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The Financial Objectives

of Different Types of
Organizations
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Financial Management and Financial Objectives

Framework
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Objectives
• Explain the nature of financial management.
• Explain the purposes of financial management (raising finance,
allocation of financial resources, maintaining control over
resources).
• Distinguish between financial management and financial and
management accounting and explain the relationship between
them.
• Define and distinguish between financial strategy and financial
objectives.
• Describe the relationship between corporate strategy,
corporate objectives, and financial objectives.
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Objectives
• Explain the features of the financial objective of
shareholder wealth maximization.
• Distinguish between shareholder wealth maximization and
satisfaction in a scenario.
• Explain the financial management in a not-for-profit
organization.
• Explain the agency problems and describe the methods
of how to reduce such problems
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What is Financial Management?

• can be defined as the management of the finances of an
organization to achieve the financial objectives of the
organization. The usual assumption in financial
management for the private sector is that the objective
of the company is to maximize shareholders' wealth.
• Encompass financial reporting, the way a company
finances its operations, assets and liabilities, and market
risk.
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Role of the Financial Manager

• financial manager makes decisions relating to

investment, financing, and dividends.
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Nature and Scope of Financial Management

• Financial Management and Economics

• Financial Management and Accounting
• Financial Management or Mathematics
• Financial Management and Production
Management
• Financial Management and Marketing
• Financial Management and Human Resource
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Financial Management and Economics

• The fields of finance and economics are intertwined. Financial management is
concerned with the management of funds in order to meet a company's goals or
objectives. Commodity creation, use, and transfer are the focus of economics.

• Economic concepts like micro and macroeconomics are directly applied with the
financial management approaches. Investment decisions, micro and macro
environmental factors are closely associated with the functions of financial
manager.

• Financial economics is important in making investment decisions, identifying risks,

and valuing securities and assets.
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Financial Management and Accounting

• Accounting is measuring, processing, and recording of financial transactions of an
organization. The process is to summarize, analyze, and record such information to
be reported to management, creditors, shareholders, investors, and the oversight
officials or tax officials.
• The primary objective is reporting the financial information or transactions using Generally
Accepted Accounting Principles (GAAP).
• Accounting can be divided into several fields like Financial Accounting, management
accounting, tax accounting, and cost accounting.

The two main types are:

• Financial Accounting: Reporting financial information to external users like creditors,
suppliers, government agencies, analysts, etc. is financial accounting
• Management accounting: Reporting financial information to internal users like management
and employees is called management accounting.
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Financial Management
and Accounting

• Financial Management helps to manage the finances and economic

resources of the organization. It is about managing the economic
activities of the organization efficiently to achieve financial objectives.
Financial management aids management in better decision making.
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Financial Management and Accounting

The basis for Comparison Accounting Financial Management

Art of recording and reporting past Manages assets and liabilities of the
Basic Definition financial transactions firm to plan for future growth

It gives the financial position of the It helps to decide on future projects

Why is it important? business. and manage the assets.

Management, shareholders, regulators, Majorly management of the company

Who are the end-users? analysts, creditors and the shareholders

•Create wealth
Key objectives Reporting financial management •Generate cash
•Earn good returns
•Effective use of assets

There are no such types, but the

It has two major types: process involves three key elements:
Types and key elements •Financial Accounting •Financial planning
•Management Accounting •Financial control
•Financial decision making
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Financial Management or Mathematics

• Financial mathematics describes the application of mathematics and
mathematical modeling to solve financial problems. It is sometimes
referred to as quantitative finance, financial engineering, and
computational finance. The discipline combines tools from statistics,
probability, and stochastic processes and combines it with economic
theory.

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Financial Management and Production

Management
• The financial management and the production management are interrelated.
Production management of any firm is concerned with the production cycle,
skilled and unskilled labor, storage of finished goods, capacity utilization, etc. and
the cost of production assumes a substantial portion of the total cost.

• Production management is the operational part of the business concern, which

helps to multiply the money into profit. Profit of the concern depends upon the
production performance. Production performance needs finance, because
production department requires raw material, machinery, wages, and operating
expenses.

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Financial Management and Marketing

• The marketing department is concerned with the selling of goods
and services to the customers. It is entrusted with framing marketing,
selling, advertising and other related policies to achieve the sales
target. It is also required to frame policies to maintain and increase
the market share, to create a brand name. For all this finance is
required, so the finance manager has to play an active role for
interacting with the marketing department.

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Financial Management and Human

Resource
• The HR department is entrusted with the responsibility of
recruitment, training and placement of the staff. This
department is also concerned with the welfare of the
employees and their families. This department works with
finance manager to evaluate employees' welfare, revision
of their pay scale, incentive schemes, etc.

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Significance of Financial Function for the

Organization's Success
• Assessing the Requirement of the Capital
• Deciding the Composition of Capital
• Selection of Financial Resources
• Allocation and investment of Funds
• Distribution of Surplus
• Administration of Cash and Financial Control
• Utilization of Funds

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Assessing the Requirement of the Capital

• Capital is money you use to finance the purchase of equipment, supplies and
products. Working capital is money you use to cover the day-to-day operating
costs of your business. You must consider both when determining your business's
fiscal needs.
• When planning capital needs for a start-up, simply calculate the costs of setting
up the business. To determine capital needs for an existing business, calculate the
costs of growth and expansion, but don't include items like salaries, utility costs,
insurance, and other fixed business expenses.
• To determine working capital needs, create projections for accounts receivable,
inventory and accounts payable. Compare current, actual costs to your
projections. Then subtract the increase in current liabilities from the increase in
current assets. The difference is your working capital needs — the amount you will
need to keep the doors open.
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Deciding the Composition of Capital

• After making the
estimation, the structure
of capital is to be decided
which includes both short
term and long term debt
equity scrutiny. The
structure of capital
depends on the amount
of equity capital a concern
is possessing and further
funds which have to be
raised from investors
outside.
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Selection of Financial Sources

• A business concern has many
choices for getting additional
funds and has to choose source
out of which are issue of shares
and debentures, loans from
banks and financial institutions,
public deposits in the form of
bonds.
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Allocation and Investment of Funds

• It is the finance manager who
has to decide to allocate funds
into profitable ventures based
on the possibility of safety on
investment and regular returns.
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Distribution of Surplus

• The finance manager has to take decision about net profits. Such can be done by
the way of dividend declaration and retained profits.
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Administration of Cash and Financial Control

• Administration of available money and achieving control over money are

challenging tasks before finance manager. Taking decision regarding cash
management is a very important duty of finance manager. Ready money is
necessary for payment of wages and salaries, electricity bills and water bills,
interest payment, meeting existing liabilities, maintenance of enough stock,
purchase of raw materials, etc. Financial control is critically important activity to
help the business in meeting its objectives.
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Utilization of Funds
 Funds should be invested in those
ventures which provide safety and
adequate return with least cost.
 Accumulating the desired amount of
funds and using them helps to
maximize wealth and increase
savings. Thus the utilization of funds
helps with the long-term growth of
the company. If a firm is under-
utilizing its funds and the resources
are sitting idle. It prevents the firm
from earning to its maximum
capacity.
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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

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Financial Institutions
• Companies that specialize in financial matters
– Banks – commercial and investment, credit unions,
savings and loans
– Insurance companies
– Brokerage firms
• Job opportunities

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International Finance
• This is an area of specialization within each of the areas
discussed so far
• It 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

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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

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Business Finance
• Some important questions that are answered
using finance
– What long-term investments should the firm take on?
Stocks, bonds, real estate- through accepting a certain amount of risk because of its potential in capital appreciation.

– Where will we get the long-term financing to pay

for the investments? It may be done through borrowing or selling bonds to the
firm along with its promissory notes that they oblige pay interest at specific times.

– How will we manage the everyday financial activities

of the firm? Through monitoring the financial transactions report, this will allow the firm to
reduce the risk and to meet the firm's objectives.

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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

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Financial Management Decisions

• Capital budgeting
– What long-term investments or projects should the
business take on?
• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?
• Working capital management
– How do we manage the day-to-day finances of the
firm?

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Forms of Business Organization

• Three major forms:
– Sole proprietorship
Owner- the one who runs the business itself.
Shoulder all the liabilities

– Partnership
• General
• Limited liabilities base on the equal share
– Corporation
• S-Corp
• Limited liability company

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Sole Proprietorship

• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all of owner's personal wealth
the profits – Unlimited liability
– Taxed once as personal – Difficult to sell ownership
income interest

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Partnership

• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
– Relatively easy to start • Limited partnership
– Income taxed once as – Partnership dissolves when
personal income one partner dies or wishes
to sell
– Difficult to transfer
ownership

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Corporation

• Advantages • Disadvantages
– Limited liability – Separation of ownership and
– Unlimited life management (agency
problem)
– Separation of ownership
and management – Double taxation (income
taxed at the corporate rate
– Transfer of ownership is and then dividends taxed at
easy personal rate, while
– Easier to raise capital dividends paid are not tax
deductible)

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Goal of Financial Management

• What should be the goal of a corporation?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company's stock?
• Does this mean we should do anything and
everything to maximize owner wealth?
• Sarbanes-Oxley Act

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The Agency Problem

• 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

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Managing Managers
• Managerial compensation
– Incentives can be used to align management and
stockholder interests
– The incentives need to be structured carefully to make sure
that they achieve their goal
• Corporate control
– The threat of a takeover may result in better management
• Other stakeholders

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Example: Work the Web

• The Internet provides a wealth of information
about individual companies
• One excellent site is finance.yahoo.com
• Click on the Web surfer to go to the site,
choose a company and see what information
you can find!

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Figure 1.2

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Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ

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Quick Quiz
• What are the four basic areas of finance?
• What are the three types of financial management
decisions, and what questions are they designed to
answer?
• What are the three major forms of business
organization?
• What is the goal of financial management?
• What are agency problems, and why do they exist
within a corporation?

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