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Esson: An Overview of Financial Management
Esson: An Overview of Financial Management
TOPICS
1. Goals of Financial Management
2. Functions of Financial Management
3. Financial Manager’s Responsibility
4. Alternative Forms of Business Organization
5. Agency Relationships
LEARNING OUTCOMES
At the end of the lesson, you should be able to:
1. Differentiate goals and functions of financial management.
2. Identify financial manager’s responsibility.
3. Identify alternative forms of business organization.
Though a firm may pursue the profit motive it is arguable that achieving this objective alone
guarantees the satisfaction of all constituent’s interests and corporate survival. A company driven
exclusively by the profit motive may, in an attempt to maximize profit embark on high risk
projects. High risk projects have the potential for high returns but at the same time puts at
jeopardy the interest of the owners, especially fixed interest owners who do not often bargain
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for such level of risk. Profit maximization can at best be a short run objective. It implies that the
firm pursue only those decisions that will lead to immediate profit and not those that will
enhance the future earning potential. It assumes that a firm is evaluated on the basis of current
earnings alone to the exclusion of future earnings stream.
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TOPIC 2: FUNCTIONS OF FINANCIAL MANAGEMENT
Forecasting
and Planing
According to Anastacio et al (2016)
presented the activities that are
inherent to a financial manager’s job.
Making Crucial
Risk
Management
Investment
and Financing
These are:
Decisions
Financial
Manager's 1. Forecasting and Planning. The
Responsibilities
financial manager must interact
with other executives as they
jointly look ahead and lay the
Trading in
Financial
Coordinating
and
plans which will shape the firm's
Markets Controlling
future position.
2. Making Crucial Investment and Financing Decisions. On the basis of long-run plans, the
financial manager must raise the capital needed to support growth. A successful firm usually
achieves a high rate growth in sales, which requires increased investments in the plant,
equipment and current assets necessary to produce goods and services. The financial manager
must help determine the optimal rate of growth in sales, which requires increased investments
in the plant, equipment' and current assets necessary to produce goods and services. The
financial manager must help determine the optimal rate of sales growth, and he or she must help
decide on the specific investments to be made as well as on the types of funds to be used to
finance these investments. Decisions must be made about the use of internal versus external
funds, the use of debt versus equity and the use of long-term versus short-term debt.
3. Coordinating and Controlling. The financial manager must interact with executives in other
parts of the business if the firm is to operate as efficiently as possible. All business decisions have
financial implications, and all managers - financial and otherwise - need to take this into account.
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For example, marketing decisions affect sales growth, which in tum changes investment
requirements. Thus, marketing decision makers must take into account how their actions affect
(and are affected by) such factors as the availability of funds, inventory policies, and plant
capacity utilization.
4. Trading in Financial Markets. The financial manager must deal with the money and capital
markets. Each firm affects and is affected by the general financial markets, where funds are
raised, where the firm's securities are traded, and where its investors are either rewarded or
penalized.
5. Risk Management. All business entities are exposed from risks. These risks could be financial
risks such as prices of commodities, currency exchange rates, and fluctuating interest rates. It
could also be from natural calamities, such as earthquakes, floods, fires, and the recent health
pandemic, the COVID-19. A financial manager is responsible and accountable for the risk
management policies and programs of the firm that involve the detection of the risks.
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Partnership. A partnership is a form of business where two
or more people share ownership, as well as the responsibility
for managing the company and the income or losses the
business generates. That income is paid to partners, who
then claim it on their personal tax returns – the business is
not taxed separately, as corporations are, on its profits or
losses. Business partners are jointly and individually liable
for the actions of the other partners. Profits must be shared
with others. You have to decide on how you value each
other’s time and skills. What happens if one partner can put in less time due to personal
circumstances? Since decisions are shared, disagreements can occur. A partnership is for the
long term, and expectations and situations can change, which can lead to dramatic and traumatic
split ups. The partnership may have a limited life; it may end upon the withdrawal or death of a
partner. A partnership usually has limitations that keep it from becoming a large business. You
have to consult your partner and negotiate more as you cannot make decisions by yourself. You
therefore need to be more flexible. A major disadvantage of a partnership is unlimited liability.
General partners are liable without limit for all debts contracted and errors made by the
partnership. For example, if you own only 1 percent of the partnership and the business fails, you
will be called upon to pay 1 percent of the bills and the other partners will be assessed their 99
percent. However, if your partners cannot pay, you may be called upon to pay all the debts even
if you must sell off all your possessions to do so. This makes partnerships too risky for most
situations. The answer would be a different business structure.
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TOPIC 5: AGENCY RELATIONSHIPS
An agency relationship consists of the principal and the
agent where the principal gives the agent legal
permissions to act on the principal's behalf. In this type of
relationship, agents should not have any conflicts of
interest in executing any act the principals appoint them
to do. This relationship that exists between principal and
agent is appropriately called the "agency." The law of
agency has well-established specifications for this legal
relationship.
Agency Conflicts
An agency conflict between managers and shareholders can develop when managers have
different knowledge and perspectives than owners have. Managers may decide that the
company's health requires retaining earnings rather than issuing large dividends. The owners,
who don't have the same in-depth knowledge of the company's position, may think the managers
have failed and demand an explanation. Risk is another of the causes of agency problems
because agents and principals often assess risk differently. Shareholders may be willing to
tolerate greater risk than managers because of the lure of greater rewards. Managers who don't
see the same gains from risky moves may be more cautious. In a large corporation, for example,
the managers may enjoy many fringe benefits, such as golf club memberships, access to private
jets, and company cars. These benefits (also called perquisites or perks) may be useful in
conducting business and may help attract or retain management personnel, but there is room
for abuse. The abuse of perquisites imposes costs on the firm—and ultimately on the owners of
the fi rm. There is also a possibility that managers who feel secure in their positions may not
bother to expend their best efforts toward the business. This is referred to as shirking, and it too
imposes a cost to the firm.
Agency Costs
The agency costs definition is the internal costs incurred from asymmetric information or
conflicts of interest between principals and agents in an organization. In a corporation, the
principals would be the shareholders and the agents would be the managers. The shareholders
want the managers to run the company in a way that maximizes shareholder value. Conversely,
the managers may want to run the company in a way that maximizes the managers’ own personal
power or wealth, even if it lowers the market value of the company. These divergent interests
can result in agency costs. There are three common types of agency costs: monitoring, bonding,
and residual loss. Dealing with the agency problem is never free -- there is an agency cost
associated with coping with the agency problem. Such agency costs usually fall under the
category of operating expenses.