FTX2024S: FINANCIAL MANAGEMENT NOTES
MODULE 1: FINANCIAL OVERVIEW (CHAPTER 1)
Role of the Financial Manager
• Uses quantitative tools and analyses to make financial decisions that create
value for the firm’s owners (maximise firm value or shareholder value/wealth).
• Maximising firm value is about cash-flows:
- Firm generates cash inflows by selling goods and services produced by its
productive assets and human capital.
- Firm is successful in creating value when cash inflows > cash outflows
needed to pay operating expenses, creditors and taxes.
- Firm pays the residual cash flows (remaining cash) to the owners as cash
dividends or reinvests them in the business.
- Failure to generate sufficient cash flows results in bankruptcy or insolvency.
Firm then requires business rescue or liquidation.
- The value of any asset is determined by the future cash flows it will
generate, through use or sale.
• Stakeholders = Any person with a financial claim or interest in the firm.
• Shareholders = Stakeholders who have an ownership claim in the firm.
• To create firm value, financial managers make 3 fundamental decisions.
• Capital budgeting or investment decision:
- Also known as capital expenditure (CAPEX) decision.
- Involves deciding what productive assets to buy (tangible and intangible).
- The decision rule = Accept investment project if the value of future cash
inflows exceeds the cost of the project.
- Considered the most important decision because:
(1) Productive assets generate most of the firm’s cash inflows (firm value).
(2) Decisions are long-term.
, (3) Decisions involve huge cash outlays. Mistakes mean huge financial
losses. E.g. Daimler-Benz and Chrysler’s “worst merger of all time”.
- Affects non-current assets in the SOFP.
• Financing or capital structure decision:
- Determines how productive assets are finance.
- Involves trade-offs between the advantages (interest on debt is a tax
deductible expense) and disadvantages (more debt comes with greater
risk) of debt and equity financing – the optimal mix must be selected.
- Ways of raising equity finance:
(1) Share issue.
(2) Reinvesting residual cash flow.
- Bad financing decisions can destroy firm value, especially if the firm faces
liquidation if it is unable to meet its financial obligations.
- Affects non-current liabilities and shareholder’s equity in the SOFP.
• Working capital management (WCM) decision:
- Determines how day-to-day financial matters, current assets (inventory,
accounts receivable, cash) and current liabilities in the SOFP are managed.
- Seeks to maximise firm value creation (investing idle cash to earn interest)
and minimise destroying value.
- Mismanagement can cause bankruptcy, even if the firm is profitable.
- Net working capital = Current assets – Current liabilities.
Forms of Business Organisations
• Sole proprietorship or sole-trader business:
- Unincorporated (legally, the business does not exist separately from the
owner, both entities are treated as one and the same).
- Owner-managed.
- Most common type of business.
- Advantages:
(1) Easy and cheap to from.
(2) Least regulated.
(3) Business income is taxed once as the personal income of the owner.
MODULE 1: FINANCIAL OVERVIEW (CHAPTER 1)
Role of the Financial Manager
• Uses quantitative tools and analyses to make financial decisions that create
value for the firm’s owners (maximise firm value or shareholder value/wealth).
• Maximising firm value is about cash-flows:
- Firm generates cash inflows by selling goods and services produced by its
productive assets and human capital.
- Firm is successful in creating value when cash inflows > cash outflows
needed to pay operating expenses, creditors and taxes.
- Firm pays the residual cash flows (remaining cash) to the owners as cash
dividends or reinvests them in the business.
- Failure to generate sufficient cash flows results in bankruptcy or insolvency.
Firm then requires business rescue or liquidation.
- The value of any asset is determined by the future cash flows it will
generate, through use or sale.
• Stakeholders = Any person with a financial claim or interest in the firm.
• Shareholders = Stakeholders who have an ownership claim in the firm.
• To create firm value, financial managers make 3 fundamental decisions.
• Capital budgeting or investment decision:
- Also known as capital expenditure (CAPEX) decision.
- Involves deciding what productive assets to buy (tangible and intangible).
- The decision rule = Accept investment project if the value of future cash
inflows exceeds the cost of the project.
- Considered the most important decision because:
(1) Productive assets generate most of the firm’s cash inflows (firm value).
(2) Decisions are long-term.
, (3) Decisions involve huge cash outlays. Mistakes mean huge financial
losses. E.g. Daimler-Benz and Chrysler’s “worst merger of all time”.
- Affects non-current assets in the SOFP.
• Financing or capital structure decision:
- Determines how productive assets are finance.
- Involves trade-offs between the advantages (interest on debt is a tax
deductible expense) and disadvantages (more debt comes with greater
risk) of debt and equity financing – the optimal mix must be selected.
- Ways of raising equity finance:
(1) Share issue.
(2) Reinvesting residual cash flow.
- Bad financing decisions can destroy firm value, especially if the firm faces
liquidation if it is unable to meet its financial obligations.
- Affects non-current liabilities and shareholder’s equity in the SOFP.
• Working capital management (WCM) decision:
- Determines how day-to-day financial matters, current assets (inventory,
accounts receivable, cash) and current liabilities in the SOFP are managed.
- Seeks to maximise firm value creation (investing idle cash to earn interest)
and minimise destroying value.
- Mismanagement can cause bankruptcy, even if the firm is profitable.
- Net working capital = Current assets – Current liabilities.
Forms of Business Organisations
• Sole proprietorship or sole-trader business:
- Unincorporated (legally, the business does not exist separately from the
owner, both entities are treated as one and the same).
- Owner-managed.
- Most common type of business.
- Advantages:
(1) Easy and cheap to from.
(2) Least regulated.
(3) Business income is taxed once as the personal income of the owner.
