Financial Management 244:
Chapter 1: Introduction:
• All businesses are guided by the same corporate financial principles
• Financial function: mainly concerned with flow of capital to and from businesses
• Decisions to be made:
- Financing decisions – where the business will source capital to finance activities
- Investment decisions – assets and projects (is the business going to invest that
financing)
- Relationship between acquisition and application of capital
Defining Financial Management:
• Process of creating value within an organisation
• This process consists of planning, organising, directing and controlling financial
activities
• Value created = increase in the wealth of the shareholders within the organization
• Financial management ≠ Accounting
- Accounting: a historical perspective (report)
- Financial managers: focus on value creation going forward. Use information from
accountants to make decisions about the future of the business in order to create
value for shareholders
Links between financial management, accounting and economics
- Financial management is also linked to other fields such as accounting and
economics
, - Financial managers have to make decisions within an ever-changing economic
environment as such, information such as GDP, inflation rate and interest rate all
have an influence on the financial decisions that the financial manager has to
make in order to ensure value is created within an organization
- In SA, given we are an emerging market, we are also more susceptible to adverse
developments in global financial markets, thus these developments need to be
taken into consideration to ensure that financial managers make the correct
financial decisions for the future of the firm
Financial Management decisions:
3 main decisions:
• What should the business invest in? (which assets and which projects should the
business undertake)
- Capital – budgeting decision
• Where will the business get long-term financing to pay for the new investment? (will
they use debt/equity to finance all new decisions)
- Capital – structure decision
• How will the business manage its day-to-day financial activities?
- Working – capital management decision
Capital Budgeting:
• First main category of decisions
• Involves the acquisition and management of NCA (aka capital projects/investments)
• Only invest in value-adding non-current assets
• In order to determine if the investment is value adding, the manager needs to
determine the net present value of that particular asset
• To Calculate the NPV - determine size, timing and risk of the cash flows
- Size – how much initial investment is required (cash outflow) and how much
income will be received (cash inflows)
- Timing – when the cash flow is going to take place and for how long income will
be received from that asset
- Risk – the likelihood of receiving the income (guaranteed/ or is there some risk
that I might not receive income at a specified time)
• Positive vs Negative NPVs
- Only assets that yield positive NPV are then taken into consideration by the
business (deemed to be value adding assets) cash flows exceed the cost to
invest in the asset (inflows > outflows)
Capital Structure:
• Second major category
• The mix of debt and equity a company uses to fund the firm’s activities
• Three options available:
- Borrow long-term funds (debt) – risk increase
- Use savings of the company (retained earnings)
, - Issue more shares (equity) – ownership declines within the organization
• Options will have an effect - risk and value perspective of the firm
• Which form of financing is the cheapest?
- Each form has its own cost associated with it, for example debt financing the
business will have an increase in finance costs. Savings = no real cost because it is
the businesses own income that they are using. More shares = additional
dividends as the cost of equity capital
Working Capital Management:
• Third main category
• Working capital = current assets and current liabilities (typically include inventory,
cash, trade receivables and trade payables)
• How will you approach the day-to-day financial management? decisions to be
made
- Will you sell new product for cash, credit or both?
- Who will receive credit and who won’t?
- How many days until debtors have to pay?
- Will you pay expenses in cash or on credit?
• All these decisions are important to ensure:
- Firms function efficiently; and
- sufficient resources to remain profitable and liquid.
Main categories of financial decisions:
- A (asset side) = capital budgeting decisions
- B & C = Equity and liabilities – capital structure decisions
- Current assets and current liabilities = working capital decisions
• Look at the SFP
The goals of financial management:
• Need goals to guide and motivate when making decisions
• Could have a number of goals eg increasing turnover, enhance market share, min.
costs, avoid solvency etc.
, • Other financial management goals could include max rate of return, max shareholder
wealth and your market value added
• 3 of the goals deserve closer attention given how prevalent they are in practice:
• Profit maximisation accounting based goal (reflect historical performance of the
firm – cant only look at this because firm won’t grow)
- Increase revenue and decrease operating and other expenses
- Main flaws:
o Accounting profit can be manipulated through malpractice
o Goal of profit max ignores the issues of timing and risk associated with the
profit
• Maximising the rate of return accounting based goal
- Ratio of net profit after tax to total assets needs to be maximised
- Same risks associated with profit maximisation (still uses accounting values)
• Maximising shareholders’ wealth forward looking goal
- Shareholder’s wealth influenced by # of shares and current share price
- Only engage in activities that will positively influence the current share price
- The focus on shareholder wealth maximization, considers both risk and return
which already makes it an improved option over profit max and max the rate of
return
- Profit and rate of return maximization = short-term goals
- Share price maximization: short-term and long-term goal
Stakeholders:
• In addition to meeting the needs of shareholders, the financial manager also has to
weigh up the costs of various other stakeholders
• People involved in the business and / or on whom the business has an impact
(interest/stake in the business)
- Shareholders
- Employees
- Suppliers
- Customers
- General public
- Industry regulators
• Why is it important to also consider the interests of other stakeholders of a company
and not just shareholders' interest?
- Because stakeholders have been increasingly effected by the consequences of
various corporate scandals and the businesses operations increasingly have an
impact on various other stakeholders, as such, in order to enlist stakeholders
support it would make sense for a business to then take their interests into
consideration as well as the interests of the shareholders
The corporate forms of business in SA: pg 11-14
• Sole proprietorship – single person has controlling interest in the business. Aka one
person business. Success entirely in the hands of one person who receives all the
benefits and/or losses. Main characteristics:
Chapter 1: Introduction:
• All businesses are guided by the same corporate financial principles
• Financial function: mainly concerned with flow of capital to and from businesses
• Decisions to be made:
- Financing decisions – where the business will source capital to finance activities
- Investment decisions – assets and projects (is the business going to invest that
financing)
- Relationship between acquisition and application of capital
Defining Financial Management:
• Process of creating value within an organisation
• This process consists of planning, organising, directing and controlling financial
activities
• Value created = increase in the wealth of the shareholders within the organization
• Financial management ≠ Accounting
- Accounting: a historical perspective (report)
- Financial managers: focus on value creation going forward. Use information from
accountants to make decisions about the future of the business in order to create
value for shareholders
Links between financial management, accounting and economics
- Financial management is also linked to other fields such as accounting and
economics
, - Financial managers have to make decisions within an ever-changing economic
environment as such, information such as GDP, inflation rate and interest rate all
have an influence on the financial decisions that the financial manager has to
make in order to ensure value is created within an organization
- In SA, given we are an emerging market, we are also more susceptible to adverse
developments in global financial markets, thus these developments need to be
taken into consideration to ensure that financial managers make the correct
financial decisions for the future of the firm
Financial Management decisions:
3 main decisions:
• What should the business invest in? (which assets and which projects should the
business undertake)
- Capital – budgeting decision
• Where will the business get long-term financing to pay for the new investment? (will
they use debt/equity to finance all new decisions)
- Capital – structure decision
• How will the business manage its day-to-day financial activities?
- Working – capital management decision
Capital Budgeting:
• First main category of decisions
• Involves the acquisition and management of NCA (aka capital projects/investments)
• Only invest in value-adding non-current assets
• In order to determine if the investment is value adding, the manager needs to
determine the net present value of that particular asset
• To Calculate the NPV - determine size, timing and risk of the cash flows
- Size – how much initial investment is required (cash outflow) and how much
income will be received (cash inflows)
- Timing – when the cash flow is going to take place and for how long income will
be received from that asset
- Risk – the likelihood of receiving the income (guaranteed/ or is there some risk
that I might not receive income at a specified time)
• Positive vs Negative NPVs
- Only assets that yield positive NPV are then taken into consideration by the
business (deemed to be value adding assets) cash flows exceed the cost to
invest in the asset (inflows > outflows)
Capital Structure:
• Second major category
• The mix of debt and equity a company uses to fund the firm’s activities
• Three options available:
- Borrow long-term funds (debt) – risk increase
- Use savings of the company (retained earnings)
, - Issue more shares (equity) – ownership declines within the organization
• Options will have an effect - risk and value perspective of the firm
• Which form of financing is the cheapest?
- Each form has its own cost associated with it, for example debt financing the
business will have an increase in finance costs. Savings = no real cost because it is
the businesses own income that they are using. More shares = additional
dividends as the cost of equity capital
Working Capital Management:
• Third main category
• Working capital = current assets and current liabilities (typically include inventory,
cash, trade receivables and trade payables)
• How will you approach the day-to-day financial management? decisions to be
made
- Will you sell new product for cash, credit or both?
- Who will receive credit and who won’t?
- How many days until debtors have to pay?
- Will you pay expenses in cash or on credit?
• All these decisions are important to ensure:
- Firms function efficiently; and
- sufficient resources to remain profitable and liquid.
Main categories of financial decisions:
- A (asset side) = capital budgeting decisions
- B & C = Equity and liabilities – capital structure decisions
- Current assets and current liabilities = working capital decisions
• Look at the SFP
The goals of financial management:
• Need goals to guide and motivate when making decisions
• Could have a number of goals eg increasing turnover, enhance market share, min.
costs, avoid solvency etc.
, • Other financial management goals could include max rate of return, max shareholder
wealth and your market value added
• 3 of the goals deserve closer attention given how prevalent they are in practice:
• Profit maximisation accounting based goal (reflect historical performance of the
firm – cant only look at this because firm won’t grow)
- Increase revenue and decrease operating and other expenses
- Main flaws:
o Accounting profit can be manipulated through malpractice
o Goal of profit max ignores the issues of timing and risk associated with the
profit
• Maximising the rate of return accounting based goal
- Ratio of net profit after tax to total assets needs to be maximised
- Same risks associated with profit maximisation (still uses accounting values)
• Maximising shareholders’ wealth forward looking goal
- Shareholder’s wealth influenced by # of shares and current share price
- Only engage in activities that will positively influence the current share price
- The focus on shareholder wealth maximization, considers both risk and return
which already makes it an improved option over profit max and max the rate of
return
- Profit and rate of return maximization = short-term goals
- Share price maximization: short-term and long-term goal
Stakeholders:
• In addition to meeting the needs of shareholders, the financial manager also has to
weigh up the costs of various other stakeholders
• People involved in the business and / or on whom the business has an impact
(interest/stake in the business)
- Shareholders
- Employees
- Suppliers
- Customers
- General public
- Industry regulators
• Why is it important to also consider the interests of other stakeholders of a company
and not just shareholders' interest?
- Because stakeholders have been increasingly effected by the consequences of
various corporate scandals and the businesses operations increasingly have an
impact on various other stakeholders, as such, in order to enlist stakeholders
support it would make sense for a business to then take their interests into
consideration as well as the interests of the shareholders
The corporate forms of business in SA: pg 11-14
• Sole proprietorship – single person has controlling interest in the business. Aka one
person business. Success entirely in the hands of one person who receives all the
benefits and/or losses. Main characteristics:
