strategic financial management
DESCRIPTION
Strategic Financial Management. An Overview. Introduction. Finance is the middle ground between theoretical economics and the accounting world of numbers. Finance is applied economics. From another view, while accounting is the language of business, finance is the literature. - PowerPoint PPT PresentationTRANSCRIPT
Strategic Financial Management
Strategic Financial Management
An Overview
Introduction
Finance is the middle ground between theoretical economics and the
accounting world of numbers. Finance is applied economics.From
another view, while accounting is the language of business, finance
is the literature.Financial implications are at the heart of every
business transaction and decision.
Introduction
Finance is not an end in and of itself. It is a tool, a most
valuable tool used to communicate, judge, and monitor the results
of business decisions. It is a tool well-suited for the boardroom
as well as the shop floor; from the executive suite to the
distribution center; from corporate and divisional staff offices to
a distant sales office.In a world of geo-political, social and
economic uncertainty, strategic financial management is in a
process of change, which requires a reassessment of the fundamental
assumptions that cut across the traditional boundaries of the
subject.
Objectives of a Firm
All the traditional finance literature confirms that investors
should be rational, risk-averse individuals who formally analyze
one course of action in relation to another for maximum benefit,
even under conditions of uncertainty.
What should be (rather than what is) is what we term normative
theory.
Normative financial theory dictates what financial managers "ought
to do" when faced with financial decisions. Positive, or
descriptive, financial theory includes both research designed to
find relationships among variables and surveys designed to find out
what financial managers are actually doing. Positive studies have
revealed that financial managers do not always act in the way that
normative theories would say is appropriate for the
situation.
It represents the foundation of modern finance within which:
Investors maximize their wealth by selecting optimum investment and
financing opportunities, using financial models that maximize
expected returns in absolute terms at minimum risk.
What concerns investors is not simply maximum profit but also the likelihoodof it arising: a risk-return trade-offfrom a portfolio of investments, with which they feel comfortable and which may be unique for each individual.Thus, in a sophisticated mixed market economy where the ownership of a companys portfolio of physical and monetary assets is separated from its control, it follows that:
The normative objective of financial management should be:
To implement investment and financing decisions using
risk-adjusted wealth maximizing criteria, which satisfy the firms
owners (shareholders) by placing them all in equal, optimum
financial position.
Of course, we should not underestimate a firms financial,
fiscal, legal, and social responsibilities to all its other
stakeholders. These include alternative providers of capital,
creditors, employees and customers, through to government and
society at large. However, the satisfaction of their objectives
should be perceived as a means to an end, namely, shareholder
wealth maximization.As employees, managements own satisficing
behavior should also be subordinate to those to whom they are
ultimately accountable, namely their shareholders, even though
empirical evidence and financial scandals have long cast doubt on
managerial motivation.
In our ideal world, firms exist to convert inputs of physical
and money capital into outputs of goods and services that satisfy
consumer demand to generate money profits. Since most economic
resources are limited but societys demand seems unlimited, the
corporate management function can be perceived as the future
allocation of scarce resources with a view to maximizing consumer
satisfaction. And because money capital (as opposed to labor) is
typically the limiting factor, the strategic problem for financial
management is how limited funds are allocated between alternative
uses.The pioneering work of Jenson and Meckling resolves this
dilemma by defining corporate management as agents of the firms
owners, who are termed the principals. The former are authorized
not only to act on the behalf of the latter, but also in their best
interests.
Armed with agency theory, you will discover that the function of strategic financial management can be deconstructed into 4 major components based on the mathematical concept of expected net present value (ENPV) maximization:
Explained simply, the market price equity (shares) acts as a
control on managements actions because if shareholders (principals)
are dissatisfied with managerial (agency) performance they can
always sell part or all of their holding and move funds
elsewhere.
The investment, dividend, financing, and portfolio
decision
Axioms of Financial Management
Axiom 1: The risk-return tradeoff
We wont take additional risk unless we expect to be compensated
with additional return. Almost all financial decisions involve some
sort of risk-return trade off.
Axiom 2: The time value of money
A dollar received today is worth more than a dollar received in the
future
Axiom 3: Cash-Not Profits-is King
In measuring value we will use cash flows rather than accounting
profits because it is only cash flows that the firm receives and is
able to reinvest.
Axiom 4: Incremental cash flows
It is only what changes that counts. In making business decisions
we will only concern ourselves with what happens as a result of
that decision.
Axiom 5: The Curse of competitive markets
Why its hard to find exceptionally profitable projects.In
competitive markets, extremely large profits cannot exist for very
long because of competition moving in to exploit those large
profits. As a result, profitable projects can only be found if the
market is made less competitive, either through product
differentiation or by achieving a cost advantage.
Axiom 6: Efficient capital markets
The markets are quick and the prices are right
Axiom 7: The agency problem
Managers wont work for the owners unless its in their best
interest. The agency problem is a result of the separation between
the decision makers and the owners of the firm. As a result,
managers may make decisions that are not in line with the goal of
maximization of shareholder wealth.
Axiom 8: Taxes bias business decisions
Axiom 9: All risk is not equal
All risk is not equal since some risks can be diversified away and
some cannot. The process of diversification can reduce risk, and as
a result, measuring a projects or an assets risk is very
difficult.
Axiom 10: Ethical dilemmas are everywhere in finance
Ethical behavior is important in financial management, just as it
is important in everything we do. Unfortunately, precisely how we
define what is and what is not ethical behavior is sometimes
difficult. Nevertheless, we should not give up the quest.