This chapter introduces financial management and describes the role of financial managers. It discusses the three main financial decisions that managers make: investment, financing, and dividend decisions. The chapter also explains why shareholder wealth maximization should be the goal of the firm. It describes how modern corporations separate ownership and management, creating agency problems, and the responsibilities of treasurers versus controllers.

1. 1-1
Chapter 1
Introduction to
Financial
Management
R Singh

2. 1-2
After studying Chapter 1,
you should be able to:
1. What is Financial Management and What is the role of the
financial manager today is so important.
2. Describe "financial decision Making" in terms of the three
major decision areas that confront the financial manager.
3. Identify the goal of the firm and understand why
shareholders' wealth maximization is preferred over other
goals.
4. Understand the potential problems arising when
management of the corporation and ownership are
separated (i.e., agency problems).
5. Understand the basic responsibilities of financial managers
and the differences between a "treasurer" and a "controller."

3. 1-3
What is Financial
Management?
Concerns the acquisition,
financing, and
management of assets
with some overall goal in
mind.

4. What is Financial Management?
“Financial management is the operational
activity of a business that is responsible
for obtaining and effectively utilizing the
funds necessary for efficient operation”

5. Evolution of FM
B4 1940
• Traditional Phase
1940-1950
• Transitional Phase
After 1950
• Modern Phase

6. 1-6
Scope of FM
Undergone notable changes over the years.
Financial Managers role also changed.
Study of these changes – “Scope of FM”
Two Approaches:
1. Traditional Approach
2. Modern Approach

7. 1-7
Traditional Approach
Narrow Scope
Expected Functions:
✓ Raising funds
✓ Preparation and Preservation of financial
statements /reports
✓ Management of Cash Level

8. 1-8
Modern Approach
Wider Scope – Conceptual and
analytical frame work for financial
decision making
Covers both procurement and
efficient allocation of funds

9. 1-9
Functions of Financial
Management
1. Anticipating Financial Needs
2. Acquiring Financial Resources
3. Allocating Funds in Business
4. Administrating the Allocation of Funds
5. Analyzing the Performance of Finance
6. Accounting and Reporting to
Management

10. 1-10
Financial Decisions
Financial
Decision
Investment
Decision
Financing
Decision
Dividend
Decision

11. 1-11
Investment Decisions
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
Most important of the three
decisions.

12. 1-12
Investment Decision
Long term assets (Capital Budgeting).
Short term assets (Working Capital
Management).

13. 1-13
Financing Decisions
What is the best type of financing?
What is the best financing mix?
How will the funds be physically acquired?
Determine how the assets (RHS of
balance sheet) will be financed by(LHS
of balance sheet).

14. 1-14
Financing Decision
Decision related to the formation of an
optimum capital structure.
Proper debt equity mix – maximize
share holders wealth.
Proper balance of Risk and Return

15. 1-15
Dividend Decisions
What is the best dividend policy (e.g.,
dividend-payout ratio)?
Whether to pay dividend
Or reinvest in the business

16. 1-16
Asset Management
Decisions
How do we manage existing assets
efficiently?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.

17. 1-17
What is the Goal
of the Firm?
Maximization of
Shareholder Wealth!
Value creation occurs when
we maximize the share price
for current shareholders.

18. 1-18
Shortcomings of
Alternative Perspectives
Could increase current profits while
harming firm (e.g., defer maintenance,
Avoid advertisement, keeping SP high.).
Ignores changes in the risk level of the
firm (eg debt:Equity, asset mgmt.)
Profit Maximization
Maximizing a firm’s earnings after taxes.
Problems

19. 1-19
Wealth Maximization
Wealth of a firm is related with its market value of the shares.
How do you maximize the wealth….?
Additional Profits – Share it with equity share holders,
Creditors, Better payment to workers in the form of wages,
develop infrastructure, Create more welfare facility to the
society, prompt payment of taxes to the govt., etc
Attain self sufficiency and good reputation- Reflect in the
market value of shares in the stock market.
Wo = NPo
Wo=Wealth of the firm
N= Number of shares owned
Po=Price per share in the market

20. 1-20
Strengths of Shareholder
Wealth Maximization
Takes account of: current and future
profits and EPS
Thus, share price serves as a
barometer for business performance.

21. 1-21
The Modern Corporation
There exists a SEPARATION
between owners and managers.
Modern Corporation
Shareholders Management

22. 1-22
Role of Management
An agent is an individual
authorized by another person,
called the principal, to act in
the latter’s behalf.
Management acts as an agent
for the owners (shareholders)
of the firm.

23. 1-23
Agency Theory
Incentives include, stock options,
perquisites, and bonuses.
Principals must provide incentives
so that management acts in the
principals’ best interests and then
monitor results.

24. 1-24
Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President
Operations
Vice President
Marketing
VP of
Finance

25. 1-25
Treasurer
Capital Budgeting
Cash Management
Credit Management
Dividend Disbursement
Fin Analysis/Planning
Pension Management
Insurance/Risk Mngmt
Organization of the Financial
Management Function
Director Finance/VP of Finance/CFO
Controller
Cost Accounting
Cost Management
Data Processing
Tax Analysis/Planning
Government Reporting
Internal Control
Preparing Fin Stmts
Preparing Budgets
Preparing Forecasts