Introduction

Financial Management
Lecture 1

Dr Tasweer Hussain Syed qsl

DEM
NUST-CEME
EM-815:  Financial Management
(Credits: 03 Pre-requisite : Nil)
Course Objectives

After completing this course successfully the students are expected to: Ref Books:
1. Understand tools and techniques required in modern financial
1. Fundamentals of Financial Management (11th edition) by Eugene F.
systems and are able to apply modern financial techniques to operating
Brigham, Joel F. Houston
and investment decisions;
2. Statistics for Business and Economics, 6th edition by Paul Newbold,
2. Understand financial management concepts, principles, practices and
William Carlson and Betty Thorne, Prentice Hall, 2007.
theories are able to comprehensively analyzes working capital requirement
3. Corporate Finance, 7th edition by S A Ross, R W Westerfield, J Jaffe
and capital budgeting;
(RWJ), McGraw Hill, 2004.
3. Have reasonable understanding with the capital markets and
4. Financial Reporting and Analysis, 3rd edition by L.Revsine, D.Collins &
corporate finance.
4. Have analytical skills necessary to carry out financial analysis for B.Johnson Prentice Hall, 2005.

preparing reports and documents for corporate financial decisions and 5. Options, Futures and other Derivatives, 6th edition by Hull J, Prentice
lending organizations. Hall
6. Financial Statement Analysis and Security Valuation, 3rd Edition, by S.
Course Description Penman McGraw-Hill Irwin, 2007.

Fundamental of accounting, Foundations of finance, quantitative methods for 7. Accounting; the basis for business decisions, 10th edition, Robert F.
finance, principles of financial reporting, financial markets, financial Meigs and Mary A. Meigs, McGraw Hill Publishing, 1996
statement analysis, financial reporting for complex entities, valuation,
portfolio management, risk and return, raising capital, capital structure,
market efficiency, management control systems, advanced corporate finance,
advanced investment management, derivatives pricing, fixed income markets,
international money and finance, case studies and practices.
 Course Objectives
 1. Understand tools and techniques required in
modern financial systems and apply modern financial
techniques to operating and investment decisions;
 2. Understand financial management concepts,
principles, practices and theories to analyzes working
capital requirement and capital budgeting;
 3. Have reasonable understanding with the capital
markets and corporate finance.
 4. Have analytical skills necessary to carry out financial
analysis for preparing reports and documents for
corporate financial decisions and lending
organizations.
 Course Description
 Fundamental of accounting, Foundations of fin,
quant mtds for fin, principles of fin reporting,
fin markets, fin statement analysis, fin
reporting for complex entities, valuation,
portfolio mgt, risk and return, raising capital,
capital structure, market efficiency, Mgt control
systems, advanced corporate finance, advanced
investment management, derivatives pricing,
fixed income markets, international money and
finance, case studies and practices.
Marks Allocation - EM 815 FM

Assignments 8%
Quizzes 7%
Class Participation 5%
Mid Term / Sessional Exams 30%
Final Exam 50%
 Organization
Management
Accounting &
Finance
External Purview
Internal Purview
Organization
Organ
Set of Components
Unified Objectives
Value
Profit
 Management
EE (PO3C+6Ms)
∑f (EE{PO3C+6M}
 Finance (6Ms)
External Purview
Internal Purview
 Finance
External Purview
General
Financial Management
 Finance
Internal Purview
Financial Accounting
(Managerial Finance)
Accounting

Data Entry Techniques

GAAP
Beyond the Scope of this course
Introduction to Accounting and
Business
Accounting Equation Assets = Liabilities + Equity
Customers
Revenue

Profit Cost
Services

Materials
Owners

taxes &
Business and Accounting
Organizations: (Define wrt Organ) Profit and Non Profit
Objective : Value Creation {Cash, Image(overt) or Virtue(covert)}

A business is an organization in which basic resources (inputs),

such as materials and labor, are assembled and processed to
provide goods or services (outputs) to customers.
The objective of most businesses is to earn a profit.
Profit = Income - Outgo.
Examples: Profit orgs like Microsoft, Lever Brothers,
Non Profit like Eidhi Foundation, hospitals, churches, and
government agencies.
Types of Businesses
Three types of businesses:
service, merchandising, and manufacturing

Service Businesses: provide services rather than products to

customers, eg Delt a Air Lines (transportation services)
The Walt Disney Company (entertainment services)

Merchandising Businesses: sell products they purchase from

other businesses to customers eg Walmart (general
merchandise), Amazon .com (Internet books, music, videos, ...)

Manufacturing Businesses: change basic inputs into products

that are sold to customers, eg. Ford Motor Co. (cars, trucks, vans)
Dell Inc. (personal computers)
Role of Accounting in Business
The role of accounting in business is to provide
information
a.To managers to use in operating the business.
b. To other users in assessing the economic
performance and condition of the business.
So; Accounting can be defined as an information
system that provides reports to users about the
economic activities and condition of a business.
Accounting is the “language of business.”
Accounting Process: The process by which accounting
provides information to users is as follows: (Diagram on next
slide)
1. Identify users.
2. Assess users’ information needs.
3. Design the acct information system to meet users’ needs.
4. Record economic data about business activities and
events.
5. Prepare accounting reports for users.

Managerial Accounting: Internal users of accounting

information include managers and employees. These users
are directly involved in managing and operating the business.
The area of accounting that provides internal users with
information is called Managerial or Management
Accounting.
 Identify
User

Internal External
User User

Assess User
Info need

Design Acctg
System

Record
Economic Data

Prep Acctg
Reports
Financial Accounting :
Info for External Users eg investors, creditors,
customers, and the government, not directly involved in
managing and operating the business.
Objective of FA : Provide relevant and timely
information for the decision-making needs of users
outside of the business, eg.
1. Financial reports on the operations and cond of
the business are useful for banks and other creditors in
deciding Whether or not to lend money to the business.
2. General-purpose financial statements are one
type of financial accounting report that is distributed to
external users for a wide range of decision-making
needs
Role of Ethics in Accounting and Business
The objective of accounting is to provide
relevant, timely information for user decision
making, therefore: -
 Trustworthy Info
 Useful for decision making
Ethics is also must in managing and operating a
business since people have to invest in or loan
money to the business.
Past is abound with examples of accounting or
business fraud. Ethical violations led to fines,
firings, and lawsuits and even managers were
criminally prosecuted, convicted, and sent to
prison.
Accounting and Business Frauds led Congress passed laws
like Sarbanes-Oxley Act (SOX). SOX established a new
oversight body for the accounting profession called the
Public Company Accounting Oversight Board (PCAOB).
In addition, SOX established standards for audit independence,
corporate responsibility, and disclosure.
How does one behave ethically when faced with financial or
other types of pressure? Guidelines for behaving ethically are:-
1. Identify an ethical decision by using your personal ethical
standards of honesty and fairness.
2. Identify the consequences of the decision and its effect on
others.
3. Consider your obligations and responsibilities to those who will
be affected by your decision.
4. Make a decision that is ethical and fair to those affected by it.
Generally Accepted Accounting Principles (GAAP).
GAAP is a collection of accounting standards, principles, and
assumptions that define how financial information will be
reported.
Accounting Standards are the rules to determine the
accounting for individual business transactions.
Accounting Principles and assumptions provide the framework
upon which accounting standards are constructed.
In United States, the Financial Accounting Standards Board
(FASB) has the primary responsibility for developing and
publishing accounting standards, Statements of Financial
Accounting Concepts, and Interpretations,
which make up GAAP.
Securities Exchange Commission (SEC), is an
agency having authority over the accounting and
financial disclosures for companies whose shares of
ownership (stock) are traded and sold to the public.
The SEC normally accepts the accounting standards
set forth by the FASB.
SEC may issue Staff Accounting Bulletins on
accounting matters that may not have been addressed
by the FASB.
Outside the United States, most countries use
accounting standards and principles adopted by the
International Accounting Standards Board (IASB)
that issues International Financial Reporting
Standards (IFRS). Differences currently exist between
FASB and IASB accounting principles.
 Foundations of Fin
THE GOALS AND FUNCTIONS OF FIN MGT
 Field of Finance: An Overview
 Goal of the Firm
 Agency Problem
 Business Ethics
 Forms of Business Organization
 Globalization
 Computerization
In 1776, Adam Smith described how an “invisible hand” guides
companies as they strive for profits, and that hand leads them to
decisions that benefit society

Right Objective is therefore profit maximization and Free

Enterprise System
After 1776 now
Co. Size Growth
Complexity Within Co
Need still remains maximize profits

Therefore need a broader view and more balanced actions designed

to benefit customers, employees, suppliers, and society as a whole?
 Academics and finance professionals today subscribe to the following
modified version of Adam Smith’s theory:

●● A firm’s principal financial goal should be to maximize

the wealth of its stockholders, which means maximizing
the value of its Stock.
●● Free enterprise is still the best economic system for
society as a whole. Under the free enterprise framework,
companies develop products and services that people want
and that benefit society.
●● However, some constraints are needed—firms should not
be allowed to pollute the air and water, to engage in unfair
employment practices, or to create monopolies that exploit
consumers.
Lec 1 terminated
Lect 2 starts
 Financial Management
Types of Organizations
1.Sole Proprietorship / Enterprise
2.Partnership
3.LLP
4.Private Ltd Company
5. Public Ltd Company
 Types of Companies

One member non listed

Two or more members
Private or public
Ltd by liability or guarantee
listed and non listed
 Financial Management
Financial Management, also called corporate
finance, focuses on decisions relating to
1.How much and what types of assets to acquire,
2.How to raise the capital needed to purchase
assets, and
3.How to run the firm so as to maximize its value.
The same principles apply to both for-profit and
not-for-profit organizations
 Capital Markets
Capital markets –
1. Stock Markets where interest rates, along with stock and bond
prices, are determined.
2. Financial institutions that supply capital to businesses. Banks,
investment banks, stockbrokers, mutual funds, insurance
companies, and the like bring together “savers” who have money to
invest and businesses, individuals, and other entities that need
capital for various purposes.
3. Governmental organizations such as the Federal
Reserve System, which regulates banks and controls the supply of
money, and the Securities and Exchange Commission (SEC),
which regulates the trading of stocks and bonds in public markets,
are also studied as part of capital markets.
 Investment
Investments - The decisions concerning stocks and bonds and include a
number of activities:
(1)Security Analysis - Finding the proper values of individual
securities (i.e., stocks and bonds).
(2)Portfolio Theory - The best way to structure portfolios, or
“baskets,” of stocks and bonds. Rational investors want to hold
diversified portfolios in order to limit risks, by choosing a balanced
portfolio.
(3)Market Analysis – Issue whether stock and bond markets at any
given time are “too high,” “too low,” or “about right.” Included in
market analysis is behavioral finance, where investor psychology is
examined in an effort to determine whether stock prices have been bid
up to unreasonable heights in a speculative bubble or driven down to
unreasonable lows in a fit of irrational pessimism
 Finance
Within an
Organization
Financial Management
 Foundations of fin
Financing decisions vs. investment decisions: raising
money vs. allocating money
Activity (1) is a financing decision
Activity (2) is an investment decision
Activities (4a) and (4b) are financing decisions
The role of a financial manager
Forecasting and planning of firms’ financial needs
Making financing and investment decisions
Coordinating with other departments/divisions
Dealing with financial markets
Managing risks
Finance within an organization: importance of finance
 Basic Terms
Money is anything that is commonly accepted in exchange for
goods and services(measure or store of value),
Financial assets (including money) are contracts or certificates
indicating financial claims.
A security is a financial asset that can be purchased or sold in
financial markets. Eg corporate bond - a security that
indicates a claim by its owner (the investor or bond holder) on
a specified series of interest payments and principal
repayment by the firm which issued the bond. The corporation
is obligated to make payments to the bondholder as specified
by the bond contract.
A share of corporate stock is a residual claim, shareholders have
a right to receive all cash flows
 Derivatives
Derivative instruments include options and futures contracts. The value of a derivative
instrument is derived from the value of another security or asset. An option
contract provides its owner the right to buy or sell another security or asset at a
specified price on or before a given date. The owner of the option contract may
choose whether claim; that is, shareholders have a right to receive all cash flows
(according to a schedule determined by the firm) which remain in the corporation
after obligations to all other claimants have been satisfied. Shareholders also have
the right to direct certain discretionary activities of the firm. Corporations and other
business enterprises issue securities for the purpose of raising money to engage in
business activities; investors may be willing to purchase securities in order to
receive cash flows associated with these business activities. Markets exist for
securities enabling investors to buy, sell, or trade securities. Among these markets
are exchanges and over-the-counter markets for stocks and bonds and networks of
financial institutions engaged in the trade of derivative instruments and other
securities. An understanding of these markets is crucial to successful investing in
the securities that trade in them.
A share of corporate stock is a residual claim; that is, shareholders
have a right to receive all cash flows (according to a schedule
determined by the firm) which remain in the corporation after
obligations to all other claimants have been satisfied.
Shareholders also have the right to direct certain discretionary
activities of the firm.
Corporations and other business enterprises issue securities for the
purpose of raising money to engage in business activities; investors
may be willing to purchase securities in order to receive cash flows
associated with these business activities. Markets(20)exist for securities
enabling investors to buy, sell, or trade securities.
Corporate issues are made either to specific investors (private
placements, e.g., a bank note) or to the general public
(public placements, e.g., publicly traded common stock).
Primary markets for securities are the markets of original issue;
by participating in these markets, corporations sell their own
securities to raise money.
Thus, a corporation may raise money by issuing or selling
securities in primary markets. Investment banks are financial
institutions whose function is to assist corporations in the
placement of their securities to investors. Investment banks
provide advice and other assistance to firms concerning the
marketing and pricing new issues. Advertisements (sometimes
called “tombstone ads”) related to primary market offerings
may be seen in financial publications such as the Wall Street
Journal.
Secondary markets exist for many previously issued
securities to provide liquidity for primary market
participants. That is, secondary markets provide the
opportunity for original purchasers of securities to
sell their securities before they mature, expire or
cease generating payments from the corporations.
Stock Exchanges (SE) like KSE, NYSE etc provide
secondary markets for listed corporate issues. Issues
not traded on exchanges are traded in the “over-
the-counter” markets – markets for all publicly
traded securities not listed on exchanges eg National
Association of Security Dealers Automated Quotation
System (NASDAQ) is an example of most visible
components of the over-the-counter markets.
In addition to the markets for corporate securities, there exist well-
developed markets for a variety of instruments created by other types of
issuers. For example, the federal government raises money through the
sale of U.S. Treasury issues, including Treasury bills, Treasury notes, and
Treasury bonds. These are all debt securities indicating that the United
States government has borrowed money from their original purchasers.
Such treasury instruments, particularly those of shorter term to maturity,
are often regarded to be free of many of the risks associated with other
issuers of debt instruments.
The United States Treasury is a very reliable debtor and there is a very well
developed market for treasury issues. State and local governments issue
municipal bonds (the term “muni” does apply to state issues as well as to
municipal issues) which often confer certain income tax advantages
Derivatives & their Markets

A variety of other institutions offer securities, including

nonprofit institutions, mutual funds, and government agencies. There
even exist
active markets for instruments representing claims on other securities
(derivative
instruments). Derivative instruments include options and futures
contracts. The value of
a derivative instrument is derived from the value of another security or
asset. An option
contract provides its owner the right to buy or sell another security or
asset at a specified
price on or before a given date
Finance - three areas
Finance - three areas
 The goal of a firm
To maximize shareholder’s wealth (or firm’s long-run
value)
Why not profit or EPS maximization?
Profit maximization usually ignores timing and risk of
cash flows
EPS sometimes can be manipulated or misleading
Why not focusing on short-term?
Top executives receive huge bonuses for engaging in
risky transactions that could generate short-term
profits and those transactions collapse later on, eg
subprime mortgage
Field of Finance: An Overview

E c o n o m ic s A c c o u n tin g

F in a n c e

F in a n c ia l F in a n c ia l In v e s tm e n ts
M anagem ent M a r k e ts
Financial Management (Insiders)

 Investment Decisions - Assets

 Using Funds
 Financing Decisions - Debt and Equity
 Acquiring Funds
Investments (Outsiders)
 Security Analysis

 Portfolio Management
Financial Markets

 Money and Capital Markets

 Primary and Secondary Markets
 Financial Institutions: Banks, Insurance
Companies, Credit Unions, Mutual Funds, Etc..
 Federal Reserve: Interest Rates, Regulation
Goal of the Firm
 Wealth Maximization
 Maximize the wealth of the firm’s existing
common stockholders
 Wealth Defined
 Market Value of the firm’s common stock
 (Price per share)(number of shares)
Goal of the Firm
(Continued)
 Factors Affecting Price Per Share
 Earnings per share (EPS)
 Price/Earnings Ratio
 Timing of EPS
 Risk
 Problem With Earnings Maximization
 Ignores many of the important variables that
impact on the stockholders’ well being (i.e..,
wealth)
Agency Problem
 Stockholders Versus Managers
 Managers, in light of their self interest, may
at times make decisions that are not oriented
towards maximizing stockholder wealth. This
does not, however, invalidate the goal itself.
 Incentives for management to act in the
stockholders’ best interest
 Threat of being fired - PERS is quite active
 Hostile takeover if stock price is too low
 Performance based salaries
Business Ethics
 Ethics Defined
 Standards of conduct and moral judgment
 Unethical conduct may be obvious at times.
 Insider Trading
 Ethical dilemmas, however, can also exist.
 Profits and ethics sometimes conflict
 Often there is no clear-cut right or wrong answer
Forms of Business
Organization
 Sole Proprietorship
 About 75% of all firms

 Partnership

 Corporation
 About 90% of all sales dollars
Sole Proprietorship
 A single owner
 Unlimited liability
 Taxed at personal income tax rates
 Easiest and least expensive to establish
 Market value of firm difficult to estimate
 Difficult to raise equity capital
Partnership
 Two or more owners
 Unlimited liability
 Taxed at personal income tax rates
 Not too costly to establish
 Market value of firm difficult to estimate
 Difficult to raise equity capital
 Easier to raise capital compared to a sole
proprietorship, however.
Corporation (Publicly
Traded)
 Unlimited life
 Legal entity
 Easy to transfer ownership
 Limited liability of stockholders
 Double taxation
 Corporate earnings taxed
 Stockholders’ dividends taxed
 Most attractive form for raising capital
 Market Value easy to determine
Hybrid Forms of Organization
 Limited partnership (LLP)
 Liability limited to investment

 S Corporation
 Shareholders enjoy limited liability, but income
is taxed at personal income rates.
Globalization
 Financial managers must have a multinational
perspective regarding many decisions
 Various international aspects of financial
management will be introduced throughout the
semester
Technology

 Strong computer skills are essential

 Internet and World Wide Web
 Electronic Commerce
Questions