1-1 Chapter 1 The Role of Financial Management Fundamentals of Financial Management Prepared by: Waseem Ullah Khan Kardan Institute of Higher Studies Kabul Afghanistan

1-2 The Role of Financial Management 1.What is Financial Management? 2.What is the Goal of the Firm? 3.Organization of the Financial Management Function:

1-3 The Role of Financial Management What is Financial Management? Financial management is a discipline which study all the matters related with acquisition of assets, financing of assets and management of assets with some overall goal in mind. We use (FM) as a short abbreviation for financial management

1-4 Continue… What is the Goal of the Firm? Firm is individual unit of business, when setting goals, financial manager see the basic financial requirement of business, how much money/capital will be required for: 1.Fixed capital 2.Working capital

1-5 Continue… Organization of the Financial Management Function: This means that financial manager will assign duty and responsibility to lower Level to complete the task/goal within stated time.

1-6 What is Financial Management? overall goal Concerns the acquisition, financing, and management of assets with some overall goal in mind.

1-7 Investment Decisions 1.What is the optimal firm size? 2.What specific assets should be acquired? 3.What assets (if any) should be reduced or eliminated? Most important of the three Decisions.

1-8 Investment Decisions u What is the optimal firm size You will decide the exact size of your business the very start of your business whether your business is of : 1. Small Scale Business 2. Medium Scale Business 3. Large Scale Business

1-9 Continue… What specific assets should be acquired? As finance manager you will specify which asset you will purchased 1 st,you will see the requirement of your business. The asset which is very much beneficial you will purchase 1 st then next.

1-10 Continue … What assets (if any) should be reduced or eliminated? As a manager finance you have purchased more assets and few of them are not working properly, so initially you will repair it,if still are not working properly you will sale it out.

1-11 Financing Decisions u What is the best type of financing? u What is the best financing mix? u What is the best dividend policy? u How will the funds be physically acquired?

1-12 Financing Decisions What is the best type of financing? To purchase your assets you will required money, so you will decide from which source I should arranged money. normally we arrange from three sources : 1.Short term financing 2.Medium term financing 3.Long term financing

1-13 Continue… What is the best financing mix? Financing mix means to use more then 1 option for arranging loan e.g 1.Mix 1 (short +medium term) 2.Mix 2 (short + long term) 3.Mix 3 (medium+ long term) Note: interest is used as tool in the selection of financial mix deciaion.

1-14 Continue… What is the best dividend policy? Financial manager will select the best dividend policy for profit declaration in annual general meeting (AGM). He will prefer a policy which will be attractive for shareholder and general share holders.

1-15 Continue… How will the funds be physically acquired? The financial manager will arrange fund, he will also maintain the fund in such a way that increase the assets of business in near future.

1-16 Asset Management Decisions u How do we manage existing assets efficiently? u Financial Manager has varying degrees of operating responsibility over assets. u Greater emphasis on current asset management than fixed asset management.

1-17 Continue… How do we manage existing assets efficiently? If the firm is not financially sound enough,so in such case the financial manager prefer to utilize the old asset with full capacity. As the firm is weak, so it can't afford new asset, so old asset is used with full swing.

1-18 Continue… Financial Manager has varying degrees of operating responsibility over assets. Financial manager perform his routine operating activity to control the organization financial matters. he maintain the asset with proper book keeping record.

1-19 Continue… Greater emphasis on current asset management than fixed asset management. Financial manager besides his other financial activities,he pay much attentions towards current asset and fixed asset management. He properly keep exact and accurate record.

1-20 What is the Goal of the Firm? Maximization of Shareholder Wealth! Value creation occurs when we maximize the share price for current shareholders.

1-21 Shortcomings of Alternative Perspectives u Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.). u Ignores changes in the risk level of the firm. Profit Maximization u Maximizing a firm’s earnings after taxes.Problems

1-22 The Modern Corporation There exists a SEPARATION between owners and managers. Modern Corporation ShareholdersManagement

1-23 Role of Management agent Management acts as an agent for the owners (shareholders) of the firm.

1-24 Continue… What is agent ? agent An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. What is principal? Principal is the owner of contract or business.

1-25 Agency Theory u Agency Theory u Agency Theory is a branch of economics relating to the behavior of principals and their agents. agency theory u Jensen and Meckling developed a theory of the firm based on agency theory.

1-26 Agency Theory stock options, perquisites, bonuses u Incentives include stock options, perquisites, and bonuses. incentives monitor u Principals must provide incentives so that management acts in the principals’ best interests and then monitor results.

1-27 Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Vice President Operations Vice President Marketing VP of Finance

1-28 Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning Organization of the Financial Management Function VP of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts