Overview of Financial Management

LECTURER: ISAAC OFOEDA

 Outline
• Business Finance
• Definition of Financial Management
• Objectives of the Firm
• Financial Management Decisions
• Importance of Financial Management
• Forms of Business Organizations
• Agency Problems and the Control of Corporations
• Financial Markets and Corporations
• Market Efficiency
 Business Activities
Generally , business activities are centered
around;
• Production
• Marketing
• Finance
 Business Finance Functions
• The finance function is performed by the
Finance Manager.

• Business finance is that business activity which

concerns with the acquisition and
conversation of capital funds in meeting
financial needs and overall objectives of a
business
 Types Finance
• Private Finance: which includes the individual,
firms, business or corporate

• Public Finance; concerns with revenue and

disbursement of Central Government, State
Government etc, funds
 Definition of Financial Management

• It is concerned with the efficient use of an

important economic resource namely, capital
funds.
• Financial management is also concerned with
the acquisition, financing, and management of
assets with some overall goal in mind.
Definition of Financial Management Cont’d

• Financial Management deals with

procurement of funds and their effective
utilization in the business.
• It is the operational activity of a business that
is responsible for obtaining and effectively
utilizing the funds necessary for efficient
• operations
 Financial Management Decisions
• Investment Decisions
• Financing Decisions
• Dividend Policy decisions
• Working Capital Management Decisions
 Financial Objectives of the Firm
• The shareholders’ view

• Other Stakeholders’ view

 Financial Objectives of the Firm Cont’d

1. Shareholders’ View

• Profit Maximization

• Wealth Maximization
 Financial Objectives of the Firm Cont’d

Profit Maximization
• Main aim of any kind of economic activity is
earning profit. A business concern is also
functioning mainly for the purpose of earning
profit. Profit is the measuring techniques to
understand the business efficiency of the
concern.
 Financial Objectives of the Firm Cont’d

Profit Maximization
1. Favourable Arguments for Profit Maximization
• Main aim is earning profit
• Profit is the parameter of the business operation.
• Profit reduces risk of the business concern.
• Profit is the main source of finance.
• Profitability meets the social needs also
 Financial Objectives of the Firm Cont’d
Profit Maximization
2. Unfavourable Arguments for Profit Maximization
• Profit maximization leads to exploiting workers and
consumers.
• Profit maximization creates immoral practices such
as corrupt practice, unfair trade practice, etc.
• Profit maximization objectives leads to inequalities
among the stakeholders such
• as customers, suppliers, public shareholders,
 Financial Objectives of the Firm Cont’d
Profit Maximization
3. Drawbacks of Profit Maximization
• It is vague : profit is not defined precisely or
correctly
• It ignores the time value of money
• It ignores risk
• Creative accounting may influence profit
• Has no bearing on cash flows
• It assumes perfect competition
 Financial Objectives of the Firm Cont’d

Wealth Maximization
• The term wealth means shareholder wealth or
the wealth of the persons those who are
involved in the business concern
• Wealth maximization is also known as value
maximization or net present worth
maximization. This objective is an universally
accepted concept in the field of business
 Financial Objectives of the Firm Cont’d

Wealth Maximization
1. Favourable Arguments for Wealth
Maximization
• Wealth maximization is superior to the profit
maximization because the main aim of the
business concern under this concept is to
improve the value or wealth of the
shareholders
 Financial Objectives of the Firm Cont’d
• Wealth maximization considers the comparison of the
value to cost associated with the business concern.
Total value detected from the total cost incurred for
the business operation. It provides extract value of the
business concern
• Wealth maximization considers both time and risk of
the business concern.
• Wealth maximization provides efficient allocation of
resources.
• It ensures the economic interest of the society.
 Financial Objectives of the Firm Cont’d

Wealth Maximization
2. Unfavourable Arguments for Wealth
Maximization
• Wealth maximization leads to prescriptive idea of
the business concern but it may not be suitable
to present day business activities.
• Wealth maximization is nothing, it is also profit
maximization, it is the indirect name of the profit
maximization
 Financial Objectives of the Firm Cont’d

• Wealth maximization creates ownership-

management controversy
• Management alone enjoy certain benefits
• The ultimate aim of the wealth maximization
objectives is to maximize the profit
• Wealth maximization can be activated only
with the help of the profitable position of the
business concern.
 Financial Objectives of the Firm Cont’d

2. Other Stakeholders’ View

• Employees
• Community
• Suppliers
• Government
• Customers
Non-Financial Objectives of the Firm Cont’d

1. Growth
2. Diversification
3. Survival
4. Maintaining contended workforce
5. Becoming research and development leader
6. Providing top quality service to customers
7. Maintaining respect for the environment
 Objectives of Non-Profit Making
Organizations
1. Economy
2. Efficiency
3. Effectiveness
 Importance of Financial Management

• Financial Planning
• Acquisition of Funds
• Proper Use of Funds
• Financial Decision
• Improve Profitability
• Increase the Value of the Firm
• Promoting Savings
 Forms of Business Organisation

Sole Proprietorship
A sole proprietorship is an unincorporated business
owned by one individual. Going into business as a sole
proprietor is easy—one merely begins business
operations. However, even the smallest business
normally must be licensed by a governmental unit.
Advantages:
• It is easily and inexpensively
• it is subject to few government regulations, and
• the business avoids corporate income taxes.
 Forms of Business Organisation
Limitations
• It is difficult for a proprietorship to obtain large sums
of capital;
• the proprietor has unlimited personal liability for the
business’s debts, which can result in losses that
exceed the money he or she invested in the
company; and
• the life of a business organized as a proprietorship is
limited to the life of the individual who created it.
 Forms of Business Organisation
Partnership
A partnership exists whenever two or more persons
associate to conduct a non corporate business.
Partnerships may operate under different degrees of
formality, ranging from informal, oral understandings
to formal agreements filed with the secretary of the
state in which the partnership was formed.
Advantages
• low cost and
• ease of formation.
 Forms of Business Organisation
Disadvantages
• unlimited liability,
• limited life of the organization,
• difficulty transferring ownership, and
• Difficulty raising large amounts of capital.

Corporation
A corporation is a legal entity created by a state, and it
is separate and distinct from its owners and managers.
 Forms of Business Organisation
Advantages
• Unlimited life
• Easy transferability of ownership
• Limited liability.

Disadvantages
• Corporate earnings may be subject to double taxation
• Setting up a corporation, and filing the many required
state and federal reports, is more complex and time-
consuming
 Agency Problems
• The thousands, or more, investors who own
public firms could not collectively make the
daily decisions needed to operate a business.
Therefore:
• The shareholders are owners of the firm
• The officers (or executives) control the firm
 Agency Problems
Principal-Agent Problem
Principal-shareholders
Agent –managers
Principal –agent problem represents the conflict of
interest between management and owners.
For example if shareholders cannot effectively
monitor the managers’ behaviour, then managers
may be tempted to use the firm’s assets for their
own ends, all at the expense of shareholders.
 Solving Agency Problems
1. Incentives
• Bonus
• Stock
• Stock options

2. Monitoring
• Inside the corporate structure – BOD
• Outside the structure- auditors, bankers, credit
agencies and attorneys
• In government- SEC, IRS
 Solving Agency Problems
3. Other Monitors
• Market forces
• Stakeholders
• Creditors
• Employees
• Society
 Financial Market and the Corporation
Financial market is a place where SPU and DSU interact. A
market is a method of exchanging one asset (usually cash)
for another asset.

Types

1. Physical assets vs. financial assets

2. Money versus capital markets
3. Primary versus secondary markets
4. Foreign exchange market- spot and forward
5. Derivative market
 Financial Market and the Corporation
What are some financial instruments?
 T-bills
 Banker’s acceptances
 Commercial paper
 Negotiable CDs
 T-notes and T-bonds
 Mortgages
 Municipal bonds
 Corporate bonds
 Preferred stocks
 Common stocks
 Financial Market and the Corporation
Who are the providers (savers) and users (
borrowers) of capital?
• Households: Net savers
• Non-financial corporations: Net users
(borrowers)
• Governments: Net borrowers
• Financial corporations: Slightly net borrowers,
but almost breakeven
 Financial Market and the Corporation
What are three ways that capital is transferred
between savers and borrowers?
• Direct transfer (e.g., corporation issues
commercial paper to insurance company)
• Through an investment banking house (e.g.,
IPO, seasoned equity offering, or debt
placement)
• Through a financial intermediary (e.g.,
individual deposits money in bank, bank
makes commercial loan to a company)
 Financial Market and the Corporation
What are some financial intermediaries?
• Commercial banks
• Savings & Loans and credit unions
• Finance companies
• Life insurance companies
• Mutual funds
• Pension funds
 Market Efficiency
• A market is said to be efficient where prices
fully and instantaneously reflect all available
information. In an efficient market, prices
accurately and rapidly adjust to reflect the
true intrinsic value of the securities.
 Levels of Market Efficiency
• Weak Form
The weak form of the hypothesis states that share prices
fully reflect historic information, with the results that it
would be impossible to predict future share price
movement. Price movements are therefore random; hence
the weak form is referred to as random walk hypothesis.
• Semi-strong
The semi-strong form states that current prices reflect both
historic and publicly available information about the
company.
 Levels of Market Efficiency
• Strong form;
The strong form sates that current share prices
reflect historic, public and private information
about the company. Hence, price adjust rapidly
and accurately to new information.