1.1 introduction to financial management dr: el ilam si mohamed chapter 1
TRANSCRIPT
1.1
INTRODUCTION TO FINANCIAL MANAGEMENTDR: EL ILAM SI MOHAMED
Chapter 1
1.2
Key Concepts and Skills
Know the basic types of financial management decisions and the role of the financial manager
Know the goal of financial managementKnow the financial implications of the different forms of business organization
Understand the conflicts of interest that can arise between owners and managers
1.3
Chapter Outline
Finance: A Quick Look Business Finance and The Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the
Corporation Financial Markets and the Corporation
1.4
Basic Areas Of Finance
• Corporate finance• Investments• Financial institutions• International finance
1.5
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
1.6
Financial Institutions
Companies that specialize in financial matters Banks – commercial and investment, credit
unions, savings and loans Insurance companies Brokerage firms
Job opportunities
1.7
International Finance
This is an area of specialization among all 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 and speaking a foreign language fluently is also helpful
1.8
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 and profitability Personal finance
Budgeting, retirement planning, college planning, day-to-day cash flow issues
1.9
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 investment? How will we manage the everyday financial
activities of the firm?
1.10
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
1.11
Financial Management DecisionsCapital 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?
1.12
Forms of Organization
Three major forms in the united states Sole proprietorship Partnership
General Limited
Corporation S-Corp Limited liability company
1.13
Sole Proprietorship
Advantages Easiest to start Least regulated Single owner keeps all
the profits Taxed once as personal
income
Disadvantages Limited to life of owner Equity capital limited
to owner’s personal wealth
Unlimited liability Difficult to sell
ownership interest
1.14
Partnership
Advantages Two or more owners More capital available Relatively easy to start Income taxed once as
personal income
Disadvantages Unlimited liability
General partnership Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
1.15
Corporation
Advantages Limited liability Unlimited life Separation of
ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages Separation of
ownership and management
Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate)
1.16
Goal Of Financial ManagementWhat 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?
1.17
The Agency Problem
Agency relationship Principal hires an agent to represent their interest Stockholders (principals) hire managers (agents)
to run the companyAgency problem
Conflict of interest between principal and agentManagement goals and agency costs
1.18
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 goalCorporate control
The threat of a takeover may result in better management
Other stakeholders
1.19
Work the Web Example 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!
1.20
Figure 1.2
1.21
Financial Markets
Cash flows to the firmPrimary vs. secondary markets
Dealer vs. auction markets Listed vs. over the counter securities
NYSE NASDAQ
1.22
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?
Financial Management
Definitions and conceptsDr: EL ILAM SI MOHAMED
Financial management, sometimes called financial operations or finance, is how an insurance company manages its resources to meet the company’s financial goals, especially the overall goals of solvency and profitability.
Organization of Financial Management
Investment Committee Board of Directors
Audit Committee Board of Directors
Chief Investment Officer
Investment Operations
Chief Financial Officer Financial Operations
TreasurerTreasury
Operations
Controller Accounting and
Financial Reporting
Chief AuditorAudit and
Internal Control
Accounting is a system or set of rules and methods for collecting, recording, analyzing, summarizing, and reporting financial information.
Financial reporting is the process of presenting financial data about a company’s financial position. Operating performance, and flow of funds into and out of the company.
In most of the insurance companies, the controller or comptroller is the head of accounting and financial reporting
Accounting and Financial Operations
The primary responsibilities of the accounting and financial reporting function are to :
Record, track and report on financial transactions Coordinate the budget process and oversee expense analysis Prepare financial statements and reports for external
stakeholders Gather, record ,analyze and distribute financial information to
company mangers
Accounting and Financial Operations
Treasury Operations, manages the cash coming into and out of a company
The treasurer oversees the maintenance and management of records and reports for all of an insurer’s cash transactions
Treasury Operations
Treasuery operations include the following responsibilities: Cash Management-Oversees cash receipts and approves cash
disbursements Bank relations and account administration- Set up bank
accounts, reconciles bank statements Bank reconciliation-Records cash transactions and charges them to
proper accounts Short term credit activities- invests excess cash in very short –
term arrangements and arranges for very short term borrowing as needed
Cash forecasting- Forecasts and tracks the movement of money into and out of the company
Liquidity management- Manages cash on hand to meet contractual obligations by using liquidity
Treasury Operations
Investments are core insurance company operation. Typically, a CIO manages investment operations.
The CIO is responsible for : Making recommendations to the board and implementing board
directives Ensuring investment decisions are in line with investment policy and
regulatory requirements Communicating to the accounting and actuarial areas the current and
expected rates of return on the company’s investments
Investment Operations
By conducting audits of its financial and operational business activities , an insurer can objectively , and compliance with evaluate its operating procedures, management efficiency and compliance with specified rules and regulations
Audit and Internal Control
The ongoing duties of an insurer’s audit committee include: Monitoring internal controls for financial operations Supervising and meeting with internal auditors to discuss their activities
and findings Monitoring organizational activities to improve operating efficiencies Reporting the committee’s activities to the board of directors Reporting the committee’s activities in the annual report to stockholders
and policy owners
Audit and Internal Control
(1) Setting Financial strategy (2) Managing risk (3) Managing the company’s solvency
and profitability (4) Managing capital (5) Managing cash flows (6) Providing financial information to
stakeholders
Responsibilities of Financial Management
Financial strategies may be categorized as : 1) Aggressive 2) Conservative 3) combination of the above two Aggressive : A company that places a strong emphasis on taking risks that could
enhance its profitability. For e.g. investing in relatively high- risk assets, developing many new and unusual products, implementing new distribution systems
Conservative Financial Strategy: An insurer that places a strong emphasis on avoiding risks that could threaten its solvency generally pursues a conservative financial strategy. For e.g. …………….
1) Setting Financial Strategy
Risk is the possibility that an investment might have an unexpected result. Common types of risks: Investment risk- is the possibility that an investor will fail to earn some or all of an expected return
or will lose all or part of the original investment. Some important risks associated with investing are Market Risk : For e.g. real estate investment may lose value if the real estate market as a whole
declines Interest-rate risk: For e.g. if the interest rate increase, bonds tend to lose market value Default-risk: The risk that a borrower will fail to repay the debt Liquidity –risk: for e.g. I the owner of property, such as shopping mall, should suddenly need cash
quickly, the property may have to be sold for a price less than its true value Currency risk: the value of an insurer’s investments in a foreign country fluctuates with the value
of that country’s currency
2) Managing Risks
Operational Risk is a broad category of risks originating from inadequacies in an insurer’s operational areas or from external events affecting an insurer's operational areas. Two major types of operational risks are:
Business process risk- For e.g. inefficient customer service processes might create long TAT Event Risk: For e.g. an earthquake might result in technology failures and an inability to run the
business Product Risk : is the risk that a company’s [products might not sell as well or be as profitable as
expected A) Pricing risk: For e.g. more insured might die than an insurer anticipated when pricing a life
insurance product, so claims will be higher B) Policyholder behavior risk: For e.g. customer ‘s surrender patterns may be higher than an
insurer anticipated
2) Managing Risks
Risk management is the process of systematically identifying, assessing, and minimizing the negative impact of risk.
To minimize the negative impact of these various risk across the organization, most insurers practice Enterprise Risk Management. ERM is a system that identifies and quantifies risks both from potential threats and potential opportunities and manages them.
2) Managing Risks
The dual goals of financial management are to (1) protect solvency (2) increase profitability
Pursuing profitability requires a certain amount of risk taking, whereas protecting solvency involves risk avoidance and stability
Long term profitability enables an insurer to A) Provide funds for investments B) Pay policy dividends C) Pay cash dividends to stockholders and increase the attractiveness of the company’s
stock to investors D) Generate high-quality ratings from insurance rating agencies E) Provide funds to develop products, expand product lines, for company expansion e.t.c
3) Managing Solvency and Profitability
Financial managers attempt to increase the probability that the company will remain financially healthy by using the company’s capital appropriately
Capital= Assets – Liabilities Benefits to an insurer of maintaining the strong capital position include: Greater ability to withstand difficult conditions such as bad economy Greater flexibility in its operations Greater ability to raise capital on favorable terms
4) Managing Capital
Ways to Raise Capital?
Ways to Use Capital?
A cash flow is any movement of cash into or out of an organization A cash inflows include- 1) revenues from product sales 2)
investment income 3) sales of existing assets 4) external financing A Cash outflow includes 1) payments to policy owners and
beneficiaries 2) payment for operating expenses 3) purchase of new assets
The basic goal for managing cash flows is to have enough assets available so that the insurer can pay its obligations as they come due and to invest the remaining assets wisely to earn favorable returns
5) Managing Cash Flows
Insurers provide information to stakeholders in the form of
Financial statements Annual report Annual statements
6) Providing financial information to stakeholders
A financial statement is a summary of a company’s financial condition on a specified date or its performance during a specified period.
Two key financial statements are the income statement and the balance sheet The income statement shows a company’s revenues and expenses during a
defined period, such as one quarter or one year, and shows weather the company experienced a profit or loss during that period.
Revenues are amounts that a company earns from its business operations Expenses are amounts that a company spends to support its business operations The income statement also shows net income, which is calculated by subtracting
expenses from revenues
6) Providing financial information to stakeholders
Balance sheet, which lists the value of an insurer’s assets ,liabilities , and capital and surplus as of a specified date
Annual Report is a financial document that an incorporated business issues to its stakeholders and other interested parties to report the business’s activities and financial performance for the preceding year.
Annual Statement
6) Providing financial information to stakeholders