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Chapter 1Chapter 1

The Role of Financial The Role of Financial ManagementManagement

The Role of Financial The Role of Financial ManagementManagement

Fundamentals of Financial ManagementPrepared by: Waseem Ullah KhanKardan Institute of Higher Studies Kabul Afghanistan

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The Role of The Role of Financial ManagementFinancial Management

1. What is Financial Management?2. What is the Goal of the Firm?3. Organization of the Financial

Management Function:

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The Role of The Role of Financial ManagementFinancial Management

What is Financial Management?

Financial management is a discipline which study all the matters related with acquisition of assets, financing of assets and management of assets with some overall goal in mind.

We use (FM) as a short abbreviation for financial management

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What is the Goal of the Firm?

Firm is individual unit of business, when setting goals, financial manager see the basic financial requirement of business, how much money/capital will be required for:

1.Fixed capital2.Working capital

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Organization of the Financial Management Function:

This means that financial manager will assign duty and responsibility to lower Level to complete the task/goal within stated time.

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What is Financial What is Financial Management?Management?

Concerns the acquisition, financing, and

management of assets with some overall goaloverall goal in

mind.

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Investment DecisionsInvestment Decisions

1. What is the optimal firm size?2. What specific assets should be

acquired?3. What assets (if any) should be

reduced or eliminated?

Most important of the three Most important of the three Decisions.Decisions.

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Investment DecisionsInvestment Decisions

What is the optimal firm size

You will decide the exact size of your business the very start of your business whether your business is of :

1. Small Scale Business

2. Medium Scale Business

3. Large Scale Business

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What specific assets should be acquired?

As finance manager you will specify which asset you will purchased 1st ,you will see the requirement of your business.

The asset which is very much beneficial you will purchase 1st then next.

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What assets (if any) should be reduced or eliminated?

As a manager finance you have purchased more assets and few of them are not working properly, so initially you will repair it ,if still are not working properly you will sale it out.

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Financing DecisionsFinancing Decisions

What is the best type of financing?

What is the best financing mix?

What is the best dividend policy?

How will the funds be physically acquired?

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Financing DecisionsFinancing Decisions

What is the best type of financing?

To purchase your assets you will required money, so you will decide from which source I should arranged money. normally we arrange from three sources :

1.Short term financing2.Medium term financing3.Long term financing

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What is the best financing mix?

Financing mix means to use more then 1 option for arranging loan e.g

1.Mix 1 (short +medium term)2.Mix 2 (short + long term)3.Mix 3 (medium+ long term)

Note: interest is used as tool in the selection of financial mix deciaion.

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What is the best dividend policy?

Financial manager will select the best dividend policy for profit declaration in annual general meeting (AGM).

He will prefer a policy which will be attractive for shareholder and general share holders.

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How will the funds be physically acquired?

The financial manager will arrange fund, he will also maintain the fund in such a way that increase the assets of business in near future.

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Asset Management Asset Management DecisionsDecisions

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.

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How do we manage existing assets efficiently?

If the firm is not financially sound enough ,so in such case the financial manager prefer to utilize the old asset with full capacity.

As the firm is weak, so it can't afford new asset, so old asset is used with full swing.

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Financial Manager has varying degrees of operating responsibility over assets.

Financial manager perform his routine operating activity to control the organization financial matters. he maintain the asset with proper book keeping record.

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Greater emphasis on current asset management than fixed asset management.

Financial manager besides his other financial activities ,he pay much attentions towards current asset and fixed asset management.He properly keep exact and accurate record.

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What is the Goal What is the Goal of the Firm?of the Firm?

Maximization of Maximization of Shareholder Wealth!Shareholder Wealth!

Value creation occurs when we maximize the share price

for current shareholders.

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Shortcomings of Shortcomings of Alternative PerspectivesAlternative Perspectives

Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.).

Ignores changes in the risk level of the firm.

Profit MaximizationProfit Maximization Maximizing a firm’s earnings after taxes.

ProblemsProblems

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The Modern CorporationThe Modern Corporation

There exists a SEPARATION between owners and managers.

Modern Corporation

Shareholders Management

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Role of ManagementRole of Management

Management acts as an agentagent for the owners (shareholders)

of the firm.

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What is agent ?

An agentagent is an individual authorized by another person, called the principal, to act in the latter’s behalf.

What is principal? Principal is the owner of contract or

business.

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Agency TheoryAgency Theory

Agency TheoryAgency Theory is a branch of economics relating to the behavior of principals and their agents.

Jensen and Meckling developed a theory of the firm based on agency theoryagency theory.

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Agency TheoryAgency Theory

Incentives include stock optionsstock options,, perquisitesperquisites,, and bonusesbonuses.

Principals must provide incentivesincentives so that management acts in the principals’ best interests and then monitormonitor results.

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Organization of the Financial Organization of the Financial Management Function Management Function

Board of Directors

President(Chief Executive Officer)

Vice PresidentOperations

Vice PresidentMarketing

VP ofFinance

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TreasurerCapital BudgetingCash ManagementCredit Management

Dividend DisbursementFin Analysis/PlanningPension ManagementInsurance/Risk MngmtTax Analysis/Planning

Organization of the Financial Organization of the Financial Management Function Management Function

VP of Finance

ControllerCost Accounting

Cost ManagementData ProcessingGeneral Ledger

Government ReportingInternal Control

Preparing Fin StmtsPreparing Budgets

Preparing Forecasts