INTRODUCTION TO
FINANCIAL MANAGEMENT
DR: EL ILAM SI MOHAMED
1.1
Chapter 1
Key Concepts and Skills
1.2
Know the basic types of financial management
decisions and the role of the financial manager
 Know the goal of financial management
 Know the financial implications of the different
forms of business organization
 Understand the conflicts of interest that can arise
between owners and managers

Chapter Outline
1.3
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Finance: A Quick Look
Business Finance and The Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation
Basic Areas Of Finance
1.4
•
•
•
•
Corporate finance
Investments
Financial institutions
International finance
Investments
1.5
•
•
•
Work with financial assets such as stocks and bonds
Value of financial assets, risk versus return and asset
allocation
Job opportunities
•
•
•
Stockbroker or financial advisor
Portfolio manager
Security analyst
Financial Institutions
1.6
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Companies that specialize in financial matters
 Banks
– commercial and investment, credit unions,
savings and loans
 Insurance companies
 Brokerage firms

Job opportunities
International Finance
1.7
This is an area of specialization among all of the areas
discussed so far
 It may allow you to work in other countries or at least
travel on a regular basis
 Need to be familiar with exchange rates and political
risk
 Need to understand the customs of other countries and
speaking a foreign language fluently is also helpful

Why Study Finance?
1.8
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Marketing

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Accounting

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Dual accounting and finance function, preparation of financial statements
Management

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Budgets, marketing research, marketing financial products
Strategic thinking, job performance and profitability
Personal finance

Budgeting, retirement planning, college planning, day-to-day cash flow
issues
Business Finance
1.9

Some important questions that are answered using
finance
 What
long-term investments should the firm take on?
 Where will we get the long-term financing to pay for
the investment?
 How will we manage the everyday financial activities of
the firm?
Financial Manager
1.10
Financial managers try to answer some or all of these
questions
 The top financial manager within a firm is usually the
Chief Financial Officer (CFO)

 Treasurer
– oversees cash management, credit management,
capital expenditures and financial planning
 Controller – oversees taxes, cost accounting, financial
accounting and data processing
Financial Management Decisions
1.11

Capital budgeting
 What
long-term investments or projects should the business
take on?

Capital structure
 How
should we pay for our assets?
 Should we use debt or equity?

Working capital management
 How
do we manage the day-to-day finances of the firm?
Forms of Organization
1.12

Three major forms in the united states
 Sole
proprietorship
 Partnership
General
 Limited

 Corporation
S-Corp
 Limited liability company

Sole Proprietorship

Advantages
 Easiest to start
 Least regulated
 Single owner keeps all the
profits
 Taxed once as personal
income
1.13
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Disadvantages
 Limited to life of owner
 Equity capital limited to
owner’s personal wealth
 Unlimited liability
 Difficult to sell ownership
interest
Partnership

Advantages
 Two or more owners
 More capital available
 Relatively easy to start
 Income taxed once as
personal income

Disadvantages
 Unlimited liability


General partnership
Limited partnership
 Partnership
dissolves when
one partner dies or wishes to
sell
 Difficult to transfer ownership
1.14
Corporation

Advantages
 Limited liability
 Unlimited life
 Separation of ownership and
management
 Transfer of ownership is easy
 Easier to raise capital
1.15
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Disadvantages
 Separation of ownership and
management
 Double taxation (income
taxed at the corporate rate
and then dividends taxed at
personal rate)
Goal Of Financial Management
1.16

What should be the goal of a corporation?
 Maximize
profit?
 Minimize costs?
 Maximize market share?
 Maximize the current value of the company’s stock?

Does this mean we should do anything and
everything to maximize owner wealth?
The Agency Problem
1.17
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Agency relationship
 Principal
hires an agent to represent their interest
 Stockholders (principals) hire managers (agents) to run
the company

Agency problem
 Conflict

of interest between principal and agent
Management goals and agency costs
Managing Managers
1.18

Managerial compensation
 Incentives
can be used to align management and stockholder
interests
 The incentives need to be structured carefully to make sure
that they achieve their goal

Corporate control
 The

threat of a takeover may result in better management
Other stakeholders
Work the Web Example
1.19
The Internet provides a wealth of information about
individual companies
 One excellent site is finance.yahoo.com
 Click on the web surfer to go to the site, choose a
company and see what information you can find!

Figure 1.2
1.20
Financial Markets
1.21
Cash flows to the firm
 Primary vs. secondary markets

 Dealer
vs. auction markets
 Listed vs. over the counter securities
 NYSE
 NASDAQ
Quick Quiz
1.22
What are the four basic areas of finance?
 What are the three types of financial management
decisions and what questions are they designed to
answer?
 What are the three major forms of business
organization?
 What is the goal of financial management?
 What are agency problems and why do they exist
within a corporation?

Definitions and concepts
Dr: EL ILAM SI MOHAMED

Financial management, sometimes called financial
operations or finance, is how an insurance company
manages its resources to meet the company’s
financial goals, especially the overall goals of
solvency and profitability.
Organization of Financial Management
Investment Committee
Board of Directors
Audit Committee
Board of Directors
Chief Financial Officer
Financial Operations
Chief Investment
Officer
Investment
Operations
Treasurer
Treasury
Operations
Controller
Accounting and
Financial
Reporting
Chief Auditor
Audit and
Internal Control
Accounting and Financial Operations
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Accounting is a system or set of rules and methods for collecting,
recording, analyzing, summarizing, and reporting financial
information.
Financial reporting is the process of presenting financial data about
a company’s financial position. Operating performance, and flow of
funds into and out of the company.
In most of the insurance companies, the controller or comptroller is
the head of accounting and financial reporting
Accounting and Financial Operations
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The primary responsibilities of the accounting and
financial reporting function are to :
Record, track and report on financial transactions
Coordinate the budget process and oversee expense analysis
Prepare financial statements and reports for external
stakeholders
Gather, record ,analyze and distribute financial information to
company mangers
Treasury Operations
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Treasury Operations, manages the cash coming into
and out of a company
The treasurer oversees the maintenance and
management of records and reports for all of an
insurer’s cash transactions
Treasury Operations

Treasuery operations include the following responsibilities:

Cash Management-Oversees cash receipts and approves cash
disbursements
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Bank relations and account administration- Set up bank
accounts, reconciles bank statements
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Bank reconciliation-Records cash transactions and charges them to
proper accounts
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Short term credit activities- invests excess cash in very short –
term arrangements and arranges for very short term borrowing as
needed
Investment Operations
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Investments are core insurance company operation. Typically,
a CIO manages investment operations.
The CIO is responsible for :
Making recommendations to the board and implementing
board directives
Ensuring investment decisions are in line with investment
policy and regulatory requirements
Communicating to the accounting and actuarial areas the
current and expected rates of return on the company’s
Audit and Internal Control

By conducting audits of its financial and operational
business activities , an insurer can objectively , and
compliance with evaluate its operating procedures,
management efficiency and compliance with
specified rules and regulations
Audit and Internal Control
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The ongoing duties of an insurer’s audit committee
include:
Monitoring internal controls for financial operations
Supervising and meeting with internal auditors to
discuss their activities and findings
Monitoring organizational activities to improve
operating efficiencies
Reporting the committee’s activities to the board of
directors
Responsibilities of Financial Management
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(1) Setting Financial strategy
(2) Managing risk
(3) Managing the company’s solvency and
profitability
(4) Managing capital
(5) Managing cash flows
(6) Providing financial information to stakeholders
1) Setting Financial Strategy
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Financial strategies may be categorized as :
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1) Aggressive
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2) Conservative
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3) combination of the above two
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Aggressive : A company that places a strong emphasis on taking
risks that could enhance its profitability. For e.g. investing in
relatively high- risk assets, developing many new and unusual
products, implementing new distribution systems

Conservative Financial Strategy: An insurer that places a strong
emphasis on avoiding risks that could threaten its solvency
2) Managing Risks
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Risk is the possibility that an investment might have an unexpected result.
Common types of risks:
Investment risk- is the possibility that an investor will fail to earn some or
all of an expected return or will lose all or part of the original investment.
Some important risks associated with investing are
Market Risk : For e.g. real estate investment may lose value if the real
estate market as a whole declines
Interest-rate risk: For e.g. if the interest rate increase, bonds tend to lose
market value
Default-risk: The risk that a borrower will fail to repay the debt
Liquidity –risk: for e.g. I the owner of property, such as shopping mall,
should suddenly need cash quickly, the property may have to be sold for a
price less than its true value
2) Managing Risks
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Operational Risk is a broad category of risks originating from
inadequacies in an insurer’s operational areas or from external events
affecting an insurer's operational areas. Two major types of operational
risks are:
Business process risk- For e.g. inefficient customer service processes
might create long TAT
Event Risk: For e.g. an earthquake might result in technology failures and
an inability to run the business
Product Risk : is the risk that a company’s [products might not sell as well
or be as profitable as expected
A) Pricing risk: For e.g. more insured might die than an insurer
anticipated when pricing a life insurance product, so claims will be higher
2) Managing Risks
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Risk management is the process of systematically
identifying, assessing, and minimizing the negative
impact of risk.
To minimize the negative impact of these various risk
across the organization, most insurers practice
Enterprise Risk Management. ERM is a system that
identifies and quantifies risks both from potential
threats and potential opportunities and manages them.
3) Managing Solvency and Profitability
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The dual goals of financial management are to (1) protect solvency (2) increase
profitability
Pursuing profitability requires a certain amount of risk taking, whereas protecting
solvency involves risk avoidance and stability
Long term profitability enables an insurer to
A) Provide funds for investments
B) Pay policy dividends
C) Pay cash dividends to stockholders and increase the attractiveness of the company’s
stock to investors
D) Generate high-quality ratings from insurance rating agencies
E) Provide funds to develop products, expand product lines, for company expansion
e.t.c
4) Managing Capital

Financial managers attempt to increase the probability that the company
will remain financially healthy by using the company’s capital
appropriately

Capital= Assets – Liabilities
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Benefits to an insurer of maintaining the strong capital position include:

Greater ability to withstand difficult conditions such as bad economy

Greater flexibility in its operations
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Greater ability to raise capital on favorable terms

Ways to
Raise
Capital?
Ways to Use
Capital?
5) Managing Cash Flows
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A cash flow is any movement of cash into or out of an organization
A cash inflows include- 1) revenues from product sales 2)
investment income 3) sales of existing assets 4) external financing
A Cash outflow includes 1) payments to policy owners and
beneficiaries 2) payment for operating expenses 3) purchase of new
assets
The basic goal for managing cash flows is to have enough assets
available so that the insurer can pay its obligations as they come due
and to invest the remaining assets wisely to earn favorable returns
6) Providing financial information to
stakeholders
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Insurers provide information to stakeholders in the
form of
Financial statements
Annual report
Annual statements
6) Providing financial information to
stakeholders
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A financial statement is a summary of a company’s financial condition on a
specified date or its performance during a specified period.
Two key financial statements are the income statement and the balance sheet
The income statement shows a company’s revenues and expenses during a
defined period, such as one quarter or one year, and shows weather the
company experienced a profit or loss during that period.
Revenues are amounts that a company earns from its business operations
Expenses are amounts that a company spends to support its business
operations
The income statement also shows net income, which is calculated by
subtracting expenses from revenues
6) Providing financial information to
stakeholders
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Balance sheet, which lists the value of an insurer’s assets
,liabilities , and capital and surplus as of a specified date
Annual Report is a financial document that an incorporated
business issues to its stakeholders and other interested parties
to report the business’s activities and financial performance
for the preceding year.
Annual Statement