FINA 252 FINA 252
Basics of Financial Management
INTRODUCTORY CLASS
INTRODUCTORY CLASS
Lesson Plan Lesson Plan
Introduction – (Me and You)-15 minutes
Subject Overview – 25 minutes
Important Instructions- 10 Minutes
Discussion on Topic 1: The role of Financial Management.
Introduction Introduction
Me
– Personal – Education – Professional
Now You
– Background (Name, Home location) – Life goals
– What do you want from this subject
My Background-
My Background- Work Work
Associate Professor, KAU – (2013-current)
Senior Lecturer, Swinburne University of Technology, Australia (2010-2012, currently on leave)
Post Doctoral Research Fellow: RMIT University, Australia (2008-2010)
Lecturer: Faculty of Business Administration, Universiti Tun Abdul Razak, (2004-2007)
Research Assistant: National University of Malaysia and International Islamic University of Malaysia.
Graduate Research Assistant: National University of Malaysia, Malaysia, (1997-2003)
Introduction Introduction
Now Your turn
– Background (Name, Home location) – Life goals
– What do you want from this subject?
Subject Overview
Subject Overview - Objectives - Objectives
To familiarize the student with the concept of finance and the role financial managers.
Recognize the ten different principles of financial management.
To understand the concept of corporate world, time value of money, financial statements and cash flow, tradeoff between risk and return, difference between simple interest and compound interest, financial ratios and their limitations.
How to calculate both present value and future value, the value of bonds, and the major financial ratios.
Subject Overview
Subject Overview--Learning MethodsLearning Methods
Lectures (interactive).
Tutorials (class exercise).
– Problem solving Group (home work)
Subject Overview -
Subject Overview - Assessment Assessment
Individual assignments
– Class Participation Activities (10%) – 2 Quizzes (15%)
– Mid-term exam (15%) – Final exam (40%)
Group assignments – Homework (20%)
Total = 100%
Subject Overview –
Subject Overview – Course MaterialsCourse Materials
Recommended textbook
Ross/ Westerfield/ Jordan (2010), Fundamentals of Corporate Finance, 9th Edition, McGraw-Hill/ Irwin, NY, USA (any edition can be used).
Other References; (Journals, Reports, Websites, E. Library…etc.)
Lecture slides
The Firm and the
Financial Manager
The Firm and the
Financial Manager
Chapter Objectives Chapter Objectives
What is Financial Management?
10 principles of financial management.
What are the Decisions that Financial Manager must be Concern?
The Goal of the Firm.
Organization of the Financial Management Function.
Understand the agency problems.
What is Financial What is Financial
Management?
Management?
Financial Management means planning, organizing, directing
and controlling the financial activities of the organization.
(ةرطيسلاو هيجوتلا و ميظنتلاو طيطختلا ينعي ةيلاملا ةرادلإا ةمظنملل ةيلاملا ةطشنلأا ىلع)
It refers the efficient and effective management of money (funds) in such a manner as to achieve the
goals of the organization.
“It is necessary to understand these principles in order to understand finance.”
Ten Principles of Financial Management Ten Principles of Financial Management
We won’t take on additional risk unless we expect to be compensated with additional return.
Investment choices have different amounts of risk and expected returns.
The more risk an investment has, the higher its expected return will be.
Principle 1: The Risk- Principle 1: The Risk-
Return Trade-off
Return Trade-off
A dollar received today is worth more than a dollar received in the future.
Because we can earn interest on money received today, it is better to receive money earlier rather than later.
Principle 2: The Time Principle 2: The Time
Value of Money
Value of Money
Cash Flow, not accounting profit, is used as our measurement tool.
Cash flows, not profits, are actually can be reinvested.
Principle 3: Cash
Principle 3: Cash — — Not Profits
Not Profits — — Is King Is King
The incremental cash flow is the difference between the projected cash flows if the project is selected, versus what they will be, if the project is not selected.
Principle 4: Incremental Principle 4: Incremental
Cash Flows
Cash Flows
It is hard to find exceptionally profitable projects
If an industry is generating large profits, new entrants are usually attracted. The additional competition and added capacity can result in profits being driven down to the required rate of return.
Product Differentiation, Service and Quality can separate products from
Principle 5: The Curse of Principle 5: The Curse of
Competitive Markets
Competitive Markets
The markets are quick and the prices are right.
The values of all assets and securities at any instant in time fully reflect all available information.
Principle 6: Efficient Principle 6: Efficient
Capital Markets
Capital Markets
Managers won’t work for the owners unless it is in their best interest
A agency problem resulting from conflicts of interest between the manager/agent and the stockholder/owners.
Managers may make decisions that are not in line with the goal of maximization of
shareholder wealth.
Principle 7: The Agency Principle 7: The Agency
Problem
Problem
The cash flows we consider are the after-tax incremental cash flows to the firm as a whole.
Principle 8: Taxes Bias Principle 8: Taxes Bias
Business Decisions
Business Decisions
Some risk can be diversified away, and some cannot
The process of diversification
can reduce risk, and as a result, measuring a project’s or an
asset’s risk is very difficult.
Principle 9: All Risk is Principle 9: All Risk is
Not Equal
Not Equal
Each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing
Principle 10: Ethical Behavior is Doing Principle 10: Ethical Behavior is Doing
the Right Thing, and Ethical Dilemmas the Right Thing, and Ethical Dilemmas
Are Everywhere in Finance Are Everywhere in Finance
Investment Decisions (Capital Budgeting)
(Investment decisions revolve around how to best allocate money to maximize their value.)
Financing Decisions (Capital Structure)
(Financing decisions revolve around how to pay for investments and expenses)
Asset Management Decisions (Working Capital Management Decisions)
Decisions of Financial Decisions of Financial
Manager
Manager
Investment Decisions Investment Decisions
how, when, where and how much money will be spent on investment opportunities.
A firm has many options to invest their funds but firm has to select the most appropriate assets for
investment which will bring maximum benefit for the firm.
What specific assets should be acquired?
What assets (if any) should be reduced or
Investment Decisions Investment Decisions
What specific assets should be acquired?
What assets (if any) should be reduced or eliminated?
Financing Decisions Financing Decisions
A company can raise finance from various sources such as by issue of shares,
debentures or by taking loan and advances.
These sources of finance can be divided into two categories: owners fund (no risk involve) and borrowers fund (risk involve).
Find the least expensive sources of fund.
Determine how the assets will be financed.
Determine how the assets will be financed.
Financing Decisions Financing Decisions
What is the best type of financing?
Mix type financing.
What is the best financing mix?
Mixer debt and equity.
What is the best dividend policy?
Paying a consistent percentage of net earnings.
How will the funds be physically acquired?
Asset Management Asset Management
Decisions Decisions
How do we manage existing assets efficiently?
Financial Manager has varying degrees of operating responsibility over assets.
Greater emphasis on current asset management than fixed asset
management.
Interrelationship of the decisions Interrelationship of the decisions
made by a Financial Manager made by a Financial Manager
What are the Goals of the What are the Goals of the
Firm?
Firm? (General Goals) (General Goals)
Survival
Avoid financial distress and bankruptcy
Beat the competition
Maximize sales or market share
Minimize costs
Maximize profits
Maintain steady earnings growth.
Shortcomings of these Shortcomings of these
General Goals General Goals
These goals are either associated with increasing profitability or reducing risk.
Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy Treasury-bills,
etc.).
Does not specify timing or duration of expected returns.
Calls for a zero payout dividend policy.
They are not consistent with the long-term interests of shareholders.
Problems Problems
So it is necessary to find a goal that can encompass
The Real Goal of The Real Goal of
the Firm the Firm
Maximization of Maximization of
Shareholder Wealth!
Shareholder Wealth!
Shareholders’ wealth can be measured as the current value
per share of existing shares.
Strengths of Shareholder Strengths of Shareholder
Wealth Maximization Wealth Maximization
Takes account of: current and future current and future profits and EPS
profits and EPS; the timing, the timing, duration, and risk of profits
duration, and risk of profits; dividend dividend policy
policy; and all other relevant factors.
Thus, share priceshare price serves as a
barometer for business performance.
The Modern Organization The Modern Organization
There exists a SEPARATION between owners and managers.
Modern Organization
Shareholders Management
Role of Management Role of Management
An agent is an individual agent
authorized by another person, called the principal, to act in the latter’s behalf.
Management acts as an agent agent for the owners (shareholders)
of the firm.
Agency Theory Agency Theory
Agency TheoryAgency Theory is a branch of
economics relating to the behavior of principals and their agents.
Jensen and Meckling developed a theory of the firm based on
agency theory agency theory.
Agency Theory Agency Theory
Incentives include stock optionsstock options, , perquisites
perquisites, , and bonuses.bonuses
Principals must provide incentivesincentives so that management acts in the
principals’ best interests and then monitor
monitor results.
Social Responsibility Social Responsibility
Wealth maximization does not stop the firm from being socially responsiblesocially responsible.
Assume we view the firm as producing both private and social goods.
Then shareholdershareholder wealthwealth maximizationmaximization remains the appropriate goal in
governing the firm.
Organization of the Financial Organization of the Financial
Management Function Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President Operations
Vice President Marketing Vice President
Finance
Treasurer
Capital Budgeting Cash Management Credit Management Dividend Disbursement
Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning
Organization of the Financial Organization of the Financial
Management Function Management Function
Vice President of Finance Vice President of Finance
Controller
Cost Accounting Cost Management
Data Processing General Ledger
Government Reporting Internal Control
Preparing Fin Stmts Preparing Budgets
