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Introduction When financial management emerged as a separate field of study in the early 1900s, the emphasis was on the legal aspects of mergers, the formation of new firms, and the various types of securities firms could issue to raise capital. During the Depression of the 1930s, the emphasis shifted to bankruptcy and reorganization,corporate liquidity, and the regulation of security markets. During the 1940s and early 1950s, finance continued to be taught as a descriptive, institutional subject, viewed more from the standpoint of an outsider rather than that of a manager. However, a movement toward theoretical analysis began during the late 1950s, and the focus shifted to managerial decisions designed to maximize the value of the firm. The focus on value maximization continues as we begin the 21st century. However, two other trends are becoming increasingly important: (1) the globalization of business and (2) the increased use of information technology. Both of these trends provide companies with exciting new opportunities to increase profitability and reduce risks. However, these trends are also leading to increased competition and new risks. To emphasize these points throughout the book, we regularly profile how companies or industries have been affected by increased globalization and changing technology. These profiles are found in the boxes labeled “Global Perspectives” and “Technology Matters.” Financial Management can be defined as the management of the finances of a business / organisation in order to achieve financial objectives taking a commercial business as the most common organisational structure destinations.The financial management should be regarded as a component of the company’s general management. From this perspective, the financial management can be defined as an under-system of the company’s general management, having as purpose insuring the necessary financial resources, their profitable assignment and usage, improving the value and the safety of its patrimony, by fulfilling an active role, starting with the financial resources meant for the establishment of the company’s strategic and tactical objectives and for the control and evolution of their fulfillment. Beginning with this definition, it can be stated that the financial management has at least the following tasks:  to evaluate the effort, from the financial point of view, of all the actions that are about to be made in a given administration period; to provide, at the right moment, in the structure and the quality conditions claimed by necessities, the capital, at the lowest possible cost; to follow how the capital is used; to influence the decision factors in each performance centre in order to insure an efficient usage of all funds attracted in the circuit;    1   to insure and maintain the financial balance according to the company’s needs; to try to obtain the anticipated financial result and to distribute it on key objectives of financial management The key objectives of financial management would be to: • Create wealth for the business • Generate cash, and • Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested There are three key elements to the process of financial management: (1) Financial Planning Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit. In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions. (2) Financial Control Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as: • Are assets being used efficiently? • Are the businesses assets secure? • Do management act in the best interest of shareholders and in accordance with business rules? (3) Financial Decision-making The key aspects of financial decision-making relate to investment, financing and dividends: • Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers • A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further. 2 The Goal of the Firm A firm cannot survive with mere profit maximisation, but must increase long-term security through investment and meeting shareholder expectations. This will increase their productive capacity for the furture as well as encourage the risky capital investment of the shareholders. Maximization of Shareholder Wealth and Value creation occurs when we maximize the share price for current shareholders or by profit maximaization or maximizing the EPS. 1) Shortcomings of Alternative Perspectives: a. Profit Maximization:Maximizing a firm’s earnings after taxes,but someitmes the firm faces some problems like increasing current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.). or Ignores changes in the risk level of the firm. Earnings per Share Maximization:Maximizing earnings after taxes divided by shares outstanding but we need to know if it does not specify timing or duration of expected returns or sometimes calls for a zero payout dividend policy. b. 2) Strengths of Shareholder Wealth Maximization: When business managers try to maximize the wealth of their firm, they are actually trying to increase their stock price. As the stock price increases, the individual who holds the stock wealth increases. As the stock price goes up, the value of the firm increases and the net worth of the individual who owns the stock increases.Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors.Thus, share price serves as a barometer for business performance • • • • Cadbury Schweppes: “governing objective is growth in shareowner value” Credit Suisse Group: “achieve high customer satisfaction, maximize shareholder value and be an employer of choice” Dow Chemical Company: “maximize long-term shareholder value” ExxonMobil: “long-term, sustainable shareholder value” Stockholders own the firm and elect the board of directors, which then selects the management team. Management, in turn, is supposed to operate in the best interests of the stockholders. We know, however, that because the stock of most large firms is widely held, managers of large corporations have a great deal of autonomy. This being the case, might not managers pursue goals other than stock price maximization? For example, some have argued that the managers of large, well-entrenched corporations could work just hard enough to keep stockholder returns at a “reasonable” level and then devote the remainder of their effort and resources to public service activities, to employee benefits, to higher executive salaries, or to golf.It is almost impossible to determine whether a particular management team is trying to maximize shareholder wealth or is merely attempting to keepstockholders satisfied while managers pursue other goals. 3 For example, how can we tell whether employee or community benefit programs are in the long-run best interests of the stockholders? Similarly, are huge executive salaries really necessary to attract and retain excellent managers, or are they just another example of managers taking advantage of stockholders?It is impossible to give definitive answers to these questions. However, we do know that the managers of a firm operating in a competitive market will be forced to undertake actions that are reasonably consistent with shareholder wealth maximization. If they depart from that goal, they run the risk of being removed from their jobs, either by the firm’s board of directors or by outside forces. We will have more to say about this in a later section. 3) The Modern Corporation: The modern concept of corporate power holds that the rights of the participants as well as the conduct of the enterprise must be the subject of managerial discretion. The salient characteristic of the modern corporation is the separation of management from ownership. Management of industrial corporations now requires executive managers and a corporate bureacracy to oversee its complex and interlacing activities. The large business corporation has strongly influenced the control of property in the modern world. The large corporations are typically controlled by a small minority of the stockholders. There are several methods employed by small groups of stockholders to gain control of large corporations. These include pooling of the majority of stock in the hands of trustees having the power to vote it and the use of proxies (agents for the actual stockholders pledged to vote for particular candidates for managerial positions). Proxies are generally successfully used because stockholders rarely attend meetings or name proxies other than those suggested to them by management. A more recent type of corporation is the holding company, organized to buy a controlling interest in other corporations; this type of corporation typically possesses no physical assets. The amount of cash needed to control a concern is lessened by pyramiding holding companies. This is done by creating a company to hold a voting control of one or more operating companies. A third company is created to hold a controlling interest in the second, and so on. The control of the last holding company is sufficient to control all; and such control, because of the scattering of stock among many small holders, may need the ownership of only 10% or 20% of the stock available Read more: corporation: The Modern Corporation — 4) Role of Management : Management acts as an agent for the owners (shareholders) of the firm.An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. 4 5) Agency Theory • • • • Jensen and Meckling developed a theory of the firm based on agency theory. Agency Theory is a branch of economics relating to the behavior of principals and their agents. Principals must provide incentives so that management acts in the principals’ best interests and then monitor results Incentives include, stock options, perquisites, and bonuses. 6) Social Responsibility • Wealth maximization does not preclude the firm from being socially responsible. • Assume we view the firm as producing both private and social goods. • Then shareholder wealth maximization remains the appropriate goal in governing the firm. Another issue that deserves consideration is social responsibility: Should businesses operate strictly in their stockholders’ best interests, or are firms also responsible for the welfare of their employees, customers, and the communities in which they operate? Certainly firms have an ethical responsibility to provide a safe working environment, to avoid polluting the air or water, and to produce safe products. However, socially responsible actions have costs, and not all businesses would voluntarily incur all such costs. If some firms act in a socially responsible manner while others do not, then the socially responsiblefirms will be at a disadvantage in attracting capital. To illustrate, suppose all firms in a given industry have close to “normal” profits and rates of return on investment, that is, close to the average for all firms and just sufficient to attract capital. If one company attempts to exercise social responsibility, it will have to raise prices to cover the added costs. If other firms in its industry do not follow suit, their costs and prices will be lower. The socially responsible firm will not be able to compete, and it will be forced to abandon its efforts. Thus, any voluntary socially responsible acts that raise costs will be difficult, if not impossible, in industries that are subject to keen competition. What about oligopolistic firms with profits above normal levels—cannot such firms devote resources to social projects? Undoubtedly they can, and many large, successful firms do engage in community projects, employee benefit programs, and the like to a greater degree than would appear to be called for by pure profit or wealth maximization goals.4 Furthermore, many such firms contribute large sums to charities. Still, publicly owned firms are constrained by capital market forces. To illustrate, suppose a saver who has funds to invest is considering two alternative firms. One devotes a substantial part of its resources to social actions, while the other concentrates on profits and stock prices. Many investors would shun the socially oriented firm, thus putting it at a disadvantage in the capital market. After all, why should the stockholders of one corporation subsidize society to a greater extent than those of other businesses? For this reason, even highly profitable firms (unless they are closely held rather than publicly owned) are generally constrained against taking unilateral cost-increasing social actions. 5 Does all this mean that firms should not exercise social responsibility? Not at all. But it does mean that most significant cost-increasing actions will have to be put on a mandatory rather than a voluntary basis to ensure that the burden falls uniformly on all businesses. Thus, such social benefit programs as fair hiring practices, minority training, product safety, pollution abatement, and antitrust actions are most likely to be effective if realistic rules are established initially and then enforced by government agencies. Of course, it is critical that industry and government cooperate in establishing the rules of corporate behavior, and that the costs as well as the benefits of such actions be estimated accurately and then taken into account. In spite of the fact that many socially responsible actions must be mandated by government, in recent years numerous firms have voluntarily taken such actions, especially in the area of environmental protection, because they helped sales. For example, many detergent manufacturers now use recycled paper for their containers, and food companies are packaging more and more products in materials that consumers can recycle or that are biodegradable. To illustrate, McDonald’s replaced its styrofoam boxes, which take years mto break down in landfills, with paper wrappers that are less bulky and decompose rapidly. Some companies, such as The Body Shop and Ben & Jerry’s Ice Cream, go to great lengths to be socially responsible. According to the president of The Body Shop, the role of business is to promote the public good, not just the good of the firm’s shareholders. Furthermore, she argues that it is impossible to separate business from social responsibility. For some firms, socially responsible actions may not de facto be costly—the companies heavily advertise their actions, and many consumers prefer to buy from socially responsible companies rather than from those that shun social responsibility. Corporate Governance: The essence of the corporate governance debate is the effects of the particular relationship between directors and shareholders. The greater the separation between the two, the greater the potential for abuse and also the greater the possibility of suboptimal behaviour by managers as viewed by shareholders. At present in the UK there is a voluntary system of governance in place. The framework has evolved through, or been impacted upon, by six key ,reports starting with the Cadbury report in 1992. The various recommendations of these reports have been incorporated into the combined code which is included in the Listing Rules of the London .Stock Exchange as an appendix. The rules require a company to Corporate Governance represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. Then shareholder wealth maximization remains the appropriate goal in governing the firm. Board of Directors u Typical responsibilities: u Set company-wide policy; 6 u Advise the CEO and other senior executives; Hire, fire, and set the compensation of the CEO; Review and approve strategy, significant investments, and acquisitions; and Oversee operating plans, capital budgets, and financial reports to common shareholders. CEO/Chairman roles commonly same person in US, but separate in Britain (US moving this direction). u u u u Financial management and risk Since financial management is concerned with making decisions, and decision making is concerned with the future and the future is uncertain, risk must be a major factor in all aspects of financial management. Risk may be defined as the extent to which what we estimate will happen in the future may or may not happen. If there is only one single possible outcome, there is no risk. If there are many possible outcomes and many of them are very different from our estimate of the outcome, then there is a lot of risk. Broadly speaking, both theory and practice show us that risk and return are correlated. We seek higher expected returns for investing in riskier projects. Where we perceive little risk (e.g. an investment in government securities), we are prepared to accept relatively small returns. Organization of the Financial Management Function: Organizational structures vary from firm to firm, but Figure 1-1 presents a fairly typical picture of the role of finance within a corporation. The chief financial officer (CFO) generally has the title of vice-president: finance, and he or she reports to the president. The financial vice-president’s key subordinates are the treasurer and the controller. In most firms the treasurer has direct responsibility for managing the firm’s cash and marketable securities, for planning its capital structure, for selling stocks and bonds to raise capital, for overseeing the corporate pension plan, and for managing risk. The treasurer also supervises the credit manager, the inventory manager, and the director of capital budgeting (who analyzes decisions related to investments in fixed assets). The controller is typically responsible for the activities of the accounting and tax departments. 7 Conclusion 8 Knowledge through financial management will not restrict only to numerical data. For a complete image of the cause and effect type of relations, it is necessary to combine the structured information – data – with the non-structured information – text. Consequently, in a society of latest generation information technology knowledge, a Web environment at the level of the whole company allows the interaction, the distribution of results and achievement of the organization’s personality. The financial management offers the possibility to plan the “way” to achieve the proposed objectives, to cover a well-defined path and to take advantage of the new opportunities which come along. At the same time, it offers an image of the compatibility between the company’s internal processes, the existing financial sources, their cost and way of appropriation, offering strategic recommendations to avoid unpleasant events that may occur. The most decisive matter regarding the financial management is represented by the managing team’s level of involvement into the necessary changes. Without a strong involvement, the financial management can not be implemented. 9