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DEBRE MARKOS UNIVERSITY DEPARTMENT OF MANAGEMENT Course code: MGMT322, Financial Management UNIT-I AN OVERIEW OF FINANCIAL MANAGEMENT

Financial Management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources. Though it was a branch of economics till 1890, as a separate activity or discipline it is of recent origin. Financial managers are interested in this subject because among the most crucial decisions of the firm are those which relate to finance. Financial management is important in all types of businesses including banks and other financial institutions, as well as industrial and retail firms. Definition of financial management: Guthmann and Dougall: “Business finance can be broadly defined as the activity concerned with the planning, raising, controlling and administering the funds used in the business”. Wheeler: “The business activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise.” Definition of Finance: “Determining acquisition, allocation, understanding and utilizing of financial resources usually in the aim of achieving of some particular goals or objectives”. Finance refers to the management of flows of money through an organization. Different authorities have interpreted the term finance differently. However, there are three main approaches to finance. 1. The first approach views finance as to providing of funds needed by a business on most suitable terms. This approach confines finance to the raising of funds and to the study of financial institutions and instruments from where funds can be procured. 2. The second approach relates finance to cash. 3. The third approach views finance as being concerned with rising of funds and their effective utilization. Finance consists of three interrelated areas: (1) money and capital markets, (2) investments, and (3) financial management. ALTERNATIVE FORMS OF BUSINESS ORGANIZATION There are three main forms of business organization: (1) sole proprietorships, (2) partnerships, and (3) corporations, plus several hybrid forms. In terms of numbers, about 80 percent of businesses are operated as sole proprietorships, while most of the remainder is divided equally between partnerships and corporations.

Partnerships may operate under different degrees of formality. ranging from informal. (3) Difficulty of transferring ownership. . Going into business as a sole proprietor is easy—one merely begins business operations. even the smallest businesses normally must be licensed by a governmental unit. This separateness gives the corporation three major advantages: (1) Unlimited life. A corporation can continue after its original owners and managers are deceased. CORPORATION: A corporation is a legal entity created by a state. and it is separate and distinct from its owners and managers. The major advantage of a partnership is its low cost and ease of formation. The disadvantages are similar to those associated with proprietorships: (1) Unlimited liability.SOLE PROPRIETORSHIP: A sole proprietorship is an unincorporated business owned by one individual. The proprietorship has three important advantages: (1) It is easily and inexpensively formed. oral understandings to formal agreements filed with the secretary of the state in which the partnership was formed. (2) limited life of the organization. The proprietorship also has important limitations: (1) It is difficult for a proprietorship to obtain large sums of capital. However. (2) The proprietor has unlimited personal liability. PARTNERSHIP: A partnership exists whenever two or more persons associate to conduct a non corporate business. and (3) The business avoids corporate income taxes. (2) It is subject to few government regulations. and (4) Difficulty of raising large amounts of capital.

which in turn are dependent on the firm’s ability to attract capital. most business is conducted by corporations because this organizational form maximizes larger firms’ values. in their employees’ welfare. THE GOALS OF THE CORPORATION Shareholders are the owners of a corporation. 3. Losses are limited to the actual funds invested. Ownership interests can be divided into shares of stock. Since corporations can attract capital more easily than can un incorporated businesses. (3) Limited liability. Limited liability reduces the risks borne by investors. in turn.(2) Easy transferability of ownership interest. they are better able to take advantage of growth opportunities. shareholders elect directors. Investment Decisions Financing Decisions Dividend Decisions Liquidity Decisions . 2. Firms do. the lower the firm’s risk. Still. is more complex and time-consuming than for a proprietorship or a partnership. (4). Finance Functions: The finance functions are divided into three categories. it follows that they should pursue policies that enhance shareholder value. In most cases. and they purchase stocks because they are looking for a financial return. which translates into maximizing the price of the firm’s common stock. The corporate form offers significant advantages over proprietorships and partnerships. 4. A firm’s value is dependent on its growth opportunities. but it also has two disadvantages: (1) Corporate earnings may be subject to double taxation—the earnings of the corporation are taxed at the corporate level. and. Since managers are working on behalf of shareholders. and filing the many required state and federal reports. and then any earnings paid out as dividends are taxed again as income to the stockholders. who then hire managers to run the corporation on a day-to-day basis. the assumption that management’s primary goal is stockholder wealth maximization. Although each form of organization offers advantages and disadvantages. and in the good of the community and of society at large. can be transferred far more easily than can proprietorship or partnership interests. which. the managers who make the actual decisions are interested in their own personal satisfaction. (5). have other objectives—in particular. stock price maximization is the most important goal for most corporations. Consequently. of course. the higher its value. 1. other things held constant. (2) Setting up a corporation.

Financing Decisions: The finance manager must decide when. Liquidity Decisions: Current assets management that affects a firm’s liquidity is yet another important finance function. THE FINANCIAL STAFF’S RESPONSIBILITIES The financial staff’s task is to acquire and then help operate resources so as to maximize the value of the firm. and inventory. The financial staff must deal with the money and capital markets. A successful firm usually has rapid growth in sales. 3. All business decisions have financial implications. All businesses face risks. and all managers—financial and otherwise—need to take this into account. Investment Decisions: This is also known as capital budgeting decisions involves the decision of allocation of capital or commitment of funds to long-term assets that would yield benefits in the future. which requires investments in plant. uncertainties in commodity and security markets. The main issue before the finance manager is to determine the proportion of equity and debt. Dividend Decision: The financial manager must decide whether the firm should distribute all profits. equipment. or retain them for future developmental purpose. many of these risks can be reduced by purchasing insurance or by hedging in the derivatives markets. and fluctuating foreign exchange rates. 3. The financial staff is responsible for the firm’s overall risk management program. where and how to acquire funds to meet the firm’s investment needs. help decide what specific assets to acquire. The financial staff must coordinate the planning process. 2. 5. and then choose the best way to finance those assets. The dividend policy is one that maximizes the market value of the firm’s shares. Here are some specific activities: 1. Major investment and financing decisions. The financial staff must help determine the optimal sales growth rate. including identifying the risks that should be managed and then managing them in the most efficient manner. Risk management. Coordination and control. Forecasting and planning. This means they must interact with people from other departments as they look ahead and lay the plans that will shape the firm’s future. However. . 4. 4. Each firm affects and is affected by the general financial markets where funds are raised. volatile interest rates. Current assets should be managed efficiently for safeguarding the firm against the dangers of liquidity and insolvency. 2. including natural disasters such as fires and floods. The financial staff must interact with other personnel to ensure that the firm is operated as efficiently as possible. where the firm’s securities are traded.1. Dealing with the financial markets. The mix of debt and equity is known as the firm’s capital structure. and where investors either make or lose money.

FINANCIAL MANAGEMENT IN THE NEW MILLENNIUM The focus on value maximization continues as we begin the 21st century. (4) In a world populated with multinational firms able to shift production to wherever costs are lowest. the costs of developing new products have increased. a firm whose manufacturing operations are restricted to one country cannot compete unless costs in its home country happen to be low. Thus.HYMA .S. we will see continued advances in computer and communications technology. These rising costs have led to joint ventures between such companies as General Motors and Toyota. 5. survival requires that most manufacturers produce and sell globally. What the financial staff’s responsibilities? What is the role of financial management in the new millennium? Faculty: T. highcost domestic manufacturers and their workers. and this will continue to revolutionize the way financial decisions are made. 4. 2. a condition that does not necessarily exist for many U. and to their customers’ and suppliers’ computers. two other trends are becoming increasingly important: (1) the globalization of business and (2) the increased use of information technology. and to global operations for many firms as they seek to expand markets and thus spread development costs over higher unit sales. Both of these trends provide companies with exciting new opportunities to increase profitability and reduce risks. INFORMATION TECHNOLOGY: As we advance into the new millennium. who desire low-cost. Companies are linking networks of personal computers to one another. However. to the Internet and the World Wide Web. GLOBALIZATION OF BUSINESS: Four factors have led to the increased globalization of businesses: (1) Improvements in transportation and communications lowered shipping costs and made international trade more feasible. What are the different forms of business organizations? What are its advantages and 3. (2) The increasing political clout of consumers. What do you understand by the term finance and Financial Management? Define. 6. financial managers are increasingly able to share information and to have “face-to-face” meetings with distant colleagues through video teleconferencing. This has helped lower trade barriers designed to protect inefficient. corporations. to the firms’ own mainframe computers. (3) As technology has become more advanced. disadvantages? What is main goal of a corporation? Explain various finance functions. highquality products. QUESTIONS FOR STUDY: 1. As a result of these four factors.

Example of business finance is _____________________________ 12. 6.There are ________main forms of business organization: They are__________________.________________ is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources. 7. The finance functions are: 8. Example of non-profit organization in Ethiopia____________________ Faculty: T.HYMA . A _____________________ exists whenever two or more persons associate to conduct a non corporate business. A _________________________ is an unincorporated business owned by one individual 4. Example of personal finance is _____________________________ 11. A ___________________ is a legal entity created by a state._________________________. 2. 3.Objective type Questions: 1. Public finance means: 10. and it is separate and distinct from its owners and managers. The management’s primary goal is _____________________________.__________________. Owners of the corporation are: 9. 5.