The Nature and Purpose of Financial Management

Every business, from a trader in Onitsha to a listed manufacturer in Lagos, has to answer the same questions about money. How much does it need, and for what? Where will the money come from, and at what cost? What will it do with the profit it makes: pay it out or reinvest it? And how will it protect itself from changes in prices, interest rates and exchange rates?

Financial management is the part of management that answers these questions. This topic explains what financial management is, the decisions it covers, how it differs from and relies on financial accounting and management accounting, and how a business turns a general purpose into a measurable financial objective and a plan. The next topic covers the main financial objectives of a company.

The subject builds on what you learnt in Management Accounting, which supplies the cost and budget information that most financial decisions use. The paper is a calculation-and-application paper: the compulsory question and most of the others ask you to apply a technique to a business and advise, so the purpose of every technique in the course is to help one of the decisions described here.

What financial management is

Financial management is the aspect of management which involves planning and controlling the financial affairs of an organisation to ensure that it achieves its objectives. The word “financial affairs” is wide. It includes the money coming in from owners and lenders, the money tied up in assets and day-to-day operations, the money paid back to investors, and the risks that the value of that money will change.

The people who do the work include the finance director, the treasurer (who deals with funding, cash and risk) and the controller (who deals with reporting and control). But every manager who commits money takes part in financial management.

The decisions of financial management

Financial management involves decisions about:

• How much finance the business needs, for day-to-day operations and for longer-term investment projects (the investment decision and the working capital decision).
• Where the finance should be obtained: long term (equity or debt) or short term (trade suppliers and bank overdrafts) (the financing decision).
• How to manage short-term cash surpluses and deficits: investing surpluses and covering deficits (the cash management decision).
• How much to pay as dividends and how much to retain (the dividend decision).
• How to protect the organisation against financial risks, such as changes in interest rates and exchange rates (the risk management decision).

The decisions are linked. A decision to invest requires finance, the cost of finance is the hurdle the investment must clear, the dividend decision determines how much finance is generated internally. The choice of finance affects the risk to shareholders. This is why the syllabus is arranged around these areas: function and environment, working capital, investment appraisal, business finance, valuation and risk management.

The decisions in numbers

A company is considering a project that costs ₦200 million and will bring in ₦60 million a year for five years. Its cost of capital is 12%. The investment decision: present value of the inflows is ₦60m × 3.605 (the five-year annuity factor at 12%) = ₦216.3m, so the net present value is ₦216.3m − ₦200m = ₦16.3 million, which is positive.

The financing decision: the ₦200m is raised half from equity at 16% and half from debt at 12% before tax, which is 12% × (1 − 0.30 tax) = 8.4% after tax, so the average cost is 0.5 × 16% + 0.5 × 8.4% = 12.2%, in line with the 12% used. The dividend decision: profit after tax is ₦90m. A payout of 40% gives a dividend of ₦36m, leaves ₦54m retained, and the dividend is covered 2.5 times; with 120 million shares the dividend per share is 30 kobo.

Financial management, financial accounting and management accounting

• Financial accounting is mainly concerned with preparing financial statements for shareholders and other external users. It reports the historical results of past plans and decisions, and its focus is external reporting.
• Management accounting provides information for the daily control and decision making of internal users: financial and non-financial information to help management plan and control the organisation’s resources. Its focus is internal reporting.
• Financial management is focused on managing the organisation’s finance: raising finance and making sure it is used efficiently and effectively, with the effective allocation of resources. It assists both internal and external users.

They share principles and information. The ratio analysis of the financial statements is used by financial management to advise investors on the viability of the organisation. The budgeting process from management accounting supports financial management in strategic planning. Long-term investment appraisal is an area where management accounting and financial management overlap.

And all three play a part in working capital management: management accounting supplies information on inventory, receivables and other components, financial accounting handles the day-to-day records of trade receivables, and financial management is concerned with the efficient management of working capital as a whole.

Corporate and financial objectives

Every organisation exists for a purpose. Objectives explain what an organisation is trying to achieve and strategy is concerned with how it will achieve it. A corporate objective is the major purpose that the organisation is trying to achieve. The main objective of a company might be to maximise the wealth of its owners, its equity shareholders.

The main objective of a state-owned organisation might be to provide a certain standard of public service, and that of a charity to fulfil its charitable purpose. When the main objective is not financial, there is always a financial constraint on it, such as providing the best possible service with the available funds.

A corporate objective is usually expressed as a financial objective: a specific, measurable, achievable, relevant and time-bound (SMART) goal that the organisation seeks to accomplish through financial management. For example, “increase earnings per share from 45 kobo to 54 kobo within three years” is specific (earnings per share), measurable (54 kobo), achievable (a rise of 20%, which is about 6.3% a year compounded), relevant (shareholder wealth) and time-bound (three years).

The strategic process

1. Identify the corporate objective, usually a financial objective.
2. Establish targets for the financial objective.
3. Develop business strategies for achieving the objective and targets.
4. Convert the strategies into action plans (budgets, projects, responsibilities).
5. Monitor performance against the targets and take corrective action.

Identifying the primary objective is therefore the starting point for the strategy. Without it, the company cannot say which investments are worthwhile, which finance is suitable or how much to pay out.

The ideas in more depth

Why finance is a management function and not only a department

Almost every operating decision commits money: hiring, buying machinery, extending credit, entering a market. Financial management supplies the framework for making those commitments consistently, by relating them to the objective and to the cost of the finance they use. A department of specialists runs the function, but the thinking is used throughout the business.

Why an objective must be measurable

A purpose such as “to be successful” cannot guide a decision between two projects. A target such as a return above the cost of capital, or a growth in earnings per share, can. Measurability also allows management and shareholders to judge whether the objective has been achieved, which links to the later topics on agency theory and the evaluation of objectives.

Sources and references

• No accounting standard governs this topic. It rests on the principles of corporate finance and management, as in the Institute’s Financial Management syllabus, area A.

These points are stated as at 5 November 2026.

Worked examples

1. Present value.
   ₦60m × 3.605 = ₦216.3m.
2. NPV.
   ₦216.3m − ₦200m = ₦16.3m: accept.

1. After-tax cost of debt.
   12% × 0.70 = 8.4%.
2. Average cost.
   0.5 × 16% + 0.5 × 8.4% = 12.2%.

1. Total growth.
   54 ÷ 45 = 1.20, a rise of 20%.
2. Annual growth.
   1.20^1/3 − 1 = 6.3% a year.

How to answer in the exam

• Define the term in one sentence and then give the content, as in the list of decisions.
• Link each decision to the techniques in the syllabus (for example investment decision: net present value).
• Distinguish the three roles by user, time orientation and purpose.
• Apply to the scenario: name the objective and say how the proposal contributes.

Common mistakes in the exam

• Describing financial management as keeping accounting records.
• Leaving out the dividend decision or risk management.
• Saying that financial accounting is forward-looking.
• Writing objectives that are not measurable.
• Forgetting that non-financial organisations face a financial constraint.
• Listing the strategic process steps in the wrong order.

Quick revision

• Decisions: investment, financing, dividend, working capital and cash, risk.
• Financial accounting: external, historical. Management accounting: internal, planning and control. Financial management: raising and allocating finance.
• SMART: specific, measurable, achievable, relevant, time-bound.
• Process: objective, targets, strategies, action plans, monitoring.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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