The Goals and Functions of
Financial Management
Outline
Definition of Finance
Areas of Finance
Career Opportunities in Finance
Finance as related to Accounting and Economics
The Goal of the Financial Manager
Agency issue as it relates to owner wealth
maximization
Stakeholder focus, and ethical behavior relate to firms
goal.
Activities of Financial Management
Forms of Organization
What is Finance?
Finance is the study of
financial planning, asset
management, and fund
raising for businesses and
financial institutions.
Financial management
can be described using a
balance sheet.
Areas of Finance
1. Financial Markets
- Markets of users and savers of funds.
- Money markets deal in short-term securities (<=1 year)
Ex.; Treasury Bills, commercial paper
- Capital markets deal in long-term securities
Ex.; common stock, preferred stock, corporate bonds, government bonds
2. Financial Services
- Design and delivery of financial advice and products to individuals, businesses,
government.
3. Managerial Finance
- Financial management of business firms.
- Financial management involves the efficient use of financial resources in the
production of goods
A well-developed financial system is a hallmark and essential characteristic of any modern
developed nation.
Career Opportunities in Finance
Financial Analyst prepares and analyze firms financial plans and budgets; other
duties include financial forecasting, financial ratio analysis.
Capital budgeting analyst/manager evaluation/recommendation of proposed asset
investments, implementation of approved projects.
Project finance manager arranges financing for approved asset investments;
coordinates with investment bankers and legal counsel.
Cash manager - maintain and control firms daily cash balances; manages cash
collection, short-term investment/borrowing, disbursement activities and banking
relationships.
Credit analyst/manager administers firms credit policy by analyzing/managing the
evaluation of credit applications, extending credit, monitoring/collecting A/Rs.
Finance as related to Accounting and Economics
Finance is related to:
Accounting, which provides information in financial statements
Economics, which provides:
analysis tools such as pricing theory through supply and
demand analysis, cost-benefit analysis etc.
information on the economic and financial environment in
which the company operates for sound financial decisions.
These include inflation rate, exchange rate, international
capital flows, unemployment rate, etc.
All of these factors must fit into the financial decisions
Difference Between Finance and
Accounting
Recognition of Revenue and Expenses
Accrual Basis: recognizes sales revenue and expenses incurred to make sale
at time of sale.
Cash Basis: recognizes revenues and expenses as they occur.
Accounting vs. Financial View
Accounting View
(Accrual Basis)
Income Statement
XYZ Ltd
For year ended 31/03/2014
Financial View
(Cash Basis)
Cash Flow Statement
XYZ Ltd.
For year ended 31/03/2014
Sales revenue Rs.10000000
Less: Costs
8000000
Net Profit
Rs. 2000000
Cash inflow
Rs.
0
Less: Cash outflow 8000000
Net cash flow
(Rs. 8000000)
Goal of the Financial Manager
Should it be Profit Maximization?
Corporations commonly define profit as
Earnings per Share (EPS).
EPS ignores at least 2 critical factors:
the timing of the returns.
risk factors facing the firm.
Profitability Risk
Profitability Risk
ex., investing in stocks vs. savings accounts
Stocks may be more profitable but are riskier
Savings accounts are less profitable and less risky (or safer)
Goal of the Financial Manager
Or should it be Shareholder Wealth Maximization?
Shareholder Wealth Maximization considers factors
of EPS timing, and risk ignored by the EPS.
Therefore, Maximizing Shareholder Wealth is a more
comprehensive goal for the firm, its managers and
employees.
Goal of the Financial Manager
Also, shareholder wealth maximization is in general,
consistent with the social responsibility of the firm.
Adopting policies that will improve the share price can
attract capital and provide employment.
But could conflict with
social / ethical goals (for example, pollution control)
interests of management (for example, short-term compensation)
Management can encourage an increase in share price
by earning an attractive return at an acceptable level of
risk
Agency Theory:
The Principal-Agent Problem
Agency Theory is about the conflict that may arise
between management and owners whenever owners
are not also the managers.
Management may not always act in the best interest of
the owners because management has interest of its
own, like personal wealth, job security, lifestyle, and
benefits. Thus, these concerns may conflict with
shareholder interests.
The pursuit of socially or ethically acceptable goals may
have to come at the expense of shareholders wealth.
Importance of Ethics to Stakeholders
Stakeholders are those groups that have direct economic links to the firm.
Stakeholders include not only owners, but also employees, customers,
suppliers, unions, and creditors.
Honesty, trustworthiness, fair dealing are foundations of sustainable
business relations with these stakeholders.
Ethical behaviour is necessary to achieve the goal of maximizing
shareholder wealth.
Maintaining positive stakeholder relationships helps maximize long-term
benefits to shareholders.
Financial ManagerKey Activities
Activities include:
Short-Term Financial Decisions
Working Capital Management
- ex., careful monitoring of cash position on a day-to-day basis
Financial Analysis and Planning
Investment Decisions (Capital Budgeting)
long-term (L/T) financial decisions (>1 year)
- ex., purchasing a new machine in the future
Financing decisions (capital structure)
how to raise money: loans? leases? shares? bonds?
Forms of Organization:
Sole Proprietorships
Advantages
Freedom
Disadvantages
Unlimited
Liability
Simplicity
Lack of Continuity
Low Start Up
Difficulty in
Costs
A business owned by Raising Money
one person
Tax Benefits
Reliance on One Person
Forms of Organization:
Partnerships
Disadvantages
Advantages
Unlimited Liability
Lack of Continuity
Ownership
Transfer
Difficult
Possibility of
Conflict
More Capital
Greater Talent Pool
Ease of Formation
Tax Benefits
A business venture with two or more owners
Forms of Organization:
Corporations/Companies
Advantages
Disadvantages
Limited Liability
Potential Shareholder
Revolts
Continuity
Greater Likelihood
of Professional
Management
Easier Access to
Money
Higher StartStart-Up
Costs
Regulation
Double Taxation
A corporation
is a separate legal entity
Summary and Conclusions
The Financial Manager:
controls the daily cash inflows and
outflows resulting from business
operations
makes the occasional investment and
financing decisions essential for the
future financial success of the business
may work in a corporation or other form
of business organization
Their overriding goal is to maximize the
wealth of the owners by earning an
attractive return in the business at an
acceptable level of risk
