The Advanced Financial Management exam at Strategic Professional follows on from the Financial Management exam at Applied Skills. As throughout the ACCA syllabus, the underlying exam covers the main technical areas that all accountants are required to master, whereas the Strategic Professional exam builds on that knowledge and explores advanced skills and techniques.
In particular Advanced Financial Management expects candidates to have more depth of knowledge, better analytical skills, and to be able to exercise greater professional judgement than at Financial Management. Hence, instead of being asked to value a bond, a potential Financial Management question, candidates will need to be able to recognise the need to calculate a bond value given the scenario. For instance candidates may be required to evaluate the potential gain to the shareholders of a target company, of various offers from a predator company. If one of these offers includes bonds then the value of the bonds will need to be calculated, unless of course it is given in the question.
Another key distinction between Financial Management and Advanced Financial Management is that in general the scenarios that candidates will be faced with will refer to larger, more complex and more international organisations. A calculative example of this is the need to be able to appraise projects carried out overseas whereas a discursive example is the need to be able to discuss the role of key international organisations such as the International Monetary Fund.
WHAT IS THE KEY KNOWLEDGE I NEED TO BRING FORWARD FROM FINANCIAL MANAGEMENT AND HOW MUST I DEVELOP MY KNOWLEDGE FOR ADVANCED FINANCIAL MANAGEMENT?
In this section I will consider each of the key topics within Financial Management and give some thoughts on what remains crucial and how it is developed further in Advanced Financial Management. Given the constraints of this article please do not consider this list to be exhaustive.
THE FINANCIAL MANAGEMENT FUNCTION
This topic comprises knowledge that must be retained and developed as it will often help candidates generate relevant points in discursive questions. Candidates should remember that the overarching aim of their recommendations and decisions should be to add value to a business. In particular candidates should recognise the responsibility financial managers have to all stakeholders when they take decisions. Hence, decisions should be taken with due regard to ethical, environmental and stakeholder concerns and, hence, the potential impact on the reputation of the business. Additionally the strategic impact of Financial Management decisions and modern developments in Financial Management become important in Advanced Financial Management.
THE FINANCIAL MANAGEMENT ENVIRONMENT
This topic also comprises knowledge that must be retained and developed. Financial managers must understand the environment in which they work if they are to take suitable decisions. At Advanced Financial Management an up-to-date understanding of the macroeconomic environment and the operation of those financial institutions that govern trade and the operation of the global financial markets is essential.
WORKING CAPITAL MANAGEMENT
At Advanced Financial Management it is unlikely that there will be questions regarding the detail of how each element of working capital could be managed. However candidates should remember the key questions regarding how much should be invested in working capital (the profitability/liquidity trade off) and how the working capital investment could be funded. Equally the ability to calculate the relevant working capital ratios and the operating cycle and discuss their significance should be retained.
This topic remains core. Out of the investment appraisal methods learnt at Financial Management the discounted cash flow methods and in particular Net Present Value are the most important. Key new techniques in Advanced Financial Management include Modified Internal Rate of Return, the Adjusted Present Value approach and the ability to calculate the NPV for an overseas project. Additionally students should also be able to understand the use of Value at Risk and how Linear Programming can be used to solve a multi-period capital rationing problem. However actually solving the Linear Programming problem is beyond the syllabus.
BUSINESS FINANCE – INCLUDING THE COST OF CAPITAL
With regard to Business Finance the knowledge developed at Financial Management needs to be retained and developed. However as previously mentioned the focus in Advanced Financial Management will be on larger, more complex and more international businesses. Hence, a past exam question asked students to consider the ability of a company to pay its desired dividend given that the profits were being earned in a number of different countries with different tax rates and that transfer prices were being charged between some of those divisions. Additionally students need to understand and discuss how an acquisition could be financed.
With regard to the Cost of Capital the key knowledge to be brought forward is the Capital Asset Pricing Model including de-gearing and re-gearing, and the calculation of a Weighted Average Cost of Capital. The detailed calculations for calculating the cost of debt are rarely used in Advanced Financial Management. Instead candidates need to be able to calculate a cost of debt using credit spreads expressed in basis points. Advanced Financial Management also requires candidates to be able to use the Miller and Modigliani Proposition 2 (with tax) formula to de-gear and re-gear a cost of equity. De-gearing and re-gearing in order to calculate a suitable cost of equity for the given scenario is an area which has been much examined in Advanced Financial Management. Hence, it is an area well worth mastering.
While everything from Financial Management remains examinable, the key valuation methods to remember are the free cash flow and price earnings methods. Furthermore the ability to forecast growth using past growth or Gordon’s growth approximation remains important as growth is a key driver of value. This knowledge is then used in Advanced Financial Management when considering mergers and acquisitions and corporate reconstructions. Additionally candidates should be able to value intangible assets, although as yet this has not been examined to any great extent.
With regard to mergers and acquisitions candidates at Advanced Financial Management should be able to distinguish between the different acquisition types and carry out appropriate valuations and evaluate bids being made for a company from the point of view of the various interested parties. Equally candidates need to be able to discuss the rationale for such transactions and the actions a company could take to defend itself against a takeover bid.
With regard to corporate reconstructions candidates at Advanced Financial Management need to be able to understand and discuss the potential causes of financial distress and failure and how the risk of failure can be evaluated. The basic process that is likely to be used in any reconstruction should be understood as this will help candidates better understand the scenario of a question and what they are required to do in the question. Candidates should understand the various types of business reorganisation, such as demergers, and discuss and evaluate a potential Management Buy-Out. Demergers have arisen in a couple of recent exams, and there is a common misconception that demerged companies are still controlled by the same senior management which is simply not the case.
In Financial Management the focus is on foreign exchange risk and interest rate risk. While these remain important in Advanced Financial Management candidates should learn to think about risk more broadly and be able to identify a great variety of risks from a scenario and suggest ways in which they could be managed and mitigated.
With regard to foreign exchange risk candidates must remember what they learnt at Financial Management. A past exam question in Advanced Financial Management required candidates to consider the various types of foreign exchange risk that exist which is very much a Financial Management topic. Additionally a key skill that candidates must bring forward from Financial Management, or relearn, is the ability to successfully convert from one currency to another as candidates without this skill will always struggle to score well on a calculative foreign exchange risk question. Having been briefly introduced to futures, options and swaps at Financial Management candidates for Advanced Financial Management need to learn how to carry out the necessary calculations for these instruments. This is a tricky, but commonly examined area.
The situation with interest rate risk is similar. As well as remembering their knowledge from Financial Management candidates for Advanced Financial Management must also learn the detailed calculations required for futures, options, collars and swaps.
THE BLACK-SCHOLES OPTION PRICING MODEL
The Black-Scholes option pricing model is a key new skill that has to be mastered for Advanced Financial Management. Candidates must ensure that they can use the formula to confidently and accurately value an option. Furthermore candidates must understand the various determinants of option value and the various sensitivities such as delta and the other ‘Greeks’. Indeed candidates also need to be able to use delta to set up suitable hedging strategies. The use of the Black-Scholes option pricing model to value real options also needs to be understood.
The Black-Scholes option pricing model can arise in a multitude of questions. A question could require the valuation of a financial or real option followed by related discussion and analysis. Equally a project could have an embedded real option which needs to be valued in addition to carrying out the usual project appraisal. Additionally candidates should be able to discuss other uses of the model such as how it can be used to value the equity of a company.
HOW TO STUDY ADVANCED FINANCIAL MANAGEMENT
Initially candidates for Advanced Financial Management must ensure that they remember or revise the key knowledge from Financial Management as well as studying the new topics and techniques required for Advanced Financial Management. While doing this candidates must make sure that they become confident with all the formulae given in the formula sheet provided. Any formula provided is likely to be of importance but candidates very often seem unable or unsure how to use them. Equally candidates must make sure that they can use their calculator quickly and confidently and get correct answers to their calculations. It is not uncommon for students to show a formula with all the correct inputs but calculate an incorrect answer.
Candidates should not spend excessive amounts of time studying the necessary topics as you will pass Advanced Financial Management by applying your knowledge to the questions set, not by rote learning. Hence, as soon as possible candidates should be working past exam questions as this is how the application skills are learnt. Initially this is difficult as many questions (especially those in Section A) will require knowledge from a number of topic areas. However candidates must persevere as it is by doing questions that they will pass the exam.
Initially when working questions candidates may find that they need to refer to their notes or textbooks or even have a very brief look at the answer to get them moving in the right direction. However candidates must learn to tackle the question themselves and must avoid becoming expert at ‘auditing’ the examiners answer. I have never seen an exam question where candidates are given the answer and asked to check it!
When working questions candidates should train themselves to use rounding in their calculations as this saves time. A candidate who answers all the questions but whose answers are more rounded than the printed answers is much more likely to pass than a candidate who provides more detailed answers to only a few questions. Equally using rounding keeps the numbers small and, hence, silly calculation errors are less likely to arise. Furthermore candidates should learn to give some sort of brief explanation of their calculations where necessary. All too often markers are faced with large calculations which have inevitably strayed from the model answer and, hence, are incorrect. If there is no explanation as to what the candidate was trying to do or thought the answer was showing it is very hard for credit to be given. If there is a bit of explanation then, so long as sound financial management techniques have been used, credit can be given to such answers.
With regard to the discursive elements of questions candidates must train themselves to write brief concise points in short sentences. Candidates should aim to make as many different points as the marks available. Equally there will always be more credit given to points which relate to the scenario and which truly add value. Indeed a list of points not related to the scenario is unlikely to earn enough marks to pass. There is no point repeating the same point or explaining it in huge depth. Showing you have breadth of knowledge is crucial.
Within the exam there will be four professional marks available. Typically the Section A question requires you to draft a report. Candidates must make sure that they learn how to earn these marks as they could easily make the difference between a pass and a fail. Assuming a report is required then candidates should:
- Show the bulk of the necessary calculations in an appendix. Very often you need to do the calculations before writing the report. Hence, the examiner is quite happy that the appendix comes first as he understands the constraints of the answer booklet you are provided with.
- Start the report on a new page as this looks professional and means that you will have some spare space in your appendix should you suddenly decide you need an additional calculation.
- Show a brief but good report rubric showing who the report is to and from, the date and the subject.
- Start with a brief introduction. Keep it short as your marker knows what the report is about!
- Structure your answer. Use sub-headings which indicate which requirement you are currently dealing with and keep your sentences and paragraphs short and easy to read. Don’t let yourself ramble.
- Leave blank lines between your paragraphs as it looks, and is, much more professional and is easier for your marker to read.
- Finish with a brief conclusion.
- Keep your writing as neat as possible.
As your skills develop you should aim to start working questions to time. If you always give yourself the luxury of additional time before the exam you will not be able to complete the exam in the time required.
By working questions in this way candidates will not only learn how to apply their knowledge, but will also learn the nature of their examiner and what he is looking for. Indeed students must learn to read the questions carefully. Especially when a question is dealing with a tricky area the scenario and requirement often provides a significant amount of information as to how the question should be answered. I would also recommend that candidates read a couple of past examiner’s reports and the examiner’s approach article in the examiner’s guidance section of the Advanced Financial Management pages on the ACCA website. By doing this you will learn more about what the examiner is looking for and what he likes and does not like.
At the same time as learning the necessary topics and working questions candidates should be reading around the subject using the financial press and the technical articles shown on the Advanced Financial Management pages on the ACCA website. Taking an interest in the subject can pay real dividends in the exam as a candidate who has been reading about real world mergers and acquisitions is in a far better position to understand the scenario set in in a mergers and acquisitions question and will also be far more able to come up with ideas relevant to the scenario.
As the exam approaches candidates should avoid question spotting. The examiner is keen that candidates do not pass when they have only mastered a few selected topics and sets the paper accordingly.
Finally, prior to going into the exam candidates should decide their exam technique. How much time should they spend reading the question and planning their answer? What order will they attempt the questions in? I believe exam technique is very individual and candidates should decide what will suit them best given their nature and based on their past experience. I would however advise against leaving the Section A question until last as achieving a reasonable mark in this question is so fundamental to achieving a pass.
WHAT TO DO IN THE ADVANCED FINANCIAL MANAGEMENT EXAM
In the Advanced Financial Management exam students should:
- Avoid panic – I often think that candidates who fail, when they have the knowledge to pass, do so because they end up in a panic. While it may be hard to avoid, knowing your exam technique and sticking to it can help avoid panic. Additionally remember that while the exam is designed to test you and the scenario may be very different to anything you have tackled before the solution must use the tools that you have learnt.
- Read and think carefully about a question before starting it – Too often candidates seem to waste valuable time making a false start on one or more questions.
- Don’t give up – In calculation questions there are always easy marks available and if you give up you will miss out on them. For instance in a Net Present Value question make sure you get the marks for discounting the net cash flows and adding them up and making the basic conclusion as to whether or not the project seems acceptable. If necessary make assumptions. If you need to calculate a Weighted Average Cost of Capital but cannot see how to calculate the cost of equity you should simply assume a sensible number. While you will have lost some marks you can at least continue with the question. In discursive questions even if the situation is something you have never thought about before try to think what you could say that would be useful or would add value.
- Maintain good structure – Keep your answers as neat as possible and keep your sentences and paragraphs short and meaningful.
- Timings – Make sure you allocate sufficient time to each question. As soon as you do not have a fair attempt at three questions your chances of passing start declining rapidly.
- Rounding – Use rounding to keep your calculations simple and save time. Equally save time by not writing out formulae unless you really need to – you win the mark by using the formulae!
- Professional marks – Make sure you get as many of them as possible.
Unfortunately, Advanced Financial Management earned the reputation of being a very hard paper to pass. While it remains a testing paper, a candidate who prepares well and tackles the exam in a sensible fashion should be able to pass. Candidates should try and be confident and treat the exam as their chance to show off the knowledge and skills they have acquired.
William Parrott, freelance tutor and senior FM tutor at MAT Uganda