Learning Objectives

• Know the goal of financial management

FHBM 1224
Financial Management
Foundation in Arts
• Understand the conflicts of interest that can
arise between owners and managers
• Know the basic types of financial management
decisions and the role of the financial manager
• Know the financial implications of the different
forms of business organization
• Understand the various types of financial
markets

What is finance?
• Finance studies and
addresses the ways in
which individuals,
businesses and
organizations raise,
allocate and use
monetary resources
over time, taking into
account the risks
entailed in their
projects.

Possible Goals of Financial Management Problems with these Goals

• Survival • Each of these goals presents problems.
• Avoid financial distress and • These goals are either associated with
bankruptcy increasing profitability or reducing risk.
• Beat the competition • They are not consistent with the long-term
• Maximize sales or market share interests of shareholders.
• Minimize costs • It is necessary to find a goal that can
• Maximize profits encompass both profitability and risk.
• Maintain steady earnings growth

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The Firm’s Objective
• The goal of financial management is to
maximize shareholders’ wealth.
• Shareholders’ wealth can be measured as
the current value per share of existing
shares.
• This goal overcomes the problems
encountered with the goals outlined
above.
Agency Relationships/Problems
Ownership (shareholders)
• Problem
created by
separation of Control (Management
& Employees)
• Management may maximize own
welfare ( job securities ) instead of
owners’ wealth ( higher profit )
Alignment of Goals
The conflict of interests is limited due to:
• management compensation schemes
• monitoring of management (Board of
Directors)
• the threat of takeover
The Agency Problem
• Agency relationship
– Principal hires an agent to represent his/her interest
– Stockholders (principals) hire managers (agents) to
run the company
• Agency problem
– Conflict of interest between principal and agent
Do Managers Act in Shareholders’ Interests?
The answer to this will depend on two
factors:
• how closely management goals are
aligned with shareholder goals
• the ease with which management can be
replaced if it does not act in shareholders’
best interests.
Responsibility of Financial Managers
• To acquire funds (cash) needed by a firm
• To direct those funds into profitable
activities
• To maximize value of a firm
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Financial Management Decisions 1. The Investment Decision
1. Investment Decisions (Capital Budgeting)
– What long-term investments or projects should the
business take on? • Capital budgeting is the planning and
2. LT Financing Decisions (Capital Structure) control of cash outflows in the expectation
– Should we use debt or equity?
of deriving future cash inflows from
3. ST Financial Decisions (Working Capital
Management) investments in non-current assets.
– How do we manage the day-to-day finances of the
firm?
4. Dividend Decisions (Dividend Distribution Policy) • Involves evaluating the:
– How much dividends should we pay to our – size of future cash flows
shareholders?
– timing of future cash flows
– How much earnings should we retain for
reinvestment? – risk of future cash flows.

Cash Flow Size Cash Flow Timing

• Accounting income does not mean cash • A dollar today is worth more than a dollar
flow. at some future date.

• For example, a sale is recorded at the time • There is a trade-off between the size of an
of sale and a cost is recorded when it is investment’s cash flow and when the cash
incurred, not when the cash is exchanged. flow is received.

Cash Flow Timing Cash Flow Risk

Which is the better project? • The role of the financial manager is to deal
with the uncertainty associated with
Future Cash Flows
investment decisions.
Year Project A Project B
1 $0 $20 000
• Assessing the risk associated with the size
2 $10 000 $10 000 and timing of expected future cash flows is
3 $20 000 $0 critical to investment decisions.
Total $30 000 $30 000

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2. Long Term Financing Decisions
• A firm’s capital structure is the specific
mix of debt and equity used to finance the
firm’s operations.
• Decisions need to be made on both the
financing mix and how and where to raise
the money.
4. Dividend Decision
• Involves the decision of whether to pay a
dividend to shareholders or maintain the
funds within the firm for internal growth.
• Factors important to this decision include
growth opportunities, taxation and
shareholders’ preferences.
Sole Proprietorship
• The business is owned by one person.
• The least regulated form of organization.
• Owner keeps all the profits but assumes
unlimited liability for the business’s debts.
• Life of the business is limited to the
owner’s life span.
• Amount of equity raised is limited to
owner’s personal wealth.
3. Short Term Financial Decisions
- working capital management
• How much cash and inventory should be
kept on hand?
• Should credit terms be extended? If so,
what are the conditions?
• How is short-term financing acquired?
Forms of Business Organization
• Three major forms in Malaysia
1. Sole proprietorship
2. Partnership
• General
• Limited
3. Corporation
• Private Limited Company ( Sdn Bhd )
• Public Limited Company ( Bhd )
Partnership
• The business is formed by two or more
owners.
• All partners share in profits and losses of the
business and have unlimited liability for debts.
• Easy and inexpensive form of organization.
• Partnership dissolves if one partner sells out or
dies.
• More capital available but amount is limited to
the combined personal wealth of the partners.
• Income is taxed as personal income to
partners.
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Liability of Partners Corporation
• General Partner • A business created as a distinct legal entity
- Has unlimited liability for all obligations composed of one of more individuals or
of the business disadvantage entities.
• Most complex form of organization.
• Limited Partner • Easy to raise capital.
-Liability limited to the partnership • Shareholders and management are usually
agreement advantage separated.
- Limited partnership involves at least • Ownership can be readily transferred.
one general partner and one or more • Life of a company is not limited.
limited partners
• Owners (shareholders) have limited liability.

Private vs. Public Companies A financial market is …

• Private Limited Company (Sdn Bhd)
• a mechanism to facilitate the transfer of
- cannot offer its shares for sale to the public savings from those economic units that
- shares normally held by one shareholder or a have a savings surplus to those that
small group of shareholders have a savings deficit.

• Public Limited Company (Bhd) • It brings together the buyers and sellers
- offers its shares for sale to the public through a of debt and equity securities.
stock exchange (e.g. Bursa Malaysia)

Structure of Financial Markets Financial Market Components

Money markets
– Market for short-term securities
– Less risk, low return ( T-bills, Fixed Deposits,
Commercial Paper)
Financial Markets

Money Market Capital Market

Capital markets
– Market for long-term securities
Primary Market Secondary Market Primary Market Secondary Market – High risk, higher return
( Common Shares, Preference
Shares and Bonds )

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Primary vs. Secondary Markets The Corporation and Financial Markets

1. Primary - new securities or primary claims are Corporation

issued, resulting in cash inflow to the issuer. Investors
- firms issuing common shares to public for the
1st time is known as Initial Public Offering
(IPO).

2. Secondary - already existing financial claims

such as stocks and bonds are bought and sold,
no resulting cash inflow to the issuer.

Government

The Corporation and Financial Markets The Corporation and Financial Markets

Corporation Primary Market Investors Corporation Investors

Capital Capital

Securities Securities
Secondary
market

Government Government

The Corporation and Financial Markets The Corporation and Financial Markets

Corporation Investors Corporation Investors

Capital Capital

Securities Securities
Secondary Secondary
market market

Cash Flow Cash Flow

tax

Government Government

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The Corporation and Financial Markets The Corporation and Financial Markets

Corporation Investors Corporation Investors

Capital Capital

Securities Securities
Secondary Secondary
market market
reinvest reinvest

Cash Flow Cash Flow (dividends)

tax tax

Government Government

Movement of Savings: 1.The direct transfer Movement of Savings: 2. Indirect transfer

of funds with investment banker

cash funds funds

firm
saver
saver

investment
banker firm
securities securities
securities

Movement of Savings: 3. Indirect transfer

with financial intermediary Lecture Exercise
Match the following with the questions below:
funds funds (a.) restructuring
(b.) capital market
(c.) money market
(d.) inflation
(e.) primary market
(f.) secondary market
saver financial (g.) financial capital
intermediary firm
intermediary firm
securities securities

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1.______This form of capital is found on the
balance sheet under long-term liabilities and
equity.
2.______The purchasing power of the dollar
shrinks over time.
3.______A market where the securities being
"I hear and I forget.
traded are new public offerings.
I see and I remember.
4.______Securities with a maturity of less than 1
year. I do and I understand."
5.______Redeploying the asset and liability
structure of the firm. -- Confucius
6.______Market composed of common stock,
preferred stock, commercial and government
bonds and other long-term securities.
7.______This market trades previously issued
securities.