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Chap 1

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79 views28 pages

Chap 1

Uploaded by

hansdeep479
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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NATURE OF FINANCIAL

CHAPTER 1 MANAGEMENT
LEARNING
2
OBJECTIVES
 Explain the nature of finance and its interaction with other
management functions
 Review the changing role of the finance manager and his/her
position in the management hierarchy
 Focus on the Shareholders’ Wealth Maximization (SWM)
principle as an operationally desirable finance decision
criterion
 Discuss agency problems the relationship
arising from between shareholders and
managers
 Illustrate the organization of finance
function
Important Business
3
Activities
Production
Marketing
Finance
Real And Financial
4
Assets
Real Assets: Can be Tangible or Intangible
⭬ Tangible real assets are physical assets that include
plant, machinery, office, factory, furniture and
building.
⭬ Intangible real assets include technical know-how,
technological collaborations, patents and copyrights.
Financial Assets, also called securities, are
financial papers or instruments such as shares and
bonds or debentures.
Equity and Borrowed
5
Funds
Shares represent ownership rights of their holders.
Shareholders are owners of the company. Shares
can be of two types:
⭬ Equity Shares
⭬ Preference Shares
Loans, Bonds or Debts represent liability of the
firm towards outsiders. Lenders are not owners of
the company. These provide interest tax shield.
Equity and Preference
6
Shares
Equity Shares are also known as ordinary shares.
⭬ Do not have fixed rate of dividend.
⭬There is no legal obligation to pay dividends to equity
shareholders.
Preference Shares have preference for
dividend payment over ordinary shareholders.
⭬ They get fixed rate of dividends.
⭬They also have preference of repayment at the time of
liquidation.
Finance and Management
7
Functions
All business activities involve
acquisition and use of funds.
Finance function makes money
available to meet the costs of production and
marketing operations.
Financial policies are devised to fit production and
marketing decisions of a firm in practice.
Finance
8
Functions
Finance functions or decisions can be
divided as follows
⭬ Long-term financial decisions
• Long-term asset-mix or investment decision
or capital
budgeting decisions.
• Capital-mix or financing decision or capital structure and
leverage decisions.
• Profit allocation or dividend decision.
⭬ Short-term financial decisions
• Short-term asset-mix or liquidity decision or
working
capital management.
Financial Procedures and
9
Systems
 For effective finance function some routine functions have to
be performed. Some of these are:
 Supervision of receipts and payments and safeguarding of
cash balances
 Custody and safeguarding of securities, insurance policies
and other valuable papers
 Taking care of the mechanical details of
new outside financing
 Record keeping and reporting
Finance Manager’s
10
Role
Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets
Financial
11
Goals
Profit
maximization (profit after tax)
Maximizing earnings per share
Wealth maximization
Profit
12
Maximization
Maximizing the rupee income of a firm
 Resources are efficiently utilized
 Appropriate measure of firm performance
 Serves interest of society also
Objections to Profit
13
Maximization
🗵 It is Vague
🗵 It Ignores the Timing of Returns
🗵 It Ignores Risk
🗵Assumes Perfect Competition
🗵 In new business environment Profit
maximization is regarded as
⭬ Unrealistic
⭬ Difficult
⭬ Inappropriate
⭬ Immoral
Maximizing Profit after Taxes or
14
EPS
Maximizing PAT or EPS does not
maximize the economic welfare of the owners.
Ignores timing and risk of the expected benefit.
Market value is not a function of EPS.
Maximizing EPS implies that the firm should make
no dividend payment so long as funds can be
invested at positive rate of return—such a policy
may not always work.
Shareholders’ Wealth
15
Maximization
Maximizes the net present value of a
course of action to shareholders.
Accounts for the timing and risk of
the expected benefits.
Benefits are measured in terms of cash flows.
Fundamental objective—maximize the
market value of the firm’s shares.
Need for a Valuation
16
Approach
SWM requires a valuation model.
The financial manager must know,
⭬ How much should a particular share be worth?
⭬ Upon what factor or factors should its value
depend?
Risk-return Trade-
17
off
 Financial decisions of the firm are guided by
the
risk-return trade-off.
The return and risk
relationship:
Return = Risk-free rate + Risk premium
Risk-free rate is a compensation
for time and risk premium for risk.
Risk Return Trade-
18
off

Risk and expected return move in tandem; the greater the risk, the greater
the expected return.
Overview of Financial
19
Management
Agency Problems: Managers Versus
Shareholders’ Goals
20

There is a Principal Agent relationship between


managers and shareholders.

In theory, Managers should act in the best interests of


shareholders.

In practice, managers may maximise their own


wealth (in the form of high salaries and perks) at the
cost of shareholders.
Agency Problems: Managers Versus
21
Shareholders’ Goals
 Managers may perceive their role as reconciling conflicting
objectives of stakeholders. This stakeholders’ view of
managers’ role may compromise with the objective of SWM.

 Managers may avoid taking high investment and financing


risks that may otherwise be needed to maximize shareholders’
wealth. Such “satisfying” behaviour of managers will frustrate
the objective of SWM as a normative guide.

 Thisconflict is known as Agency problem and it results into


Agency costs.
Agency
22
Costs
Agency costs include the less than optimum share
value for shareholders and costs incurred by them
to monitor the actions of managers and control their
behaviour.
Financial Goals and Firm’s Mission and
23 Objectives
 Firms’ primary objective is maximizing the welfare of
owners, but, in operational terms, they focus on the
satisfaction of its customers through the production of
goods and services needed by them.
 Firms state their vision, mission and values in broad terms.
 Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
 Goals or objectives are missions or basic purposes of a firm’s
existence.
Financial Goals and Firm’s Mission and
24 Objectives
The shareholders’ wealth maximization is the second-
level criterion ensuring that the decision meets the
minimum standard of the economic performance.
In the final decision-making, the judgement of
management plays the crucial role.
The wealth maximization criterion would simply
indicate whether an action is economically viable or
not.
Organisation of the Finance
25
Functions
Reasons for placing the finance
functions in the hands of top management-
⭬ Financial decisions are crucial for the survival of the
firm.
⭬ The financial actions determine solvency of the firm.
⭬ Centralisation of the financefunoicnts can
result in a number of economies to the firm.
Organisation of Finance
26
Function

Organization for finance function Organization for finance function


in a multidivisional company
Status and Duties of Finance
27 Executives
The exact organisation structure for financial
management will differ across firms.
The financial officer may be known as the financial
manager in some organisations, while in others as
the vice-president of finance or the director of
finance or the financial controller.
Role of Treasurer and
28
Controller
Two officers—the treasurer and the controller—
may be appointed under the direct supervision of
CFO to assist him or her.
The treasurer’s function is to raise and manage
company funds while the controller oversees
whether funds are correctly applied.

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