FUNDAMENTAL CONCEPTS OF

FINANCIAL MANAGEMENT
By Kaniz Fatema
Lecturer, Finance, AIBA
FINANCE
Finance is the systematic process of –
▪ Identifying the financial & investment opportunity

▪ Comparison of among the options

▪ Choose the optimal level of financial and investment

decision making process

Encyclopedia of Britannica conveys the idea of finance in

the flowing words;
“Finance is the act of providing the means of payment”
Finance can be justified two broad categories-
❑ Private Finance
❑ Public Finance

✔ Private Finance concerned with financial activities of

private individuals and institutions.
✔ Public Finance concerned with financial requirements
receipts and disbursement of various governmental
bodies/sectors.
 Private
Finance

Finance for
Personal Business
non-profit
Finance Finance
organization

▪ Personal finance concerned with the fundamentals of

managing one’s day to day many affairs.
▪ Business finance concerned with the fundamentals of
managing private commercial organization.
▪ Finance for non–profit organization concerned with the
fundamentals of managing financial activities of various
non-profit organization. Like- Public hospitals, University,
Library etc.
BUSINESS FINANCE
It refers the funds that are required for floating, running and
conducting the affairs of a business efficiently.
Two approach

Procurements
Issuing share Utilization
Loans- Banks, (Should be done to ensure
Loans- Friends & Family the maximization of profit)
Issuing bonds
(Should be done at minimize
cost)
Area of business finance
Three interrelated areas-
1. Money and Capital Market
2. Investment
3. Financial Management

Money and Capital Market-

They are deal with financial securities and institutions.
Money market Short term security
- Promissory notes
- Commercial papers
❖ Which has a maturity period of less than 1 year
Capital market Long term security
- Stock
- Bond
❖ Which has maturity period more than 1 year.

Investment-
Business finance focus on the investment decision made for
individual and intuitional investors as they choose the securities
for their investment portfolios.

Financial Management-
Financial management involves with financial decisions made
within business organizations. It is that kind of managerial
activities which are concerned with planning and controlling the
financial recourses of the firm to maximize the value or wealth of
the firm.
Function of Financial Management
The main function of financial management is plan to acquire
and utilize the firm’s fund to maximize the efficiency or value
of the firm.
Some specific functions are-
❑ Forecasting and planning
❑ Major investment and financing decisions- It helps to
determine the sales growth , through-
- Optimal sales growth
- Specific assets to acquire
- Way to finance the assets
❑ Coordinating and controlling
❑ Dealing with financial market
❑ Risk management
Treasurer-
✔ For managing cash and marketable securities
✔ For planning capital structure
✔ For selling stock and bonds
✔ For raising capital
✔ For minimizing risk
✔ For supervising activities

Controller-
Basically responsible for tax account
Forms of Business
Three common forms of business-
1. Sole Proprietorship
2. Partnership
3. Corporation

- When an individual runs his/her business activities without

any legal forms. These types of activities are called sole
proprietorship business.
- When a few people conduct their business activities
under some contractual or mutual agreements, these
types of activities are called partnership business.
- When the business activities of a firm are conducted by
an establishment-
▪ Created by a specific law of country (Company Act 1994
in Bangladesh)
▪ By a group of people
▪ With an artificial legal entity
▪ Enjoy perpetual life
Then these types of business activities are the corporation
form of business.
 Goals of Corporation
Two common goals-
1. Maximization of profit
2. Maximization of wealth
Maximization of profit-
By increasing the revenue, sell volume , selling price profit
can be maximized.
Profit= Revenue - Expenses
❖ Positive difference between revenues – expenses

Limitation of profit maximization-

- Concept of profit is vague
- It ignores the time value of money
- It overlooks the quality aspects of future activities
- It focus on only short-term project
- It ignores the timing of return
Maximization of wealth-
This goal means the maximization of wealth of the firm over long
run where the wealth is defined as the net present worth of the
firm. This emphasize on the impact of profit on the current
market price of the firm’s common stock.
-Focus on long-term profitability
- Stability
C.S Market = Net income/ Required Return
Example:
Calculate the value of the firm, if –
Net income= $1,50,000 & 2,25,000
R= 15%
CS mkt = $1,50,000/15% = $1,000,000
CS mkt = $2,25,000/15% = $1,500,000
Other factors to be considered in maximizing the wealth in
addition to profit-
▪ Avoid high level risk-
Ensure long run prospects the firm should avoid the
unnecessary high level risk. Like - Junk bond
▪ Pay dividend-
Payment from the corporation to its stockholders.
▪ Seek growth-
Firm can maintain continuous sell and profit to maximize wealth
by protecting from adverse movement.
▪ Maintain the market price of the firms common stock-
By explaining the firm policy, motivation to the potential party
firm can maintain the market price of common stock.
The maximization of wealth is more useful than the
maximization of profit. So the ultimate goal of a firm should be
the maximization of wealth of the shareholders.
Managerial action to maximize the stock price
Stock price depends on-
1. Amount of cash flows paid to stockholders.
2. Timing of cash flows paid to stockholders.
3. Riskiness of cash flows paid to stockholders.
So need to;
1. Increase the amount of cash flows.
2. Spread them up.
3. Reduce their riskiness
All these functions control by the,
1. General financial environment of the firm
2. Some major decisions taken by manager.
Decisions of Manager
1.Financing decision-
What would be the mixture of the firm capital structure,
what types of security should be issued and when?
2. Investment decision-
What types of goods and services to be produce and how
to deliver these?
3. Dividend policy decision-
How much current earnings will be paid out as dividends to
stockholders rather than retain for reinvestment in the firm?
 Agency Relationship
The ultimate goals of corporation-
To maximize the current market price of the firm’s common
stock/wealth.
When does Agency Relationship arise?
An agency relationship arises whenever one or more
individuals, called principals, hire another individual or
institution, called an agent, to perform some service and
delegate decision making authority to that agent. In
financial management the agency relationship arise
between;
1. Managers and Stockholders
2. Managers and Debt holders.
Agency Problem-
A potential conflict of interests between the manger and
stockholders or manager and creditors called agency problem.
When does agency problem arise?
This problem arise whenever the managers of a corporation
owns less than 100% of a firm’s common stocks.
In that situation manager may try for-
1. To increase their job security
2. To increase their job status and benefits
3. To create more opportunities for middle and lower level
mangers.
Managers can be encouraged through incentives that reward
them for good performance but punished them for bad
performance.
Some mechanism/tools can be used to motivate the
managers are-
1. Managerial Compensation:
It includes increased salary, performance shares and
executive stock option etc.
2. Direct interaction by stockholders:
This action can be taken by appointing a lobbyist or by
passing a special proposal that hurt the existing manager.
3. Threat of firing:
This action can be taken through a hostile takeover which
means the acquisition of a company over the opposition of
its management.
4. The threat of takeovers:
This occurs where the shares of a company are selling at a
price which is below the potential price due to
mismanagement. Such a company can be taken over and the
management is fired. Managers will strive to maximize share
prices so as to minimize possibility of takeover.
5. Regular audit:
Incur costs in monitoring management actions by regular
audits.
6. Restructuring:
Restructure the organization in such a way as to limit
management behavior e.g. appoint outside investors who are
non-shareholders to the board of directors.
7. Restrictions:
Putting restrictions such as requiring shareholders to vote on
certain issues which can limit the ability of management to
take action that can affect the shareholders wealth. This is an
opportunity lost since manager’s hands are tied.
 Assignment
1. What is the primary goal of the corporation?
2. Is maximizing stock price the same thing maximizing
profit?
3. Is stock price maximization good or bad for society?