financial management functions & objectives

8/9/2019 Financial Management Functions & Objectives

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Strategic Financial Management

Session -1

Functions & Objectives


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Corporate Finance: Objectives?

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What is Corporate Finance? Corporate Finance addresses the following questions:

What long-term investments should the firm choose?

How should the firm raise funds for the selected

investments?

How should short-term assets be managed and financed? How much short-term cash flow firm need to pay its bills?

What proportion of the funds should be reinvested in thefirm and what should be distributed to the shareholders?

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The Capital Budgeting Decision

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Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

CurrentLiabilities

Long-TermDebt

What long-terminvestments

should the firmchoose?


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The Capital Structure Decision

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How should thefirm raise fundsfor the selectedinvestments?

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

CurrentLiabilities

Long-TermDebt


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Short-Term Asset Management

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How shouldshort-term assets

be managed and

financed?

NetWorkingCapital

ShareholdersEquity

CurrentLiabilities

Long-TermDebt

Current Assets

Fixed Assets

1 Tangible

2 Intangible


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Risk and Return Financial Management involves three decisions:

Investment Decisions Financing Decisions

Dividend Decisions

Whenever a financial decision involves investment and/orfinancing, it is also concerned with two specific factors:expected return and risk.

Expected return is the difference between potential benefits and potential costs.

Risk is the degree of uncertainty associated with these expectedreturns.

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Cash Flow Btw the Firm and the Financial Markets

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Cash flowfrom firm (C)

T a x e s

( D )

Government

Retainedcash flows (F)Invests

in assets(B)

Dividends and debt payments (E)

Current assetsFixed assets

Short-term debt

Long-term debt

Equity shares

Ultimately, the firmmust be a cashgenerating activity.

The cash flows fromthe firm must exceedthe cash flows fromthe financial markets .

Firm ReceiveCash, generate

profits throughits operations

(B)

Firm Firm issues securities (A) Financialmarkets


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Corporations

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Forms of Business Organization The Sole Proprietorship

The Partnership General Partnership Limited Partnership

The Corporation

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A Comparison

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Corporation Partnership

Liquidity Shares can be easilyexchanged

Subject to substantialrestrictions

Voting Rights Usually each share gets onevote

General Partner is in charge;limited partners may havesome voting rights

Taxation Double Partners pay taxes on

distributionsReinvestment anddividend payout

Broad latitude All net cash flow isdistributed to partners

Liability Limited liability General partners may have

unlimited liability; limited partners enjoy limitedliability

Continuity Perpetual life Limited life


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Hypothetical Organization Chart

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Chairman of the Board and Chief Executive Officer (CEO)

President and Chief Operating Officer (COO)

Vice President and Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager

Capital Expenditures

Credit Manager

Financial Planning

Tax Manager

Financial Accounting

Cost Accounting

Data Processing

Board of Directors


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Accounting and Financial Management The firms finance (treasurer) and accounting (controller)

functions are closely related and overlapping. In smaller firmsusually financial manager generally performs both functions.

One major difference is that accountants generally uses accrualmethod while in finance, the focus is on cash flows.

Finance and accounting also differ with respect to decisionmaking. While accounting is primarily concerned with the

presentation of the financial data, financial manager is primarily concerned with the analyzing and interpreting thisinformation for the decision making purposes.

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Role of Financial Managers The Financial Managers primary goal is to increase

the value of the firm by:

Selecting value creating projects

Making smart financing decisions How to minimize the cost of capital

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Financial Objective There is actually one financial objective:

The maximization of the economic wellbeing, or wealth, ofthe owners.

Whenever a decision is to be made, managementshould choose the alternative that most increases the

wealth of the owners of the business.

The market value of shareholders equity generally

measures the owners economic well being.

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How to maximize shareholders wealth? If the stock market is efficient, the value of a share

should reflect investors expectations regarding thefuture prospects of the corporation.

The value of a stock will change as investorsexpectations about the future change.

For financial managers decisions to add value, the present value of the benefits resulting from decisions

must outweigh the associated costs, where costsinclude the costs of capital.

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Finance Managers: Additional Issues If there is a separation of the ownership and

management of a firmthat is, the owners are not themanagers of the firmthere are additional issues toconfront.

What if a decision is in the best interests of the firm,

but not in the best interest of the manager? How can owners ensure that managers are watching

out for the owners interests?

How can owners motivate managers to makedecisions that are best for the owners?

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The Agency Relationship An agent is a person who acts forand exerts

powers ofanother person or group of persons calledPrincipal.

Agency relationship

Stockholders (principals) hire managers (agents) to run thecompany/ to represent his/her interest

Agency problem Conflict of interest between principal and agent

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Managerial Goals Managerial goals may be different from shareholder

goals Expensive perquisites Survival Independence

Increased growth and size are not necessarilyequivalent to increased shareholder wealth

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Agency Cost There are costs involved with any effort to

minimize the potential for conflict between the

principals interest and the agents interest. These are:

Lost of opportunity Monitoring Costs Takeovers

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Questions Which of following actions are the result of a

financing decision and which are the result of aninvestment decision?1. A firm introduces a new product.2. A firm issues new bonds.3. A corporation issues new shares of stock.4. A firm expands its existing manufacturing facilities.5. A firm leases a new building to be used in its

manufacturing.

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financial management functions & objectives

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