Lecture 2.

Financial
Management in an Enterprise.
Corporate structure
Lecturer: Leyli Melikova
 Structure
• Classification of finance
• Evolution of finance
• Finance Functions
• Long-term financial decisions (Investment Decisions,
Financing Decisions, Dividend Decisions)
• Short-term Financial Decision: Liquidity Decision
• CapEx and OpEx
• Role of a finance manager (Fund Raising, Fund
Allocation, Profit Planning, Understanding Capital
Markets)
• Organization of Finance Functions
• Agency issues. Types of Agency problem. Solving
Agency issues
• Business ethics and social responsibility. Elements of
Business Ethics
• Social Responsibility
• Kinds of Social Responsibility
 Classification of finance
The Finance can be categorized into three parts:
Public Finance
This type of finance is related to states, municipalities, provinces in short government
required finances. It includes long term investment decisions related to public entities. Public
finance takes factors like distribution of income, resource allocation, economic stability in
consideration. Funds are obtained majorly from taxes, borrowing from banks or insurance
companies.
Corporate Finance
Corporate Finance is about funding the company expenses and building the capital
structure of the company. It deals with the source of funds and the channelization of those
funds like the allocation of funds for resources and increasing the value of the company by
improving the financial position. Corporate finance focuses on maintaining a balance between
the risk and opportunities and increasing the asset value.
Personal Finance
Personal Finance is managing the finance or funds of an individual and helping them
achieve the desired goals in terms of savings and investments. Personal Finance is specific to
individuals and the strategies depend on the individuals earning potential, requirements, goals,
time frame, etc. Personal finance includes investment in education, assets like real estate, cars,
life insurance policies, medical and other insurance, saving and expense management.
 Corporate Finance
Corporate finance deals with the capital structure of a
corporation, including its funding and the actions that management
takes to increase the value of the company. Corporate finance also
includes the tools and analysis utilized to prioritize and distribute
financial resources.
The ultimate purpose of corporate finance is to maximize the
value of a business through planning and implementation of
resources, while balancing risk and profitability.
“Corporate Finance is concerned with the efficient use of an
important economic resource, namely capital funds” – “Corporate
Finance is the operational activity of a business that is responsible for
obtaining and effectively utilizing the funds necessary for efficient
business operations”
The three Important Activities that Govern Corporate Finance:
1. Investments & Capital Budgeting
2. Capital Financing
3. Dividends and Return of Capital
 Evolution of finance
The stages in the evolution of finance discipline can be categorized into three phases:
Finance, as capital, was part of the economics discipline for a long time. So, financial management
until the beginning of the 20th century was not considered as a separate entity and was very much a part of economics
Traditional phase:
This phase started from 1920 and lasted till 1940. During this phase focus was mainly on below aspects:
- Arranging, formation, issuance of funds.
- Business expansion, merger, reorganization, and liquidation during the life cycle of the firm.
- The instruments of financing, the institutions and procedures used in capital markets, and
the legal aspects of financial events.
Transitional phase
This phase started from early 1940 and lasted till early 1950. During this phase focus was mainly on
below aspects:
- Nature of financial management was similar to same as Traditional phase.
- But more emphasis was put on financial problems faced by managers in day-to-day operations hence leading to
increased focus on working capital management.
Modern Phase
This phase started in middle of 1950 and has witnessed an accelerated pace of development with
the infusion of ideas from economic theories and applications of quantitative methods of analysis.
During this phase focus was mainly on below aspects:
- The scope of financial management got broadened.
- A well-managed Finance department came into existence.
- Role of Financial manager got defined, which include acquisition of funds required in the business at the least
possible cost, investing the funds obtained in an optimum manner so as to maximize returns and taking decisions relating to
distribution of profits i.e., deciding the dividend policy and retention of profits.
Finance Functions

Finance function is the most important

function of a business. Finance is closely
connected with production, marketing and
other activities. In the absence of finance, all
these activities come to a halt. In fact, only
with finance, a business activity can be
commenced, continued and expanded.
Finance functions or decisions are
divided into long-term and short-term
decisions.
 Long-term financial decisions
Long-term financial decisions can be further classified into three
categories:
Investment Decisions:
Investment decision deals with the decisions related to the allocation of capital to long-term assets
that would yield benefits in the future like Plant and machinery, Building etc. This decision related
to allocation of capital or commitment of funds to long-term assets that would generate cash flows
in the future. It involves the evaluation of the prospective profitability of new investments. The
Future benefits of investments are difficult to predict with certainty. The Risk in investment arises
because of the uncertain returns. Hence, investment proposals should, therefore, be evaluated in
terms of both expected return and risk and while, making these kinds of decisions, the financial
manager must weigh the costs and benefits of each investment.
Financing Decisions:
Financing decisions are other important decisions to be made by the finance manager of firm, these
decisions essentially relate with the arrangement of funds to fulfil the requirements of the firm.

Long-
These decisions answer the question: from where and how to acquire funds to meet the Firm’s
Investment needs. The Financial Manager must decide whether to raise more money by equity or
debt or by a combination of these finance sources. Use of each type of finance has certain costs and
benefits attached with it. The main concern while selecting the finance source is its cost to the firm.
Firm should select an optimum capital structure, it’s the capital structure at which the cost of the
capital is lowest for the firm.
Dividend Decisions:
term
These decisions are related to the distribution of earnings. The financial manager must decide
whether the firm should distribute all profits, or retain them, or distribute a portion and retain the
balance. The proportion of profits distributed as dividends is called the dividend-payout ratio and
financial
decisions
the retained portion of profits is known as the retention ratio. Like the debt policy, the dividend
policy should be determined in terms of its impact on the shareholders’ value. The optimum
dividend policy is one that maximizes the market value of the firm’s shares.The financial manager
should also answer the questions of dividend stability, bonus shares and cash dividends in practice.
 Short-term Financial Decision: Liquidity Decision

Management of current assets that affects a firm’s

liquidity is yet another important finance function.
Investment in current assets affects the firm’s
profitability and liquidity. Current assets should be
managed efficiently for safeguarding the firm against
the risk of illiquidity.
A trade-off exists between profitability and
liquidity while managing current assets. If the firm
does not invest sufficient funds in current assets, it
may become illiquid and therefore, risky. On the other
hand, it would lose profitability, as idle current assets
would not earn anything. Thus, a proper trade-off
must be achieved between profitability and liquidity.
 CapEx
and
OpEx
 There are a variety of costs and expenses that companies have to pay to continue
running their businesses. These costs can be one-off or they can be recurring, and it can
often be challenging to keep up with all of these expenses.
 One way is to divide them into different categories. The most common are capital
expenditures (CapEx) and operating expenses (OpEx).
 Capital expenditures are major purchases that a company makes, which are used over
the long term. Operating expenses, on the other hand, are the day-to-day expenses that a
company incurs to keep its business running.
 CapEx
Capital expenditures (CapEx) are purchases of significant
goods or services that will be used to improve a company’s
performance in the future. They include the cost of fixed
assets and the acquisition of intangible assets such as patents
and other forms of technology. Capital expenditures are
typically for fixed assets like property, plant, and equipment
(PP&E). For example, if an oil company buys a new drilling
rig, the transaction would be a capital expenditure.
CapEx represents the company’s spending on physical
assets. The following are common examples of capital
expenditures:
• Manufacturing plants, equipment, and machinery
• Building improvements
• Computers
• Vehicles and trucks
 OpEx
Operating expenses are the costs that a company incurs for running its day-to-day operations. As such, they
don't apply to any costs related to the production of goods and services.
These expenses must be ordinary and customary costs for the industry in which the company operates.
Companies report OpEx on their income statements and can deduct OpEx from their taxes for the year when the
expenses were incurred.
Operating expenses are incurred through normal business operations. The goal of any company is to
maximize output relative to OpEx. In this way, OpEx represents a core measurement of a company’s efficiency
over time.
The following are common examples of operating expenses:
• Rent and utilities
• Wages and salaries
• Accounting and legal fees
• Overhead costs such as selling, general, and
administrative expenses (SG&A)
• Property taxes
• Business travel
• Interest paid on debt
• Research and development (R&D) expenses
 Accounting rules may dictate whether an item is
classified as CapEx or OpEx. For example, if a
company chooses to lease a piece of equipment
instead of purchasing it as a capital expenditure, the
lease cost would likely be classified as an operating
expense. If a company purchased the equipment
instead, it would likely capitalize it.
 Both capital expenditures and operating expenses
represent outlays by the company. Both are usually
acquired in exchange for cash and may go through a
similar purchasing process. This includes solicitation
of a bid, contracting, legal review, orchestration of
financial payment, and receipt of the purchase.

 Both CapEx and OpEx reduce a company’s net

income, though they do so in different ways. OpEx is
expensed immediately, while CapEx is depreciated.
 Role of a finance manager
A financial manager is a person in a firm who main
responsibility is to carry out the finance functions. In
a modern enterprise, the financial manager occupies
a key position. He or she is one of the members of
the top management team, The role of finance
manager is becoming more important day by day.
Finance manager performs a lot of tasks, some of
his/her important responsibilities are giver below:
The Basic Goal: Creating Shareholder Value

a) Profit Maximization
Profit Maximization is the capability of the firm in
producing maximum output with the limited input, or it uses
minimum input for producing stated output. It is termed as
the foremost objective of the company. Profit maximization
is considered as an important goal in financial decision
making in an organization. It ensures that firm utilizes its
available resources most efficiently under conditions of
competitive markets. But in recent years, profit
maximization is regarded as unrealistic, difficult,
inappropriate goal.
 (b) Wealth Maximization
The prime objective of a business entity is to maximize value for its owners, equity
shareholders. Therefore, the ultimate objective of financial management should be wealth
maximization.
Wealth maximization means maximizing the ‘net present value’ of a course of action or
investment project.
The net present value of a course of action is the difference between the present value of its
benefits and the present value of its costs. It is the versatile goal of the company and highly
recommended criterion for evaluating the performance of a business organization.
Favorable Arguments for Wealth Maximization
• Contrary to profit maximization objective, wealth maximization is based on cash flows,
and not on profits.
• The objective of wealth maximization focuses on the long run picture.
• Wealth maximization considers the time value of money.
• Wealth-maximization criterion considers the risk and uncertainty factor.
Profit Maximization V/s Shareholder Wealth Maximization
The objective of wealth maximization is generally preferred over profit maximization
because of the following reasons:
• It considers wealth for the long-term.
• Wealth-maximization criterion considers the risk and uncertainty factor.
• It considers the timing of returns
 Organization of Finance Functions
 Responsibility of carrying out the finance functions lies with
the top management.
 Financial Department may be created under the direct
control of the board of directors The executive heading the
finance department is the firm’s Chief Finance Officer
(CFO).
 However, the exact nature of the organization of the
financial management function differs from firm to firm
depending upon factors such as size of the firm, nature of its
business type of financing operations, ability of financial
officers and the financial philosophy, and so on.
 Similarly, the designation of the chief executive of the
finance department also differs widely in case of different
firms.
 In some cases, they are known as finance managers while in
others as vice-president (finance), director (finance), and
financial controller and so on. He reports directly to the top
management. Various sections within the financial
management area are headed by managers such as controller
and treasurer.
 Chief Executive Officer (CEO) - He or she is a member of the Top
Management and is closely associated with the formulation of policies and
making decisions for the firm. The Treasurer and Controller operates under
CFO’s supervision.
Treasurer - is a manager responsible for financing, cash management, and
relationships with financial markets and institutions. His/her duties include
forecasting the financial needs, administering the flow of cash, managing credit,
floating securities etc.
Controller - is an officer responsible for budgeting, accounting and auditing.
The functions of the controller relate to the management and control of assets.
 Top management commitment: The (CEO) and other
higher-level managers need to be openly and strongly
committed to ethical conduct. They must give continuous
leadership for developing and upholding the values of the
organization.
 Publication of a ‘Code’: Businesses that have effective

Elements
ethics programmers write out the standards of behavior for
the entire organization in written documents known as the
"code” covering areas such product safety and quality;
health and safety in the workplace; conflicts of interest etc.
 Establishment of compliance mechanisms: In order to
ensure that actual decisions and actions comply with the
of
firm’s ethical standards, suitable mechanisms should be
established.
 Involving employees at all levels: It is the employees at
Business
different levels who implement ethics policies to make
ethical business a reality. Therefore, their involvement in
ethics programs becomes a must.
Ethics
 Measuring results: Although it is difficult to accurately
measure the end results of ethics programs, the firms can
certainly perform audit to monitor compliance with ethical
standards.
 Social Responsibility
Social responsibility of business refers to its obligation to take those decisions and perform
those actions which are desirable in terms of the objectives and values of our society. Business
is part of society. It should fulfill the aspirations of society, and respect the values and norms of
society. Thus, social responsibility relates to the voluntary efforts on the part of the businessmen
to contribute to the social wellbeing.
Social responsibility is broader than legal responsibility of business. Legal responsibility
may be fulfilled by mere compliance with the law. Social responsibility is more than that. It is a
firm’s recognition of social obligations even though not covered by law.

Kinds of Social Responsibility:

 Economic responsibility: A business enterprise is basically an economic entity and,
therefore, its primary social responsibility is economic.
 Legal responsibility: Every business has a responsibility to operate within the laws of the
land. Since these laws are meant for the good of the society, a law-abiding enterprise is a
socially responsible enterprise as well law-abiding enterprise.
 Ethical responsibility: This includes the behavior of the firm that is expected by society but
not codified in law. For example, respecting the religious sentiments and dignity of people
while advertising for a product.
 Discretionary responsibility: This refers to purely voluntary obligation that an enterprise
assumes, for instance, providing charitable contributions to educational institutions or
helping the affected people during floods or earthquakes.
Social • Towards the shareholders or owners: A business
Responsibility: enterprise has the responsibility to provide a fair return to
Towards the shareholders on their capital investment and to ensure the
Different Interest safety of such investment.
Groups • Towards the workers: Management of an enterprise is
also responsible for providing opportunities to the workers
for meaningful work. It should try to create the right kind of
working conditions so that it can win the cooperation of
workers
• Towards the consumers: Supply of right quality and
quantity of goods and services to consumers at reasonable
prices constitutes the responsibility of an enterprise toward
its
customers.
• Towards the government and community: Enterprise
must respect the laws of the country and pay taxes regularly
and honestly. It must behave as a good citizen and act
according
to the well accepted values of the society. It must protect the
natural environment.
Thank You!