LECTURE 1 Introduction to Financial Management

Page 1: Introduction to Financial Management

• Overview of financial management and its significance in achieving organizational objectives.

Page 2: Learning Outcomes

• Upon completion of this lecture, students should be able to:

  • Explain the nature of financial management.

  • Understand the purposes of financial management:

    • Raising finance.

    • Allocation of financial resources.

    • Maintaining control over resources.

  • Define and distinguish between:

    • Financial management.

    • Financial accounting.

    • Management accounting.

  • Explain the relationship between financial management and accounting fields.

Page 3: Financial Objectives

• Features of financial objectives:

  • Shareholder wealth maximization.

  • Profit maximization.

  • Understanding agency relationships and strategies to minimize associated problems.

Page 4: Key Responsibilities of Financial Managers

• Efficient acquisition and use of short- and long-term financial resources.

• Achieving organizational objectives through strategic financial management.

Page 5: Focus Areas for Financial Managers

• Key areas of decision-making for financial managers include:

  • Setting corporate financial objectives.

  • Financial decisions in:

    • Investment (assessing potential projects).

    • Finance (sources of funds).

    • Dividends (distribution to shareholders).

  • Resource control for effective utilization.

Page 6: Economic Environment and Risk Management

• Financial managers must consider the broader economic context and potential risks related to financial decisions.

Page 7: Investment Appraisal

• Investment appraisal focuses on:

  • Long-term planning.

  • Identifying and selecting appropriate projects to meet financial objectives.

  • Initial investments in non-current assets.

Page 8: Working Capital Management

• Essential for daily operations:

  • Management of liquidity by ensuring timely collection of debts and maintaining minimal inventory.

  • Proper investment of cash balances and timely payments to creditors.

Page 9: Sources of Finance

• Importance of identifying suitable financing sources, considering:

  • Company requirements.

  • Investor demands.

  • Available funding amounts.

Page 10: Distinction of Financial Management

• Financial management differs from:

  • Financial Accounting: Focuses on historical results of past decisions.

  • Management Accounting: Involves control and decision-making for day-to-day operations.

Page 11: Long-term vs Short-term Focus

• Financial management emphasizes long-term finance and resource allocation.

• Management accounting typically operates within a 12-month time frame.

Page 12: Functions of Management Accounting

• Aids in:

  • Budgeting.

  • Cost accounting.

  • Variance analysis.

  • Evaluating short-term resource allocation options.

Page 13: Importance of Financial Accounting

• Provides historical data on past decisions for stakeholders.

• Maintains transparency about the overall financial position without involving intricate internal management details.

Page 14: Role of Financial Manager

• Key personnel include:

  • Treasurer: oversees cash management and financial planning.

  • Controller: manages financial statements and taxes.

Page 15: Business Organization Types

• Various legal forms include:

  • Sole Proprietorship.

  • Partnership (general and limited).

  • Corporation.

Page 16: Sole Proprietorship Features

• Owned by a single individual.

• Advantages:

  • Simple formation process, minimal costs, full owner control of profits.

• Disadvantages:

  • Unlimited liability, limited equity, business ends with owner's death.

Page 17: General Partnership Characteristics

• Involves two or more owners with:

  • Unlimited liability.

• Advantages:

  • Simple organization, minimal regulations.

• Disadvantages:

  • Unlimited liability for partners, difficulty in capital raising.

Page 18: Limited Partnership

• Comprises:

  • General partners (unlimited liability).

  • Limited partners (liability limited to investment).

• Advantages:

  • Improved capital raising, continuity despite limited partner changes.

Page 19: Disadvantages of Limited Partnership

• Limitations include:

  • Mandatory general partner.

  • Limited partners cannot manage business or be named in the firm title.

  • Higher establishment costs due to necessary documentation.

Page 20: Corporate Structure

• Corporations are distinct entities from owners, providing:

  • Ability to sue, acquire property, and transfer ownership through shares.

  • Governed by shareholders through a board of directors.

• Advantages:

  • Limited liability, easier ownership transfer, sustained longevity, capacity for capital raising.

Page 21: Challenges of Corporations

• Noted difficulties include:

  • Complexity and costs in establishment and termination.

  • Tax burdens and legal restrictions.

Page 22: Financial Objectives Overview

• Companies are created for shareholder profit maximization:

  • The core aim is to maximize shareholder wealth, a key part of financial management.

Page 23: Alternatives to Wealth Maximization

• Profit maximization, while an alternative, presents issues like:

  • Short-term focus.

  • Ignoring cash flows and time value of money.

  • Risk factors neglected.

Page 24: Short-Term Nature of Profit Maximization

• Case study of ABC Co.'s choice to boost earnings:

  • Risks affecting investments in long-term growth like R&D and repairs.

Page 25: Project Return Timing

• Comparison of two investment projects:

  • Importance of timing in returns influences choices and perceived value.

Page 26: Evaluating Projects

• Profit understanding indicates that earnings need adjustments for timing:

  • Preference for earlier cash flows due to reinvestment potential.

Page 27: Time Value of Money

• Early earnings yield better value:

  • Project A's advantages over Project B are highlighted through financial calculations.

Page 28: Further Illustration on Returns

• Comparison of Project X and Project Y earnings over three years and reinvestment rates.

Page 29: Total Returns Analysis

• Financial comparison shows:

  • Project X demonstrates higher return potential due to earlier earnings.

Page 30: Conclusion on Project Evaluation

• Despite equal nominal earnings, Project X provides superior financial outcomes when properly analyzed for timing and reinvestment.

Page 31: Risk Characteristics of Profit Maximization

• Risk defined by potential deviations from expected results with examples of product performance forecasting.

Page 32: Earnings Comparison between Products

• Analysis indicates projected earnings need risk considerations beyond surface totals.

Page 33: Evaluating Risk vs Return

• Higher earnings from risky products need compensation through higher expected returns for stakeholders.

Page 34: Risk Evaluation Using Two Projects

• Examination of economic conditions against profitability for Projects A and B, underlining risk considerations.

Page 35: Average Earnings Misconception

• Profits perceived as equal without assessing risks associated with economic variability.

Page 36: Project Equivalence Misjudgment

• Interpretation error in risk assessment of potential returns from differing projects under varying economic conditions.

Page 37: Agency Theory Overview

• Explanation of principal-agent dynamics in corporate governance:

  • Conflicts between shareholders (principals) and management (agents).

Page 38: Principal-Agent Relationship

• Visual representation of how agents undertake tasks on behalf of principals.

Page 39: Agency Theory and Management Actions

• Managers viewed as agents with possible conflicts of interest regarding shareholder objectives.

• Structure pivotal to aligning management decisions with principal objectives.

Page 40: Aligning Managerial Interests

• Strategies to ensure managerial actions align with shareholder goals:

  • Clear compensation structures, linking rewards to shareholder wealth, and synchronizing timelines and risk perceptions.