Chapter 01

The Role and Environment of Managerial Finance

Copyright 2006 Pearson Addison-Wesley. All rights reserved.

1-*What is Finance?Finance can be defined as the art and science of managing money.The process of determining the required fund for an activity or a purpose, identifying the available sources for raising the fund, calculating the cost of each source, collecting the fund from optimal source and allocating the collected fund in such a way that maximizes the wealth of shareholders is called finance.

FINANCE (Continue.)Functions?According to R. C. Osborn The Finance function is the process of acquiring and utilizing funds of a business.According to Bonneville and Dewey Financing consists of raising , providing , managing of all the money , capital or funds of any kind to be used in connection with the business.Finance DepartmentCalculating funds requirement of organization Means how much money we require to run the businessFinding sources of finance It means to check from where we can raise money & out of that which source of finance is suitable for our organizationUtilization of funds It means utilization of profits which a company earns during a financial year Investment DecisionFinancial DecisionDividend DecisionLiquidity Decision

1-*Functions/Activities/Roles of Financial Manager

Key Activities of The Financial ManagerPrimary ActivitiesPerforming Financial Analysis and PlanningMaking Investment DecisionsMaking Financing DecisionTransforming financial data into a form that can be used to monitor the firms financial conditionEvaluating the need for increased (or reduced) productive capacityDetermining what additional (or reduced) financing is requiredDetermine both the mix and the type of assets found on the firms balance sheet

The left-hand side of the balance sheetDeals with The right-hand side of the balance sheet and involves two major area:Most appropriate mix of short-term and long-term financing must be establishedWhich individual short-term or long-term sources of financing are the best at given point in time

1-*Types of FinanceBusiness finance: The process of determining the required fund for an activity or a purpose by a business enterprise, identifying the available sources for raising the fund, calculating the cost of each source, collecting the fund from the minimum cost source and utilizing the collected fund in such a way that maximizes the profit is called finance.

Public/Government finance: The process of determining the required fund for an activity or a purpose by the government of a particular country, searching the available sources for collecting the required fund, estimating the cost of each source, raising the fund from the minimum cost source and disbursing the collected fund in such a way that maximizes the welfare of the common people of the country is called public finance.

Personal/Private finance: The process of determining the required fund for an activity or a purpose by an individual, identifying the available sources for raising the fund, calculating the cost of each source separately, collecting the fund from the minimum cost source and using the fund for maximizing personal and family benefit is called personal finance.

1-*Major Areas & Opportunities in Finance: Financial ServicesFinancial Services is the area of finance concerned with the design and delivery of advice and financial products to individuals, businesses, and government.Career opportunities include banking, personal financial planning, investments, real estate, and insurance.Managerial finance is concerned with the duties of the financial manager in the business firm.The financial manager actively manages the financial affairs of any type of business, whether private or public, large or small, profit-seeking or not-for-profit. They are also more involved in developing corporate strategy and improving the firms competitive position.

1-*Legal Forms of Business Organization

1-*Corporate Organization

*Managerial Finance is closely related to, but quite different from, Economics and Accounting. Organizational ViewSince most business decisions are measured in financial terms, the financial manager plays a key role in the operation of the firmThe size and importance of the managerial finance depend on the size of the firm.In small firm the finance function generally performed by the accounting departmentIn medium-to-large-size firmSeparate department, vice-president of finance (CFO),Treasurer, ControllerThe officer responsible for the firms financial activities: financial planning and fund raising, managing cash, making capital expenditure decision, managing credit activities and managing the investment portfolioThe officer responsible for the firm accounting activities: tax management, data processing, and cost and financial accountingFinancial Manager The Managerial Finance Function

Relationship to EconomicsThe Financial Manager must understand the economic framework, and be alert to the consequences of varying levels of economic activity and changes in economic policyMust be able to use economic theories as guidelines for efficient busineness operationSupply-demand analysisProfit-Maximazing strategiesPrice TheoryMarginal AnalysisEconomic principle which states that financial decisions should be made and actions taken only when the added benefit exceed the added costsExampleThe Managerial Finance Function

Relationship to AccountingThe finance and accounting function are closely related and generally overlap; indeed, managerial finance and accounting are not often easily distinguishable. In small firm the controller often carries out of the finance function, and in large firms many accountants are intimately involved in various finance activitiesTwo Basic DifferencesEmphasis of cash flowsDecision MakingAccrual Method vs. Cash MethodRecognizes revenue at the point of sale and recognized expenses when incurredRecognized revenues and expenses only with respect to actual inflow and outflows of cashAccounting ViewFinancial ViewIncome statementABC CorporationFor the year xxxx

Sales Revenue BDT 100.000Less: Costs 80.000

Net Profit BDT 20.000Income statementABC CorporationFor the year 2015Cash inflow BDT 0Less: Cash Outflow 80.000

Net Profit ($80.000)The accountant devotes the majority of attention to the collection and presentation of financial data

The financial manager evaluates the accountants statements, develops additional data, and makes decisions based on subsequent analyses

This does not mean that accountant never make decision, or that financial manager never gather dataThe Managerial Finance Function

1-*Goal of the Firm: Maximize Profit or Wealth Maximization

Source:Reference Materials

Maximize Profit?Some people believe that the owners objective is always to maximize profits

The Financial Manager are expected to make a major contribution to the firms overall profit

For Corporation, profit are commonly measured in terms of Earnings per Share (EPS)EPS:The amount earned during the period on each outstanding share of common stock

Profit maximization fails for reason:Timing of returnCash flow available to stockholderRiskThe chance that actual outcomes may differs from those expected

Basic primises in managerial finance is that trade-off exist between return (cash flow) and risk

Return and risk are in fact the key determinant of share price which represents the wealth of the owners in the firmStockholder are risk-averse ?Goal of the Firm: Maximize Profit or Wealth Maximization

Maximizing Shareholder WealthThe goal of the financial manager is to maximize the wealth of the owners for whom the firm is being managedMeasured by the share price of the stockTiming of return (cash flow)magnitudeRisk Financial decisions and share priceGoal of the Firm: Maximize Profit or Wealth Maximization

1-*Goal of the Firm: What About Other Stakeholders?Stakeholders include all groups of individuals who have a direct economic link to the firm including employees, customers, suppliers, creditors, owners, and others who have a direct economic link to the firm.The "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions that could be detrimental to the wealth position of its stakeholders.Such a view is considered to be "socially responsible."

The Agency IssueThe goal of the financial manager should be to maximize the wealth of the owners of the firmManagement can be viewed as agents of the owners who have hired them and given them decision-making authority to manage the firm for the owners benefitIn theoryIn practiseMost financial managers would agree with the goal of owner wealth maximizationHowever, managers also concern with their personnel wealth, job security, lifestyle, and privilegeAgency problemThe likelihood that managers may place personnel goals ahead of corporate goalsAgency CostMonitoring expenditureBonding expenditureStructuring expenditureOpportunity costAudit & controlFidelity bondManagerial compensationStock option, performance share, cash bonusesThe Agency Issue: The Agency Problem

1-*The Role of Ethics: Ethics DefinedEthics is the standards of conduct or moral judgmenthave become an overriding issue in both our society and the financial communityEthical violations attract widespread publicityNegative publicity often leads to negative impacts on a firm

The Role of EthicsEthics Standard of conduct or moral judgement exampleCorporate Ethics Guidelines and PoliciesEthics and share priceIssues UpdateGood Corporate GovernanceCorporate Social Responsibility Certified Financial AnalystResponsibilityFairnessTransparencyAccountabilityEthics & Corporate Governance

1-*Financial Institutions & MarketsFirms that require funds from external sources can obtain them in three ways:through a bank or other financial institutionthrough financial marketsthrough private placementsFinancial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments.The key suppliers and demanders of funds are individuals, businesses, and governments.In general, individuals are net suppliers of funds, while businesses and governments are net demanders of funds.

Types of Financial Market

Classification by the Nature of Maturity: Money Vs Capital MarketClassification by the seasoning of Claim: Primary Vs Secondary MarketClassification by the Nature of Claim: Debt Vs Equity MarketClassification by the Immediate Delivery: Spot Vs Derivative MarketClassification by Organizational Structure: Auction Vs OTC MarketOther types: Private Vs Public Market

Financial markets are differentiated according to the types of investment, maturity of investment, trading structures, types of lender & Borrower, location of the market & types of transactions. Types of Financial Market

Difference between Money & Capital Market

ParticularsMoney MarketCapital MarketDefinitionMoney market s a component of the financial markets where short-term borrowing takes placeCapital market is a component of financial markets where long-term borrowing takes placeMaturity PeriodFor one year or less than one yearFor more than one yearInstrumentsThe main credit instruments of the money market are call money, T-Bill, Commercial Paper, Bankers Acceptance, REPO, Reserve REPO, Certificates of Deposit etc.The main instruments used in the capital market are stocks, shares, debentures, bonds, securities of the government.Nature of Credit InstrumentsHomogenous. A lot of variety causes problems for investors.Heterogeneous. A lot of varieties are required.Purpose of LoanShort-term credit required for small investments.Long-term credit required to establish business, expand business or purchase fixed assets.Basic RoleLiquidity adjustmentPutting capital to workInstitutionsCentral banks, Commercial banks, Acceptance houses, Nonbank financial institutions, Bill brokers, etc.Stock exchanges, Commercial banks and Nonbank institutions, such as Insurance Companies, Mortgage Banks, Building Societies, etc.Purpose of LoanThe money market meets the short-term credit needs of business; it provides working capital to the industrialists. The capital market, on the other hand, caters the long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc.RiskThe degree of risk is small in the money market. The risk is much greater in capital market.Market RegulationMoney market is regulated by central bank of Bangladesh (Bangladesh Bank). Capital Market is regulated by Bangladesh Security & Exchange Commission (BSEC). Relation with Central BankClosely related to the central banks of the country.Indirectly related with central banks and feels fluctuations depending on the policies of central banks.

1-*Difference between Primary Market & Secondary MarketThe Primary market refers to the market where new securities are issued for the purpose of obtaining capital. Firms and public or government institutions can raise funds from the primary market through making a new issue of stock (to obtain equity financing) or bonds (to obtain debt financing). The secondary market refers to the market where securities that have already been issued are traded. Instruments that are usually traded on the secondary market include stocks, bonds, options and futures.

DAFFODIL INTERNATIONAL UNIVERSITYDAFFODIL INTERNATIONAL UNIVERSITY**DAFFODIL INTERNATIONAL UNIVERSITYFinancing Decisions These decisions basically deal with acquiring funds & deployment of fundsInvestment Decisions These decisions are related with selection of assets . Assets are classified into two types Fixed Assets - Current AssetsThe decisions regarding Fixed Assets are known as capital budgeting decisions The decisions regarding current assets come under Working Capital ManagementDividend Policy Decisions Whatever profit company earns , the owners are entitled to receive them. These decisions are related with distribution of dividends i e to decide how much profit we should distribute as dividend & how much should be retained in business DAFFODIL INTERNATIONAL UNIVERSITY**DAFFODIL INTERNATIONAL UNIVERSITYProfit Maximization The primary objective of any business is to earn profit so the finance dept has to manage the funds so that the company can get maximum profit. All such actions which generate profit or cut down costs should be undertaken & those that are likely to have adverse impact on profitability should be avoided.According to then financial experts , this objective is simple & has the in built advantage of judging economic performance . It will direct the resources in those channels that promise maximum return.

DAFFODIL INTERNATIONAL UNIVERSITY**DAFFODIL INTERNATIONAL UNIVERSITYObjectives Of Financial Management Wealth Maximization It means the value of any business activity should not be measured in terms of costs but in terms of benefits it produce.The word Wealth refers to Net Present Worth, which is the difference between gross present worth & the amount of capital investment required to achieve the benefitsThis objective is widely accepted , it considers time value of money .DAFFODIL INTERNATIONAL UNIVERSITY**