Fin Man Lecture 1

8/8/2019 Fin Man Lecture 1

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FHBM 1224Financial Management

Foundation in Arts

Learning Objectives

• Know the goal of financial management

• Understand the conflicts of interest that canarise between owners and managers

• Know the basic types of financial managementdecisions and the role of the financial manager

• Know the financial implications of the differentforms of business organization

• Understand the various types of financialmarkets

What is finance?

• Finance studies andaddresses the ways inwhich individuals,businesses andorganizations raise,allocate and usemonetary resourcesover time, taking intoaccount the risksentailed in theirprojects.

Possible Goals of Financial Management

• Survival

• Avoid financial distress andbankruptcy

• Beat the competition

• Maximize sales or market share

• Minimize costs

• Maximize profits

• Maintain steady earnings growth

Problems with these Goals

• Each of these goals presents problems.

• These goals are either associated withincreasing profitability or reducing risk.

• They are not consistent with the long-terminterests of shareholders.

• It is necessary to find a goal that canencompass both profitability and risk.



The Firm’s Objective

• The goal of financial management is tomaximize shareholders’ wealth.

• Shareholders’ wealth can be measured asthe current value per share of existingshares.

• This goal overcomes the problemsencountered with the goals outlinedabove.

The Agency Problem

• Agency relationship

– Principal hires an agent to represent his/her interest

– Stockholders (principals) hire managers (agents) torun the company

• Agency problem

– Conflict of interest between principal and agent

• Management may maximize ownwelfare ( job securities ) instead ofowners’ wealth ( higher profit )

Ownership (shareholders)• Problemcreated byseparation of

Agency Relationships/Problems

Control (Management& Employees)

Do Managers Act in Shareholders’ Interests?

The answer to this will depend on twofactors:

• how closely management goals arealigned with shareholder goals

• the ease with which management can bereplaced if it does not act in shareholders’

best interests.

Alignment of Goals

The conflict of interests is limited due to:

• management compensation schemes

• monitoring of management (Board ofDirectors)

• the threat of takeover

Responsibility of Financial Managers

• To acquire funds (cash) needed by a firm

• To direct those funds into profitableactivities

• To maximize value of a firm



Financial Management Decisions1. Investment Decisions (Capital Budgeting)

– What long-term investments or projects should thebusiness take on?

2. LT Financing Decisions (Capital Structure) – Should we use debt or equity?

3. ST Financial Decisions (Working CapitalManagement)

– How do we manage the day-to-day finances of thefirm?

4. Dividend Decisions (Dividend Distribution Policy)

– How much dividends should we pay to ourshareholders?

– How much earnings should we retain forreinvestment?

1. The Investment Decision

• Capital budgeting is the planning and

control of cash outflows in the expectationof deriving future cash inflows frominvestments in non-current assets.

• Involves evaluating the:

– size of future cash flows

– timing of future cash flows

– risk of future cash flows.

Cash Flow Size

• Accounting income does not mean cashflow.

• For example, a sale is recorded at the timeof sale and a cost is recorded when it isincurred, not when the cash is exchanged.

Cash Flow Timing

• A dollar today is worth more than a dollarat some future date.

• There is a trade-off between the size of aninvestment’s cash flow and when the cashflow is received.

Cash Flow Timing

Which is the better project?

$30 000$30 000Total

$0$20 0003

$10 000$10 0002

$20 000$01

Project BProject AYear

Future Cash Flows

Cash Flow Risk

• The role of the financial manager is to dealwith the uncertainty associated withinvestment decisions.

• Assessing the risk associated with the sizeand timing of expected future cash flows iscritical to investment decisions.



2. Long Term Financing Decisions

• A firm’s capital structure is the specific

mix of debt and equity used to finance thefirm’s operations.

• Decisions need to be made on both thefinancing mix and how and where to raisethe money.

3. Short Term Financial Decisions

- working capital management

• How much cash and inventory should bekept on hand?

• Should credit terms be extended? If so,what are the conditions?

• How is short-term financing acquired?

4. Dividend Decision

• Involves the decision of whether to pay adividend to shareholders or maintain thefunds within the firm for internal growth.

• Factors important to this decision includegrowth opportunities, taxation andshareholders’ preferences.

Forms of Business Organization

• Three major forms in Malaysia

1. Sole proprietorship

2. Partnership• General

• Limited

3. Corporation• Private Limited Company ( Sdn Bhd )

• Public Limited Company ( Bhd )

Sole Proprietorship

• The business is owned by one person.

• The least regulated form of organization.

• Owner keeps all the profits but assumesunlimited liability for the business’s debts.

• Life of the business is limited to theowner’s life span.

• Amount of equity raised is limited toowner’s personal wealth.

Partnership

• The business is formed by two or moreowners.

• All partners share in profits and losses of thebusiness and have unlimited liability for debts.

• Easy and inexpensive form of organization.

• Partnership dissolves if one partner sells out ordies.

• More capital available but amount is limited tothe combined personal wealth of the partners.

• Income is taxed as personal income topartners.



Liability of Partners

• General Partner

- Has unlimited liability for all obligations

of the business disadvantage

• Limited Partner

-Liability limited to the partnershipagreement advantage

- Limited partnership involves at leastone general partner and one or morelimited partners

Corporation

• A business created as a distinct legal entitycomposed of one of more individuals or

entities.• Most complex form of organization.

• Easy to raise capital.

• Shareholders and management are usuallyseparated.

• Ownership can be readily transferred.

• Life of a company is not limited.

• Owners (shareholders) have limited liability.

Private vs. Public Companies

• Private Limited Company (Sdn Bhd)

- cannot offer its shares for sale to the public

- shares normally held by one shareholder or asmall group of shareholders

• Public Limited Company (Bhd)

- offers its shares for sale to the public through astock exchange (e.g. Bursa Malaysia)

A financial market is …

• a mechanism to facilitate the transfer ofsavings from those economic units thathave a savings surplus to those thathave a savings deficit.

• It brings together the buyers and sellersof debt and equity securities.

Structure of Financial Markets

Primary Market Secondary Market

Money Market

Primary Market Secondary Market

Capital Market

Financial Markets

Financial Market Components

Money markets

– Market for short-term securities

– Less risk, low return ( T-bills, Fixed Deposits,Commercial Paper)

Capital markets

– Market for long-term securities

– High risk, higher return

( Common Shares, Preference

Shares and Bonds )



Primary vs. Secondary Markets

1.Primary - new securities or primary claims are

issued, resulting in cash inflow to the issuer.- firms issuing common shares to public for the1st time is known as Initial Public Offering(IPO).

2. Secondary - already existing financial claimssuch as stocks and bonds are bought and sold,no resulting cash inflow to the issuer.

The Corporation and Financial Markets

Corporation

Investors

Government


Corporation Investors

Government

Capital

Securities

Primary Market



Government

Capital

SecuritiesSecondary

market



Government

Capital

SecuritiesSecondary

market

Cash Flow



Government

Capital

SecuritiesSecondary

market

Cash Flow

tax





Government

Capital

SecuritiesSecondary

market

Cash Flow

tax

reinvest



Government

Capital

SecuritiesSecondary

market

Cash Flow (dividends)

tax

reinvest

Movement of Savings: 1.The direct transferof funds

cash

securities

saver

firm

Movement of Savings: 2. Indirect transferwith investment banker

securities

fundsfunds

securities

saver

investment

banker firm

Movement of Savings: 3. Indirect transferwith financial intermediary

funds

intermediarysecurities

funds

firmsecurities

financial

intermediary firm

saver

Lecture Exercise

Match the following with the questions below:(a.) restructuring(b.) capital market

(c.) money market(d.) inflation(e.) primary market(f.) secondary market(g.) financial capital



1.______This form of capital is found on thebalance sheet under long-term liabilities andequity.

2.______The purchasing power of the dollarshrinks over time.

3.______A market where the securities beingtraded are new public offerings.

4.______Securities with a maturity of less than 1year.

5.______Redeploying the asset and liabilitystructure of the firm.

6.______Market composed of common stock,preferred stock, commercial and governmentbonds and other long-term securities.

7.______This market trades previously issuedsecurities.

"I hear and I forget.I see and I remember.

I do and I understand."

-- Confucius

Fin Man Lecture 1

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Transcript of Fin Man Lecture 1