Module 1 Intro to Financial Management.pdf

TOPICS: The Role and Environment of Managerial Finance: Finance and Business The Managerial Finance Function and Goal of the Firm Financial Institutions and markets Ten Axioms of Managerial Financial Management Risk and Return Discussion and Time Value of Money ILO: know and understand the basic...

TOPICS: The Role and Environment of Managerial Finance: Finance and Business The Managerial Finance Function and Goal of the Firm Financial Institutions and markets Ten Axioms of Managerial Financial Management Risk and Return Discussion and Time Value of Money ILO: know and understand the basic concepts in financial management WHAT IS FINANCIAL MANAGEMENT? What is Financial Management? Definitions: The efficient and effective planning and controlling of financial resources so as to maximize profitability ensuring of achievement of organization goals The process of putting the available funds to the best advantage from the long-term point of view of business objectives. What is Financial Management? Financial management capacity is a cornerstone of organizational excellence. Financial management pervades the whole organization as management decisions almost always have financial implications. Financial management is an integrated decision making process, concerned with acquiring,managing and financing assets to accomplish overall goals within a business entity. Speaking differently, it is concerned with makingdecisions relating to investments in long termassets, working capital, financing of assets and soon. Financial Management Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow, including the administration and maintenance of financial assets. Some experts refer to financial management as the science of money management. Financial Management Definitions: The efficient and effective planning and controlling of financial resources so as to maximize profitability ensuring of achievement of organization goals The process of putting the available funds to the best advantage from the long-term point of view of business objectives. The Business Organization Shareholders The Board of Directors Elects among themselves Corporation Appoints Top Management (may or may not be shareholders, usually not) Scope/ ElementsofFinancial Management: 1. Financial Decisions 2. Investment Decisions 3. Dividend Decisions InvestmentDecisions: Thisdecisionrelates tothe careful selectionofassetsin whichfundswill be investedby the firm.ItInvolvesbuying, holding,reducing,replacing,selling & managingassets. Commonquestionsinvolving Investmentsinclude: Inwhat linesofbusinessshouldthe firmengage? Should the firmacquire other companies? What sortofproperty,plant,equipment shouldthe firm hold? Should the firmmoderniseorsell anold production facility? Sincethe futureisuncertaintherefore there are difficulties in calculationofexpected return.Therefore while considering investmentproposalit isimportanttotake intoconsideration bothexpected returnandthe riskinvolved. Investmentdecisionnotonly involvesallocating capital to long termassetsbut alsoinvolvesdecisionsofusingfundswhich are obtainedby selling thoseassetswhich become lessprofitable andlessproductive.Itwisedecisionstodecomposedepreciated assetswhich are notaddingvalue andutilize thosefundsin securingotherbeneficial assets. Financing Decisions: Financingdecisionsinvolve the acquisitionof fundsneeded to supportlong-terminvestments. While taking thisdecision,financial managementweighsthe advantages anddisadvantages ofthe differentsourcesoffinance. Thebusinesscaneither finance fromitsshareholderfundswhich canbe subdividedintoequity share capital, preference share capital andthe accumulated profits. Borrowingsfromoutsidersinclude borrowedfundslike debenturesandloansfromfinancial institutions. A soundfinancialstructureissaidtobe onewhichaimsat maximizingshareholders returnwithminimumrisk.Insucha scenariothe marketvalue ofthe firmwill maximizeandhence an optimumcapital structurewouldbe achieved. Other thanequity anddebt there are severalothertoolswhich areusedindeciding a firmcapital structure. Financefunctions/Decisionsare divided into Longtermdecisions Shorttermdecisions ❖ Long-termfinance functionsordecisionshave a longer time horizon,greater thana year ❖ Affect the firm’sperformanceandvalue inthe long run ❖ Relate tothe firm’sstrategy ❖ Involveseniormanagementintaking the final decision InvestmentDecisions: Thisdecisionrelates tothe appropriation ofprofitsearned.The twomajoralternatives are to retainthe profitsearnedorto distributetheseprofitstoshareholders. While declaring dividend,a large numberofconsiderationsare kept inmindsuchas: Trendofearnings Stability individends Thetrendofsharemarketprices Therequirementoffundsforfuturegrowth Thecashflow situation Restrictionsunderthe CompaniesAct Thetax impact onshareholdersetc. A soundfinancialstructureissaidtobe onewhichaimsat maximizingshareholders returnwithminimumrisk.Insucha scenariothe marketvalue ofthe firmwill maximizeandhence an optimumcapital structurewouldbe achieved. Other thanequity anddebt there are severalothertoolswhich areusedindeciding a firmcapital structure. Importantaspects ofInvestmentdecision:- Involve capital expenditures Referred ascapital budgeting decisions Decisionofallocation ofcapital tolong termassetsthat wouldyield benefits (cashflows)inthe future Evaluation oftheprospective profitability ofnewinvestments Measurement ofa cut-off rate against whichthe prospective return onnewInvestmentscould be compared FunctionsofFinancialMangement/ Manager: 1. Estimation of Capital Requirement: Estimationdepends uponexpected costs,profits,future programsandpolicies ofa firm.Estimationmustbe adequate, asit canincrease theearning capacity ofthe firm. A finance managerhastomakeestimationwith regardstocapital requirementsofthe company.Thiswill dependuponexpected costsandprofitsandfutureprogrammesandpolicies ofa concern. Estimationshave tobe madeinanadequate mannerwhich increases earning capacity ofenterprise. 2.Determinationof Capital Composition: Itisbased onlong term-short termdebt equity analysis. Thiswill depend uponthe proportionofequity capital a company isprocessing andadditional fundswhichhave tobe raised fromoutsideparties. Once theestimationhave beenmade, the capital structure have tobe decided.  Thisinvolves short- termand long- termdebt equity analysis. Thiswill depend upon the proportion of equity capital a company is possessing andadditional fundswhichhavetobe raisedfromoutside parties. 3. Choice of sourcesof funds:Choice offundsdepend upontherelative meritsanddemerits ofeach resource.Varioussourcesoffundsare: ▪ Issueofsharesanddebentures ▪ Loansto be taken frombanksandfinancial institutions ▪ Public depositstobe drawn,like intheformofbonds Choice offactorwill depend onrelative meritsanddemerits ofeach sourceandperiod offinancing. 4. Investment of Funds: Financial Manager has to decide to allocate funds into profitable ventures so that there is safety on investment andregular returnsare possible. 5. Disposal of surplus:Itreferstothe decisionsonthe netprofitsmade aboutthe dividend declaration andretainedearnings. Thenet profitsdecisionhave tobe madeby the finance manager. Thiscanbe doneintwoways: a) Dividend declaration - Itincludes identifying the rate ofdividends and otherbenefits like bonus. b) Retained profits- Thevolumehastobe decided whichwill depend uponexpansional, innovational, diversification plansofthe company. 6. Managementof cash:TheFinancialmanager hastomake decisionswith regardstocashmanagement.Itisrequiredformany purposeslike payment ofwagesandsalaries, bills, creditors, maintenanceofstock,rawmaterials, etc. 7.Financial Control: FinancialManager notonly hasto plan,procure andutilizefundsbut he alsohasto exercise controlover finances. Thiscanbe donethroughmanytechniqueslike ratio analysis, financial forecasting,costandprofit control, etc. Financial MANAGER Possible Roles Position Description Cash manager Maintains and controls the firm’s daily cash balances. Frequently manages the firm’s cash collection and disbursement activities and short-term investments and coordinates short-term borrowing and banking relationships. Credit Administers the firm’s credit policy by evaluating credit analyst/manager applications, extending credit, and monitoring and collecting accounts receivable. Financial analyst Prepares the firm’s financial plans and budgets. Other duties include financial forecasting, performing financial comparisons, and working closely with accounting. Financial MANAGER Possible Roles Position Description Capital Evaluates and recommends proposed long-term investments. May expenditures be involved in the financial aspects of implementing approved manager investments. Project finance Arranges financing for approved long-term investments. manager Coordinates consultants, in- vestment bankers, and legal counsel. Pension fund Oversees or manages the assets and liabilities of the employees’ manager pension fund Foreign Manages specific foreign operations and the firm’s exposure to exchange fluctuations in exchange rates. manager Financial Environment Components Financial Institutions Financial Securities Financial Markets Financial Institutions and Markets They provide the platform for businesses to raise capital, invest funds, and manage risks.  Financial Environment Components Financial Institutions An intermediary that channels the savings of individuals, businesses, and governments into loans or investments Commercial banks, investment banks/underwriters, cooperatives, Financial Securities Financial Markets  Financial Environment Components Financial Institutions Financial Securities Negotiable financial instruments Assets or packages of capital that can be traded. In the form of cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one’s ownership in some entity. Bonds (Negotiable promissory notes), Shares and Stocks, Foreign Currency Financial Markets Financial Environment Money markets vs Capital Markets Components Financial Institutions Financial Securities Primary vs Financial Markets Secondary/Tertiary place in which suppliers of markets funds and demanders of funds can transact Spot vs Futures business directly Organized vs Centralized Financial Environment Financial Environment Other terms of note: Private Placement vs Public Offering Private Placement the sale of a new security directly to an investor or group of investors. Public Offering the sale of either bonds or stocks to the general public. Initial Public Offering (IPO) of stocks First issuance by a corporation of its shares to the public Indicator of a corporation being “publicly listed” Financial Environment Examples: Commercial Banks – Over-the-counter market for currency, mutual funds and loans Investment Banks – stock and bonds market, primary market, centralized market Philippine Dealing System Holdings Corp. - Bonds Market – Centralized market – Capital Market – secondary market Philippine Stock Exchange - Stock Market – Centralized market – capital market – secondary market Bond Market in the Philippines: Philippine Dealing System Holdings Corp. STOCK Market in the Philippines: Philippine STOCK EXCHANGE STOCK Market in the Philippines: Philippine STOCK EXCHANGE Objectives of financial management The term ‘objective’ refers to a goal or decision for taking financial decisions. ProfitMaximisation Thetermprofitmaximisationisdeep rooted inthe economictheory. Itisneed that whenfirmspursuethe policy ofmaximising. Society’s resourcesare efficiently utilised. Itmakesallocation ofresourcesto profitable anddesirable areas. Italso ensuresmaximumsocial welfare. Alternative toprofitmaximization whichsolves all thoseproblems Theobjective isconsidered asconsistent with the survival goal andwith the personal objectives ofmanagers suchasrecognition,power,statusand personal wealth SWMmaximizing the net presentvalue ofa courseofactiontoshareholders Net PresentValue (NPV)orwealth ofa courseofactionisthe difference between the presentvalue ofits benefitsandpresentvalue ofitscost A financial action that hasa positive NPVcreates wealth forshareholders and therefore isdesirable MeritsofProfitMaximization ❖ Best Criterionondecisionmaking. ❖ Efficient allocationof resources. ❖ Optimumutilization. DrawbacksofProfitMaximization ❖ Itignorestimevalue ofmoney. ❖ Itisvague conceptually. ❖ Itignoresthe riskfactor. ❖ It may tempt to make such decisions which may in the long runprove disastrous.SItsemphasisisgenerally on Shortrunprojects. ❖ Inthe newbusinessenvironmentProfitmaximizationis regarded asunrealistic,difficult, inappropriateand immoral.  Wealth Maximisation Wealth maximizationisalso knownasvalue ornet present worthmaximization.Itshould satisfy all three requirement, i.e. exactness, quality andmoneyvalue oftime. Thetechnical flaws ofWealth Maximizationare: 1. FocusonStakeholders :Stakeholders include groupsof employees,investors andstakeholders which are directly related tothefirm. 2. EVA (EconomicValueAdded) :EVA isequal to after tax operating benefitsofa firmlessthe costofthe firm MeritsofWealth Maximization ❖ Itfocusesonthe long term. ❖ Ittakesintoaccountthe timevalue ofmoney. ❖ Itconsidersrisk. ❖ Itmaintainsmarketprice ofthe sharesofthe organization. ❖ Itrecognizesthe value ofregulardividend payments.  Conflict ProfitMaximization Wealth Maximization o Itsmainobjective istoearnlarge o Itsmainobjective istoachieve amountofprofits. highest marketvalue ofcommon stock. o Itemphasizesshortterm. o Itemphasizeslong term o Itignorestimevalue ofmoney. o Itconsiderstimevalue ofmoney. o Itignoresriskanduncertainty. o Itrecognizes riskanduncertainty. o Itignorestimingofreturn o Itrecognizes the timingsofreturn. Other Objectives: Toensureregular and adequate supplyoffundstothe concern. Toensureadequate returnstothe shareholders which will dependuponthe earning capacity, marketprice of the share,expectationsofthe shareholders. Toensureoptimumfundsutilization.Once the fundsare procured,they shouldbe utilizedinmaximumpossibleway at least cost. Toensuresafety oninvestment,i.e,fundsshould be invested insafe venturessothat adequate rate of returncan be achieved. Toplan a soundcapital structure-Thereshould be soundand fair compositionof capital sothat a balance is maintainedbetween debt and equity capital. The Role and Environment of Managerial Finance ~~ Managerial finance is the practice of managing a firm's financial resources to achieve its goals and objectives. It involves making decisions related to investments, financing, and dividends, all aimed at maximizing the firm's value. Finance and Business ~~ Finance is integral to every aspect of a business. Whether it's setting up a new project, expanding operations, or managing day-to-day activities, financial considerations are always at the forefront. The Managerial Finance Function and Goal of the Firm ~~ The primary goal of managerial finance is to maximize the wealth of the firm's shareholders. Financial Institutions and Markets ~~ They provide the platform for businesses to raise capital, invest funds, and manage risks. Ten Axioms of Financial Management 1. The Risk-Return Trade-off 2. The Time Value of Money 3. Cash Flows is King 4. Incremental Cash Flows 5. The Curse of Competitive Markets 6. Efficient Capital Markets 7. The Agency Problem 8. Taxes Bias Business Decisions 9. All Risks are Not Equal 10.Ethical Behavior is Doing the Right Thing Ten Axioms of Financial Management 1. The Risk-Return Trade-off ~~ Investments with higher expected returns typically come with higher levels of risk. 2. The Time Value of Money ~~ A dollar received today is worth more than a dollar received in the future due to its potential earning capacity through investment or interest. Ten Axioms of Financial Management 3. Cash Flows is King ~~ This states that Cash flows and not profits is king in terms of financial management 4. Incremental Cash Flows ~~ Only the cash flows that changes are the ones that count Ten Axioms of Financial Management 5. The Curse of Competitive Markets ~~ Why it’s hard to find exceptionally profitable projects 6. Efficient Capital Markets ~~ The markets are quick, and the prices are right Ten Axioms of Financial Management 7. The Agency Problem ~~ Managers will not work for the owners unless it is in their best interests 8. Taxes Bias Business Decisions ~~ In evaluating projects, income taxes play a significant role in the decision- making Ten Axioms of Financial Management 9. All Risks are Not Equal ~~ Some risks can be diversified away, and some cannot. 10. Ethical Behavior is Doing the Right Thing ~~ Ethical dilemmas are everywhere in finance Conclusion Financial Management is the mixture of financial planning, administration and control. Financial corporation deals with how corporation obtains the funds and how corporation allocates that funds.