1

TOPIC 1: INTRODUCTION
TO FINANCIAL
MANAGEMENT
1.1 Financial markets and business organisation
1.2 Goals of a firm
1.3 Functions of a financial manager
1.4 Risks and return relationship

Faizal Basri
UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation
What is finance?
Finance can be defined as the “art and science of
managing money” (Gitman, 2009).
To obtain and allocate financial resources effectively
and efficiently
Maintenance and creation of economic value and
wealth.
Integrate with other department (i.e.. Marketing,
operations).
Deal with financial decision (e.g. new product, new
asset, borrowing, issue stocks & debts).

Faizal Basri
UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation
Finance is concerned with the process, institutions,
markets and instruments involved in the transfer of
money among individuals, businesses and
governments.
Those who work in non-financial jobs will benefits by
being able to interact effectively with the firm’s financial
personnel, processes, and procedures.

Faizal Basri
UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation
Financial institutions
 An intermediary that channels the savings of individuals,
businesses and governments (depositors) into loans or
investments.
Financial markets
 Forums in which suppliers of funds and demanders of funds can
transact business directly.
 Two key financial markets; money market and capital market
1. Money market
• Where short term debt and marketable securities are traded.
2. Capital market
• Involving transactions in long term securities (bonds and stocks).

Faizal Basri
UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation
Types of financial market
1. Primary market: for new issues of shares
2. Secondary market (second-hand market):
Increases liquidity of shares
Generates pricing information
Barometer of corporate performance

3. Stock exchange market

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UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation
Legal forms of business organisation
1. Sole proprietorships
 A business owned by one person and operated for his or her own profit.
 Easy to set up.
2. Partnerships
 A business owned by two or more people and operated for profit.
 May operate under different degrees of formality, ranging from informal,
oral understandings to formal agreements.
3. Corporations
 A legal entity created by state, separate and distinct from its owners and
managers, having unlimited life, easy transferability of ownership, and
limited liability.
 A business entity with a legal rights as a person.
 Two types; private limited and public limited.

Faizal Basri
UiTM Puncak Alam, 2016
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1.1 Financial markets and business

organisation

Faizal Basri
UiTM Puncak Alam, 2016
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TOPIC 1: INTRODUCTION
TO FINANCIAL
MANAGEMENT

1.2 Goals of a firm

Faizal Basri
UiTM Puncak Alam, 2016
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1.2 Goals of a firm

Possible goals of a firm:
 Maximisation of Profit???
 Financial manager would only take actions that were expected to
make major contributions to the firm’s overall profits.
 Corporations normally measure profits by Earning Per Share
(EPS), which represent the amount earned during the period on
behalf of each outstanding share of common stock.
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒
 EPS =
𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝑜𝑜𝑜𝑜 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠
 However, profit maximisation alone is not enough as it
ignores the timing of returns, cash flows available to
stock holders and risk.
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UiTM Puncak Alam, 2016
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1.2 Goals of a firm

1. Shareholder wealth maximisation
 The primary goal for management decisions; considers the risk
and timing associated with expected earning per share in order
to maximise the price of the firm’s common stock.
2. Corporate governance
 The system used to direct and control a corporation.
 Defines the right and responsibilities of key corporate
participants, decision-making procedures, and the way in which
the firm will set, achieve, and monitor its objectives.
3. Social Responsibility
 The concept that businesses should be actively concerned with
the welfare of society at large.
Faizal Basri
UiTM Puncak Alam, 2016
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TOPIC 1: INTRODUCTION
TO FINANCIAL
MANAGEMENT

1.3 Functions of a financial manager

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UiTM Puncak Alam, 2016
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1.3 Functions of a financial manager

The financial managers’ responsibilities
1. Forecasting and planning
Coordinate the planning process which involve interacting with
other departments as they look ahead and lay the plans that will
shape the future of the firm.
2. Major investment and financing decisions
Must help to determine the optimal sales growth rate, help decide
what specific assets to acquire, and then choose the best way to
finance those assets.
3. Coordination and control
Must interact with other personnel in order to ensure that the firm is
operated as efficiently as possible.

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UiTM Puncak Alam, 2016
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1.3 Functions of a financial manager

4. Dealing with the financial markets
Each firms affects and is affected by the general financial markets
where funds are raised, where the firm’s securities are traded, and
where investors either make or lose money.
5. Dividend policy
 To decide whether to distribute the profit to the shareholders or
to retain the profit in the business itself.
6. Risk management
Responsible for the firm’s overall risk management programme,
including identifying the risks that should be managed and then
managing them in the most efficient manner.
E.g. managing risks of fire and natural disasters by purchasing
insurance, or managing the uncertainties in commodity and security
markets, volatile interest rates and fluctuating in foreign exchange
rate by hedging in the derivatives market.
Faizal Basri
UiTM Puncak Alam, 2016
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TOPIC 1: INTRODUCTION
TO FINANCIAL
MANAGEMENT

1.4 Risks and return relationship

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

Risk defined as the chance of financial loss or more formally,
the variability of return associated with a given asset. E.g. if
you forecast that your company will get RM1,000,000 of
profits next year and due to the presence of risk, you may
find that the actual income will be less than expected.
Risk refers to the possibility that actual outcome may differ
from expected outcome.; measured by standard deviation.
Two types of risk:
1. Systematic risk
2. Unsystematic risk

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

Systematic risk
Is non-diversifiable risks that cannot be eliminated no
matter how many securities are held in investment
portfolio..
These risk occur outside the company (external) and
beyond the financial manager’s control.
Types of systematic risks:
1. Market risk
2. Interest rate risk
3. Purchasing power risk

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

1. Market risk
It is the result of investors’ expectation towards the
price of the company's securities in the market, or the
consumers‟ expectation towards the price of the
company's products in the market.
E.g. if the investor expects that the price of the
company's shares to go up in the near future, he or she
will buy the shares now in expectation of higher return.

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

2. Interest rate risk
Interest rate is the price mechanism for supply and
demands for funds in the market, and therefore any
fluctuations or movements in the current interest rate
represent risk to both investors and firms alike.
Higher interest rate will increase the interest expense
and hence, lowering the company's profit and reduce
the value of return received by investors.

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

3. Purchasing power risk
This risk relates to the increasing inflation rate; that is
the purchasing power of the consumers will decline due
to rapid increase in prices.
It will lead to lower sales for the company as well as the
profits, especially those that are dealing with non-
durable goods.
The effect will be lesser on companies that produce
basic needs products, e.g. food and drinks compared to
luxury goods.

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

Unsystematic risk
Is a diversifiable risk that is unique only to a particular
company.
These are the risks that occur inside or within the
company and thus within the financial manager’s
control.
This type of risk cannot be eliminated but can be
reduced to some extent with proper mixture of securities
in the investment portfolios.
Types of unsystematic risk:
1. Business risk
2. Financial risk
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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

1. Business risk
Risks are caused by mismanagement of the
company's asset.
A normal company may comprise of several
departments, such as the personnel, marketing,
production, and etc.
All these departments must be able to
cooperate with each other in order for the
company to achieve its stated objectives.

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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

1. Business risk (cont.)
A failure to manage any of the assets and/ or one of
the departments in the company will lead to lower
performances and hence lower profits.
E.g. if the management of the production department
is poor, the output produced by the company will
decrease.
This leads to lower sales and consequently lower
profits.

Faizal Basri
UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

2. Financial risk
This is cause by improper financing mix used by
the company to finance its investment activities.
E.g. if the firm depends too much on debts, it will
have to incur higher amount of interest expenses
and increase the firm's risks of insolvency.
The company is perceived to be highly risky by
investors if the company has too much fixed
obligations of principals and interest payments on
debt.
This leads to future difficulty in the event that the
company is trying to raise more funds externally.
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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

Return defined as the total gain or loss experience on an
investment over a period of time.
The payoff from an investment or effort for foregoing current
consumption.
Investors require increasing compensation (return) for taking on
increasing risk.
Return on an investment can be measured over a standard period,
i.e. one year which represents the annual rate of return.
Shareholder return is annual dividend (D1) plus share price
increase (P1 – P0).
Relative return in percentage terms is
100 x [(P1 – P0) + D1]/P0; total shareholder return.
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UiTM Puncak Alam, 2016
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1.4 Risk and return relationship

It is logical to take account of the riskiness of projects/funds/companies. A risk

premium is added to the risk-free rate to derive the appropriate rate of return. A
higher return will normally be expected from projects where the risks are higher.
Thus, the riskier the project, the higher the risk premium.
Faizal Basri
UiTM Puncak Alam, 2016
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END OF TOPIC 1

Faizal Basri
UiTM Puncak Alam, 2016