Managerial Finance
Introduction
Objectives



What is Financial Management?
Types of Decisions and Theories
10 basic finance principles
What is Finance Management?
Financial management is simply
“the ways and means of managing
money”
(MacMenamin, 1999, p. 9).
What is Finance Management?
“Concerns the acquisition, financing,
and management of assets with some
overall goal in mind”
(Van Horne & Wachowicz, 2001).
Investment Decisions
Most important of the three
decisions.


What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
Financing Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).
 What is the best type of financing?
What is the best financing mix?
 What is the best dividend policy?
 How will the funds be physically
acquired?
Asset Management
Decisions
 How
do we manage existing assets
efficiently?
 Financial Manager has varying
degrees of operating responsibility
over assets.
 Greater emphasis on current asset
management than fixed asset
management.
What is the Goal
of the Firm?
Maximization of
Shareholder
Wealth!
Value creation occurs when we
maximize the share price for
current shareholders.
Strengths of Shareholder Wealth
Maximization


Takes account of: current and future profits
and EPS; the timing, duration, and risk of
profits and EPS; dividend policy; and all
other relevant factors.
Thus, share price serves as a barometer for
business performance.
What is Financial
Management?
MacMenamin (1999) further develops
this definition:
“analyzing financial situations, making
financial decisions, setting financial
objectives, formulating financial plans
to attain those objectives, and
providing effective systems of financial
control to ensure plans progress
towards the set objectives” (p. 9).
What is Financial
Management?
What is Financial
Management?
MacMenamin, (as seen in Figure 1),
proffers that financial management is
concerned with analysis, decisionmaking, planning, and control. The
key ingredient in these interrelated
activities is financial data and
information.
What is Financial
Management?


INFORMATION: the quality of the
information used and processed, and the
professionalism of the financial manger are
determining factors in financial analysis,
decision-making, planning and control.
FINANCIAL ANALYSIS AND REVIEW refers
to the process by which managers evaluate
and review the current financial situation of
an organization, and based on this review,
make decisions, objectives and strategies
What is Financial
Management?


FINANCIAL PLANNING is the tool that makes the
achievement of goals and objectives possible. An
example of a key financial planning tool is the
budget. The essence of financial planning is to plan
the allocation, coordination, and prioritizing of
human capital and financial resources, e.g., to
ensure that financial resources and input are
available for the good or service that will be
provided.
FINANCIAL CONTROL: ensures that all activities and
strategies are in accordance with the overall plan,
consisting of accounting, reporting and control
management system(s)
What is Financial
Management?
McKinney, (as seen in Figure 2), expands the
definition of financial management to include not
only financial activities and processes, but also
management activities, with both processes
depending on the financial administrative system.
He further defines these two processes into six
sequential components: 1) planning, 2) strategy,
3) budgeting, 4) financing, 5) controlling and 6)
evaluation.
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
PLANNING is the first
step and establishes
the mission, vision,
values, goals, and
objectives that will
be pursued.
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
STRATEGY
translates the
values and mission
of the organization
into detailed and
measurable goals
and objectives to be
achieved within a
specific time-frame.
Financing
MIS
What is Financial Management?
Financial Activities
Organizational Planning
Activities
BUDGETING
Planning
Evaluating
Strategy
Controlling
Budgeting
is the mechanism
that makes it
possible to achieve
these goals and
objectives via
allocation,
coordination, and
prioritizing between
the services needed
and resources
available.
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
FINANCING:
Financial resources
facilitate and make
possible the
achievement of the
desired outcomes
detailed in strategic
plans, goals, and
objectives.
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
Financing
CONTROLLING
“assures that the
activities planned
and programmed are
carried out according
to the detailed preestablished work
plan” (McKinney,
1986, p. 3).
The major functions
involved are
accounting, auditing,
reporting, and
MIS
purchasing.
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
EVALUATION of
activities and
results is also
essential to
determine
whether the
organization is
complying with its
overall goals and
objectives.
Financing
MIS
Financial Activities
Organizational Planning
Activities
What is Financial Management?
Planning
Evaluating
Strategy
Controlling
Budgeting
MIS:
1. Provides timely
information when
needed
2. Allows to monitor,
control and solve
problems
3. Facilitates
managers to
respond to the
needs of the
organization
Financing
MIS
Review Question
TAKE TEN
MINUTES
In your groups of 3
or 4,
in your own words
describe what is
financial
management.
Ten Principles That Form The
Foundations of Financial Management
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Risk & Return Trade Off
Time Value of Money
Cash (Not Profits)
Incremental Cash Changes
Curse of Competitive Market
Efficient Capital Markets
Agency Theory
Tax Effect
All risk is not equal
Ethical Behavior Is Doing the Right Thing
Principle 1: The Risk-Return
Trade-off
We won’t take on additional risk
unless we expect to be
compensated with additional
return.
 Investment alternatives have
different amounts of risk and
expected returns.
 The more risk an investment has,
the higher its expected return will
be.

Principle 2: The Time Value of
Money


A dollar received today is worth
more than a dollar received in the
future.
Because we can earn interest on
money received today, it is better
to receive money earlier rather
than later.
Principle 3: Cash—Not
Profits—Is King


Cash Flow, not accounting profit, is
used as our measurement tool.
Cash flows, not profits, are actually
received by the firm and can be
reinvested.
Principle 4: Incremental Cash
Flows


It is only what changes that counts
The incremental cash flow is the
difference between the projected
cash flows if the project is
selected, versus what they will be,
if the project is not selected.
Principle 5: The Curse of
Competitive Markets



It is hard to find exceptionally profitable
projects
If an industry is generating large profits, new
entrants are usually attracted. The additional
competition and added capacity can result in
profits being driven down to the required rate
of return.
Product Differentiation, Service and Quality
can insulate products from competition
Principle 6: Efficient Capital
Markets


The markets are quick and the prices
are right.
The values of all assets and securities
at any instant in time fully reflect all
available information.
Principle 7: The Agency Problem
Modern Corporation
Shareholders
Management
There exists a SEPARATION between
owners and managers.
Role of Management
Management acts as an
agent for the owners
(shareholders) of the firm.

An agent is an individual authorized
by another person, called the
principal, to act in the latter’s
behalf.
Agency Theory
 Jensen
and Meckling developed
a theory of the firm based on
agency theory.

Agency Theory is a branch of
economics relating to the behavior of
principals and their agents.
Agency Theory
 Principals
must provide
incentives so that management
acts in the principals’ best
interests and then monitor
results.

Incentives include, stock options,
perquisites, and bonuses.
Principle 8: Taxes Bias
Business Decisions

The cash flows we consider are the
after-tax incremental cash flows to
the firm as a whole.
Principle 9: All Risk is Not
Equal


Some risk can be diversified away,
and some cannot
The process of diversification can
reduce risk, and as a result,
measuring a project’s or an asset’s
risk is very difficult.
Principle 10: Ethical Behavior Is Doing
the Right Thing, and Ethical Dilemmas
Are Everywhere in Finance

Each person has his or her own set of
values, which forms the basis for
personal judgments about what is the
right thing
Review Question
In groups of 2 or 3:
Provide an example for
each principle