INTRODUCTION
Financial management.
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Chapter 1
The Role of Financial
Management
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After studying Chapter 1,
you should be able to:
1. Explain why the role of the financial manager today is so
important.
2. Describe "financial management" in terms of the three major
decision areas that confront the financial manager.
3. Identify the goal of the firm and understand why
shareholders' wealth maximization is preferred over other
goals.
4. Understand the potential problems arising when
management of the corporation and ownership are
separated (i.e., agency problems).
5. Demonstrate an understanding of corporate governance.
6. Discuss the issues underlying social responsibility of the
firm.
7. Understand the basic responsibilities of financial managers
1-3 and the differences between a "treasurer" and a "controller."
The Role of
Financial Management
What is Financial Management?
The Goal of the Firm
Corporate Governance
Organization of the Financial
Management Function
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Finance
“Financeis the art and science of
managing money”.
Finance function is the
procurement of funds and their
effective utilization in business
concerns.
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What is Financial
Management?
It is Concerned with
planning, acquiring, and
utilization of funds with
some overall goal in mind.
It is science of money
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management.
Financing
(acquiring)Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g.,
dividend-payout ratio)?
How will the funds be physically
acquired?
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Investment(Utilization)
Decisions
Most important of the three
decisions.
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
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Asset Management
Decisions
How do we manage existing assets
efficiently?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.
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Business Finance
“Business finance can broadly be
defined as the activity concerned
with planning, raising, controlling,
administering of the funds used in
the business”.
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Corporate Finance
Corporate finance is concerned with
budgeting, financial forecasting, cash
management, credit administration,
investment analysis and fund procurement of
the business concern and the business
concern needs to adopt modern technology
and application suitable to the global
environment.
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“Corporate Finance is the
area of finance dealing with
the sources of funding and
the capital structure of
corporations and the actions
that managers take to
increase the value of the firm
to the shareholders, as well
as the tools
and analysis used to allocate
financial resources.”
What is the Goal
of the Firm?
Maximization of
Shareholder Wealth!
Value creation occurs when
we maximize the share price
for current shareholders.
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Shortcomings of
Alternative Perspectives
Profit Maximization
Maximizing a firm’s earnings after taxes.
Problems
Could increase current profits while
harming firm (e.g., defer maintenance,
issue common stock to buy T-bills, etc.).
Ignores changes in the risk level of the
firm.
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Shortcomings of
Alternative Perspectives
Earnings per Share Maximization
Maximizing earnings after taxes divided
by shares outstanding.
Problems
Does not specify timing or duration of
expected returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.
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Strengths of Shareholder
Wealth Maximization
Takes account of: current and future
profits and EPS; the timing,
duration, and risk of profits and EPS;
dividend policy; and all other
relevant factors.
Thus, share price serves as a
barometer for business performance.
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What companies say about
their corporate goal*
Cadbury Schweppes: “governing objective is
growth in shareowner value”
Credit Suisse Group: “achieve high customer
satisfaction, maximize shareholder value and
be an employer of choice”
Dow Chemical Company: “maximize long-term
shareholder value”
ExxonMobil: “long-term, sustainable
shareholder value”
*Refer to text for additional details
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The Modern Corporation
Modern Corporation
Shareholders Management
There exists a SEPARATION
between owners and managers.
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Role of Management
Management acts as an agent
for the owners (shareholders)
of the firm.
An agent is an individual
authorized by another person,
called the principal, to act in
the latter’s behalf.
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Agency Theory
Jensen and Meckling developed
a theory of the firm based on
agency theory.
Agency Theory is a branch of
economics relating to the
behavior of principals and their
agents.
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Agency Theory
Principals must provide incentives
so that management acts in the
principals’ best interests and then
monitor results.
Incentives
include, stock options,
and bonuses.
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Social Responsibility
Wealth maximization does not
preclude(prevent) the firm from being
socially responsible.
Assume we view the firm as producing
both private and social goods.
Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
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Corporate Governance
Corporate governance: represents the
system by which corporations are
managed and controlled.
Includes shareholders, board of
directors, and senior management.
Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
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Board of Directors
Typical responsibilities:
Set company-wide policy;
Advise the CEO and other senior executives;
Hire, fire, and set the compensation of the CEO;
Review and approve strategy, significant investments, and
acquisitions; and
Oversee operating plans, capital budgets, and financial
reports to common shareholders.
CEO/Chairman roles commonly same person in US,
but separate in Britain (US moving this direction).
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Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President VP of Vice President
Operations Finance Marketing
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Organization of the Financial
Management Function
VP of Finance
Treasurer Controller
Capital Budgeting Cost Accounting
Cash Management Cost Management
Credit Management Data Processing
Dividend Disbursement General Ledger
Fin Analysis/Planning Government Reporting
Pension Management Internal Control
Insurance/Risk Mngmt Preparing Fin Stmts
Tax Analysis/Planning Preparing Budgets
Preparing Forecasts
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