Chapter 1

Introduction to
Financial
Management

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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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Key Concepts and Skills

• Know the basic types of financial
management decisions and the role of
the financial manager
• Know the financial implications of the
different forms of business organization
• Know the goal of financial management
• Understand the conflicts of interest that
can arise between owners and managers

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Chapter Outline
• Finance: A Quick Look
• Business Finance and The Financial
Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Problem and Control of the
Corporation
• Financial Markets and the Corporation
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Basic Areas Of Finance

• Corporate finance
• Investments
• Financial institutions
• International finance

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Investments
• Work with financial assets such as
stocks and bonds
• Value of financial assets, risk versus
return, and asset allocation
• Job opportunities
– Stockbroker or financial advisor
– Portfolio manager
– Security analyst

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Financial Institutions
• Companies that specialize in financial
matters
– Banks – commercial and investment, credit
unions, savings and loans
– Insurance companies
– Brokerage firms
• Job opportunities

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International Finance
• This is an area of specialization within each of
the areas discussed so far
• It may allow you to work in other countries or
at least travel on a regular basis
• Need to be familiar with exchange rates and
political risk
• Need to understand the customs of other
countries; speaking a foreign language
fluently is also helpful

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Why Study Finance?

• Marketing
– Budgets, marketing research, marketing financial
products
• Accounting
– Dual accounting and finance function, preparation
of financial statements
• Management
– Strategic thinking, job performance, profitability
• Personal finance
– Budgeting, retirement planning, college planning,
day-to-day cash flow issues
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Business Finance
• Some important questions that are
answered using finance
– What long-term investments should the firm
take on?
– Where will we get the long-term financing to
pay for the investments?
– How will we manage the everyday financial
activities of the firm?

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Financial Manager
• Financial managers try to answer some, or
all, of these questions
• The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
– Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning
– Controller – oversees taxes, cost accounting,
financial accounting, and data processing

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Financial Management
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?
• Working capital management
– How do we manage the day-to-day
finances of the firm?

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Forms of Business Organization

• Three major forms in the United States
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• S-Corp
• Limited liability company

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Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all owner’s personal
of the profits wealth
– Taxed once as – Unlimited liability
personal income – Difficult to sell
ownership interest

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Partnership
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
• Limited partnership
– Relatively easy to
start – Partnership dissolves
– Income taxed once as when one partner dies
personal income or wishes to sell
– Difficult to transfer
ownership

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Corporation
• Advantages • Disadvantages
– Limited liability – Separation of
– Unlimited life ownership and
– Separation of management (agency
problem)
ownership and
management – Double taxation
– Transfer of ownership (income taxed at the
is easy corporate rate and
then dividends taxed
– Easier to raise capital at personal rate, while
dividends paid are not
tax deductible)

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Goal Of Financial Management

• What should be the goal of a corporation?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company’s
stock?
• Does this mean we should do anything
and everything to maximize owner wealth?
• Sarbanes-Oxley Act
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The Agency Problem

• Agency relationship
– Principal hires an agent to represent its
interests
– Stockholders (principals) hire managers
(agents) to run the company
• Agency problem
– Conflict of interest between principal and
agent
• Management goals and agency costs

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Managing Managers
• Managerial compensation
– Incentives can be used to align management and
stockholder interests
– The incentives need to be structured carefully to
make sure that they achieve their goal
• Corporate control
– The threat of a takeover may result in better
management
• Other stakeholders

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Example: Work the Web

• The Internet provides a wealth of
information about individual companies
• One excellent site is finance.yahoo.com
• Click on the Web surfer to go to the site,
choose a company and see what
information you can find!

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Figure 1.2

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Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ

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Meaning of Financial Management

Financial Management means planning,
organizing, directing and controlling the
financial activities such as procurement
and utilization of funds of the enterprise.
It means applying general management
principles to financial resources of the
enterprise.

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Scope/Elements
Investment decisions includes investment in
fixed assets (called as capital budgeting).
Investment in current assets are also a part
of investment decisions called as working
capital decisions.
Financial decisions - They relate to the
raising of finance from various resources
which will depend upon decision on type of
source, period of financing, cost of financing
and the returns thereb

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Dividend decision - The finance

manager has to take decision with
regards to the net profit distribution. Net
profits are generally divided into two:

Dividend for shareholders- Dividend

and the rate of it has to be decided.

Retained profits- Amount of retained

profits has to be finalized which will
depend upon expansion and
diversification plans of the enterprise. 24
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Objectives of Financial Management

The financial management is generally concerned with
procurement, allocation and control of financial resources of a
concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders which will depend

upon the earning capacity, market price of the share, expectations
of the shareholders.

To ensure optimum funds utilization. Once the funds are procured,

they should be utilized in maximum possible way at least cost.

To ensure safety on investment, i.e, funds should be invested in

safe ventures so that adequate rate of return can be achieved.

To plan a sound capital structure-There should be sound and fair

composition of capital so that a balance is maintained between debt
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and equity capital.
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Functions of Financial Management

Estimation of capital requirements: A finance manager
has to make estimation with regards to capital
requirements of the company. This will depend upon
expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of
enterprise.

Determination of capital composition: Once the

estimation have been made, the capital structure have to
be decided. This involves short- term and long- term debt
equity analysis. This will depend upon the proportion of
equity capital a company is possessing and additional
funds which have to be raised from outside parties.
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•Choice of sources of funds: For additional funds to be procured, a company
has many choices like-
a.Issue of shares and debentures
b.Loans to be taken from banks and financial institutions
c.Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and
period of financing.

•Investment of funds: The finance manager has to decide to allocate funds

into profitable ventures so that there is safety on investment and regular returns
is possible.

•Disposal of surplus: The net profits decision have to be made by the finance
manager. This can be done in two ways:
b.Retained profits - The volume has to be decided which will depend upon
expansional, innovational, diversification plans of the company.

a.Dividend declaration - It includes identifying the rate of dividends and other

benefits like bonus.

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Management of cash: Finance manager has to make decisions with

regards to cash management. Cash is required for many purposes like
payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintenance of enough
stock, purchase of raw materials, etc.

Financial controls: The finance manager has not only to plan, procure
and utilize the funds but he also has to exercise control over finances.
This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.

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Financial Planning - Definition,

Objectives and Importance

Definition of Financial Planning

Financial Planning is the process of estimating the capital required and
determining it’s competition. It is the process of framing financial
policies in relation to procurement, investment and administration of
funds of an enterprise.

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to:

Determining capital requirements- This will depend upon factors like

cost of current and fixed assets, promotional expenses and long- range
planning. Capital requirements have to be looked with both aspects:
short- term and long- term requirements.

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•Determining capital structure- The capital structure

is the composition of capital, i.e., the relative kind and
proportion of capital required in the business. This
includes decisions of debt- equity ratio- both short-term
and long- term.

•Framing financial policies with regards to cash

control, lending, borrowings, etc.
•A finance manager ensures that the scarce financial
resources are maximally utilized in the best
possible manner at least cost in order to get maximum
returns on investment.

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Importance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures,

programmes and budgets regarding the financial activities of a concern.

This ensures effective and adequate financial and investment policies. The
importance can be outlined as-
Adequate funds have to be ensured.

Financial Planning helps in ensuring a reasonable balance between outflow

and inflow of funds so that stability is maintained.

Financial Planning ensures that the suppliers of funds are easily investing in
companies which exercise financial planning.

Financial Planning helps in making growth and expansion programmes which

helps in long-run survival of the company.

Financial Planning reduces uncertainties with regards to changing market

trends which can be faced easily through enough funds.

Financial Planning helps in reducing the uncertainties which can be a

hindrance to growth of the company. This helps in ensuring stability an d
profitability in concern. 31
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ADMINISTRATIVE AND FINANCIAL

MANAGEMENT DIVISION

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DUTIES AND FUNCTIONS 

1. Provide administrative, personnel
management, career development, and
general services for the members of the IAS; 
2. Formulate training plans and policies for
the members of the IAS; 
3. Provide financial management, budgetary
services, logistics and supply management
services; 

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4. Undertake liaison services with other government

and non-government agencies on matters relating to
the IAS areas of functional interest including foreign
counter parts for purposes of training and other
requirements; 
5. Act as the central repository of IAS records; 
6. Serve as the all-source clearinghouse of all PNP
disciplinary, administrative and criminal cases; 
7. Maintain accurate and up-to-date records of
disciplinary and criminal cases against PNP
personnel; 
8. Keep up-to-date records of all PNP and IAS
personnel including their places of assignments; and 
9. Performs other tasks as the Inspector General may
direct.
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Administrative and Human Resource Management

Section
 
1. Provide administrative, personnel management and
general services for members of IAS including
preparation of documents needed for retirement; 
2. Undertake liaison services with other government
and non-government agencies on matter relating to
the IAS areas of functional interest; 
3. Assist in providing career development services for
members of IAS; 
4. Assist AFMD in formulating training plans and
policies for the members of IAS; 

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5. Evaluate the performance of PNCOs and

NUP of AFMD personnel relative to their
efficiency and deficiency on their respective
assigned task; 
6. Assume responsibility for the preparation of
reports relative to the activities, deficiencies
and efficiencies involving discipline, details,
assignments and other related matters
affecting personnel matters; and 
7. Performs such other related duties as may
be directed.

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Records Management Section

 
1. Act as the Central repository of IAS
records; 
2. Administer and maintain the IAS Clearance
System; 
3. Maintain accurate up-to-date records of
disciplinary and criminal cases against PNP
personnel; and 
4. Keep up-to-date records of all IAS
personnel as well as all PNP personnel with
their places of assignments.

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Logistics Section
 
1. Oversee all logistics related activities of the
Central, Regional, Provincial and District IAS Offices; 
2. Assist on the administration and management of
logistics and each functional areas for the successful
accomplishment of IAS mission; 
3. Prepare logistics plans, programs, policies,
procedure and guidelines relative to logistics activities
of IAS; and 
4. Provide guidelines for the direction and control of
the function of supply, maintenance, facilities and
installation, transportation, services and other
logistics objectives.

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Budget, Finance and Accounting Section

 
1. Provide financial management and
budgetary services; 
2. Supervise the control, distribution and
allocation of funds. 
3. Facilitate payment of salaries, retirement
and other benefits of IAS personnel. 
4. Provide records pertaining to comptroller
and finance transaction; and 
5. Coordinate with PNP Comptrollership and
Finance Center on Matters of budget and
other financial requirements of IAS.
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