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Financial Management

Chapter 1

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4 views

Financial Management

Chapter 1

Uploaded by

shafeza zulaikha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 1

Introduction
to Financial
Management
Learning Objectives

❑ Financial Markets and Business Organizations


❑ Goals of the Firm
❑ Functions of Financial Manager
❑ Risk and Return Relationship
What is Finance?

▪ Finance is the art and science of


management of money and other assets.
▪ 3 areas of finance:
- Personal finance
- Public finance
- Corporate finance
What is Financial Management?

“ A process involved in an attempt to obtain


and allocate financial resources effectively
and efficiently to achieve the firm’s goal that
is to maximize the shareholder’s wealth by
maximizing share price”
Financial Markets

❑ An organization that is responsible for the


distribution of funds to the end user.
❑ Provide sources of funds to the deficit unit.
❑ Types :
- Primary market
- Secondary market
- Money market
- Capital market
Supplier and Demanders of Funds
□ Also known as surplus & deficit units
□ Consists of Households, Govt, Firms
□ They are the provider of funds and receiver
of funds
□ Provider of funds – purchasing financial
assets (i.e. financial instruments) offered by
deficit units or financial institutions
□ Receiver of funds – issued financial assets
Financial Market
Money Market vs. Capital Market

▪ Transaction of long term securities


▪ Transaction of short term securities (or no maturities)
▪ The securities are very liquid ▪ Comprise of primary and secondary
market

Primary Market vs. Secondary Market

▪ When a corporation issues securities, ▪ Involve the sale of “used” securities


cash flows from investors to the firm. from one investor to another.
▪ Usually an underwriter is involved ▪ Securities may be exchange traded or
trade over-the-counter in a dealer
market.
Forms of Business Organization

1 2 3

Sole
Partnership Corporation
Proprietorship
1. Sole Proprietorship

Owned by 1 person 1 4 Easy to form

Termination occurs-
Owner may gain all
Profit/ suffer all losses 2 5 owner’s death
@owner’s choice

Difficult to exploit new Tax impose on personal


business 3 6 income
2. Partnership

Owned by 2 or more
person 1

Profit and loss sharing by


2 mutual agreement

Can raise more capital 3

Tax impose on personal


4 income
3. Corporation

A separate legal entity


Life of corporation does
-Can be sued, sue,
purchase, sell and own 1 4 not depend on the
Status of its owner
property

Shareholder’s liability is
restricted 2 5 Easy to transfer ownership

Managers & stockholders


Double taxation 3 6 is a separate group
Functions of Financial Manager

Forecasting and Planning

Investment and Financing Decisions

Controlling and Coordinating

Dealing with the Financial Market


The Financial Manager

To create value, the financial manager should:


1. Try to make smart investment decisions.

2. Try to make smart financing decisions.


Financial Management Decisions

01 02
Capital Budgeting Capital Structure

03
Working Capital Management
Financial Management Decisions

Capital The process of planning and managing a


Budgeting firm’s long-term investments

Capital The mixture of debt and equity maintained by


Structure the firm

Working
How to finance daily operations
Capital
A firm’s short-term assets and liabilities
Management
Possible Goals of Financial
Management

▪ MAXimization of Share Price


▪ MAXimization of Profit
▪ MAXimization of Sales
▪ MINimization of Risk
Goals of Financial Management

Maximization of Shareholder Value

The primary goal is shareholder’s wealth


maximization, which translates to
maximizing stock price.
Goals of Financial Management

❑ To achieve wealth maximization objective, the


firm requires:

a) Efficient and low cost operations


b) Development of new technologies and products
c) Providing efficient and courteous services.
Goals of Financial Management
□ Profit Maximization
To obtain Profit as much as possible
Reasons:
■ Maintain its operating stability
■ Maintain growth
■ Reward to stakeholders (i.e. contributors of idea,
capital etc)
Goals of Financial Management

The Problems of Profit Maximization :


■ Time Horizon (i.e. short-term profit)
■ Timing of Returns (i.e. ignore future project)
■ Distributions of Returns (i.e. dividends)
■ Risk (i.e. ignore risk factor)
Risk and Return
▪ RISK is the chances that real outcomes are not in line with
expectation (☹)
▪ RETURN is the benefits that an investor will receive from an
investment over some period (Keown, XXXX). It is normally
expressed in a % form.
▪ Risk-Return Tradeoff - the relationship between risk and
return, in which investments with more risk should provide
higher returns, and vice versa.
▪ For example, a government Treasury bond is considered to
be one of the safest investments and, when compared to a
corporate bond, provides a lower rate of return.
RISK-RETURN TRADEOFF
Risk- Return Trade-off

EXPECTED
RETURN
RETURN

Y1

0
RISK
CLASSIFICATION OF RISK
Classification of Risk

SYSTEMATIC RISK UNSYSTEMATIC RISK


(Market Risk) (Non-Market Risk)
▪ The systematic risk is a ▪ Unsystematic risk is a diversifiable
non-diversifiable risks that risk that is unique only to a
cannot be eliminated no matter particular company
how many ▪ These are the risks that occur
securities are held in investment inside or within the company,
portfolio and thus within the financial
▪ The risks occur outside the manager's
company and beyond the control
financial manager's control ▪ Factors: New competition,
▪ Factors: inflation, recessions, lawsuits, etc
interest rate, political attitudes,
etc
The possible correlation is:
1. Positive correlation;
□ The securities involved has a direct
relationship; an increase risk in one security,
tend to increase risk in another
2. Negative correlation;
□ The securities involved has an inverse
relationship; an increase risk in one security,
tends to reduce risk in another
3. Zero correlation;
□ The securities involved has no relationships
with one another
The Expert In Anything Was Once A
Beginner

- Helen Hayes -

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