Financial Management – Theoretical Revision sheet (midterm)

Finance can be defined as the science and art of managing money.

Corporate Finance managers are concerned with the following 3 decisions:

- Investment decision = Fixed Assets = Capital Expenditure
- Financing decision = Long Term Liabilities and Equity
- Managing the working capital = CA – CL = what short term cash is needed to cover CL

Who are the financial managers?

Treasurer (the firm’s chief financial manager) Controller (the firm’s chief accountant)
responsible for the firm’s financial activities responsible for the firm’s accounting
such as financial planning and fund raising activities, such as cost accounting

Finance
Future : Take the financial decisions
Current market value
Cash basis: recognizes revenues & expenses
only with respect to actual inflow & outflow
of cash (NCF)
Accounting
Past: Record financial transaction
Historical cost
Accrual Basis: recognizes revenues at the
point of sale & recognizes expenses when
incurred (accounting profit)

 Marginal Analysis: economic principle that states that financial decision should be made
& actions taken only when added benefit exceeds the added costs

* Corporation’s goal of financial managers should be Maximizing Shareholder Wealth in terms

of Earnings per share (EPS). Therefore, Maximizing Profit is a WRONG goal, as it may not lead to
the highest possible share price for at least three reasons:

1. Profits do not necessarily result in cash flows available to stockholders

2. Time value of money —the receipt of funds sooner rather than later is preferred

3. Profit maximization fails to account for risk

Governance and the Agency Issue:

A principal-agent relationship is when shareholders of a company (principals) elect Board of

Directors and management (agents) to act on their behalf.

Agency problems arise when managers place personal goals ahead of the goals of shareholders.
To fix Agency Problem: The management compensation system should be related to the share
price & not to annual profits to reduce any conflict of interest between shareholders & the
management

* Firms that require financing from external sources can obtain them in three ways:

1. through a financial institution

2. through financial markets

3. through private placements

Ahmed Mashaly 1
01063335292
Financial Management – Theoretical Revision sheet (midterm)

1- Financial institution: an intermediary that channels the savings of individuals, businesses &
government into LOANS or investment. The major financial institutions are commercial banks,
investment banks & insurance companies.

Commercial banks Investment banks

institutions that provide savers with a secure institutions that assist companies in raising
place to invest their funds and that offer capital (issue securities in the primary
loans to individual and business borrowers market), and advise firms on major financial
transactions

2- Financial Markets provide a forum in which supplier of funds and demanders of funds can
transact business directly. Money market (short-term fund) and Capital market (long-term fund)

Money market Capital market

Marketable securities (short –term debt Capital market securities: bonds (long-term
instrument such as government treasury bills debt) and both common and preferred stock
and commercial paper). (equity).

Primary Markets Secondary Markets

Financial markets in which securities are Financial markets in which pre-owned
initially issued through an securities are traded.
Intermediate: investment bank Intermediate: stock market.

Interest
An expense that the company is going to pay
each year to the bondholders regardless of
the amount of profit.
(After EBIT, reduces taxes)
Dividends
Dividends are cash outflows only paid only
when there is net earnings after the Board
decides how much to retain.
Has no effect on net profit.

3- Private placement: the sale of a new security issue, typically bonds or preferred stock,
directly to an investor or group of investors such as insurance companies & pension funds.

The opposite of private placement: Public offering is the nonexclusive sale of either bonds or
stocks to general public

Ahmed Mashaly 2
01063335292