CHAPTER 1:

Financial Management Function

 The Nature & Purpose of Financial
Study 01 Management

Guide 02
Financial Objectives and the
Relationship with Corporate Strategy

Stakeholders and Impact on Corporate

03 Objectives

Financial and Other Objectives in Not-

04 for-profit Organizations
 Learning Outcomes
At the end of the chapter, you should be able to:

Describe the
importance of financial
Define and explain the
management in a firm
concept of shareholders’
wealth maximization

Describe the role of a

finance manager in a
firm

Explain agency problem

and suggest solutions
Describe and explain to overcome agency
the goal of a firm problem
 What is Financial Management?
Refers to the process of: Involves with range of
• Planning activities, such as:
• Organizing
• Controlling • Financial planning
• Monitoring • Budgeting
• Forecasting
• Financial analysis
Effective financial • Risk management
management: • Financial reporting
• understanding of financial principles
and concepts
• ability to analyze and interpret
financial data Goals!
• ability to make informed decisions
based on this information in order to To maximize
optimize the use of financial shareholders’
resources and minimize risk wealth
 Nature & Purpose of FM

Planning Analysis Control Reporting

setting financial assessing the monitoring the preparing financial
goals, developing financial position of organization's statements and
strategies to achieve the organization, financial reports to
them, and creating a analyzing financial performance, communicate
budget to ensure data to identify ensuring that financial information
that resources are trends, and making financial policies and to internal and
used efficiently informed decisions procedures are external
based on the results followed, and taking stakeholders
corrective action
when necessary

PURPOSE to create value for the organization and its stakeholders

Feature Financial Management Financial Accounting Management Accounting
Purpose Maximizing value and profitability Providing accurate financial Providing financial information to
through effective management of information to external internal stakeholders, such as
financial resources. stakeholders, such as investors management, for decision
and creditors, for decision making purposes.
making purposes.
Users Managers, investors, creditors, Investors, creditors, and other Managers and other internal
and other external stakeholders. external stakeholders. stakeholders.
Timeframe Long-term Historical Past, present, and future.
Focus Overall financial health of the Record keeping and reporting of No standardized reporting
organization. financial transactions. requirements.
Reporting Generally Accepted Accounting Generally Accepted Accounting No standardized reporting
standards Principles (GAAP). Principles (GAAP). requirements.
Information Financial statements, budgets, Financial statements, such as Internal financial reports, such as
sources forecasts, and other financial balance sheets, income cost reports and performance
reports. statements, and cash flow reports.
statements.
Key areas of Capital budgeting, financing Preparation of financial Cost accounting, performance
concern decisions, risk management, and statements, compliance with management, and decision
financial analysis. accounting standards, and analysis.
external reporting requirements.
 FM Objectives
Financial planning
to develop a comprehensive financial
plan that aligns with the organization's
goals and objectives
Risk management
to minimize financial risk by identifying
and assessing potential risks and
implementing risk management
strategies
Cash flow management
ensuring that the organization has
sufficient cash flow to meet its financial
obligations
Compliance
ensure compliance with applicable financial
regulations, accounting standards, and
reporting requirements
Capital Budgeting
develop and evaluate investment
opportunities to ensure that capital is
allocated efficiently to achieve the
organization's financial goals
Performance measurement
develop metrics and methods to
measure financial performance and
ensure that financial objectives are
being achieved
Cost management
to reduce costs by implementing cost-saving
measures, negotiating favorable supplier contracts,
and optimizing resource utilization
 Tutorial Question 1.1
A shareholder purchased 1,000 shares in SJG Co on 1 January at a
market price of RM2.50 per share. On 31 December the shares had
ex-div value of RM2.82 per share. The dividend paid during the period
was RM0.27 per share. What is the total shareholder return and what
are the elements of total shareholder return?
 Tutorial Question 1.1 (Answer)
The elements of total shareholder return are the increase or decrease in stock price (Capital gain) and any dividends paid out to
shareholders (Return from dividends). To calculate the total shareholder return for the given scenario, we can use the following formula:

Total shareholder return = (𝑷𝟏 - 𝑷𝟎 + 𝑫𝟏 ) ÷ 𝑷𝟎

where 𝑷𝟎 is the initial purchase price, 𝑷𝟏 is the final selling price (or ex-dividend value in this case), and 𝑫𝟏 is the dividend paid out during
the holding period.

In this case, the shareholder purchased 1,000 shares at RM2.50 per share, so the initial investment was RM2,500. The ex-dividend value of
the shares on 31 December was RM2.82 per share, which gives a final value of RM2,820 for the 1,000 shares. The dividend paid out during
the period was RM0.27 per share, or RM270 in total.

Plugging these values into the formula, we get:

Total shareholder return = (RM2,820 - RM2,500 + RM270) ÷ RM2,500

= RM590 ÷ RM2,500

= 0.236 or 23.6%

Therefore, the total shareholder return for this investment over the holding period was 23.6%, which is made up of a 12.8% increase in
stock price (2,820 ÷ 2,500 - 1) and a 10.8% dividend yield (0.27 ÷ 2.5).
Corporate stakeholders
 • Providers of the risk capital of a company
Shareholders
• Goal: Maximize wealth by ownership of the shares in the company

• May have different objectives with shareholders

Management • Increase short-term profits for a bonus
• Resist Change (Privatisation/Modernisation)

• Wages and salaries • Secure long term employment

Employees • Impact of trade unions on firm’s profitability
• company safety standards & staff welfare (pension, sick pay etc.)

• Prompt Payment
Suppliers • Fair prices offered with reasonable credit terms offered

• Quality product that is value for money

Customers • Environmentally-friendly

Financial Institutions / • Ability to do repayments • Operational cash flows

banks
 What an Effective FM can do?
Improve
supplier
relationships
and
availability
of critical
supplies
Improve employee
satisfaction and
retention
Improve customer
satisfaction and
loyalty
Improve liquidity
and reduce financial
risk
Improve profitability
and increase
shareholder value
 Corporate Strategy and Objectives
Course of action to achieve a
specific objective
Relate to key i.e. short-term / long-term
success factors
e.g. market share,
products’ quality
ext.

14
Corporate Strategy & Objectives Impact on FM

1. Investment decisions 4. Budgeting & planning

Sets the direction for the Develop comprehensive financial plans
organization's growth and and budgets that align with the
expansion organization's strategy and objectives and
allocate resources effectively

2. Risk management 5. Mergers & acquisitions

Determines the organization's risk
As a means of achieving growth
appetite and tolerance
and expansion

3. Financial performance metrics 6. Corporate governance

Include financial performance metrics Ensure that financial decisions and
such as revenue growth, profitability, practices are consistent with the
and return on investment organization's values and
standards of governance
The Role & Importance of a Finance Manager

Financial Financial Treasury Strategic

Funding &
Planning & Control Management Planning
Investment
Analysis

Responsible for To ensure that Responsible for Responsible for Key member of
developing and the company's managing the managing the the company's
implementing financial company's capital company's cash leadership team
structure and
the financial transactions are ensuring that the
and liquidity and plays a
plan for the accurate, company has critical role in
company complete, and access to the developing and
compliant with funding it needs to implementing
regulatory support its the company's
requirements operations and overall strategic
growth plan
 Distinction between profit maximization and wealth maximization
Aspect Profit maximization Wealth maximization
Definition A goal of financial management that seeks to A goal of financial management that seeks to
maximize profits or earnings in the short-term. maximize shareholder wealth in the long-term.

Timeframe Short-term focus on achieving immediate Long-term focus on creating sustainable value
profitability. for shareholders over time.

Measurement Emphasis on maximizing revenue or minimizing Emphasis on increasing shareholder value

costs to generate higher profits. through a combination of earnings growth and
dividend pay-outs.
Risk May involve taking on higher risk to achieve Balances the trade-off between risk and return to
short-term profitability goals. create long-term value for shareholders.

Stakeholders Primarily focused on meeting the needs of Balances the needs of various stakeholders,
shareholders. including shareholders, employees, customers,
and the broader community.

Limitations Does not consider the time value of money or Incorporates the time value of money and
the impact of investments on future earnings. considers the long-term impact of investments
on shareholder value.
 Agency Theory
• Agency relationships occur when one party, the principal, employs another party,
the agent, to perform a task on their behalf
• Objectives of principals and agents may not coincide
• Problem of goal congruence

PRINCIPAL Shareholders Directors Loan Creditors

AGENT Directors Employees Shareholders

Minimize risk
AGENT’S Generate Work to
from uses of
RESPONSIBILITY maximum return maximum
borrowed
for shareholders efficiency
funds
 Accountability
Corporate Governance

Good Corporate Governance

Responsibility
• Definition:
Fairness
System by which organisations
are directed & controlled
Transparency

• Objective: Independence
to reduce agency costs to a
level acceptable to shareholders Ethics

Risk
Management
 Headed by an effective board which should lead & control the company

Clear division of responsibilities between running the board (chairman) & running the
Principles of Good Governance

business (CEO)

Board of director (BOD) should have a balance of executive & independent non-executive
directors

All directors should be required to submit themselves for re-election on a regular basis

Remuneration committees should provide the packages needed to attract, retain and
motivate executive directors and avoid paying more

No director should be involved in setting his own remuneration

BOD should maintain a solid system of internal control to safeguard shareholders’

investment & company’s assets
 Goal for Not for profit organisations (NFPO)
Definition: Objective: Examples:
An organisation Efficient use of Charities, statutory
whose attainment of resources bodies, public utilities
its prime goal is not
assessed by
economic measures

Economy Wise use of money

Getting the Maximum output from inputs

best possible Efficiency
or wise use of resources
combination Value for Money
from the least (VFM)
Effectiveness Achieving objectives or getting
resources the job done
Key ratios
Tutorial Question 1.2
 Tutorial Question 1.2 (Cont…)
a) Using profitability and shareholders’ investment ratios, discuss the performance of ABC Co
over the last two year.
b) Discuss how good corporate governance procedures can help to manage under-
performance in private sector companies.
Solution Tutorial 1.2 (a)
Ratio Analysis Workings Current year Previous year
Profitability
ROCE 𝑃𝐵𝐼𝑇/(𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑)×100% $14,749/$(39,900+14,000) ×100% $13,506/($(35,087+17,500))×100%
= 27.26% = 25.68%
Net profit margin 𝑃𝐴𝐼𝑇/𝑅𝑒𝑣𝑒𝑛𝑢𝑒×100% $8,849/$74,521×100% $7,917/$68,00 × 100%
= 11.87% = 11.64%
Discussion:
ABC Co has grown in terms of turnover and profits. Revenue has grown by 9.59% [($74,521- $68,000) ÷$68,000×100%] and
return on capital employed has increased from 25.68% to 27.26%. There may be some concern over the 25.43% increase
[($11,489-$9,160) ÷$9,160×100%] and more information is needed to determine if this is one-off increase or a worrying long-term
trend.
 Tutorial Question 1.2 (Cont…)
Solution Tutorial 1.2 (a)
Ratio Analysis Workings Current year Previous year
Profitability
ROCE 𝑃𝐵𝐼𝑇/(𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑)×100% $14,749/$(39,900+14,000) ×100% $13,506/($(35,087+17,500))×100%
= 27.26% = 25.68%
Net profit margin 𝑃𝐴𝐼𝑇/𝑅𝑒𝑣𝑒𝑛𝑢𝑒×100% $8,849/$74,521×100% $7,917/$68,00 × 100%
= 11.87% = 11.64%
Discussion:
ABC Co has grown in terms of turnover and profits. Revenue has grown by 9.59% [($74,521- $68,000) ÷$68,000×100%] and
return on capital employed has increased from 25.68% to 27.26%. There may be some concern over the 25.43% increase
[($11,489-$9,160) ÷$9,160×100%] and more information is needed to determine if this is one-off increase or a worrying long-
term trend.
 Tutorial Question 1.2 (Cont…)
Shareholders’ Investment
Earnings per share (EPS) 𝑃𝐴𝐼𝑇/(𝑁𝑜. 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠) $8,849/14,000 $7,917/14,000
= $0.63 = $0.57
Dividend per share (𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑎𝑏𝑙𝑒)/(𝑁𝑜. 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠) $4,800/14,000 $3,100/14,000
= $0.34 = $0.22
Discussion:
• The shareholders’ investment ratios all indicate that shareholders’ wealth increased.
• The P/E ratio reflects the market appraisal of the share’s future prospects and this has improved. It is still lower than
the industry average which suggests that more growth could be achieved.

(b) Corporate governance is the system by which organisations are directed and controlled.
• Those directors who have the power for direct and control the organisations also have the duty of accountability to the
organization’s stakeholders.
• Although the directors’ role is a key one in determining how the divergent interests of the various stakeholders should be
promoted, the directors’ primary duty is to enhance the value of shareholders’ investment over time.
• Business that comply with corporate governance regulations can therefore help to manage under-performance by:
• Identifying the under-performance areas as part of their risk-management processes.
• Ensuring that management is incentivized to deal with issues that have been identified.
• Controlling the corporate strategy of the company and ensuring it is effective and well throughout.
THANK YOU