CHAPTER1
FINANCIAL MANAGEMENT OVERVIEW
NOTES
OUTCOMES
• Define financial management.
• What is Financial Management?
• Why is the objective of financial management to maximize the value of the firm?
• What is the role of a financial manager?
• What is the relationship of corporate finance to accounting and economics?
• What are the various forms of business organization?
• How do agency issues that arise between managers and owners impact on wealth maximization?
• What are some of the underlying concepts of financial management?
• What is the role of corporate governance and King III?
• How does a firm decide on its corporate strategy?
• What is the role of ethics in business?
Introduction
Financial management is concerned with the acquisition, financing, and management of assets with
some overall goal in mind. Thus the decision function of financial management can be broken down
into three major areas: the investment, financing, and asset management decisions (Van Horne and
Wachowics, 2008:2).
The fundamental objective of financial management is to seek to maximise the value of the firm and
thereby maximising the shareholders’ value and the share price. “Financial management focuses on
decision making gave readily available information and other information that may be not available.”
(Correira, 2019). The major question to be answered is how the management can invest capital to
earn returns that are above the cost of capital given the underlying risks of the company’s
investments.
, The objective of financial management to maximize the value of the firm!
The investment decision is the most important of the firm’s three major decisions when it comes to
value creation. It begins with a determination of the total amount of assets needed to be held by the
firm. Picture the firm’s balance sheet in your mind for a moment. The financial manager needs to
determine the dollar amount of assets – that is, the size of the firm. Managers decide the
composition of the assets. For example, how much of the firm’s total assets should be devoted to
cash or to inventory? Also, the flip side of investment – disinvestment – must not be ignored. Assets
that can no longer be economically justified may need to be reduced, eliminated, or replaced.
The objective of financial management to maximize the value of the firm!
Financial decision efficiency must be made in light of some standard. Although various objectives are
possible, we assume in this book that the goal of the firm is to maximize the wealth of the firm’s
present owners.
Shares of common stock give evidence of ownership in a corporation. Shareholder wealth is
represented by the market price per share of the firm’s common stock, which, in turn, is a reflection
of the firm’s investment, financing, and asset management decisions. The idea is that the success of
a business decision should be judged by the effect that it ultimately has on share price.
DISCUSION FORUM QUESTION
Why is profit maximization not the right objective for corporate firms?
• Manipulation of accounting profits- management increase profitability by reducing costs.
This has an impact on future profits and may result in decrease in quality e.g. reducing
research and development costs of a pharmaceutical company. Maximizing profits by
retaining profits has a detrimental effect on shareholders who are not getting return on
investment.
• Accounting profits depend on accounting policies and management selection of policies may
not reflect economic reality. E.g when to expense cost of assets( depreciation)
• Timing- profit maximization does not factor in time value of money. If a project promises to
give the firm a higher profit in a short term it will be preferred over another with low profits
but for a longer period.
• Cash flows - accounting profits does not factor in flow of cash
• Accounting profits factor in actual costs but are not adjusted for cost of capital financing
which is an opportunity cost of shareholders’ funds.
• Risk impact of risk is ignored by profit maximization
FINANCIAL MANAGEMENT OVERVIEW
NOTES
OUTCOMES
• Define financial management.
• What is Financial Management?
• Why is the objective of financial management to maximize the value of the firm?
• What is the role of a financial manager?
• What is the relationship of corporate finance to accounting and economics?
• What are the various forms of business organization?
• How do agency issues that arise between managers and owners impact on wealth maximization?
• What are some of the underlying concepts of financial management?
• What is the role of corporate governance and King III?
• How does a firm decide on its corporate strategy?
• What is the role of ethics in business?
Introduction
Financial management is concerned with the acquisition, financing, and management of assets with
some overall goal in mind. Thus the decision function of financial management can be broken down
into three major areas: the investment, financing, and asset management decisions (Van Horne and
Wachowics, 2008:2).
The fundamental objective of financial management is to seek to maximise the value of the firm and
thereby maximising the shareholders’ value and the share price. “Financial management focuses on
decision making gave readily available information and other information that may be not available.”
(Correira, 2019). The major question to be answered is how the management can invest capital to
earn returns that are above the cost of capital given the underlying risks of the company’s
investments.
, The objective of financial management to maximize the value of the firm!
The investment decision is the most important of the firm’s three major decisions when it comes to
value creation. It begins with a determination of the total amount of assets needed to be held by the
firm. Picture the firm’s balance sheet in your mind for a moment. The financial manager needs to
determine the dollar amount of assets – that is, the size of the firm. Managers decide the
composition of the assets. For example, how much of the firm’s total assets should be devoted to
cash or to inventory? Also, the flip side of investment – disinvestment – must not be ignored. Assets
that can no longer be economically justified may need to be reduced, eliminated, or replaced.
The objective of financial management to maximize the value of the firm!
Financial decision efficiency must be made in light of some standard. Although various objectives are
possible, we assume in this book that the goal of the firm is to maximize the wealth of the firm’s
present owners.
Shares of common stock give evidence of ownership in a corporation. Shareholder wealth is
represented by the market price per share of the firm’s common stock, which, in turn, is a reflection
of the firm’s investment, financing, and asset management decisions. The idea is that the success of
a business decision should be judged by the effect that it ultimately has on share price.
DISCUSION FORUM QUESTION
Why is profit maximization not the right objective for corporate firms?
• Manipulation of accounting profits- management increase profitability by reducing costs.
This has an impact on future profits and may result in decrease in quality e.g. reducing
research and development costs of a pharmaceutical company. Maximizing profits by
retaining profits has a detrimental effect on shareholders who are not getting return on
investment.
• Accounting profits depend on accounting policies and management selection of policies may
not reflect economic reality. E.g when to expense cost of assets( depreciation)
• Timing- profit maximization does not factor in time value of money. If a project promises to
give the firm a higher profit in a short term it will be preferred over another with low profits
but for a longer period.
• Cash flows - accounting profits does not factor in flow of cash
• Accounting profits factor in actual costs but are not adjusted for cost of capital financing
which is an opportunity cost of shareholders’ funds.
• Risk impact of risk is ignored by profit maximization
