FUNDAMENTAL FINANCIAL

MANAGEMENT (MAF253)

LECTURER
DR TAMOI JANGGU
019-888 2851/ 082 – 677647
tamoi@uitm.edu.my
Office: B230

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 Chapter 1:

Introduction to
financial management

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 Learning outcome:

At the end of this topic, students should be able to:

➢Identify the goal of the firm and the role of the financial
manager
➢Analyse working capital of a business
➢Apply the concept of the time value of money
➢Evaluate the sources of financing of a business
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 1.1 What is finance?

• Finance refers to study of financial planning, asset

management, and fund raising for business and
financial institutions.
• Business finance is defined as business activity which
is concerned with the acquisition and conservation
of capital funds in meeting the financial needs, and
overall objectives of business enterprise.

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 1.1 What is finance?

• Financial market, financial intermediaries, and financial

management are the important components.
• Financial markets and financial intermediaries facilitate
the flow of funds from borrowers to savers.
• Financial management involves the efficient use of
financial resources in the production of goods.

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 1.2 Importance of finance

• To make many personal decisions in investment

• To make business decisions on financial implications:
a. What factors determine the price of company’s stock.
b. How managers make choices that will add value to their
companies
c. how managers ensure that their companies do not run out of
cash while executing their plans.

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1.3 Components of financial environment

a) Financial manager
b) Investors
c) Financial markets
d) Financial institutions

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 b) investors
• Individuals or financial institutions that provide
funds to firms, governments, agencies or other
individuals who need those funds.
• Financial institutions or institutional investors
provide funds:
• By giving loans to individuals or firms or
• By purchasing securities issued by other firms
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 Financial Markets
▪ Financial markets represent forums that facilitate
the flow of funds between investors, firms,
and government units and agencies.
• Money Market- Short-term, very liquid, easily
converted to cash; commercial paper.
• Capital Market - have a life of more than a year;
common stock, preference stock & bonds.
▪ Primary market: new securities bought and sold 1st
time
▪ Secondary market: existing securities traded among
investors.
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 FINANCIAL INSTITUTIONS

• financial institution is an institution that provides

financial services for its clients or members.
• Probably the most important financial service provided
by financial institutions is acting as financial
intermediaries.
• Most financial institutions are highly regulated by
government.

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 1.4 Roles of financial manager
 Forecasting & planning – must coordinate planning process.
Need to interact with people from other dept and lay plans
that will shape co’s future.
 Major investment & financing decisions - Manage funds &
assets efficiently and effectively
 Coordination & control – Business decision have financial
implications. FM need to interact with other personnel to
ensure operation runs efficiently.
 Dealing with financial market - Each co affects and is affected
by general financial markets where funds are raised, securities
are traded and investors make or lose the money.
 Risk management – natural disasters, uncertainties and
fluctuation foreign exchange rates. FM responsible to manage
it effectively. 13
 7) Goal of the firm
• Short term goal
• Stress on the efficient use of
Profit capital resources
maximization • Drawbacks
• 1) Short-term concept
• 2) Not consider the timing of
returns
• 3) ignore risk

shareholders’ • Goal is to max the wealth of the

owners
wealth • Wealth are measured by share price
maximization of the stock
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 Profit Vs Shareholders wealth Maxi
Profit maximization
Meaning •amount in excess after
deducting all costs from
sales and revenues, which
will include non-cash
items.
•To maximizing profit is to
increase sales and reduced
costs.
•Profits can be maximized
through the efficient use of
capital resources and
without achieving
shareholders wealth.
Shareholder wealth
•value of stock that is held in
the company. It is reflected
by the market value of the
shares.
•To maximize wealth, is to
maximize share price.
•Thus earnings and
dividends should show some
growth apart from stability
and room for expansion.
•To maximize wealth
therefore profits has to be
maximized 15
 ADVANTAGES & DISADVANTAGES OF
PROFIT MAXIMIZATION
Advantages
•Easy to calculate profit
•Easy to determine the link
between financial decisions and
profit
•Stresses on the efficient use of
capital resources
Disadvantages
•Emphasizes short-term gains
•Ignores the risk involved when
making financial decisions
•Ignores timing of returns
•Concentrates on EPS
•Ignores real world complexities when
making financial decisions
•Ignores the cost of funds provided by
the shareholders in the computation of
profit.
•If the firm’s goal is to maximize EPS,
the firm may implement a dividend
policy that might never pay dividends.16
ADVANTAGES & DISADVANTAGES OF
SHAREHOLDER WEALTH
Advantages Disadvantages
•Emphasizes long-term returns •The goal does not offer any
•Considers risk or uncertainty clear relationship between
when making financial stock price and financial
decisions decisions
•Considers the timing of • This is a long-term process
returns
•Takes into account economic
expectations since it affects
movements in stock price.
•Emphasizes market price per
share.

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 Profit maximization
Timing •Emphasize on the amount
of of profits received and not
return on when the profits are
received.
•It does not matter if profit
is derived so much latter in
the projects live.
•i.e. ignores profits in
future years
Shareholder wealth
•Time value of money is
applied here. A dollar
received today is worth more
than if it is to be received in
10 years time.
•The earlier the cash is
received the better (given
that equivalent cash flows
from profits), for the money
can be invested in another
project so that earnings can
be increased.
•This will lead to overall
increase in the company’s
profit, hence shareholder
wealth. 18
 Profit maximization
Uncertainty •This goal ignores the fact
And risk. that there is a certain
degree of risk due to the
Projects differ uncertainty that surround
in respect of
risk a business. It assume that
characteristics. the projects equivalent in
terms of desirability.
•Projects are compared by
examining their expected
values or weighted average
profits
•By ignoring this fact
could lead to incorrect
investment.
Shareholder wealth
•e.g. Projects in
construction would have
higher risk than those in
retailing
•Uncertainty and risk are
considered.
•Investors demand a
higher expected return for
taking added risk.
•High risk, high return
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 Profit maximization
Ignoring •Increase in profit does not
cash flow mean there is an increase in
cash flow.
•Profit include depreciation
and provisions (non-cash
items)
Shareholder wealth
Increase in shareholders wealth is
related to increase in cash flows
(increase in stock price) i.e.
concerned with when the money
is actually received in hand. Only
then dividend can be paid and
payment for expansion and other
projects can be made.
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 Areas of decision functions

Decision function can be broken down into 3 major

categories:

a) Investing decision
b) Financing decision
c) Assets management decision

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a) Investing decision
Capital investment decision
Involve large sums of money
Non-routine
Effect of decision is critical
e.g.: acquire a new machine
Working capital investment
decision
Usually small then capital
investment decision
More routine – daily basis
Effect of decision is not critical
e.g. inventory, cash, marketable
securities, account receivables.
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 b) Financing decision
Sources of
finance

borrowing capital

Long-term Short- Common Preference

debt term debt equity stock

Retained Issue new

earning share 24
 c) Assets management decision

• Once the assets have been acquired and appropriate financing

provided, these assets must be managed efficiently.
• Finance involve:
- securing funds from investors
- investing the funds obtained
- receiving returns from various investment
- periodically distributing returns to investors in the form of
dividends
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 1.6 Legal Forms of Business Organization.
1. Sole proprietor
• business owned by single individual.
• Owner – own title to assets, personally liable
without limitation for liabilities occurred.
• Entitle to profits and absorb all losses
• No legal requirement must be met.
• Starting and terminate by owner’s choice

Advantages Disadvantages
1. Easily and inexpensive to 1. Difficult to obtain large
form sums of capital
2. Subject to few govt. 2. Has unlimited personal
regulations liability
3. business avoids corporate 3. Life of business is limited
income taxes to life of creator. 26
 2. Partnership
• An association of 2 or more indiv. joining together as
co-owners to operate business for profits.

General partnership Limited P/ship & limited liability

Each partner fully responsible for
liabilities incurred by p/ship
Conduct of one partner will bind
others (either thru oral commitment
or formal document.
Limited P/ship
At least 1 general partner must remain
Names of limited partners may not
appear in name of firm
Limited partners not participate in
mgmt of buss.
Limited Liability (LLC)
Cross between p/ship & corp.
Limited liabilities to owners but run &
taxed like p/ship
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 1.6 Legal forms of business org (Cont).

Advantages Disadvantages
1. Low cost 1. Unlimited liability
2. Ease of formation 2. Limited life of
organization
3. Difficulty of transferring
ownership
4. Difficulty of raising large
amounts of capital

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1.6 Legal Forms of Business Organization (Cont)
3. Corporation
 An entity that legally functions separate & apart from its owners.
 Can individually sued & be sued, purchase, sell & own property,
subject to criminal punishment.
 Owners select BOD; BOD select corporate officers (mgmt).
 Ownership transferable; determine through no of shares owned
relative to total no of shares outstanding
 Investor’s liability restricted to amount invested.

Advantages Disadvantages
1. Unlimited life  Double taxation
2. Easy transfer of ownership  Cost of set-up and report
3. Limited liability filing
4. Ease of raising capital
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Thank you

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 Question

1. Explain three (3) criticism of profit maximization

as a goal of the company
2. Identify three (3) responsibilities of financial
manager
(Mar 2015Q1a)

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 Question
3. Explain briefly two(2) important components of
financial environment
4. Discuss three (3) differences between profit
maximization and shareholders’ wealth
maximization.
(Sep 2015Q1)

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