goals and functions of fm

8/2/2019 Goals and Functions of FM

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The Goals and Functions of

Financial Management


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Chapter Outline

Introduction to Finance

Risk-Return Tradeoff

Forms of Organizations Corporate Governance

Goals of Financial Management

Social Responsibility and Finance Role of Financial Markets

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Financial Management

Financial Management or business finance is

concerned with managing an entitys money.

For example, a company must decide: where to invest its money.

whether or not to replace an old asset.

when to issue new stocks and bonds.

whether or not to pay dividends.

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Relationship between Finance, Economics

and Accounting

Economics provides structure for decisionmaking in many important areas. Provides a broad picture of economic

environment. Accounting provides financial data in various

forms. Income statements, balance sheets, and

statement of cashflows. Finance links economic theory with the

numbers of accounting.

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Evolution in the Field of Finance

At the turn of the century: Emerged as a field

separate from economics.

By 1930s: Financial practices revolved aroundsuch topics as:

Preservation of capital.

Maintenance of liquidity.

Reorganization of financially troubled corporation.

Bankruptcy.

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Evolution in the Field of Finance (contd)

By mid-1950s: Finance becomes more

analytical.

FinancialC

apital (accounting capital/ money) wasused to purchase Real Capital (economic capital/

long-term plant and equipment).

Cash and inventory management

Capital structure theory Dividend policy

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Recent Issues in Finance

Recent focus has been on:

Risk-return relationships.

Maximization of returns for a given level of risk.

Portfolio management.

Capital structure theory.

New financial products with a focus on hedging are

being widely used.

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Recent Issues in Finance (contd)

The following are significant to financial

managers during decision making:

Effects of inflation and disinflation on financialforecasting.

Required rates of return for capital budgeting

decisions.

Cost of capital.

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Advances in Internet and Finance

Internet and its acceptance has enabled accelerationof e-commerce solutions for old economycompanies.

E-commerce solutions for existing companies B2C B2B

Spurt in new business models and companies Amazon.com eBay

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Advances in Internet and Finance (contd)

For a financial manager e-commerce impactsfinancial management because it affects thepattern and field through which cash flows

through the firm. B2C Model: Products are bought with credit cards,

credit card checks are performed, and selling firmsget the cash flow faster.

B2B: Orders can be placed, inventory managed,and bids to supply products can be accepted allonline.

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Functions of the Financial Manager

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Risk-Return Trade-Off

Influences operational side (capital versuslabor/ Product A versus Product B)

Influences financial mix (stocks versus bondsversus retained earnings) Stocks are more profitable but riskier.

Savings accounts are less profitable and less risky(or safer)

Financial manager must choose appropriatecombinations

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Corporate Governance

Agency theory

Examines the relationship between the owners

and managers of the firm.

Institutional investors

Have more to say about the way publicly owned

companies are managed.

Public Company Accounting Oversight Board(PCAOB)

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Sarbanes-Oxley Act of 2002

Set up a five member Public CompanyAccounting Oversight Board (PCAOB) withresponsibility for: Auditing standards within companies Controlling the quality of audits Setting rules and standards for the independence

of the auditors.

Major focus is to make sure that publicly-

traded corporations accurately present theirassets, liabilities, and equity and income ontheir financial statements.

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Goals of Financial Management

Valuation Approach

Maximizing shareholder wealth (shareholderwealth maximization)

Management and stockholder wealth Retention of position of power in long run is by

becoming sensitized to shareholder concerns.

Sufficient stock option incentives to motivate

achievement of market value maximization. Powerful institutional investors are increasing

management more responsive to shareholders.

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Social Responsibility

Adoption of policies that maximize values in

the market attracts capital, provides

employment and offers benefits to the society.

Certain cost-increasing activities may have to

be mandatory rather than voluntary initially,

to ensure burden falls equally over all business

firms.

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Ethical Behavior

Ethical behavior creates invaluable reputation.

Insider trading

Protected against by the Securities andExchange Commission (SEC).

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The Role of Financial Markets

Financial markets are indicators ofmaximization of shareholder value and theethical or the unethical behavior that may

influence the value of the company. Participants in the financial market range over

the public, private and governmentinstitutions.

Public financial markets

Corporate financial markets

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Structure and Functions of the Financial

Markets

Money markets Securities in this market include commercial paper

sold by corporations to finance their daily

operations or certificates of deposit withmaturities of less than 12 months sold by banks.

Capital markets Long-term markets

Securities include common stock, preferred stockand corporate and government bonds.

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Stocks versus Bonds

Stock = ownership or equity

Stockholders own the company

Bond = debt or IOU

Bondholders are owed $ by company

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Allocation ofCapital

Primary market

When a corporation uses the financial markets to

raise new funds, the sale of securities is made by

way of a new issue.

Secondary market

When the securities are sold to the public

(institutions and individuals). Financial managers are given a feedback about

their firms performance.

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Return Maximization and Risk Minimization

Investors can choose risk level that meetstheir objective and maximizes return for thatgiven level of risk.

Companies that are rewarded with high-pricedsecurities can raise new funds in the moneyand capital markets at a lower cost comparedto competitors.

Firms pay a penalty for failing to performcompetitively.

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Restructuring

Restructuring can result in:

Changes in the capital structure (liabilities and

equity on the balance sheet).

Selling of low-profit-margin divisions with the

proceeds of the sale reinvested in better

investment opportunities.

Removal or large reductions in the of currentmanagement team.

It has resulted in acquisitions and mergers.

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Internationalization of Financial Markets

Allocation of capital and the search for lowcost sources of financing on the rise in globalmarket.

The impact of international affairs andtechnology has resulted in the need for futurefinancial managers to understand

International capital flows.

Computerized electronic funds transfer systems.

Foreign currency hedging strategies.

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Technological Impact on Capital Market

Consolidation among major stock markets andmergers of brokerage firms with domestic andinternational partners.

Electronic markets have gained popularity asagainst traditional organized exchanges andNASDAQ.

Resulted in the merger of NYSE withArchipelago and NASDAQ bought out Insinetfrom Reuters.

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goals and functions of fm

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