Understanding Financial Management Principles

 
FINANCIAL MANAGEMENT
 
 
Syed Muhammad Majid Shah – Lecturer QACC
 
INTRODUCTION
 
Financing means the provision of money at the time
when it is required
Financial management is:
Concerned with the planning & controlling of firm’s
financial resources and to find various sources for
raising further funds for the firm
The application of the general management
principles in the area of  financial decision-making
The art of planning; organizing, directing and
controlling of the funds and safe disposal of profits
The art and science of managing money
 
FUNCTIONS OF FINANCIAL MANAGEMENT
 
Estimating Financial Requirements
Deciding Capital Structure
Selecting a Source of Finance
Selecting a Pattern of Investment
Proper Cash Management
Implementing Financial Controls
Return on Investment, Ratio analysis, Break Even Analysis, Cost Control, Audit
Proper use of Surpluses
 
 
 
GOALS/OBJECTIVES OF FINANCIAL
MANAGEMENT
 
The main objective of a business is to maximize the owner’s economic welfare
Financial management of a firm helps maximize economic welfare of is shareholders
by providing a framework for selecting a commercial strategy
There are two versions of the main goal of financial management:
Profit maximization
Wealth maximization
The functions of FM are directed toward achieving the above goals
 
WEALTH MAXIMIZATION
 
Financial theory asserts that the wealth maximization is the single MAIN substitute for
stakeholders’ utility
When the firm maximizes the shareholders’ wealth, the individual stakeholders can
use this wealth to maximize his individual utility
Stockholder’s current wealth in the firm
Number of shares owned × Current stock price per share
 
CHIEF FINANCIAL OFFICER
 
CFOs play an important role in ensuring proper reporting based on
substance to the stakeholders of the company. CFO reports to BODs.
Under CFO, normally two senior officers normally operate:
 
Treasurer
Treasurer
Obtaining required finance
Obtaining required finance
Liaison with term lending and other
Liaison with term lending and other
financial institutions
financial institutions
Managing working capital
Managing working capital
Managing investment in real assets
Managing investment in real assets
Controller/Comptroller
Controller/Comptroller
Accounting and Auditing
Accounting and Auditing
Management control systems
Management control systems
Taxation and insurance
Taxation and insurance
Budgeting and performance evaluation
Budgeting and performance evaluation
Maintaining assets intact to ensure
Maintaining assets intact to ensure
higher productivity
higher productivity
 
FINANCE AND OTHER BUSINESS FUNCTIONS
 
Finance And Accounting
The purpose of accounting is to report the financial performance of the business for the
period under consideration. Financial analysis is carried out on basis of accounting
Accounting is historical in nature, while FM uses this to make future oriented decisions
 
Finance And Marketing
Channels of distribution, advertisement policy, remunerating the salesmen
etc. have financial implications
Marketing cost analysis is a function of finance managers
Credit management and credit terms for increasing sales
 
FINANCE AND OTHER BUSINESS FUNCTIONS
 
Finance And Productions (Operations)
Decisions on plant layout, technology selection, productions / operations,
process plant size etc.
Capital Budgeting is closely related to productions
Inventory management involves many financial variables
 
Finance And HR
Attracting and retaining the best man power in the industry cannot be done unless they
are paid salary at competitive rates
The better the quality of manpower, the higher the value of the human capital and
consequently the higher the productivity of the organization
 
THE MODERN CORPORATION
 
There exists a SEPARATION between owners and managers.
 
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ROLE OF MANAGEMENT
 
An 
An 
agent
agent
 is an individual authorized by another person,
 is an individual authorized by another person,
called the principal, to act in the latter’s behalf.
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 Theory 
is a branch of economics relating to the
is a branch of economics relating to the
behavior of principals and their agents.
behavior of principals and their agents.
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AGENCY THEORY
 
Incentives include, 
Incentives include, 
stock options, perquisites, 
stock options, perquisites, 
and
and
 bonuses
 bonuses
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.
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CORPORATE
SOCIAL RESPONSIBILITY
 
Wealth maximization does 
Wealth maximization does 
not
not
 prohibit the
 prohibit the
firm from being 
firm from being 
socially responsible 
socially responsible 
at the
at the
corporate level.
corporate level.
Assume we view the firm as producing 
Assume we view the firm as producing 
both
both
private and social goods.
private and social goods.
Then
Then
 
 
shareholder wealth maximization
shareholder wealth maximization
remains the appropriate goal in governing
remains the appropriate goal in governing
the firm.
the firm.
CORPORATE GOVERNANCE
 
Corporate governance
Corporate governance
: represents the system
: represents the system
by which corporations are managed and
by which corporations are managed and
controlled
controlled
.
.
Includes shareholders, board of
Includes shareholders, board of
directors, and senior management.
directors, and senior management.
Then
Then
 
 
shareholder wealth maximization
shareholder wealth maximization
remains the appropriate goal in governing
remains the appropriate goal in governing
the firm.
the firm.
FINANCIAL
ENVIRONMENT
 
Businesses interact continually with the
Businesses interact continually with the
financial markets.
financial markets.
Financial Markets
Financial Markets
 
 
are composed of all
are composed of all
institutions and procedures for bringing
institutions and procedures for bringing
buyers and sellers of financial instruments
buyers and sellers of financial instruments
together.
together.
The purpose of financial markets is to
The purpose of financial markets is to
efficiently allocate savings to ultimate users.
efficiently allocate savings to ultimate users.
 
FLOW OF FUNDS
 
IN THE ECONOMY
 
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FLOW OF FUNDS
 
IN THE ECONOMY
 
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INVESTMENT
INVESTMENT
SECTOR
SECTOR
 
Businesses
 
Government
 
Households
 
INVESTMENT SECTOR
INVESTMENT SECTOR
 
FLOW OF FUNDS
 
IN THE ECONOMY
 
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SAVINGS SECTOR
SAVINGS SECTOR
 
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SAVINGS
SAVINGS
SECTOR
SECTOR
 
Households
 
Businesses
 
Government
 
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FLOW OF FUNDS
 
IN THE ECONOMY
 
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FINANCIAL BROKERS
FINANCIAL BROKERS
 
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FINANCIAL
FINANCIAL
BROKERS
BROKERS
 
Investment Bankers
 
Mortgage Bankers
 
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FLOW OF FUNDS
 
IN THE ECONOMY
 
FINANCIAL
FINANCIAL
INTERMEDIARIES
INTERMEDIARIES
 
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FINANCIAL
FINANCIAL
INTERMEDIARIES
INTERMEDIARIES
 
Commercial Banks
Savings Institutions
Insurance Cos.
Pension Funds
Finance Companies
Mutual Funds
 
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FLOW OF FUNDS
 
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SECONDARY MARKET
SECONDARY MARKET
 
SECONDARY
SECONDARY
MARKET
MARKET
 
Security
Exchanges
 
OTC
Market
 
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ALLOCATION OF FUNDS
 
In a rational world, the highest expected
In a rational world, the highest expected
returns will be offered only by those economic
returns will be offered only by those economic
units with the most promising investment
units with the most promising investment
opportunities.
opportunities.
Result
Result
: 
: 
Savings tend to be allocated to the most
Savings tend to be allocated to the most
efficient uses.
efficient uses.
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Financial management involves planning, organizing, controlling financial resources, and finding sources for raising funds. It includes functions such as estimating financial requirements, decision-making on capital structure and investment, cash management, and financial controls. The main objectives of financial management are profit maximization and wealth maximization. It plays a crucial role in maximizing economic welfare for shareholders by providing a framework for commercial strategies.


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  1. FINANCIAL MANAGEMENT Syed Muhammad Majid Shah Lecturer QACC

  2. Financing means the provision of money at the time when it is required Financial management is: Concerned with the planning & controlling of firm s financial resources and to find various sources for raising further funds for the firm INTRODUCTION The application of the general management principles in the area of financial decision-making The art of planning; organizing, directing and controlling of the funds and safe disposal of profits The art and science of managing money

  3. Business Finance OR Corporate Finance Money Markets Financial Management Financial Markets Capital Markets Financial Economics (Studies the Financial System) Financial Institutions Banking Institutions Economics Finance Financial Instruments Non-Banking Institutions Security Analysis Investments Portfolio Theory Personal Finance Market Analysis Public Finance Behavioral Finance

  4. FUNCTIONS OF FINANCIAL MANAGEMENT Estimating Financial Requirements Deciding Capital Structure Selecting a Source of Finance Selecting a Pattern of Investment Proper Cash Management Implementing Financial Controls Return on Investment, Ratio analysis, Break Even Analysis, Cost Control, Audit Proper use of Surpluses

  5. Functions of Financial Management Financing Decision Investment Decision Dividend Decision Liquidity Decision Analysis of Risk/Return for achieving these Goals/Objectives: Profit Wealth Maximization Maximization

  6. GOALS/OBJECTIVES OF FINANCIAL MANAGEMENT The main objective of a business is to maximize the owner s economic welfare Financial management of a firm helps maximize economic welfare of is shareholders by providing a framework for selecting a commercial strategy There are two versions of the main goal of financial management: Profit maximization Wealth maximization The functions of FM are directed toward achieving the above goals

  7. WEALTH MAXIMIZATION Financial theory asserts that the wealth maximization is the single MAIN substitute for stakeholders utility When the firm maximizes the shareholders wealth, the individual stakeholders can use this wealth to maximize his individual utility Stockholder s current wealth in the firm Number of shares owned Current stock price per share Maximi ze Stock Price Maximize Stakehold er Wealth Refers to Result s in Maximu m Utility

  8. Economic Environment Economic activity, Tax rates Management Decisions Competition, Business conditions Products & Services, Technology Shareholder s Wealth Capital structure, Dividend Policy Market Price of the Stock Financial Markets Interest rates, Inflation Amount, Timing, Risk of expected Cash Flow

  9. CHIEF FINANCIAL OFFICER CFOs play an important role in ensuring proper reporting based on substance to the stakeholders of the company. CFO reports to BODs. Under CFO,normally two senior officers normally operate: Treasurer Controller/Comptroller Obtaining required finance Accounting and Auditing Liaison with term lending and other financial institutions Management control systems Taxation and insurance Managing working capital Budgeting and performance evaluation Managing investment in real assets Maintaining assets intact to ensure higher productivity

  10. FINANCE AND OTHER BUSINESS FUNCTIONS Finance And Accounting The purpose of accounting is to report the financial performance of the business for the period under consideration. Financial analysis is carried out on basis of accounting Accounting is historical in nature, while FM uses this to make future oriented decisions Finance And Marketing Channels of distribution, advertisement policy, remunerating the salesmen etc.have financial implications Marketing cost analysis is a function of finance managers Credit management and credit terms for increasing sales

  11. FINANCE AND OTHER BUSINESS FUNCTIONS Finance And Productions (Operations) Decisions on plant layout,technology selection, productions / operations, process plant size etc. Capital Budgeting is closely related to productions Inventory management involves many financial variables Finance And HR Attracting and retaining the best man power in the industry cannot be done unless they are paid salary at competitive rates The better the quality of manpower, the higher the value of the human capital and consequently the higher the productivity of the organization

  12. THE MODERN CORPORATION Modern Corporation Shareholders Management There exists a SEPARATION between owners and managers.

  13. ROLE OF MANAGEMENT Management acts as an agent for the owners (shareholders) of the firm. An agent is an individual authorized by another person, called the principal, to act in the latter s behalf.

  14. AGENCY THEORY Jensen and Meckling developed a theory of the firm based on agency theory. Agency Theory is a branch of economics relating to the behavior of principals and their agents.

  15. AGENCY THEORY Principals must provide incentives so that management acts in the principals best interests and then monitor results. Incentives include, stock options, perquisites, and bonuses.

  16. CORPORATE SOCIAL RESPONSIBILITY Wealth maximization does not prohibit the firm from being socially responsible at the corporate level. Assume we view the firm as producing both private and social goods. Then shareholder wealth maximization remains the appropriate goal in governing the firm.

  17. CORPORATE GOVERNANCE Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. Then shareholder wealth maximization remains the appropriate goal in governing the firm.

  18. FINANCIAL ENVIRONMENT Businesses interact continually with the financial markets. Financial Markets are composed of all institutions and procedures for bringing buyers and sellers of financial instruments together. The purpose of financial markets is to efficiently allocate savings to ultimate users.

  19. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR INTERMEDIARIES FINANCIAL FINANCIAL BROKERS SECONDARY MARKET SAVINGS SECTOR

  20. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR INVESTMENT SECTOR INTERMEDIARIES FINANCIAL Businesses FINANCIAL BROKERS Government SECONDARY MARKET Households SAVINGS SECTOR

  21. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR SAVINGS SECTOR INTERMEDIARIES FINANCIAL Households FINANCIAL BROKERS Businesses SECONDARY MARKET Government SAVINGS SECTOR

  22. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR FINANCIAL BROKERS INTERMEDIARIES FINANCIAL Investment Bankers FINANCIAL BROKERS Mortgage Bankers SECONDARY MARKET SAVINGS SECTOR

  23. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR FINANCIAL INTERMEDIARIES INTERMEDIARIES FINANCIAL Commercial Banks Savings Institutions Insurance Cos. Pension Funds Finance Companies Mutual Funds FINANCIAL BROKERS SECONDARY MARKET SAVINGS SECTOR

  24. FLOW OF FUNDS IN THE ECONOMY INVESTMENT SECTOR SECONDARY MARKET INTERMEDIARIES FINANCIAL Security Exchanges FINANCIAL BROKERS OTC Market SECONDARY MARKET SAVINGS SECTOR

  25. ALLOCATION OF FUNDS Funds will flow to economic units that are willing to provide the greatest expected return (holding risk constant). In a rational world, the highest expected returns will be offered only by those economic units with the most promising investment opportunities. Result: Savings tend to be allocated to the most efficient uses.

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