Management Accounting and

Finance II

MODULE : ONE
Introduction to Financial Management and Concept
1st Semester
Mr G RAMAVHEA
 LEARNING OBJECTIVES AND UNDERSTANDING

1. Define financial management and why is it important

2. Describe the role of financial manager
3. Understand the underlying concepts of financial management
4. Understand how agency issues that arise between managers and owners
impact on wealth maximization
5. Define the role of ethics in financial decision and understand the codes of
conduct issued by professional body
6. Outline the focus of financing, investing decision and dividend decision
7. Identify key stakeholders

Extra questions on this topic:

Question 1-part B on practice question part 3 (question bank).

Question 1 test 1 2019 (question bank).

Practice question in the prescribed textbook: question 1.1-1.5

Define financial management

Financial management refers to the strategic planning, organising, directing, and
controlling of financial undertakings in an organisation or an institute.
It also includes applying management principles to the financial assets of an
organisation, while also playing an important part in fiscal management.
Financial management strategically plan how a business should earn and spend
money
 Maintaining enough supply of funds for the organisation;
 Ensuring shareholders of the organisation to get good returns on their investment;
 Optimum and efficient utilization of funds;
 Creating real and safe investment opportunities to invest in
 Decisions about raising capital, borrowing money and budgeting
 Financial management also involves setting financial goals and analysing data..

Why is Financial Management important?

Helps organisations in financial planning;
Assists organisations in the planning and acquisition of funds;
Helps organisations in effectively utilising and allocating the funds received or
acquired;
Assists organisations in making critical financial decisions;
Helps in improving the profitability of organisations;

Increases the overall value of the firms or organisations;

Provides economic stability;
Encourages employees to save money, which helps them in personal financial
planning.

Describe the role of financial manager

Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and
liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of
a financial manager to decide the ratio between debt and equity. It is important to
maintain a good balance between equity and debt.
Allocation of Funds

Once the funds are raised through different channels the next important function is to
allocate the funds. The funds should be allocated in such a manner that they are
optimally used. In order to allocate funds in the best possible manner the following
point must be considered

 The size of the firm and its growth capability

 Status of assets whether they are long-term or short-term

 Mode by which the funds are raised

Profit Planning

Profit earning is one of the prime functions of any business organization. Profit
earning is important for survival and sustenance of any organization. Profit planning
refers to proper usage of the profit generated by the firm.

Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale
and purchase of securities. Hence a clear understanding of capital market is an
important function of a financial manager. When securities are traded on stock market
there involves a huge amount of risk involved. Therefore a financial manger
understands and calculates the risk involved in this trading of shares and debentures.

It’s on the discretion of a financial manager as to how to distribute the profits. Many
investors do not like the firm to distribute the profits amongst share holders as
dividend instead invest in the business itself to enhance growth. The practices of a
financial manager directly impact the operation in capital market.

Understand how agency issues that arise between

managers and owners impact on wealth maximization
What is agency theory

 An agent is employed by a principal to carry out a task on their behalf.

 Agency refers to the relationship between a principal and their agent.

 Agency costs are incurred by principals in monitoring agency behaviour
because of a lack of trust in the good faith of agents.

 By accepting to undertake a task on their behalf, an agent becomes

accountable to the principal by whom they are employed. The agent is
accountable to that principal.

Principal
(employs) (CEO)
|
Agent
(eg Directors)
| to perform
Management of the company
The separation of ownership and control in a business leads to a potential conflict of
interests between directors and shareholders.

 The conflict of interests between principal (shareholder) and agent (director)

gives rise to the 'principal-agent problem' which is the key area of corporate
governance focus.
 The principals need to find ways of ensuring that their agents act in their (the
principals') interests.
 As a result of several high profile corporate collapses, caused by over-
dominant or 'fat cat' directors, there has been a very active debate about the
power of boards of directors, and how stakeholders (not just shareholders) can
seek to ensure that directors do not abuse their powers.
 Various reports have been published, and legislation has been enacted, in the
which seek to improve the control that stakeholders can exercise over the
board of directors of the company.
Define the role of ethics in financial decision and
understand the codes of conduct issued by professional
body
Self reading

(Explained in Lectures)

Outline the focus of financing and investing decision

There are three decisions that financial managers have to take:

 Investment Decision

 Financing Decision and

 Dividend Decision

Investment Decision
These are also known as Capital Budgeting Decisions. A company’s assets and
resources are rare and must be put to their utmost utilization. A firm should pick where to
invest in order to gain the highest conceivable returns.This decision relates to the careful
selection of assets in which funds will be invested by the firms. The firm puts its funds in
procuring fixed assets and current assets. When choice with respect to a fixed asset is
taken it is known as capital budgeting decision.

Factors Affecting Investment Decision

 Cash flow of the venture: When an organization starts a venture it invests a

huge capital at the start. Even so, the organization expects at least some form of
 income to meet everyday day-to-day expenses. Therefore, there must be some

regular cash flow within the venture to help it sustain.

 Profits: The basic criteria for starting any venture is to generate income but

moreover profits. The most critical criteria in choosing the venture are the rate of

return it will bring for the organization in the nature of profit for, e.g., if venture A is

getting 10% return and venture В is getting 15% return then one must prefer

project B.

 Investment Criteria: Different Capital Budgeting procedures are accessible to

a business that can be utilized to assess different investment propositions.
Above all, these are based on calculations with regards to the amount of
investment, interest rates, cash flows and rate of returns associated with
propositions. These procedures are applied to the investment proposals to
choose the best proposal.

Financing Decision
Financial decision is important to make wise decisions about when, where and how
should a business acquire fund. Because a firm tends to profit most when the market
estimation of an organization’s share expands and this is not only a sign of development
for the firm but also it boosts investor’s wealth. Consequently, this relates to the
composition of various securities in the capital structure of the company.
Factors affecting Financing Decisions

 Cost: Financing decisions are all about allocation of funds and cost-cutting. The

cost of raising funds from various sources differ a lot. The most cost-efficient

source should be selected.

 Risk: The dangers of starting a venture with the funds from various sources

differ. Larger risk is linked with the funds which are borrowed, than the equity

funds. This risk assessment is one of the main aspects of financing decisions.

 Cash flow position: Cash flow is the regular day-to-day earnings of the

company. Good or bad cash flow position gives confidence or discourages the

investors to invest funds in the company.

 Control: In the situation where existing investors need to hold control of the

business then finance can be raised through borrowing money, however, when

they are prepared for diluting control of the business, equity can be utilized for

raising funds. How much control to give up is one of the main financing decisions.

 Condition of the market: The condition of the market matter a lot for the

financing decisions. During boom period issue of equity is in majority but during a

depression, a firm will have to use debt. These decisions are an important part of

financing decisions.

Dividend Decision
Dividends decisions relate to the distribution of profits earned by the organization. The

major alternatives are whether to retain the earnings profit or to distribute to the

shareholders.

Factors Affecting Dividend Decisions

 Earnings: Returns to investors are paid out of the present and past income.

Consequently, earning is a noteworthy determinant of the dividend.

 Dependability in Earnings: An organization having higher and stable earnings can

announce higher dividend than an organization with lower income.

 Balancing Dividends: For the most part, organizations attempt to balance out

dividends per share. A consistent dividend is given every year. A change is

made, if the organization’s income potential has gone up and not only the income

of the present year.

 Development Opportunity: Organizations having great development openings if

they hold more cash out of their income to fund their required investment. The

dividend announced in growing organizations is smaller than that in the non-

development companies.

Other Factors

 Cash flow: Dividends are an outflow of funds. To give the dividends, the

organization must have enough to provide them, which comes from regular cash

flow.

 Shareholders’ Choices: While announcing dividends, the administration must

remember the choices of the investors. Some shareholders want at least a

 specific sum to be paid as dividends. The organizations ought to consider the

preferences of such investors.

 Taxes: Compare tax rate on dividend with the capital gain tax rate that is

applicable to increase in market price of shares. If the tax rate on dividends is

lower, shareholders will prefer more dividends and vice versa.

 Stock market: For the most part, an expansion in dividends positively affects the

stock market, though, a lessening or no increment may negatively affect the stock

market. Consequently, while deciding dividends, this ought to be remembered.

 Access to Capital Market: Huge and organizations with a good reputation, for

the most part, have simple access to the capital market and, consequently, may

depend less on retained earnings to finance their development. These

organizations tend to pay higher dividends than the smaller organizations.

 Contractual and Legal Constraints: While giving credits to an organization,

once in a while, the lending party may force certain terms and conditions on the

payback of dividends in future. The organizations are required to guarantee that

the profit payout does not abuse the terms of the loan understanding in any

manner.

Identify key stakeholders