Chapter 1 Introduction to Financial Management PDF

Chapter 1 Introduction to Financial Management 1 What is financial management? Finance is art and science of management of money and other assets. A process involved in an attempt to obtain and allocate financial resources effective and efficiently to ac...

Chapter 1 Introduction to Financial Management 1 What is financial management? Finance is art and science of management of money and other assets. A process involved in an attempt to obtain and allocate financial resources effective and efficiently to achieve the firm’s goal. The firm goal is ‘to maximize the shareholders wealth by maximizing the share price.’ 2 3 Objective and goal of the firm Maximize sales Minimize costs Maximize profits Maintaining steady earning growth Survival Avoid financial distress and bankruptcy Beat the competition ‘to maximize the shareholders wealth by maximizing the share price.’ 4 Why wealth maximization is more appropriate goal than profit maximization? a) Timing of return : wealth maximization takes account the timing of returns and time value of money. However, profit maximization ignores this. b) Time horizon : profit maximization tend to be a short term approach. c) Distribution of return : the profit max. ignore the owners wish to receive a portion of earning in term of received dividend. d) Risk orientation : Profit max. tend to give less consideration to risk in an attempt to 5 The financial management functions Planning The process involves the development and evaluation of the firms goals and strategies to ensure the achievement of the stated objectives. Controlling Involved the activities of the analysis of causes and responsibilities. Investment decisions The investment decision in the asset structure. Financing decisions The determination of the financial structure. 6 Financial Management Decisions  Capital budgeting What long-term investments or projects should the business take on? Capital structure How much should the firm borrow to pay for its assets?  What is the best mixture of debt and equity?  The least expensive sources of funds? Working capital management How do we manage the day-to-day finances of the firm? 1-7 8 Financial market To help allocate financial resources within the economy Those has surplus invest, need borrow Financial institution = financial intermediaries Why? reduce cost of transferring funds reduce risk faced by investors increase the liquidity of the borrowers 9  The Investment Process Individuals Business Some need for loans Investments in production of (house, auto) goods and services Typically net suppliers of Typically net demanders of funds funds Government Federal, state and local projects & operations Typically net demanders of funds Financial market Consists of Money Market and Capital market. 1. Money market 1. Provides trading facilities for individuals or institutions with temporary surpluses and shortages. 2. It deals with the marketable securities or money market instruments. 3. Mature one year or less. 4. Low default risk, short maturities, high liquidity, and high marketability. 11 2. Capital market Consist of EQUITY market and DEBT market it is a long term securities. Example: bonds, common stocks, preferred stocks. 12 Financial market Divided into 2 market: Primary market  Deals with newly issued securities that involve issuer and investors. Secondary market deals with the securities previously issued. 13 Forms of Business Organization Three major forms Sole Proprietorship Partnership  General  Limited Corporation  Limited Liability Company  Limited Liability Partnerships 1-14 Corporation Advantages Disadvantages Limited liability Separation of Unlimited life ownership and Separation of management ownership and May involve management double taxation in Transfer of some countries ownership is easy (income taxed at Easier to raise the corporate rate and then capital dividends taxed at the personal rate) 1-15 Task Agency problem and control of the corporation?? 16