Finance

Financial management focuses on ratios, equity and debt. Financial

managers are the people who will do research and based on the
research, decide what sort of capital to obtain in order to fund the
company's assets as well as maximizing the value of the firm for all
the stakeholders.

Financial Management is a vital activity in any organization. It is the

process of planning, organizing, controlling and monitoring financial
resources with a view to achieve organizational goals and objectives.
 Finance
Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and utilization
of funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.
 Finance
Take a look at the objectives involved:

Maintaining enough supply of funds for the organisation; Ensuring

shareholders of the organisation to get good returns on their
investment; Optimum and efficient utilization of funds;

Creating real and safe investment opportunities to invest in.

 Corporation
A corporation is an entity separate and distinct from its owners. A
corporation is an artificial being created by law and its continued
existence depends upon the statutes of the state in which it is
incorporated. It must abide by law and pay taxes.

A Corporation may be classified as two common bases :

Purpose: Making Profit; ex - PepsiCo, Ford Motor Company,
Grameen Phone Ltd., Square Pharmaceuticals Ltd.
Nonprofit; Nonprofit corporations are organized for
charitable, medical, or educational purposes, ex - Cancer
society, Heart Foundation
 Corporation………..
Ownership: Classification by ownership -

Publicly held corporation: A publicly held corporation may have

thousands of stock holders and its stock is regularly traded in stock
exchange. Most of the largest corporations are publicly held. Ex -
Intel, IBM.

Privately held corporation: Often referred to as closely held

corporation much smaller than publicly held corporation, usually has
only a few stockholders, and does not offer its stock for sale to the
general public. Ex - Cargill Inc. that trades in grain and other
commodities
 Corporation………..
Characteristics of a Corporation

1.Separate Legal Existence

As an entity separate and distinct from its owners, the corporation

acts under its own name rather than in the name of its stockholders.
Ford Motor Company may buy, borrow, and sell property, and may
Enter into legally bindings contracts in its own name.
If you owned shares of Grameen Phone stock, you would not have
The right to purchase bandwidths for the company unless you were

Appointed as an agent of the corporation.

 Corporation………..
Characteristics of a Corporation

2. Limited Liabilities of Stockholders

The liability of stockholders is normally limited to their investment

in the corporation. Creditors make claim only to corporate assets to
satisfy their claims. But, creditors have no legal claim on the personal
assets of the owners.

3. Transferable Ownership Rights

The transfer of stock is entirely at the discretion of the stockholder. It
does not require the approval of either the corporation or other
stockholders. Because the transfer of ownership rights has neither
 Corporation………..
Effect on the operating activities of the corporation nor it affects the
corporation’s assets, liabilities, and equity.

4. Ability to Acquire Money

Buying stock in a corporation is often attractive to an investor
because a stockholder has limited liability and shares of stock are
readily transferable.

5. Additional Taxes
Double Taxation – once at corporate level and again at the individual
level.
 Corporation………..
6. Government Regulations

A corporation is subject to numerous rules and regulations prescribed

by state law.

Securities and Exchange Commission –

Issuing stock, distributions of earnings permitted to
stockholders, disclosure of intensive financial reports (Publicly held)
to SEC, qualify reporting requirements.

Government regulations are designed to protect owners of the

corporation. Such protection is needed because most stockholders do
not participate in the day to day management of the company.
 Corporation………..
7. Corporation Management

Stockholders legally own the corporation. But they manage the

corporation indirectly through a board of directors they elect. The
board, in turn, formulates the operating policies of the company.

The stockholders (owners) vote periodically to elect members of the

board of directors and to decide other issues such as amending the
corporate charter. The board of directors is typically responsible

for approving strategic goals and plans, setting general policy,

guiding corporate affairs, and approving major expenditures, and
hiring or firing, compensating, and monitoring key officers and
 Corporation………..
Executives. The board consists of “inside” directors, such as key
corporate executives, and “outside” or “independent” directors, such
as executives from other companies, major shareholders, and national
or community leaders.

The board also selects presidents and one or more vice presidents, to
execute policy and to perform daily management functions.

The CEO/President has overall responsibility for managing the

business, day to day operations and carrying out the policies
established by the board of directors . CEO delegates responsibility
to other officers and reports periodically to the firm’s director’s.
 Corporation………..
The chief accounting officer is the controller whose responsibilities
include (i) maintaining the accounting records (ii) maintaining the

System of internal control, and (iii) preparing financial statements,

tax, and internal reports.

The treasurer has custody of the corporation’s funds and is

responsible for maintaining the company’s cash position.

The separation of ownership and management prevents owners from

having an active role in managing the company, which some owners
like to have.
Corporation………..
 Managerial Finance
Managerial finance is concerned with the duties of the financial
manager working in a business. Financial managers administer the
financial affairs of all types of businesses—private and public, large
and small, profit seeking and not for profit. They perform such varied
tasks as developing a financial plan or budget, extending credit to
customers, evaluating proposed large expenditures, and raising
money to fund the firm’s operations.

Today’s financial managers actively involved in developing

strategies aimed at Growing the firms and improving its competitive
position. Hence, Top executives have come from finance area.
 The Managerial Function
when considering a new product, the financial manager needs to
obtain sales forecasts, pricing guidelines, and advertising and
promotion budget estimates from marketing personnel. The
managerial finance function can be broadly described by considering
its role within the organization, its relationship to economics and
accounting, and the primary activities of the financial manager.

Organization of the Finance Function

The size and importance of the managerial finance function depend
on the size of the firm. In small firms, the finance function is
generally performed by the accounting department.
 The Managerial Function………..
As a firm grows, the finance function typically evolves into a
separate department linked directly to the company president or CEO

through the chief financial officer (CFO).

Reporting to the CFO are the treasurer and the controller. The
treasurer (the chief financial manager) typically manages the firm’s
cash, investing surplus funds when available and securing outside
financing when needed. The treasurer also oversees a firm’s pension
plans and manages critical risks related to movements in foreign
currency values, interest rates, and commodity prices.
 The Managerial Function………..
The controller (the chief accountant) typically handles the accounting
activities, such as corporate accounting, tax management, financial
accounting, and cost accounting. The treasurer’s focus tends to be
more external, whereas the controller’s focus is more internal.

If international sales or purchases are important to a firm, it may well

employ one or more finance professionals whose job is to monitor
and manage the firm’s exposure to loss from currency fluctuations. A
trained financial manager can “hedge,” or protect against such a loss,
at a reasonable cost by using a variety of financial instruments. These
foreign exchange managers typically report to the firm’s treasurer.
 The Managerial Function………..
RELATIONSHIP TO ECONOMICS

The field of finance is closely related to economics. Financial

managers must understand the economic framework and be alert to
the consequences of varying levels of economic activity and changes
in economic policy. Examples include supply-and-demand analysis,
profit-maximizing strategies, and price theory. The primary
economic principle used in managerial finance is marginal
cost–benefit analysis, the principle that financial decisions should be

made and actions taken only when the added benefits exceed the
added costs.
 The Managerial Function………..

Dollars ) would be $3000. Applying marginal cost–benefit analysis, Jamie organizes

the data as follows:
 The Managerial Function………..
RELATIONSHIP TO ACCOUNTING (Emphasis on Cash Flows)

Nassau Corporation, a small yacht dealer, sold one yacht for $100,000 in the
calendar year just ended. Nassau originally purchased the yacht for $80,000.
Although the firm paid in full for the yacht during the year, at year-end it has yet
to collect the $100,000 from the customer. The accounting view and the financial
view of the firm’s performance during the year are given by the following income
and cash flow statements, respectively.
 The Managerial Function………..
Personal Finance

You have to either borrow $215 (putting it on a credit card is a form of borrowing)
or withdraw $215 from her savings. Or she may decide to
reduce her outflows in areas of discretionary spending—for example, clothing
purchases, dining out, or areas that make up the $425 of miscellaneous expense.
 The Managerial Function………..
Accountants devote most of their attention to the collection and

presentation of financial data. Financial managers evaluate the

accounting statements, develop additional data, and make decisions
on the basis of their assessment of the associated returns and risks.

In addition to ongoing involvement in financial analysis and

planning, the financial manager’s primary activities are making
investment and financing decisions.

Investment decisions determine what types of assets the firm holds.

Financing decisions determine how the firm raises money to pay for
the assets in which it invests.
 Goal of the Firm
MAXIMIZE PROFIT

Some people believe that the firm objective is always to maximize

profit.

Corporations commonly measure profits in terms of earnings per

share (EPS), which represent the amount earned during the period on
behalf of each outstanding share of common stock. EPS are
calculated by dividing the period’s total earnings available for the
firm’s common stockholders by the number of shares of common
stock outstanding.
 Goal of the Firm….
Zaha, the financial manager of Neyman Group, a producer of

Fabric, is choosing between two investments, Denim and Terry

Towel. The following table shows the EPS that each investment is
expected to have over its 3-year life.

In terms of the profit maximization goal, Terry Towel would be

preferred over Denim because it results in higher total earnings per
share over the 3-year period ($3.00 EPS compared with $2.80 EPS).
 Goal of the Firm….
But is profit maximization a reasonable goal? No. It fails for a
number of reasons: it ignores (i) the timing of returns (ii) cash flows
available to stock holder and (iii) risk

Timing
Cash Flows:
Risk
Because profit maximization does not achieve the objective’s of
firm’s owner’s, it should not be the primary goal of financial
manager.
 Goal of the Firm….
The goal of the firm, and therefore of all managers and employees, is
to maximize the wealth of the owners for whom it is being operated.
The wealth of corporate owners is measured by the share price of the
stock, which in turn is based on the timing of returns (cash flow),
their magnitude, and their risk. Financial manager should accept
those actions that are accepted to increase share price.

Maximizing share price will maximize owner’s wealth.

Return (cash flows) and risk are the key decision variables in
maximizing owner wealth.
Goal of the Firm….
 Goal of the Firm…
What about Stakeholders
Stakeholders are groups such as employees, customers, suppliers, creditors,
owners, and others who have a direct economic link to the firm. A firm with a
stakeholder focus consciously avoids actions that would prove detrimental to
stakeholders. The goal is not to maximize stakeholder well-being but to preserve it.

The stakeholder view does not alter the goal of maximizing shareholder
wealth. Such a view is often considered part of the firm’s “social responsibility.”
It is expected to provide long-run benefit to shareholders by maintaining positive
relationships with stakeholders. Such relationships should minimize stakeholder
turnover, conflicts, and litigation. Clearly, the firm can better achieve its goal of
shareholder wealth maximization by fostering cooperation with its other
stakeholders, rather than conflict with them.
 The Agency Problem
We have seen that the goal of financial manager should be to
maximize the wealth of the firm’s owners. Shareholders give
managers decision-making authority over the firm; thus managers
can be viewed as the agents of the firm’s shareholders. Technically,
any manager who owns less than 100 percent of the firm is an agent

acting on behalf of other owners.

The classic principal–agent relationship, where the shareholders are
the principals. In general, a contract is used to specify the terms of a
principal–agent relationship. This arrangement works well when the
agent makes decisions that are in the principal’s best interest but
doesn’t work well when the interests of the principal and agent differ.
 The Agency Problem….
In theory, most financial managers would agree with the goal of
shareholder wealth maximization. In reality, however, managers are
also concerned with their personal wealth, job security, and fringe
benefits. Such concerns may cause managers to make decisions that
are not consistent with shareholder wealth maximization. For
example, financial managers may be reluctant or unwilling to take
more than moderate risk if they perceive that taking too much

risk might jeopardize their job or reduce their personal wealth.

So, agency problems problems that arise when managers place

personal goals ahead of the goals of shareholders.
 The Agency Problem….
Agency costs

Costs arising from agency problems that are borne by shareholders

and represent a loss of shareholder wealth.

Incentive plans
Management compensation plans that tie management compensation
to share price; one example involves the granting of stock options,
cash bonus, performance share.
Financial Institutions and Markets