Lecture 1 - Overview of FM

Welcome to
Advanced
Financial Decisions (FIN4274)
Introduction to Advanced Financial Decisions
•Objectives:
1. What is Financial Management?
2. Main Financial Goal of the Firm
3. Financial Management Decisions
4. The Finance Manager
5. Agency Problem
LO1) What is Financial
Management?
What is Financial Management?
• Imagine that you are the owner of a construction

firm.
• As the owner, you need to tackle these 3 questions:
1. What
investments
should you make?
E.g. Building,
machine &
projects
2. Where do you
find the money to
pay for these
investments?
Equity vs. debt.
3. How to manage
the day-to-day
financial activities?
E.g. Collecting
income, paying
expenses and tax.
• Therefore, financial management is a form of

management that attempts to answer these 3
questions:
1. What
investments
should you take?
3. How to
2. How do you manage the
get the money everyday
to pay for these financial
investments? activities?
• In other words, financial management refers to the efficient and

effective management of money (via capital budgeting, capital
structure, etc.) in such a manner as to accomplish the goals (i.e.
maximize shareholder wealth) of the organization.
LO2) Main Financial Goal
of the Firm
Main Financial Goal of the Firm
• But why are these 3 questions important?
• In other words, what is achieved when a firm successfully answers

these questions?
• Come to think of it, what is the firm’s most important goal?

• Some possible goals of the firm include:
• Survival
• Avoid bankruptcy
• Maintain status quo
• Minimize cost
• Increase market share
• Maximize profit
• Etc.
• In financial management, however, these are

not the best goals. Why?
• For example, we can avoid bankruptcy by never
borrowing any money or never taking any risks.
• To gain market share, we can just keep decreasing
the products’ price.
• We can minimize cost by firing all our workers.
• Even “maximizing profit” can be quite challenging to

interpret.
• For example, are we referring to maximizing profit
now or over the long term?
• E.g. A manager who wants a higher bonus payments
(based on profit) this year can increase the profit by
pushing sales aggressively, firing workers, etc.. This
can lead to negative consequences later (e.g. angry
customers, lower worker morale).
• Also, profit figures can be increased or
decreased by accounting manipulation i.e.
“cooking the books”.
• For example, to get a higher profit figure
now, you can treat the next year’s income as
if it has been received this year!
Actual Profit Manipulated Profit

Income 1000 Income 1500
Cost (500) Cost (500)
Profit 500 Profit 1000
• As you can see, these goals can lead to actions

(as the examples earlier shows) that are harmful
to the firm’s owners.
• What is the best goal, then?

• The best financial goal, when achieved,
should be beneficial to the firm owner or
shareholder.
• And since owners benefit “directly” when
their shares in the firm increases in value
(thereby becoming wealthier), therefore the
best financial goal for a firm should be:
To maximize the share/stock value

over the long term
• Although this goal seems simple, take note that

it does not lead to actions that harm the
owners’ financial well-being.
• This is because financial manager’s actions must

be directed to increasing the value of owners’
shares i.e. wealth over time.
• So let’s come back to our earlier question: why is it

important to answers these 3 questions?
1. What
investments
should you take?
3. How to
2. How do you
manage the
get the money
everyday
to pay for these
financial
investments?
activities?
• The answer:
Answering these 3 questions

successfully will maximize the
share/stock value of
the firm over time.
LO3) Financial Management
Decisions
Financial Management Decisions
• Now, let’s look at the tools used to answers the 3

questions:
3. How to
1. What 2. How do you
manage the
investments get the money
everyday
should you to pay for these
financial
make? investments?
activities?
Capital Capital Working Capital

Budgeting Structure Management
• Capital Budgeting
• The main tool used to manage & plan a business’ long term
assets/investments.
• This tool helps you to identify investment opportunities whose cash flow
exceeds the cost of investment.
• In other words, it means the income generated by the investment
should be more than the cost of the investment.
generates
Cost $1M Income $0.5M for 4 years

• Different businesses will face different capital budgeting decisions:
a) A retailer giant (like Giant or Carrefour) deciding
whether to open an additional store outlet.
b) Microsoft deciding to develop a new Windows
program.
c) A construction company deciding on a new shopping
mall construction project.
• Remember, the decision on whether to go ahead with the investment for
these different business will depend on:
Income from Investment

Investment > Cost
• Other factors to consider when deciding on an investment:
• Timing - How often do you receive the income from the investment? Weekly, monthly,
annually?
• Risk – What are chances the investment will fail to generate income? High, moderate or
low?
• Size – How much income will you receive every time?

• Capital Structure
• Capital structure refers to the combination of debt and equity that a business
uses to fund the investment.
Equity
• For example, if a firm were to invest in a $50m office building project, how
much money should it borrow?
• If the firm borrowed $20m (debt), that means that the rest, $30m, are
funded by its own money (i.e. equity).
• Besides thinking about the debt/equity mixture, you also need to think about
the cost of funds.
• For example, how much interest do you need to pay (per year) on the debt?
• Even equity has a cost i.e. owners demand a certain % of return on their own
money.
• You also need to think about where to raise these funds.
• For example, debt can be raised via bank loans, and bond market, etc.
• Equity can be raised via personal savings, inviting new partners and selling
shares.
• With a good mixture of debt and equity, a firm can reduce its cost of funds
(e.g. by getting low-interest loans).
• However, firms must be careful about taking too much debt or it could end
up going bankrupt.
• Working Capital Management (WCM)

• The term working capital refers to a business’ short-term assets (e.g.
inventory) and short term liabilities (e.g. money owed to suppliers).
• Managing working capital is a day-to-day activity that ensures that a business

has sufficient resources to run smoothly.
• Working Capital Management

• Examples of WCM:
• How much money and inventory should we keep on hand?
• Should we sell to our customers/clients on credit (i.e. give them the product now but
they pay later)? If so, on what terms (e.g. how long)?
• How do we obtain short-term borrowings? Via bank overdraft? Purchase inventories on

credit?
• Dividend Policy
• An additional issue we need to consider is the dividend policy of a company.
• Should the company pay dividends to its shareholders? And (if yes) how
much dividends to pay are questions that also pertain to FM.
• We will talk more about this in a future topic.

LO4) The Finance
Manager
The Finance Manager
• Depending on the size of the business, the 3
questions of FM are dealt by different people.
• In a small business, the owner will answer these

questions himself.
• In a large corporation, these questions/decisions

are passed on to the finance manager.
The Finance Manager
• So what are the jobs of a finance manager?
• It can be divided into 3 areas:

• Raise funds from various sources such as lenders, investors, etc.
• Put those funds into (hopefully) profitable long- term investments.

The Finance Manager
• And, manage the day-to-day cash needs of the business.

The Finance Manager
Provide Finance Puts the

money to Manager money in
Business’
Investors &
investments,
lenders
projects, etc.
Finance Generates
Returns Manager money i.e.
money to income
Manages
Daily cash needs

LO5) Agency Problem
• Please refer to the BB for further understanding of this area.

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Welcome to

• Imagine that you are the owner of a construction

• Therefore, financial management is a form of

• In other words, financial management refers to the efficient and

• But why are these 3 questions important?

• In other words, what is achieved when a firm successfully answers

• Come to think of it, what is the firm’s most important goal?

• Some possible goals of the firm include:

• In financial management, however, these are

• Even “maximizing profit” can be quite challenging to

Actual Profit Manipulated Profit

• As you can see, these goals can lead to actions

• What is the best goal, then?

To maximize the share/stock value

• Although this goal seems simple, take note that

• This is because financial manager’s actions must

• So let’s come back to our earlier question: why is it

Answering these 3 questions

• Now, let’s look at the tools used to answers the 3

Capital Capital Working Capital

Cost $1M Income $0.5M for 4 years

Income from Investment

• Size – How much income will you receive every time?

• Working Capital Management (WCM)

• Managing working capital is a day-to-day activity that ensures that a business

• Working Capital Management

• How do we obtain short-term borrowings? Via bank overdraft? Purchase inventories on

• We will talk more about this in a future topic.

• In a small business, the owner will answer these

• In a large corporation, these questions/decisions

• So what are the jobs of a finance manager?

• It can be divided into 3 areas:

• Put those funds into (hopefully) profitable long- term investments.

• And, manage the day-to-day cash needs of the business.

Provide Finance Puts the

Daily cash needs

• Please refer to the BB for further understanding of this area.

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