The Goals and Functions of Financial Management

The Goals and Functions of Financial Management

Outline Definition of Finance Areas of Finance Career Opportunities in Finance Finance as related to Accounting and Economics The Goal of the Financial Manager Agency issue as it relates to owner wealth

maximization Stakeholder focus, and ethical behavior relate to firms

goal. Activities of Financial Management Forms of Organization

Finance is the study of financial planning, asset management, and fund raising for businesses and financial institutions.

Financial management can be described using a balance sheet.

What is Finance?

Areas of Finance1. Financial Markets

- Markets of users and savers of funds.- Money markets deal in short-term securities (

Career Opportunities in Finance

Financial Analyst prepares and analyze firms financial plans and budgets; other duties include financial forecasting, financial ratio analysis.

Capital budgeting analyst/manager evaluation/recommendation of proposed asset investments, implementation of approved projects.

Project finance manager arranges financing for approved asset investments; coordinates with investment bankers and legal counsel.

Cash manager - maintain and control firms daily cash balances; manages cash collection, short-term investment/borrowing, disbursement activities and banking relationships.

Credit analyst/manager administers firms credit policy by analyzing/managing the evaluation of credit applications, extending credit, monitoring/collecting A/Rs.

Finance as related to Accounting and Economics

Finance is related to:

Accounting, which provides information in financial statements

Economics, which provides:

analysis tools such as pricing theory through supply and demand analysis, cost-benefit analysis etc.

information on the economic and financial environment in which the company operates for sound financial decisions. These include inflation rate, exchange rate, international capital flows, unemployment rate, etc.

All of these factors must fit into the financial decisions

Difference Between Finance and Accounting

Recognition of Revenue and Expenses Accrual Basis: recognizes sales revenue and expenses incurred to make sale

at time of sale. Cash Basis: recognizes revenues and expenses as they occur.

Accounting vs. Financial View

Accounting View(Accrual Basis)

Income StatementXYZ Ltd

For year ended 31/03/2014

Financial View(Cash Basis)

Cash Flow StatementXYZ Ltd.

For year ended 31/03/2014

Sales revenue Rs.10000000Less: Costs 8000000

Net Profit Rs. 2000000

Cash inflow Rs. 0Less: Cash outflow 8000000

Net cash flow (Rs. 8000000)

Goal of the Financial Manager

Should it be Profit Maximization? Corporations commonly define profit as

Earnings per Share (EPS). EPS ignores at least 2 critical factors:

the timing of the returns. risk factors facing the firm.

Profitability Risk Profitability Risk

ex., investing in stocks vs. savings accounts Stocks may be more profitable but are riskier Savings accounts are less profitable and less risky (or safer)

Goal of the Financial Manager

Or should it be Shareholder Wealth Maximization?

Shareholder Wealth Maximization considers factors of EPS timing, and risk ignored by the EPS.

Therefore, Maximizing Shareholder Wealth is a more comprehensive goal for the firm, its managers and employees.

Goal of the Financial Manager

Also, shareholder wealth maximization is in general, consistent with the social responsibility of the firm. Adopting policies that will improve the share price can attract capital and provide employment.

But could conflict with social / ethical goals (for example, pollution control) interests of management (for example, short-term compensation)

Management can encourage an increase in share price by earning an attractive return at an acceptable level of risk

Agency Theory: The Principal-Agent Problem

Agency Theory is about the conflict that may arise between management and owners whenever owners are not also the managers.

Management may not always act in the best interest of the owners because management has interest of its own, like personal wealth, job security, lifestyle, and benefits. Thus, these concerns may conflict with shareholder interests.

The pursuit of socially or ethically acceptable goals may have to come at the expense of shareholders wealth.

Importance of Ethics to Stakeholders Stakeholders are those groups that have direct economic links to the firm.

Stakeholders include not only owners, but also employees, customers, suppliers, unions, and creditors.

Honesty, trustworthiness, fair dealing are foundations of sustainable business relations with these stakeholders.

Ethical behaviour is necessary to achieve the goal of maximizing shareholder wealth.

Maintaining positive stakeholder relationships helps maximize long-term benefits to shareholders.

Financial ManagerKey Activities

Activities include: Short-Term Financial Decisions

Working Capital Management- ex., careful monitoring of cash position on a day-to-day basis

Financial Analysis and Planning

Investment Decisions (Capital Budgeting) long-term (L/T) financial decisions (>1 year)

- ex., purchasing a new machine in the future

Financing decisions (capital structure) how to raise money: loans? leases? shares? bonds?

A business owned byA business owned byone personone person

FreedomFreedomSimplicitySimplicity

Low Start UpLow Start UpCostsCosts

Tax BenefitsTax Benefits

Unlimited Unlimited LiabilityLiability

Lack of ContinuityLack of ContinuityDifficulty in Difficulty in Raising MoneyRaising Money

Reliance on One PersonReliance on One Person

AdvantagesAdvantagesDisadvantagesDisadvantages

Forms of Organization: Sole Proprietorships

Greater Talent PoolGreater Talent Pool

More CapitalMore Capital

Ease of FormationEase of Formation

Tax BenefitsTax Benefits

Unlimited LiabilityUnlimited Liability

Lack of ContinuityLack of ContinuityOwnershipOwnershipTransferTransferDifficultDifficult

Possibility of Possibility of ConflictConflict

A business venture with two or more ownersA business venture with two or more owners

AdvantagesAdvantagesDisadvantagesDisadvantages

Forms of Organization:Partnerships

Limited LiabilityLimited Liability

ContinuityContinuity

Greater LikelihoodGreater Likelihoodof Professionalof ProfessionalManagementManagement

Easier Access to Easier Access to MoneyMoney

Potential Shareholder Potential Shareholder RevoltsRevolts

Higher StartHigher Start--UpUpCostsCosts

RegulationRegulationDouble TaxationDouble Taxation

A corporation A corporation is a separate legal entityis a separate legal entity

AdvantagesAdvantages DisadvantagesDisadvantages

Forms of Organization:Corporations/Companies

Summary and ConclusionsThe Financial Manager: controls the daily cash inflows and outflows resulting from business operations

makes the occasional investment and financing decisions essential for the future financial success of the business

may work in a corporation or other form of business organization

Their overriding goal is to maximize the wealth of the owners by earning an attractive return in the business at an acceptable level of risk