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• Historical reference: Enron Corporation scandal, resulting in significant shareholder loss ($63 billion).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