CHAPTER ONE

An
An Overview
Overview
of
of
Financial
Financial Management
Management
 Why recently apple win a global beauty
contest for companies?
 All successful companies are able to accomplish two
main goals
1. To identify, create, and deliver products or services that
are highly valued by customers - surpass their
competitors.
2. To sell their products/services at prices that are high
enough to cover costs and to compensate owners and
creditors for the use of their money and their exposure
to risk.

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Key Attributes of Successful Companies

 have skilled people at all levels inside the company,

including leaders, managers, and a capable
workforce.
 have strong relationships with groups outside the
company. For example, successful companies
develop win–win relationships with suppliers and
excel in customer relationship management.
 have enough funding to execute their plans and
support their operations.

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 Why FM for MBA students?

 To address raising the capital your company needs to

implement its plans. In short to give you the skills you
need to help a company achieve its first goal: producing
goods and services that customers want.
 To help your company accomplish the second goal-
generating enough cash to compensate the investors
who provided the necessary capital- you must be able
to evaluate different proposals from different areas. For
this, you must have expertise in finance, and hence
finance is a critical part of an MBA education.
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 What is Financial Management?

 Financial management is a managerial activity

which is concerned with the planning and
controlling of the firm’s financial resources/
efficient use of an important economic resource
namely, capital funds.
 Finance expertise in financial management actively
participates in the decision-making areas of
finance.

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 Financial decision-making areas

 The financial manager should strive to maximize

the value of shares and participate in the following
decision - making areas :-
1. Investment decision
2. financing decision
3. dividend decision
4. liquidity decision

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 1. Investment decision

 The first and perhaps the most important decision that

any business has to make are to define the business or
businesses that it wants to be in. This decision has a
significant focusing on how capital is allocated in the
business.
 For example, develop a plan to invest in machineries,
equipment, research and development, distribution
network…
 Hence such decision involve capital expenditure, also
referred as capital budgeting decision (Asset
investment decisions).
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 2. Financing decision

 Once a business has decided the investment projects

it wants to undertake, it has to figure out ways and
means of financing them.
 Generally, the central issue of financing decision is
to determine the appropriate proportion of equity
and debt. The mix of debt and equity is known as
the firm’s capital structure decision.

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 3. Dividend decision

 The financial manager must decide whether the

firm should distribute all profits, or retain them, or
distribute a portion and retain the balance.
 The dividend policy should be determined in terms
of its impact on the shareholders' value.

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 4. Liquidity decision

 It is also known as Working capital management

also referred to as short-term financial
management, refers to the day-to-day financial
activities that deal with current assets and current
liabilities.
 Current assets should be managed efficiently for
safeguarding the firm against the dangers of
illiquidity and insolvency. Investment in current
assets affects the firm's profitability, liquidity and
risk.
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 Summary of Financial Decisions

 Capital budgeting
 What long-term investments or projects should the
business take on?
 Capital structure
 How should we pay for our assets?
 Should we use debt or equity?
 Dividend decision
 What to do regarding the profit?
 whether the firm should distribute all profits, or retain
them or distribute a portion and retain the balance.
 Working capital management
 How do we manage the day-to-day finances of the firm?
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 Goal of Financial Management

 What will be the rational goal of a business?

 There are two widely-discussed alternative
approaches which can be used a as decision
criterion for the maximization of owners' economic
welfare:
 Profit maximization approach, and
 Wealth maximization approach.

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 Profit maximization approach

 The process of increasing the profit earning

capability of the company is profit maximization.
 According to this approach, actions that increase
profits should be undertaken and those that
decrease profits are to be avoided.
 Drawbacks of the profit maximization
 Ambiguity: The term profit is a vague and
ambiguous concept. It has no precise implication.
For example: long-term or short-term profit, profit
before tax or profit after tax.
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 Cont…

 Ignore timing of benefits: ignores the differences in

the time pattern of the benefits received from
investment proposals or courses of action/ignores
time value of money concept. Follows 'the bigger the
better' principle.
 Ignore quality of benefits: since profit
maximizations is not consider the degree of risk and
uncertainty, the quality of benefits are not
considered.

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 Wealth maximization approach

 The ability of the company to increase the value for

the stockholders of the company, mainly through an
increase in the market price of the company’s share
over some time.
 Increasing the value of the stockholders of the
company in the long term.
 Market price of the company’s share is valued
based on the timing of returns, and their risk level.

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 Cont…

Profit maximization Wealth maximization

(Short term) (long term)

Traditional approach Modern approach

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 The Agency Problem

 Agency relationship
 Principal hires an agent to represent their interest
 Stockholders (principals) hire managers (agents) to run the
company.
 Agency problem
 Conflict of interest between principal (firm’s owners) and
agent(managers).
 Agency costs

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 Managing Managers

1 - Compensation plans
2 - Board of Directors
 If shareholders believe that the corporation is
underperforming and that the board of directors is not
sufficiently aggressive in holding the managers to task,
they can try to replace the board in the next election.

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 Cont…
3 – Takeovers
 Poorly performing companies are also more likely to
be taken over by another firm. After the takeover, the
old management team may find itself out on the street.
4 - Specialist Monitoring
 managers are subject to the scrutiny of specialists.
Their actions are monitored by the security analysts
who advise investors to buy, hold, or sell the
company’s shares.
5 - Auditors
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 Functional Linkages Between Management & Accounting

 Historically, accounting functions have been to record,

analyze, and report the results of business operations.
 Based on such information, through managerial
accounting ,management can:
 Plan future operations
 Control key variables,
 Decide among alternative courses of action, and
 Analyze past performance.

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 For example,

 Airline managers at Lufthansa need to know the capacity

utilization of their aircraft. They need information on the
number of flight tickets sold and prepaid.
 Airline managers at Lufthansa need to know the capacity
utilization of their aircraft. They need information on the
number of flight tickets sold and prepaid.
 Managers at car manufacturer will ask for the cost of raw
materials used in car production. How many cars have been
produced on stock during the last month and have not yet been
sold?
 Such information's are communicated to the management for
decision making through accounting.
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Thank you and stay safe

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