T1_INTRODUCTION TO FINANCIAL MANAGEMENT

DPA30063
FINANCIAL
MANAGEMENT 1

Topic 1
INTRODUCTION TO FINANCIAL
MANAGEMENT

BY :
PN. ROSMARIA BINTI ISMAIL

DEPARTMENT OF COMMERCE

1.3 Provide the discussion on the 1.1 Nature and importance of financial
five principles that form the management
foundation of finance:
1.1.1 Define financial management
a. Principle 1: Money has a time value 1.1.2 Discuss the roles and the importance
b. Principle 2: There is a risk-return trade-off
c. Principle 3: Cash flows are the source of value of financial manager
d. Principle 4: Market prices reflect information a. Financial analysis and planning
e. Principle 5: Individuals respond to incentive b. Investment decisions
c. Financing decisions
d. Monitoring and controlling
e. Involvement in financial market

1.2 Explain the goals of the firm

1.2.1 Identify the goals of the firm
1.2.2 Explain maximizing profit and maximizing
shareholder’s wealth

INTRODUCTION Managers daily face questions such as :

Any business has important financial Every key decision made by a  Will a particular capital investment be
concerns, and its success or failure firm’s managers has important successful?
depends in large part on the quality of its financial implications.
financial decisions.  Where will the funds come from to finance the
investment

 Does the firm have adequate cash, or access
to cash, through bank borrowing agreements,
for example, to meet its daily operating needs?

 Which customers should be offered credit, and
how much should they be offered?

To most, the first impression is that The latter argued it is an art and science  How much inventory should be held?
finance is about money, while a few because in any financial decisions it will  Is a merger or acquisition advisable?
believe that finance is the art and involve intuition or gut feelings of decision  How should cash flows be used or
science of management of money and maker and certain procedures that must
other assets. be followed before any decisions are distributed?
made, respectively.  In trying to arrive at the best financial

management decisions, how should
risk and return be balanced?





FINANCE Involves :

Application of the principles of Securing funds from investors
financial economics to an inter-
related set of monetary problems Investing the funds obtained
Receiving returns from various
Process by which money is
transferred among businesses, investments
individuals &governments via the Periodically distributing returns to
financing and investing activities of investors in the form of dividends

these parties.

FINANCIAL
MANAGEMENT

A process involved in an attempt to obtain and allocate
financial resources effectively and efficiently to achieve
the firm’s goal ; that is to maximize the shareholders’
wealth by maximizing the share price.

Therefore, finance management requires all departments
in the firm to develop their departmental objectives in
order to support and ensure the achievement of the firm’s
overall objectives

DECISION FUNCTIONS

Investment Decision Financing Decision

Capital Investment Decision Borrowings
- large sums of money, non-routine Long term debt (payable after 1 year)
Ex : acquire new machine, set up a new plant
[debentures, bonds, 5-year loan]
Working Capital Investment Decision Short term debt (payable within 1 year)
more routine / scheduled, daily basis [3-month loan, bank overdraft, commercial

Ex : determination of amount of inventories, paper, trade credits]
Capital

Common stock [ordinary shares], Preference
stock [preference shares], Retained earnings

ROLES & IMPORTANCE OF
FINANCIAL MANAGER

Financial analysis • Forecasting is made based on company’s past & present performance, economic
and planning performance, customers’ preferences & future demand for their products.
Investment Then, FM will lay plans which will shape the comoany’s future position
decisions
• Determine what specific assets to purchase

Financing decisions • Determine the best method of financing those assets whether to use
debt orequity

Monitoring and • FM have to interact with other departments within the organization
controlling • Decisions of other departments might affect investment decisions

Involvement in • FM has to obtain financing either through the money market or capital market.
financial market • Decide on investing excess or idle funds in the financial market.
• Foster relationships with creditors [bank loan officers], stockholders, investors & governmental

regulatory bodies.

GOALS OF THE FIRM

Maximize Profit Maximize Shareholder’s Wealth

Stresses the efficient use of capital resources Maximizing the total market value (market
Financial Manager might only implement price) of the existing shareholders’ common

actions that would result in maximum profits stock.
without considering the impact of his actions Financial Manager cannot directly control the
firm’s stock price, but can only act in a way
on the company’s future performance.
that is consistent with the desires of the
stockholders.

THE DIFFERENCES

PROFIT MAXIMIZATION SHAREHOLDER’S WEALTH
MAXIMIZATION
Maximize profit by increase either sales units
@ sales price & reduce costs. Maximize wealth by maximizing common
stock price
Can be achieved in short term by
manipulating sales & costs by either Has to accomplish all the short term targets
increasing or decreasing the variables such as growth in earnings & dividends,
involved. increase in profitability & maintaining
financial stability.
Emphasizes the amount of profits received,
not when the profits are received. Applies principle of time value of money 
a dollar received today > if it is to be
Ignores risk or uncertainty received.
Increase in profit doesn’t mean increase in
cash flows. Considers uncertainty or risk

Increase in shareholder’s wealth is related to
increase in cash flows.

Traditional Objective

To maximize the wealth of shareholders

Practical reason Legal reason
Shareholders are the owners of the firm. Firms come
into being due to the contributions and risks taken on
When making investment and financing by the shareholders.
decisions for the firm, decisions can be
made much more simply and quickly.
Shareholders are protected by the provisions of the
Companies Act, 2016.
If the interests of other stakeholders
were also to be considered, decisions
may not be made quickly and efficiently. Finance managers owe some kind of allegiance to the
‘owners’ of the firm.



FIVE PRINCIPLES THAT FORM
THE FOUNDATION OF FINANCE

Principle 1 Principle 2

Money has a time value There is a risk-return trade-off

a dollar received today is worth more we won’t take on additional risk
than a dollar received in the future unless we expect to be compensated

with additional return

FIVE PRINCIPLES THAT FORM
THE FOUNDATION OF FINANCE

Principle 3 Principle 4

Cash flows are the source of value Market prices reflect information
Cash, not profits  is the KING Efficient Capital Markets  the
markets are quick and the prices are

right

FIVE PRINCIPLES THAT FORM
THE FOUNDATION OF FINANCE

Principle 5

Individuals respond to incentive

The Agency problem  managers
won’t work for the owners unless it’s in

their best interest

The Agency Problem

For larger firms, Difficult to expect Management
there usually every team is engaged
exists a large to manage the
spread of shareholder to firm on behalf of
ownership over participate in the
the
huge number of management shareholders.
shareholders and running of
with varying the business.
backgrounds.

The Agency Problem

Principal–Agent Relationship or the Agency Relationship

• Exists when one party, known as the principal, engages another party, know as the
agent, to act in the former’s interest.

• Separation of ownership and control

The Agency Problem

Ownership of the firm lies in the hands of the shareholders.
Control (management of the firm—strategic and operational decisions) lies in the management team of the

firm
Agency costs are incurred by the firm, when:
(i) Managers do not attempt to maximize firm value
(ii) Shareholders incur costs to monitor the managers and

influence their actions

The Agency Problem

Shareholders impose Shareholders monitor Stock market
organizational checks management’s behaviour quotation—control
and revamp the firm to device whereby a firm’s
keep everyone on their through use of audit relative share price
committee or establishing performance to other
toes. companies acts as a
management audit
procedures, reporting signal about
requirements or obtain managerial effort and

assurances from ability
management about
shareholders’ interest.

The Agency Problem

Satisficing Principle

Management would do just sufficient to keep shareholders
satisfied (dividends/capital gains) while concentrating on

the pursuit of their own objectives.
Management’s performance is based on short-term results

and on accounting rather than on economic results.

THE
END