DG

LECTURE #1 - Basic Finance - Role of Management

Lecture Overview

  • Title: Managing Finance Role of Management

  • Prepared by: Roy Bauelua

  • Institution: Divine Word University

  • Department: Business Studies

Learning Objectives

  • Understand the history of financial management.

  • Grasp the financial goals driving firm decisions.

  • Recognize the limitations of profit maximization.

  • Acknowledge risk-return trade-offs in financial decisions.

  • Explore ethical dilemmas faced by managers.

  • Gain an overview of key financial decision areas.

Overview of Financial Management

  • Financial managers are a vital part of the management team.

  • Management roles include planning, organizing, leading, and controlling.

  • The primary function of the financial manager is effective finance management.

Early Functions of Financial Management

  • Objective: Maximize the firm's value and profit relative to investments.

  • Long-term maximization may require short-term unprofitable activities.

  • Accurate definition and measurement of profit are crucial.

The Contribution of the Financial Manager

  • Must possess knowledge in various fields:

    • Financial and Management Accounting

    • Law

    • Economics

    • Quantitative Methods

    • Taxation

  • Financial management involves acquiring resources for business operations effectively.

  • Finance should be procured in favorable markets and used economically.

Specific Functions of a Financial Manager

  • Ensure that funds are:

    • Available at the right time.

    • Available for the appropriate duration.

    • Obtained at the lowest cost.

    • Utilized efficiently.

Maximization of Shareholders' Wealth

  • Definition of Shareholders:

    • Legal owners of the firm.

  • Shareholders' wealth maximization applies to large companies and SMEs.

  • Sometimes termed maximization of owners' wealth.

The Agency Problem

  • Managers may not act to maximize shareholders' wealth unless it benefits them.

  • There is a separation between business owners and management, leading to potential conflicts of interest.

Addressing the Agency Problem

  • Practices such as stock options can mitigate the agency problem by aligning managers' interests with those of shareholders.

  • Agency costs arise from these practices.

  • Historical reference: Enron Corporation scandal, resulting in significant shareholder loss ($63 billion).

Ethics in Financial Management

  • Ethical behavior involves "doing the right thing."

  • Variability in individual values can complicate ethical definitions.

  • The importance of ethics discussions is increasing in business education.

Ethical Dilemmas in Decision-Making

  • Questions to consider:

    • Use of funds for unintended purposes.

    • Withholding critical information.

    • Selling prohibited products.

    • Misleading labeling practices.

    • Environmental impacts of operations.

Ethical Obligations of Financial Managers

  • Financial managers are tasked with maximizing shareholder wealth ethically.

  • Ethical misconduct can exacerbate agency problems.

Functions of Financial Management Revisited

  • Emphasizing the importance of interrelated functions for effective financial management.

  • Timing and cost-effectiveness of funds are critical for achieving firm objectives.

Consequences of Poor Financial Management

  • Example scenario:

    • Project requiring K100,000 delayed by poor fund management can incur additional costs.

  • Incorrectly timing fund availability or incurring high-interest loans can lead to losses.

Financial Decisions and Risk-Return Trade-Off

  • All financial decisions involve a risk-return trade-off.

  • Higher risk is typically accompanied by higher expected returns.

  • Assessing and balancing these trade-offs is essential for shareholder value maximization.

Investment Examples

  • Investors require higher returns for riskier stock investments.

  • Managing working capital: Lower inventory can raise returns but increases the risk of stock-outs.