Session 2023/2024 Semester I (A231)

Course Name: Financial Management

Course Code: BWFF2033

Main reference:

Ross, S., Westerfield, R., & Jordan, B. (2022). Fundamentals of

corporate finance (13th Edition). McGraw-Hill.

Additional references:

Sheridan. T, Keown, A. J, & Martin, J. D. (2018). Financial

Management, Principles and Applications. Pearson

Gittman, L., & Zutter, C. (2015). Principles of Managerial Finance

(14th ed.). London: Pearson
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 Topic 1

INTRODUCTION TO FINANCIAL
MANAGEMENT

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 Learning Objectives

• What is finance?
• Financial manager and financial
management
• Legal forms of business organization
• The goal of financial management
• The agency problems
• Financial markets and institutions
• Principles underlying the financial
management

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What is Finance?
• Finance can be defined as the science and art of
managing money.

• Finance is the study of how people and businesses

evaluate investments and raise capital to fund them.

• Why Study Finance?

• Knowledge of financial tools is critical to making good

decisions in both corporate world and personal lives.

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•Financial Management is concerned with the duties
of the financial manager working in a business.

•Financial managers administer the financial affairs of

all types of businesses—private and public, large and
small, profit-seeking and not-for-profit. Tasks include:
• developing a financial plan or budget
• extending credit to customers
• evaluating proposed large expenditures
• raising money to fund the firm’s operations.

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 Figure 1.1 Organizational Structure of a Corporation

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Financial Management (cont.)
• The top financial manager within a firm is usually
the Chief Financial Officer (CFO) (figure 1.1)

– Treasurer – oversees cash management, credit

management, capital expenditures, and financial
planning

– Controller – oversees taxes, cost accounting, financial

accounting and data processing

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Financial Management Decisions
• Capital budgeting
– What long-term investments or projects should the
business take on?

• Capital structure
– How much should the firm borrow to pay for its assets?
• What is the best mixture of debt and equity?
• The least expensive sources of funds?

• Working capital management

– How do we manage the day-to-day finances of the firm?

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 Forms of Business Organizations

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 Forms of Business Organizations
• A sole proprietorship is a business owned by one person and
operated for his or her own profit.

• A partnership is a business owned by two or more people and

operated for profit.

General Partnership:
– All partners are fully responsible for liabilities incurred by the
partnership.
Limited Partnerships:
– One or more partners can have limited liability, restricted to the
amount of capital invested in the partnership. There must be at least
one general partner with unlimited liability. Limited partners cannot
participate in the management of the business and their names
cannot appear in the name of the firm.

• A corporation is an entity created by law. Corporations have the

legal powers of an individual in that it can sue and be sued, make
and be party to contracts, and acquire property in its own name.
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 Sole Proprietorship

• Advantages • Disadvantages
– Easiest to start – Limited to life of
– Least regulated owner
– Equity capital
– Single owner keeps all
limited to
the profits
owner’s personal
– Taxed once as wealth
personal income
– Unlimited
liability
– Difficult to sell
ownership
interest
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 Partnership

• Advantages
– Two or more owners
– More capital available
– Relatively easy to
start
– Income taxed once
as personal income
• Disadvantages
– Unlimited liability
• General partnership
• Limited partnership
– Partnership
dissolves when one
partner dies or
wishes to sell
– Difficult to transfer
ownership

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 Corporation

• Advantages • Disadvantages
– Limited liability – Separation of
– Unlimited life ownership and
management
– Separation of
– May involve double
ownership and
taxation in some
management
countries (income
– Transfer of taxed at the
ownership is easy corporate rate and
– Easier to raise capital then dividends
taxed at the
personal rate)

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 Goal of Financial Management

• What should be the goal of a corporation?

– Maximize profits?
– Minimize costs?
– Maximize market share?
– Maximize shareholders’ wealth?

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 Maximizing Shareholders’ Wealth

• Maximizing the share price is equivalent to

maximizing shareholders’ wealth.

• Why is this a valid goal?

– Decisions are made in shareholders‘ best interest

– Considers cash flows not profits
– considers risk not profitability
– Incorporates time dimension

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 The Agency Problem
• A principal-agent relationship is an arrangement in
which an agent acts on the behalf of a principal. For
example, shareholders of a company (principals) elect
management (agents) to act on their behalf.

• Shareholders (principals) hire managers (agents) to run

the company.

• Agency problem is the conflict of interest between

principal and agent. It arises when managers place
personal goals ahead of the goals of shareholders.

• Agent may not work in the best interest of the principal.

Management may focus on increasing their own growth
rather than increasing shareholders’ wealth.

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Solutions of Agency Problem
• Managerial compensation
A common approach is to structure management
compensation to correspond with firm performance.

• Incentive plans are management compensation plans

that tie management compensation to share price; one
example involves the granting of stock options.

• Performance plans tie management compensation to

measures such as EPS or growth in EPS. Performance
shares and/or cash bonuses are used as compensation
under these plans.

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Solutions of Agency Problem

• Corporate control
– The threat of a takeover may result in better
management

• The threat of takeover by another firm, which

believes it can enhance the troubled firm’s value by
restructuring its management, operations, and
financing, can provide a solution to the agency
problem.

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 Financial Institutions and Markets

• There are three principal sets of players in the

economy of a country:

– Savers (mostly individual investors)

– Borrowers (individuals and businesses)

– Financial Institutions (Financial Intermediaries)

(example. Commercial banks)

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Figure 1.2: Financial Markets, Institutions, and the Circle of Money

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 Financial Institutions
• Financial institutions are intermediaries that channel
the savings of individuals, businesses, and
governments into loans or investments.

• Commercial banks are institutions that:

– provide savers with a secure place to invest their
funds
– offer loans to individual and business borrowers

• Investment banks are institutions that:

– assist companies in raising capital
– advise firms on major transactions such as mergers
or financial restructurings
– engage in trading and market making activities
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 Financial Markets
• Financial markets are forums in which suppliers of
funds and demanders of funds can transact business
directly.

• The primary market is the financial market in which

securities are initially issued; the only market in which
the issuer is directly involved in the transaction.

• Secondary markets are financial markets in which

pre-owned securities (those that are not new issues)
are traded.

• Transactions in short term marketable securities take

place in the money market while transactions in long-
term securities take place in the capital market.
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 Financial Markets (cont.)

The Money Market

• The money market is created by a financial
relationship between suppliers and demanders of
short-term funds.
• Most money market transactions are made in
marketable securities which are short-term debt
instruments, such as:
• U.S. Treasury bills issues by the federal government
• commercial paper issued by businesses
• negotiable certificates of deposit issued by financial
institutions
• Investors generally consider marketable securities to
be among the least risky investments available.

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 Financial Markets (cont.)
The Capital Market

• The capital market is a market that enables

suppliers and demanders of long-term funds to make
transactions.
• The key capital market securities are bonds (long-
term debt) and both common and preferred stock
(equity, or ownership).
– Bonds are long-term debt instruments used by businesses
and government to raise large sums of money, generally
from a diverse group of lenders.
– Common stock are units of ownership interest or equity in
a corporation.
– Preferred stock is a special form of ownership that has
features of both a bond and common stock.

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Principles Underlying the Financial Management

Five Basic Principles of Finance:

 Cash flow is what matters

 Money has a time value

 Risk requires a reward/ return

 Market prices are generally right

 Conflicts of interest cause agency problems

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 Thank You For Your Attention !!!

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