Examiner’s report

Financial Management (FM)

July 2020

The examining team share their observations from the marking process to highlight strengths and
weaknesses in candidates’ performance, and to offer constructive advice for future candidates.
This report should be used in conjunction with the published March/June 2020 sample exam. Due
to the COVID-19 pandemic, the June 2020 exam was postponed and sat in July 2020. This report
labelled July 2020 refers to this exam.

General comments

The Financial Management (FM) exam is offered as a computer-based exam (CBE). The model of
delivery for the exam means that candidates do not all receive the same set of questions. In this
report, the examining team share their observations from the marking process to highlight
strengths and weaknesses in candidates’ performance, and to offer constructive advice for future
candidates.

• Section A objective test questions – we focus on two specific questions that caused
difficulty in this sitting of the exam.
• Section B objective test case questions – here we look at the key challenge areas for this
section in the exam.
• Section C constructed response questions - here we provide commentary around some of
the main themes that have affected candidates’ performance in this section of the exam,
identifying common knowledge gaps and offering guidance on where exam technique could
be improved, including in the use of the CBE functionality in answering these questions.

Congratulations to those candidates who were successful in this examination diet. If you were not
successful, I hope that you will study the content of this report carefully as part of your preparation
for your next attempt.

Performance in the July 2020 examination diet was generally satisfactory and there were some
very good individual performances in all questions. That said, it is disappointing to see that once
again some candidates were inadequately prepared for the Financial Management examination.
As has been said in previous examiner’s reports, candidates preparing for this examination need to
learn the syllabus in its entirety in order to be able to cope with the type of questions set in this test
of Financial Management skills.

This is particularly true of Section C of this examination, where candidates are expected to
demonstrate in-depth knowledge through performing detailed calculations and discussing and
explaining Financial Management concepts as applied to the given scenarios. In order to do this,
candidates must prepare well for the examination through dedicated study and question practice
and be ready to apply this knowledge to the Section C questions.

In general, candidates were well prepared in some areas of the syllabus, particularly those that
have featured regularly such as preparing a discounted cash flow appraisal of an investment
project and estimating the weighted average cost of capital. For both examples candidates clearly

Examiner’s report – FM July 2020

presented their work in an appropriate format, labelling individual items with the correct terminology
and showing detailed workings correctly. However, some candidates were less prepared to
demonstrate knowledge in some areas of the syllabus such as specific investment decisions in
leasing or borrowing to buy and the discursive parts of the questions.

Section A

The objective test questions in Section A ensure a broad coverage of the syllabus, and so all areas
of the syllabus need to be carefully studied, as all learning outcomes can be tested in this part of
the examination. Candidates preparing for the examination are therefore advised to work through
as many objective test questions as possible, reviewing carefully to see how correct answers are
derived in areas where they experience difficulty.

The following questions are reviewed with the aim of giving future candidates an indication of the
types of questions asked which have caused difficulty and guidance on dealing with such exam
questions.

Example 1 is numerical and tests interest rate hedging.

Example 2 is a question testing knowledge of SME funding.

Example 1

A company that has a $14m loan, with a variable rate of interest, has acquired a forward rate
agreement (FRA) with a financial institution that offered a 4-11, 2.85% - 2.35% spread.

What would be the amount received from the financial institution, under the terms of the
FRA, if the actual rate of interest was 3.75% (to the nearest dollar)?

The correct answer is $73,500

The period covered by the FRA is seven months and fixes borrowing at an annual rate of 2.85%.

Actual interest is payable at a rate of 3.75%.

The amount received from the financial institution = $14m x (3.75% - 2.85%) x 7/12 = $73,500

Example 2

Small and medium sized entities (SMEs) often face a funding gap problem.

Indicate, whether the following statements about SMEs are TRUE or FALSE, by selecting
the correct answer next to the relevant statement.

SMEs will often experience a funding gap, due to them TRUE FALSE
being seen as a higher risk investment than a larger
company
Founding shareholders of an SME will often have to TRUE FALSE
sacrifice limited liability in order to obtain bank finance

Examiner’s report – FM July 2020 2

A lack of suitable, sufficient, non-current assets increases TRUE FALSE
the funding gap problem for an SME

The correct answers are TRUE, TRUE and TRUE.

SMEs are seen as higher risk due to a lack of trading history as well as fewer assets to provide
security.

The lack of suitable assets for security will often make it difficult to obtain bank finance unless the
founders provide personal guarantees on the debt. These guarantees mean the sacrificing of
limited liability as the founders will now be personally liable for the debt.

Section B

Similarly to Section A, questions can come from any area of the syllabus. This reinforces the
earlier point about the need for candidates to study the whole syllabus.

General comments

Candidates should read the question carefully and follow the instructions on how to answer the
question. For example if a question asks the candidate to select two correct statements, then
marks can only be awarded if two statements have been selected. There is no partial marking, so
an answer which only selects one statement will be awarded no marks. A candidate who selects
three statements will also receive no marks.

In addition, when answering a number entry question, candidates must ensure they are entering
their answer in the correct format as stated in the requirement. If a number is being requested in
millions, there will be an ‘m’ after the number entry box. If a candidate puts a full answer of say
13000000 in the box rather than 13, this will be marked as incorrect.

If there is no format specified, answers may be given as an integer or to one or two decimal places.
The exam system is configured to allow any correct answer, under these formats, to be awarded
the available marks.

Issues that were noted under specific syllabus areas are as set out below.

Working capital

A number of candidates were unable to correctly calculate the percentage cost of an early
settlement discount, with the most common error appearing to be not using the correct change in
payment days in the calculation.

A further question, testing what impact a reduction in the percentage discount offered and a
general increase in interest rates would have on the financial acceptability of an early settlement
discount, appeared to create significant confusion for a number of candidates.

Examiner’s report – FM July 2020 3

Business finance

In addition to the example in Section A, a number of candidates made errors on a question

regarding possible sources of finance for SMEs and in particular, which sources would be
applicable in a given situation. A further question which asked for reasons why an SME may have
difficulty raising sufficient finance was also challenging to candidates.

Another issue, which has appeared in many different exam sessions, and in all sections of the
exam is that some candidates do not correctly include the impact of tax in their calculations of the
cost of redeemable debt.

Business valuation

Many candidates appeared not to know the components of the Gordon growth model for estimating
the dividend growth rate.

One question highlighted that a significant number of candidates appeared to be unsure of the
process for valuing a company’s equity using discounted cash flows.

Some candidates do not remove internally generated goodwill when calculating a net asset value
for a company.

One question highlighted that a significant number of candidates appeared to be unaware of the
inverse relationship between the cost of debt and the market value of debt.

Risk management

It continues to be the case that candidates are not strong on questions which feature derivatives.
One specific example in this session was a question testing the features of interest rate
derivatives, where a significant number of candidates believed futures contracts allowed you to
benefit from a fall in interest rates.

A further question involved testing understanding of the four-way equivalence model. Future
candidates should ensure they understand each of the relationships that make up this model.

A number of candidates were not able to identify which given situation would correctly use asset
and liability management to hedge a transaction.

In a further question, many candidates were unclear on what situations give rise to basis risk for
interest rate hedging.

Section C

It is essential in Section C that candidates read the scenarios provided carefully and answer the
requirements directly e.g. question requirements refer to the company that forms part of the
scenario, in which case candidates must refer to the company in their answers in order to
maximise the marks awarded.

Examiner’s report – FM July 2020 4

Candidates were presented with questions drawn from the areas of:

• Working capital management

• Investment appraisal
• Business finance

Working capital management

This is a topic that candidates have traditionally struggled with, but this sitting saw a marked
improvement in performance.

Questions on working capital management will vary as there are several different angles that the
topic can be approached from. A common requirement is to ask candidates to evaluate the
financial effect of using factoring, invoice discounting, offering early settlement discounts or obtain
bulk discount on purchases. Before starting to write and calculate, candidates need to be clear
about the approach that they will take. These requirements do not have a set format and,
consequently, candidates are free to approach it in any way that they see fit, however it is vital that
a logical layout supported by appropriate workings (including formulae) are used to ensure the
marker can make sense of the response they are faced with. It is an acceptable approach to such
a question to compare the cost of the current policy with the cost of the proposed policy. Likewise,
it is an acceptable approach to look at the issue from an incremental perspective i.e. what changes
financially as a result of the policy. Candidates need to take care with their arithmetic and providing
an indication of monetary magnitude in answers, for example, writing ‘0.075’ instead of ‘$0.075
million’ or ‘$75,000.

Errors of principle are to be avoided as these display a lack of knowledge. These include
incorrectly applying:
• An annual holding cost to all items purchased (i.e. demand) in a year rather than the
average inventory level;
• Finance cost percentage to the (change in) sales value, when the percentages should be
applied to (changes in) receivables balances (it is a concern that some candidates did not
seem to appreciate that holding receivables has an associated finance cost);
• A discount or service fee percentage to a receivables balance, when the percentage should
be applied to the credit sales revenue.

Where candidates were required to calculate the financial effect of accepting a bulk purchase
discount, the common errors included:
• Ignoring the buffer inventory in calculating holding cost and calculating average inventory
incorrectly;
• Applying annual holding cost to all items purchased in a year rather than the average
inventory level;
• Finance cost percentages applied to the change in sales value, rather than the change in
receivables balance.

Where requirements indicate the need to comment upon the financial acceptability of an option,
then candidates need to state whether the option is acceptable and why e.g. Option 1 is financially

Examiner’s report – FM July 2020 5

acceptable/not acceptable as it will yield a net benefit/cost of $xx,xxx i.e. net off the calculated
costs and benefits. The financial acceptability requirements allow candidates to score relatively
simple marks and the majority of candidates do tend to score well, any other comments waste
valuable time in the examination. Many candidates failed to pick up these easy marks here by not
justifying their comments on financial acceptability, or by not commenting on financial acceptability
at all.

Whilst use of the question scenario is encouraged, simply copying out exact phrases, and even
whole sentences, also won’t score marks and it is a waste of valuable time in the examination. By
contrast the scenario should be used to frame a response when asked to address the particular
circumstances of the company in question e.g. what it does, where it trades, how it manages
operations. However, too many candidates simply rewrite the key information provided to them
within the scenario and give no further insight. This does not score marks. If candidates make
generic points and don’t refer to the scenario, they are unable to score many marks. This was a
real issue in this session.

As per previous reports, a word or simple phrase is insufficient when asked to discuss a ‘way’ of
doing something. If asked to ‘discuss four ways’ for an eight-mark requirement, it is expected to be
understood that each way is worth two marks, and the length and depth of the discussion of each
way should reflect this.

As is often the case, however, the discursive parts of these questions continue to prove a
challenge, with candidates often providing generic answers to a question or not answering the
question asked. For example, in many cases the responses were either too brief, i.e. a list of few
words, to be considered a discussion or simply were not clearly explained.

Candidates need to be able to distinguish between the investment in working capital on the one
hand and the financing of working capital on the other, and read the question requirement carefully
to understand which aspect of working capital is being considered. If a requirement asks about the
cash operating cycle relationship with the level of investment in working capital for the company in
the scenario then a response which discusses the financing of working capital will score very few
marks, if any. Candidates must learn to differentiate between these two policy areas, even though
the terms aggressive, conservative and moderate are used in both.

For future candidates, it is recommended that they also review the published sample questions
September/December 2019 (Dusty Co), along with September/December 2018 (Oscar) and
March/June 2017 (Pangli). The latter question is a particularly good one for testing understanding
of working capital. The following article on working capital management will also be useful:

https://www.accaglobal.com/uk/en/student/exam-support-resources/fundamentals-exams-study-
resources/f9/technical-articles/wcm.html

Investment appraisal

Investment appraisal is a core and popular examinable topic in the Financial Management syllabus
and has been well represented in the exam. Detail in the scenario and questions can take a variety
of different forms although most of these questions tend to adopt a similar format requiring the

Examiner’s report – FM July 2020 6

calculation of net present value (NPV) and discussion of the financial acceptability of the project.
This diet has followed a very similar format to previous examinations (see e.g. Pinks Co -
March/June 2019 and Pelta Co - September/December 2017). Its similarity highlights the
importance of thorough preparation and as much practice as possible of past questions. There are
many resources available on the ACCA’s website which will help you prepare, and past exam
questions are one of the best ways to help you cover the syllabus and get used to the style of the
questions.

Candidates need thorough knowledge of a range of NPV calculations. Although, the PV/NPV
questions are clear in its requirements, the biggest reasons for marks being lost is because
candidates often make errors in the following areas:

• First, the treatment of inflation. It highlights the importance of reading the requirements
carefully. hence candidates are advised to read carefully the question scenario to identify
whether there are different annual inflation rates for selling price or cost elements. Where
inflation is given as a percentage per year, it is important to recognise that cash flows
arising more than one year in the future will need to include incremental inflation for each
subsequent year.
• Second, candidates must carefully check the timing of cash flows, for example, whether tax
liabilities are paid one year in arrears or in the year to which it relates. Some candidates
also incorrectly used a taxation rate that was different from the figure provided in the
question. Some candidates erroneously included the working capital and the residual value
in calculating the tax liability for the year. Some candidates converted the tax liability as
cash inflows.

• Third, tax-allowable depreciation (TAD) can be calculated on a straight line basis or on a

reducing balance basis, and candidates should read the question requirements carefully.
Although many candidates did well in relation to the calculation of TAD, but some
candidates made errors in calculating the final year balancing charge/allowance and
omitted a balancing charge/allowance from the fourth-year calculation of TAD. In addition,
some candidates incorrectly treated TAD as a cash flow benefit or failing to add back TAD
when it was used to calculate a taxable profit figure. Some candidates mixed up the tax rate
for TAD percentage and vice versa. As for the tax liability calculation some candidates used
a different figure for taxation rate to that provided in the question. Candidates need to read
the question carefully to ascertain whether the tax benefit is available in the year in which it
arose or one year in arrears, occasionally mistiming either in tax liability or TAD benefits.

• Fourth, candidates should consider the time horizon, so for example if a four year time
horizon is used, then the tax effects of the fourth year must be considered, even if tax is
paid in arrears and the cash flows arise in the fifth year.

• Fifth, working capital has initial investment, incremental investment and working capital
recovery and all of these cashflows need to be correctly timed as required by the question
scenario. Some candidates included total investment in working capital each year, rather
than incremental working capital. Some candidates ignored to include initial working capital
investment in year zero and or incorrectly located this in year one. Some candidates

Examiner’s report – FM July 2020 7

 calculating incremental working capital and recovery correctly but applying it with the
opposite sign.

• Sixth, some candidates incorrectly placed the initial investment and or initial working capital
at the end of the first year rather than the year zero.

• Finally, some candidates did not include the residual value at the end of project period, but
in the following year and some candidates included the residual value in year zero.

These and many other relevant issues are coved in the ‘Advanced Investment Appraisal’ article on
the ACCA website, as follows: https://www.accaglobal.com/uk/en/student/exam-support-
resources/fundamentals-exams-study-resources/f9/technical-articles/advanced-investment-
appraisal.html.

Return on Capital Employed

The calculation of Return on Capital Employed (ROCE) was required at this diet. ROCE was
generally calculated well with most candidates able to compute average investment. The most
common errors were in computing average profit.

Expected net present value

Candidates were able to score high marks in the NPV calculation question by doing the basics well
i.e. inflation, taxation and working capital (see e.g. Vyxyn Co - March/June 2017; Degnis Co
March/June 2016). An investment appraisal question using the expected net present value (ENPV)
approach of an investment project was done well, gaining full marks. It is important that candidates
should avoid spreadsheet errors in summation formulae, for example adding variable costs and
fixed costs to revenue or adding tax liability to before-tax cash flows

Some candidates commented correctly on the financial acceptability of the investment project by
referring to its positive NPV, while failing to comment on the fact the calculated value was an
ENPV and hence was a mean or average value that was not expected to actually occur. The
investment project’s financial acceptability therefore also depended on management’s attitude to
risk, for example with reference to the probability of a negative NPV.

Candidates may notice that the comments in this examiner’s report for this topic are very much in
line with what was said in the March 2020 Examiner’s Report. It is important that candidates take
on board the comments.

Specific investment decisions

Specific topics of investment decisions include calculation of cost of lease and cost of borrowing to
buy (see e.g. Dink Co September/December 2019; Melanie Co September/December 2018), using
the before and after tax costs of debt. Some candidates had produced good answers and scored
high marks. However, there were some issues that contributed to a lack of understanding of the
nature of discounted cash flow. The main error was the inclusion of interest payments in the

Examiner’s report – FM July 2020 8

computation of the net cash flow. Candidates should be aware that the cost of capital used to
discount the cash flows incorporate the cost of the debt financing been used and hence the
inclusion of interest payments would be double counting. Most of the points below were noted in
the Examiner’s report for September 2018.

Leasing - Common issues noted:

• Failing to recognise the cost of borrowing as the discount rate and hence either not using it
or misusing it in the calculation. There were several candidates using different discount
rates for the two options. Additionally, some candidates erroneously used the post-tax
discount rate and hence lost marks;
• Treating lease rental payments as year-end cash flows and not, as the question stated,
cash flows in advance – i.e. the lease rentals should commence in year 0;
• Including tax saving on lease rental payments as a cost;
• Mistiming tax savings on lease rental payments;
• Including TAD or TAD benefits for a leased asset, mainly using the TAD figures from the
borrowing to purchase part of the question;
• Some candidates mistakenly showed inflows as outflows and vice versa.

Borrowing to purchase a non-current asset - Common issues noted:

• Omitting the purchase cost or mistreatment of this cost such as putting the bank loan at end
of year 4 and some candidates even divided the loan into four equal annual amounts/actual
loan amount showed in each year;
• Overlooking tax benefits on TAD;
• Including both TAD and TAD benefits in the calculation of the present value.

In response to the requirement asking for a comment as to whether the leasing or borrowing to buy
option should be chosen, some answers were too brief to justify the mark on offer.

Risk and Uncertainty

Candidates should note that when they are asked to explain the difference, for example, between
risk and uncertainty (see e.g. Vyxyn Co March/June 2017), candidates must mention clearly the
differences and go beyond merely stating that risk can be quantified but uncertainty is non-
quantifiable. The typical techniques discussed in this area are: Expected values (probability
analysis); simulation, adjusted payback, risk adjusted discount rate. Candidates should provide a
balanced answer on any of these techniques discussing both the pros and cons. A list of points
poorly expressed will yield few marks or none at all. Answers were varied and often discussed
irrelevant issues such as difference between systematic and unsystematic risk, and investment
appraisal techniques such as ARR and IRR. Candidates should clearly answer the specifics of the
question requirement and not just general description of techniques.

Additional comments on whether or not a technique is appropriate in a particular situation depends

on the attitude of the decision-maker to risk and the difficulties of establishing probabilities.
Candidates often overlook this.

Examiner’s report – FM July 2020 9

Investment appraisal techniques under capital rationing

In another question requirement was a discussion of investment appraisal techniques to use to

make optimal investment decisions under a capital rationing situation. This question did not require
the discussion of hard or soft capital rationing and its reasons, although many candidates did this
thus losing time in the examination. Good answers managed to discuss divisibility, profitability
index, profitability index method and the combination approach.

Business finance

This area of the Financial Management syllabus includes sources of and raising business finance,
estimating the cost of capital, sources of finance and their relative costs and capital structure
theories and practical considerations.

Calculation of the weighted average cost of capital (WACC)

Examples of earlier questions on these types of WACC calculation are Tufa Co in the
September/December 2017 published sample questions and Dinla Co in the March/June 2016 –
published sample questions.

The requirement was to calculate the cost of equity using CAPM model. For most candidates this
was done correctly. However for those candidates who did not do well in this computation the
errors included:
• Calculation of cost of equity – although the use of the CAPM formula posed little difficulty,
candidates have to read the question to identify whether the market return or the equity risk
premium figure is provided in the scenario;
• Calculation of cost of debt – not using the after tax interest in the calculation of NPVs for
use in the IRR calculation;
• Reversing the market price for year 0 and the nominal value on redemption in the
calculation of NPVs for use in the IRR calculation;
• Some candidates assumed the loan notes were irredeemable;
• For the bank loan - not using the after tax cost of the bank loan;
• Using book values instead of market value for both debt and equity – even though the
question requirement was to ‘calculate the current market value after-tax weighted average
cost of capital’;
• Taxing after-tax cost of debt again in the WACC calculation.

Calculation of project specific cost of equity.

In this session many candidates did well in the calculation of project specific cost of equity.

The common errors were:

• Failing to use the after-tax value of debt in the regearing calculation;

• Ignoring the average proxy company asset beta;
• Using the equity risk premium as the market return;

Examiner’s report – FM July 2020 10

 • Using the sector average gearing in the regearing calculation rather than the company’s
gearing.

The discursive areas focused on sources of finance and capital structure theory:

Candidates should have answered these questions in the context of the scenario and the choice of
finance. However, many candidates made general comments without adding any value.

Finally, in this syllabus area, when asked to critically discuss capital structure theories, a good
proportion of candidates produced reasonable responses based upon the optimum capital
structure debate, with the main theories: traditional, Modigliani and Miller without tax and with tax.
That said, some responses were far too brief and/or generic for the marks on offer, and there were
only a few responses discussing market imperfections. Many answers were very brief for the
marks on offer, and often employed a bullet-point approach which was at odds with the
requirement for discussion.

Two articles covering this syllabus area can be found on the ACCA website here:
https://www.accaglobal.com/uk/en/student/exam-support-resources/fundamentals-exams-study-
resources/f9/technical-articles/capm-1.html

Spreadsheet and Word Processing Technique

Candidates should take full advantage of the spreadsheet functionality that is available. There
were many instances where numerical responses were well-presented, professionally constructed
and clearly labelled, with workings showing how the final figures were computed.

For some candidates, presentation of the answers often lack clarity and understandability.
Candidates need to be continually mindful of the presentation of their work and whether it can be
easily read and understood i.e. it should be clearly visible without the need for markers to
manipulate the cell. Cell formulae should be used to perform computations, but, for example,
correct use of the =SUM formula is still not as widespread as it should be. Greater care must be
taken in entering formulae in the spreadsheet, such as sub-totalling or totalling the correct rows
within a column of figures or when the =IRR formula is used, as explained above. Both NPV and
IRR functions can be used for section C of the examination.

Take care when writing comments in the spreadsheet tool, for example, on the financial
acceptability of an investment project and the comment runs across a single row, which makes it
harder for markers to see and require the markers to manipulate the row/cell. It is recommended
that where text is entered into a cell, the words should not disappear or scroll into a non-visible part
of the spreadsheet. This would be good practice expected in the workplace.

The detailed workings should be shown in order that ‘method marks’ can be awarded and workings
should be shown where markers can see them.

Use heading and labels in the top row before you begin your calculations.

Provide adequate and appropriate labels along with the detailed workings and not just the final
answer in a cell.

Examiner’s report – FM July 2020 11

Exam technique

As always, exam technique is an important aspect of success in any exam. Throughout this report
the importance of reading and interpreting requirements very carefully has been reiterated many
times; failure to do this is often the cause of poor scores. The tendency for some candidates is to
answer the question that they want to get rather than answering the question which they have
been given. Future candidates are encouraged to study the whole breadth of the syllabus to give
them a better chance of answering the question which has been set.

Candidates should ensure that they have read all the requirements and noted the mark allocation
for each requirement; this is especially important in CBE as the requirements might be split over
several screens. Each requirement should be properly broken down so that it can be established
what is being asked. A recommended approach to this would be that at the start of an answer,
candidates should do a small plan in which they have broken down a requirement and asked
themselves how many things they are being asked to do, making sure that they consider all
aspects of the requirement.

It is easier to be more focused when answering a question using word processing and
spreadsheets, as the mere fact that what has been written or calculated can be seen more clearly,
which helps candidates to avoid the temptation to discuss things which are irrelevant. Also, if
candidates realise that they have missed a point out from an earlier part of a question, it is easier
to go back and insert it in the correct place.

Finally, please remember to use the spreadsheet functionality available. Totals should be
calculated by inserting formulae rather than typing in the number.

Guidance and Learning Support resources to help you succeed in your exam

Preparing for the Financial Management examination may appear daunting but there are many
support resources available to help candidates. There are technical articles available on many of
the topics discussed in this report and all the past exams referred to (and many more) are available
on ACCA’s website. Candidates should refer to these regularly when studying for their exams.
These resources are provided to help candidates develop confidence in their knowledge and
understanding of the Financial Management syllabus.

http://www.accaglobal.com/uk/en/student/exam-support-resources/fundamentals-exams-study-
resources/f9.html

Examiner’s report – FM July 2020 12