MBA_653_PPT [Autosaved].pptx

General Overview
Financial management focuses on decisions
relating to how much and what types of
assets to acquire, how to raise the capital
needed to buy assets, and how to run the
firm so as to maximise its value.
2

General Overview
It is concerned with the efficacy of the
management of the financial resources of an
organisation in the purpose for which the
organisation was set up
3

General Overview
This involves planning and controlling the
provision of resources:
where funds are raised from;
the allocation of resources i.e. where
funds are deployed to; and
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General Overview
the control of resources (i.e. the efficacy of
the use funds).
The fundamental aim is the optimal
allocation of the scarce resources available
to them – the scarce resource being
financial resources.
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Concepts of Financial Management
Two key concepts are pivotal:
relationship between risk and return –
stakeholder take on more risk only, if a higher
return is offered in compensation; and
time value of money – a key concept in
financial management and is relevant to
stakeholders.
6

Compounding & Discounting
Compounding: the way to determine the
future value of a sum of money invested
now, for example in a bank account, where
interest is left in the account after it has
been – Since interest received is left in the
account, interest is earned on interest in
future years.
7

Discounting: the opposite of compounding,
take account of the time value of money in
Financial Management.
While compounding takes investors forward from
the current value of an investment to its future
value, discounting takes investors backward from
the future value of a cash flow to its present value.
8

Compounding, mathematically
FV = C0(1 + i)n or
Where: FV = future value
C0 (PV) = sum deposited now
I (r) = interest rate
n = number of years until the cash flow
occurs
9
n
r
PV
FV )
1
( 


Discounting, mathematically
PV = FV/ (1 + i)n or
Where: PV = present value
FV = future value
I (r) = discount rate/cost of capital
n = number of years until the cash flow
occurs
10
n
r
FV
PV )
1
( 


The role of the Financial
Manager
Responsible for:
Dividend decisions – strike a balance between the
amount of earnings they retain and the amount they pay out to
shareholders as dividend.
Financing decisions – raising funds, choosing from a
wide variety of institutions and markets, with each source of finance
having different features as regards cost, availability, maturity and
risk.
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Manager
Responsible for:
Investing decisions – advising on the allocation of
funds in terms of the total amount of assets, the composition of fixed
and current assets, and the consequent risk profile of the choices.
The Financial Manager thus takes account
of the interrelationship among dividend,
financing and investment decisions.
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Manager
13
Investment: company
decides to take on a
large number of
attractive new
investment projects
Finance: company will need to
raise finance in order to take up
projects
Dividends: if finance is not
available from external sources,
dividends may need to be cut in
order to increase internal
financing
Dividends: company
decides to pay higher
levels of dividends to its
shareholders
Finance: lower level of retained
earnings for investment means
company may have to find
finance from external sources
Investment: if finance is not
available from external sources
the company may have to
postpone future investment
projects
Finance: company
finances itself using
more expensive sources,
resulting in a higher cost
of capital
Investment: due to a higher cost
of capital the number of
projects attractive to the
company decreases
Dividends: the company’s ability
to pay dividends in the future
will be adversely affected

Manager
How the finance function fits within a
company’s management structure can thus
be best explained by using an organogram
14

Manager
Hypothetical Organisation Chart
15

Corporate objectives
To make decisions that maximise the value
of the company for its owners. As the
owners of the company are its shareholders,
the primary financial objective of corporate
finance is usually stated to be the
maximisation of shareholder wealth.
16

Maximisation of profits
The concept of economic profit is far
removed from the accounting profit found in
a company’s profit and loss account. While
economic profit broadly equates to cash,
accounting profit does not.
First there are quantitative difficulties
associated with profit;
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Maximisation of profits
Second the timescale over which profit
should be maximised – short term, medium
term or long term;
Third profit does not take account of, or make
an allowance for, risk – maximising
accounting profit usually conflicts with one of
the key determinants of shareholder wealth.
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Maximisation of shareholder wealth
Three variables that directly affect
shareholders’ wealth:
the magnitude of cash flows accumulating to the
company;
the timing of cash flows accumulating to the
company;
the risk associated with the cash flows
accumulating to the company. 19

Goals of financial management
A goal (often referred to as objective in
financial management perspective) is a
focus/target/stand point that a person or an
institution hopes to achieve/attain. It is
different from a mission and a vision.
A mission refers to the purpose for the existence of
an organisation.
20

The vision of an organisation is the long
term objectives/goals of the firm. This
statement is a summary document
containing all the long term goals/objectives
of an organisation.
21

The objectives of an organisation are
broadly divided into two main groups –
financial and non-financial objectives.
22

The most important objective is the primary
objective, which is the maximisation of the
wealth of equity shareholders. Wealth (from an
accounting perspective) of shareholders is
maximised at the point where revenue generated
are greater than cost incurred in generating
revenue.
23

Conflicting interest
a) Maximising and Satisficing
b) Multiple Stakeholders
Examples of stakeholders are as follows:
• Connected:
Shareholders
Debt lenders
Customers
Banks
Suppliers
24

Examples of stakeholders are as follows:
• External:
Government
Local authorities
The community at large
• Internal:
Employees
Managers
25

The influence of the various stakeholders
results in many firms adopting non-financial
objectives in addition to financial ones.
These might include objectives such as:
Becoming research and development
leaders;
Growth;
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Maintaining a contented workforce;
Providing top quality services to
customers;
Showing respect for the environment;
Survival.
27

Value for money (vfm)
Economy i.e. obtaining resources at a
‘faire’ price;
Effectiveness i.e. obtaining good results;
Efficiency i.e. making good use of
resources – using resources in order to
achieve the organisation’s objectives:
again, in the case of a hospital one way of
attempting to measure this could be to
calculate the number of patients per nurse.
28

Value for money (vfm)
Equity i.e. fair dealings in respect of all and
focuses on determining whether the distribution of
resources is fair to both relational partners. It is
measured by comparing the ratio of contributions
(or costs) and benefits (or rewards) for each
person.
Ethics i.e. consideration of all the codes of values
and principles that enable a person to choose
between right and wrong, and therefore, select
from alternative courses of action. Further, ethical
dilemmas arise from conflicting interests of the
parties involved.
29

Conflicting stakeholder interests
A number of different theoretical frameworks (i.e.
Theories supporting differing views of the primary
corporate objectives) have evolved to explain and
analyse CG. Each of these frameworks approaches
CG in a slightly different way, using different
terminology, and views CG from a different
perspective, arising from a different discipline
Agency theory;
Political change theory;
Resource dependency theory;
Stakeholder theory;
Stewardship theory;
30

Sociological theory; and
Transaction cost economic theory
31

Agency problem
The agency problem is said to occur when
managers make decisions that are not consistent
with the objective of shareholder wealth
maximisation.
Three important features that contribute to the
existence of the agency problem within public
limited companies are as follows:
divergence of ownership and control;
goals of the managers;
information asymmetry.
32

Agency theory
Agency theory was developed by Jensen and
Meckling (1976), is based on the separation of the
ownership and control.
Jensen and Meckling argued that when directors
and managers are appointed to run a company, an
agency-principal relationship is created.
However, Jensen and Meckling argued that this
agency relationship creates a serious conflict of
interest between the company’s owners and
managers.
33

Agency theory
Agency conflicts are differences in the interests of
owners and managers due to:
Earnings retention;
Time horizon.
34

Dealing with the agency problem between
shareholders and managers
35
Jensen and Meckling (1976) suggested that there
are two ways of seeking to optimise managerial
behaviour in order to encourage goal congruence
between shareholders and managers:
shareholders to monitor the actions of management;
shareholders to incorporate clauses that formalise
constraints, incentives and punishments into managerial
contracts to encourage goal congruence.

Political change theory
Political change theory is based on the assumption
that political influence in the governance structure of
companies is evidenced by the participation of the
government in the capital of companies or laws
adopted by political structures, which have a
significant influence on corporate governance.
36

Resource dependency theory
This theory assumes that a firm's power over its
external environment is critical to earning a
competitive advantage for a firm. The external
environment such as suppliers, customers and board
of directors, are contingencies of the organisation's
power.
37

Stakeholder theory
Unlike the agency theory that makes assumption
that the main objective of a company should be to
maximise the wealth of shareholders, the
stakeholder theory is based on the view that the
purpose of corporate governance should be to
satisfy, as far as possible, the objectives of all key
stakeholders – employees, investors, major
creditors, customers, major suppliers, the
government, local communities and the general
public
38

Stewardship theory
The stewardship theory of CG discounts the possible
conflicts between corporate management and
owners and shows a preference for a board of
directors made up primarily of corporate insiders.
This theory assumes that managers are basically
trustworthy and attach significant value to their own
personal reputations. The market for managers with
strong personal reputations serves as the primary
mechanism to control behaviour, with more reputable
managers being offered higher compensation
packages (Shleifer and Vishny, 1986).
39

Sociological theory
The sociological theory assumes that outside
dominated boards, transparent accounting
disclosures and corporate accountability are
effective and essential tools to promote impartiality
and fairness in the society, which are considered as
the socio-economic objectives of a corporate firm.
40

Transaction cost economic theory
This theory provides a different explanation of the
relationship between the owners of a company and
its management, but reaches a similar conclusion as
agency theory.
Here, total costs are defined as the sum of
production costs and transaction costs.
incurring production costs are on ideal economic
market;
transaction costs are additional costs incurred
whenever the perfect economic market is not
achieved. 41

Transaction cost economic theory
Transaction cost theory also considers the
implications of human behaviour for the way in which
a company is managed and governed. Williamson
made two assumptions about behaviour:
Bounded rationality describes the way that humans
make decisions that departs from perfect economic
rationality, because our rationality is limited by our
thinking capacity, the information that is available to
us, and time. Instead of making the 'best' choices, we
often make choices that are satisfactory.
42

Opportunism shows human behaviour that is self-
interest seeking with guile. It is manifested in
behaviors such as stealing, cheating, dishonesty, and
withholding information. Opportunism negatively
impacts relational exchange tenets such as trust,
commitment, cooperation, and satisfaction.
43

Corporate governance (CG)
A set of relationships between a company’s
directors, its shareholders and other stakeholders. It
also provides structure through which the objectives
of the company are set, and the means of obtaining
these objectives and monitoring performance are
determined.
Sought to influence the structure and nature of the
mechanisms by which owners govern managers in
promoting accountability, fairness and transparency.
For CG to be effective it must be a feature of the
inherent business culture, i.e. the way business is
conducted.
44

CG Core Principles
It is a fundamental internal controls system ensuring
the best interests of the company are serviced in the
most effective manner.
Accountability
Fairness
Independence
Integrity
Judgement
Openness
Probity
Reputation
Responsibility
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CG and agency theory
Agency is a key component of corporate
governance because it defines directors (and
managers) as acting as agents of the
shareholders.
Agency theory would describe the shareholders in
a company are the principal, with the board their
agents who are empowered to act in their interests
by negotiating and contracting with third parties
(e.g. clients, suppliers, regulators)
46

Stakeholders in CG
Stakeholders are people, groups or organisations
that can influence, affect or be affected by the
actions or policies of an organisation. Each
stakeholder group has different expectations about
what it wants, and therefore different claims upon
the organisation.
47

Stakeholders in CG
Classification by proximity
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Classification of Stakeholders in CG
Stakeholder group Members
Connected Shareholders, customers, suppliers, lenders, trade unions, competitors
External The government, local government, the public, pressure groups, the media
Internal Employees, management, the board

Stakeholders in CG
Mendelow classifies stakeholders on a matrix or
framework whose axes are power held and
likelihood of showing an interest in the organisation’s
activities. These factors will help define the type of
relationship the organisation should seek with its
stakeholders, and how it should view their concerns.
Stakeholder influence (claims) is determined by level
of interest and power they have…The legitimacy of
each stakeholder's claim depends on ethical and
political perspective on whether or not certain groups
should be considered as stakeholders.
Influence = Interest x Power
49

Stakeholders in CG
Mendelow’s Matrix
50
Level of Interest
Low High
Power
Low
Minimal efforts – Minimal effort is
expended on this segment since not too
much is expected from them and as such
do not take part in any critical decision
making process.es
Keep informed – Stakeholders in
this segment do not have great
ability to influence strategy, but
their views can be important in
influencing more powerful
stakeholders, perhaps by
lobbying. They should therefore
be kept informed. Community
representatives and charities
might fall into segment.
High
Keep satisfied – They should be kept
satisfied since they are capable of moving
to high interest; high power category of
stakeholders, i.e. Key players. Large
institutional shareholders might fall into
this category.
Key players – The organisation's
strategy must be acceptable to
them, at least. An example would
be a major customer…

Stakeholders in CG
Classification by Legitimacy/Validity
51
Legitimate Those who have valid claims upon the organisation
Illegitimate Those whose claims upon the organisation are not valid

Stakeholders in CG
Classification by Effect/Traceability
52
Direct
Those who know they can affect or are affected by the
organisation's activities – employees, major customers and
suppliers
Indirect
Those who are unaware of the claims they have on the
organisation or who cannot express their claim directly – wildlife,
individual customers or suppliers of a large organisation, future
generations

Stakeholders in CG
Classification by Identification/Recognition
53
Recognised
Those whose interests and views managers consider when
deciding upon strategy
Unrecognised
Those whose claims aren't taken into account in the organisation's
decision-making – likely to be very much the same as illegitimate
stakeholders

Stakeholders in CG
Classification by Scope
54
Narrow Those most affected by the organisation's strategy – shareholders,
managers, employees, suppliers, dependent customers
Wide Those less affected by the organisation's strategy – government,
less dependent customers, the wider community

Stakeholders in CG
Classification by involment
55
Primary
Those without whose participation the organisation will have
difficulty continuing as a going concern, such as shareholders,
customers, suppliers and government (tax and legislation)
Secondary
Those whose loss of participation won't affect the company's
continued existence such as broad communities (and perhaps
management)

Stakeholders in CG
Classification by Function
56
Active
Those who seek to participate in the organisation's activities and
include managers, employees and institutional shareholders, but
may also include other groups not part of the organisation's
structure such as regulators or pressure groups
Passive Those who do not seek to participate in policy-making such as
most shareholders, local communities and government

Stakeholders in CG
Classification by Engagements
57
Voluntary
Those who engage with the organisation of their own free will and
choice, and who can detach themselves from the relationship –
management, employees, customers, suppliers, shareholders and
pressure groups.
Involuntary
Those whose involvement with the organisation is imposed and
who cannot themselves choose to withdraw from the relationship
– regulators, government, local communities, neighbours, the
natural world, future generations

Stakeholders in CG
Classification by Existence
58
Known Those whose existence is known to the organisation
Unknown
Those whose existence is unknown to the organisation
(undiscovered species, communities in proximity to overseas
suppliers)

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