DPB5043 – CHAPTER 1

FINANCIAL
MANAGEMENT

DPB5043 - BUSINESS FINANCE

 TOPIC AND LEARNING
OUTCOMES
1.0 FINANCIAL MANAGEMENT
1.1 Explain the nature and purposes of financial
management
1.1.1 Describe the financial management roles and
growth
1.1.2 Explain the different company’s objective in
a. maximizing profit
b. maximizing shareholder’s wealth

DPB5043 - BUSINESS FINANCE

 • 1.2 Explain the basics of financial management
• 1.2.1 Define principles that form the basics:
a. the risk return trade off
b. the time value of money
c. cash not profits is the king
d. incremental cash flows
e. the curse of competitive markets
f. efficient capital markets
g. the agency problems
h. taxes bias business decisions
i. all risk is not equal
j. ethical behavior means doing the right thing
DPB5043 - BUSINESS FINANCE
 • 1.3 Describe the financial manager
responsibilities in organization
• 1.3.1 Identify the duties of a financial manager in
a. financial analysis and planning
b. investment decisions
c. financing decisions
d. monitoring and controlling
e. involvement in financial market

DPB5043 - BUSINESS FINANCE

 DEFINITION

The art and science of managing

money

The application of the principles of

financial economics to an inter-related
set of monetary problems.

The process by which money is transferred

among businesses, individuals and
governments via the financing and investing
activities of these parties.
 IMPORTANCE OF FINANCE
• Knowledge of finance aids in planning, problem
solving and decision making.
• Finance allows for better communications
among departments.
• Example of financial activities include
borrowing of funds, buying a house, building
additional stores, expansion of product lines,
closing product lines, restructuring businesses,
issuing share or debentures, etc.
 AREAS OF DECISION
FUNCTIONS
• It begin with the firm determining the total
Investment amount of assets needed to be held by the firm
Decision • Two types of investment decisions

• After deciding on what assets to purchase or

what securities to invest in, he would have to
Financing decide on how to finance these assets.
Decision • There are 2 sources of finance open to firms ,
one is borrowings and the other is capital

Assets • Once the assets have been acquired and

Management appropriate financing provided, these assets
Decision must be managed efficiently.
 GOAL OF THE
FIRM

Profit Wealth
Maximization Maximization
 GOAL OF THE FIRM
1) Profit Maximization
• It is a single-period or short term goal to be achieved
within one year.
• Stresses the efficient use of capital resources
• In order to maximize profits, the financial manager
might only implement actions that would result in
maximum profits without considering the impact of
his actions on the company’s future performance.
• Two major factors not considered by the goal of
profit maximization : uncertainty & timing.

DPB5043 - BUSINESS FINANCE

 • DRAWBACKS OF PROFIT MAXIMIZATION
• The drawbacks of profit maximization are as
follow:
i. Profit maximization is a short term concept
ii. Profit maximization does not consider the
timing of returns
iii. Profit maximization ignores risk

DPB5043 - BUSINESS FINANCE

 2) Maximization of Shareholder Wealth
 Maximizing the total market value
 The wealth of corporate owners is measured by the share
price of the stock, which in turn is based on the timing of
returns, the amount of return and the risk or
uncertainty of the returns.
 It also means maximizing the total market value of the
existing shareholders' common stock. All financial
decisions will affect the achievement of this goal.
Shareholders' wealth maximization can be achieved by
considering the present and potential future earnings
per share, timing of returns, dividend policy and other
factors that affect the market price of the company's
stock.
DPB5043 - BUSINESS FINANCE
 THE BASIC FINANCIAL
MANAGEMENT

DPB5043 - BUSINESS FINANCE

 1. THE RISK-RETURN TRADE OFF
We won’t take on additional risk
The more risks an investment has, the
unless we expect to be compensated
higher will be its expected return
with additional return

2. THE TIME VALUE OF MONEY

The time value of money is referred to
A dollar received today is worth more
as the opportunity cost of passing up
than a dollar received a year from
the earning potential of a dollar
now.
today
3. CASH NOT PROFITS IS THE KING
It is the cash flows that are actually
received by the firm and can be
reinvested, not profits
4. CASH FLOWS
The difference between the cash flows if
the project is taken on versus what they
will be if the project is not taken on.
Accounting profits, however appear when they
are earned rather than when the money is
actually in the hand. As a result, a firm’s cash
flow and accounting profit may not be the same.
Eg – capital expenses - depreciation
The difference reflects the true impact
of the decision
 5. THE CURSE OF COMPETITIVE
MARKETS
It is hard to find projects and investments
that are exceptionally profitable. In
reality, it is much easier evaluating
profitable projects than finding them.
6. EFFICIENT CAPITAL MARKETS
A market in which the values of all assets
and securities at any instant in time fully
reflect all available public information.
The key to locating profitable investments
projects is first to understand how and where
they exist in competitive markets. The two most
common ways of making markets less
competitive are to differentiate the product in
some key way and to achieve a cost advantage
over one’s competitors.
The implications of efficient capital
markets are the price is right and the
company will make good decisions,
leading to the increase in the company’s
stock prices.
 7. THE AGENCY PROBLEMS
Problem resulting from conflicts of
Managers may make decisions that
interest between the manager ( the
are not in line with a goal of
shareholder’s agent) and the
maximization of share holder wealth
shareholders.

8. TAXES BIAS BUSINESS DECISIONS

When the company is analyzing the
possible acquisition of a plant or Must consider after-tax incremental
equipment, the return from investment cash flows
should be measured on an after tax basis.
 9. ALL RISK IS NOT EQUAL
Some risk can be diversified away
and some cannot.
10. ETHICAL BEHAVIOUR
Doing the right thing. Each person has
his or her own set of values, which forms
the basis for personal judgments about
what is the right thing.
The process of diversification can
reduce risks and as a result measuring
a project’s or an asset’s risk is very
difficult.
Unethical behavior eliminates trust.
Without trust, companies can’t
interact
 FINANCIAL MANAGER
RESPONSIBILITIES / DUTIES
IN ORGANIZATION

DPB5043 - BUSINESS FINANCE

 Financial
Analysis &
Planning

Dealing
with Investment
Financial decisions
Market
FINANCIAL
MANAGER
RESPONSIBILITIES

Monitoring
Financing
and
decisions
controlling
A. Financial Analysis & Planning
 Financial managers must be able to forecast
the company’s future performance.
 Forecasting is made based on the company’s
past and present performance as well as other
factors such as economic performance,
customer preference and the future demand for
their products.
 B. Investment decisions
 It begins with the firm determining the optimum
growth rates of sales, and also determines the mix and
types of assets to be acquired.
 There are TWO (2) types of investment decision:
1. Capital investment decision
 The type of decision involve large sums of money. It is
usually non-routine. The effect of this decision on the
firm is normally critical. Example: whether to acquire a
new machine or to set up a new plant.
2. Working capital investment decision
 This is amore routine or scheduled form of decision. It
usually take place on a daily basis. The effect of this
decision is as critical as the capital investment decision.
DPB5043 - BUSINESS FINANCE
 C. Financing decisions
 Determine the best method of financing those assets,
whether to use debt or to use equity. If a firm decides to
use debt, the it has to choose between long-term or
short-term debt.
 Most of the time, a firm will finance an investment
partly using debt and partly using equity. Therefore it
is very important for financial manager to determine
the financing mix, that is the proportion of debt to
equity.
 The dividend policy of the company is important
because it will affect the financing decision of the
company. This is because when the company pays
dividends, it will reduce the cash flow of the company.
DPB5043 - BUSINESS FINANCE
D. Monitoring and controlling
 Financial managers have to interact with other
departments within the organization. All
managers should be aware that all business
decisions have financial implications. This is
necessary because the decision of other
departments might affect investment decisions.
E. Dealing with Financial Market
 The financial managers has to obtain financing
either through the money market or capital
market.
 Have to foster the relationships with creditors,
stockholders, investors and governmental
regulatory bodies.