AC 311: Financial

Management
Dr. Benedicto Kulwizira Lukanima
 Part 1
Overviews of Financial Management
 Learning Outcomes

1 2 3
Understand the role Explain the main Explain the key
of financial goal of a firm financial decisions
management
 Existence of A Firm
THE ECONOMIC ENVIRONMENT AND UNCERTAINTY

Government Capital Markets

Raise Invest Invest Returns

Tax obligations Funds

Customers, Suppliers, A FIRM Invest

Other stakeholders Exchange of assets MANAGERS Investors
and mutual interests (EMPLOYEES) (owners)
Returns
Financial Resources

THE ECONOMIC ENVIRONMENT AND UNCERTAINTY

A firm:
Financial management requires an existence of a FIRM, which is the center of value
creation as an existing body that facilitates resource allocation and value creation.
 The economy Place for existence of all key players

Sources of funds
Capital markets Investment ground

Existence of
A Firm Investors
Equity holders (Owners)
Debtholders

Key Players
Managers/Employees Acting on behalf of investors (owners)

Government
Customers
Other Players Suppliers
Other stakeholders
Firm’s Obligations to Invetors
The main firm’s obligations to investors is to generate value and
returns.

External investors (preference shareholders or debtholders) have

fixed claims from the firm.

Internal investors (owners) do not have fixed claims: their

rewards depend primarily on the performance of the firm
Key Managerial Decisions
Financing Decisions:
Financing how do we raise funds and how to repay
Decision
the cost of such funds?

Investing Decisions:
Managerial what do we do with the available funds
Decisions regarding long-term investments or assets?
Investing Dividend
Decision Decision Dividend Decisions:
How do we use our earnings?
 The Interactive Role of Financial Management
CAPITAL MARKETS FIRM

MANAGEMENT
Invest in security 2 5

FINANCIAL
markets
2
Acquire real assets
Raise equity capital 1

3 5
Generate revenues
Raise debt capital 1

Retained 4
Financial claims held by earnings
investors 7
Pay interest 4
6 Pay dividend
Investors’ returns

OTHER STAKEHOLDERS
The Interactive Role of Financial Management
Summary
7. Good returns
enable investors
to meet their
financial claims
held in capital
markets. The
4. Meet financial fulfilment of
obligations by 5. Make financial
2. Use the
3. Generate paying interest decision on the obligations to
available funds 6. The fulfilment
revenues from on debt. use of retained investors
raised from of investors’
business Depending on earnings - it can creates good
1. Raise capital capital markets financial
operations (use the dividend be used to relationship
from security to acquire real obligations
of real assets) policy, use acquire with the capital
markets in form assets and/or (paying interest
and/or from profit to pay additional real market and
of equity or debt invest in and dividend)
other dividend while assets and/or increases
or both. security generates return
investments in retaining some invest in investors’
markets by on their
security earnings to security confidence over
buying equity or investments.
markets. increase markets (stocks the company.
bonds.
shareholders’ and bonds). This, in turn,
equity. creates more
investment
opportunity and
access to more
funds for more
value creation
(1).
What is the Main Goal of a Firm?

MAXIMIZE IMPROVE COMMAND SATISFY OR WHAT?

PROFIT? GROWTH? MARKET SHARE? CUSTOMERS?
A firm can have Main Goal
many financial and Shareholder Wealth
Maximization
non-financial
objectives to
Financial Goals:
achieve in short- profit maximization, pay
term and long-term. dividend, improve cash
flows, improve growth,
maximize returns, etc.

But the perceived

main goal of a firm
has been to Non-Financial goals:
customer satisfaction,
maximize corporate social
shareholders’ responsibility, market
leadership,
wealth environmental
conservation, etc.
 Shareholder Wealth Maximization Vs Profit Maximization

Profit Maximization Wealth maximization

Goals Short-term profit goals may be at the expense Long-term goals for wealth creation regardless of
of long-term profitability and value. level of profits.
Risk and Profits may not consider risks associated with Considers uncertainty and the risks associated
Uncertainty how the profit is made. with business operations.
Time value Profitability returns are only a single period Wealth maximization focuses on the entire life of
of money measure. They only reflect the state of a firm a firm, considering the future returns to
during a specific period. shareholders and time value of money.
Value Profits are based on book values from Wealth creation is measured by the market value
measures operations during a specific period. of the firm’s stocks, which reflects investors’
perception about the firm.
Managerial Profits may be realized from managers’ personal Wealth maximization avoids personal objectives
motives objectives that may destroy shareholder value and focus on shareholders’ value.
as in the case of Enron and others.
Accounting Profits figures arise from accounting reports Wealth maximization goals avoid most of the
problems which may be subjected to manipulations. accounting problems. The focus is on cashflows
rather than profits.
 Shareholder Wealth Maximization Vs Profit Maximization

Profit Maximization Wealth maximization

Goals Short-term profit goals may be at the expense Long-term goals for wealth creation regardless of
of long-term profitability and value. level of profits.
Risk and Profits may not consider risks associated with Considers uncertainty and the risks associated
Uncertainty how the profit is made. with business operations.
Time value Profitability returns are only a single period Wealth maximization focuses on the entire life of
of money measure. They only reflect the state of a firm a firm, considering the future returns to
during a specific period. shareholders and time value of money.
Value Profits are based on book values from Wealth creation is measured by the market value
measures operations during a specific period. of the firm’s stocks, which reflects investors’
perception about the firm.
Managerial Profits may be realized from managers’ personal Wealth maximization avoids personal objectives
motives objectives that may destroy shareholder value and focus on shareholders’ value.
as in the case of Enron and others.
Accounting Profits figures arise from accounting reports Wealth maximization goals avoid most of the
problems which may be subjected to manipulations. accounting problems. The focus is on cashflows
rather than profits.
Cash Flow Vs. Profit

Cash flows is a better proxy for wealth maximization than

accounting profit.

Companies can make profits but still face cash problems.

In the absence of cash, a firm cannot fulfil its financial

obligations – hence no value creation.
 Principal: delegates
Conflict of authorities to the agent
Interest
Between
business owners
Principal Agent

Agency
Costs
and
management
Conflict of interest

Costs arise
due conflict
of interest
Agency

Agent: makes decision and

act on behalf of the principle
 incentive
Control and
schemes (low
agency cost)
Monitoring

Solutions to Ownership
schemes
Ability to
influence
the Agency management

Problem Value
creation Voting rights
rewards

Threats:
E.g.,
dismissal and
take-over
Revision Questions
Why is financial management regarded as an interactive role?

What is the main goal of a firm? Give reasons.

Why is profit not the same as cash? Give examples to support your answer?

Outline the key differences between shareholders’ wealth maximization and profit maximization.

Explain the meaning of the agency-cost problem in the context of conflict of interest between
business owners and managers. Suggest some possible solutions.
Gracias

Thank You