chart Letter of Credit Nature and role of financial markets and institutions

173

Mnemonic The main organisations acting as financial intermediaries


174

Mnemonic The main functions (roles) served by financial intermediaries in the market


175

Chart Organisations operating as financial intermediaries


176

Chart The role of financial intermediaries - 1 Nature and role of financial markets and institutions

177


178


179


180


181

Mnemonic Ways that investors benefit from financial intermediation


182

Chart The financial markets Nature and role of financial markets and institutions

183

Chart Money Nature and role of financial markets and institutions

184

Chart The role of the Central Bank in the money market


185

Chart The London Stock Exchange (LSE) - 1 Nature and role of financial markets and institutions

186


187


188

Chart Risk/return trade-off - 1 Nature and role of financial markets and institutions

189

Chart Risk/return trade-off - 2 Nature and role of financial markets and institutions

190


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Mnemonic Types of risks concerning financial and investment decisions


191

Mnemonic Key factors in choosing sources of finance

Business finance 192

Mnemonic The relative merits of short-term debt compared with long-term debt


Mnemonic The problems of using short-term debt sources compared with long-term debt


Mnemonic Sources of short-term finance Business finance 194Mnemonic Bank investigation concerning a loan

applicationBusiness finance 195

Mnemonic Danger signs for a bank when assessing a bank loan application


Mnemonic Factors that influence the rate of interest charged on a new bank loan


Mnemonic The ‘Sale and lease-back’ decision Business finance 198Chart Public equity company raising long-term

financeBusiness finance 199

Chart Ordinary shares and their characteristics -1


Chart Ordinary shares and their characteristics -2


Chart Ordinary shares and other things to know - 1








Mnemonic Factors affecting a share price Business finance 206Mnemonic Retained earnings compared with a new

issue of equityBusiness finance 207

Mnemonic Factors relating to a public issue of equity Business finance 208

Chart Rights issue - overview Business finance 209Chart Rights issue - 1 Business finance 210Chart Rights issue - 2 Business finance 211


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Chart Rights issue - 3 Business finance 212Mnemonic Contents of a Prospectus for a Rights

issueBusiness finance 213

Mnemonic Benefits of a rights issue in a bull market Business finance 214Mnemonic The drawbacks of a rights issue Business finance 215

Chart Initial Public Offering (IPO) - 1 Business finance 216Chart Initial Public Offering (IPO) - 2 Business finance 217Chart Initial Public Offering (IPO) - 3 Business finance 218

Mnemonic Advantages of getting listed on a stock exchange


Mnemonic Disadvantages of getting listed on a stock exchange


Mnemonic Methods for a company to obtain a listing on a stock exchange


Mnemonic Costs of an issue on the stock exchange Business finance 222Mnemonic Ways investors use to assess a company

that is making an initial public offer (IPO)Business finance 223

Mnemonic Ways an unquoted company might restructure its balance sheet prior to the initial offer (IPO)


Mnemonic Dividend policy – the practical considerations


Chart The dividend decision - 1 Business finance 226Chart The dividend decision - 2 Business finance 227Chart The dividend decision - 3 Business finance 228Chart The dividend decision - 4 Business finance 229Chart The dividend decision - 5 Business finance 230

Mnemonic Different dividend policies Business finance 231Mnemonic Reasons why dividend policy is important Business finance 232

Chart Main characteristics of bonds Business finance 233Chart Bonds - 1 Business finance 234Chart Bonds - 2 Business finance 235Chart Bonds - 3 Business finance 236

Mnemonic Different forms of corporate bond Business finance 237

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Chart Internal sources of finance and dividend policy


Chart The influence of interest rates on the market value of bonds


Chart Convertible bonds Business finance 240Chart The floor value of a convertible bond Business finance 241

Mnemonic Factors relating to a public issue of corporate bonds


Mnemonic Advantages of eurobonds Business finance 243Mnemonic Drawbacks in the eurobond market Business finance 244Mnemonic Factors that should be considered by a

listed company when choosing between the issue of debt and an issue of equity


Mnemonic Ways by which an unlisted company can obtain funds


Chart The financing of SMEs Business finance 247

Mnemonic Reasons why SMEs gave difficulty in raising finance


Mnemonic Source of funds for SMEs – using UK as an example


Mnemonic Problems faced by SMEs in respect of credit management


Mnemonic Steps that could be taken by SMEs to minimise the effects of their poor credit management


Mnemonic Purposes of venture capital Business finance 252Chart The main financial markets Business finance 253Chart The capital budgeting process Investment appraisal 254Chart The ‘rolling’ capital budget system Investment appraisal 255

Mnemonic Seven steps involved in successfully evaluating and controlling a capital budget

Investment appraisal 256

Mnemonic Component parts of a ‘Business Case’ for an investment proposal


Mnemonic Possible benefits of an investment project Investment appraisal 258


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Mnemonic Main responsibilities of the ‘Capital Expenditure Committee’


Mnemonic Relevant (or opportunity) costs that would affect the future cash flow of a project


Mnemonic Costs which are not relevant when carrying out a DCF appraisal


Chart Capital investment appraisal techniques Investment appraisal 262Mnemonic The main capital investment evaluation

techniques and criteriaInvestment appraisal 263

Mnemonic Limitations of the payback period method of capital investment appraisal


Mnemonic Advantages of the payback period method of capital investment appraisal


Mnemonic Limitations of the Accountant’s Rate of Return (ARR) measure for evaluating capital investment proposals


Mnemonic Strengths of the ARR measure Investment appraisal 267Mnemonic Advantages of using discounted cash flow

(DCFR) techniques for capital investment appraisal


Mnemonic Data required to calculate the net present value (NPV) of an investment project


Mnemonic Advantages of IRR over NPV Investment appraisal 270Mnemonic Limitations of using the IRR measure for

capital investment appraisalInvestment appraisal 271

Mnemonic Advantages of NPV over other investment appraisal techniques


Mnemonic General limitations of net present value (NPV) when applied to investment appraisal


Mnemonic Steps taken to address the limitations of NPV analysis


Chart Capital investment appraisal applications Investment appraisal 275


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To manage a business well is to manage its future: and to manage the future is to manage information.

Marion Harper

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Chart Effects of inflation on NPV Investment appraisal 276Chart NPV and risk Investment appraisal 277Chart Business and financial risks Investment appraisal 278

Mnemonic Factors contributing to business risk Investment appraisal 279Mnemonic Factors contributing to financial risk Investment appraisal 280Mnemonic Ways that risk can be managed in capital

investmentInvestment appraisal 281

Mnemonic Problems of using the ‘expected value’ approach when making investment decisions


Mnemonic Limitations of sensitivity analysis Investment appraisal 283Chart The lease or borrow-to-buy decision Investment appraisal 284

Mnemonic Advantages of leasing assets Investment appraisal 285Mnemonic Disadvantages of leasing assets Investment appraisal 286

Chart Capital rationing: Overview Investment appraisal 287Mnemonic Hard capital rationing:

characteristics and reasons forInvestment appraisal 288

Mnemonic Soft capital rationing: characteristics and reasons for


Mnemonic Exploiting opportunities which are rejected because of capital rationing


Mnemonic Limitations of using the Profitability index (PI) in a capital rationing situation


Chart Capital Replacement Theory - 1 Investment appraisal 292Chart Capital Replacement Theory - 2 Investment appraisal 293

Mnemonic The factors to consider in a replacement decision


Chart The process of capital budgeting and investment appraisal: overview


Mnemonic Four different ways of valuing a company (or an equity share)

Business valuations 296

Mnemonic Purpose of company or share valuation Business valuations 297Mnemonic The main implications of the ‘Efficient

Market Hypothesis’Business valuations 298

Chart Different methods of valuing a company or its shares


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Mnemonic Weaknesses of the dividend valuation model


Mnemonic Assumptions underlying CAPM Cost of capital 301Chart Systematic and unsystematic risk Cost of capital 302

Mnemonic Limitations of using the beta factor Cost of capital 303Chart Traditional gearing Cost of capital 304Chart Traditional gearing ratios Cost of capital 305Chart Managing foreign currency risk Cost of capital 306

Mnemonic The uniqueness of the foreign exchange (FE) market

Risk management 307

Mnemonic Factors that affect a currency’s supply and demand and thus its price

Risk management 308

Mnemonic Forecasting exchange rates Risk management 309Mnemonic Four ways of forecasting (estimating)

future currency ratesRisk management 310

Chart Four-way Equivalence Model Risk management 311Mnemonic Techniques available to help reduce

foreign exchange risk involved in foreign trade or business

Risk management 312

Mnemonic The steps involved when using a money market hedge to cover foreign currency payments

Risk management 313

Mnemonic Advantages of using futures to hedge risks compared with a forward exchange contract

Risk management 314

Mnemonic Difficulties of using futures to hedge risks Risk management 315Mnemonic The reasons for using currency options Risk management 316

Mnemonic Benefits of currency swaps Risk management 317Mnemonic Drawbacks of currency options Risk management 318

Chart Currency and interest rate management Risk management 319

Mnemonic Pattern of interest rates Risk management 320Mnemonic Reasons why interest rates may be

expected to fallRisk management 321


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Financial Analysis

Who needs to

analyse?

Management Investors Potential investors Creditors Other lenders Employees

What data is used for the analysis?

Profit and Loss Account(Income statement)

Balance Sheet

Other data are also useful:

Cash flow forecasts Industrial statistics Details of accountancy policies Post-balance sheet events Government statistics Inflation adjusted figures

What basis of analysis?

Internal/external

Stakeholders

Appraisal/evaluation

Comparisons

Main comparisons:

Time series analysis(over different periods of time)

Interfirm comparison Against objectives

(budgets, etc.)

What to measure?

Criteria

How to measure?

Analytical techniques

What to learn?

Information

Five main areas of appraisal:

Earnings- profitability- capital efficiency

Growth Risk Control Shareholders’ investments

Three main techniques:

Common sizing(vertical analysis)

Horizontal analysis Ratio analysis

Scope for improvement

Control action

required

Financial problems

Management action

required

Overtrading

Danger of liquidation

Financial performance analysis - overview

Start here and follow the

numbers ….

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FINANCIALANALYSIS

Vertical analysis(Common-sizing)

Horizontal analysis(Side-by-side)

Ratio analysis

Financial performance analysis –categories of ratios

Usually based on:

Income statement …… 1 year

Balance sheet …… Assets

Basis for performance comparisons:

Time-series analysis(Trend analysis over periods)

Cross-sectional analysis(inter-firm analysis)

Budgets Other objectives Inter-unit/ division/

department Geographical

Performance is normally conducted by

comparisons

CRITERIA used for

comparisons

EARNINGS MEASURES

RONA (Net profit x 100/net assets) NET MARGIN (Net profit x 100)/

sales revenue) NET ASSET TURNOVER

(Profit x 100/net assets employed)

PROFITABILITY

GROSS MARGIN (Gross profit x 100/sales revenue)

OPERATING MARGIN(Profit before interest and tax x 100/sales revenue)

COST OF SALES PERCENTAGE(Cost of sales x 100/sales)

COST MEASURES (Each element of costx 100/sales)

CAPITALEFFICIENCY

FIXED ASSET TURNOVER (Profit x 100/fixed assets employed)

CURRENT ASSET TURNOVER(Profit x 100/current assets)

INVENTORY TURNOVER THROUGH SALES

(Profit x 100/inventory)

GROWTH MEASURES

EARNINGS-PER-SHARE GROWTH (%) SALES REVENUE GROWTH (%) DIVIDEND COVER

(Profit after interest andtax/total dividend) (times)

RETENTION % (1 – (Dividends for the year x 100%/profits after interest and tax))

DIVIDEND YIELD(Total dividend x 100/earnings for ordinary shareholders)

RISK MEASURES

GEARING (Debt/equity value) (times)(There are other ways of calculating this ratio)

INTEREST COVER(Profit before interest and tax/interest payable)

GEARING

LIQUIDITY

CURRENT RATIO (Current assets/current liabilities) (times) QUICK RATIO

((Current assets – inventory)/current liabilities)

WORKING CAPITAL CONTROL

MEASURES

INVENTORY TURNOVER((Inventory value x 365)/purchases) (days)

CREDITORS PAYMENT PERIOD(Accounts payable x 365/purchases) (days)

DEBTORS COLLECTION PERIOD(Accounts receivable x 365/sales) (days)

INVESTORS’ RATIOS

DIVIDEND YIELD(Dividend per share x 100/market price per share)

PRICE EARNINGS RATIO(Market price per share/earnings per share)

DIVIDEND COVER(Earnings per share/dividend per share) (times)

EARNINGS YIELD(Earnings per share x 100/Market price per share)

RETURN ON EQUITY(Net profit x 100/equity value (book or market value)

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RETURN ON NET ASSETS

Profit margin Capital turnover(Activity)

Sub-analysis

Sub-analysis Sub-analysis

Total cost/Sales x 100 Sales/Fixed assets = times

Fixed costs/Sales x 100 Variable cost/Sales x 100

Sub-analysis

Rent/Sales x 100 = %Rates/Sales x 100 = %Deprec./Sales x 100 = %Insurance/Sales x 100 = %Etc.

Material costs/Sales x 100 = %Labour costs/Sales x 100 = %Variable overhead/Sales x 100 = %Insurance/Sales x 100 = %Etc.

Sub-analysis

Sales/Land value = timesSales/Property value = timesSales/Plant & Equip. value = timesSales/Vehicle values = timesSales/Fix. and Fittings = timesEtc.

Sales/Inventory value = timesSales/Receivables = timesSales/Cash = timesEtc.

Net profit/Net assets x 100 = %

The RONA Pyramid

Sub-analysis

Sales/Current assets = times

Profit/Sales x 100 = % Sales/Net assets = times






Implications/issues of the ROI measure

The ROI ratio (sometimes called RONA [return on net assets] or ROCE [return on capital employed]) measures the overall effectiveness of management in generating profits with its available resources. It is a key, but rough, measure of performance. Although ROI shows the extent to which earnings are achieved on the investment in the business, the actual value is generally somewhat distorted. There are basically three ratios that evaluate the ROI. They are: net profit margin, net assets turnover, and return on equity.

The implications/issues of the ROI measure are:

C Company’s cost of capital. Is the ROI high enough with regard to the company's marginal cost of capital (say the bank's overdraft rate)?

O Other companies/competitors/industrial norm. How does the ROI compare against other companies (competitors) or divisions (within the company)?

A Asset valuation. Are assets correctly valued? (The ROI ratio is overstated if the assets are under-valued.)

S Shareholders’ cost of capital. Consider the overall return. Is the ROI high enough with regard to shareholders' cost of capital? (The return the shareholders could earn elsewhere at the same level of risk.)

T Trend of the ROI. Is the trend satisfactory/unsatisfactory?

A company can’t COAST along happily – even when the ROI is high!

The very best financial presentation is one that’s well thought out and anticipates any questions … answering them in advance.

Nathan CollinsExecutive Vice

PresidentValley National Bank

CFO, August 1985






So ……

There are 5 main criteria for measuring financial performance

1. Earnings measures- principal measures, sub-analysed as:

- profitability- capital efficiency

2. Growth measures3. Risk measures

- gearing- liquidity

4. Working capital control measures5. Investors’ ratios

And ……

There are 3 techniques for measuring financial performance

1. Vertical analysis (‘Common-sizing’)2. Horizontal analysis (‘Side-by-side’)3. Ratio analysis

5 criteria ….

3 techniques ….

Measuring financial

performance -overview






The FIVE main groupings for financial performance analysis

There are many ratios that an analyst can use, depending on what he or she considers to be important relationships. For our purposes we will classify ratios into five groups:

S Shareholders’ investment measures. The main measures are:- Dividend yield (Dividend per share/market price per share x 100).- Earnings per share (Earnings for ordinary shareholders/number of shares eligible for dividend).- Price earnings ratio (Market value per share/earnings per share).- Dividend cover (Earnings per share/dividend per share).- Earnings yield (Earnings per share/market price per share x 100).- Return on equity (Earnings for ordinary shareholders/equity (book or market) value x 100).

U Underlying control measures. The main measures are:- Inventory turnover (Inventory value x 365/purchases) (days).- Payables period (Payables’ value x 365/purchases) (days).- Receivables (Receivables’ value x 365/sales) (days).

R Risk measures. The main measures are:- Gearing (Debt/equity). (There are other ways of calculating this ratio.)- Interest cover (Profit before interest and tax/interest payable).- Current ratio (Current assets/current liabilities)- Quick ratio (sometimes called ‘Acid test’) (Current assets – inventory value/current liabilities)

G Growth measures. The main measures are:- Earnings-per-share growth (%).- Sales revenue growth (%).- Dividend cover (as shown above)- Retention % (1 – (dividends for year x 100/profits for ordinary shareholders).- Dividend yield (as shown above).

E Earnings measures. The main measures are:- ROI (or RONA or ROCE) (Net profit/net assets x 100).- Net margin (Net profit/sales revenue x 100).- Net asset turnover (Net profit x 100/net assets employed).(Operating profit may be used in place of net profit in all three of these ratios.)

A company’s share price will SURGE ahead when these measures are consistently favourable.






The implications of the growth measures used by financial managers

R Retention percentage ratio. The retentions percentage is the inverse of the dividend cover (explained below) and provides much the same information.

E Earnings per share growth %. This is an important ratio for the present and prospective shareholders and management. The earnings per share represent the number of £s earned on behalf of each outstanding share of equity capital. They are closely watched by the investing public and are considered an important indicator of corporate success. The value does not represent the amount of earnings actually distributed to shareholders. Growth (year by year) suggests strong corporate performance.

D Dividend cover ratio. The dividend cover indicates (a) the proportion of distributable profits for the year that is being retained by the company; and (b) the level of risk that the company will not be able to maintain the same dividend payments in future years, should earnings fall. A high dividend cover means that a high proportion of profits are being retained, which might indicate that the company is investing to achieve earnings growth in the future.

S Sales revenue growth %. The sales growth when measured against industry growth for the same period can provide useful information about the company's share of the market. Sales growth can also be used to evaluate the company's marketing, such as the effectiveness of an advertising campaign run during the period of report.

A company will usually keep out of the REDS on the stock exchange board when these measures are strong.

Growth for the sake of growth is the ideology of the cancer cell.

Edward Abbey






Reasons/benefits of financial ratio analysis

Ratio analysis is widely used for analysing a company and is frequently employed by external stakeholders -creditors, investors and financial institutions, as well as by senior management for internal performance appraisal. In more detail, the technique can help in the following ways:

I Identifies a moving picture of trends. A 'moving picture of the company', i.e. trends over a period of years can be analysed (‘time-series analysis’).

S Segregates performance. It segregates performance into distinct groups such as: earnings, growth, control, risk and investment.

M Models and simulates. Ratios can be used for modelling and simulation purposes. Many large corporate finance models are based on ratios.

A Accounting software facilitates the quick production of ratios.

G Government statistics. Ratios allow a company to compare its performance against macro-economic indices produced by government.

I Industrial norms. Ratios allow for comparison of the company’s performance with other companies or the industry average, and hence for management to make judgement about the company's position in the competitive arena. Most inter-firm comparison schemes are based on ratios. Internal comparisons (between divisions/departments) are also made possible.

C Comparison with the budget for the same period. Management can use ratios to compare results with the budget covering the same period.

It IS MAGIC the way ratios can reveal a picture of performance results.






Limitations of ratio analysis

The analytic approach used in ratio analysis must be used with circumspection and in conjunction with other analytical tools and techniques as it has a number of limitations. The limitations include the following:

O Orientation that is historical. The approach is based on historical data and thus the ratios may not be a good guide to the future;

F Financial measures are used. Ratios are normally based exclusively on finance, and reflect only financial indicators of performance. There are, of course, non-financial implications associated with performance.

T Trading environments change over time. The changing value of money and differences in trading environments over time influence the ratios.

S Sub-optimal results might be encouraged. The use of ratios to measure performance may encourage sub-optimal behaviour by managers, e.g. short term manipulation of results.

A Accountancy practice influences the ratios. Differences in accounting practices adopted by companies over the treatment of fixed asset depreciation and revaluation, stock valuation, research and development expenditure, goodwill, write-off and profit recognition affect the ratios.

I Interpretation of change. Difficulties in deciding on a suitable yardstick and the interpretation of change, e.g. is a higher return on net assets (ROI) good or bad?

D Distortion can be a result. The quality of the analysis is determined by the quality of the accounting information upon which it is based (consider here the distortion that can result from 'creative accounting', such as 'window dressing' of financial statements to hide short-term fluctuations).

It’s OFT SAID that too much emphasis is placed on only using ratio analysis.

The numbers tell you how your business is going, not why.

Jonatghan P. SiegelSpeech, McLean, Virginia, 12 September, 1987






Information required for meaningful ratio analysis

For meaningful financial ratio analysis and other performance analysis the following information would be useful:

I Information and details concerning future plans of the company.

F Fixed assets. Details of fixed assets, with projected remaining lives and likely replacement costs.

A Accounts adjusted to take account of inflation during the period under review.

C Cash flow forecasts.

C Current financial statements. Balance sheet [Statement of Affairs], Profit and Loss Statement [Income Statement] and Cash Flow Statement.

A Accountancy policy and changes to it. Details of the company's accounting policies and changes to any basis of accounting.

B Budgets and associated variances. Details of the company's budget plans with a schedule of variances.

A After balance sheet events (post-balance sheet). Details of any post-balance sheet events, and of any contingencies.

S Statistics provided within the industry. Statistics of the industry as a whole, and in particular financial and other ratios showing best, industry average and worst results.

E Economic indicators and other macro-environmental factors. Government statistics concerning inflation and interest levels and other economic indicators.

IF ACCA BASE a question on what information is required for financial performance analysis to be meaningful then this is a useful list.






Key amounts, measure and ratios would be: YEAR 1 YEAR 2

Increase in sales revenue (%) XX % Gross margin (Gross profit x 100)/sales revenue) XX % XX % Increase in non-current assets ($) $XX Non-current asset turnover ratio (Sales revenue x 100/

non-current assets employed) XX % Total working capital ($) $XX $XX Inventory turnover through sales (Sales revenue/average inventory) XX times XX times Inventory turnover ((Inventory value x 365)/purchases) XX days XX days Payables period ((Payables value x 365)/purchases) XX days XX days Receivables collection period ((Receivables value x 365)/sales revenue) XX days XX days Reduction in liquidity (cash and bank overdraft levels) $XX $XX Current ratio (Current assets/current liabilities) XX times XX times Quick ratio (Current assets – inventory value)/current liabilities) XX times XX times Financial gearing (Debt x 100/equity funds) XX % XX %

An exam question that requires you to assess the extent of a firm’s overtrading position would need to present;

Two or more years’ of financial data, and/or data concerning industrial/sector averages.

CHARACTERISTIC OF OVERTRADING

The characteristics, or features of an overtrading situation include the following:

The firm is under-capitalised (i.e. there are insufficient funds or credit lines).

The firm is probably profitable. The firm has problems maintaining its asset base

(non-current and current assets) with the level of its activities.

Management may be focusing on sales (‘top line’) at the expense of the costs (‘middle line’) and profit (‘bottom line’).

The firm’s sales may be growing too fast and outstripping the available working capital.

The firm’s quality is suffering (because of some of the points raised above).

Inflation simply exacerbates the problems

SYMPTONS OF OVERTRADING

Over the period ….

Growth in sales. Growth in the volume of assets. Reduction in the firm’s liquidity. Increase in inventory turnover period (days). Increase in debtors’ assets (including the

Accounts receivable collection period [days]). More use made of short-term credit (e.g.

increase in Accounts payable payment period [days]).

Increase in financial gearing. Quality problems

Measures for assessing the extent of overtrading

Extending turnover too quicklyOvertrading is a problem which arises from a firm extending its turnover at too rapid a rate. The ultimate result is a serious shortage of cash which means that wages, creditors and corporation tax cannot be met.A typical pattern of eventsA typical pattern of events commence when a firm takes on additional orders. This would then be followed by engaging additional workers or working overtime. At the same time, extra materials would be purchased on credit. If the working capital cycle is fairly long this means that although extra cash has to be paid out more or less immediately, additional revenue may not be forthcoming for a considerable period. This assumes that the additional production will be sold without delay, but in some circumstances the process may take the form of build up of stock. If this is the case, then the shortage of cash may necessitate an emergency sale at greatly reduced prices and this is likely to have adverse effects on profitability.

YOUR COMMENTS WOULD BE AN IMPORTANT PART OF AN EXAM ANSWER.

OvertradingMAP NEXT CHART NEXT MNEMONIC





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Fairy Nuff Engineering plc

Industry average

Combined cross-sectional and time-series analysis of the average collection for the period 2005 - 2008

Average collection period for Fairy Nuff Engineering plc

The most informative approach to ratio analysis is one that combines cross-sectional (inter-firm) and time-series analysis. A combined view permits assessment of the trend of behaviour of the ratio in relation to the trend for the industry. The diagram below depicts this type of approach using a company's average debtor collection period in the years 2005 to 2008.

Combined analysis

There’s few things as uncommon as common sense.

Frank McKinney Hubbard, 1868 – 1930American caricaturist and humorist






Characteristics of overtrading

Overtrading is a problem which arises from extending turnover at too rapid a rate. The ultimate result is a serious shortage of cash which means that wages, creditors and corporation tax cannot be met.

When a company is overtrading this is marked by large increases in sales which are not matched by increases in the asset base to support the greater level of activity. Working capital is used more intensively and there is little increase in the level of fixed assets. Expansion is financed by short term credit, and stock and debtor turnover can slow as the company tries to secure additional sales on the basis of improved credit terms and as it tries to manufacture ahead of demand.

When analysing the situation shown on a Balance Sheet/Income Statement it is very important to watch for signs of overtrading. Some of the more important of these signs are summarised below.

S Sales growing too fast. Very rapid growth in sale turnover. The ‘Growth of sales ratio’would be a useful indicator.

A Asset maintenance. Inventories may increase more proportionately than the increase in sales turnover with a deterioration in ‘Inventory turnover ratios’. Rapid growth in the volume of current assets and possibly fixed assets. Consider here the ‘Asset turnover ratio’.

L Liquidity problems. Increased significance of credit in financing along with the growth in assets. This may show in slower payment of payables and a bank overdraft which is close to its limit. Similarly, a comparison of the period of credit being taken by the company with the norm for the particular industry will be a guide. Look to see if there has been an increase in the ‘Payables turnover ratio’. Also, look for any sudden upward or downward swing in cash figures, or the appearance of new items such as short-term loans. The ‘Current ratio’ and ‘Quick ratio’ would indicate the liquidity problem.

E Excessive inflation causing capital replacement problems.

S Sales focus to the exclusion of other factors. Management focusing on sales (advertising expenditure, generous credit terms, price reductions, etc.) possibly at the expense of profits and cash flow. The ‘Gross profit margin’ is an important indicator of sales to costs.

U Undercapitalisation. This often occurs because of a growth in the rate of borrowing so that the proportion of borrowing in relation to the assets owned by shareholders is excessive. Reductions in the current and quick ratios, possibly leading to a liquid deficit. The ‘Gearing ratio’ and ‘Cash Flow’ would be used here.

P Profitable, but! Total profit, gross and/or net, begins to diminish

A company’s SALES may be UP but its cash could be seriously down. It might be overtrading.






Ratios/measures that can be used to indicate overtrading

When a company is overtrading this is marked by large increases in sales which are not matched by increases in the asset base to support the greater level of activity. Working capital is used more intensively and there is little increase in the level of fixed assets. Expansion is financed by short term credit, and inventory and debtor turnover can slow as the company tries to secure additional sales on the basis of improved credit terms and as it tries to manufacture ahead of demand.

To carry out a meaningful appraisal two or more years of data are required including industry/sector statistics.

Signs that a company may be overtrading include the following:

G Gross margin. (Gross profit/sales revenue x 100).

I Increase in bank overdraft $. (Current level – previous level).

A Asset turnover ratio (particularly fixed asset turnover) (Gross profit/fixed assets employed x 100)

N Net working capital size. (Current assets – Current liabilities). (Current compared with previous).

T Turnover of inventory through sales. (Sales revenue/inventory) (times)

C Current ratio. (Current assets/current liabilities) (times)

A Acid test (often called ‘Quick ratio’). Now (Current assets – inventory/current liabilities) (times).

R Reduction in liquidity ($). (Bank + cash – overdraft) (current compared with previous).

T Turnover of inventory in days. (Inventory value x 365/purchases or cost of goods sold) (days).

R Receivables payment days. (Receivables value x 365/sales) (days).

I Increase in fixed assets %. (Current fixed asset value – previous fixed asset value/previous fixed asset value x 100)

P Payments days. (Payables x 365/purchases) (days).

S Sales revenue increase%. (Current sales – previous sales/previous sales x 100).

GIANT CAR TRIPS don’t have anything to do with overtrading, but the mnemonic does give you a list of 13 ratios or other measures than can be used to assess whether a company is overtrading.






Parties who need to analyse corporate financial figures in addition to management

Financial analysis is an evaluation of both the company's past financial performance and its prospects for the future. Typically, it involves an analysis of the company's financial statements and its flow of funds. Financial statement analysis involves the calculation of ratios and also uses other ways of measuring.

The analysis of a firm's financial statements is of interest to a number of different groups including present and prospective shareholders, creditors, and the firm's own employees.

S Shareholders - current. The present shareholders are interested in the current and future level of risk, liquidity, activity, debt and return (profitability). These are the dimensions which influence share price.

C Creditors. The firm's creditors, such as the bank, are primarily interested in the short-term liquidity of the firm and its ability to service its debts over the long run. Present creditors want to assure themselves that the firm is liquid and that it will be able to make scheduled interest and principal payments. Prospective creditors are concerned with determining whether the firm can support the additional debt that would result if they extended credit to the firm.

O Other lenders, such as customers who pay forward on a contract would want to assess the financial stability of the company.

P Potential investors. In the same way as the company’s present shareholders, prospectiveshareholders are interested in the current and future level of risk, liquidity, activity, debt and return (profitability). For this reason, the business advisory group is also interested in carrying out performance analysis.

E Employees. Employees (present, past with pension, and potential)), like the shareholders, are concerned with all aspects of the firm's financial situation. Employee representatives (such as trade unions) would need to evaluate the company’s position with regard to negotiating pay rises (pay increments).

There is a big SCOPE of different people who have an interest in the financial standing and performance of a company

EVER ONWARD – EVER ONWARD

That’s the spirit that brought us fame!We’re big, but bigger we will be.We can’t fail for all to see, That to serve humanity has been our aim.Our products are now known in every zone.Our reputation sparkles like a gem.We’ve fought our way through, and newFields we’re sure to conquer too.Forever onward IBM.

IBM Company Song






Reasons why comparisons should be based on companies in the same industry or market

sectorComparison of the company’s performance with that of other companies operating in the same industry or market sector is a significant part of performance assessment. By carrying out inter-firm assessment management is able to (i) compare operating and financial performances and identify strengths and weaknesses in the organisation; (ii) contrast strategic structures and detect threats and opportunities, product-market gaps, competitive moves and market movements; (iii) plot take-over bids, or alternatively plan defensive measures to avert possible take-over strikes by other companies; (iv) assess the company's worth (or the disposal worth of divisions) and (v) view the company through the eyes of interested parties, e.g., the capital market, trade unions, employees and creditors.

Methods of conducting inter-firm comparisons include: (i) subscription to a formal scheme; (ii) informal and internal research (which uses data provided by the relevant trade association and central government); and (iii) benchmarking exercises.

It is centrally accepted that comparisons should be made with companies operating in the same industry or sector for the following reasons.

W Working capital. Different industries have different working capital requirements. For example, the retail sector will have a much lower level of debtors than the manufacturing sector due to the different levels of inventory. Similarly, manufacturing concerns generally require a much greater investment in inventory than do service providers.

A Applicable for the ‘investor group’. Investors often group in sectors, and therefore the internal comparison will be similar to the comparisons made by the company’s investors.

F Fixed costs level. Different industries have different levels of fixed costs. For example, the fixed costs of service providers are generally a lot lower than for companies involved in heavy engineering.

E Earnings volatility. There will be different levels of earnings volatility in different industries and market sectors influenced by seasonal fluctuations and cyclical changes. For example, the furniture retail sector is more influenced by the business cycle (say a downturn in the economy) than the food retail sector.

R Risk. Leading from the last point, business risk is also different between industries making it impossible to compare important performance indicators.

Without inter-firm (or inter-sectional) comparison within the same industry or

market sector the exercise of financial performance analysis is WAFER thin.






The difficulties involved in inter-firm comparison.

The comparison of financial information (such as ratios) from one firm to another, even in the same industry, involves a number of difficulties, particularly in the following.

I Inventory valuation. The method of accounting for inventory (FIFO, average cost, etc.) may vary.

D Depreciation. Depreciation calculations and rates may differ.

E Expenses. When comparison of different items of expense is possible, then there might be inconsistency in the classification of costs under the main headings of operating costs, marketing costs and administration costs, etc. and also in the method of apportioning common costs.

A Asset valuation. Where historical values are used the asset-based ratios will vary according to the average age of the assets held which would be different company by company.

S Several ways of valuing work in progress and finished goods. The cost content of work in progress and finished goods inventory may differ. Some companies will include a share of administration costs, others will cut off at factory cost or include direct costs only.

A number of trade associations or federations have prepared manuals of standard practices in accounting for their members (which are in additional to the GAAP standards) and these help to make reported results more suitable for comparative analysis.

Financial managers need IDEAS on how to make the necessary corrections for distortions caused by lack of uniformity in the way that financial information is reported by different companies.

A problem well stated is a problem half solved.

Charles F. Kettering






MacroeconomicsMacroeconomicsThis involves the study of the entire economy. (For accountancy students, the specific areas are anticipated government/central bank economic policy; and economic events and influences which affect decisions of financial/treasury managers, mainly changes, and anticipated changes in the rates of interest, inflation and currency exchange rates.)

Macroeconomic policyThe conduct of government/central bank policy in such a way as to influence the performance and behaviour of the national economy as a whole.

Macroeconomic models and the forecasts they provide are used by both governments and large companies to assist in the development and evaluation of economic policy and business strategy.

Macroeconomics then is a branch of ‘Economics’ that deals with the performance, structure, and behaviourof the economy as a whole. Macroeconomists seek to understand the determinants of aggregate trends in the economy with particular focus on the following:

N National income (Gross National Product, etc.), projections and targets.

A Aggregate unemployment and regional unemployment and causes of.

T Trends in foreign exchange rates, causes and lessons learned, etc.

I Interest rates and their effect on the economy.

O Outward investment, trends and implications.

N Net trade figures (exports less imports).

A Accrued government debt and current public sector borrowing requirements.

L Level of inflation, causes and implications.

Macroeconomics has a NATIONAL prospective.

Reference:Wikipedia




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Eradicate extreme poverty

Increase/maintain economic

growthAvoid

extreme economic

fluctuations

Sustain a ‘healthy’

(controlled)balance of payments Achieve full

employment

Maintain price stability

ECONOMIC OBJECTIVES OF

UK GOVERNMENT

The economic goals of government

He slept beneath the moon,He basked beneath the sun,He lived a life of going-to-do,And died with nothing done.

James Albery, 1839 – 1889English playwrightEpitaph for himself






Main economic goals of most governments

The main economic aims of government (and the central bank which usually acts as an independent agency) are sixfold:

F Full employment. Government aims to reduce the number of involuntary unemployed people to an acceptable level, or the creation of more jobs. (It is possible to create more jobs without reducing unemployment, e.g. by more school leavers entering the jobs market than new jobs being created.)

I Inflation control and price stability. Government have a continuous policy of containing the rate of national inflation at an acceptable level.

G Growth of gross national product. Economic growth happens when there is an expansion in national income (gross national product) in relation to the size of the population. Measures of national income and output are used in economics to estimate the value of goods and services produced in an economy. They use a system of national accounts (or national accounting) first developed in the 1940s. Some of the more common measures are Gross National Product (GNP), Gross Domestic Product (GDP) and Net National Income (NNI). There are at least two or three different ways of calculating these numbers. The expenditure approach determines aggregate demand (or Gross National Expenditure), by summing consumption, investment, government expenditure and net exports. On the other hand, the income approach can be seen as the summation of wages, rents, interest, profits, non-income charges, and net foreign income earned.

H Healthy, controlled balance of payments. When the balance of visible (trading) and invisibles (investment income) are combined they form what is effectively the nation's current balance of payments.

(i) The capital accountThe flow of investment and capital flows provide (the concept of) a capital account.

(ii) Interaction of the two flowsThe two sets of flows are likely to move in the same direction, e.g. a balance of payments surplus would be taken as a sign of economic strength by other countries and attract capital; a deficit as a sign of weakness with money moving out of the currency.

Government/Central Bank policy to counteract these tendencies(i) The Central Bank might raise interest rates in an attempt to counteract the fall in the value of the home currency.(ii) Convincing overseas financiers/merchants that the Government is taking effective action to reverse a weak

economy.(iii) Maintaining controls over the moment of money owned by its own nationals. (An unlikely policy in most countries,

but it can happen.)

T Trim the economy – reduce the economic fluctuations. Unmanaged economies tend to grow in cyclical fashion - periods of recession followed by recovery, then boom. Problems with this economic tendency are:(i) In recession there are unemployed assets and lost output.(ii) In boom the economy is in danger of overheating leading to an increase in demand-inflation, with a consequent

loss of international competitiveness of the nation state.The Bank of England (BOE) (or central bank of most national economies) intervenes to avoid the economy overheatingwith two main policy instruments(i) By increasing the BOE's 'repo' rate of interest(ii) By taking money out of the economy

S Share wealth and reduce extreme poverty. Government policy attempts to eradicate extreme poverty by redistributing factor incomes - normally by transferring funds from profits, rents, interest and wages into social servicespayments, such as unemployment benefits, family aid and so on. The policy is usually achieved by taxation policy e.g., corporate tax, value-added tax (VAT) and personal direct taxes.

The Government FIGHTS hard to improve economic conditions in the country.






Main sources of inflationDemand inflation occurs when demand and purchasing power outstrips (exceeds) the rate of output (supply).

Options for government to reduce demand include: increasing taxation (corporate, VAT, direct taxes) - to cut consumer spending, lowering government expenditure (and lower government borrowing) with the aim of using the multiplier effect

to spread out in reverse. increasing interest rates (Bank of England policy).

Costs rise because of a shortage of factors of supply. Money is such a factor, but there are others, particularly labour. A shortage of labour tends to cause an increase in the level of wages.

Options for government to increase the factors of supply include: de-regulating labour markets (e.g. reducing the

power of trade unions to impose 'closed shops'), encouraging greater productivity, applying controls over wages and price rises

(prices and incomes policy) encourage immigrant labour

Imported inflation is a consequence of prices rising because of the weakening (softening) value of the country's foreign exchange rate against other trading currencies. The result of this is that imports cost more..

Options for government to counter-balance foreign exchange disadvantages include:

appreciation or depreciation of the domestic currency rate (rare),

the Central Bank raising interest rates to counteract fall in currency value,

trying to achieve a balance of trade (imports and exports).

Money supply inflation results from an over expansion of the money supply. (A simplistic explanation of the 'Monetarists' position on the relationship between money supply and the rate of inflation, is that inflation is caused by money supply growth - 'too much money chasing too few goods'.)

Options for government/Central Bank to reduce the rate of money supply growth include:

cutting the public sector borrowing requirement (PSBR), funding the PSBR by borrowing from the non-bank

private sector (which would pull money from other corporate and private investments),

control or reduction of bank lending, using interest rates to deter money supply growth (e.g.

the higher the rate of interest the less attractive investments become; less money would be borrowed and thus 'created').

Expected effect inflation occurs because of an anticipation that inflation will occur within currentwages bargaining and price adjustments. For example, employees negotiating an annual wage settlement who anticipate an increase in inflation during the year ahead would consequently demand a higher rate of wage increase to compensate for this future inflation. In this respect, inflation becomes a self-fulfilling prophesy.

Options for government to reduce the self fulfilling influences include:

pursuing clear policies which indicate its intention to contain/reduce rates of inflation,

not practising 'U-turn' economic policy.

Expectationseffect

inflation

Money-supplyinflation

Imported inflation

Cost inflation

Source of inflation

Demand inflation






Sources of inflationA principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase. Rising prices -inflation - reduces the value of money. Monetary policy is directed at achieving this objective and providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly throughinfluencing the price of money - the interest rate, In May 1997 the Government gave the Bank of England independence to set monetary policy by deciding the level of interest rates ('repo rates') to meet the Government's inflation target - currently 2% (August 2007).

Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy. Price stability is a precondition for achieving a wider economic goal of sustainable growth and employment. High inflation can be damaging to the functioning of the economy. Low inflation can help foster sustainable long-term economic growth.

Financial managers need to be aware of:- the probable level of future inflation, and- the effects on their organisation of likely government (central bank) policies to deal with rising inflation.

There are five types (or sources) of inflation, some of which overlap, which might lead the government (central bank) to pursue deflationary policy:

M Money supply inflation. Money supply inflation results from an over expansion of the money supply. (A simplistic explanation of the 'Monetarists' position on the relationship between money supply and the rate of inflation, is that inflation is caused by money supply growth - 'too much money chasing too few goods‘.) Options for government(central bank) to reduce the rate of money supply growth include:- cutting the public sector borrowing requirement (PSBR),- funding the PSBR by borrowing from the non-bank private sector (which would pull money from other corporate

and private investments),- control or reduction of bank lending,- using interest rates to deter money supply growth (e.g. the higher the rate of interest the less attractive

investments become; less money would be borrowed and thus 'created').

E ‘Expectations effect’ inflation. Expected effect inflation occurs because of an anticipation that inflation will occur within current wages bargaining and price adjustments. For example, employees negotiating an annual wage settlement who anticipate an increase in inflation during the year ahead would consequently demand a higher rate of wage increase to compensate for this future inflation. In this respect, inflation becomes a self-fulfilling prophesy. Options for government to reduce the self fulfilling influences include:- pursuing clear policies which indicate its intention to contain/reduce rates of inflation,- not practising 'U-turn' economic policy.

D Demand inflation. Demand inflation occurs when demand and purchasing power outstrips (exceeds) the rate of output. Options for government to reduce demand include:- increasing taxation (corporate, VAT, direct taxes) - to cut consumer spending,- lowering government expenditure (and lower government borrowing) with the aim of using the multiplier effect to

spread out in reverse.- increasing interest rates (central bank policy, perhaps).

I Imported inflation. Imported inflation is a consequence of prices rising because of the weakening (softening) value of the country's foreign exchange rate against other trading currencies. The result of this is that imports cost more. Options for government to counter-balance foreign exchange disadvantages include:- appreciation or depreciation of the domestic currency rate (rare),- the central bank raising interest rates to counteract fall in currency value,- trying to achieve a balance of trade (imports and exports).

C Cost inflation. Costs rises because of a shortage of factors of supply. Money is such a factor, but there are others, particularly labour. A shortage of labour tends to cause an increase in the level of wages. Options for government to increase the factors of supply include:- de-regulating labour markets (e.g. reducing the power of trade unions to impose 'closed shops'),- encouraging greater productivity,- applying controls over wages and price rises (prices and incomes policy).- encourage immigrant labour.

‘MEDIC’, may have no word association with ‘inflation’ but high levels of inflation are unhealthy for an economy..






Government policy: Full employmentThe Government aims to reduce the number of involuntary unemployed people to an acceptable level, or the creation of more jobs. (It is possible to create more jobs without reducing unemployment, eg by more school leavers entering the jobs market than new jobs being created.)

G Growth in private sector. Encouraging growth in the private sector.

E Encouraging training in job skills.

T Training grants to employers in selected regional areas.

S Spending money directly on jobs, e.g. employing more civil servants.

T Trade union ‘closed shops’ agreements disallowed or discouraged.

H Higher education and university places made available.

E Encouraging labour mobility.

M Minimum wage legislation. Careful balancing of minimum-wage legislation.

Memory jog: Government policy ‘GETS THEM’, (people) into work.




ACCA Paper F9 Mnemonics Revision (Sample Download)

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