Financial Management

Lecture 1:An Introduction to Financial Management

About Me• Salim Darmadi• Kediri, 9 December 1982• Married• Sukamaju Baru, Cimanggis, Depok• Bapepam-LK, Capital Market Research Division• STAN: D-III Accounting (2004)• STAN: D-IV Accounting (2006)• Master of Commerce in Finance

The University of Queensland, Brisbane (2010)• salim.darmadi@gmail.com• +62 81310172465

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Today’s Agenda

• Introduction• Questionnaire on “Financial Literacy”• Course profile• Rules• Why studying Finance?• Lecture 1: An Introduction to Financial

Management

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Questionnaire on Financial Literacy

• Independent research• Title: “Financial Literacy of College Students:

The Role of Finance Course”• Please put your best efforts to answer the

questions• Do not indicate your name on the

questionnaire• 15 minutes

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Course Profile

• The syllabus will be distributed • Textbook: Keown et al. (2005), “Financial

Management: Principles and Application”, 10th edition, Prentice Hall

• Assessment:40% Mid-exam40% Final exam20% Quizzes and Assignments

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Rules

1. Be proactive2. Keep motivated 3. Show mutual respect

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Rules

During the lecture, students are expected:• to respect the lecturer and their fellow students• to dress according to the code• to be punctual• to pay their full attention to the lecture

(What if I am sleepy?)• not to eat (drinking water is permitted)• not to talk to each other unless permitted• to keep away from your (bloody hell) cell phones and

gadgets.8

Rules

In learning activities:• Read your textbook; do not make the lecture notes the only

source of learning• Discuss the materials with your fellow students• Revise the materials at home, do not wait until mid- and final-

exams• Prepare yourselves for the quizzes (held 2-3 times during the

semester)• Show your integrity

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Why Studying Finance?

One of the characteristics of andragogy: Adults are willing to learn something if they can benefit from it.•Finance is very much related to accounting as your major.•Knowledge on finance may be required when you work for the government (Ministry of Finance, BPK, BPKP, etc).•Knowledge on finance is very beneficial in your personal/family financial planning.

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Lecture 1: Introduction to Finance

• Definition and decisions of finance• Goal of the firm• Legal forms of business organization• Corporation and financial market• Ten principles that form the basics of finance

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Definition of finance

Financial management is concerned with the maintenance and creation of economic value or wealth.

The examples of financial decisions:•When to introduce a new product?•When to invest in new assets?•When to replace existing assets?•When to borrow from banks?•When to issue stocks or bonds?•When to extend credit to a customer?•How much cash to maintain?

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Goal of the Firm

In microeconomics: Maximization of profit

This “too-simplified goal” ignores:• the uncertainty and risk of the firm’s projects• the timing of the project’s return• the cost of funds provided by the firm’s

shareholders (owners)

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Goal of the Firm

In finance: Maximization of the shareholder’s wealth• This means: Maximization of the market value of existing common shares•Good decisions lead to increasing stock price•Poor decisions lead to decreasing stock price•Lessons from Enron

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Legal Forms of Business Organizations

1. Sole proprietorship• A business owned by a single individual• Owner maintains title to the firm’s assets• Owner has unlimited liability

2. Partnership• Similar to a sole proprietorship, except that

there are two or more owners15

Legal Forms of Business Organizations

General partnership• All partners have unlimited liabilityLimited partnership• Consists of one or more general partners, who have unlimited

liability, and• One or more limited partners (investors) whose liability is

limited to the amount of their investment in the business.Limited liability company (LLC)• A cross between a partnership and a corporation• Owners have limited liability• The firm is run like a partnership

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Legal Forms of Business Organizations

3. Corporation• A business entity that legally functions separate and apart from its

owners.• Owners’ liability is limited to the amount of their investment in the

firm.• Owners hold common stock certificates, and ownership can be

transferred by selling the certificates.• Large and growing firms choose corporate form for one reason:

ease in raising capital ideal business entity in terms of attracting new capital

• Unitary board vs. Two-tier board • Figure 1-1

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Corporation and Financial Market

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cash Investors

Secondarymarkets

Government

securities

Cash flow

reinvest

tax

Corporation

dividend,etc.

Corporation and Financial Market

1. Primary market: Market in which new issues of a security are sold to initial buyers.Initial public offering (IPO): The first time the firm’s stock is sold to the general public.Seasoned new issue: A new stock offering by a firm that already has stock that is traded in the secondary market.

2. Secondary market: Market in which previously issued securities are traded.

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Ten Principles

1. Risk-return trade-off• We will not take on additional risk unless we expect

to be compensated with additional return.• High risk, high return2. Time value of money• A dollar received today is worth more than a dollar

received in the future.• It is better to receive money earlier.• Cost-benefit analysis is used.

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Ten Principles

3. Cash (not profit) is king• Cash flows, not profits, are actually received by the

firm and can be reinvested.• Cash flows and accounting profit may not be the

same. Why?4. Incremental cash flows• It is the difference between “if the project is taken”

and “if the project is not taken.”• Is it worth to accept a new project?

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Ten Principles

5. The curse of competitive markets• It is hard to find exceptionally profitable projects

(Recall the concept of “perfectly-competitive market” in microeconomics)

• Product differentiation or cost advantage6. Efficient capital markets• Under EMH, publicly-available information is

reflected in stock prices.• The markets are quick and the prices are right.

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Ten Principles

7. Agency problem• Managers may not behave in the best interests of the

shareholders.• Managers have other incentives: salary, personal wealth,

prestige, job security.• Examples of agency problem8. Taxes bias business decisions• After-tax incremental cash flows should be considered.• Government can use taxes to implement certain policies.

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Ten Principles

9. All risk are not equal• Some risk can be diversified away; diversification can

reduce risk.• Don’t put all of your eggs in one basket.• It is often difficult to measure risk.10. Ethical dilemmas are everywhere in finance• Some are commonly agreed, some need personal

judgment.• Is ethics relevant? Unethical behavior eliminates trust

(lesson from Enron and Arthur Andersen).

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Next Week (Lecture 2)

Chapter 2• Understanding financial statements, taxes,

and cash flowsChapter 3• Evaluating a firm’s financial performance

Homework• Revise Chapter 1

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