Chapter 01 (Class Lecture 1 & 2)

Introduction to Financial Management/Managerial Finance

1. Definition and Purpose of Financial Management
Financial Management refers to the strategic planning, organizing, directing, and
controlling of financial activities in an organization or business. It involves
managing the firm’s financial resources efficiently to achieve its long-term and
short-term goals. The core of financial management lies in making decisions
regarding investments, financing, and dividends.
Purpose:
 To ensure that the organization has adequate funds to meet its operational
needs.
 To manage the allocation of resources in a way that maximizes returns.
 To maintain financial stability and grow the value of the company for its
stakeholders.
Example:
A growing company, like Tesla, needs financial management to decide how much
to invest in expanding manufacturing plants, how much to borrow to fund that
expansion, and how much of its profits should be distributed to shareholders or
reinvested in new projects like research on electric vehicles.

2. Objectives of Financial Management

The objectives of financial management are:
1. Profit Maximization: One of the traditional objectives is to maximize
profits by increasing revenue and reducing costs. However, this has
limitations as it doesn’t consider risks, long-term sustainability, or
shareholder value.
2. Wealth Maximization: The modern and primary objective is to maximize
shareholders’ wealth by increasing the value of the business over time. This
considers factors like risks, market conditions, and time value of money.
3. Ensuring Liquidity: Managing funds in a way that ensures the company
can meet its short-term obligations, such as paying suppliers and employees
on time.
4. Efficient Use of Capital: Properly utilizing capital so that investments yield
the highest possible returns.
Example:
In 2020, Amazon reinvested a large portion of its earnings into expanding its
logistics network and cloud computing services (AWS), focusing on wealth
maximization. Although profit in the short term was not maximized, the company
grew in value, increasing shareholder wealth.
3. Importance of Financial Management
Financial management is essential because:
 Optimal Resource Utilization: It ensures that a business's resources are
allocated efficiently, leading to higher productivity and returns.
 Profitability and Growth: Good financial management drives profitability,
which supports business growth.
 Risk Management: It helps in identifying financial risks and developing
strategies to mitigate them.
 Decision-Making Support: Provides a framework for making informed
decisions on investments, financing, and dividend distribution.
Example:
A company like Coca-Cola must decide whether to launch a new product line.
Financial management will assess the potential profitability, the capital required,
and the risks involved before making an investment decision.

4. Key Functions of Financial Management

1. Investment Decisions:
o These decisions revolve around how to allocate capital into long-term
investments such as new projects, acquisitions, or infrastructure.
o Capital Budgeting is a common tool used to evaluate which projects
or assets the company should invest in based on their expected
returns.
Example:
When Apple decides to invest in a new iPhone model, it goes through
extensive financial analysis to determine whether the potential return on
investment justifies the costs of R&D and production.
2. Financing Decisions:
o These involve deciding how to raise the required capital for
investments, either through equity financing (issuing shares) or debt
financing (taking loans or issuing bonds).
o The goal is to find the optimal mix of debt and equity to minimize the
company’s cost of capital and enhance returns for shareholders.
Example:
Microsoft may decide to issue corporate bonds to finance a large acquisition
rather than using cash reserves, allowing them to spread out the financial
burden over time.
3. Dividend Decisions:
o Companies must decide how much profit to return to shareholders in
the form of dividends and how much to retain for future investments
or debt repayment.
 o A balance between retaining earnings for growth and satisfying
shareholders is crucial.
Example:
Google (Alphabet) retains a significant portion of its earnings to reinvest in
new technologies like artificial intelligence and self-driving cars, focusing
on long-term growth over immediate dividend payouts.

5. Types of Financial Decisions

Financial management involves three major types of decisions:
1. Investment Decisions (Capital Budgeting):
These focus on long-term investments in assets that will generate future
income. The goal is to select projects or investments that offer the best
returns for the risk involved.
Example:
A company like Starbucks may evaluate whether to open new stores in
international markets, weighing the cost of expansion against the potential
revenue growth in those regions.
2. Financing Decisions (Capital Structure):
These are decisions about how the firm will finance its operations and
growth—either by raising funds through debt (borrowing) or equity (selling
shares). The firm must maintain a balance to minimize the cost of capital
while maximizing shareholder value.
Example:
When Tesla needed capital for its Gigafactory construction, it issued new
shares (equity financing) rather than increasing its debt burden, considering
its high stock valuation.
3. Dividend Decisions:
These decisions revolve around how much of the company’s profits will be
returned to shareholders in the form of dividends and how much will be
retained for reinvestment in the business. The right balance ensures that
shareholders are rewarded while keeping sufficient funds for future growth.
Example:
Johnson & Johnson, a company with a long history of paying dividends,
must decide each year how much to distribute to shareholders and how much
to retain for research and development in new healthcare products.

6. Role of Financial Manager

The financial manager plays a critical role in ensuring the financial health of an
organization by making decisions on investments, financing, and dividends. They
are also responsible for:
  Financial Planning: Creating forecasts and budgets that align with the
company's goals.
 Raising Capital: Deciding how to fund long-term investments through a
combination of debt and equity.
 Risk Management: Identifying and mitigating financial risks, such as
currency fluctuations or interest rate changes.
 Ensuring Liquidity: Managing cash flow to ensure that the company can
meet its obligations without running into financial difficulties.
Example:
At Ford Motors, the financial manager might assess the risk of entering a new
international market. This would involve studying currency risks, trade policies,
and potential returns before deciding whether to invest.

An Overview of Managerial Finance

1. Concept of Finance and Managerial Finance

Definition of Finance:
Finance is the science and art of managing money. It involves the processes of
acquiring, investing, and managing financial resources to achieve individual or
organizational objectives. It encompasses various activities such as budgeting,
forecasting, saving, lending, and investing.

Definition of Managerial Finance:

Managerial finance focuses on the financial management of a firm, where financial
managers make decisions to maximize the firm's value. It involves planning,
directing, monitoring, organizing, and controlling the financial activities such as
procurement and utilization of funds of a business.

Explanation:
Managerial finance extends beyond just recording and reporting financial
information; it also emphasizes the strategic decision-making necessary for
achieving the financial goals of a firm. This includes evaluating investment
opportunities, managing risks, and ensuring efficient capital allocation.
Examples:
 Making decisions on whether to invest in new equipment or expand
operations.
 Deciding how much dividend should be paid to shareholders.
 Analyzing the risk associated with different financing options like debt or
equity.
2. Types of Finance
Personal Finance:
Deals with individual or household financial management, including budgeting,
saving, investing, insurance, and retirement planning.

Corporate Finance:
Focuses on the financial management of businesses. It includes decisions on
investment, capital structuring, and dividend policies.

Public Finance:
Refers to the financial activities related to the government, including taxation,
government spending, budgeting, and debt issuance.

International Finance:
Deals with financial transactions that involve different countries. It encompasses
exchange rates, foreign investment, and international trade.

3. Functions of Managerial Finance

Investment Decisions (Capital Budgeting):

Involves determining which long-term projects or assets the company should
invest in. The objective is to maximize the firm's value by selecting projects that
offer the highest returns relative to their risk.

Financing Decisions:
Concerned with how to raise the necessary funds for investments. This may
involve issuing stocks, bonds, or taking loans. The aim is to choose the financing
mix that minimizes the cost of capital and maximizes shareholder wealth.

Dividend Decisions:
Focuses on deciding whether to distribute profits to shareholders as dividends or
retain them for reinvestment in the company.

Liquidity Management:
Ensures that the firm has enough cash or liquid assets to meet its short-term
obligations and operational needs. This includes managing working capital (cash,
inventory, receivables, and payables).
4. Forms of Businesses

Sole Proprietorship:
A business owned and operated by a single person. It is easy to establish and has
minimal regulatory requirements, but the owner has unlimited liability.

Partnership:
A business owned by two or more individuals. Partners share profits, losses, and
management responsibilities. It can be a general or limited partnership, depending
on the liability structure.

Corporation:
A legal entity separate from its owners. It offers limited liability protection to
shareholders, who own shares of the company. Corporations are more complex to
establish and have higher regulatory requirements.

Limited Liability Company (LLC):

Combines the characteristics of both partnerships and corporations. It provides
limited liability to its owners while allowing flexibility in management and profit
distribution.

5. Goals of the Corporation

Primary Goal:
Maximizing shareholder wealth, which is achieved by increasing the stock price of
the corporation. It focuses on long-term growth and profitability.
Alternative Goals:
 Profit Maximization: This goal focuses on increasing the company's
earnings in the short term. However, it may not always align with long-term
value creation.
 Stakeholder Value Maximization: This approach considers the interests of
all stakeholders, including employees, customers, and the community, in
addition to shareholders.

6. Principles of Finance

Time Value of Money (TVM):

A dollar today is worth more than a dollar in the future due to its potential earning
capacity. This principle is the foundation for concepts like present value and future
value.
Risk and Return Trade-off:
Investors expect higher returns for taking on higher risks. This trade-off is crucial
for making investment decisions.

Diversification:
Spreading investments across various assets can reduce risk. This principle
underlies portfolio management strategies.

Market Efficiency:
Financial markets are considered efficient if prices reflect all available information.
In such markets, securities are fairly valued, and it is challenging to consistently
outperform the market.

Cost of Capital:
The cost of capital is the return expected by investors for providing funds to the
company. It is used as a benchmark for making investment decisions.

7. Agency Relationship
Definition:
An agency relationship occurs when one party (the principal) hires another (the
agent) to act on their behalf. In a corporate context, shareholders (principals) hire
managers (agents) to run the company.
Explanation:
Agency problems arise when the interests of managers (agents) diverge from those
of shareholders (principals). Managers may pursue personal goals rather than
focusing on maximizing shareholder wealth.
Examples of Agency Issues:
 Managers using company funds for personal benefits.
 Engaging in projects that benefit managers but do not necessarily increase
shareholder value.
Solutions to Agency Problems:
 Incentive Mechanisms: Aligning managers' compensation with company
performance.
 Monitoring: Implementing governance practices such as board oversight.
 Restrictive Covenants: Including specific conditions in contracts to limit
managers' discretion.
8. Business Ethics
Definition:
Business ethics refers to the moral principles that guide the behavior of individuals
and organizations in the business environment.
Importance:
Ethical behavior is crucial for building trust, maintaining a good reputation, and
ensuring long-term success. Unethical practices can lead to legal issues, financial
losses, and damage to the firm's reputation.
Examples of Ethical Issues in Finance:
 Insider trading.
 Misleading financial reporting.
 Bribery and corruption.
Promoting Ethical Practices:
 Establishing a code of ethics.
 Conducting regular ethics training.
 Implementing whistleblowing mechanisms.

9. Multinational vs. Domestic Managerial Finance

Multinational Finance:
Involves financial management in companies that operate in multiple countries. It
faces additional complexities such as exchange rate risk, political risk, and cultural
differences.

Domestic Finance:
Deals with financial management in companies that operate within a single
country. It generally involves fewer complexities compared to multinational
finance.
Challenges in Multinational Finance:
 Currency Exchange Risk: Fluctuations in exchange rates can impact cash
flows.
 Political Risk: Changes in government policies may affect business
operations.
 Regulatory Differences: Compliance with various financial regulations
across countries.
Example:
A U.S.-based multinational company like Coca-Cola must consider foreign
exchange rates and local regulations when operating in markets such as Europe and
Asia, unlike a company that only operates within the U.S.
Assignment - 1:
1. “What challenges do you think financial managers face today in
Bangladesh?”
2. “How do you think technology impacts financial decision-making in modern
businesses?”