Financial Management: An Overview

Introduction to Financial Management

• Finance involves managing money, banking, investments, and credit
• It includes raising funds, allocating resources, and managing risks for economic objectives

Areas of Finance

• Public finance deals with government revenue and expenditure.
• Corporate finance focuses on how companies manage their finances to maximize value.
• Personal finance is how individuals manage their money, including budgeting, saving, and investing.
• International finance involves the financial interactions between countries like exchange rates and foreign investment.
• Entrepreneurial finance relates to funding and financial management of new businesses.

Forms of Business Organizations

• Sole proprietorships are businesses owned and run by one person.
• Partnerships involve two or more individuals who agree to share in the profits or losses of a business.
• Corporations are legal entities separate from their owners, offering limited liability and separated ownership/control.

Corporate Finance

• Corporate finance addresses long-term investments, financing for those investments, and short-term financial management.
• It encompasses financial decisions corporations make, using tools/analysis to guide these decisions.
• Corporate finance aims to maximize firm value through investment, financing, and dividend policy decisions.

Financial Management Decisions

• Making decisions about long-term investments, which assets the firm should invest in
• Making decisions about long-term financing, how the firm should finance its investments
• This related to decisions involving managing working capital
• Dividend payout decisions

Financial Management Examples

• NXT PLC issued 20,000 new shares at Rs.100 each.
• BPL PLC is introducing a new computer system.
• EXO maintains an inventory level of Rs.200,000.
• Sunshine declared Rs.0.50 per share dividends.
• CMB PLC is expanding into a new market.

Balance Sheet Model

• The left side of the model showcases the investment decisions comprising of current and total fixed assets
• The right side shows the financing decision and compromises of current liabilities, short term liabilities, and shareholders equity

Role of the Finance Manager

• Cash is raised from investors through financial markets
• Cash is then invested into the firms operations
• Cash is generated from operations to then be reinvested or returned to investors

Goal of a Corporation

• Profit maximization lacks a clear definition, ignores risks, cash flow, timing and relies on assumptions
• Shareholder Wealth Maximization (SWM) aims to increase the market price per share (MPS).
• The firms Market Price per Share, or MPS, can be increased by maximizing the Net Present Value (NPV) of a course of action

Shareholders’ Wealth Maximization example

• Purchasing 10,000 shares of NDB Bank PLC at Rs. 80 each
• The net asset value of each share is Rs. 50
• The current market price is Rs. 126.75 each
• Wealth is Rs. 126.75*10,000 shares
• Wealth increase can then be determined

Shareholders’ Wealth Maximization

• Focus on share market price.
• Objective and impersonal.
• Timing, size, and risk are all important factors.
• Dividend payments and growth oriented plans is encouraged

Counter Arguments to Shareholders’ Wealth Maximization

• Shareholder's wealth assumes an efficient capital market.
• Focuses primarily on shareholders, not stakeholders.

Separation of Ownership and Management:

• Stockholders elect a board of directors.
• Board of directors hire management/officers.

Management of a Corporation:

• Shareholders own the business, but control is usually given to the managers and directors by the shareholders
• Directors deals with broad policy.
• Managers are hired to make most of the decisions.

Agency Problem

• Managers are agents of the shareholders and act as principals
• Managers may make decisions that conflict with the interests of shareholders.
• Due to the separation of ownership from control; this allows share ownership to change freely, although this results in agency costs

Enron Scandal

• Enron executives inflated performance via fraudulent accounting, which increased stock prices and compensated executives short-term
• The company collapsed when the truth surfaced in 2001, wiping out $74 billion in shareholder value, where both employees and shareholders lost investments

Sources of Agency Problems

• Own utility and welfare
• Long run survival
• Asymmetry of information

Costs of Agency Problems

• Restructuring
• Monitoring
• Bonding
• Lost opportunities

Shareholders vs. Bondholders

• Bondholders/lenders provide loan capital.
• Shareholders should ensure correct utilization of loans without reduction in bondholders' wealth.
• Bondholders' wealth is influenced by bond values and holdings.
• An agency problem arises when shareholders reduce bond market value, negatively impacting bondholder wealth.

Toys "R" Us example

• Toys "R" Us went through a leveraged buyout in 2005 financed by debt
• The company struggled to make payments and filed for bankruptcy in 2018
• Bondholders faced larger losses while shareholders already extracted value via dividends before collapse.