CHAPTER 1

INTRODUCTION
FINANCIAL MANAGEMENT
 WHAT IS FINANCE?

• It is the process by which money is transferred among

businesses, individuals, and governments thru financing and
investing activities of these parties
• Finance can be used by :
i) individuals - personal finance
ii) government- public finance
iii) Institutions / non profit organization – corporate finance
 Why you need to study Financial Management??

• Importance of Finance
 The knowledge of finance will help you to solve personal decision
such as investing your saving and choose the best alternative for
your housing loan
 It is very important for people in marketing, personnel,
accounting, sport science and recreation department to
understand financial management in order to do a good job in
their own fields
 Knowledge of finance aids in planning, problem solving and
decision making
 Examples of financial activities – borrowing funds, buying a
house, issuing shares, expansion product line
 AREAS OF DECISION FUNCTIONS
 Decision function of financial management
i) Investment Decision
 The most important decision involve capital investment decision
(large sum –non-routine: buy new machine) and working capital
investment decision (more routine: determine amount of
inventories, marketable securities)
ii) Financing decision
 Two sources of finance -
a) borrowing (debt)
 Long term debt – payable after 1 year i.e: debentures
 Short term debt – payable within 1 year i.e: bank overdraft,
commercial papers, trade credit
b) Capital – common equity and preferred stocks
iii) Asset Management Decision
 Financial manager will manage current assets effectively and
efficiently , the company will increase its return and minimize its
risk
Debentures Banker acceptance

Promissory notes Preferred stock

Commercial paper Common stock

 Important Parties in the Financial Environment

1) Financial Managers
• Responsible for deciding how to invest the firm’s funds for
expanding business (investment decision) and how to obtain funds
(financing decision) for investment
• Financial managers have to deal with variety of plans such as
financial plans, production plans, marketing plans
2) Investors
• Individual or financial institutions that provide funds to firms, the
governments, agencies or other individuals who need those funds
• i.e: Individual – purchasing securities of firms
• i.e: Financial institutions – giving loans to individual and firm
3) Financial Markets
• Facilitate the flow of funds among investors, firms, government units
and agencies
• Meeting place where suppliers and demanders of loans and investments
can transact business directly

• i) Money Market
 Deal with short term securities – life 1 yr or less
 The securities very liquid, easily converted into cash
 i.e: short term securities : commercial papers, banker acceptance,
money market funds, certificate of deposit
 i.e: This marketable securities are very liquid securities that can be
converted into cash quickly at a reasonable price. For example:Nike Inc's
marketable securities for the quarter that ended in Nov. 2018 was $618
Mil.

ii) Capital Market

 Long term securities life more than 1 yr
 i.e: common stock, preferred stock and bonds
 It encompasses development of financial institutions saving, insurance
institution, EPF etc
a) Primary Market
 New securities are bought and sold for the first time
 Issuer directly involved in the transaction and receives
the sales of securities

b) Secondary Market
 Existing securities are traded among investors
 Issuer not involved in the transaction
 I.e: Bursa Malaysia (K.L Stock Exchange), MESDAQ,
MDEX
4) Financial Institutions
 As intermediaries that channel the savings of individual,
businesses and governments into loan or investments
 i.e: Commercial banks, saving institutions, insurance
companies, finance companies, mutual fund, pension
fund
 MIDF (Malaysia Industrial Development Finance BHD),
Bank Industri dan Teknologi Mlysia Bhd (BITM)
 RESPONSIBILITIES OF FINANCIAL MANAGERS

1) Forecasting and Planning

• Able to forecast the company future performance
• Base on company’s past and future performance such as economic
performance, customer preferences and future demand of
product

2) Investment and Financing Decision

• Determine sales growth rate
• Determine specific assets to purchase
• Determine the best method of financing assets - using debt (long
term/short term), equity (common stock, preferred stock)
3) Coordination and control
• Financial managers have to interact with other departments within
the organization. This is necessary because the decision of other
departments might effect investments decision.
• i.e: the company has decided to increase sale promotion activities
(marketing decision) so it require production capacity that will
influence the investment requirements

4) Dealing with Financial Markets

• Financial Managers have to obtain financing either through money
markets or capital markets
• He has to decide on investing excess or idle funds in the financial
market
• Must have to foster relationships with creditors, stockholders,
investors
 GOAL OF THE FIRM
• Maximization of Shareholder Wealth
 It means by maximizing the total market value (market price) of
the existing shareholder common stock (ordinary share)
 Maximize the wealth of the owners that measured by share price,
which in turn is based on the timing of returns, amount of returns,
and the risk or uncertainty of the returns
 Financial manager cannot control the stock price because it
affected by economic environment
 Shareholders react to:-
 Poor investment decision (market value of firm’s stock to fall)
 Good investment decision (pushing the stock price up)
• Financial manager must always have the strategy to increase the
stock price to maximize the shareholder wealth
• Financial manager must always do the strategies to maximize
sales, maximize marketing
• Maximized the shareholder wealth is measured = stock price x
amount of shares

PROFIT MAXIMIZATION
• It is short-terms target to be achieved within 1 year
• It stresses the efficient use of capital resources
• To maximize the profit, the financial manager might only choose
the project that give the maximize profit
• i.e: If a firm able to increase its profit, it may pay good dividend to
shareholders. It makes the shareholder happy and willing to
contribute more funds in the future
• Problems of Profit Maximization
i) Profit maximization ignore the size of shareholder investment
ii) Profit maximization ignore timing of returns
 Timing of return – how quickly a firm earns a return from
investment in fixed assets
iii) Profit maximization ignores risk
• Risk is defined as the possibility that something unpleasant would
occur or the actual results would differ from the expected result
• Profit ignores size of share holder investment
• Profit maximization ignore timing of returns

• Profits are same but timing of return differs.

• Product A - RM15,000 investment that earned at the end of year
1 with 5% interest will be grown RM15750 in 2nd year
• Compared to product B starting 2nd year investment RM15000
• The firm prefer cash flows sooner rather than later
• Profit ignores uncertainty of returns

• The two products appear to have the same expected returns

• But, the returns associated with Product B involve much greater
risk
• Depending on shareholders attitude towards risk, the first
investment may be preferable to the second investment
 TIME VALUE OF MONEY

• Simply means that a dollar received today is worth more than a

dollar received in the future
• Understanding how shares and bonds are valued, how the value
of a new project is determined and etc

Concept of Time Value of Money

• The value of money will change depending on where and when

it’s being used

• The value of money will change according to time

• A ringgit today is more valuable than a ringgit a year

 Factors affect the value of money
i) Interest Rate

ii) Inflation and deflation

iii)Risk or uncertainty
 Present Value
• The value today of a sum of money to be received in the future. The
value of money now
• It can be referred as reverse compounding or discounting
• Discounting determines the present value of a future sum, assuming an
opportunity to earn a certain return on the value. Process of finding
present value
• Annual rate of return can be referred to as discount rate, required
return, cost of capital or opportunity cost.
• Equation: PV = FVn (PVIF i,n)
where:
PV = present value or amount invested at beginning of the first year
FVn = future value of an investment at the end of n years
n = number of years before payment is received
i = annual discount rate
• Example:
What will the present value be of RM1,000 to be received 8 years
from today if the discount rate is 5%?

PV = FV8 (PVIF 5%, 8 years)

The present value interest factor for i and n (PVIF i, n) can be

obtained from present value tables

Referring to i= 5% and n = 8 years, we get value of 0.6768

Therefore, PV = 1000 (0.6768) = RM676.80

 Future Value
• When we invest our money in a bank, we will get a return plus the
principal that we initially put
• Future value of money is the value of money in the future
• Compound interest means interest is earned not only on the
principal or initial investment but also on the interest earned
earlier
• If interest is earned only on the initial investment it is called simple
interest
• Equation: FVn = PV (FVIF i, n)
PV = present value or amount invested at beginning of the first year
FVn = future value of an investment at the end of n years
n = number of years compounding occurs
i = annual discount rate
• Example:
Azrul has decided to place RM500, which he received as a birthday
gift, in a saving account paying 4% interest. How much will accrue to
Azrul’s account in 6 years time?

FV6 = PV (FVIF 4%, 6 years)

The future value interest factor for i and n (FVIF i, n) can be obtained
from future value tables

Referring to i= 4% and n = 6 years, we get value of 1.2653

Therefore, FV = 500 (1.2653) = RM632.65