INTRODUCTION TO

FINANCIAL
MANAGEMENT

FINANCIAL MANAGEMENT AND INNOVATIONS

 What is Finance?

• Finance can be defined as the art and

science of managing money.
• Finance is concerned with the process,
institutions, markets, and instruments
involved in the transfer of money
among individuals, businesses, and
governments.
 Financial Management
• Financial management can be defined as
strategizing the organization’s financial
direction as well as the performance of its
day-to-day financial operations.
Purpose of Financial Management

• To determine the strategic financial direction

of the organization.
– The primary job is to prepare and present the
organization’s strategic financial plan to the
board for endorsement and approval.
Purpose of Financial Management

• To manage the day-to-day financial

operations.
– This function means making sure that the payroll
and the suppliers are paid and that the revenues
generated by the operation are billed out in an
accurate and timely manner and collected
efficiently with a minimum of write-offs.
 Major Areas & Opportunities in
Finance: Financial Services

• Financial Services is the area of

finance concerned with the design and
delivery of advice and financial products
to individuals, businesses, and
government.
• Career opportunities include
banking, personal financial planning,
investments, real estate, and insurance.
 Major Areas & Opportunities in
Finance: Financial Management

• The financial manager actively manages

the financial affairs of any type of business,
whether private or public, large or small,
profit-seeking or not-for-profit.
• They are also more involved in developing
corporate strategy and improving the firm’s
competitive position.
Major Areas & Opportunities in Finance:
Financial Management
• Increasing globalization has complicated
the financial management function by
requiring them to be proficient in
managing cash flows in different
currencies and protecting against the
risks inherent in international
transactions.
• Changing economic and regulatory
conditions also complicate the financial
management function.
Corporate Organization
Career Opportunities in
Financial Management
The Managerial Finance Function
• The size and importance of the managerial
finance function depends on the size of the
firm.
• In small companies, the finance function may
be performed by the company president or
accounting department.
• As the business expands, finance typically
evolves into a separate department linked to
the president.
 The Managerial Finance Function:
Relationship to Economics

• The field of finance is actually an

outgrowth of economics.
• In fact, finance is sometimes referred to
as financial economics.
• Financial managers must understand
the economic framework within which
they operate in order to react or
anticipate to changes in conditions.
 The Managerial Finance Function:
Relationship to Economics

• The primary economic principal used by

financial managers is marginal cost-
benefit analysis which says that
financial decisions should be
implemented only when added benefits
exceed added costs.
 The Managerial Finance Function:
Relationship to Accounting

• The firm’s finance (treasurer) and

accounting (controller) functions are
closely-related and overlapping.
• In smaller firms, the financial manager
generally performs both functions.
 The Managerial Finance Function:
Relationship to Accounting

• One major difference in perspective and

emphasis between finance and
accounting is that accountants generally
use the accrual method while in
finance, the focus is on cash flows.
 The Managerial Finance Function:
Relationship to Accounting

• Finance and accounting also differ with

respect to decision-making.
• While accounting is primarily concerned with
the presentation of financial data, the
financial manager is primarily concerned with
analyzing and interpreting this
information for decision-making purposes.
• The financial manager uses this data as a
vital tool for making decisions about the
financial aspects of the firm.
Financial Activities
 Goal of the Firm:
Maximize Shareholder Wealth

• The process of shareholder wealth

maximization can be described using the
following flow chart:
 Goal of the Firm:
What About Other Stakeholders?
• Stakeholders include all groups of individuals
who have a direct economic link to the firm
including employees, customers, suppliers,
creditors, owners, and others who have a direct
economic link to the firm.
• The "Stakeholder View" prescribes that the firm
make a conscious effort to avoid actions that
could be detrimental to the wealth position of its
stakeholders.
• Such a view is considered to be "socially
responsible."
 Corporate Governance

• Corporate Governance is the system used to

direct and control a corporation.
• It defines the rights and responsibilities of
key corporate participants such as
shareholders, the board of directors, officers
and managers, and other stakeholders.
Individual versus Institutional Investors
• Individual investors are investors who purchase
relatively small quantities of shares in order to earn a
return on idle funds, build a source of retirement
income, or provide financial security.
• Institutional investors are investment professionals
who are paid to manage other people’s money.
• They hold and trade large quantities of securities for
individuals, businesses, and governments and tend to
have a much greater impact on corporate
governance.
The Sarbanes-Oxley Act of 2002
• The Sarbanes-Oxley Act of 2002 (commonly called
SOX) eliminated many disclosure and conflict of
interest problems that surfaced during the early
2000s.
• SOX:
– established an oversight board to monitor the accounting
industry;
– tightened audit regulations and controls;
– toughened penalties against executives who commit
corporate fraud;
– strengthened accounting disclosure requirements;
– established corporate board structure guidelines.
The Role of Ethics: Ethics Defined
• Ethics is the standards of conduct or
moral judgment—have become an
overriding issue in both our society and
the financial community
• Ethical violations attract widespread
publicity
• Negative publicity often leads to
negative impacts on a firm
 Financial Institutions &
Markets
• Firms that require funds from external
sources can obtain them in three ways:
– through a bank or other financial institution
– through financial markets
– through private placements
 Financial Institutions & Markets:
Financial Institutions
• Financial institutions are intermediaries that
channel the savings of individuals,
businesses, and governments into loans or
investments.
• The key suppliers and demanders of funds
are individuals, businesses, and
governments.
• In general, individuals are net suppliers of
funds, while businesses and governments are
net demanders of funds.
 Types of Markets
Product markets

Financial markets

Flow of funds (savings)

Producing units (mainly Flow of financial services,
business firms and income, and financial claims Consuming units (mainly
governments) households)

Factor markets
 Financial Institutions & Markets:
Financial Markets
• Financial markets provide a forum in which
suppliers of funds and demanders of funds
can transact business directly.
• The two key financial markets are the money
market and the capital market.
• Transactions in short term marketable
securities take place in the money market
while transactions in long-term securities take
place in the capital market.
 Types of Financial Markets
Within the Global Financial System
• The money market is for short-term (one
year or less) loans, while the capital market
finances long-term investments by
businesses, governments, and households.
• In particular, governments borrow from
commercial banks in the money market, while
in the capital market, insurance companies,
mutual funds, security dealers, and pension
funds supply the funds for businesses.
 Types of Financial Markets
Within the Global Financial System
• The money market may be subdivided into
Treasury bills, certificates of deposit (CDs),
bankers’ acceptances, commercial paper,
federal funds and Eurocurrencies.
• The capital market may be subdivided into
mortgage loans, tax-exempt (municipal)
bonds, consumer loans, Eurobonds and
Euronotes, corporate stock, and corporate
notes and bonds.
 Types of Financial Markets
Within the Global Financial System

• In open markets, financial instruments are sold

to the highest bidder, and they can be traded
as often as is desirable before they mature. In
negotiated markets, the instruments are sold to
one or a few buyers under private contract.
• Financial capital is raised when newly issued
securities are sold in the primary markets.
Security trading in the secondary markets then
provides liquidity for the investors.
 Types of Financial Markets
Within the Global Financial System
• In the spot market, assets or financial services
are traded for immediate delivery (usually
within two business days).
• Contracts calling for the future delivery of
financial instruments are traded in the futures
or forward market.
• Contracts granting the right to buy or sell
certain securities at specified prices within a
certain period are traded in the options
market.
Flow of Funds
 The Money Market
• The money market exists as a result of the
interaction between the suppliers and
demanders of short-term funds (those having
a maturity of a year or less).
• Most money market transactions are made in
marketable securities which are short-term
debt instruments such as T-bills and
commercial paper.
• Money market transactions can be executed
directly or through an intermediary.
 The Money Market
• The international equivalent of the domestic
(U.S.) money market is the Eurocurrency
market.
• The Eurocurrency market is a market for
short-term bank deposits denominated in U.S.
dollars or other marketable currencies.
• The Eurocurrency market has grown rapidly
mainly because it is unregulated and because
it meets the needs of international borrowers
and lenders.
 The Capital Market
• The capital market is a market that enables
suppliers and demanders of long-term funds to make
transactions.
• The key capital market securities are bonds (long-
term debt) and both common and preferred
stock (equity).
• Bonds are long-term debt instruments used by
businesses and government to raise large sums of
money or capital.
• Common stock are units of ownership interest or
equity in a corporation.
 CAPITAL MARKET

 The market where investment instruments

like bonds, equities and mortgages are traded
is known as the capital market.

 The capital markets are places where those

who require additional funds seek out others
who wish to invest their excess.
 CAPITAL MARKET

 These are also places where

parties/participants can manage and spread
their risks.

 The primal role of this market is to make

investment from investors who have surplus
funds to the ones who are running a deficit.
 CAPITAL MARKET
 Users of Financial Capital
1. Governments
2. Corporations
3. State, provincial, city and municipal
authorities
4. International agencies ( World Bank, Asian
Development Bank )

 Suppliers of Capital
Everyone can be considered suppliers of
capital.
 CAPITAL MARKET

 The capital market offers both long term

and overnight funds.

 The different types of financial instruments

that are traded in the capital markets are:
> equity instruments
> credit market instruments,
> insurance instruments,
> foreign exchange instruments,
> hybrid instruments and
> derivative instruments.
 CAPITAL MARKET
 Commercial banking – Commercial banks
took in deposits and made loans to
businesses. They assumed credit or default
risk by evaluating the creditworthiness of
borrowers.

 Investment banking – Investment banks

underwrite new issues of securities and deal
in shares and bonds.

 Underwriting risk – This arises when a bank

or a syndicate buys an issue of securities from
the issuer at a fixed price and assumes
responsibility for selling or “placing” the stock
into the capital markets.
 CAPITAL MARKET
 One of the most distinctive features of
investment banking is the trading function.
Essentially, traders buy and sell assets to make
a profit.

 Over-the-counter (OTC) – OTC are deals

that are arranged directly between two parties,
one of which is normally a bank. Most corporate
bonds are traded OTC.

 Value-at-Risk (VaR) – VaR uses statistical

methods to forecast the maximum loss likely to
be made on a particular trading position over a
given time period to a given level of confidence.
 CAPITAL MARKET

 Stress Testing – This involves
investigating the losses the bank would
be likely to make in extreme
circumstances, when asset prices
become highly volatile or when ‘liquidity’
dries up in the market – that is, when it
becomes difficult to trade at all without
having a major impact on prices.
 CAPITAL MARKET
 Clients of Investment Banks
1. Corporations
2. Investing institutions – pension funds,
governments, hedge funds, municipal authorities
and supranational bodies
3. Commercial and other investment banks

 Initial Public Offering (IPO) – A company sells

its shares to the public and obtain a listing on
a regulated stock exchange.
 CAPITAL MARKET
 Hedge Funds – Hedge funds are investment
vehicles aimed at wealthier investors and run by
professional managers. Hedge funds use leverage
(borrowing) in an attempt to magnify the returns
to the investors.

 Typically, a hedge fund manager takes 2%

annual management fee plus 20% of the profits.
Investors also tend to be “locked in” for agreed
time periods and so cannot quickly redeem their
investments.
 CAPITAL MARKET
 Prime brokerage – Prime brokerage involves
providing high-value services to hedge funds
such as stock lending, research advice, trading
and settlement services, administrative support,
providing loans against collateral, and tailoring
advanced structured products to help a hedge
fund implement a particular investment
strategy.
 Sovereign Wealth Funds (SWFs) – SWFs make
international investments using wealth derived
from the sale of natural resources and other
export activities.
 International Capital Markets
• In the Eurobond market, corporations and
governments typically issue bonds
denominated in dollars and sell them to
investors located outside the United States.
• The foreign bond market is a market for
foreign bonds, which are bonds issued by a
foreign corporation or government that is
denominated in the investor’s home currency
and sold in the investor’s home market.
 International Capital Markets
• Finally, the international equity
market allows corporations to sell
blocks of shares to investors in a
number of different countries
simultaneously.
• This market enables corporations to
raise far larger amounts of capital than
they could raise in any single national
market.
 Strategic Financial Planning
• Strategic financial plan can be defined as
quantification of a series of strategic
planning policy decisions. The strategic
financial plan is meant to quantify the
tactics surrounding the organization’s
strategic plan.
 Strategic Financial Planning
• Any organization that aims to be financially
competitive must possess a number of
critical attributes and meet the following
criteria:
– The chief executive has a clear fi nancial vision.
– Management follows the simple rule that “what
gets measured gets done.”
– Management understands and applies principles
of corporate fi nance.
– Management has a sophisticated financial plan.
 Strategic Financial Planning
– The organization favors a quantitative capital
allocation process.
– Management consistently applies quantitative
decision support tools.
– Management sets annual fi nancial goals and
objectives, welcoming organizationwide input.
– The organization has a visible operating plan
and disseminates its financial goals.
– The organization has a strategic plan that takes
the requirements of the capital market into
account.
 Strategic Financial Planning
– Management reduces expenses while improving
service and quality.
 Converting Vision (Strategic Plan)
Into Financial Reality
• There are four steps involved in developing
a strategic financial plan. The organization
must:
(1) Analyze its financial position and prior
growth patterns,
(2) Determine the growth in total assets
needed for the planning period,
(3) Define an acceptable level of debt for both
current and long-term categories,
 Converting Vision (Strategic Plan)
Into Financial Reality

(4) Assess the reasonableness of the required

growth rate in equity (net assets).
 End of
Presentation