Module 1 - The Goals and Functions of Financial Management

Definition of Financial Management

The Field of Finance
The Economic Environment
The Evolution of Finance
The Goals of Financial Management
A Risk-Return Trade-Off
Functions and Activities of Financial Management
Forms of Organization
Financial Markets
Interest Rates
Summary and Conclusions
 What is Financial Management?
The planning, directing, monitoring, organizing, and
controlling of the monetary resources of an organization.

The business function involving:

Managing daily financial activities-cash inflows and
outflows
Choosing long-term investments of value and obtaining
the funds to pay for them
Managing the risks taken by the firm
 The Field of Finance

Finance is related to:

Accounting, which provides information in
financial statements
Economics, which provides
decision-making tools such as pricing theory
(supply and demand), risk analysis,
comparative return analysis
information on the economic and financial
environment in which the company operates

 The Economic Environment

The financial manager considers many economic
. factors, such
as
inflation
unemployment
industrial production
domestic and international competition
foreign trade statistics
international capital flows
exchange rates
changes in technology
consumer and investor attitudes
the state of financial markets
changes in government policy
etc. etc
 The Goals of Financial Management

Primary goal is to maximize the wealth of the

companys shareholders (owners) by increasing the
market value (price) of their shares
May 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
 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)
Financial manager must choose appropriate
combination of potential profit (return) and
level of risk (safety)
 Functions and Activities of Financial Management

Functions involve:
raising funds for the firm at minimal cost and acceptable
risk
investing those funds in company assets so as to earn an
attractive return given acceptable risks
Activities include:
Working Capital Management
short-term (S/T) financial decisions (<1 year)
ex., managing cash and other current assets
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?
 Figure 1-1
Functions of the Financial Manager

Daily Occasional Profitability

Cash management
(receipt and disbursement of funds)
Intermediate financing
Bond issues
Goal:
Credit management Leasing Maximize
Inventory control Stock issues Trade-off
Short-term financing
Exchange and interest rate hedging
Capital budgeting
Dividend decisions
shareholder
Bank relations Forecasting wealth

Risk
Forms of Organization: Sole Proprietorships
A business owned by one person
Advantages
Freedom
Simplicity
Low Start Up Costs
Tax Benefits

Disadvantages
Unlimited Liability
Lack of continuity
Difficulty in raising money
Reliance on one person
Forms of Organization: Partnerships

Disadvantages
Unlimited Liability
Lack of continuity
Ownership transfer difficult
Possibility of conflict

Advantages
More capital
Greater talent pool
Ease of formation
Tax benefits
A business venture with two or more owners
Forms of Organization: Corporations
Advantages
Limited Liability
Continuity
Greater Likelihood of professional management
Easier access to money

Disadvantages
Potential shareholders revolts
Higher start-up costs
Regulation
Double taxation
A corporation is a separate legal entity
Public and Private Corporations

Public corporations shares are available for purchase on the market for
the general public

The shares in a private corporation are held by a small group of

individuals and are not sold to the public
 Financial Markets

Global network of corporations, financial institutions,

governments and individuals that either need money or
have money to lend or invest
Money markets deal in short-term securities (<1 year)
Ex.; Treasury Bills, commercial paper
Capital markets deal in long-term securities
Ex.; common stock, preferred stock, corporate bonds,
government bonds
Financial markets determine value and allocate capital to
the most productive use on a risk-return basis
Financial market characteristics
reliance on debt, and low but volatile interest rates
internationalization
 Stocks vs. Bonds

Stock (Share)= ownership or equity

Shareholders own the company
Bond = debt or liability
Bondholders are owed $ by company

Capital raised in primary markets

Securities traded in secondary markets
 Summary and Conclusions

The 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