Chapter 1

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Introduction to Financial Management

Prof. Tarunika J. Agrawal

WINTER

Learning Objectives
Demonstrate an understanding of finance and financial management nature. Understand the interrelations between finance and various other related disciplines Explain how the role of the financial manager today has transformed and is so important. Describe "financial management" in terms of the three major decision areas that confront the financial manager. Identify the goal of the firm and understand why shareholders' wealth maximization is preferred over other goals. Understand the potential problems arising when management of the corporation and ownership are separated (i.e., agency problems). Discuss the changing organizational structure of finance functions .

Roadmap
What is finance & financial Management Interdisciplinary approach
Changing role of finance manager Different finance function Goals & objective of financial management Agency Problem Changing organizational structure of finance functions

Role of Finance Manager

Traditional Outlook
It is concerned with raising of funds and administration of funds Issuing securities and raise funds Raising funds from financial institutions Maintaining proper records and legal activities.

Modern Outlook
To decide how much amount is required from where and maintain records. What type of assets are required In what ways the funds utilized i.e optimum utilization Taking dividend decision

Financial Decision Areas 1. Investment analysis 2. Working management 3. Sources funds and capital cost of Primary Disciplines Support Accounting Macroeconomics Microeconomics

4. Determination of capital structure 5. Dividend policy 6. Analysis of risks and returns Resulting in

Support

Other Related Disciplines Marketing Production Quantitative methods

Shareholder wealth maximization

Organizational Structure of Finance functions

BOARD OF DIRECTORS

President / CEO

VP Human Resource

VP Finance

VP Marketing

VP Operations

Treasurer

Controller

Finance Decisions
Investing decision Financing decisionDividend Decision
Asset mix Optimal firm size Relates to the selection of assets in which funds will be invested by a firm. Long-term assets (Capital Budgeting) Short-term or current assets (Working Capital Management). Capital mix Minimize cost of capital Covers two interrelated aspects Capital structure theory Capital structure decision Profit Allocation mix Analyzed in relation to the financing decision of a firm. Two alternatives are available in dealing with the profits of a firm: o they can be distributed to the shareholders in the form of dividends or othey can be retained in the business itself. The decision as to which course should be followed depends largely on a, the dividend-pay out ratio

o o

o o

Financial Objectives
Profit maximization(Maximizing the Rupee Income of Firm)
OR

EPS maximization(Maximizing earning per share of the Firm)

Arguments For Resources are efficiently utilized Appropriate measure of firm performance Serves interest of society also Arguments Against Profit maximization is Vague It Ignores the risk and timing of returns Assumes Perfect Competition In new business environment profit maximization is regarded as Unrealistic Difficult Inappropriate Immoral. Market value is not a function of EPS. Calls for a zero dividend payout policy

Financial Objectives
Shareholders Wealth Maximization
Maximizes the net present value of a course of action to shareholders
Strengths Unambiguous measure Benefits are measured in terms of cash flows. Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors. Fundamental objectivemaximize the market value of the firms shares, reflection of shareholders wealth.

Agency Problem
Jensen and Meckling developed a theory of the firm based on agency theory. There exists a SEPARATION between owners and managers Management acts as an agent for the owners (shareholders) of the firm. Principals must provide incentives so that management acts in the principals best interests and then monitor results. Incentives include, stock options, perquisites, and bonuses.