Chapter One

Introduction to Managerial Finance

Md. Rizvy Ahmed
Lecturer
Faculty of Business Administration
Eastern University
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Learning Goals
Define finance and describe its major
areas and career opportunities.
LG2 Review basic forms of business
organization, their strengths and
weaknesses.
LG3 Describe managerial finance function and
differentiate from economics and
accounting.
LG1

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Learning Goals (continued)

Identify key activities of financial
manager within the firm.
LG5 Explain why wealth maximization is
firms goal.
LG6 Explain how EVA, stakeholder focus,
and ethical behavior relate to firms goal.
LG7 Discuss agency issue as it relates to
owner wealth maximization.
LG4

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What is Finance?
Finance is concerned with the process, institutions,
market and instruments involved in the transfer of
money among individuals, business and governments.
Financial markets, financial intermediaries, and
financial management are the important components.
Financial markets and financial intermediaries
facilitate the flow of funds from borrowers to savers.
Financial management involves the efficient use of
financial resources in the production of goods.
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What is Finance?
At the macro level, finance is the study of financial
institutions and financial markets and how they operate
within the financial system in global economies.
At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions.
Financial management can be described in brief using
the following balance sheet.

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What is Finance?
Macro Finance
Assets:

Liabilities & Equity:

Current Assets

Current Liabilities

Cash & M.S.

Accounts payable

Accounts receivable

Notes Payable

Inventory

Working
Capital

Investment
Decisions

Total Current Assets

Fixed Assets:
Gross fixed assets

Total Current Liabilities

Long-Term Liabilities
Total Liabilities
Equity:

Less: Accumulated dep.

Common Stock

Goodw ill

Paid-in-capital

Other long-term assets

Retained Earnings

Total Fixed Assets

Total Assets

Total Equity
Total Liabilities & Equity

Working
Capital

Financing
Decisions

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Areas of Specialization in Finance

Financial Markets
Markets of users and savers of funds.

Financial Services
Design and delivery of financial advice and
products to individuals, businesses, government.

Managerial Finance
Financial management of business firms.

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Areas of Employment in Finance

Financial Analyst
Capital budgeting analyst/manager
Project finance manager
Cash manager
Credit analyst/manager
Pension fund manager

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Basic Forms of Business

Organization
Sole Proprietorship
Owned by one person, operated for personal profit.

Partnerships
Owned by two or more people, operated for joint
profit.

Corporations
Legal entity, owned by individuals, operated for
joint profit.
2005 Pearson Education Canada Inc.

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Sole Proprietorship
STRENGTHS:
Low organizational cost
Income taxed once as
personal income
Independence
Secrecy
Ease of dissolution

WEAKNESSES:
Unlimited liability
Limited funding
Proprietor must be all
Difficult to develop staff
career opportunities
Lack of continuity on
death of proprietor
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Partnerships
STRENGTHS:
Improved funding sources
than sole proprietorship
Borrowing power enhanced
by more owner
Increased managerial talent
Income split by partnership
contract, taxed as personal
income

WEAKNESSES:
Unlimited liability to all
partners
Partnership dissolved
upon death of partner
Difficult to liquidate or
transfer ownership

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Corporations
STRENGTHS:
Owners own liability
Large capitalization possible,
greater funding
Ownership readily
transferable
Indefinite life
Professional management
Receive tax advantage and
has better access to finance.

WEAKNESSES:
Higher corporate tax rates as
well as dividend paid is also
taxed.
More expensive to organization
than other business forms
Greater government regulation
When publicly traded, lacks
secrecy

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Corporate Organization Chart

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Organization of Finance Functions

The importance of managerial finance function depends on the
size of the firm.
CFO Chief Financial Officer
Treasurer responsibilities:
Financial planning, fund raising, capital expenditure decisions, cash
and credit management.
The treasurers focus tends to be more external, the controllers focus
more internal.

Controller responsibilities:
Corporate accounting, cost accounting, and tax management.

Foreign Exchange manager

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Relationship to Economics
Economic theories:
Supply and Demand analysis
Profit maximizing Strategies
Fundamental Economic Principle:
Marginal Analysis
Financial decisions should be made and actions
taken only when the added benefits exceed the
added costs.

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Example
Jamie Teng is a financial manager for Nord Department Stores,
a large chain of upscale department stores operating primarily
in the western United States. She is currently trying to decide
whether to replace one of the firms online computers with a
new, more sophisticated one that would both speed processing
and handle a larger volume of transactions. The new computer
would require a cash outlay of $80,000, and the old computer
could be sold to net $28,000. The total benefits from the new
computer (measured in todays dollars) would be $100,000.
The benefits over a similar time period from the old computer
(measured in todays dollars) would be $35,000.

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Example
Benefit with new
computer
Less: Benefit with
old computer
Marginal benefit
Cost of new
computer
Less: Proceed from
sale of old computer

1,00,000
35,000
65,000
80,000
28,000

Marginal Added cost

52,000

Net Benefit

13,000
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Relationship to Accounting
Cash Flows
Accrual Basis: recognizes sales revenue and
expenses incurred to make sale at time of sale.
Cash Basis: recognizes revenues and expenses
as they occur.

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Accounting vs. Financial Views

Accounting View
(Accrual Basis)
Income Statement
Peakes Quay, Inc.
For year ended 12/31
Sales revenue
Less: Costs
Net Profit

$100,000
80,000
$ 20,000

Financial View
(Cash Basis)
Cash Flow Statement
Peakes Quay, Inc.
For year ended 12/31
Cash inflow
$
0
Less: Cash outflow 80,000
Net cash flow
($80,000)

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Financial ManagerKey Activities

Financial Analysis & Planning
Balance Sheet
Making
Investment
Decisions

Current
Current
Assets
Liabilities
Making
_______________ _______________ Financing
Fixed
Long-Term Funds Decisions
Assets
(Debt & Equity)

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Goal of the Firm: Should Firms

Maximize Profit?
Corporations commonly define profit as Earnings
per Share (EPS).
A measure of total available earnings for shareholder
by total number of ownership shares.

Profit Maximization goal fails for 3 critical factors

the timing of the returns.
Future cash flows , ex- may have higher earnings by
reducing R&D expenditure
risk factors facing the firm.

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Or Should Firms Maximize

Shareholder Wealth?
Evaluating Shareholder Wealth addresses
factors of timing, cash flows and risk
ignored by the EPS.
Therefore, Maximizing Shareholder Wealth
is a more comprehensive goal for the firm,
its managers and employees.
This can be explored through economic
valued added and a focus on stakeholders.
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Two important issues related

to maximize share price
1. EVA
2. Focus on stakeholder

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1. Economic Value Added EVA

EVA measures whether an investment
contributes to shareholder wealth.
EVA is calculated by subtracting cost of
funds used from after-tax operating profits.
While popular, EVA is essentially derived
from the concept of net present value.

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2. What about Stakeholders?

Stakeholders include groups that have direct
economic links to the firm.
Wealth maximization cant be possible as long
as other stakeholder has got conflict.
Maintaining positive stakeholder relationships
helps maximize long-term benefits to
shareholders and the goal is not to maximize it
rather preserve it.
Example: CSR
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Importance of Ethics
The standards of conduct or moral judgment:
Honesty, trustworthiness, fair dealing are
foundations of sustainable business relations:

With customers,
With suppliers,
With creditors,
With employees,
With owners.

Ethical behaviour is necessary to achieve the goal

of maximizing shareholder wealth.
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Internal Ethical Review

Are rights of stakeholders being violated?
Does firm have extra duties to stakeholders?
Will a decision unfairly discriminate benefits
among stakeholders?
If stakeholders are harmed, should this be
remedied? How?
What is the relationship between shareholders
and stakeholders?
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Financial Goals of a Company

Maximize sales.
Maximize cash flow.
Maximize market
share.
Maximize profit.
Minimize costs.

Maximize return on
sales, investment,
equity.
Ensure earnings
stability.
Achieve target goals
for sales, profits,
market share or return.

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Agency Issues:
The Principal-Agent Problem
Whenever ownership is independent of
management there exists potential problem of
conflicts.
The owners goals for the firm are best described
as maximizing shareholder wealth.
Managers are also concerned with personal
wealth, job security, lifestyle, and benefits. These
concerns may conflict with shareholder interests.

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Resolving the Agency Problem

Good corporate governance by the Board of
Directors is the heart of any resolution.
Agency Costs the costs of this governance:
Monitoring costs,
Bonding costs,
Structuring compensation costs.

Market forces, such as the potential for hostile

takeover provide some prevention

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Current View on Incentive Plans

Executive compensation packages generally
include incentive plans that grant stock
options, performance-based shares, or cash
bonuses upon meeting or exceeding
corporate goals.
Such packages may also include long-term
benefits that can protect the manager against
poor corporate performance.
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Financial Institutions and

Market
Financial institution: An intermediary that
channels the savings of individuals,
businesses, and governments into loans or
investments.
Key customers of Financial Institutions:
Individuals
Businesses
Government
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Major Financial Institutions

Commercial Banks
NBFIs
Insurance Companies
Pension funds
Mutual Fund
Credit Union & Savings Banks

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Financial Markets
Financial markets are forums in which
suppliers of funds and demanders of funds
can transact business directly.
Two key markets are
Money market
Capital market

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Money market
Transactions in short-term debt instruments, or
marketable securities, take place in the money
market.
marketable securities means Short-term debt
instruments, such as U.S. Treasury bills,
commercial paper, and negotiable certificates of
deposit issued by government, business, and
financial institutions, respectively.

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Capital market
Long-term securitiesbonds and stocks
are traded in the capital market.
In Capital market to raise money, firms can
use either
private placements or
public offerings.

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Capital market

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Some key Concept

Eurocurrency Market
LIBOR
Bond
Preferred stock
SEC
OTC market
Eurobond Market
Foreign Bond and International Equity Market
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Eurocurrency Market
The international equivalent of the domestic
money market is called the Eurocurrency market.
This is a market for short-term bank deposits
denominated in U.S. dollars or other easily
convertible currencies.
Historically, the Eurocurrency market has been
centered in London, but it has evolved into a truly
global market.

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Eurobond Market
The market in which corporations and
governments
typically
issue
bonds
denominated in dollars and sell them to
investors located outside the United States.

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Foreign Bond
Bond that is issued by a foreign corporation
or government and is denominated in the
investors home currency and sold in the
investors home market.

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