Nature of Financial Management By Lucky Yona Management Consultant- ESAMI

Coverage Introduction Finance Functions Financial Manager’s Role Financial Goals of the Firm Management Objectives Review Questions

Introduction Financial Management is a managerial activity concerned with planning and controlling financial resources of an organization A branch of Economics till Though it is a separate discipline it borrows heavily on economics for its theoretical concepts.

Finance Functions Making Investment Decisions Making Financing Decisions Dividend ( Profit Allocation Decisions) Liquidity Decisions

Investments Decisions It involves the decision of allocation of capital or commitment of funds to long term assets that would yield benefits in the future. Aspects of investment decisions The Evaluation of the prospective profitability of new investments Measurement of a cut-off rate ( opportunity cost of capital ) against the prospective return of new investments.

Investment Decisions The investment decision may also involve The Identification of investment Opportunities Evaluating them Deciding on the optimum allocation of scarce funds available between investments. Forms of Investment Decision Undertaking New Projects Take-over Merger with another company.

Financing Decisions It involves making decision on when, where and how to acquire funds to meet firm’s investment needs. The central issue is to determine the proportion of equity and debt ( Capital Structure). The issue here is to obtain the best financing mix or the optimum capital Structure. However, many factors in deciding the capital structure need be considered such as control, flexibility, loan covenants and legal aspects.

Dividend Decisions A third major financial Decision. Decision on whether the firm should distribute all profits or retain them, or distribute a portion and retain the Balance. Dividend decisions will determine the dividend policy in terms of impact to shareholders value.

Liquidity Decisions Current Assets management for safeguarding the firm against the dangers of illiquidity and insolvency. Liquidity and profitability trade off must be reached to avoid these problems.

Financial Manager’s Roles Traditional Roles Routine Finance Questions such as - Supervision of cash Receipts & Payments - Custodian of Assets - Record Keeping and Reporting Modern Roles ( Managerial Functions Raising of Funds Allocation of Funds Profit Planning ( e.g Pricing, Costs, Volume etc) Understanding Capital Markets

Specific Functions- Summary The specific functions of the financial manager are to ensure that funds are made available at the right time made available for the right length of time obtained at the lowest cost used in the most effective way.

Financial Goals of the Firm There are main two financial Goals of the firm 1. Profit Maximization Goals- The main issue here is to make profit. This objective has been recently criticized in recent years Why ? It is vague it ignores the timings of returns- There is no distinction between returns received in different time periods. It ignores risk Definition of term profit is ambiguous. Does it mean Profit before tax or after tax? Does it mean short term profit-or long term profit? Total profits or profit per share?

Financial Goals of the Firm 2. Shareholder’s Wealth Maximization The goal of the firm is to maximize the wealth of the owners for whom it is being operated. The wealth is measured by share price of the stock. Therefore managers should accept only those actions that are expected to increase share price. Any Financial decision which does not increase share price should be rejected. However, it is considered important to take into account to broaden the focus to include the interests of stakeholders as well as shareholders

Management Objectives Growth Objective- Especially non- Profit making Organizations such as services organizations, where the profit motive cannot operate.

Risk Reduction or Minimization Most profitable companies carry a high risk of expensive projects such as prospecting oil or mining companies. In case of a rich strike they make big profits however they can make huge losses in case exploration proves abortive. In this case management objective can be to ensure survival by the avoidance of risk, profit becoming a secondary objective.

Social Objectives A social Purpose as a management Objective Concerned about improvement of employees working conditions Provide a wholesome product for customers Avoid anti-social actions such as environmental pollution or undesirable promotion practices.

Efficiency For organizations such as charities or public services the fundamental objective might be to provide a required service which is not supplied in the market place. A suitable management objective will be the provision of such service at minimum cost

Personal Aspiration Management team are likely to be highly motivated towards their own career objectives. In this case the important objectives for the manager may be therefore the improvement of his salary, career prospects or security. The consequences of this is a managers desire to get quick results which will stand to the immediate credit of the manager involved as against more solid but longer term profit making objectives.

Financial Objectives and Financial Management in Governments Financial management in government is different from financial management in an industry or commercial company because: Government departments do not operate to make profits, Government services are provided without the commercial pressure of competition and ‘ the market’. There are no competitive reasons for controlling costs, being efficient or keeping prices down The government departments have full time professionals Civil servants as their managers, but planning and control decisions are also taken by politicians,. The government gets its money from

Strategies to achieve Financial Goals A strategy may be defined as a course of action, including the specification of resources required, to achieve a specific objective. Strategy can be short term or long term Strategy depends on the objectives or targets. The starting point for strategy formulation is the identification and formulation of objectives.

Characteristic of Strategic Decisions. Strategic Decisions will be concerned with the scope of the organization’s activities Strategy Involves the matching of an organization’s activities to the environment in which it operates. Strategy involves the matching of an organization’s activities to its resource capability. Strategic decisions therefore involve major decisions about the allocation or-re-allocation of resources. Strategic decisions will be affected by Environment Considerations Resources Availability The Values of Expectations of the people in power within the organization

Characteristic of Strategic Decisions. Strategic decisions are likely to affect the long –term direction that the organization takes Strategic decisions have implications for change throughout the organization, and so are likely to be complex in nature.

Levels of Strategy Corporate Strategy - This is concerned with a broader issues such as ‘ what business are we in? – Financial aspects of this level of strategic decision making – include the choice of method in entering a market or business.

Business Strategy or Competitive Strategy This covers the question of how strategic business units compete in individual markets, and therefore of the resources which should be allocated to them. Competitive Strategy examines the threat on the performance of the company of factors such as The potential Charges in the Industry in which the firm operates, through entry of new competitors

The competition between existing firms in terms of costs, pricing and product quality The development of substitute products that may affect the industry as a whole The monopolistic power of individual companies in the input markets The monopolistic power of companies in the various product markets

Operational Strategy This is to do with how different functions within the business – including the finance function- contribute to the business strategies.

Discussion Questions 1.Discuss the likely consequences of the following errors in financial management (i) bad timing for capital raising (ii) inefficient capital raising (iii) Inefficient use of funds

2. How can a company achieve corporate social objectives in its day to day operations? Should the Government put some laws to ensure that Companies are contributing to social objectives in your country?

3. Define the scope of financial management. What role should the financial manager play in the modern enterprise?

Bad Timing of Capital Delays in business activities Possibility of Bankruptcy and possible liquidation Hampers Cash Flow Cost of Borrowing might be high Bad Timing - World Recession - Political Turmoil ( Internal ) – especially new business - Labour Unrest - Trade Policy- more restrictive

Inefficient capital raising Firm not in position to provide the required services Inability to honor its obligation Inability to achieve business objective Inability to pay dividends? Inability to acquire assets Inability to penetrate the Markets.

Inefficient use of Funds Inability to meet its obligation. Possibility of liquidation Denial of Services Loss of Confidence with investors Civil Unrest Inability to Compete Lead to Misallocation of resources. Overspending

Presentation-1 Bad Timing of Capital Raising Inability to implement the project Losses due to inflation, exchange rate fluctuations Loss of staff due to funds delays Time value of Money Increased cost of funds ( e.g Untimely implementations of the project Loss on anticipated profits Misallocation of funds to other projects Loss of control on investment decisions

Inefficient High Cost of raising the funds( High interest) Missing the targeted funds EPS is lower. Inability to implement projects

Innefficency - Failure to meet strategic goals - Problems with liquidity - Inability to meet social objectives - Impaired Growth -