Updated: Aug 18, 2020
ACCA SBL exam started its first attempt in September 2018. I review all published past papers and examiner’s reports. One of my observations is financial management (FM, was F9) topics are seen quite often. It implies a revision of key topics in financial management would be helpful for students to pass SBL exam in future.
In the latest SBL study support guide published by ACCA, it specifies SBL exam contains knowledge and skills in prior level exams what is called underpinning knowledge.
However, this underpinning knowledge and skills are not re-examined in the same level of detail in SBL. Therefore, you no need to go back and re-study large parts of those exam materials in detail or even spend time to practice those exam questions.
What you need to do is to refresh gaps in knowledge from those exams when you come across them in your SBL studies and focus on SBL question practice that relevant to those knowledge.
In this article, I will base on the published SBL materials, such as past paper, examiner’s reports and guidance, to advise what are important in financial management in your SBL studies.
Financial management questions found in ACCA SBL past exams
In the past three SBL exams, I see three financial management topics were tested, namely, investment appraisal, cost of capital and financing (e.g. gearing). A summary below helps you to get the ideas quickly –
Surprisingly, a few number of students did not demonstrate their knowledge in investment appraisal and cost of capital. They had very little to write about investment appraisal method, such as discounted cash flow analysis, and earned very little marks.
In March 2019, examiner’s report clearly stated the key problems with a question relevant to financial management as below –
Lack of basic financial management knowledge;
No evidence of scepticism over the assumptions that underpin the logic behind the analysis;
Stating the obvious but not developing it further.
To refresh your financial management knowledge for SBL exam, here I pick the key financial management topics to share with you.
Capital investment is a key element in financial management and a thorough understanding of the techniques of investment appraisal is very important. Textbooks compare non discounted cash flow methods (namely payback and ARR) with the discounted cash flow methods (namely NPV and IRR), concluding that NPV is the best.
Net present value is just the present value of all cash flows, discounting using cost of capital. Cost of capital is simply the opportunity cost of using the company source of finance in the project, or simply the expected rate of return an investor required for him to invest his fund in the project.
If the project NPV is positive, that means the project return is higher than the expected required return by investors and as such the project should be accepted. This positive NPV project is said to have increased the investors wealth in the company. On the other hand, project should be rejected if the NPV is negative.
Benefits of NPV methods –
Its rule takes into account the time value of money of cost of capital in evaluating project;
It has a direct impact on companies share prices. When a company accepts project with positive NPV, the share price of the company normally rises and vice versa for negative NPV project. Thus, NPV method helps to increase shareholders wealth;
It uses relevant cash flows in it’s project evaluation, thus not affected by accounting profit manipulation problem;
It is perhaps the most sensible method of appraisal among all methods.
In addition to NPV method, Internal Rate of Return (IRR) and Discounted Payback are another popular discounted cash flow methods in investment appraisal.
IRR is defined as the discount rate which results in zero NPV for a particular project. The decision rule now become – accept the project if its IRR is greater than the cost of capital, reject the project if the IRR is less than the cost of capital.
However, in some complex cash flow pattern, there may be multiple IRRs which leads a problem in decision making.
Payback method determine how long will a project “payback” its initial investment. It concentrates on cash flow instead of on profit. It is suitable for evaluating projects with uncertain duration with high research and development cost which need to be recovered as soon as possible.
If the cash flow is discounted by cost of capital, it considers time value of money in investment appraisal but it cannot tell how much of shareholder value added.
Dealing with uncertainty in investment appraisal
It is quite often to see SBL exam materials showing you different scenarios or uncertainty in cash flow forecast. If it is the case, discounted cash flow analysis is still possible but more works are required. Sensitivity analysis and expected value with assigned probabilities are methods dealing with uncertainty in investment appraisal.
Sensitivity analysis looks at each input variable in turn to calculate how sensitive the NPV is to any change in that variable. The procedures involving the change to an input variable (or even two or more input variables) such as life of the project, capital cost, etc and to observe the effect on the output such as NPV, contribution, etc.
The starting point for a sensitivity analysis is the NPV using the most likely value or best estimate for each key variable. Taking the resulting `base case’ NPV as a reference point, the aim is to identify those factors which have the greatest impact on the profitability of the project if their realised values deviate from expectations. This is done by finding the input values required to make NPV = 0.
Another way of dealing with the uncertainty of future cash flows is to assign probabilities of occurrence to them, and calculate the expected cash flows and expected NPV. Therefore, in your exam if probabilities are given, just simply calculate the expected cash flow for the variable where probabilities are assigned to, and proceed your answer as usual.
Cost of capital
To use the NPV rule we need a discount rate in order to obtain present values. The discount rate used is actually the company’s cost of capital.
Capital provided by investors in the company may be classified into equity capital and debt capital. Equity capital consists of all ordinary shares, while debt capital consists of all capital, which commits the company in paying them a fixed amount each period, thus an obligation by the company.
Based on this concept, cost of capital applied to discount project cash flow should be a weighted average of both cost of equity and cost of debt.
In ACCA Financial Management (FM, was F9), a formula sheet is provided during exam. It is good to refresh your memory here –
The idea is that this rate is used to calculate the NPV of the project. If the NPV is positive then the project will generate sufficient cash flows to pay to the providers of the capital used to finance it the return that they require and then a bit extra (the NPV). The extra accrues to the ordinary shareholders. This means that the project will pay a return in excess of that which the shareholders require.
Gearing and liquidity
A question in September 2018 SBL exam asked students to analyze the financial and non-financial issues about accepting a very large contract. Regarding to the financial issues, they are relevant to liquidity and gearing which I would like to tell you their principles as below.
Gearing: non-current liabilities ÷ ordinary shareholders funds % (this is sometimes described as the debt to equity ratio)
Also known as leverage. Capital gearing looks at the proportions of owner’s capital and borrowed capital used to finance the business. A large proportion of borrowed capital is risky as interest and capital repayments are legal obligations and must be met if the company is to avoid insolvency.
Gearing relates to an organisation’s ability to meet its long term debts.
For liquidity, two ratios are common in the measure –
Current ratio: current assets ÷ current liabilities
Quick ratio (or Acid test): (current assets – inventory) ÷ current liabilities
Liquidity measures the ability of the organisation to meet its short-term financial obligations.
The simple rule is higher the ratios (current ratio or quick ratio), higher the liquidity of a corporation. In practice a company’s current ratio and quick ratio should be considered alongside the company’s operating cash flow.
Financial management is a popular topic to be seen in SBL exam. As shared above, investment appraisal, cost of capital and financing were found in past SBL papers.
You no need to open your financial management textbook and read all chapters again. The level of details is not the same as what you did in financial management exam. What you only need to do is refresh your knowledge and attempt SBL questions.
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