Chapter
1
The Goals and Functions of
Financial Management
Prepared By: P Chua
Slides Based on: Terry Fegarty
Seneca College
Book References:
1. Block, Short and Hirt
2. Gitman and Hennessey
McGraw-Hill Ryerson
2003 McGraw-Hill
RyersonLimited
Limited
©2003©McGraw-Hill
Ryerson
PPT 1-2
Chapter 1 - Outline
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Definition of Finance
Areas of Finance
Career Opportunities in Finance
Finance as related to Accounting and Economics
The Goal of the Financial Manager
Agency issue as it relates to owner wealth maximization
Stakeholder focus, and ethical behaviour relate to firm’s
goal.
Activities of Financial Management
Forms of Organization
© 2003 McGraw-Hill Ryerson Limited
PPT 1-3
What is Finance?
Finance
is the study of
financial planning, asset
management, and fund
raising for businesses and
financial institutions.
Financial
management can
be described using a balance
sheet.
© 2003 McGraw-Hill Ryerson Limited
Macro Finance
Assets:
Liabilities & Equity:
Current Assets
Current Liabilities
Cash & M.S.
Accounts payable
Accounts receivable
Notes Payable
Inventory
Working
Capital
Investment
Decisions
Total Current Assets
Fixed Assets:
Gross fixed assets
Total Current Liabilities
Long-Term Liabilities
Total Liabilities
Equity:
Less: Accumulated dep.
Common Stock
Goodw ill
Paid-in-capital
Other long-term assets
Retained Earnings
Total Fixed Assets
Total Assets
Total Equity
Total Liabilities & Equity
Working
Capital
Financing
Decisions
© 2003 McGraw-Hill Ryerson Limited
Areas of Finance
1. Financial Markets
- Markets of users and savers of funds.
- Money markets deal in short-term securities (<=1 year)
Ex.; Treasury Bills, commercial paper
- Capital markets deal in long-term securities
Ex.; common stock, preferred stock, corporate bonds, government bonds
2. Financial Services
- Design and delivery of financial advice and products to individuals, businesses,
government.
3. Managerial Finance
- Financial management of business firms.
- Financial management involves the efficient use of financial resources in the
production of goods
 A well-developed financial system is a hallmark and essential characteristic of
any modern developed nation.
© 2003 McGraw-Hill Ryerson Limited
Career Opportunities in Finance
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Financial Analyst – prepares and analyze firm’s financial plans and
budgets; other duties include financial forecasting, financial ratio
analysis.
Capital budgeting analyst/manager – evaluation/recommendation of
proposed asset investments, implementation of approved projects.
Project finance manager –arranges financing for approved asset
investments; coordinates with investment bankers and legal counsel.
Cash manager - maintain and control firm’s daily cash balances;
manages cash collection, short-term investment/borrowing, disbursement
activities and banking relationships.
Credit analyst/manager – administers firm’s credit policy by
analyzing/managing the evaluation of credit applications, extending
credit, monitoring/collecting A/R’s.
© 2003 McGraw-Hill Ryerson Limited
Finance as related to Accounting and
Economics
PPT 1-4
Finance is related to:
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Accounting, which provides information in financial
statements
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Economics, which provides:
 analysis tools such as pricing theory through supply
and demand analysis, cost-benefit analysis etc.
 information on the economic and financial
environment in which the company operates for sound
financial decisions. These include inflation rate,
exchange rate, international capital flows,
unemployment rate, etc.
 All of these factors must fit into the financial decisions
© 2003 McGraw-Hill Ryerson Limited
Difference Between Finance and
Accounting
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Recognition of Revenue and Expenses
 Accrual Basis: recognizes sales revenue and expenses incurred to
make sale at time of sale.
 Cash Basis: recognizes revenues and expenses as they occur.
Accounting vs Financial View
Accounting View
(Accrual Basis)
Income Statement
Peakes Quay, Inc.
For year ended 12/31
Sales revenue
Less: Costs
Net Profit
$100,000
80,000
$ 20,000
Financial View
(Cash Basis)
Cash Flow Statement
Peakes Quay, Inc.
For year ended 12/31
Cash inflow
$
0
Less: Cash outflow 80,000
Net cash flow
($80,000)
© 2003 McGraw-Hill Ryerson Limited
Goal of the Financial Manager
Should it be Profit Maximization?
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Corporations commonly define profit as “Earnings per
Share” (EPS).
EPS ignores at least 2 critical factors:
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the timing of the returns.
risk factors facing the firm.
 Profitability   Risk
 Profitability   Risk
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ex., investing in stocks vs. savings accounts
Stocks may be more profitable but are riskier
Savings accounts are less profitable and less risky (or safer)
© 2003 McGraw-Hill Ryerson Limited
Goal of the Financial Manager
Or should it be Shareholder Wealth Maximization?
 Shareholder
Wealth Maximization considers factors
of EPS timing, and risk ignored by the EPS.
 Therefore,
Maximizing Shareholder Wealth is a
more comprehensive goal for the firm, its managers
and employees.
© 2003 McGraw-Hill Ryerson Limited
PPT 1-7
Goal of the Financial Manager
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Also, shareholder wealth maximization is in general,
consistent with the social responsibility of the firm. Adopting
policies that will improve the share price can attract capital
and provide employment.
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But could conflict with
 social / ethical goals (for example, pollution control)
 interests of management (for example, short-term
compensation)
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Management can encourage an increase in share price by
earning an attractive return at an acceptable level of risk
© 2003 McGraw-Hill Ryerson Limited
Agency Theory:
The Principal-Agent Problem
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Agency Theory is about the conflict that may arise between
management and owners whenever owners are not also the
managers.
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Management may not always act in the best interest of the
owners because management has interest of its own, like
personal wealth, job security, lifestyle, and benefits. Thus,
these concerns may conflict with shareholder interests.
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The pursuit of socially or ethically acceptable goals may have
to come at the expense of shareholder’s wealth.
© 2003 McGraw-Hill Ryerson Limited
Importance of Ethics to Stakeholders
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Stakeholders are those groups that have direct economic links to the firm.
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Stakeholders include not only owners, but also employees, customers,
suppliers, unions, and creditors.
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Honesty, trustworthiness, fair dealing are foundations of sustainable
business relations with these stakeholders.
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Ethical behaviour is necessary to achieve the goal of maximizing
shareholder wealth.
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Maintaining positive stakeholder relationships helps maximize long-term
benefits to shareholders.
© 2003 McGraw-Hill Ryerson Limited
PPT 1-9
Financial Manager–Key Activities
Activities include:
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Short-Term Financial Decisions
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Investment Decisions (Capital Budgeting)
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Working Capital Management
- ex., careful monitoring of cash position on a day-to-day basis
Financial Analysis and Planning
long-term (L/T) financial decisions (>1 year)
- ex., purchasing a new machine in the future
Financing decisions (capital structure)
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how to raise money: loans? leases? shares? bonds?
© 2003 McGraw-Hill Ryerson Limited
PPT 1-11
Forms of Organization:
Sole Proprietorships
Advantages
Freedom
Disadvantages
Unlimited
Liability
Simplicity
Lack of Continuity
Low Start Up
Difficulty in
Costs
A business owned by Raising Money
one person
Tax Benefits
Reliance on One Person
© 2003 McGraw-Hill Ryerson Limited
Forms of Organization:
Partnerships
Disadvantages
PPT 1-12
Advantages
Unlimited Liability
Lack of Continuity
Ownership
Transfer
Difficult
Possibility of
Conflict
More Capital
Greater Talent Pool
Ease of Formation
Tax Benefits
A business venture with two or more owners
© 2003 McGraw-Hill Ryerson Limited
Forms of Organization:
Corporations
PPT 1-13
Advantages
Disadvantages
Limited Liability
Potential Shareholder
Revolts
Continuity
Greater Likelihood
of Professional
Management
Easier Access to
Money
Higher Start-Up
Costs
Regulation
Double Taxation
A corporation
is a separate legal entity
© 2003 McGraw-Hill Ryerson Limited
PPT 1-18
Summary and Conclusions
The financial manager:
 controls the daily cash inflows and
outflows resulting from business
operations
makes the occasional investment
and financing decisions essential for
the future financial success of the
business
may work in a corporation or
other form of business organization
Their overriding goal is to maximize
the wealth of the owners by earning
an attractive return in the business
at an acceptable level of risk
© 2003 McGraw-Hill Ryerson Limited