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8/9/2019 Financial Management Functions & Objectives
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Strategic Financial Management
Session -1
Functions & Objectives
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Corporate Finance: Objectives?
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What is Corporate Finance? Corporate Finance addresses the following questions:
What long-term investments should the firm choose?
How should the firm raise funds for the selected
investments?
How should short-term assets be managed and financed? How much short-term cash flow firm need to pay its bills?
What proportion of the funds should be reinvested in thefirm and what should be distributed to the shareholders?
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The Capital Budgeting Decision
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Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders
Equity
CurrentLiabilities
Long-TermDebt
What long-terminvestments
should the firmchoose?
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The Capital Structure Decision
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How should thefirm raise fundsfor the selectedinvestments?
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders
Equity
CurrentLiabilities
Long-TermDebt
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Short-Term Asset Management
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How shouldshort-term assets
be managed and
financed?
NetWorkingCapital
ShareholdersEquity
CurrentLiabilities
Long-TermDebt
Current Assets
Fixed Assets
1 Tangible
2 Intangible
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Risk and Return Financial Management involves three decisions:
Investment Decisions Financing Decisions
Dividend Decisions
Whenever a financial decision involves investment and/orfinancing, it is also concerned with two specific factors:expected return and risk.
Expected return is the difference between potential benefits and potential costs.
Risk is the degree of uncertainty associated with these expectedreturns.
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Cash Flow Btw the Firm and the Financial Markets
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Cash flowfrom firm (C)
T a x e s
( D )
Government
Retainedcash flows (F)Invests
in assets(B)
Dividends and debt payments (E)
Current assetsFixed assets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firmmust be a cashgenerating activity.
The cash flows fromthe firm must exceedthe cash flows fromthe financial markets .
Firm ReceiveCash, generate
profits throughits operations
(B)
Firm Firm issues securities (A) Financialmarkets
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Corporations
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Forms of Business Organization The Sole Proprietorship
The Partnership General Partnership Limited Partnership
The Corporation
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A Comparison
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Corporation Partnership
Liquidity Shares can be easilyexchanged
Subject to substantialrestrictions
Voting Rights Usually each share gets onevote
General Partner is in charge;limited partners may havesome voting rights
Taxation Double Partners pay taxes on
distributionsReinvestment anddividend payout
Broad latitude All net cash flow isdistributed to partners
Liability Limited liability General partners may have
unlimited liability; limited partners enjoy limitedliability
Continuity Perpetual life Limited life
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Hypothetical Organization Chart
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Chairman of the Board and Chief Executive Officer (CEO)
President and Chief Operating Officer (COO)
Vice President and Chief Financial Officer (CFO)
Treasurer Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors
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Accounting and Financial Management The firms finance (treasurer) and accounting (controller)
functions are closely related and overlapping. In smaller firmsusually financial manager generally performs both functions.
One major difference is that accountants generally uses accrualmethod while in finance, the focus is on cash flows.
Finance and accounting also differ with respect to decisionmaking. While accounting is primarily concerned with the
presentation of the financial data, financial manager is primarily concerned with the analyzing and interpreting thisinformation for the decision making purposes.
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Role of Financial Managers The Financial Managers primary goal is to increase
the value of the firm by:
Selecting value creating projects
Making smart financing decisions How to minimize the cost of capital
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Financial Objective There is actually one financial objective:
The maximization of the economic wellbeing, or wealth, ofthe owners.
Whenever a decision is to be made, managementshould choose the alternative that most increases the
wealth of the owners of the business.
The market value of shareholders equity generally
measures the owners economic well being.
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How to maximize shareholders wealth? If the stock market is efficient, the value of a share
should reflect investors expectations regarding thefuture prospects of the corporation.
The value of a stock will change as investorsexpectations about the future change.
For financial managers decisions to add value, the present value of the benefits resulting from decisions
must outweigh the associated costs, where costsinclude the costs of capital.
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Finance Managers: Additional Issues If there is a separation of the ownership and
management of a firmthat is, the owners are not themanagers of the firmthere are additional issues toconfront.
What if a decision is in the best interests of the firm,
but not in the best interest of the manager? How can owners ensure that managers are watching
out for the owners interests?
How can owners motivate managers to makedecisions that are best for the owners?
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The Agency Relationship An agent is a person who acts forand exerts
powers ofanother person or group of persons calledPrincipal.
Agency relationship
Stockholders (principals) hire managers (agents) to run thecompany/ to represent his/her interest
Agency problem Conflict of interest between principal and agent
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Managerial Goals Managerial goals may be different from shareholder
goals Expensive perquisites Survival Independence
Increased growth and size are not necessarilyequivalent to increased shareholder wealth
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Agency Cost There are costs involved with any effort to
minimize the potential for conflict between the
principals interest and the agents interest. These are:
Lost of opportunity Monitoring Costs Takeovers
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Questions Which of following actions are the result of a
financing decision and which are the result of aninvestment decision?1. A firm introduces a new product.2. A firm issues new bonds.3. A corporation issues new shares of stock.4. A firm expands its existing manufacturing facilities.5. A firm leases a new building to be used in its
manufacturing.
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