Prepared By: Md.

Golam Sharoar
Lecturer; Department of Finance and
Banking.
BSMRSTU- Gopalganj

Chapter 1
INTRODUCTION OF
FIN A N C IA L MA N A GEMEN T
Finance
What is Finance?
- The science and arts of fund/money
management.
- Facts principles and theories that dealing with
raising and using of money by individuals,
governments and businesses.
Areas:
- Individual finance
- Government- Public Finance
- Business- Corporate Finance
 Business/Corporate Finance
• Corporate finance deals with the capital structure of a corporation, including
its funding and the actions that management takes to increase the value of the
company. Corporate finance also includes the tools and analysis utilized to
prioritize and distribute financial resources.

Dividends & return of

Capital Investment Capital Financing
capital
• Decide what projects • Determine how to • Decide how and
or acquisitions to be find capital when to return
invested in. investments. capital to the
• Earn the highest • Optimize the firm’s investors
possible risk capital structure
adjustment return
Importance of Business Finance

• Financial Planning • Protection of fund

• Raising of fund • Profit Planning
• Investment of fund • Retained earnings
• Allocation of fund • Distribution of profit
• Financial control • Understanding capital
market
Principles of Business Finance

• Investment principle • Cost principle

• Financing principle • Capital structure

• Profit maximization • Liquidity and profitability

• Wealth maximization • Flexibility Principle

• Risk return trade-off • Portfolio principle

• Time value of money • Dividend principle

 Agency Theory/Problem
• The agency problem arises in organizations when there is a conflict of interest between principals
(owners/shareholders) and agents (managers/executives).
• Shareholders (principals) want to maximize firm value and long-term wealth.
• Managers (agents), who control day-to-day operations, may pursue personal goals such as higher
compensation, job security, perks, or short-term performance.
• Because managers have more information than shareholders (information asymmetry), they may make
decisions that don’t fully align with shareholder interests.
• Examples of Agency Problems:
• Excessive Perks - A CEO uses company funds for luxury offices, private jets, or personal benefits.
• Empire Building - Managers expand the business unnecessarily to increase their power/status instead of
profitability.
• Short-Termism - Managers manipulate earnings to show short-term profits (to secure bonuses) even if it
harms long-term value.
• Risk Aversion - Managers avoid risky but profitable projects because failure might threaten their jobs.
 Ways to Resolve Agency Problems
1. Incentive Alignment
• Stock options / performance-based pay: Compensating managers with shares or bonuses tied to firm performance
encourages them to act in shareholders’ best interests.
• Example: Apple grants stock options to executives, so when Apple’s share price rises, both shareholders and
managers benefit.
2. Monitoring
• Board of Directors: Independent directors oversee management decisions.
• Auditing: External auditors review financial statements to prevent manipulation.
• Example: Enron’s collapse showed the cost of weak auditing; stricter auditing rules (Sarbanes-Oxley Act, 2002 in the
US) were introduced.
3. Corporate Governance Mechanisms
• Separation of CEO and Chairman roles: Reduces concentration of power.
• Shareholder activism: Large investors (like hedge funds) influence management decisions.
• Example: Elon Musk’s pay package at Tesla was tied to ambitious performance milestones, approved by
shareholders.
 Ways to Resolve Agency Problems

14. Debt Financing (Disciplining Effect of Debt)

• Taking debt obliges managers to generate enough cash to pay interest, preventing wasteful spending.
• Example: Leveraged buyouts (LBOs) by private equity firms reduce free cash flow misuse.
5. Market for Corporate Control
• Poorly managed firms risk takeover by more efficient firms. The threat of takeover disciplines managers.
• Example: Kraft’s takeover of Cadbury- shareholders agreed because they felt Cadbury’s management wasn’t
maximizing value.
Leveraged Buyouts (LBOs):
• A leveraged buyout (LBO) is when a company (often a private equity firm) acquires another company mainly
using borrowed money (debt) instead of its own equity.
• The assets and cash flows of the target company are often used as collateral for the borrowed funds.
• The idea is that the acquired company’s future earnings will repay the debt.
 Agency Cost
• Agency cost is the cost incurred due to conflicts of interest between principals (owners/shareholders) and agents
(managers).
• It represents the loss in firm value or the actual expenses needed to ensure managers act in the best interests of
shareholders.
• 💡 Put simply:
Because managers don’t always act like owners, shareholders must spend money to monitor, control, and align
them → that’s agency cost.
Types of Agency Costs
• Monitoring Costs
• Expenses shareholders bear to monitor managers.
• Examples: hiring external auditors, establishing an independent board, performance reviews.

• Bonding Costs
• Costs borne by managers to assure shareholders they are acting properly.
• Examples: performance-based contracts, managers holding company shares as a guarantee.

• Residual Loss
• The unavoidable loss of value because even after monitoring and bonding, managers may not perfectly align with shareholders.
• Example: A CEO still avoids risky but profitable projects due to personal job security concerns.
Agency Cost =Monitoring Costs + Bonding Costs + Residual Loss
Functions of Finance
• The finance function refers to practices and
activities directed to manage business
finances.
The Finance Function Involves-
• Ensure enough funds at a reasonable cost.
• Ensure the safety of funds.
• Ensure efficient effective and profitable
utilization of funds.
• Ensure that finance funds don’t remain idle.
6 Major Functions of Finance:
6 Major Functions of Finance:
- Determining asset management policies.
- Determining the allocation of net profits.
- Estimating cash flow requirements and control of such flows.
- Taking decision on needs and sources of new external finance.
- Carrying on negotiations with outside financiers.
- Checking upon financial performance
Financial Decisions •Investment
Decision
• These four major decisions are being driven through the
CFO and financial managers of a firm.
• They ensure that the liquidity position of the company is
satisfactory and that the company remains in a sound
financial position. Major
Financing Liquidity
• These managers are professionals and specialize in making Decision Decisions of Decision

and executing financial plans and decisions for the Finance

company.
• Key Financial Decisions:
4 key financial decisions are-
Dividend
• Investment Decisions Decision

• Financing Decisions
• Dividend Decisions
• Liquidity decisions

Please Read:
Financial Decisions
 4 major decisions of Finance
• Investment decision concerns with capital budgeting in an organization that involves the analysis of investment opportunities.
• Analyze investment alternative by PBP, NPV, IRR, PI and take investment decisions.
•Investment • Selecting the projects with minimum risk at a given level of return and vice versa.
Decision

• From where the capital will be collected at a minimum cost of capital.

• It’s a mix of debt and equity that provides and optimal capital structure.
Financing • The financing decisions always focus on maintaining good capital structure ratios.
Decision

• How much profit will be distributed among shareholders and how much will be reinvested as retained earnings?
• A company’s dividend policy influences the company’s market value and stock prices.
Dividend
Decision

• Liquidity decision generally revolves around working capital decisions and management.
• the priority is managing current assets to follow the going concern concept.
Liquidity • The lack of liquidity results in issues like financial crisis and insolvencies.
Decision
Goal of a Firm
4 main financial objective of a firm-
1. Profit Maximization Objective:
- The profit of the firm became the income of the
owner. Maximization of profit then ensured the
self-interests of the owner/manager, who both
decide the actions of the firm and ensure that
these are carried out.
- Simply a single-period or a short-term goal to
be achieved within one-year Management
mainly focus on efficient utilization of capital
resources to maximize profits WITHOUT
considering the consequences of its actions
towards the company’s future performance.
Profit Maximization Objective
The profit maximization objective of a firm is criticized for the following reasons-
- The concept of profit maximization is vague and narrow.
- It ignores the risk factor, as well as timing of returns.
- It may allow decisions to be taken at the cost of long-run stability and profitability of the concern.
- It emphasizes the short-run profitability and short-term projects.
- It may cause to decrease in share price.
- The profit is only one of the many objectives of a modern firm in which the different stakeholders
participate in firm’s success like shareholders, debenture holders, financial institutions, banks,
managers, employees, Government, creditors, suppliers, customers etc.
- It fails to consider the social responsibility of business, maximization of firm’s profit at the cost of
society is very much short-sighted view.
Wealth Maximization Objective
2. Wealth Maximization Objective:
- Wealth maximization means maximizing the net present value (or wealth) of a
course of action.
- The net present value of a course of action is the difference between the present
value of its benefits and present value of its costs.
- A financial action which has a positive net present value creates wealth and,
therefore, is desirable.
The wealth maximization goal is advocated on the following grounds:
- It takes into consideration long-run survival and growth of the firm.
- It is consistent with the object of owner's economic welfare.
- It suggests the regular and consistent dividend payments to the shareholders.
 Wealth Maximization Objective
• The financial decisions are taken with a view to improve the capital appreciation of the share
price.
• It considers the risk and time value of money.
• It considers all future cash-flows, dividends and earnings per share.
• Maximization of firm’s value is reflected in the market price of share, since it depends on
shareholders’ expectations as regards profitability, long-run prospects, timing differences of
returns, risk, distribution of returns etc. of the firm.
• Profit maximization partly enables the firm in wealth maximization.
• The shareholders always prefer wealth maximization rather than maximization of inflow of
profits.
 Value Maximization Objective
3. In company form of business, the wealth created is reflected in the market value of its shares. Therefore, the
financial decisions will cause to create wealth and it is indicated or reflected in market price of company’s
shares. Hence the prime objective of financial management is to maximize the value of the firm.
4. Other Maximization Objectives:
i) Sales Maximization objective
ii) Growth Maximization Objectives
iii) Maximization of ROI
iv) Social Objective
v) Group of Objectives
- Production goal
- Sales Goal
- Market Share Goal
- Inventory Goal
- Profit Goal
 Ultimate Goal of A Firm
• Wealth Maximization:
Why Wealth Maximization!!
Profit Maximization vs Wealth Maximization:

Profit maximization is a Profit maximization ignores Profit maximization avoids

short-term object, whereas the risk; on the other hand, uncertainty; conversely,
wealth maximization is a wealth maximization wealth maximization does
long-term objective. concern the risk. not prevent the possibility.

Profit maximization
Profit maximization avoids concentrates on the profit of
the time value of money; on the association; on the other
the flip side, wealth hand, wealth maximization
maximization cares about concentrates on the
the time value of money. increasing value of
stakeholders.
Organization of the finance function:
• The ultimate responsibility of carrying out the finance
function lies with the top management. However,
organization of finance function differs from company to
company depending on their respective requirements. In
many organizations one can note different layers among the
finance executives such as Assistant Manager (Finance),
Deputy Manager (Finance) and General Manager
(Finance). The designations given to the executives are
different. They are
• Chief Finance Officer (CFO)
• Vice-President (Finance)
• Financial Controller
• General Manager (Finance)
• Finance Officers
The End

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