1
Chapt
The Goals and Functions of
er
Financial Management
Chapter 1 - Outline
Definition of Finance
The Field of Finance
Functions and Activities of Financial Management
Agency problem and Corporate Governance
Forms of Organization
Goal of Financial Management
Financial Market: Its Classification
Share VS Bond
Summary and Conclusions
What is Finance?
Finance, in general terms, is the raising and utilization of
required fund.
Finance is the process of planning, identification, selection,
raising and utilization of fund in order to achieve the
objective of an organization
Finance is efficient raising and allocation of funds in order to
attain certain objective
The science and art of managing money.
FINANCE
Investment Financing
Finance
INVESTMENT: FINANCING:
The investment decision is the most The second major decision of the firm.
important decision for a financial manager.
• concerned with determining the best
• allocation of capital to investment financing mix or capital structure
proposal
• capital structure involves best mix of
• whose benefits are to be realized in the debt and equity
future
• short-term or long-term
• should be evaluated in relation to their
expected return & risk
The Field of Finance: Importance of
Managerial Finance
You must have some understanding of finance
People in
◦ Economics > Micro (Demand & Supply, Pricing) Vs. Macro (GDP,
Inflation, Unemployment Rate, Interest Rate)
◦ Accounting > Supplies information for finance (Income Statement,
Balance Sheet, Cash-Flow Statement)
◦ Management > Personnel decisions, Financial impact of strategic
planning
◦ Marketing > Pricing of product, Promotion of product
ALL OF THEM NEED TO UNDERSTAND FINANCE TO DO THEIR JOB
WELL
Forms of Organization
Business
Law Offices
Sally’s
Grocery
Proprietorship Partnership Corporation
Characteristics of Business
Organizations
Characteristics Sole Proprietorship Partnership Corporation
Number of Owner One Owner Multiple (2 to 10 owners) Number of shareholders
Legal Entity No No Yes (Company Act)
Limited Liability No No Yes (Share Value)
Unlimited Life No No Yes (Going Concern)
Business Tax No No Yes (Double Taxation)
Flexibility of Making Decision Flexible Moderate Hard
**Limited
Limitedpartnerships
partnershipsand andlimited
limitedliability
liabilitypartnerships
partnershipsspecifically
specificallyrestrict
restrict
certain
certainpartners’
partners’liabilities.
liabilities.
Start-up Business:
Corporate Governance and Agency Problem
The system of rules, practices and processes by which a company is directed and
controlled.
- Corporate governance essentially involves balancing the interests of the many stakeholders in a
company - these include its shareholders, management, customers, suppliers, financiers, government
and the community.
Agency problem: Conflict of interest between a company's management and the company's
shareholders (Owners).
Example: car sell, broker
Financial manager in a corporation must act in the best interest of the shareholder..
But sometimes management and shareholder interest might differ and cause
“agency problem”
“Do Managers Act in the Stockholders' Interest?”
[Link]
Goal of Financial Management
Major objectives –
Profit Maximization- earn highest possible return for
the firm
Wealth Maximization- through achieving the highest
possible value from the firm
Social Responsibility and Ethical Behavior- Pollution
control,
indiscrimination in hiring practice, fair pricing standards
Goal of Financial Management
Profit Maximization Vs. Wealth Maximization
Corporate Profits Vs Earning Per Share
Arguments against profit maximization (Disadvantages)
Provides vague concept regarding profit and ignores time value of
money as well as risk.
Wealth maximization provides a clear concept regarding profit i.e.
it considers Net Cash Benefit (NCB), & it considers time value of
money as well as risk.
Certain Goals?
Functions of Finance Manager
Profitability
Daily Occasional
• Stock Issue Goal:
• Credit Management Maximize
• Inventory Control • Bond Issue Trade-off: Risk
• Capital Budgeting & Profitability shareholder
• Receipt and disbursement wealth
of fund • Dividend Decision
Risk
Goal of Financial Management
1. What are the advantages and disadvantages of profit
maximization?
2. What should be the ultimate goal of a finance manager?
Financial Market: are the meeting place for people, corporation and institutions that either need money or have money to lend or
invest.
Money market: Deals with short-term securities that have a life of one year
or less Based on types of
Capital market: Deals with securities have a life of more than one securities/financial
year
instruments
Securities include: Money Market
Capital Market
Less than 1 year
◦ Common stock Debt securities only
More than 1 year
Debt plus equity securities
◦ Preferred stock T-bill, CDs, Commercial
Shares, Bonds
paper
◦ Bond/ Debenture
Primary market >>raised in (New Issue, IPO: Initial Public Offering)
Based on allocation of
Secondary market >> traded in (Existing Securities) capital, issuing &
trading of securities
Ex- Dhaka Stock Exchange (DSE); Chittagong Stock Exchange (CSE)
Share Vs Bond
Definition of Share: a single unit of ownership in a company
Definition of Bond: A bond is a fixed income investment in which an investor loans money to an entity
(corporate or government)
Return from share and bond is called !
Certainty of getting return !
Source of purchase: Stock exchange / Gov or public or private firms
Times of maturity:
Types of ownership: debt / equity
In terms of bankruptcy who will get the preference first to get return?
Voting right
Summary and Conclusions
The financial manager:
controls the daily cash inflows and outflows
resulting from business operations
makes the occasional investment and financing
decisions essential for the future financial success of
the business
may work in a corporation or other form of
business organization
Their overriding goal is to maximize the wealth of
the owners by earning an attractive return in the
business at an acceptable level of risk