Nature of Financial Management

By Lucky YonaManagement Consultant- ESAMI

CoverageIntroductionFinance FunctionsFinancial Manager’s RoleFinancial Goals of the FirmManagement ObjectivesReview Questions

IntroductionFinancial Management is a managerial

activity concerned with planning and controlling financial resources of an organization

A branch of Economics till 1890.Though it is a separate discipline it borrows

heavily on economics for its theoretical concepts.

Finance FunctionsMaking Investment DecisionsMaking Financing DecisionsDividend ( Profit Allocation Decisions)Liquidity Decisions

Investments DecisionsIt involves the decision of allocation of capital

or commitment of funds to long term assets that would yield benefits in the future.

Aspects of investment decisions The Evaluation of the prospective profitability of

new investments Measurement of a cut-off rate ( opportunity cost of

capital ) against the prospective return of new investments .

Investment DecisionsThe investment decision may also involve

The Identification of investment Opportunities Evaluating them Deciding on the optimum allocation of scarce

funds available between investments.Forms of Investment Decision

Undertaking New ProjectsTake-over Merger with another company.

Financing DecisionsIt involves making decision on when, where

and how to acquire funds to meet firm’s investment needs.

The central issue is to determine the proportion of equity and debt ( Capital Structure).

The issue here is to obtain the best financing mix or the optimum capital Structure.

However, many factors in deciding the capital structure need be considered such as control, flexibility, loan covenants and legal aspects.

Dividend DecisionsA third major financial Decision.Decision on whether the firm should

distribute all profits or retain them, or distribute a portion and retain the Balance.

Dividend decisions will determine the dividend policy in terms of impact to shareholders value.

Liquidity DecisionsCurrent Assets management for safeguarding

the firm against the dangers of illiquidity and insolvency.

Liquidity and profitability trade off must be reached to avoid these problems.

Financial Manager’s RolesTraditional Roles

Routine Finance Questions such as - Supervision of cash Receipts & Payments - Custodian of Assets - Record Keeping and Reporting

Modern Roles ( Managerial Functions Raising of Funds Allocation of Funds Profit Planning ( e.g Pricing, Costs, Volume etc) Understanding Capital Markets

Specific Functions- SummaryThe specific functions of the financial

manager are to ensure that funds are made available at the right time made available for the right length of time obtained at the lowest cost used in the most effective way.

Financial Goals of the FirmThere are main two financial Goals of the firm 1. Profit Maximization Goals- The main issue

here is to make profit. This objective has been recently criticized in recent years

Why ? It is vague it ignores the timings of returns- There is no distinction

between returns received in different time periods. It ignores risk Definition of term profit is ambiguous. Does it mean

Profit before tax or after tax? Does it mean short term profit-or long term profit? Total profits or profit per share?

Financial Goals of the Firm 2. Shareholder’s Wealth Maximization

The goal of the firm is to maximize the wealth of the owners for whom it is being operated.

The wealth is measured by share price of the stock.Therefore managers should accept only those

actions that are expected to increase share price.Any Financial decision which does not increase

share price should be rejected.However, it is considered important to take into

account to broaden the focus to include the interests of stakeholders as well as shareholders

Management ObjectivesGrowth Objective- Especially non- Profit

making Organizations such as services organizations , where the profit motive cannot operate.

Risk Reduction or Minimization

Most profitable companies carry a high risk of expensive projects such as prospecting oil or mining companies.

In case of a rich strike they make big profits however they can make huge losses in case exploration proves abortive.

In this case management objective can be to ensure survival by the avoidance of risk, profit becoming a secondary objective.

Social ObjectivesA social Purpose as a management ObjectiveConcerned about improvement of employees

working conditionsProvide a wholesome product for customersAvoid anti-social actions such as

environmental pollution or undesirable promotion practices.

EfficiencyFor organizations such as charities or public

services the fundamental objective might be to provide a required service which is not supplied in the market place.

A suitable management objective will be the provision of such service at minimum cost

Personal AspirationManagement team are likely to be highly

motivated towards their own career objectives.

In this case the important objectives for the manager may be therefore the improvement of his salary, career prospects or security.

The consequences of this is a managers desire to get quick results which will stand to the immediate credit of the manager involved as against more solid but longer term profit making objectives.

Financial Objectives and Financial Management in GovernmentsFinancial management in government is

different from financial management in an industry or commercial company because:

Government departments do not operate to make profits, Government services are provided without the

commercial pressure of competition and ‘ the market’. There are no competitive reasons for controlling costs , being efficient or keeping prices down

The government departments have full time professionals Civil servants as their managers, but planning and control decisions are also taken by politicians,.

The government gets its money from

Strategies to achieve Financial GoalsA strategy may be defined as a course of

action , including the specification of resources required, to achieve a specific objective.

Strategy can be short term or long termStrategy depends on the objectives or

targets.The starting point for strategy formulation

is the identification and formulation of objectives.

Characteristic of Strategic Decisions.Strategic Decisions will be concerned with the

scope of the organization’s activitiesStrategy Involves the matching of an organization’s

activities to the environment in which it operates.Strategy involves the matching of an organization’s

activities to its resource capability.Strategic decisions therefore involve major

decisions about the allocation or-re-allocation of resources.

Strategic decisions will be affected by Environment Considerations Resources AvailabilityThe Values of Expectations of the people in power within

the organization

Characteristic of Strategic Decisions.Strategic decisions are likely to affect the

long –term direction that the organization takes

Strategic decisions have implications for change throughout the organization , and so are likely to be complex in nature.

Levels of StrategyCorporate Strategy - This is concerned with a broader issues

such as ‘ what business are we in? – Financial aspects of this level of strategic decision making – include the choice of method in entering a market or business.

Business Strategy or Competitive Strategy This covers the question of how strategic

business units compete in individual markets, and therefore of the resources which should be allocated to them.

Competitive Strategy examines the threat on the performance of the company of factors such as The potential Charges in the Industry in which

the firm operates, through entry of new competitors

The competition between existing firms in terms of costs, pricing and product quality

The development of substitute products that may affect the industry as a whole

The monopolistic power of individual companies in the input markets

The monopolistic power of companies in the various product markets

Operational Strategy This is to do with how different functions

within the business – including the finance function- contribute to the business strategies.

Discussion Questions1.Discuss the likely consequences of the

following errors in financial management (i) bad timing for capital raising (ii) inefficient capital raising (iii) Inefficient use of funds

2. How can a company achieve corporate social objectives in its day to day operations? Should the Government put some laws to ensure that Companies are contributing to social objectives in your country?

3. Define the scope of financial management. What role should the financial manager play in the modern enterprise?

Bad Timing of CapitalDelays in business activitiesPossibility of Bankruptcy and possible

liquidationHampers Cash FlowCost of Borrowing might be highBad Timing- World Recession- Political Turmoil ( Internal ) – especially

new business- Labour Unrest- Trade Policy- more restrictive

Inefficient capital raisingFirm not in position to provide the required

servicesInability to honor its obligationInability to achieve business objectiveInability to pay dividends?Inability to acquire assetsInability to penetrate the Markets.

Inefficient use of FundsInability to meet its obligation .Possibility of liquidationDenial of ServicesLoss of Confidence with investors Civil UnrestInability to CompeteLead to Misallocation of resources.Overspending

Presentation-1Bad Timing of Capital Raising

Inability to implement the project Losses due to inflation, exchange rate

fluctuationsLoss of staff due to funds delaysTime value of MoneyIncreased cost of funds ( e.gUntimely implementations of the projectLoss on anticipated profitsMisallocation of funds to other projectsLoss of control on investment decisions

Inefficient High Cost of raising the funds( High interest) Missing the targeted funds EPS is lower.Inability to implement projects

Innefficency- Failure to meet strategic goals- Problems with liquidity- Inability to meet social objectives- Impaired Growth-