Introduction
Competent financial management is critical to the success and survival of a wide variety of organizations. In the business community, selecting the chief financial officer for advancement to chief executive officer has become increasingly common. For non financial executives and managers, an understanding of the basics of financial management has become even more important during the current era of economic uncertainty. Adequate financial planning is a key element in the success of any business venture. Conversely, the lack of adequate financial planning is often a key element in the failure of many business enterprises. The objectives for both short-term and long-term planning are the same, and the techniques employed differ primarily in the degree of detail developed in the analysis. Both types of planning have as their overriding objective the development of a financial planning and control system to guide the financial future of the firm (Droms 1997). All kinds of firms need to make sure that their finances are well managed. The finances are used to pay for everything that helps the firm operate. It is used to pay for materials and resources used by the firm. Just like other companies Northern PLC has strategies to ensure that their finances is well managed but there are some deficiencies on deficiencies in the financial management systems of the company. There were already some discussions with the divisional heads on the key areas for improvement. There were some key areas for improvement that can help the firm in its financial management systems. This paper intends to discuss about the different things that can be done to counter the deficiencies.
Overview of market efficiency
The role of capital markets
Integration with the global markets and institutions tends to speed up the reform process to achieve a resilient financial system. Summing up these arguments, it can be concluded that the emerging market economies have benefited from financial liberalization in two ways. The first was by having an increased access to the global pool of capital, which helped to raise the level of investment and output. The second channel of benefit was improvement in the efficiency of capital allocation. Both of these are known to underpin economic growth (Das 2004). This logic in the international economics literature as well as in the capital market literature is based on the view that market failures and distortions pervade capital markets around the world. Although capital account liberalization is subsumed in financial liberalization, it has been an important issue for the emerging market economies, and deserves to be analyzed as a distinct policy move. In the wake of the recent economic and financial crises in several emerging market economies, capital account liberalization has taken on additional importance. Some of the blame for the recent crises has attached to premature or poorly sequenced liberalization of the capital account (Das 2004).
The capital account is liberalized by removing statutory restrictions on cross-border global capital flows, which in turn is an important facet of general financial liberalization. It entails the relaxation or removal of controls on transactions in the capital and financial accounts of the balance-of-payments. One of the most important removals of restriction is on the convertibility of foreign exchange. The financial markets detect an environment of unsound fundamentals; exchange rate inflexibility at an unsustainable level, or other financial and systemic limitations, the impact is generally pernicious. For market perceptions, perception is reality. A change in market sentiment can lead to the drying up of global financial flows, recession, exchange rate depreciation, and interest rate hikes. The decade of the 1990s suffered a spate of speculative attacks on emerging markets as well as matured industrial economies (Das 1993).Speculative attacks are squarely based on market perceptions and the presence of imperfections in the global financial markets. The presence of institutional investors in the global financial markets exposed the emerging market economies to further vulnerability. Institutional investors and currency speculators could potentially take substantial short positions in a weak currency. It was observed during the recent emerging market crises that as soon as an inflexible exchange rate and other financial sector weaknesses became apparent in an economy, institutional investors and currency speculators were attracted toward it, making a currency crisis imminent (Das 1993). The capital market is a market where a company and a government can raise funds that will be used in the long term. Some call it the market for securities. In such market money can be lent for longer periods of time. The capital market can be an additional source of fund for Northern Plc. This can reduce some of the financial management system deficiencies by providing alternative sources of income. Such fund will provide backup funds for the company once they mismanage their current funds and budget.
Levels of market efficiency
When a financial market is informationally efficient, the current price of a security in the market fully reflects all known information, any new information is rapidly reflected in the security price and new information arrives in the market in a random and unpredictable manner. The concept of financial market efficiency is important because it is the share price at any point in time in the market which is used to measure shareholders’ wealth and the value of the firm. Therefore it is necessary that the share price should be a fair reflection of the firm’s value. This does not imply that the share price, or the price of any other security traded in the markets, will always be perfectly correct but that the market price does at least represent an objective evaluation of the share’s true value. An efficient or competitive market implies that if an investor obtains some new important information about a firm’s future prospects, that investor will act quickly to benefit from this information either by buying or selling the firm’s shares. In a sufficiently competitive market, the firm’s share price will not remain over or undervalued for very long. Other investors will quickly react to take account of any new information which becomes available and either buy or sell the firm’s shares until they believe that its market price is close to its true value (Mcmenamin 1999).
As a result of competitive race between wealth maximizing investors striving to maximize their returns for a given level of risk, the share price will quickly rise or fall to take account of the new information (Shleifer 2000). It is this competition between investors searching for wealth-enhancing investment opportunities which ensure that the market price of a security appropriately reflects its expected future returns and risks and consequently the market value of the firm. In such a competitive market it is not possible for any investor to consistently earn superior returns. The concept of efficiency in financial markets is based on the concept of perfect competition in product markets. For a financial market to be perfectly efficient the following conditions would need to apply: there are no taxes, transaction costs or other barriers to trading; information is symmetrical, that is, every player in the market has equal and free access to the same information at the same time; there are many players, all of whom are rational, and no single player is able to dominate or influence market prices (Shleifer 2000). Market efficiency can be in a weak form, strong form or semi strong form. In a strong form of market efficiency all information whether they are public or private are reflected in share price and excess returns cannot be earned. In a weak form of efficiency historical data or historical share prices cannot be used as basis for predicting future prices. Excess returns cannot also be earned in the long run even if investment strategies are used. In Semi strong efficiency share prices adjust in an unbiased fashion and it adjust very rapidly in publicly available new information. Semi strong efficiency lets excess returns be earned by trading on publicly available new information. It is a goal for firms like Northern Plc to at least have a semi strong form of efficiency so that it can maintain levels of finances that can be used as another alternative source of income. Gaining a strong efficiency for Northern Plc would help a company boost its value.
Implications for the company’s manager and shareholder
A security’s market price at any point in time is a true reflection of its intrinsic value, thus in an efficient market intrinsic value and market value are the same. In an efficient market it is not possible to accurately predict security price movements As security prices already incorporate all past and publicly available information, that is, there is semi-strong from efficiency, then prices will only be affected by new, currently unknown information at some stage in the future if the information was known now it would already be reflected in the security’s current price, it would not be news (Murphy 2000). If future events are uncertain, random and unpredictable then new information will arrive in the markets in an uncertain, random and unpredictable manner. The best estimate of a security’s value is the consensus view of a competitive, efficient market. Thus individual investors performing their own security analysis and trying to beat the market are simply wasting their time. This does not imply, however, that it is similarly a waste of time for investment firms to engage in security analysis. If this activity were to cease then paradoxically markets would no longer be efficient (Murphy 2000). Northern Plc needs to have market efficiency before attempting to correct its financial management system. Once it is efficient enough, the manager can focus on acquiring a strong form of market efficiency and a balanced capital market. The manager should then make sure that all aspects of its financial management system will be adaptable to changes that will be done. The stakeholders should not panic and not do anything that will sabotage the firm’s goal to have an efficient market.
Source of capital available for long term projects
Many economic decisions have a time dimension, which can show up in terms of which agent goes first and which goes second in an economic interaction. The sequence of moves can have a profound influence on an outcome. With the recognition that time matters should come; the realization that inter temporal consequences of transactions matter (Sandler 2001). Unquestionably, any explanation of economic growth or economic sustainability must account for the sequence of decisions. But with the insight that time matters should come the recognition that space also matters. Knowledge and insight can guide the allocation of resources, even if most people, including the country's political leaders, do not share that knowledge or do not have the insight to understand what is happening. Clearly this is not true in the kind of economic system where political leaders control economic decisions, for then the limited knowledge and insights of those leaders become decisive barriers to the progress of the whole economy. Economic decisions are ultimately being directed or controlled by those who have specific knowledge in a price-coordinated economy, while those decisions move in the opposite direction from those with less knowledge, who are giving orders to those with more knowledge in a centrally planned economy (Sowell 2000).
A part of economic decision is where to get the capital. One way of getting capital is through capital investments. Almost all firms recognize that they face major uncertainties about the future, yet most firms' strategic investment decisions are primarily based on a single projection of future events. Although managers do recognize that the failure to include a consideration of uncertainty can lead to costly errors, the difficulty of such planning leads many to ignore the potential costs and hope that serious problems will not arise (Trigeorgis 1995). Suppose a company is considering a strategic decision, such as building a large now plant or embarking on a large research project. Major projects such as these require significant commitments of both capital and managerial attention. The reward from the project depends not only on its technical success, but also on the market conditions and industry structure at the time of completion. Uncertain future developments and the firm's response to these developments can turn such projects into either resounding successes or abysmal failures. However, managers are often baffled by the question of how to include uncertain future outcomes and potential future strategic responses in a prospective analysis of a capital investment project. The actual staging of capital investment as a series of outlays over time creates valuable options to default at any given stage (Trigeorgis 1995). Engaging in investment projects is vital for the growth of the firm. It serves as way for the firm to gather the capital it needs. Investment capital is a long term source of capital since it is a process that cannot dwindle immediately and can adapt to changes in the environment. The problem with such kind of source of capital is the level of capital that can be acquired once there is a chance in the environment. Such source of capital is affected by any change in the environment thus the firm will have not acquire any permanent amount of capital that it can use to change its financial management system.
Dividend decision
The dividend decision is an integral part of the firm’s strategic financing decision. It essentially involves a firm’s directors deciding how much of the firm’s earnings, after interest and taxes (EAIT), should be distributed to the firm’s ordinary shareholders in return for their investment in the firm, and how much should be retained to finance future growth and development. The objective of the firm’s dividend decision, like all financial decisions, should be the maximization of shareholder wealth (Leuz, Hopwood, & Pfaff 2004). Although how, if at all, the dividend decision affects shareholder wealth is a highly contentious point. If an optimal dividend policy does exist then clearly managers should concern themselves with its determination; if it does not, then any dividend policy will do, as one policy will be equal to another. It should be noted that the dividend decision and dividend policy relate only to ordinary share capital. The payment of preference share dividends is not considered part of a firm’s dividend policy, as the level of, or method of calculating, the preference dividend is fixed in advance by the terms and conditions of the original preference share offer (Leuz, Hopwood, & Pfaff 2004).
Once a dividend policy has been formulated, setting out the amount and timing, etc. of dividend payments, it should be followed with stability and consistency as its guiding principles. In practical terms a firm’s dividend payment is important to its shareholders. It is part of the return which shareholders receive for their investment in the firm. The dividend payment is also a favored method by which shareholders and investors estimate a firm’s share value, where the value of a share is equal to the present value of the expected future dividend payment (Da Silva, Goergen & Renneboog 2004). Dividend decision is known as the amount and timing of cash given back to the stakeholders. It may influence the firm's stock price and capital structure. It gives an idea of what taxes a stockholder might pay. In most cases the dividend given by the firm is constant for every stockholder. The dividend decision is affected by Free-cash flow; Dividend clienteles and Information signaling. With dividends and decisions related to it the firm can gain higher stock price. As the company’s stock price rises, its value rise and this can be used to gather more clients to gain more income. Dividend can help the firm gather the needed resources to change its financial management system.
Conclusion
To change the financial management system, Northern Plc needs to make sure that it has a strong market. It should have capital markets and capital investments that will serve as a source of funding. The firm then need to make the best dividend decision to make sure that thee sources of funding would not be loss. If all these things are working well, the firm can then focus on adjusting the different aspects of its financial management system. It can use the changes to observe how the flow of cash goes within the company, what is the main problem, how it can be solved and will there be any need for the funding for the change in the financial management system.
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