Chapter One

Goals and Functions of Financial Management

An Overview of Managerial Finance

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 Learning Goals
1. Define finance and describe its relationship with Accounting
and Economics as well as Management and other disciplines.
2. Identify the analysis and decision-making nature of financial
management while considering return and risk
3. Examine the primary goal of financial management as the
maximization of shareholders’ wealth as measured by share
price.
4. Debate alternative goals of the firm on the basis of social or
management interests.
5. Identify financial manager functions connected to the
efficient raising and investing of funds.
6. Outline the role of financial markets in allocating capital,
determining value, and establishing yields

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 What is Financial Management?

Financial management is a branch of

finance (as science) that effectively and
efficiently manages firm’s funds
occurred in major business activities
within the risk and return framework in
order to maximize firm’s market value.

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 What is Finance?
• Finance is the science of • Corporate Finance is
management of money! about making financial
– Theories decisions that focus on
– Techniques creating extra value
– Ethical Issues within the corporate.
• Broad Areas: • Dynamic Field:
– Personal Finance – Time
– Corporate Finance – Geographic
– Public Finance – Risk-return framework
– International Finance – Multi-disciplines
– Financial System/Markets – Qualitative vs. Quantitative

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 Finance and other disciplines
Finance builds upon the disciplines of accounting
economics, management and other subjects.
• Accounting supplies financial data and data analysis
tools;
• Economics provides theories about economic system
and decision making;
• Management paves a foundation with planning,
organizing, leading and controlling framework;
• Quantitative Analysis equips financial management
with reliable tools and scientific methods in data
collection and measurement as well as analysis and
decision making

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 Finance and Accounting
Major financial statements – Accounting is the
science of recording, summarizing, reporting, and
analyzing financial transactions and data. It provides a
record such as funds paid or received from a person or
business
Fundamental Accounting Principle – Cash Flows:
– Accrual Basis: income is reported in the fiscal period while
it is “earned”, regardless of when it is received, and expense
is deducted in the fiscal period while it is incurred.
– Cash Basis: a method of bookkeeping in which income is
considered earned when it is received, and expense is not
taken into account until it is paid. (a couple of examples)
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 Management
• Planning – financial strategic planning and policy
• Organizing – funds allocation and distribution
• Leading – financial budgeting and preparation
• Controlling – financial scheduling and monitoring

Effectively and Efficiently

Decision Making
on cash-flows, budgeting and fund utilization
In order to achieve value added outcomes.

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Review of Natures of Organizations
– Private vs. Public (two different types)
• Stock market: “publicly traded company”
“privately owned company”
– Profit vs. Non-Profit Organization (NPO)
– Government vs. Non-government (NGO)
– International vs. Multinational
– Any other forms?

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 Basic Forms of Business Organizations
• Sole Proprietorship
– Owned by one person, operated for personal profit.
• Partnerships
– Owned by two or more people, operated for joint profit.
• Corporations
– owned by individuals/owners/ shareholders, managed by
“agents” and operated for profit.

• LLP – Limited Liability Partnership

• LLC – Limited Liability Companies

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 Sole Proprietorship
STRENGTHS: WEAKNESSES:
• Low organizational cost • Unlimited liability
• Flexible to manage • Limited funding
(SOHO) • Proprietor must be all
• Income taxed once as • Difficult to develop staff
personal income career opportunities
• Independence • Weak when economy is
• Simple in Finance in downturn
• Secrecy • Lack of continuity on
• Ease of dissolution death of proprietor
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 Partnerships
STRENGTHS: WEAKNESSES:
• Improved funding • Unlimited liability
sources to all partners
• Increased (pooled) • Partnership
managerial talent
dissolved upon
• Income split by death of partner
partnership
contract, taxed as • Difficult to
personal income liquidate or transfer
ownership
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 Corporations
STRENGTHS: WEAKNESSES:
• Owners’ liability limited • Heavier financial and
• Large capitalization legal responsibilities
possible, greater funding • Higher tax rates
• Well structured finance • Expensive organization
system/management • Greater government
• Ownership readily regulations
transferable • When publicly traded,
• Indefinite life lacks secrecy
• Professional management • Agency issues.
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 Other Forms
• Limited Liability Companies (LLCs)
• Limited Liability Partnership (LLPs): are hybrids
between partnership and corporations.
– Relatively easy to form
– Limited liabilities
– Dies with owners (partners)
– Separate legal entity
– Degree of control by owners depends on the number of
owners
– LLCs pass their profits/losses through to their owners
without taxation of the LLC itself, as partnership do.

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Story about Apple, Google, Facebook, Twitter,
LinkedIn, Nortel, Dell & RIM/Blackberry
• Why Google goes to IPO?
– From private to public (500/$10 millions by the law of the United
States)
• From Google to “Googol”
– From two people’s business to more than 500 owners
– Developed to a large organization with more than 2,000
employees & unique organizational culture
– From $1 million to $27 billion in 6 years (created $18
million/day!!!!!)
• Dell – De-listed from public stock market.
• Nortel – Canadian telecommunication giant.

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Financial Functions of Organizations
• CFO – Chief Financial Officer
– Supervise all aspects of financial management
– Oversees investments and financial decisions
• Different organizations have different structures in
financial management
– CFO's in Governmental Organization
– What do CFO's do? and How to talk to CFOs?

• Controller responsibilities:
– General Accounting, Corporate accounting, cost accounting,
payroll, Internal auditing, and tax management.
• Treasurer responsibilities:
– Financial planning, fund raising, capital expenditure decisions,
cash and credit management.
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 Corporate Organization Chart

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Financial Manager – Key Objectives and Activities
Making Operating Decisions

Balance Sheet

Current Current
Assets Liabilities Making
Making
Investing _______________ _______________ Financing
Fixed Long-Term Funds Decisions
Decisions
Assets (Debt & Equity)

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 Functions of the Financial Manager

Daily Occasional Profitability/Return

Cash management
(receipt and disbursement of funds) Intermediate financing
Credit management Bond issues Goal:
Inventory control Leasing
Trade-off Maximize
Short-term financing Stock issues
Exchange and interest rate Capital budgeting shareholder
Hedging Dividend decisions wealth
Bank relations Forecasting
Risk

Combine this with firm’s balance sheet

and the content of textbook
 Goal of the Financial Managers

1. Maximizing firm’s market share?

2. Maximizing firm’s profit?
3. Maximizing firm owner’s wealth?
4. Maximizing welfare of community?
5. Maximizing benefit of society?
6. Maximizing firm’s market value?
7. Maximizing firm’s book value?
8. Maximizing firm stakeholders’ wealth?

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 Goal of financial management
• The ultimate goal for financial
managers in any companies is to
maximizing its stock price……not
only the profits or the earning per
share.
• Only higher stock price can
continuously increase shareholders
wealth.
• Preserving stakeholder's wealth.
• Different opinions and debates…..

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How Firms Maximize Shareholders’ Wealth?
• Evaluating Shareholder Wealth addresses factors of
timing, cash flows and risk ignored by the EPS.
• Therefore, Maximizing Shareholder Wealth is a more
integrated and comprehensive goal for the firm, its
managers and employees.
• This can be explored through “Economic Valued
Added” (EVA) and a focus on stakeholders.

Financial Financial Analyzing return Increase price Accept

Manager decision TVM and Risk of per share? The best
alternatives
No Yes
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 Economic Value Added (EVA)

• EVA measures whether an investment

contributes to shareholder’s wealth.
• EVA is calculated by subtracting cost
of funds used from after-tax operating
profits.
• While popular, EVA is essentially
derived from the concept of “net
present value (NPV).”

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 Example: Evaluating a business investment opportunity
• A low-risk, 4-year investment
opportunity promises to pay $3,000,
$6,000, and $5,000 at the end of the
first, second and fourth year,
respectively. A cash injection of $1,000
is required at the end of the third year.
The investment may be purchased for
$10,000, which would have to be
borrowed at an effective interest rate of
10%. Use Economic Value-Added
principle to determine whether the
investment should be undertaken.
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 What about Stakeholders?
• Stakeholders include groups
that have direct economic /
financial links to the firm.
• Stakeholders include not only
owners, but also employees,
customers, suppliers, and
creditors.
• Maintaining positive
stakeholder relationships helps
maximize long-term benefits to
shareholders.
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 Agency Issue
Management Owners Goal
Company's Goals Maximizing
Goal
Their Wealth

Personal Maximizing
interests share price and
investment return Corporate Governance
Agent
problems Board of Directors
Minimizing Duties and responsibilities
Agent cost Agent Cost Disclosure and transparent

Monitoring expenditures: auditing and control procedures – prevention!!

Bonding Expenditures: protect against the consequence of dishonest/F. Bond.
Structuring Expenditures: incentive plans (stock options) and compensation
plans [performance plans (EPS)– performance shares/cash bonus]
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 Importance of Ethics
Ethical behaviour is absolutely necessary in order to
achieve the goal of maximizing shareholder wealth.
The standards of conduct or moral judgment:
• Honesty, trustworthiness, fair dealing are foundations
of sustainable business relations:
– With customers,
– With suppliers,
– With creditors,
– With employees,
– With owners.
– With regulators
• Internal Ethical Review
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 Role of Financial Markets
• Financial markets are a vast global network of
corporations, financial institutions, governments and
individuals that either need money or have money to
lend or invest.
• Canadian financial system and financial markets
– Money market and capital market
– Primary market and secondary market
• The effect of managerial decisions on the value of the
firm bases on if market is efficient (Chapter 14)
– Public financial markets are those markets for governments
to borrow funds for public activities.
– Corporate financial markets are those markets for
corporations to raise funds.
Structure and Functions of Financial Market
• Money markets deal in short-term securities (<1 year)
– e.g.: Treasury Bills, commercial paper and short-term bonds
• Capital markets deal in long-term securities
– e.g.: common stock, preferred stock, corporate bonds,
government bonds
• Primary market is where a firm issues new bonds or
shares
• Secondary market is where investors buy and sell
(trade) outstanding bonds or shares.
• International Financial Markets: globalization
 Areas of Employment in Finance
• Specialty in financial management/services
• Accountant (CPA, CA, CGA, CMA)
• Chartered Financial Analyst (CFA)
• Capital budgeting analyst/manager
• Project finance manager (PMP/CMP)
• Cash manager
• Credit analyst/manager
• Payroll/benefit manager
• Pension fund manager (CFA)
• Insurance/re-insurance companies
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 Questions?

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