Financial Management and Financial Objectives Session No. 1 Advanced Financial Management SMIU 2025 by Raza Ali The Nature of Financial Management Definition Key Decisions Financial management is the management of an Financial management decisions encompass investment, organization's finances to achieve its financial objectives. financing, dividend, and risk management. These The primary objective for private sector companies is decisions are crucial for the long-term success and typically to maximize shareholder wealth. sustainability of the organization. Financial Planning 1 Short-Term Financial managers ensure 2 Medium-Term Financial managers plan for 3 Long-Term Financial managers contribute to sufficient short-term funding for medium-term capital needs, such long-term investment decisions working capital needs, such as as acquiring non-current assets by analyzing financial data to inventory purchases and like plant and equipment. determine the best use of funds managing receivables and to meet the organization's payables. financial objectives. Financial Control Financial control involves monitoring the organization's activities to ensure they are meeting objectives and assets are being used efficiently. This involves comparing actual performance with forecasts, taking into account historical data and anticipated future changes. Investment Decisions Internal Investment decisions within the business include undertaking new projects, investing in new plant and machinery, research and development, and marketing campaigns. External Investment decisions involving external parties include mergers, acquisitions, joint ventures, and disinvestment decisions, such as selling off unprofitable segments of the business. Financial Management Decisions Investment decisions involve Financing decisions involve Dividend decisions involve Risk management involves allocating funds to assets determining how to raise determining the proportion identifying, assessing, and that will generate returns funds to finance of profits to distribute to mitigating potential risks and contribute to the investments, considering shareholders as dividends that could impact the organization's growth. options like debt, equity, and and the proportion to retain organization's financial retained earnings. for future investment. performance. Financial Objectives Profitability Earnings Per Share Growth Maximizing profits is a key objective, but it's not Investors look for consistent earnings and the sole measure of success. Accounting profits growth in earnings per share (EPS), which is a can be manipulated, and profit maximization key indicator of a company's performance and may come at the expense of other important its ability to pay dividends and reinvest for factors. future growth. 1 2 3 4 Shareholder Wealth Maximization Other Financial Targets The primary financial objective for most Companies may set additional financial targets, companies is to maximize shareholder wealth, such as restrictions on gearing, profit retention which is achieved by increasing the market value targets, and operating profitability targets, to of shares and dividends received. support their main financial objective and manage risk. Shareholder Wealth Maximization Valuation Methods Companies can be valued using various methods, including statement of financial position valuation, break-up basis, and market value. The most relevant method for financial objectives is market value, which reflects the price at which buyers and sellers trade shares. Shareholder Return Shareholders receive returns through dividends and capital gains from increases in the market value of their shares. A company's share price will increase when it makes attractive profits, pays out dividends, and reinvests for future growth. Total Shareholder Return Total shareholder return combines the increase in share price and dividends paid, providing a comprehensive measure of shareholder value creation. Corporate Objectives Profitability Profitability is a key corporate objective, measured by return on investment (ROI), which reflects the efficiency with which the company uses its assets to generate profits. Market Share Market share represents the company's proportion of the total market for its products or services. Increasing market share indicates a strong competitive position and potential for growth. Growth Growth is a crucial objective, indicating the company's ability to expand its operations, increase sales, and create new opportunities. Cash Flow Cash flow is essential for the company's liquidity and its ability to meet its financial obligations. Strong cash flow allows the company to invest, pay dividends, and manage its operations effectively. Customer Satisfaction Customer satisfaction is vital for long-term success. Satisfied customers are more likely to make repeat purchases, recommend the company to others, and contribute to its growth. Financial Strategy Objectives 1 Financial strategy is driven by the organization's objectives, which provide a clear direction for decision-making and resource allocation. Strategies 2 Financial strategy involves identifying and selecting strategies that are most likely to maximize the organization's net present value, considering factors like investment opportunities, capital allocation, and risk management. Implementation 3 Implementing the chosen financial strategy involves putting plans into action, allocating resources, and monitoring progress to ensure the strategy is achieving its objectives. Understanding Stakeholders Internal Stakeholders Connected Stakeholders External Stakeholders Internal stakeholders are directly Connected stakeholders have a direct External stakeholders are not directly involved in the company's operations. financial or contractual relationship with involved in the company's operations but They include employees, managers, and the company. This group includes are affected by its activities. They include pensioners. Their primary interests lie in shareholders, debtholders, customers, government, pressure groups, local job security, fair compensation, and a bankers, and suppliers. Their objectives communities, and professional bodies. positive work environment. are often tied to financial returns, Their interests encompass product quality, and reliable service. environmental protection, social responsibility, and regulatory compliance. Stakeholder Objectives 1 3 Ordinary Shareholders 2 Trade Payables Ordinary shareholders, the providers of risk capital, aim to Trade payables, suppliers of goods or services, seek to be maximize their wealth through share ownership. Their goal paid the full amount due by the agreed date. They also aim is to see the company's value increase and receive to maintain a positive trading relationship with the dividends. company. Long-Term Payables (Creditors) 4 Employees Long-term payables, often banks, aim to receive timely Employees strive to maximize their rewards in salaries and interest and capital repayments on their loans. They benefits, based on their skills and the market value of their prioritize minimizing the risk of default and ensuring the expertise. They also value job security and a positive work company's ability to repay. environment. Government's Role in Stakeholder Relationships Taxation The government raises taxes on sales, profits, and dividends. It also expects companies to act as tax collectors for income tax and VAT. The tax structure can influence investors' preferences for dividends or capital growth. Encouraging Investments The government might provide funds for investment projects or offer tax incentives to encourage private investment. This can stimulate economic growth and create jobs. Legislation The government influences company operations and stakeholder relationships through legislation, including the Companies Acts, employment laws, health and safety regulations, consumer protection laws, and environmental regulations. Economic Policy Government economic policy, such as exchange rate policy, economic growth strategies, inflation control, and interest rate adjustments, directly impacts business activity and stakeholder interests. The Agency Relationship: Shareholders and Management The relationship between shareholders and management is often described as an agency relationship. Managers act as agents for shareholders, using delegated powers to run the company in their best interests. However, potential conflicts of interest can arise, such as managers prioritizing their own rewards over shareholder wealth. Shareholders have the right to remove directors from office, but this requires initiative and organization. Managers are often motivated to improve financial performance because their compensation is often tied to the company's size or profitability. The Interplay of Stakeholders: Long-Term Creditors Long-term creditors provide debt finance to companies, relying on management to generate sufficient cash flows to make interest payments and repay loans. Creditors often take security for their loans, such as a fixed charge over an asset, to minimize the risk of default. The profits generated from investments financed by long-term creditors can provide extra dividends or retained profits for shareholders. This creates a potential conflict of interest, as shareholders may benefit from risky investments financed by creditors' money. Measuring Corporate Performance: Financial Ratios Financial ratios are essential tools for measuring a company's performance and assessing its financial health. They provide insights into profitability, debt levels, liquidity, and shareholder returns. By comparing ratios over time and across similar businesses, companies can identify areas for improvement and make informed strategic decisions. The Du Pont system of ratio analysis involves constructing a pyramid of interrelated ratios, allowing for a comprehensive assessment of profitability and the identification of key drivers of performance. Profitability Ratios: Assessing Financial Performance Profitability ratios measure a company's ability to generate profits from its operations. Key ratios include return on capital employed (ROCE), which compares profit before interest and tax (PBIT) to capital employed, and profit margins, which measure the percentage of sales revenue that translates into profit. Analyzing profitability ratios helps identify areas for improvement, such as cost control, pricing strategies, and asset utilization. It also allows for comparisons with industry benchmarks and competitors. Debt and Gearing Ratios: Managing Financial Leverage Debt ratios measure a company's reliance on debt financing. They indicate the level of financial leverage and the risk associated with high debt levels. High debt can increase profitability but also increases the risk of financial distress if the company cannot meet its debt obligations. Analyzing debt ratios helps assess a company's financial stability and its ability to manage its debt burden. It also provides insights into the company's risk profile and its potential for future growth. Shareholder Investment Ratios: Appraising Investor Returns Shareholder investment ratios measure the returns that investors receive from their investments in a company. They provide insights into dividend payouts, earnings per share, and the market's valuation of the company's future prospects. Analyzing shareholder investment ratios helps investors assess the attractiveness of a company's stock and make informed investment decisions. It also provides insights into the company's dividend policy and its ability to generate shareholder value.
