Pearson BTEC Level 5 Higher National Diploma in Business
Unit 23: Financial Management
Unit code: D/618/5073
Unit level: 5
Credit value: 15
LO1: Role & Purpose of Financial Management Function
What is Financial Management?
• Financial management is concerned with the acquisition, financing,
and management of assets with some overall goal in mind.
• It is the art and science of managing money. Financial management is
the most essential requirement of any organized business or activity.
• It is the process of procuring and judicious use of resources with a
view to maximize the value of the firm. Financial management is
interdependent with other areas of 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.
What is Financial Management?
What is financial management?
- Financial management involves planning, organising, controlling
and monitoring financial resources in order to achieve
organisational objectives.
- Financial management can be achieved only if you have a sound
organisational plan. A plan in this context means having set
objectives and having agreed, developed and evaluated the
policies, strategies, tactics and actions to achieve these objectives.
- Sound financial management will involve you in long-term
strategic planning and short-term operations planning. This
financial planning should become part of your organisation's
ongoing planning process.
Content brief
Objectives/Goals of FM
Functions of FM (What does FM do?)
Types of FM
Roles of stakeholders in FM
Legal requirements and ethical constrains in FM
KEY FINANCIAL MANAGEMENT PRINCIPLES
1. Financial management objectives
• 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 such as:
1. Profit maximization
2. Wealth maximization.
KEY FINANCIAL MANAGEMENT PRINCIPLES
Financial management objectives
Profit Maximization
- 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.
KEY FINANCIAL MANAGEMENT PRINCIPLES
Financial management objectives
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.
Financial management objectives
Profit Maximization weakness:
• ‘Profit’ definition is unclear: Different perceptions of the term exist among
organizations and individuals. For example, profit can be the gross profit, net profit,
before tax profit or the profit rate.
• Time value of money is ignored: The formula is based on the idea that the higher
the profit, the better the proposal, but what about its timing? In finance, when
considering present value, we know that cash now won’t have the same value in the
future.
• Attention not paid to risk: In the pursuit of profit, risks involved are ignored, which
may prove unaffordable at times, simply because higher risk directly questions the
survival of a business.
• Ignores quality: The most challenging part of profit maximization as a goal is that it
neglects the intangible benefits such as quality, image, technological advancements
etc. However, the input of intangible assets in generating value for a business is not
worth neglecting, as they indirectly create assets for the organization.
Financial management objectives
Wealth Maximization
- Wealth maximization is one of the modern approaches, which involves
latest innovations and improvements in the field of the business concern.
The term wealth means shareholder wealth or the wealth of the persons
those who are involved in the business concern.
- Wealth maximization is also known as value maximization or net present
worth maximization. This objective is an universally accepted concept in
the field of business.
Financial management objectives
Maximising shareholder wealth is done through increasing profits which
can be achieved through:
- Increasing profitability, through cost reduction and efficiency programs
- Investing in profitable projects or investments
- Expanding through new products and new markets
- Acquiring or merging with other organisations
The objectives of the organisation must incorporate all stakeholders and
the organisation has to balance the needs of all interested parties.
KEY Financial management objectives
Profit maximization
Or
Wealth maximization???
2. Main tasks of finance function
2. Main tasks of finance function
• Financial planning. It is vital for managers to assess the potential impact
of proposals on future financial performance and position. They can
more readily evaluate the implications of their decisions if they are
provided with estimates of financial outcomes. These can often take the
form of projected financial statements, such as projected cash flow
statements and projected income statements.
• Investment project appraisal. Investment in new long-term projects can
have a profound effect on the future prospects of a business. By
undertaking appraisals of the profitability and riskiness of investment
project proposal, managers can make informed decisions about whether
to accept or reject them. These appraisals can also help in prioritizing
investment projects that have been accepted.
2. Main tasks of finance function
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
Career jobs and opportunities with financial management
Basic Areas Of Finance
1. Corporate finance = Business Finance
2. Investments
3. Financial institutions
4. International finance
Career jobs and opportunities with financial management
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
Career jobs and opportunities with financial management
Financial Institutions
• Companies that specialize in financial matters
– Banks – commercial and investment, credit unions,
savings and loans
– Insurance companies
– Brokerage firms
• Job opportunities
Career jobs and opportunities with financial management
International Finance
• An area of specialization within each of the areas
discussed so far
• 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
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?
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
Corporate Organization Chart
Financial Management
• Organization of the Financial Management
Function
Board of Directors
President (Chief Executive Officer)
Executive Vice President (Operations)
Executive Vice President (Marketing)
Executive Vice President (Finance - CFO)
3. Types of FM
• There are four main financial decisions:
- Capital Budgeting or Long term Investment decision
(Application of funds),
- Working Capital Management Decision
- Capital Structure or Financing decision
(Procurement of funds),
- Dividend decision (Distribution of funds)
in order to accomplish goal of the firm viz., to
maximize shareholder’s (owner’s) wealth.
Capital Budgeting Decision
• The process of planning and managing a firm’s
long-term investments is called capital budgeting. In
capital budgeting, the financial manager tries to
identify profitable investment opportunities, i.e.,
assets for which value of the cash flow generated
by asset exceeds the cost of that asset. Evaluating
the size, timing, and risk of future cash flows (both
cash inflows & outflows) is the essence of capital
budgeting.
Working Capital Management Decision
• Working capital management is concerned with
management of a firm’s short-term or current
assets, such as inventory, cash, receivables and
short-term or current liabilities, such as creditors,
bills payable. Assets and Liabilities which mature
within the operating cycle of business or within one
year are termed as current assets and current
liabilities respectively.
Capital Structure Decision
• A firm’s capital structure or financing decision is concerned
with obtaining funds to meet firm’s long term investment
requirements. It refers to the specific mixture of long-term
debt and equity, which the firm uses to finance its assets.
The finance manager has to decide exactly how much funds
to raise, from which sources to raise and when to raise.
• Different feasible combinations of raising required funds
must be carefully evaluated and an optimal combination of
different sources of funds should be selected. The optimal
capital structure is one which minimises overall cost of
capital and maximises firm’s vale. Capital structure decision
gives rise to financial risk of a firm.
Dividend Decision
• Dividend decision involves two issues-whether to
distribute dividends and how much of profits to
distribute as dividends. A finance manager has to
decide what percentage of after tax profit is to be
retained in the business to meet future investment
requirements and what proportion has to be
distributed as dividend among shareholders. Should
the firm retain all profits or distribute all profits or
retain a portion and distribute the balance?
Dividend Decision
• Proportion of profits distributed as dividend is called
dividend pay-out ratio and the proportion of profits
retained in the business is retention ratio. Finance
manager here is concerned with determining the
optimal dividend pay-out ratio which maximises
shareholder’s wealth. However, the actual decision
is affected by availability of profitable investment
opportunities, firm’s financial needs, shareholder’s
expectations, legal constraints, liquidity position of
the firm and other factors.
Forms of Business
Nature & purposes Organization
of financial management
environment
in different business
Three major forms in the United States
• Sole proprietorship
• Partnership
– General
– Limited
• Corporation
– S-Corp
– Limited liability company
Nature & purposes of financial management in different business
environment
Sole Proprietorship
Business owned by one person
• Advantages • Disadvantages
– Limited to life of owner
– Easiest to start
– Equity capital limited to
– Least regulated
owner’s personal
– Single owner keeps all of
wealth
the profits
– Unlimited liability
– Taxed once as personal
– Difficult to sell
income
ownership interest
Nature & purposes of financial management in different business
environment
Partnership
Business owned by two or more persons
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
– Relatively easy to • Limited partnership
start – Partnership dissolves
– Income taxed once as when one partner dies or
personal income wishes to sell
– Difficult to transfer
ownership
Nature & purposes of financial management in different business
environment
Corporation
A legal “person” distinct from owners and a resident of a state
• Advantages • Disadvantages
– Limited liability – Separation of ownership
– Unlimited life and management (agency
problem)
– Separation of – Double taxation (income
ownership and taxed at the corporate rate
management and then dividends taxed
– Transfer of ownership is at personal rate, while
easy dividends paid are not tax
– Easier to raise capital deductible)
Nature & purposes of financial management in different business
environment
International Corporate Forms
• Joint stock companies
• Public limited companies
• Limited liability companies
• All share:
– Public ownership
– Limited liability
4. Roles of stakeholder in financial management
a) Internal stakeholder: the employees’ and the
manager’s perspectives on the situation
b) External stakeholder: supplier’s or investors
vested interests
4. Roles of stakeholder in financial management
• ‘In whose interests is the firm run?’
4. Roles of stakeholder in financial management
• These are the types of stakeholders most commonly found in a business
structure:
– Customers: Customers have a stake in the product. They are directly impacted by
the product or service of the business.
– Employees: Employees have a stake in their income and job security.
– Investors: Investors have a stake in the financial returns of the business. Often,
they have invested funds and are awaiting a return.
– Suppliers and vendors: Suppliers/vendors have a stake in the revenues and the
safety of their business.
– Communities: Communities have a stake in the local health and safety of their
community. They are considered major stakeholders in larger businesses that enter
into their local community.
– Governments: Governments have a stake in the taxes earned and GDP delivered.
– Competitor: The competitor has a stake in the knowledge of the business to
improve and adjust their own business strategy.
Legal requirements and ethical constrains
Definition
Ethics are principles based on doing the right thing. They are the moral
values by which an individual or business operates.
In theory, a business or individual can act ethically and still attain
ultimate success. A history of doing the right thing can be used as a
selling point to heighten a person's or organization's reputation in the
community. Not only are ethics morally valued, they are backed by legal
repercussions for failure to act within certain guidelines.
ETHICAL FINANCIAL MANAGEMENT
Legal requirements and ethical constrains
The study of ethics in the context of financial management is a relatively
new discipline. While ethical issues have been a factor in business as long
as there has been commerce, the academic study of ethics in the business
setting has only been around for approximately 40 years.
ETHICAL FINANCIAL MANAGEMENT
Legal requirements and ethical constrains
The passing of the Sarbanes-Oxley Act of 2002 was a direct result of these
ethical crises in financial management. SOX made provisions for the
formation of the Securities and Exchange Commission which now
oversees financial auditors in the United States.
The Sarbanes-Oxley Act of 2002 is a law the U.S. Congress passed on July 30 of that year to
help protect investors from fraudulent financial reporting by corporations. Also known as the
SOX Act of 2002 and the Corporate Responsibility Act of 2002, it mandated strict reforms to
existing securities regulations and imposed tough new penalties on lawbreakers.
The act took its name from its two sponsors—Sen. Paul S. Sarbanes (D-Md.) and Rep. Michael
G. Oxley (R-Ohio).
Legal requirements and ethical constrains
Sarbanes-Oxley Act (SarBox, 2002)
• Driven by corporate scandals
– Enron, Tyco, WorldCom, Adelphia
• Intended to strengthen protection against accounting
fraud and financial malpractice
• Compliance very costly
– Firms driven to:
• Go public outside the U.S.
• Go private (“go dark”)
ETHICAL FINANCIAL MANAGEMENT
Legal requirements and ethical constrains
•The Sarbanes-Oxley (SOX) Act of 2002 came in response to highly
publicized corporate financial scandals earlier that decade.
•The act created strict new rules for accountants, auditors, and corporate
officers and imposed more stringent recordkeeping requirements.
•The act also added new criminal penalties for violating securities laws.
Legal requirements and ethical constrains
ETHICAL FINANCIAL MANAGEMENT
The Act also implemented stiffer penalties for fraud and requires that chief
financial officers sign off on their organization’s financial statements. This
places greater responsibility on the CFO, holding the CFO directly
accountable in cases of fraud.
Legal requirements and ethical constrains
ETHICAL FINANCIAL MANAGEMENT
The role of ethics in financial management is to balance, protect and
preserve stakeholders' interests.
The ethics of a finance manager should be above approach. This includes
more than just acting in an honest, above-board manner.
It means establishing boundaries that prevent professional and personal
interests from appearing to conflict with the interest of the employer.
Legal requirements and ethical constrains
ETHICAL FINANCIAL MANAGEMENT
• A finance manager must provide competent, accurate and timely
information that fairly presents any potential disclosure issues, such as
legal ramifications.
• The manager is also ethically responsible for protecting the
confidentiality of the employer and staying within the boundaries of
law.
Legal requirements and ethical constrains
ETHICAL DECISIONS
Managers have a duty (in most entities) to aim for profit.
At the same time, modern ethical standards impose a duty to guard,
preserve and enhance the value of the entity for the good of all touched
by it, including the general public. Large organisations tend to be more
often held to account over this than small ones. In the area of products and
production, managers have responsibility to ensure that the public and their
own employees are protected from danger.
Legal requirements and ethical constrains
ETHICAL DECISIONS
Attempts to increase profitability by cutting costs may lead to dangerous
working conditions or to inadequate safety standards in products. In the
United States, product liability litigation is so common that this legal threat
may be a more effective deterrent than general ethical standards.
Another ethical problem concerns payments by companies to government
or municipal officials who have power to help or hinder the payers'
operations. In The Ethics of Corporate Conduct, Clarence Walton refers to
the fine distinctions which exist in this area.
Legal requirements and ethical constrains
ETHICAL DECISIONS
- Businesses are part of society. Society expects its individuals to behave
properly, and similarly expects companies to operate to certain standards.
- Business ethics is important to both the organisation and the individual.
The Agencyand
Legal requirements Problem
ethical constrains
• 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
Do Managers Act in the Shareholders’
Legal requirements and ethical constrains
Interests?
• Managerial compensation
– Incentives can be used to align management and
stockholder interests
– Incentives need to be carefully structured to insure that
they achieve their goal
• Corporate control
– Threat of a takeover may result in better management
• Other stakeholders
