1. Financial Management I
BBA-II

2. Chapter 1 An Overview of Financial Management

3. Learning Objectives
The purpose of this chapter is to give you an idea of what financial management is all about.
Key aspects of this course would include:
Forces that will affect financial management in future.
The place of finance in a firm’s organization.
The relationships between financial managers and their counterparts .
The goals of a firm.
The way financial managers can contribute to the attainment of these goals.

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

5. Role of Financial Management
Why is financial management important?
The goal of the firm
Organization of the financial management function

6. Investment Decisions Most important of the three decisions.
Includes issues like:
What is the optimal firm size?
What specific assets should be acquired?
What assets (if any) should be reduced or eliminated?

7. Financing Decisions
Determine how the assets (LHS of balance sheet) will be financed by RHS of the balance sheet.
Includes issues like:
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy?
How will the funds be physically acquired?

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

9. What is the Goal of the Firm?
Maximization of Shareholder wealth Value creation occurs when we maximize the share price for current shareholders.

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

11. B. Earnings Per Share Maximization: Maximizing earnings after taxes divided by shares outstanding.
Problems:
Does not specify timing or duration of expected returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.

12. Strengths of Shareholder Wealth Maximization
Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors.
Thus, share price serves as a barometer for business performance

13. The Modern Corporation
There exists a SEPARATION between owners and managers.
Modern Corporation
Shareholders
Management

14. Role of Management
Management acts as an agent for the owners (shareholders) of the firm.
An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.

15. Agency Theory
Jensen & Meckling developed a theory of firm based agency theory.
Agency theory is a branch of economics relating to behavior of principals & their agents.
Principals must provide incentives so that management acts in principals’ best interests & then monitor results.
Incentives include stock options, perquisites & bonuses.

16. Agency Relationships
A potential conflict of interests between the agent (manager) and (1) the outside stockholders or (2) the creditors (debt holders)

17. Cont’d Stockholders versus managers
Managerial compensation
Direct intervention by shareholders
The threat of firing.
The threat of takeovers.
Stockholders (through managers) versus creditors.

18. Career Opportunities in Finance
Money & Capital markets: deals with securities markets and financial institutions.
Investments: which focuses on the decisions made by both individual and institutional investors as they chose securities for their investment portfolios.
Financial Management or Business Finance: involves decisions within the firms.

19. Role of Finance in a Typical Business Organization

20. Responsibility of Financial Staff
Maximize stock value by:
Forecasting and planning
Investment and financing decisions
Coordination and control
Transactions in the financial markets
Managing risk
Note: The key responsibility of financial staff is to align the goals of the corporation with the maximization of its stock price. Will be covered in following slides.

21. Financial Management in the New Millennium
The effect of changing technology (Information technology).
Globalization
Improvement in transportation and communication has lowered shipping costs.
Increased demand of low cost, high quality products.
Increased costs of developing new products due to R&D expenditures.
International markets have opened new avenues for new and existing products.

22. Forms of Business Organization
Sole proprietorship
Partnership
Corporation

23. Sole proprietorships & Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life

24. Corporations Advantages Disadvantages Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of set-up and report filing

25. Managerial Actions to Maximize Shareholder Wealth
Dividend Policy Decisions
DOES IT MAKE SENSE TO TRY TO MAXIMIZE EARNINGS PER SHARE????

26. Major Factors Affecting Stock Price
Projected cash flows to shareholders
Timing of the cash flow stream
Riskiness of the cash flows

27. Factors that Affect Level & Riskiness of Cash Flows
Decisions made by financial managers:
Investment decisions
Financing decisions (the relative use of debt financing)
Dividend policy decisions
The external environment

28. Business Ethics
Do it Yourself