Financial Management

What is the Role of finance managers????

Why finance???
What is Finance?
o Finance can be defined as the art and science of
managing money.
o Finance is concerned with the process, institutions, markets,
and instruments involved in the transfer of money among
individuals, businesses, and governments.
o Finance events
o businesses,
o opening of new product line
o Closing an unit
o Individuals
o Rise in stock price of the company after acquiring
other company
o governments.
o Interest rate declines
Finance functions
oInvestment or long term asset mix
decision
oFinancing or capital mix decision
oDividend or profit allocation
decision
oLiquidity or short term asset mix
decision
Legal Forms of Business Organization
Corporate Organization
Career Opportunities
The Managerial Finance Function
oThe size and importance of the
managerial finance function depends on
the size of the firm.
oIn small companies, the finance function
may be performed by the company
president or Accounting department.
oAs the business expands, finance
typically evolves into a separate
department linked to the president as
was previously described in Figure 1.1.
o Financial managers are responsible for
deciding how to raise and invest company
funds.
o Collectively, these decisions are referred
to as financial management.
o Financial managers are expected to make
decisions that will maximize stock price and
firm value and are frequently compensated
in a manner that encourages the
achievement of these activities.

Financial Manager
The Managerial Finance Function: Relationship to Economics
oThe primary economic principal
used by financial managers is
marginal cost-benefit analysis
which says that financial decisions
should be implemented only
when added benefits exceed
added costs.
The Managerial Finance Function: Relationship to Accounting
oOne major difference in perspective
and emphasis between finance and
accounting is that accountants
generally use the accrual method
while in finance, the focus is on cash
flows.


INCOME STATEMENT SUMMARY

ACCRUAL CASH
Sales Rs.100,000 Rs. 0
Less: Costs (80,000) (80,000)
Net Profit/(Loss) Rs. 20,000 Rs. (80,000)

Sales Rs.100,000 (1 car sold, 100% still uncollected)
Costs Rs. 80,000 (all paid in full under supplier terms)
The Tata Corporation experienced the following activity last year:
The Managerial Finance Function: Relationship to
Accounting (cont.)
oFinance and accounting also differ with
respect to decision-making.
oWhile accounting is primarily concerned
with the presentation of financial data,
the financial manager is primarily
concerned with analyzing and
interpreting this information for decision-
making purposes.
oThe financial manager uses this data as
a vital tool for making decisions about
the financial aspects of the firm.
Primary Activities of
the Financial Manager
Investment Year 1 Year 2 Year 3 Total (years 1-3)
Rotor 1.40 $ 1.00 $ 0.40 $ 2.80 $
Valve 0.60 $ 1.00 $ 1.40 $ 3.00 $
Earnings per share (EPS)
Which Investment is Preferred?
Goal of the Firm: Maximize Profit???
o Profit maximization fails to account for differences
in the level of cash flows (as opposed to profits), the
timing of these cash flows, and the risk of these
cash flows.
Share Price = Future Dividends
Required Return
level & timing
of cash flows
risk of cash
flows
Goal of the Firm: Maximize Shareholder Wealth!!!
o Because maximizing shareholder wealth properly
considers cash flows, the timing of these cash flows,
and the risk of these cash flows.
o This can be illustrated using the following simple
stock valuation equation:
Financial
Environment
Financing
decisions
Investment
decisions
Dividend policy
decisions
Goal of the Firm:
Maximize Shareholder Wealth!!! (cont.)
Corporate Governance
o Corporate Governance is the system used
to direct and control a corporation.
o It defines the rights and responsibilities of
key corporate participants such as
shareholders, the board of directors, officers
and managers, and other stakeholders.
o The structure of corporate governance was
previously described in Figure 1.1.
The Agency Issue: The Agency Problem
o Whenever a manager owns less than 100% of the firms
equity, a potential agency problem exists.
o In theory, managers would agree with shareholder wealth
maximization.
o However, managers are also concerned with their
personal wealth, job security, fringe benefits,
and lifestyle.
o This would cause managers to act in ways that do not
always benefit the firm shareholders.
Agency Relationship
oShareholders principal
oManagers - agents
oAgency Conflict
oShareholders Vs. Managers
oShareholders Vs. Creditors
The Agency Issue:
Resolving the Problem
oMarket Forces such as major shareholders
and the threat of a hostile takeover act to
keep managers in check.
oAgency Costs are the costs borne by
stockholders to maintain a corporate
governance structure that minimizes
agency problems and contributes to the
maximization of shareholder wealth.
The Agency Issue:
Resolving the Problem (cont.)
oExamples would include bonding or
monitoring management behavior, and
structuring management compensation
to make shareholders interests their own.
oA stock option is an incentive allowing
managers to purchase stock at the
market price set at the time of the grant.
The Agency Issue:
Resolving the Problem (cont.)
oPerformance plans tie management
compensation to measures such as EPS
growth; performance shares and/or cash
bonuses are used as compensation under
these plans.
oRecent studies have failed to find a strong
relationship between CEO compensation
and share price.

FINANCIAL SYSTEM


o System set of complex and closely
connected institutions, agents, practices,
markets, transactions, claims and liabilities in
the economy

o In any country financial system consists of
o specialized and non-specialized financial
institutions,
o organized and unorganized financial markets,
o financial instruments and
o services that facilitate transfer of funds.

FORMAL Vs. INFORMAL FINANCIAL SYSTEM
oFORMAL : Ministry of Finance, SEBI &
RBI
oINFORMAL
oIndividual money lenders neighbours,
relatives, landlords, traders, storeowners
oGroup of people working as associations
oPartnership firms consisting local brokers,
pawn brokers, NBFCs such as finance,
Chit fund companies

FUNCTIONS OF FINANCIAL SYSTEM

A financial system foster savings and channels
them to their most efficient use. It consists of
individuals (savers), intermediaries, markets and
users of savings.
Provides payment system for exchange of goods and
services
Pools funds
Provides ways for managing uncertainty and risk
Generates information and deals with problems of
information asymmetry
Financial Institutions & Markets
oFirms that require funds from external
sources can obtain them in three
ways:
othrough a bank or other financial
institution
othrough financial markets
othrough private placements
The Relationship between Financial Institutions and
Financial Markets
Financial Institutions & Markets: Financial Institutions
o Financial institutions are intermediaries that
channel the savings of individuals, businesses,
and governments into loans or investments.
o The key suppliers and demanders of funds are
individuals, businesses, and governments.
o In general, individuals are net suppliers of
funds, while businesses and governments are
net demanders of funds.
Financial Institutions & Markets: Financial Markets
o Financial markets provide a forum in which
suppliers of funds and demanders of funds
can transact business directly.
o The two key financial markets are the
money market and the capital market.
o Transactions in short term marketable
securities take place in the money market
while transactions in long-term securities
take place in the capital market.
Financial Institutions & Markets: Financial Markets (cont.)
o Whether subsequently traded in the money
or capital market, securities are first issued
through the primary market.
o The primary market is the only one in which
a corporation or government is directly
involved in and receives the proceeds from
the transaction.
o Once issued, securities then trade on the
secondary markets.