Chapter one
An overview about financial management concepts
•Financial Management:
•Is mainly concerned with the effective funds
management in the business. In simple words, Financial
Management as practiced by business firms can be called as
Corporation Finance or Business Finance.
FORMS OF BUSINESS ORGANIZATION
There are three main forms of business organization:
• (1) sole proprietorships,
• (2) partnerships
• (3) corporations.
Finance manager performs the
following major functions:
1. Forecasting Financial Requirements
2. Acquiring Necessary Capital
3. Investment Decision
4. Cash Management
5. Interrelation with Other Departments
• The Agency Issue
We know that the only duty of the financial manager is to maximize the wealth of the
firm’s owners.
Technically, any manager who owns less than 100 percent of the firm is an agent acting
on behalf of other owners.
In theory, most financial managers would agree with the goal of shareholder wealth
maximization. In reality, however, managers are also concerned with their personal
wealth, job security, and fringe benefits. Such concerns may cause managers to make
decisions that are not consistent with shareholder wealth maximization.
Agency problems arise when managers place personal goals ahead the goals of
shareholders.
Agency costs arise from agency problems that are borne by shareholders and
represent a loss of shareholder wealth.
•OBJECTIVES OF FINANCIAL MANAGEMENT
Effective procurement and efficient use of finance lead to proper
utilization of the finance by the business concern. It is the
essential part of the financial manager. Hence, the financial
manager must determine the basic objectives of the financial
management.
• Objectives of Financial Management may be broadly divided
into two parts:
• 1. Profit maximization
• 2. Wealth maximization
Profit maximization:
•Corporations commonly measure profits in terms of earning per share
(EPS), which represent the amount earned during the period on behalf of
each outstanding share of common stock.
•EPS are calculated by dividing the period’s total earnings available for the
firm’s common stockholders by the number of shares of common stock
outstanding.
•Main aim of any kind of economic activity is earning profit. A business
concern is also functioning mainly for the purpose of earning profit. Profit
is the measuring techniques to understand the business efficiency of the
concern. Profit maximization is also the traditional and narrow approach,
which aims at, maximizes the profit of the concern.
Profit maximization consists of the following important features:.
•1. Profit maximization is also called as cashing per share maximization. It
leads to maximize the business operation for profit maximization.
•2. Ultimate aim of the business concern is earning profit, hence, it
considers all the possible ways to increase the profitability of the concern.
• 3. Profit is the parameter of measuring the efficiency of the business
concern.So it shows the entire position of the business concern.
•4. Profit maximization objectives help to reduce the risk of the business.
Wealth maximization:
•Manager’s primary goal should be to maximize the wealth of the
firm’s owners (the stockholders) The simplest and the best measure of
stockholder wealth is the firms share price, so managers should take
actions that increase the firms share price.
•The goal translates into a straight forward decision rule for managers
to take the only action that are expected to increase the share price.
•To determine whether a particular course of action will increase or
decrease a firms share price , managers have to assess what return the
action will bring and how risky that return might be.
•But does profit maximization lead to the highest possible share
price?
For at least three reasons the answer is often no.
1. Timing: Because the firm can earn a return on funds it receives,
the receipt of funds sooner rather than later is preferred.
2. Cash flows: Profits do not necessarily result in cash flows
available to the stockholders. There is no guarantee that the board
of directors will increase dividends when profits increase.
3. Risk: profit maximization also fails to account for risk ( the
chance that actual outcomes may differ from those expected).
