Introduction to financial management

1. Lecture 1
Introduction to Financial
Management
by
Dr Kwame Oduro Amoako
Ph.D., MBA, BBA.

2. Key Concepts and Skills
 To understand what financial management is about
 To know the scope of financial management
 To know the basic types of financial management
decisions and the role of the financial manager
 To understand the goal of financial management
 To be aware of the sources of finance
 To understand financial markets and financial
instruments
Dr. Kwame O. Amoako

3. Financial Management?
 Finance, according to Maness (1988) is the
study of acquisition and investment of cash
for the purpose of enhancing value and
wealth.
 Management: achieving organizational
objectives by performing the planning,
organizing, leading and controlling
functions.
Dr. Kwame O. Amoako

4. Financial Management?
 Applying general management principles to financial
resources of the enterprise.
 Financial Management means planning, organizing, directing
and controlling the financial activities such as procurement
and utilization of funds of the enterprise.
 It also refers to the efficient and effective management of
money (funds) in such a manner that accomplishes the
objectives of the organization.
Dr. Kwame O. Amoako

5. Scope of financial decisions

6. Scope of Financial Management
 Financial decisions - They relate to the raising of finance from
various resources which will depend upon decision on type of source,
period of financing, cost of financing and the returns thereby.
 Investment decisions includes investment in fixed assets (called as
capital budgeting). Investment in current assets are also a part of
investment decisions called as working capital decisions.
 Dividend decisions - The finance manager has to take decision with
regards to the net profit distribution. Net profits are generally divided
into two:
 Dividend for shareholders- Dividend and the rate of it has to be decided.
 Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.
Dr. Kwame O. Amoako

7. Functions of a Financial Manager cont.
 Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This
will depend upon expected costs and profits and future programmes
and policies of a concern.
 Determination of capital composition: Once the estimation have
been made, the capital structure have to be decided. This involves
short- term and long- term debt equity analysis.
 Choice of sources of funds: For additional funds to be procured, a
company has many choices like-
 Issue of shares and debentures
 Loans to be taken from banks and financial institutions
 Public deposits to be drawn like in form of bonds.
Dr. Kwame O. Amoako

8. Functions of a Financial Manager cont.
 Investment of funds: The finance manager has to
decide to allocate funds into profitable ventures so that
there is safety on investment and regular returns is
possible.
 Disposal of surplus: The net profits decision have to be
made by the finance manager. This can be done in two
ways:
 Dividend declaration - It includes identifying the
rate of dividends and other benefits like bonus.
 Retained profits - The volume has to be decided
which will depend upon expansional, innovational,
diversification plans of the company.
Dr. Kwame O. Amoako

9. Functions of Financial Manager cont.
 Management of cash: Cash is required for many
purposes like payment of wages and salaries,
payment of electricity and water bills, payment to
creditors, meeting current liabilities, purchase of
raw materials, etc.
 Financial controls: The finance manager has not
only to plan, procure and utilize the funds but he
also has to exercise control over finances. This can
be done through many techniques like ratio
analysis, financial forecasting, cost and profit
control, etc.
Dr. Kwame O. Amoako

10. ALL MANAGERS ARE FINANCIAL MANAGERS
 The engineer, who proposes a new plant, shapes the investment policy of the
firm
 The procurement manager influences the level of investment in inventories
 The Marketing manager has a say in the determination of the receivables
policy
 The production manager contributes to credit policies.
 The Human resource manager also determines who is to be hired at what cost
to the company.
NOTE: Departmental managers, in general, are important links in the finance control system of the
firm
Dr. Kwame O. Amoako

11. THE ORGANISATIONAL STRUCTURE OF FINANCIAL
MANAGEMENT FUNCTION
Dr. Kwame O. Amoako

12. Dr. Kwame O. Amoako

13. Shortcomings of these
objectives
 These goals are either associated with increasing
profitability or reducing risk. E.g.
 Profit maximization; Profit figures can be manipulated.
o short term profits are maximized at the expense of
long term highly profitable investments.
o Managers of a business may resort to unhealthy
practices and manipulations such as reducing
operating expenses by cutting research and
development expenditure, staff training and
development.
Dr. Kwame O. Amoako

14. Shortcomings of these
General Goals cont.
 Sales/Market share maximization
o Goods can be sold at a cheaper prices or at
a loss to maximize market shares
o Sales maximization, taken to the extreme,
can lead to overtrading, and even
bankruptcy.
So it is necessary to find a goal that can
encompass both profitability and risk.
Dr. Kwame O. Amoako

15. The Real Goal of the
Firm
Maximization of
Shareholder Wealth!
Dr. Kwame O. Amoako

16. What is shareholders wealth?
 Shareholders’ wealth can be measured as
the current value per share of existing
shares.
 The shareholders wealth maximization
objective is to maintain highest market
value of shares.
 Shareholder wealth is calculated as the
number of common shares outstanding
times the market price per share.

17. Wealth maximization Vrs other corporate
objectives
 The goal of shareholder wealth maximization
is a long-term goal, and takes risk
into account.
 In order to increase shareholders wealth
entities invest in long term projects highly
profitable ventures.
 The pursuance of shareholder
wealth maximization as an objective removes
the technical limitations of profit
maximization.
Dr. Kwame O. Amoako

19. Introduction to Financial Markets
 Any marketplace where trading of
securities including equities, bonds,
currencies and derivatives occur.
 It acts as an intermediary between the
savers and investors by mobilising funds
between them.
 It plays a crucial role in allocating limited
resources, in the country’s economy.
Dr. Kwame O. Amoako

20. Financial markets constituents

22. Summary of Classification of
Financial Markets
 Classification by nature.
 Debt market; Equity market
 Classification by maturity.
 Money market; Capital market
 Classification by season.
 Primary market; Secondary market
 Etc.
Dr. Kwame O. Amoako

23. Classification by nature
 The debt market
 the market where debt instruments are traded.
Debt instruments are assets that require a fixed
payment to the holder, usually with interest.
Examples of debt instruments include bonds
(government or corporate) and mortgages.
 The equity market
 (often referred to as the stock market) is the market
for trading equity instruments. An example of an
equity instrument would be common stock shares,
such as those traded on the New York Stock
Exchange.
Dr. Kwame O. Amoako

24. Sli
de
24
Classification by maturity
 A capital market
 A capital market is a financial market in which long-term debt (over a
year) or equity securities are bought and sold.
 Capital markets channel the wealth of savers to those who can put it to
long-term productive use, such as companies or governments making
long-term investments
 Money market
 Market for short-term funds, Securities with maturities from one day up
to one year are issued and traded in the money market
 The purpose of the money market is to enable institutions and
companies to meet short-term funding needs by borrowing and
lending each other.
 E.g., certificates of deposits, treasury bills, and commercial papers.
Capital market includes
Dr. Kwame O. Amoako

25. Classification by season
 Primary Markets
 Market for issuing a new
securities
 Investment Banks—
Information and marketing
specialists for newly issued
securities.
 Secondary Markets
 Market where existing
securities can be
exchanged
 Ghana Stock Exchange
 New York Stock Exchange
 American Stock Exchange
 Conceptual
distinction:
 Selling of new
securities in
primary market
and trading of
older securities
in secondary
market occur
simultaneously.
Dr. Kwame O. Amoako

26. Financial Institutions
The three types of financial institutions in Ghana:
Commercial
Banks
Savings and
Loan
Associations
Credit
Unions

27. Efficient Market Hypothesis
 In an efficient capital market, security prices fairly
priced based on market available information
 In other words, the market quickly and correctly
adjusts to new information
Efficient-Market Hypothesis (EMH)-hypothesis used to
test whether the capital market is efficient
 The Efficient Markets Hypothesis (EMH) is made up
of three progressively stronger forms:
 Strong Form
 Semi-strong Form
 Weak Form

28. How stock prices changes
 Good news Vs Bad news are directly related to stock prices
 Good income statement or sales report in theory comes with
rise in stock prices

29. Strong form efficiency:
 At any one time, anyone and everyone knows
about all relevant information about the stock
 The strong form says that prices fully reflect all
information, whether publicly available or not (
including inside information)
 Even the knowledge of material, non-public
information cannot be used to earn superior
results.
 No investor can earn excess returns using any
information, whether or not publicly available.
 Most studies have found that the markets are not
efficient in this sense. Not true in practice

30. Semi-strong form efficiency:
 Prices of shares incorporate all publicly available
information
 No investor can earn excess returns from trading rules
based on publicly available information
 The semi-strong form says that prices fully reflect all
publicly available information and expectations about the
future.
 This suggests that prices adjust very rapidly to new
information, and that old information cannot be used to
earn superior returns.
 The semi-strong form, if correct, repudiates fundamental
analysis.
 Most studies find that the markets are reasonably efficient
in this sense, but the evidence is somewhat mixed.

31. Weak form efficiency:
 prices incorporate information about past prices
 No investor can earn excess returns by developing
trading rules based on historical price or return
information.
 If stock price changes are random, then past prices
cannot be used to forecast future prices.
 Prices should change very quickly and to the correct
level when new information arrives.
 This form of the EMH, if correct, repudiates
technical analysis.
 Most research supports the notion that the markets
are weak form efficient.

32. Efficiency market hypothesis

33. Sources of Finance
Internal:
 Owner’s investment
(start up or additional
capital)
 Retained profits
 Sale of stock
 Sale of fixed assets
 Debt collection
 External (raised from
an outside source)
External:
 Bank Loan or
Overdraft
 Additional Partners
 Share Issue
 Leasing
 Hire Purchase
 Mortgage
 Trade Credit
 Government Grants
Dr. Kwame O. Amoako

34. Internal Sources
Owner’s investment
 This is money which
comes from the
owner/s own savings
 It may be in the form
of start up capital -
used when the
business is setting up
 It may be in the form
of additional capital –
perhaps used for
expansion
 This is a long-term
source of finance
Advantages
 Doesn’t have to
be repaid
 No interest is
payable
Disadvantages
 There is a limit to
the amount an
owner can invest
Dr. Kwame O. Amoako

35. Internal Sources finance
Retained Profits
 This source of finance is
only available for a
business which has been
trading for more than
one year
 It is when the profits
made are ploughed back
into the business
 This is a medium or long-
term source of finance
Advantages
 Doesn’t have to be repaid
 No interest is payable
Disadvantages
 Not available to a new
business
 Business may not make
enough profit to plough back
Dr. Kwame O. Amoako

36. Internal Sources
Sale of Stock
 This money comes in
from selling off unsold
stock
 This is what happens in
the January sales
 It is when the profits
made are ploughed
back into the business
 This is a short-term
source of finance
Advantages
 Quick way of raising
finance
 By selling off stock it
reduces the costs
associated with holding
them
Disadvantages
 Business will have to
take a reduced price for
the stock
Dr. Kwame O. Amoako

37. Internal Sources
Sale of Fixed Assets
 This money comes in from
selling off fixed assets,
such as:
 a piece of machinery
that is no longer
needed
 Businesses do not always
have surplus fixed assets
which they can sell off
 There is also a limit to the
number of fixed assets a
firm can sell off
 This is a medium-term
source of finance
Advantages
 Good way to raise finance
from an asset that is no
longer needed
Disadvantages
 Some businesses are
unlikely to have surplus
assets to sell
 Can be a slow method of
raising finance
Dr. Kwame O. Amoako

38. Internal Sources
Debt Collection
 A debtor is someone who
owes a business money
 A business can raise finance
by collecting the money
owed to them (debts) from
their debtors
 Not all businesses have
debtors ie those who deal
only in cash
 This is a short-term source
of finance
Advantages
 No additional cost in
getting this finance, it is
part of the businesses’
normal operations
Disadvantages
 There is a risk that debts
owed can go bad and
not be repaid
Dr. Kwame O. Amoako

39. External Sources
Bank Loan
 This is money
borrowed at an
agreed rate of
interest over a
set period of
time
 This is a medium
or long-term
source of finance
Advantages
 Set repayments are spread
over a period of time
which is good for
budgeting
Disadvantages
 Can be expensive due to
interest payments
 Bank may require security
on the loan
Dr. Kwame O. Amoako

40. External Sources
Bank Overdraft
 This is where the
business is allowed
to be overdrawn on
its account
 This means they can
still write cheques,
even if they do not
have enough money
in the account
 This is a short-term
source of finance
Advantages
 This is a good way to cover
the period between money
going out of and coming into
a business
 If used in the short-term it is
usually cheaper than a bank
loan
Disadvantages
 Interest is repayable on the
amount overdrawn
 Can be expensive if used over
a longer period of time
Dr. Kwame O. Amoako

41. External Sources
Additional Partners
 This is sources of
finance suitable for
a partnership
business
 The new partner/s
can contribute extra
capital
Advantages
 Doesn’t have to be
repaid
 No interest is payable
Disadvantages
 Diluting control of the
partnership
 Profits will be split more
ways
Dr. Kwame O. Amoako

42. External Sources
Share Issue
 This is sources of
finance suitable for
a limited company
 Involves issuing
more shares
 This is a long-term
source of finance
Advantages
 Doesn’t have to be repaid
 No interest is payable
Disadvantages
 Profits will be paid out as
dividends to more
shareholders
 Ownership of the company
could change hands
Dr. Kwame O. Amoako

43. External Sources
Leasing
 This method allows a
business to obtain assets
without the need to pay a
large lump sum up front
 It is arranged through a
finance company
 Leasing is like renting an
asset
 It involves making set
repayments
 This is a medium-term
source of finance
Advantages
 Businesses can have the
use of up to date
equipment immediately
 Payments are spread over a
period of time which is
good for budgeting
Disadvantages
 Can be expensive
 The asset belongs to the
finance company
Dr. Kwame O. Amoako

44. External Sources
Hire Purchase
 This method allows a business to
obtain assets without the need to
pay a large lump sum up front
 Involves paying an initial deposit
and regular payments for a set
period of time
 The main difference between hire
purchase and leasing is that with
hire purchase after all repayments
have been made the business
owns the asset
 This is a medium-term source of
finance
Advantages
 Businesses can have the use of
up to date equipment
immediately
 Payments are spread over a
period of time which is good
for budgeting
 Once all repayments are made
the business will own the asset
Disadvantages
 This is an expensive method
compared to buying with cash
Dr. Kwame O. Amoako

45. External Sources
Mortgage
 This is a loan secured on
property
 Repaid in instalments
over a period of time
typically 25 years
 The business will own the
property once the final
payment has been made
 This is a long-term source
of finance
Advantages
 Business has the use of the property
 Payments are spread over a period of
time which is good for budgeting
 Once all repayments are made the
business will own the asset
Disadvantages
 This is an expensive method compared
to buying with cash
 If business does not keep up with
repayments the property could be
repossessed
Dr. Kwame O. Amoako

46. External Sources
Trade Credit
 Trade credit is
summed up by the
phrase:
buy now pay later
 Typical trade credit
period is 30 days
 This is a short-term
source of finance
Advantages
 Business can sell the goods
first and pay for them later
 Good for cash flow
 No interest charged if money
is paid within agreed time
Disadvantages
 Discount given for cash
payment would be lost
 Businesses need to carefully
manage their cash flow to
ensure they will have money
available when the debt is due
to be paid
Dr. Kwame O. Amoako

47. External Sources
Government Grants
 Government
organisations such as
venture capital offer
grants to businesses,
both established and
new
 Usually certain
conditions apply, such
as where the business
has to locate
Advantages
 Don’t have to be repaid
Disadvantages
 Certain conditions may
apply e.g., location
 Not all businesses may be
eligible for a grant
Dr. Kwame O. Amoako

48. Factors Affecting Choice of
Source of Finance
 The source of finance chosen will depend on
a number of factors:
Purpose – what the finance is to be used
for
Time Period – how long the finance will be
needed for
Amount – how much money the business
needs
Ownership and Size of the business
Dr. Kwame O. Amoako

50. what is the capital of a company made up?
Capital of a
company
Borrowing
Money invested
by the owners
Bonds
Long-term
bank
loans
Shares,
Stock or
Equity
SHARES = EQUITY CAPITAL
There are 2 main types of shares:
1. ORDINARY SHARES
2. PREFERENCE SHARES
Dr. Kwame O. Amoako

51. Sample of Share certificate
Dr. Kwame O. Amoako

52. Ordinary Shares
Shares,
Stock or
Equity
Company share capital
ALWAYS includes
ordinary shares
Owners of ordinary shares
They technically own the
company
FEATURES
ENTITLEMENTS
 Can be fully paid – The
shareholder has paid all of
the initial capital reflecting
the full value of the shares
owned.
 Can be partly paid - The
shareholder has not paid
the entire initial capital.
The shareholder has an
obligation to pay the
remaining amount when the
company calls upon them
to do so. This is also
known as contributing
shares.
 Full risk and reward of investing
(Shareholders do well if the company
does and vice-versa)
 Entitled to a ‘yes’ or ‘no’ vote to
each resolution at company
meetings
Receive dividends declared by the
company
 Half-yearly or quarterly
 They ratify the dividend
amount proposed by the
directors before they are
declared payable
 but dividends are not
always paid or as large as
liked

53. TYPES OF PREFERENCE SHARE
Preference
Shares
Shares,
Stock or
Equity
SOME companies have
preference shares as well
as ordinary shares
NO VOTING ENTITLEMENTS
RECIEVE FIXED DIVIDENDS
PAID BACK BEFORE ORDINARY
SHAREHOLDERS IF COMPANY IS
WOUND UP
FEATURES/ENTITLEMENT
S
CUMULATIVE
Dividend entitlements accumulate if
they are not paid one year
NON-CUMULATIVE
If a company does not pay out
dividends one year, these
shareholders miss out on this
dividend
PARTICIPATING
Entitle the holder to a basic dividend
but the directors can award a bigger
dividend in a year when the profits
exceed a certain level. i.e. preference
shareholder can participate in
bumper profits.
CONVERTIBLE
Carry an option to convert into the
ordinary shares of the company at
set intervals and on pre-set terms.
REDEEMABLE
Have a date at which the nominal
value may be redeemed - paid back
to the preference shareholder and
the shares cancelled.
Articles of Association sets
out precisely how they differ
from ordinary shares.
‘Hybrid Securities’ – they
have characteristics of bonds
and equities.
Preference shares have
legal priority (seniority) over
ordinary shareholders in
respect of their dividends and
collapse of the company (will
get their money back before
ordinary shareholders)
Non-voting - cannot vote at
the General Meetings of the
company
Pay a fixed dividend each
year, the amount set when
first issued and has to be
paid before dividends on
ordinary shares can be paid