Financial_Management_Principles_and_Applications_----. __Part_1_Introduction_to_financial_management___1_

Introduction to Financial Management

• Financial management is essential in making informed decisions regarding investment, funding, and day-to-day operations.

• Focus areas:

  • Capital budgeting: Long-term investment decisions.

  • Capital structure: Funding choices for these investments.

  • Working capital management: Management of cash flows in everyday operations.

Importance of Finance

• Knowledge of finance is crucial for career success and personal finance management.

  • Managers need to understand strategic planning and budgeting.

  • Example: GM invested in Lyft to develop self-driving cars, showcasing long-term investment strategies.

• Marketing and production graduates require finance knowledge for pricing and inventory management.

• Funding education through personal earnings or loans implicates financial decision-making.

Legal Forms of Business Organization

Sole Proprietorship

• Single ownership; easy to set up but with unlimited liability.

• Owner faces personal risk for business debts.

• Limited financing options, typically reliant on personal funds or loans.

Partnership

• Co-ownership between two or more individuals.

• General partnerships entail unlimited liability for all partners.

• Limited partnerships allow for some partners to have limited liability.

Corporation

• Separate legal entity providing limited liability to owners (shareholders).

• Allows for easier capital raising and continuity beyond the owner’s status.

• Potential disadvantages include double taxation on profits and complex regulations.

  • Example: Companies can be designated as 'Ltd' (limited liability) or 'Pty' (proprietary).

Role of the Financial Manager

• Chief Financial Officer (CFO) oversees decisions related to financing and cash management.

• Key responsibilities include:

  • Investment decisions (capital budgeting).

  • Financing decisions (capital structure).

  • Operational management (working capital management).

Principle of Finance

Principle 1: Time Value of Money

• Money today is worth more than the same amount in the future due to earning potential (interest).

  • Opportunity costs arise if not invested immediately.

Principle 2: Risk-Return Trade-Off

• Acceptance of higher risk requires higher expected returns.

  • Example: High-risk investments may offer greater rewards but come with the possibility of losses.

Principle 3: Cash Flows are the Source of Value

• Cash flow represents actual available money, influencing business valuation.

• Profit doesn't necessarily equate to cash flow.

Principle 4: Market Prices Reflect Information

• Share prices adjust quickly to new information, reflecting investor expectations and market efficiency.

Principle 5: Individuals Respond to Incentives

• Incentives drive managerial decisions; misalignment can create agency costs affecting shareholder value.

  • Example: Managers may resist taking risks that could improve shareholder value due to personal job security concerns.

Ethical Considerations in Finance

• Ethics are fundamental for trust and cooperation in business.

• Historical lapses in ethical behavior (e.g., Enron) highlight the importance of accountability and trust.

  • Ethical frameworks encourage sound decision-making to avoid conflict and align with shareholders' interests.

Conclusion

• Understanding financial principles is vital for managing corporate and personal finances, making informed decisions that maximize value and align stakeholder interests.