CHAPTER ONE
AN OVERVIEW OF
FINANCIAL MANAGEMENT
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Introduction
What is Finance?
management of money.
science of money management
it includes activities such as
investing, borrowing, lending, budgeting, saving,
forecasting, risk management
Classification of finance
Finance is broadly classified into two categories based on their
objectives:-
Private and Public Finance
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Private Finance
objective of private finance is to earn maximum
return or profit.
Private Finance:- Further divided into
a. Personal finance:- individuals and households use to
meet their different needs
b. Business finance:- management and utilization of fund
by the private business organizations as well as public
enterprises even if it is under public finance
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Public Finance
Public finance is the financial aspect of the
government.
It is about the government expenditure, public
revenue, public borrowing and financial
administration.
Sources of Finance
Both private and public businesses need capital to
operate and achieve their objectives.
So where does their money come from?
Internal sources of finance and
External sources of Finance
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What is Financial Management?
Financial Management is a management of
scarce resources of organizations.
It focuses on sourcing and managing the
assets of the organizations to achieve its
goal.
Therefore, Financial management is the
process of planning, organizing, monitoring
and controlling of all transactions in a
business to maximize the wealth of the
company.
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Basic Activities of Financial Management
The three broad activities of financial
management are
Capital budgeting
Investment decisions
Capital structure
the best mix of debt, equity and hybrid securities.
working capital management
short-term financing decisions
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The goal of Financial management
What is the goal of Financial Management?
Profit or wealth maximizations
Profit Maximization
Short term goal
Wealth Maximization
Long term goal
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Agency Relationship
The relationship between stockholders and management is called
an agency relationship. Such a relationship exists whenever
someone (the principal) employ another (the agent) to represent
his/her interests.
In this relationship the principal delegates or hires an agent
to perform work.
For example, you might delegate someone (an agent) to sell a
car that you own while you are away at school. And you agree
to pay a commission fee when the agent sells the car. In such
relationships there is a possibility of a conflict of interest
between the principal and the agent.
Take the following two cases
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Take these two alternative agreement
1. A flat commission fee, let say Birr 5,000
The agent's incentive in this case is to make the sale, not
necessarily to get you the best price
2. A 10% of the sales price
If you offer a commission of, say, 10 percent of the sales price instead
of a flat fee, then the above problem might not exist.
This example illustrates that the way in which an agent is
compensated is one factor that affects agency problems
In all such relationships, there is a possibility of a conflict of
interest between the principal and the agent. Such a conflict is
called an agency problem.
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END
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