COLLEGE OF BUSINESS EDUCATION- DODOMA CAMPUS

Module name: Principles Financial Management

Module code: ACT06205

For
DA/DBA/DMK/DPS/DAF/DAT/DBAHRM/DMTEM

Prepared by: CPA Ngata, Charles

Introduction
The purpose of this course is to provide an analysis to
financial management.
The financial management function is an important part
of every hospitality organization.
Financial management is used to make key decisions
involving expansion, renovation, choice of location, and
many others.
Prepared by: CPA Ngata, Charles
 What is financial management?
To understand the meaning of financial management, let
us observe the following definitions;
a) It is the management of finances of an organization in
order to achieve its objectives.
b) Financial mgt is that area of General Management
which is concerned with the timely procurement of
adequate finance from the various sources and its utmost
utilization for the attainment of organization objectives.

Prepared by: CPA Ngata, Charles

Cont…
c) Financial mgt is an area of finance which is
concerned primarily with financial decision-making
within an organization.
d) Financial management may be defined as
planning, organizing, directing and controlling of
financial activities in an organization.
e) Financial management is concerning with optimal
procurement and effective utilization of funds in a
manner that the risk, cost and control consideration
are properly balanced in a given situation.
Prepared by: CPA Ngata, Charles
Definition cont’d
f) Financial management is concerned with managerial decision making.
Decision making is futuristic and requires information and criterion.
Information is deduced from accounting. Criterion demands logic which
emanates from economics.
g) Financial management involves acquisition and management of financial
resources for organization to maximize the values of shareholders’ claims.
On the basis of the aforesaid definitions, now financial management may
defined as follows:
Financial management is basically the application of the general
management principles to the areas of financial decision-making
( investment, financing, dividend & working capital ) with the view to
maximize the wealth of the shareholders of the company.
Prepared by: CPA Ngata, Charles
The objectives of the entity will be determined by the purpose for which it was established. This
might be setout in a charter or trustee arrangement. However, many of the general principles of
financial management are still available for these entities to help them manage their finances to
meet their objectives and maintain their duty of care to their key stakeholders. The differences
between financial management in the private and public sectors are diminishing as governments
seek to make the public sector more commercially aware

Prepared by: CPA Ngata, Charles

Basic questions for Financial Management
1. Where to invest?

Bank? Real estate? New venture? Social security funds companies? etc

2. From where to raise funds?

Own funds? Borrowings? Etc

3. How much earnings to be retained and how much to be distributed?

4. How to manage working capital?

The main objective of the financial manager is to ensure that, shareholders

wealth is Prepared
achieved.by: Generally,Wealth
CPA Ngata, Charles of company =f(I,F,D,W)
 Planning

Key elements of Financial Management.

Reporting Allocating
Resources

Managing
Performance
& Resources

Prepared by: CPA Ngata, Charles

 Objectives of financial management
Financial management has the following objectives:-

 To maximize profit.

To maximize Earning Per Share.

Minimize Costs

To maximize market share

To maximize the Current Value of the Company's’ Stock

Prepared by: CPA Ngata, Charles
Decisions of financial manager.

The finance function relates to four major decisions which the finance manager has

to take:
a) Investment decision.

b) Financing decision.

c) Dividend decision.

d) Working capital management

 The goal of the financial manager must be consistent with the mission of the
corporation. To maximize firm value shareholder’s wealth (as measured by share
prices).
Prepared by: CPA Ngata, Charles
Continued….
While managers have to cater to all the stakeholders (such as consumers,

employees, suppliers etc.), they need to pay particular attention to the

owners of the corporation, i.e., shareholders.

If managers fail to pursue shareholder wealth maximization, they will

lose the support of investors and lenders. The business may cease to exist

and ultimately, the managers will lose their jobs.

Prepared by: CPA Ngata, Charles
 Investment Decision
Relates to careful selection of assets in which funds will be invested by the firm. It can be long term or
short term investment decision. The purpose of investment decision is to invest financial resources for
setting up new business or for expansion. For example replacing old machine with new one or expansion
of company's branches
Decision taken are;
1) Capital budgeting decision i.e. how much to invest in long term assets?
2) Working Capital decision i.e. how much to invest in short term assets such as cash, debtors and
inventory?

Prepared by: CPA Ngata, Charles

Factors affecting investment decision
Capita budgeting decision Working capital decision

Case flows of the project Nature of the business

Cost of capital Business cycle fluctuations
Investment criteria involved Seasonal variations
Technology and production cycle
Credit policy
Price level changes
Market competition

Prepared by: CPA Ngata, Charles

Importance of investment decisions
Long term growth and effects.
Large amount of funds involved.
Risk involved
Irreversible decision

Therefore, Investment decisions are those which determine how scarce resources are
committed to projects; e.g. acquisition of new plant, takeovers and mergers, divestment
from unsuccessful projects.

Prepared by: CPA Ngata, Charles

Financing Decision
 Financing decision relates to the composition of relative proportion of various sources of

finance. It involves deciding the proportion of equity and debt in capital structure.

Sources of financing are analyzed in light of cost as well as financial risk involved.

 The purpose is to decide about the source from which funds should be raised to finance

the investment decision

 Decision taken:

 What should be the proportion of debt equity in the capital structure?

 From which source the equity should be raised?

 From which source debtby:should

Prepared be Charles
CPA Ngata, raised? Debentures or loans
Cont…
Finally, Financing decisions relate to acquiring the optimum finance to meet financial objectives and
seeing that non-current assets and working capital are effectively managed.

Prepared by: CPA Ngata, Charles

Dividend Decision
 Dividend decision involves whether to distribute profits as dividend to shareholders or to retain profits

and reinvest in the business. The main objective of dividend policy is to divide net earnings in an
optimum manner so as to pay dividend to shareholders and to retain earnings for reinvestment with the

objective of maximizing the wealth of shareholders.

Prepared by: CPA Ngata, Charles

cont’d
 Decisions include;

a) How much earnings should be retained for investment opportunities?

b) How much earnings should be distributed to shareholders?

Dividend decisions relate to the determination of how much and how frequently cash can be paid
out of the profits of an entity as income for its proprietors. However, decisions will be affected by
several factors which are financial requirements of the company, stability of dividend, capital
market considerations, preferences of shareholders, legal considerations , bonus shares and inflation

Prepared by: CPA Ngata, Charles

cont’d
 Therefore, the executive whom manages the financial affairs of a business is called ‘financial

manager’. The financial manager essentially has to manage funds and is concerned with the optimum
utilization of funds and with their procurement in a manner that the risk, cost and control
considerations are properly balanced in a given situation.

Prepared by: CPA Ngata, Charles

Duties of Financial Managers.
The financial managers of a firm plays an important role in
the company’s goals, policies, and financial success.
The financial managers responsibilities include:
Financial analysis and Planning: Determining the proper
amount of funds to employ in the firm i.e. designating the size
of the firm and its rate of growth.
Investment decision: The efficient allocation of funds to
specific assets.
Financing and capital structure decisions: raising funds
on as favorable terms as possible, i.e. determining the
composition of liabilities.
Management of Financial resources: such as working
capital Prepared by: CPA Ngata, Charles
The goals of the Firm.
Typical goal of the firm include:
Stockholders/Shareholders wealth maximization.
Profit maximization.
Managerial reward maximization.
Behavioral goals.
Social responsibility.
Modern managerial finance theory operates on the
assumptions that the primary goal of the firm is to maximize
the wealth of its stockholders, which translates into
maximizing the price of the firm’s common stock.
The other goals mentioned above also influence a firm’s
policy but are less important than stock price maximization.
Prepared by: CPA Ngata, Charles
Main goal of the firm
Maximization of Shareholder Wealth!
What is wealth maximization

 The ability of a company to increase the value of its stock for all the stakeholders is referred to as
Wealth Maximization.

 It is a long-term goal and involves multiple external factors like sales, products, services, market
share, etc. It assumes the risk and recognizes the time value of money given the business environment
of the operating entity.

 Value creation occurs when we maximize the share price for current shareholders

Prepared by: CPA Ngata, Charles

Shareholder Wealth Maximization
In a Shareholder Wealth Maximization model (SWM), a
firm should strive to maximize the return to shareholders,
as measured by the sum of capital gains and dividends, for
a given level of risk.
Alternatively, the firm should minimize the level of risk to
shareholders for a given rate of return.

Prepared by: CPA Ngata, Charles

Shareholder wealth maximization
The SWM model assumes as a universal truth that the stock
market is efficient.
An equity share price is always correct because it captures all the
expectations of return and risk as perceived by investors, quickly
incorporating new information into the share price.
Share prices are, in turn, the best allocators of capital in the macro
economy

Prepared by: CPA Ngata, Charles

Implication of the wealth maximization
i. The Concept of wealth maximization is universally
accepted, because it takes care of interest of financial
institution, owners, employees and society at large.
ii. Wealth maximization guides the management in framing
the consistent strong dividend policy to reach maximum
returns to the equity holders.
iii. Wealth maximization objective not only serves the
interest of the shareholder’s by increasing the value of their
holdings but also ensures the security to the lenders.

Prepared by: CPA Ngata, Charles

Profit Maximization
a) What is profit maximization?
The process of increasing the profit earning capability of the
company is referred to as Profit Maximization. It is mainly a
short-term goal and is primarily restricted to the accounting
analysis of the financial year. It ignores the risk and avoids
the time value of money. It is primarily concerned as to how
the company will survive and grow in the existing competitive
business environment.

Prepared by: CPA Ngata, Charles

Profit Maximization
Earning profit is the main aim of any economic activity. A
firm, being an economic entity, should aim at earning in order
profit to not only cover its costs but also ensure availability of
funds for growth.
However, profit maximization as a goal of a firm has been
criticized on the following ground
The profit maximization goal is a short term concept
The profit maximization goal ignores the time value of money
The risks associated with the prospective stream of earnings
and the effect of dividend policy on the market prices of
shares are not considered under this goal.

Prepared by: CPA Ngata, Charles

Difference between wealth and profit maximization
Basis Wealth maximization Profit maximization

Definition It is defined as the management of financial It is defined as the management of financial

resources aimed at increasing the value of the resources aimed at increasing the profit of
stakeholders of the company. the company.

Focus Focuses on increasing the value of the Focuses on increasing the profit of the
stakeholders of the company in the long term. company in the short term.

Risk It considers the risks and uncertainty inherent It does not consider the risks and uncertainty
in the business model of the company. inherent in the business model of the
company.

Usage It helps in achieving a larger value of a It helps in achieving efficiency in the

company’s worth, which may reflect in the company’s day-to-day operations to make
increased market share of the company. the business profitable.

Prepared by: CPA Ngata, Charles

Agency theory
A principal-agent relationship exists where one party
appoints another to fulfill certain responsibilities on their
behalf. Generally, the agent should act in the best interests of
the principal and should not aim to benefit at the expense of
the principal.
Agency Theory is about the conflict that may arise between
management and owners where owners are not also the
managers. It is a branch of economics relating to the behavior
of principals and their agents.
Management may not always act in the best interest of the
owners because management has interest of its own, like
personal wealth, job security, lifestyle, and benefits. Thus,
these concerns Prepared
may by: conflict with shareholder interests.
CPA Ngata, Charles
Cont..
The pursuit of socially or ethically acceptable goals may have
to come at the expense of shareholder’s wealth.

Prepared by: CPA Ngata, Charles

Cont….
Shareholders are the legal owners of companies but because,
many times, they are not in a position to run the company on
a daily basis, directors are appointed. The overriding goal of
financial management is maximisation of shareholder wealth.
It is the duty of the directors (agents) to act in the best
interests of the shareholders (principals), never aiming at
personal gain at the cost of the shareholders.

Prepared by: CPA Ngata, Charles

Cont…

Prepared by: CPA Ngata, Charles

Cont…
There are other agency relationships in the company as well,
such as:
1. Directors/ shareholders and creditors
The directors and shareholders (acting through the directors)
are responsible for safeguarding the money the
company owes to the creditors and repaying them on time.
2. Employees and management
The employees of the company, in the discharge of their
duties, perform numerous acts on behalf of the company.
Therefore, they are the agents of the managers / shareholders
as they are responsible for fulfilling the duties
allocated to them.
Prepared by: CPA Ngata, Charles
Cont..
3. Directors / shareholders and customers
The customers expect certain standards to be fulfilled as
regards quality and credibility. Directors need to
ensure that these expectations are met at all times to achieve
customer loyalty

Prepared by: CPA Ngata, Charles

The agency problem
1. Directors vs. shareholders
The agency problem arises when the directors, as agents,
have different aims and objectives from the shareholders, as
principals; there is said to be a conflict of objectives. The
directors may seek to further their own interests rather than
shareholder wealth, in the following ways:
(a) Directors may design remuneration packages which are
beneficial to them, e.g. during a period of high profits; they
may keep the fixed element of remuneration packages
relatively low, but award higher percentage bonuses linked to
profits. Alternatively, in times of low profits, fixed
remuneration may be increased.
Prepared by: CPA Ngata, Charles
Cont…
(b) Directors will want to ensure that they are seen to be
‘earning their keep’. They may therefore focus on short term
profitability, opting for projects with shorter payback periods
and better short-term profits, ignoring the projects which may
give better long-term results and stability to the company.
(c) Some directors, in order to gain power and prestige, may
engage in ‘empire building’. They may therefore engage in
unprofitable takeover bids.
(d) As a means of artificially boosting the results, directors
may engage in creative accounting practices e.g. off
Statement of financial position financing.

Prepared by: CPA Ngata, Charles

Cont..
(e) To achieve a wider public profile, managers may go
for diversification, which may not be what shareholders
desire. It may result in a loss of focus on the core
business activity.
(f) The managers may push forward social projects where
they have personal interests e.g. funding the construction
of a gym at the school of the finance director’s son. If the
above is allowed to continue, the personal objectives of
the managers become a priority, thereby relegating the
objectives of the shareholders.

Prepared by: CPA Ngata, Charles

Cont…
2. Management (directors) vs. employees
As the earnings of the company improve, the employees may
believe that they need to be rewarded adequately on a
consistent basis. They may look forward to additonal bonuses
apart from regular salaries. Furthermore, employee unions
may exert force on the management if their demands are not
fulfilled.
3. Creditors vs. management
Creditors to whom the company owes significant sums of
money may wish to exercise greater control on the company.
They may require regular reports on operating revenue,
financial status, project progress etc, which
management may resist
Prepared by: CPA Ngata, Charles
Cont…
4. Customers vs. management (shareholders)
Customers may have strict preferences and may exercise
resistance to changes in products. Management may
sometimes be constrained between consumer interest vs.
cost considerations.
Furthermore, in all the above conflicts, the additional
conflict arising out of the effect of government /
regulatory interventions cannot be ignored.

Prepared by: CPA Ngata, Charles

Overcoming/mitigating Agency Problem
The cost associated with the agency problem is called agency
costs.
Agency Problem can be mitigated through:
1. Market forces
There are certain market forces which may operate to
reduce / eliminate agency problems.
(a) Certain large institutional shareholders / participants who
hold significant shares in the company may act together to
resolve the agency problem. For example, in case the
managment is incompetitive, they may act to exercise voting
rights jointly to replace the management.
Prepared by: CPA Ngata, Charles
 Cont…
(b) Weak management may face the pressure of takeovers by
firms in the same industry who may wish to takeover the
company and improve its financial position through efficient
management. The management would act in shareholder interest
due to the pressure of a hostile takeover.
2. Managerial reward such as Performance-related pay such
as profit and sales.
3. Employee stock option plans (ESOPs)
The share option scheme gives the manager the option to purchase
a specified number of shares at a fixed price, within a specified
period. If the price of a company’s shares increases above this
price, then the managers gain by exercising their options. There is
no obligation to exercise the options if the share prices are lower.
Share options can therefore act
Prepared by: CPA Ngata, as an incentive for managers.
Charles
Cont..
4. Monitoring performance
The shareholders as principals may monitor the actions of
their agents (the management) to ensure that they act in the
interest of shareholders. This is achieved through
engagement of audit and control procedures. This cost would
have to be incurred to ensure that they act to achieve the
objective of shareholder wealth maximisation.

Prepared by: CPA Ngata, Charles

Cont..
5. Regulatory requirements
(a) Corporate governance codes of best practice
(b) Corporate governence legislation in Tanzania including
stock exchange regulations

Prepared by: CPA Ngata, Charles

Other Mitigating factors
 Agency costs

These are the costs that are used to reduce the impact of agency problems. These costs may be direct
or indirect.
 These costs include:

 salary.

 Bonuses and perks paid to employees.

 Programs i.e. monitoring costs, remuneration paid to directors.

Prepared by: CPA Ngata, Charles

Cont’d
 Shareholder interference

Sometimes big shareholders like institutional investors or mutual fund may intervene

through their voting rights by electing their nominee in the board of directors to present

their interests.

 Hostile takeover

When the management is performing poorly then there is a risk that a good operating

company may take over the former company. If not performing well, its shares will be

quoted low in the market.

 Threat of dismissal

If the management is not performing well on a consistent basis then the shareholders may

force the board of directors to change the management

Prepared by: CPA Ngata, Charles
Financial Markets.
 Financial Markets/Institutions
 Bringing together of buyers and sellers of financial securities to establish prices
 The formal setting/mechanism that brings buyers and sellers together to value financial assets
 Provides a mechanism for those with excess funds (savers) to lend to those who need funds
[borrowers]
 Includes banks, savings and loans, credit unions, investment banks and brokers, mutual funds,
stock and bond markets

Prepared by: CPA Ngata, Charles

 Financial Markets. Financial markets

Organized exchanges
Primary markets Money market
Over-the-counter
Secondary markets Capital market

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Financial market cont’d
a) Primary market – primary issues of securities are sold, allows governments, banks, corporations
to raise money by directly selling financial instruments to the public. or
Primary market is the market in which new issues are sold and new capital is raised. i.e. IPO
So it is the market whose sales directly benefit the issuer of the securities. i.e. banks

b) Secondary market – allows investors to trade financial instruments between themselves.

Secondary transactions take place. Eg. DSE
In other word: A secondary market is one in which securities are resold
among investors, e.g. DSE, NYSE etc. No new capital is raised and the issuer
of the security does not benefit directly from the sale.
Trading takes place among investors.
Investors who buy and sell securities on the secondary markets may obtain
the services of stock brokers.
Stock brokers are individuals who buy or sell securities for their clients.

Prepared by: CPA Ngata, Charles

Exchange and Over-the-Counter Markets
There are two types of secondary securities markets:
exchanges and over-the-counter markets.
a) Exchanges are actual places where buyers and sellers (or
their representatives) meet to trade securities.
Examples are the Dar es Salaam Stock Exchange, New York
Stock Exchange and the Tokyo Stock Exchange.
b) Over-the-counter (OTC) markets are arrangements in
which investors or their representatives trade securities
without sharing a physical location.
An example is the Nasdaq system, which is operated by the
National Association of Securities Dealers (NASD).
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Money and capital markets
Money markets – short-term assets (maturity less than 1 year) are traded:
Certificates of deposits (CDs)
Commercial papers (CPs)
Treasury bills
Capital markets – long-term assets (maturity longer than 1 year) are traded:
Stocks
Corporate bonds
Long-term government bonds

Prepared by: CPA Ngata, Charles

REVIEW QUESTIONS
1. What is financial management?
2. List the main functions of a financial manager.
3.In financial management, what is assumed to be the main
financial objective?
4. What is meant by the ‘principal-agent’ relationship that
exists between managers and shareholders, and how does this
give rise to the ‘agency problem’?

Prepared by: CPA Ngata, Charles

Cont…
5. At a recent board meeting of Co., a non-executive director
suggested that the company’s remuneration committee should
consider scrapping the company’s share option scheme, since
the executives could be rewarded by the scheme even when
they do not perform well. A second non-executive director had
a view that, even when the executives act in ways which
decrease the agency problem, they might not be rewarded by
the share option scheme if the stock markets were in decline.
REQUIRED:
Explain the nature of the agency problem and discuss the use
of share option schemes and performance-related pay as
methods of reducing the agency problem in a stock-market
listed company.Prepared by: CPA Ngata, Charles
REVIEW QUESTION
6. What are the classifications of capital markets?
7. Explain any three ways in which the management of a
corporate firm can be encourage to achieve the objective of
maximization of shareholders’ wealth.
8. Outline FOUR limitations of profit maximization as a
financial goal of a firm
9. Distinguish between “Agency cost” and “agency problem”
as used in finance

Prepared by: CPA Ngata, Charles

Review Question
10. “Corporate performance is highly contributed by the
way in which its activities are structured and assigned by
directors to competent managers”
Required
i. Analyse the key roles of financial managers in a firm.
ii. Discuss how those roles in (i) above are related.
iii. Evaluate and advise why are those roles treated
separately at the time of making decision.

Prepared by: CPA Ngata, Charles

11. The determination of the financial objectives of a company
involves taking into account three decision policies: the
investment policy, financing policy and dividend policy.
Required
Discuss the nature of these three types of decisions,
commenting on how they are inter-related and how they
might affect the value of the frim.
12. What is financial management?
13.State the decisions involved in financial
management.
14. Give differences between wealth maximization and profit
Prepared by: CPA Ngata, Charles
15. Management of a limited liability company is appointed to
promote and protect shareholders interest in the performance
pf their functions. The aim is to maximise shareholders value.
The management, however, could have interest that might be in
conflict with shareholders interest.
Required: In reference to the above statement
(a) Identify this type of conflict in modern day financial
management of a firm
(b) Explain THREE factors that could contribute to the
conflict identified in (a) above
(c) As a financial management professional, explain FOUR
strategies that could be used to manage or mitigate this conflict
to protect shareholders.
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16. Describe four ways of encouraging managers to achieve
stakeholders’ objectives
17. Explain the advantages of wealth maximization objective
of a firm
18. The goal of profit maximization is considered to be a
short-term objective with long-term survival. The firm’s
growth cannot be achieved without continuous profitability.
Required
In relation to the above statement, summarize FOUR
arguments in favour of and FOUR arguments against profit
maximization asPrepared
a business goal.
by: CPA Ngata, Charles