Financial Management Role of Financial Manager Goals of Financial Management MARCELA HERTNEKYOVA
MAIN GOAL: MAXIMISE PROFIT SMALL BUSINESSES - managed and run by the owners of the business MAIN GOAL: MAXIMISE PROFIT LARGE BUSINESSES (CORPORATIONS) - typically owned by shareholders not involved in running the business on a day to day basis. MAIN GOAL: MAXIMISE CORPORATION’S VALUE WHILE REDUCING FINANCIAL RISK FINANCIAL MANAGERS make decisions on behalf of the shareholders
Organizational chart
KEY DECISIONS TO BE MADE INVESTMENT DECISIONS FINANCE DECISIONS DIVIDEND DECISIONS LONG TERM DECISIONS SHORT TERM OPERATIONS (managing cash, inventories, short term borrowing or lending) SHORT TERM DECISIONS
INVESTMENT DECISIONS INTERNAL INVESTMENT PROJECTS - New product development - Major equipment purchases - Opening new factory or store EXTERNAL INVESTMENT PROJECTS - Company Takeover - Merger DISINVESTMENT - Selling off unprofitable segment of the firm
FINANCING DECISIONS HOW FINANCES WILL BE OBTAINED ? DEBT FINANCING - Issue of bonds or debentures - Bank Loan EQUITY FINANCING - Share Issue - Retained Earnings MIXTURE OF BOTH
- DIVIDEND PAYMENTS → to satisfy shareholders DIVIDEND DECISIONS THE PROPORTION OF COMPANY PROFITS TO BE DISTRIBUTED TO SHAREHOLDERS - DIVIDEND PAYMENTS → to satisfy shareholders THE PROPORTION OF COMPANY PROFITS TO BE RETAINED BY THE COMPANY - RETAINED EARNINGS → to finance future growth
GOALS OF FINANCIAL Management Survive Avoid Bankruptcy Maximise Profit Minimise Cost Maximise Sales/ Market Share Corporations: Maximise Shareholders Wealth - Current market value per share of the existing stock - The size of the company’s dividend payments
AGENCY PROBLEM Agency Relationship PRINCIPAL: Shareholders (Wealth Maximisation) AGENT: Management (Salary, Employment Security, Prestige and Position) Agency Problem : The possibility of conflict of interest between shareholders and management of a firm →AGENCY COST (direct & indirect)
Why Maximising Profit is not our main goal but Maximising Shareholders wealth or the share price is our main goal Company A – Funded by 400,000 $1 Shares and $600,000 Debt Finance – Profit $70,000 – due to interest expense that we receive a tax deduction for Return per share - $70,000 / 400,000 = 17.5 cents per share Company B Funded by 1,000,000 $1 Shares – Profit $100,000 Return per share = 10 cents pershare
SOLUTION TO AGENCY PROBLEM How closely are management goals aligned with shareholders goals? MANAGEMENT COMPENSATION ● SHARE OPTIONS: Compensation tied to financial performance ● CAREER PROSPECTS: Promotion, Higher Demand- Salary Can management be replaced if they do not pursue shareholders goals? CONTROL OF THE FIRM ● Board of Directors: can fire and hire management on their behalf ● Replacement of management by takeover- poorly managed firms are more attractive for takeover as greater profit potential exists
NON- FINANCIAL OBJECTIVES Employees (welfare, safety, salary and conditions) Customers (safe products and services) Government (compliance with legislation) Community (pollution, public safety, welfare)
Financial managers Capital Budgeting: planning and managing a firm’s long term investments - Identify long term investment opportunities - Evaluate size, timing and risk of future cash flows Capital Structure: obtaining finances to support long term investments - Deciding on the specific mixture of long-term debt and equity - Where and how to raise the money ? - Evaluating different financing options and associated costs Working Capital Management: ensuring that firm has sufficient resources to continue its operations - How much cash and inventory to keep at hand? - Should credit sales be offered to customers? - How will short-term financing be obtained? Dividend Payout decision
Financial management Summary