Chapter 1

An overview of Financial Management and

1
Financial Environment

05/07/2020
2 Learning Objectives

1. Understand what financial management is all about;

2. Learn how business enterprises are organized;
3. Know the role of financial management in the growth of a
company’s wealth.
4. Components of financial system
5. Capital Allocation
6. Categories of Financial Institutions
7. Categories of Financial Markets

05/07/2020
3 What is Financial Management

 Finance – Art of managing the money,  includes activities

like investing, borrowing, lending, budgeting, saving, and
forecasting. 
 Financial – money, funds, capital
 Management – administration, control and skillful
managing
 Financial Management is the skillful managing of funds

05/07/2020
4 Why Study Finance
 Marketing
 Budgets, marketing research, marketing financial products

 Accounting
 Dual accounting and finance function, preparation of financial statements

 Management
 Strategic thinking, job performance and profitability

 Personal finance
 Budgeting, retirement planning, college planning, day-to-day cash flow issues
05/07/2020
5 Attributes of Successful Company
 1. Successful companies have skilled people
 Attitude, competency and mindset
 2. Successful companies have strong relationships
 Customer relationship management
 3. Successful companies have enough funding
 Planning about reinvesting and raising funds

05/07/2020
6 Financial System and its Components
 A financial system refers to a system which enables the transfer of
money between investors and borrowers. The financial system is
the collection of markets, institutions, laws, regulations, and
techniques through which bonds, stocks, and other securities are
traded, interest rates are determined, and financial services are
produced and delivered around the world.
 The primary task of the financial system is to move scarce loanable
funds from those who save to those who borrow to buy goods and
services and to make investments in new equipment and facilities,
so that the global economy can grow and the standard of living can
increase.

05/07/2020
7 Financial System and its Components

 Five Basic Components of Financial System

 Cash
 Financial Instruments (Assets or Securities)
 Financial Markets
 Financial Institutions
 Central Banks

05/07/2020
  1. Cash
8  Cash is used as a medium to buy goods & services. It also is a standard unit of
measurement and acts as a store of value.  However, cash may not be a good
store of value since it loses value with inflation.
 2. Financial Instruments (Financial Assets)
 Financial Instruments are formal obligations that entitle one party to receive
payments or a share of assets from another party. The products which are traded
in a financial market are financial assets, securities or other type of financial
instruments.
 Examples of tradable financial instruments include loans, stocks, debentures and
bonds.
 3  Financial Markets
 A Financial Market is a place or network where financial instruments can be sold
quickly & cheaply.

05/07/2020
  It can be broadly categorized into money markets and capital markets. Money
9 market handles short-term financial assets (less than a year) whereas capital
markets take care of those financial assets that have maturity period of more
than a year. 
 One more classification is primary markets and secondary markets. Primary
markets handles new issue of securities in contrast secondary markets take care
of securities that are presently available in the stock market.
 4. Financial Institution:
 Financial Institutions are firms that connect borrowers and lenders, provide
savers and borrowers access to financial instruments & markets. They could be
categorized into Regulatory, Intermediaries, Non-intermediaries and Others. Like
commercial banks, investment companies, brokerage firms etc.
 5. Central Banks
 Central Banks are large financial institutions that handle government finances,
they regulate the supply of money, and they serve as banks to commercial banks.

05/07/2020
10 The Corporate Life Cycle
 Three major forms of corporate life cycle
 Sole proprietorship
 Partnership
 General (Public)
 Limited (Private)
 Corporation
 S-Corp
 Professional Corporation
05/07/2020
11 Sole Proprietorship  Disadvantages
 Limited to life of owner
 Advantages
 Equity capital limited to
 Easy to start owner’s personal
 Least regulated by wealth (limited to
government growth)
 Single owner keeps all  Unlimited liability
the profits (Debts that owner
 Taxed once as personal obtains for business are
income recovered form
personal assets of
owner) 05/07/2020
12 Partnership
 Advantages  Disadvantages

 Two or more owners  Unlimited liability

 General partnership
 More capital available
(unlimited liability)
 Relatively easy to
 Limited partnership
start (Limited to the amount
 Income taxed once as they invested)
personal income  Partnership dissolves
when one partner dies or
wishes to sell
 Difficult to transfer 05/07/2020
13 Corporation – Legal entity
 Advantages  Disadvantages
 Limited liability  Separation of
 Unlimited life ownership and
 Separation of management
ownership and  Double taxation
management (income taxed at the
 Transfer of ownership is corporate rate and
easy then dividends taxed
 Easier to raise capital at personal rate)
05/07/2020
14 Setting of company involves:
 1. Charter (legal that formally establish the company identity) of
the company that includes:
 Name of proposed corporation
 Types of activities it will pursue
 Amount of capital stock (Number of shares company is authorized to issue)
 Name and address of directors
 By laws are set of rules drawn up by the founders of the
corporation that includes:
 how directors are to be elected
 Whether the existing stockholders will have the first right to buy any new
shares the firm issues
05/07/2020
 Procedures of changing the by laws by themselves or conditions required
15
Types of Corporation
 Professionals Corporation:
 S-Corporation
 A professional corporation is a
 A business electing to incorporate
corporation consisting of
with S corporation status has its
professionals who are licensed to
business income taxed only once,
practice a particular profession such
similar to how sole proprietorships
as accountants, lawyers and
and partnerships are taxed.
doctors. 
 Numbers of shareholders limited to
 Advantage of the various benefits of
35
the corporate structure such as
limited liability of shareholders,
continuity of life and centralized
management. 
 However, shares in a professional
corporation can only be transferred
to other individuals licensed to 05/07/2020
practice in the same profession.