This document provides an introduction to financial management. It defines financial management and identifies the roles of financial managers. It also outlines the basic forms of business organization - sole proprietorship, partnership, and corporation - and discusses the advantages and disadvantages of each. The goals of a company are also addressed, stating that the primary goal is to maximize shareholder wealth through increasing share prices over the long run. Financial markets and institutions are introduced, distinguishing between money markets and capital markets as well as primary and secondary markets.

1. An Introduction To The
Financial Management
Topic 1

2. Learning Objectives
1. Explain the definition of financial management.
2. Identify the roles of financial manager.
3. Determine the basic forms of business as well as the
advantages and disadvantages of each form of business.
4. Identify and explain the aims of a company.
5. Market and financial institutions.
WRMAS 2

3. WHAT IS FINANCE?
• A branch of economics concerned with resource allocation
as well as resource management, acquisition and
investment. Simply finance deals with matters related to
money and the markets (Investorword.com).
• Finance can be defined as the art and science of managing
money. Finance is concerned with the process,
institutions, markets, and instruments involved in the
transfer of money among individuals, businesses, and
governments (Gitman).
• Is concerned with the maintenance and creation of
economic value or wealth (Keown).
WRMAS 3

4. FOUNDATIONAL PRINCIPLES OF FINANCE
Principle 1: Cash flow is what matters
 Accounting profits are not equal to cash flows.
 Cash flow drives the value of a business.
 We must determine incremental cash flows (ICFs) when making
financial decisions.
(ICF = Accepted Projected CFs if the project is selected - if the
project is not selected)
Principle 2: Money has a time value
 A dollar received today is worth more than a dollar received in
the future.
 Since we can earn interest on money received today, it is better
to receive money earlier rather than later.
WRMAS 4

5. Foundational Principles Of Finance
Principle 3: Risk requires a Reward
 We won’t take on additional risk unless we expect to be
compensated with additional reward or return.
 Investors expect to be compensated for “delaying consumption”
and “taking on risk”.
WRMAS 5

6. Foundational Principles Of Finance
Principle 4: Market Prices are generally Right
 In an efficient market, the prices of all traded assets (such as stocks
and bonds) is fully reflect all available information.
 Thus stock prices are a useful indicator of the value of the firm.
Good decisions  Increase stock prices  Increase expected CFs
 Note there are inefficiencies in the market that may distort the prices.
Principle 5: Conflicts Of interest cause agency problems
 Agency problem conflicts of interest between principal (owners)
and agents (managers) due to the separation of management and the
ownership.
 Managers may make decisions that are not consistent with the goal of
the company.
 Agency conflict is reduced through monitoring (ex. Annual reports),
compensation schemes (ex. stock options), and market mechanisms
(ex. Takeovers)
WRMAS 6

7. ROLES OF FINANCIAL MANAGERS
• Actively manages the financial affairs of any type of business,
whether private or public, large or small, profit-seeking or not-for-
profit.
• Important roles in making decision in a company such as:
– Where to invest? (Capital budgeting)
– How to raise money to fund the investment? (Capital structure)
– How to manage cash flows from daily operations? (Working
capital)
• The responsibilities of a financial managers including:
– Planning and forecasting
– Investment and financing decisions
– Controlling and coordinating
– Transaction in the financial markets
– Risk management
WRMAS 7

8. WRMAS 8

9. BASIC FORMS OF BUSINESS ORGANISATION
Business Forms
Sole
Partnership Corporation
Proprietorship
WRMAS 9

10. Sole Proprietorship
 A business owned by a single individual.
 Advantages:
Ease of formation
Few regulations
No corporate tax
Complete control and decision-making power
Retention of all profits and assets
 Disadvantages:
Financing limitations
Unlimited liability (Incur all losses and debts)
Lacks continuity when proprietor dies
WRMAS 10

11. Partnerships
 Co-owned by 2 or more individuals agreed to form a business in
order to get profit based on agreement.
 2 types:
 General partnership
 All partners have unlimited liability-fully liable for the
indebtedness incurred by the partnership.
– Limited partnership
 Some partners can have limited liability to cash/property
they invested in the firm.
 There must be at least one general partner with unlimited
liability-actively manage the business, receive a salary, share
in profits and losses.
 Limited partners (investors) cannot participate in the
business management and their names cannot appear in the
name of the firm.
WRMAS 11

12. Partnerships
Advantages:
More available brain power and managerial skill
Easy to form
Able to raise capital
Disadvantages:
Unlimited liability
Difficult to transfer ownership
Partnership is dissolved by the death or withdraw of
partners
WRMAS 12

13. Corporation
• Legally functions separate and apart from its owners
– Co. can sue, be sued, purchase, sell, and own property
• Owners (shareholders) dictate direction and policies of the company.
• Life of company does not depend on the status of its owners.
• Advantages:
– Limited liability for shareholders
– Ownership can be easily transferred
– Unlimited life (unless the firm goes through corporate restructuring
such as mergers and bankruptcies)
– Easy to raise capital
• Disadvantages:
– No secrecy of information
– Maybe delays in decision making
– Greater regulation therefore expensive and complex to form
– Double taxation
WRMAS 13

14. WRMAS 14

15. WHAT SHOULD BE THE GOAL OF THE FIRM?
• The goal of the firm is to create value for the firm’s owners
(shareholders)  Maximize shareholder wealth.
• Shareholder wealth is measured by share prices. Thus,
This is equivalent to saying the goal is to maximize the price of
common stock!
WRMAS 15

16. Why is Shareholder Maximization
NOT Profit Maximization?
• Many people think the goal is to maximize profits.
• However, profit maximization goal is unclear about the time
frame over which profits are to be measured. Would this
mean short-term profit, or long-term profit?
• It is easy to manipulate the profits through various
accounting policies.
• Profit maximization goal ignores risk and timing of cash
flows.
WRMAS 16

17. FINANCIAL MARKETS & INSTITUTION
• Financial markets play a critical role in capitalist economy. Financial
markets help facilitate the transfer of funds from “saving surplus”
units to “saving deficit” units i.e. transfer money from those who
have the money to those who need it.
• Three ways to transfer capital in the economy:
WRMAS 17

18. Money Market Vs. Capital Market
• The 2 key financial markets are the MONEY MARKET and the
CAPITAL MARKET.
 Money Market
– Market for short-term debt instruments (maturity < 1 year).
– Money market is typically a telephone and computer market
(rather than a physical building)
Examples: Treasury bills (issued by federal government),
commercial paper, negotiable CDs, bankers’ acceptances.
 Capital Market
– Market for long-term financial securities (maturity > 1 year).
Examples: Corporate Bonds, Common stocks, Treasury Bonds,
term loans and financial leases.
WRMAS 18

19. Primary Market Vs. Secondary Market
 Primary Market (initial issue)
 Market in which new issues of a securities are sold to initial
buyers. This is the only time the issuing firm ever gets any
money for the securities.
 Example: Google raised $1.76 billion through sale of shares to
public in August 2004.
 Seasoned Equity Offering: It refers to sale of additional shares by
a company whose shares are already traded in the secondary
market.
 Example: Google raised $4.18 billion in September 2005
 Secondary Market (subsequent trading)
 Market in which previously issued securities are traded. The
issuing corporation does not get any money for stocks traded on
the secondary market.
 Example: Trading among investors today of Google stocks.
WRMAS 19

20. FINANCIAL MARKETS & INSTITUTION
• Public Offering – Both individuals and institutional investors
have the opportunity to purchase securities. The securities
are initially sold by the managing investment bank firm. The
issuing firm never actually meets the ultimate purchaser of
securities.
• Private Placement – The securities are offered and sold to a
limited number of investors.
WRMAS 20

21. ROLE OF FINANCIAL MARKET
1. Primary Market
Cash
Security INVESTOR
FIRM
Reinvest
3. Dividend, etc Secondary
2. Investment Market
Cash flow
Tax
GOVERNMENT
WRMAS 21