© 2003 McGraw-Hill Ryerson Limited

11Chapt

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Chapt

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Prepared By: P Chua

Slides Based on: Terry FegartySeneca College

Book References:1. Block, Short and Hirt

2. Gitman and Hennessey

The Goals and Functions of Financial Management

The Goals and Functions of Financial Management

McGraw-Hill Ryerson ©2003 McGraw-Hill Ryerson Limited

© 2003 McGraw-Hill Ryerson Limited

Chapter 1 - Outline

Definition of Finance Areas of Finance Career Opportunities in Finance Finance as related to Accounting and Economics The Goal of the Financial Manager Agency issue as it relates to owner wealth maximization Stakeholder focus, and ethical behaviour relate to firm’s

goal. Activities of Financial Management Forms of Organization

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Finance is the study of financial planning, asset management, and fund raising for businesses and financial institutions.

Financial management can be described using a balance sheet.

What is Finance?

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Assets: Liabilities & Equity:

Current Assets Current Liabilities

Cash & M.S. Accounts payable

Accounts receivable Notes Payable

Inventory Total Current Liabilities

Total Current Assets Long-Term Liabilities

Fixed Assets: Total Liabilities

Gross f ixed assets Equity:

Less: Accumulated dep. Common Stock

Goodw ill Paid-in-capital

Other long-term assets Retained Earnings

Total Fixed Assets Total Equity

Total Assets Total Liabilities & Equity

WorkingCapital

WorkingCapital

InvestmentDecisions

FinancingDecisions

Macro Finance

© 2003 McGraw-Hill Ryerson Limited

Areas of Finance

1. Financial Markets

- Markets of users and savers of funds.

- Money markets deal in short-term securities (<=1 year)

Ex.; Treasury Bills, commercial paper

- Capital markets deal in long-term securities

Ex.; common stock, preferred stock, corporate bonds, government bonds

2. Financial Services

- Design and delivery of financial advice and products to individuals, businesses, government.

3. Managerial Finance

- Financial management of business firms.

- Financial management involves the efficient use of financial resources in the production of goods

A well-developed financial system is a hallmark and essential characteristic of any modern developed nation.

© 2003 McGraw-Hill Ryerson Limited

Career Opportunities in Finance

Financial Analyst – prepares and analyze firm’s financial plans and budgets; other duties include financial forecasting, financial ratio analysis.

Capital budgeting analyst/manager – evaluation/recommendation of proposed asset investments, implementation of approved projects.

Project finance manager –arranges financing for approved asset investments; coordinates with investment bankers and legal counsel.

Cash manager - maintain and control firm’s daily cash balances; manages cash collection, short-term investment/borrowing, disbursement activities and banking relationships.

Credit analyst/manager – administers firm’s credit policy by analyzing/managing the evaluation of credit applications, extending credit, monitoring/collecting A/R’s.

© 2003 McGraw-Hill Ryerson Limited

Finance as related to Accounting and Economics

Finance is related to:

Accounting, which provides information in financial statements

Economics, which provides: analysis tools such as pricing theory through supply

and demand analysis, cost-benefit analysis etc. information on the economic and financial

environment in which the company operates for sound financial decisions. These include inflation rate, exchange rate, international capital flows, unemployment rate, etc.

All of these factors must fit into the financial decisions

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Difference Between Finance and Accounting Recognition of Revenue and Expenses

Accrual Basis: recognizes sales revenue and expenses incurred to make sale at time of sale.

Cash Basis: recognizes revenues and expenses as they occur.

Accounting vs Financial View

Accounting View(Accrual Basis)

Income StatementPeakes Quay, Inc.

For year ended 12/31

Financial View(Cash Basis)

Cash Flow StatementPeakes Quay, Inc.

For year ended 12/31

Sales revenue $100,000Less: Costs 80,000Net Profit $ 20,000

Cash inflow $ 0Less: Cash outflow 80,000Net cash flow ($80,000)

© 2003 McGraw-Hill Ryerson Limited

Goal of the Financial Manager

Should it be Profit Maximization? Corporations commonly define profit as “Earnings per

Share” (EPS). EPS ignores at least 2 critical factors:

the timing of the returns. risk factors facing the firm.

Profitability Risk

Profitability Risk ex., investing in stocks vs. savings accounts Stocks may be more profitable but are riskier Savings accounts are less profitable and less risky (or safer)

© 2003 McGraw-Hill Ryerson Limited

Goal of the Financial Manager

Or should it be Shareholder Wealth Maximization?

Shareholder Wealth Maximization considers factors of EPS timing, and risk ignored by the EPS.

Therefore, Maximizing Shareholder Wealth is a more comprehensive goal for the firm, its managers and employees.

© 2003 McGraw-Hill Ryerson Limited

Goal of the Financial Manager

Also, shareholder wealth maximization is in general, consistent with the social responsibility of the firm. Adopting policies that will improve the share price can attract capital and provide employment.

But could conflict with social / ethical goals (for example, pollution control) interests of management (for example, short-term

compensation)

Management can encourage an increase in share price by earning an attractive return at an acceptable level of risk

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Agency Theory: The Principal-Agent Problem Agency Theory is about the conflict that may arise between

management and owners whenever owners are not also the managers.

Management may not always act in the best interest of the owners because management has interest of its own, like personal wealth, job security, lifestyle, and benefits. Thus, these concerns may conflict with shareholder interests.

The pursuit of socially or ethically acceptable goals may have to come at the expense of shareholder’s wealth.

© 2003 McGraw-Hill Ryerson Limited

Importance of Ethics to Stakeholders Stakeholders are those groups that have direct economic links to the

firm.

Stakeholders include not only owners, but also employees, customers, suppliers, unions, and creditors.

Honesty, trustworthiness, fair dealing are foundations of sustainable business relations with these stakeholders.

Ethical behaviour is necessary to achieve the goal of maximizing shareholder wealth.

Maintaining positive stakeholder relationships helps maximize long-term benefits to shareholders.

© 2003 McGraw-Hill Ryerson Limited

Financial Manager–Key Activities

Activities include: Short-Term Financial Decisions

Working Capital Management

- ex., careful monitoring of cash position on a day-to-day basis Financial Analysis and Planning

Investment Decisions (Capital Budgeting) long-term (L/T) financial decisions (>1 year)

- ex., purchasing a new machine in the future

Financing decisions (capital structure) how to raise money: loans? leases? shares? bonds?

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A business owned byA business owned byone personone person

FreedomFreedom

SimplicitySimplicity

Low Start UpLow Start UpCostsCosts

Tax BenefitsTax Benefits

Unlimited Unlimited LiabilityLiability

Lack of ContinuityLack of Continuity

Difficulty in Difficulty in Raising MoneyRaising Money

Reliance on One Reliance on One PersonPerson

AdvantagesAdvantagesDisadvantagesDisadvantages

Forms of Organization: Sole Proprietorships

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Greater Talent PoolGreater Talent Pool

More CapitalMore Capital

Ease of FormationEase of Formation

Tax BenefitsTax Benefits

Unlimited LiabilityUnlimited Liability

Lack of ContinuityLack of Continuity

OwnershipOwnershipTransferTransferDifficultDifficult

Possibility of Possibility of ConflictConflict

A business venture with two or more ownersA business venture with two or more owners

AdvantagesAdvantages DisadvantagesDisadvantages

Forms of Organization: Partnerships

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Limited LiabilityLimited Liability

ContinuityContinuity

Greater LikelihoodGreater Likelihood of Professionalof Professional ManagementManagement

Easier Access to Easier Access to MoneyMoney

Potential Shareholder Potential Shareholder RevoltsRevolts

Higher Start-UpHigher Start-Up CostsCosts

RegulationRegulation

Double Double TaxationTaxationA corporation A corporation

is a separate legal entityis a separate legal entity

AdvantagesAdvantages DisadvantagesDisadvantages

Forms of Organization: Corporations

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Summary and Conclusions

The financial manager: controls the daily cash inflows and outflows resulting from business operationsmakes the occasional investment and financing decisions essential for the future financial success of the businessmay work in a corporation or other form of business organization

Their overriding goal is to maximize the wealth of the owners by earning an attractive return in the business at an acceptable level of risk

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