Topic:

Introduction to
Financial Management
Lecture 1
What is Financial Management?
 FM primarily concerns with three
What is
major tasks such as acquisition,
financial
financing and management of assets
Management?
with the goal of the firm in mind.
What is acquisition decision?
 Decisions about size/ amount of investment,
nature of the asset to invest, deciding which
assets to eliminate and so on are examples of
investment decisions/ acquisitions decisions.
Acquisition  It mainly covers following three items:
decisions
 Deciding optimal firm size
 Deciding which specific asset to acquire
 Which assets to disinvest
What is financing decision?
 Financing decisions mainly refer to the task of a
financial manager of arranging money from
different sources so that investments can be made
properly.
 It covers several items:
financing Such as –
decisions  deciding what mix of debt of equity financing will be
optimal for the organization?
 What should be considered as the best financing mix?
 How should debt or equity will actually be obtained?
Etc….
What is asset management decision?
 Asset management decision means managing
Asset assets in the most efficient way. Primarily an
management organization will put more emphasis on
decisions current asset management.
What should be the goal of the firm?
  Goal of the firm from financial point of view
can be of several sorts. Different researches
and surveys have identified that managers
consider wide range of goals while making
financial decisions. Some of them are as
Goal of the follows:
firm survival, profit maximization, wealth
maximization, minimizing bankruptcy risk,
maximizing market share, ensuring customer
satisfaction, etc. Out of these goals, profit
maximization is the most cited one.
The case of profit maximization…..
  Accounting profit is also known as Net
Accounting Income. Net income maximization has its own
profit shortcomings. Some of them are detrimental
for a company’s survival and growth.
maximization  Assume, a company has the following income
as a corporate statement:
goal
 Sales … … … … … … … … … … … 100,000
(-) COGS … … … … … … … … … … (20,000)
Accounting Gross Profit … … … … … … … … … 80,000
profit (-) Operating expenses*** … … … … (10,000)
maximization Net Operating Income (EBIT) … … … 70,000
as a corporate (-) Interest expenses … … … … … … (5,000)
goal EBT … … … … … … … … … … … … 65,000
(-) Income Tax (40%) … … … … … … (26,000)
Net Income … … … … … … … … … 39,000
  ***Operating expenses include following
items:
 Salaries expenses ……………….2,000
Accounting  Advertisement expenses………4,500
profit  Depreciation expense…………..1,000
maximization  R & D expenses……………………2,500
as a corporate One of the ways to increase profit is cutting costs.
goal Suppose, the manager has decided to cut down entire
R&D budget and half of the advertisement budget in the
next year. If all other items remains unchanged, new
income statement will be as follows:
 Sales … … … … … … … … … … … 100,000
(-) COGS … … … … … … … … … … (20,000)
Accounting Gross Profit … … … … … … … … … 80,000
profit (-) Operating expenses*** … … … … (5,250)
maximization Net Operating Income (EBIT) … … … 74,750
as a corporate (-) Interest expenses … … … … … … (5,000)
goal EBT … … … … … … … … … … … … 69,750
(-) Income Tax (40%) … … … … … … (27,900)
Net Income … … … … … … … … … 41,850
 There can also be some other measures such as
– deferring several regular expenditures like –
Accounting maintenance expense, deferring inventory
profit purchases, and so on using which profit can be
increased in the short term.
maximization
as a corporate But, are these actions desirable? Should a
manager continue to cut these costs?
goal
The answer is simple. NO. These actions will
surely result in bumping up short term profit but
at the cost of future growth of the company.
 Moreover,
When we say maximizing profit,
do we mean profit this year? Or, next year? Or, some
long run average profit?
Accounting Profit itself can also be calculated in different
profit manners.
maximization Are we talking about Net income? Or, Earning per
share?
as a corporate
Are we talking about profit available to only the
goal shareholders or to all investors?
Are we talking about profit before/after tax?
Are we talking about net operating profit or, net income?
There are lots of ambiguity surrounding this goal.
 Furthermore,
The goal of Profit maximization does not account for
time value of money and risk.
Accounting
Suppose, last year, a company had net income of Tk.
profit 5,000. This year, they have earned a net income of Tk.
maximization 5,500. Should the manager be happy? Profit has
as a corporate increased.
goal The manager should be happy if and only if value of
Tk. 5,500 this year is worth more than Tk. 5,000. If not,
then company has not increased rather has decreased
its earning.
Accounting
As far as risk is concerned, different decisions taken by
profit managers will have different level of risks associated
maximization with it. Profit maximization only focuses on making
decisions to maximize profit regardless of risks
as a corporate involved.
goal
 Summary:
Profit maximization is not a suitable goal since it
Accounting suffers from several problems. They are :
profit Profit can be maximized in undesirable ways.
maximization The goal of maximizing profit is an ambiguous goal.
as a corporate The goal of Profit maximization does not consider
goal time value of money.
The goal of Profit maximization does not consider
risk.
What if we make our goal a little specific like
maximizing EPS? Does it overcome other
problems of profit maximization?
 Some argues that EPS (Earning per share)
maximization is more appropriate than net
EPS income maximization goal. There is little truth in
maximization it since, EPS is derived from Net Income. So, any
action that increases net income will also
as a corporate increase EPS and vice versa.
goal
 Problems of EPS maximization:
EPS can be maximized in undesirable ways.
EPS The goal of EPS maximization does not
maximization consider time value of money.
as a corporate The goal of EPS maximization does not
consider risk.
goal
Sometimes managers may completely cut down
and defer dividend payments indefinitely if
EPS maximization is set as the goal.
What should be the appropriate goal????
  The most appropriate goal should be
Maximizing maximizing shareholders’ wealth or,
shareholders’ adding value to shareholders’ wealth.
wealth or, Shareholders’ wealth increases when share
maximizing price increases. Therefore, a narrow version
firm value of the goal is ‘To maximize the share price of
a firm.”
 Firstly,
Any investor invests money with an expectations
of earning returns. To be more specific, earning
Maximizing cash flows in future. If a certain asset has the
ability to pay more future cash flow, investors
shareholders’ will pay more today to buy that asset. Same
wealth or, thing goes with shares of stock of a company.
maximizing Secondly,
firm value Investors like to avoid risks. They will pay more
money for an asset with relatively certain cash
flow than an asset with more uncertain cash
flows.
Maximizing
shareholders’ How do we measure value? What type of
wealth or, actions can managers really take to
maximizing increase firm value or to maximize
firm value shareholders’ wealth?
  If a financial manager can take actions to
increase cash flows of a firm,
Maximizing or,
shareholders’  decrease uncertainty of cash flow of the firm
wealth or, or,
maximizing  generate cash flows sooner than later,
firm value or,
 can perform any combination of these
activities, value of the firm will increase.
The agency theory
 The Modern Corporation
Modern Corporation
Maximizing
shareholders’
wealth or, Shareholders Management
maximizing
firm value
There exists a SEPARATION between owners and
managers.
 In a company, shareholders are the
Jensen and principals. Managers work as the agents
Meckling’s of the principals, (i.e. shareholders).
theory of the Principal:
firm based on A person who authorizes someone else to act on
the Agency his behalf.
Theory Agent:
A person authorized by the principal to work on
his behalf.
  Jensen and Meckling developed a theory of the
firm based on agency theory.
Jensen and  Agency Theory is a branch of economics
Meckling’s relating to the behavior of principals and their
theory of the agents.
firm based on  In a large company, managers are the ones who

the Agency run the business. Shareholders’ (At least most

of them) watch from a distance. So, if left
Theory alone, managers may start taking actions for
their own benefit which may collide with the
interest of the shareholders. This conflict of
interest is termed as ‘Agency problem’.
Jensen and
Meckling’s
theory of the How to remove this
firm based on conflict of interest?
the Agency
Theory
 Principals must provide incentives so that
Jensen and management acts in the principals’ best
Meckling’s interests and then monitor results.
theory of the Incentives: (Agency cost)
firm based on
Incentives include, stock options,
the Agency perquisites, and bonuses.
Theory
Monitoring costs also qualify as agency
cost.
Do we just maximize shareholders’ wealth and
forget about everyone else?
  Wealth maximization does not prevent the
firm from being socially responsible at the
corporate level.
 the firm can be considered as producing
CSR and both private and social goods.
maximizing  Then shareholder wealth maximization
shareholders’ remains the appropriate goal in governing
wealth the firm.
 Being socially responsible, caring the
employees and customers will certainly
boost the goodwill of the company which in
turn boost the share price.
 Corporate governance:
represents the system by which corporations
are managed and controlled.
 Includes shareholders, board of directors, and
Corporate senior management.
Governance  A good corporate governance practice
ensures that the board of the company has
diversities (both in terms of gender and
experiences/expertise), presence of non-
executive and independent directors,
effective management control by the board,
etc.
Controller Vs. Treasurer
  Controller is responsible for taking care of
accounting activities.
 Treasurer, on the contrary, is responsible for
Controller and
taking care of financial management related
Treasurer’s activities. That is, investing decisions,
responsibilities financing decisions, asset management
decisions are primarily the responsibilities of
the treasurer.
 Examples:
 Deciding which long-term asset to
Controller and purchase.
Treasurer’s  Deciding what should be the
responsibilities appropriate credit term for credit sales.
 Maintaining relationship with banks so
that favorable credit terms can be
availed whenever needed.
Questions
 TOTAL MARKS: 5

 Define financial management.? Briefly

describe three major decision areas of
financial management.
Review  Describe some problems of Profit
questions for maximization.
GD  What is agency problem? How can it be
eliminated. Give some examples. What is
agency cost?
Thank You