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Chapter One Introduction To FM

The document discusses an overview of financial management including basic areas of finance, forms of organization, goals of financial management, the agency problem, and financial markets and corporations. It covers topics such as investments, financial institutions, financial management, sole proprietorships, partnerships, corporations, profit maximization versus stockholder wealth maximization, and mechanisms to control managers.

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aklilu mamo
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© © All Rights Reserved
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Download as PPT, PDF, TXT or read online on Scribd
30 views

Chapter One Introduction To FM

The document discusses an overview of financial management including basic areas of finance, forms of organization, goals of financial management, the agency problem, and financial markets and corporations. It covers topics such as investments, financial institutions, financial management, sole proprietorships, partnerships, corporations, profit maximization versus stockholder wealth maximization, and mechanisms to control managers.

Uploaded by

aklilu mamo
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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FINANCIAL MANAGEMENT

CHAPTER-ONE
OVERVIEW OF FINANCIAL
MANAGEMENT

1.1
1.1. Basic Areas of Finance

• Finance is the application of economic principles


and concepts to business decision-making and
problem solving.
• The field of finance can be considered to comprise
three broad categories:
• investments,
• financial institutions, and
• financial management

2
A. Investments

• This area of finance focuses on the behaviour of


financial markets and the pricing of securities.

• Investment decisions are concerned with the use of


funds—the buying, holding, or selling of all types
of assets.

3
B. Financial Institutions

• This area of finance deals with banks and other


firms that specialize in bringing the suppliers of
funds together with the users of funds.
• For example, a manager of a bank may make
decisions regarding granting loans, managing cash
balances, setting interest rates on loans, and dealing
with government regulations.

4
C. Financial Management

• Sometimes called corporate finance or business


finance.

• this area of finance is concerned primarily with


financial decision-making within a business entity.

• Financial Management Concerns the acquisition,


financing, and management of assets with some overall
goal in mind.
5
• Some important questions that are answered using finance

• What long-term investments should the firm take on?


(investment decisions)
• Where will we get the long-term financing to pay for the
investment? (financing decisions)
• How will we manage the everyday financial activities of the
firm? (Working capital Management Decisions)

1.6
Investment Decisions

Most important of the three decisions.

What is the optimal firm size?

What specific assets should be acquired?

What assets (if any) should be reduced or


eliminated?
Financing Decisions

• What is the best type of financing?

• What is the best financing mix?

• What is the best dividend policy (e.g.,


dividend-payout ratio)?

• How will the funds be physically acquired?


Asset Management Decisions
working capital management

• How do we manage existing assets efficiently?


• Financial Manager has varying degrees of
operating responsibility over assets.
• Greater emphasis on current asset management
than fixed asset management.
1.2 THE ROLE OF
FINANCIAL MANAGERS
• The financial manager of a firm plays an important role
in the company’s goals, policies, and financial success.

1.Financial analysis and planning: Determining the


proper amount of funds to employ in the firm, i.e.,
designating the size of the firm and its rate of growth

2. Investment decisions: The efficient allocation of funds


to specific assets
10
3. Financing and capital structure decisions: Raising funds on
as favourable terms as possible, i.e., determining the
composition of liabilities.

4. Management of financial resources (such as working capital)

5. Risk management: protecting assets.

11
1.3. Forms of Organization

• Three major forms


• Sole proprietorship

• Partnership

• Corporation

1.12
Sole Proprietorship

• Advantages • Disadvantages
• Easiest to start • Limited to life of owner

• Least regulated • Equity capital limited to

• Single owner keeps all the owner’s personal wealth

profits • Unlimited liability

• Taxed once as personal • Difficult to sell ownership


income interest

1.13
Partnership
• Advantages • Disadvantages
• Two or more owners • Unlimited liability
• More capital available • General partnership
• Relatively easy to start • Limited partnership
• Income taxed once as • Partnership dissolves when
personal income one partner dies or wishes
to sell
• Difficult to transfer
ownership

1.14
Corporation
• Advantages • Disadvantages
• Limited liability • Separation of ownership and
• Unlimited life management
• Separation of ownership and • Double taxation (income
management taxed at the corporate rate
• Transfer of ownership is and then dividends taxed at
easy personal rate)
• Easier to raise capital

1.15
1.4. Goal Of Financial Management

• What should be the goal of financial managers when


choosing financial alternatives?

• Two widely discussed goals of financial management.


• Profit Maximization

• Stockholders’ wealth Maximization

1.16
a) Profit Maximization (Traditional Goal)
• Is maximizing the birr income of firms.
• Is based on Accounting profit.
• The actions of the financial manager is profit oriented, i.e., only
actions and projects that will increase profit are undertaken.
• Advantages:
• Simple to achieve-no much calculation
• Helps for efficient allocation of resources.
• Limitations
• Does not consider the time value of money.
• Ignores risk.

17
b) Stockholders’ Maximization (Modern Goal)

• Considers the limitations of profit maximization


approach.

• Is based on cash flows/ benefits from projects.

• Is based on Maximization of market value of shares.

• Projects that maximize Net Present value (wealth) are


under taken.

18
• Additional goals of firms include
• Social responsibility- work for the welfare of:
• Employees
• Customers, and
• Community at large.

19
1.5. The Agency Problem
• Agency relationship

• Principal hires an agent to represent their interest

• Stockholders (principals) hire managers (agents) to run the


company

• Agency problem

• Conflict of interest between principal and agent

• Management lead more relaxed life style and do not work


more seriously.
• Management may consume more perquisite.
1.20
Mechanisms to control Managers
• Managerial compensation

• Incentives can be used to align management and stockholder


interests
• The incentives need to be structured carefully to make sure
that they achieve their goal

• Corporate control

• The threat of a takeover may result in better management

• Direct intervention – by Other stakeholders


1.21
1.6.Financial Markets and Corporation
 A financial market, like any market, is just a way of
bringing buyers and sellers together.

In financial markets, it is debt and equity securities that


are bought and sold.

Financial markets differ in detail, however. The most


important differences concern the types of securities
that are traded, how trading is conducted, and who the
buyers and sellers are.
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