Financial Management and its Roles

What is Financial Management?

Financial Management and its Roles

Financial Management is the study of

methods which help us plan, raise and use
firms’ financial resources of an organization in
an efficient and effective manner to achieve
corporate objectives.
 Central Role of Financial Management

Customers mgt Marketing mgt

Purchasing mgt Quality mgt

Financial
Management
Human Production mgt
Resource mgt

R&D Technology
 Goals of Financial Management
• Possible goals
– Maximize Profit
– Maximize sales or market share
– Minimize cost
– Maintain Growth
– Survival
– Avoid financial distress and Bankruptcy
– Shareholders Wealth Maximization
 Most important Goal
The Most important Goal of financial
management of a firm is shareholders’
Wealth maximization or maximize the
fundamental (intrinsic) price of the firm’s
common stock
Financial Management Decisions
 Business Organizations in Ethiopia
1. Sole proprietorship
2. Partnerships ( 1960 Commercial code, Art. 212)
– Ordinary Partnership
– Joint Venture
– General partnership
– Limited partnership
3. Companies (1960 Commercial code, Art. 212)
– Private Limited Companies (PLCs)
– Share Companies
4. Cooperatives (Unions)
5. Public Enterprises
 Financial Planning, Reporting and Analysis

Financial planning starts with Forecasting

a) Quantitative forecasting techniques
1. Regression
2. Time series analysis
3. Weighted average
b) Qualitative Forecasting techniques
4. Expert opinion
5. Delphi technique
6. Sales personnel estimate
c) Percent of sales method
Classification of Budgets:
a) Operating Budgets
1. Sales budget
2. Production budget
3. Raw material budget
4. Labor Budget
5. Manufacturing overhead Budget
6. Operating expense Budget
7. Budgeted Income statement
b) Financial Budget
8. Capital Budget
9. Cash Budget
10. Budgeted balance sheet
Financial Report
Interim Report Vs Annual Financial report
1. Income statement
2. Statement of change in retained
earning
3. Balance sheet
4. Cash flow statement
 Financial Analysis
• Trend analysis (Horizontal analysis)
• Vertical analysis
• Industry analysis
• Ratio Analysis
1. Liquidity ratios
2. Activity ratios
3. Debt ratios
4. Profitability ratios
5. Market Value ratios
Time value of Money

Time value of money formulas:

1. Future value of a sing sum
2. Present value of a single sum
3. Future value of ordinary annuity
4. Present value of ordinary annuity
5. Future value of annuity due
6. Present value of annuity due
7. Deferred annuity
 Working Capital Management
a) Current Assets
1. Cash management
2. Receivable Management
3. Inventory management
4. Other current assets
b) Current Liabilities
5. Accounts payable
6. Short term notes payable
7. Accrued liabilities
8. Other current liabilities
Capital Budgeting
Pandey (2005) defined capital budgeting as the
firm’s decision to invest its current funds most
efficiently in long term assets in anticipation of
an expected flow of benefits over a series of
years
– Maintenance projects
– Replacement projects
– Expansion of existing projects
– Expansion of new projects
– Soft Projects (R & D, ICT Projects etc)
Capital Budgeting Process
Capital Budgeting involves the following steps:
1. Strategic planning
2. Searching viable Investment Opportunities
3. Initial screening of projects
4. Forecasting net cash flow
5. Quantitative financial appraisal
6. Other qualitative appraisal
7. Accept /reject decision
8. Implementation
9. Monitoring and control
10.Post Implementation audit
 Corporate Level Strategy
• Corporate-level strategy concerns the selection and management of a mix
of businesses competing in several industries or product markets.
– It is the way a company creates value through the
configuration and coordination of multi-market activities:
– To add economic value, a corporate strategy should enable
a company, or one of its business units, to perform one or
more of the value creation functions at a lower cost, or in
a way which supports a differentiation advantage.

Copyright © 2013 CFA Institute 16

Three Dimensions of Corporate Strategy

• Business Diversification
• Integration(forward and back ward)
• Geographic/global Expansion
Extent of Corporate Diversification:
Firms vary by Degree of Diversification

• Low Levels of Diversification

• Single-Business - > 95% of revenues from a singles business unit
• Dominant-Business - 70-95% from a single business unit
• Vertically-integrated Businesses - 70% of sales in value chain
• Moderate to High Levels of Diversification
• Related-Diversified - 70% or more from businesses that are related.
Businesses must share product, technological or distribution linkages.

• High Levels of Diversification

• Unrelated-Diversified - <70% in related business units
 Motives for Diversification
• Operational economies of scope and scale
(Strategic Competitiveness)
• shared and transferred activities
• leveraging core competencies

• Financial economies of scope (Internal Capital Market)

• internal capital allocation
• risk reduction

• Anticompetitive economies of scope (Market Power)

• multipoint competition
• exploiting market power

• Employee Incentives (Growth Motive)

• diversifying employees’ risk and improving promotion chances
• maximizing management compensation
• Avoid declining industries
 Corporate Advantages from
Diversification
(1) Sharing Linkages Between Businesses

Bus. Bus. Bus. Bus.

A B C D

(2) Sharing Core Competence

Bus. Bus.
A B

Core
Competence

Bus. Bus.
C D
Scope Advantages from Diversification

Economies of scope

-- cost reduction from achieving minimum scale in

an input factor, derived from producing multiple
products

* intangible assets, e.g., brand names, corporate reputations,

technology

* organizational capabilities, e.g., management capabilities, marketing

skills
Scale Advantages from Diversification

Economies of Scale in Administration,

Financing and Control
= cost advantages from reaching minimum efficient scale in
administrative and control activities by centralizing similar activities at
the corporate HQ, and by operating an internal capital market

* Administration, e.g. centralized strategic planning, centralized legal

functions, etc.
* Control, e.g. centralized accounting and financial functions
* Financing, e.g. centralized internal capital allocation function
Information Advantages of the
Diversified Corporation

* About capabilities and characteristics of

employees

* Established firms are the most successful in

commercial development of new businesses
Diversification and Performance

• Diversification into related industries may be

more profitable than into unrelated
industries