intro to fm12

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Financial

Management Policy



Financial Management

y Financial management is that managerial activity

which is concerned with the planning and controllingof the firms financial resources. It was a branch of economics till 1890.

y In general financial management is the effective &efficient utilization of financial resources.



Main Features Of Financial

Management:Financial problems are analyzed and considered. Study

of trend of actual figures is made and ratio analysis is

done.All Managerial decisions related to finance are taken

after considering the report prepared by the finance

manager.

Larger the risk in the business larger is the expectationof profits. Financial management maintains balance

between the risk and profitability.



Maximize the Value of the Business

(Firm)

Three major decision in Finance:

1. The Investment Decision:

2. The Financing Decision

3. The Dividend Decision



Financial Management PolicyCourse:

yModule I Investment Decision (35%)

yModule II Financing Decision (30%)

yModule III Operating Decision (35%)



Investing Decision:y Introduction to Finance

y Review of TV M, Bonds & Stocks

y Review of Capital Budgetingy Risk, Return & Opportunity Cost of Capital

y Risk, Return & Capital Budgeting

y The Cost of Capital



Financing Decision:y Corporate Financing

y Capital Structure

y Debt Policy y Dividend Policy

y Term Loans & Leases



Operating Decision:y Financial Planning

y Working Capital Management

y Cash & Inventory Managementy Credit Management



Recommended Readings:y Fundamentals of Corporate Finance by

(Brealey , Myers & Marcus)

y FinancialManagement by (Eugene F Brigham)

y FMP Work Book (Available at IU book shop)



Few Questions:y How do corporation go public and continue to grow?

What are agency problems?

y What should be the primary objective of Managers?y Three aspects of cash flows affect the value of any

investment?

y What is WACC?

y How do FCF and WACC determine Firms Value?y Different types of Markets?



Principle 1: The Risk-Return Trade-off

y The more risk an investment has, the higher will be its

expected return.

y NO additional risk unless you expect to be

compensated with additional return.

y Investment alternatives have different amounts of risk

and expected returns.



Principle 2: The Time Value of Money

y A dollar received today is worth more than a dollar

received in the future.

y Interest Rate Factor



Principle 3: CashNot ProfitsIs King

y CASH FLOWs, not accounting profit, is used to

measure wealth.

y Cash flows, not profits, are actually received by the

firm and can be reinvested.



Principle 4: Incremental Cash Flows

yThe incremental cash flow is the difference betweenthe projected cash flows if the project is accepted,

versus what they will be, if the project is not accepted



Principle 5: The Curse of

Competitive Markets

y Why it is hard to find exceptionally profitable

projects?????

y If an industry is generating large profits, new entrantsare usually attracted. The additional competition andadded capacity can result in profits being driven downto the required rate of return



Principle 6: Efficient Capital

Markets

y The markets are quick and the prices are right.

y The values of all assets and securities at any instant in

time fully reflect all available information.



Principle 7: The Agency Problem

y Managers wont work for the owners unless it is in

their best interest

y The separation of management and the ownership of the firm creates an agency problem. Managers maymake decisions that are not in line with the goal of maximization of shareholder wealth



Principle 8: Taxes Bias Business

Decisions

y When a new project is evaluated, the after-tax

incremental cash flows should be considered



Principle 9: All Risk is Not Equal

� Diversification allows good and bad events or

observations to cancel each other out, thus reducing

total variability without affecting expected return

� Some risk can be diversified away, and some cannot



Principle 10: Ethical Behavior Is

Doing the Right Thing, and

Ethical Dilemmas Are

Everywhere in Finance

y Each person has his or her own set of values, which

forms the basis for personal judgments about what isthe right thing



Goal of the Firm

y TheGoal of the firm is maximization of Business/ FirmsValue.

or

yMaximize the price of the common stocks

.



Legal Forms of Business Organization

y Sole Proprietorship

y Partnership

y Corporation



Sole Proprietorshipy Owned by an individual

y Owner holds title to assets

y Unlimited liability

y Termination occurs on owners death or by owners

choice



Partnershipsy General Partnership

y Each partner is fully

responsible for liabilities

or

y Jointly responsible for

Unlimited Liability

� Limited Partnership

y Allows one or more partnerslimited liability

y Must have one general partnerwith unlimited liability

y Names of limited partners maynot appear in name of firm

y Limited partners may notparticipate in management

decisions.

y More the ONE owner



Corporationy Business organized as a Separate legal entity owned by

stockholders/ Shareholder .

y Limited Liabilityy Its can borrow or lend money/ it can be sue or be sued

and pay taxes.



Corporate Income

Sales $1,000

Cost of Goods Sold $ 200

Gross Profit $ 800

Operating ExpensesAdministrative Expenses $150

Depreciation Expense $ 50

Total Operating Expenses $200

Operating Income (EBIT) $600Other Income $0

Interest Expense $250

Taxable Income $350



Marginal TaxR

ates

� Rates applicable to next dollar of income

� Used in financial decision (Module II)

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