Vous êtes sur la page 1sur 50

FINANCIAL MANAGEMENT

Professorial Lecturer: DR. EVANGELINA G. CUSTODIO VP for Administration and Finance

INTRODUCTION
To earn profit; to increase the value, to survive, to serve or fulfill its social responsibility

What shall the organization produce? W a Goods or Services

Productive Resources (Capital)

Organization (Public or Private)

Non Human Resources -Tangibles -Intangibles

Human Resources -Internal -External

HUMAN RESOURCES
BOARD OF DIRECTORS CREDITORS STOCKHOLDERS/ OWNERS COMPETITORS

MANAGERS/ SUPERVISORS

GOVERNMENT

EMPLOYEES/ WORKERS

SUPPLIERS

NON HUMAN RESOURCES


INTANGIBLES Patent Brand Goodwill Trademark Logo
-

TANGIBLES
Financial Assets Real Assets

TO PRODUCE GOODS OR SERVICES

Organization needs to invest in real or fixed assets or productive capital. The manager of the organization must make this decision. He has to answer these questions. What assets to own, or in what assets should the organization invest? What mix of assets will best facilitate the production of goods or services?, How should the organization invest? THIS IS AN INVESTMENT DECISION

AFTER DECIDING WHAT TO INVEST . . . Organization needs to finance this investment by acquiring cash. Therefore, the manager must decide again: What securities to raise, What mix of credit best meets the objectives of the organization Where shall the organization get its fund, How much money or cash is needed, THIS IS A FINANCIAL DECISION.

WHAT IS FINANCIAL MANAGEMENT?


The two broad decisions (investment and financial decisions) are the major responsibility of the financial manager. Financial management is the art and science of making the right investment and financial decisions for the organization. The concern of Financial Management is the maintenance and creation of economic value or wealth

FORMS OF BUSINESS ORGANIZATIONS


SOLE OR SINGLE PROPRIETORSHIP - a business owned and managed by a single individual PARTNERSHIP - a business owned by two or more persons

CORPORATION - a legal entity that functions separate and apart from its owners better known as stockholders.

MAJOR GOALS OF FINANCIAL MANAGEMENT


1. Maximization of Shareholders Wealth
This is maximization of the market value of the existing shareholders wealth. This is translated by maximizing the price of the existing common stocks of a corporation. The market price of the firms stock reflects the value of the firm as seen by its owners. Shareholders are the legal owners of the firm. This is a long-term goal. The objective is to have the highest market value of common stock. This goal recognizes risk or uncertainty, timing of returns and considers stockholders return.

MAJOR GOALS OF FINANCIAL MANAGEMENT


2. Maximization of Profit
This goal stresses the efficient use of capital resources within a given period of time. This is a short-term goal and it ignores risk and timing of returns.

3. Social Responsibility
This is how the business is able to improve the quality of life in its environment and the economy.

TEN MAXIMS OF FINANCIAL MANAGEMENT


1. The Risk-Return Tradeoff We Wont

Take on Additional Risk Unless We Expect to Be Compensated with Additional Return.


- Investment alternatives have different amount of risk and expected returns

- Investors demand higher returns for taking on more risky projects.

The Risk-Return Relationship


E
x p e c t e d R e t u r n

Expected Return for taking on Added Risk

Expected Return for Delaying Consumption

Risk

10 MAXIMS OF FINANCIAL MANAGEMENT

2. The Time Value of Money A Dollar

Received Today is Worth More Than a Dollar Received in the Future


Money has a time value associated with it. A dollar received today is worth more than a dollar received a year from now. It is better to receive money earlier than later because money received today can earn interest.

10 MAXIMS OF FINANCIAL MANAGEMENT

3. Cash -- Not Profit -- is King


- Cash flows, not accounting profits, should be used as a tool for measuring wealth or value. Cash flows are used to measure the benefits and costs from taking on an investment.

- Cash flows and accounting profits may not occur together.

10 MAXIMS OF FINANCIAL MANAGEMENT

4. Incremental Cash Flows Its Only What Changes That Count


-

In making business decisions, we are concerned with the results of those decisions: What happens if we say yes versus what happens if we say no? Incremental cash flow is the difference between the cash flows if the project is taken on versus what the cash flows will be if the project is not accepted

10 MAXIMS OF FINANCIAL MANAGEMENT

5. The Curse of Competitive Markets Why Its Hard to Find Exceptionally Profitable Projects
-

In competitive markets, extremely large profits simply cannot exist for very long. Competition makes it difficult to find profitable projects but we have to invest in markets that are not perfectly competitive. Two common ways to make market less competitive are Product Differentiation and Creation of Cost Advantage through economies of scale, proprietary technology and monopolistic control of raw materials.

10 MAXIMS OF FINANCIAL MANAGEMENT 6. Efficient Capital Markets The Markets

are Quick and the Prices Are Right


Efficient Market A market in which the values of all assets and securities at any instant in time fully reflect all available public information. - Stock prices reflect all publicly available information regarding the value of the company. Market prices reflect expected cash flows available to stockholders. Prices reflect value.

10 MAXIMS OF FINANCIAL MANAGEMENT 7. The Agency Problem Managers Wont

Work for the Owners Unless Its in Their Best Interest

Agency problem is a problem resulting from conflicts of interest between the manager (the stockholders agent) and the stockholders (principal). Align their interest in such a way that what is good for shareholders must also be good for managers.

10 MAXIMS OF FINANCIAL MANAGEMENT 8. Taxes Bias Business Decision In every decision made by the financial manager, the impact of tax is considered. Tax plays important role in evaluating new projects and in determining a firms financial structure or mix of debt (liabilities) and equity (owners investment). Debt financing has cost advantage because interest payments are a tax-deductive expense. Paying interest reduces tax.

10 MAXIMS OF FINANCIAL MANAGEMENT

9. All Risk is Not Equal Some Risk Can Be Diversified Away and Some Cannot
Risk is difficult to measure. Risk is the variability of possible outcome. There are risks which can be controlled and others cannot

Dont put all your eggs in one basket. Diversification can reduce risk.

Reducing Risk Through Diversification


R
E T U R 10%
COMBINATION OF ASSET A & ASSET B ASSET B

20%

ASSET A

0%

N
TIME

10 MAXIMS OF FINANCIAL MANAGEMENT

10. Ethical Behavior is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance

Ethics are standards of conduct or moral behavior. Business ethics can be thought of as a companys attitude and conduct toward its employees, customers, community and shareholders. Beyond the questions of ethics is the question of social responsibility. Social Responsibility means that a corporation has responsibilities to society beyond the maximization of shareholders wealth.

Risk-Return Tradeoff
Risk or uncertainty refers to the variability of expected returns associated with a given investment. Let us measure risk and look at the relationships between risk and returns. Probabilities are used to evaluate the risk involved in a security. The probability of an event is defined as the chance that the event will occur.It is a percentage chance of a given outcome.

MEASURING RISK The Standard Deviation () is a measure of dispersion of the probability distribution. It is commonly used to measure risk.
n

(ri r)2 pi
i=1

Steps in calculating risk


To calculate , take the following steps: Step 1. Compute the expected rate of return ( r).
n r = ri pi i=1 where: ri = ith possible return pi= probability of ith return n = number of possible return

Step 2. Subtract each possible return from r to obtain a set of deviations (ri r ). Step 3. Square each deviation, multiply the squared deviation by the probability of occurrence for its return, and sum these products to obtain the variance (2):
n

2 = (ri r )2 pi
i=1

Step 4. Finally, take the square root of the variance to obtain the standard deviation ().

The smaller the standard deviation, the tighter the probability distribution and, thus, the lower the risk of the investment. When you compare two investment projects which have the same expected returns, you may use standard deviation to measure absolute risk. The higher the standard deviation, the higher the risk. But when you compare two projects which have different expected returns, use the coefficient of variation. The coefficient of variation is computed simply by dividing the standard deviation for the project by expected return or value: / r. The higher the coefficient, the more risky the project.

Time Value of Money


This time value of money is another critical consideration in financial and investment decisions. Finding the Future Values Compounding A dollar received today is worth more than a dollar to be received tomorrow because of the interest it can earn from putting it in a savings account or placing it in an investment account. Compounding interest means that interest earns interest.

Time line:
P at time o P Let us define: 1 F1 2 F2 3 F3 F at time n Fn

Fn = future value or the amount of money at the end of year n P = principal i = annual interest rate n = number of years

Then, F1 = the amount of money at the end of year 1 = principal and interest =P+iPt = P(1+i)

F2 = the amount of money at the end of year 2

= F1(1+i)= P(1+i) (1+i)= P(1+i)2

The future value of an investment compounded annually at rate i for n years is


Fn= P(1+i)n If (1+i)n = FVIFi,n then Fn = P(FVIFi,n) where FVIFi,n is the future value interest factor for $1. Table of Compound Interest of $1

Example: You place $100 in a savings account earning 8% interest compounded annually. How much money will you have in the account the end of 4 years? Fn= P(1+i)n = P(FVIFi,n) F4= $100(1+.08)4 = $100(FVIF8%,4) F4= $100(1.03605) = $136.05 At the end of 4 years, at 8% interest rate, your $100 today will be $136.05.

Finding Present Value Discounting Present values is the present worth of future sums of money. The process of calculating present values or discounting, is actually the opposite of compounding or finding the future value. In connection with present value calculations, the interest rate i is called discount rate.

Lets recall this formula of compounding Fn= P(1+i); from this we can derive P

Therefore, Fn P= (1 + i)n if 1/(1+i)n = PVIFi,n = Fn (1 + i)n 1

then

P = Fn (PVIFi,n)

where PVIFi,n represents the present value interest factor for $1.

Example: You are given an opportunity to receive $10,000 six years from now. If you can earn 10% on your investments, what is the most you should pay for this opportunity. To answer this question, you must compute the present value of $10,000 to be received 6 years from now at a 10% rate of discount. F6 is $10,000, i is 10%, which is 0.1, and n is 6 years. PVIF10%,6 is 0.5645. $10,000 P= = $10,000 1

(1 + .1)6
= $10,000 (0.5645) =

(1 + .1)6
$5,645

This means that at 10% interest on your investment, you could be indifferent to the choice between $5,645 now or $10,000 six years from now since the amounts are time equivalent. In other words, you could invest $5,645 today at 10% and have $10,000 in 6 years. If series of payments or receipts of a fixed amount for a specified number of periods are expected, future value and present value can be calculated using the formula for an annuity.

Annuity is a series of payments or receipts of a fixed amount for a specified number of periods For future value of an annuity: Fn= A (FVIFAi,n) For present value of an annuity: Pn= A (PVIFAi,n) Where A = the amount of an annuity FVIFAi,n represents the future value interest factor for an n-year annuity compounded at i percent.

PVIFAi,n represents the appropriate value for the present value interest factor for a $1 annuity discounted at i percent for n years.

Example: Future value of an annuity You wish to know the sum of money you will have in your savings account at the end of 6 years by depositing $100 at the end of each year for the next 6 years. The annual interest rate is 8%. The FVIFA8,6 is 7.336. Therefore,

F6 = $100 (7.336) = $733.60

Example: Future value of an annuity You wish to know the sum of money you will have in your savings account at the end of 6 years by depositing $100 at the end of each year for the next 6 years. The annual interest rate is 8%. The FVIFA8%,6 is 7.336. Therefore,
F6 = $100 (7.336) = $733.60

Example: Present value of an annuity


Your father will retire at age 65 and expects to live to age 75. At the rate of 10%, calculate the amount your father must have available at age 65 in order to receive $10,000 annually from retirement until death. A=$10,000, i = 10%, PVIFA10,10) = 6.1446 Pn = A(PVIFAi,n) = $10,000 (6.1446) = $61,446

Capital Budgeting
Capital Budgeting is the process of making long-term planning decisions for investments. Some methods of evaluating investment projects are: Payback period Net Present Value Internal Rate of Return Profitability Index (benefit/cost ratio)

Payback period. The payback period measures the length of time required to recover the amount of initial investment. It is computer by dividing the initial investment by the cash inflows through increased revenues or cost savings. Example: Assume: Cost of Investment $18,000 Annual cash savings $3,000 Then, the payback period (PBP) is: Initial Investment Cost $18,000 PBP = = Increased Revenues or Lost Savings $3,000
PBP = 6 years Decision Rule: Choose the project with the shorter payback period. The shorter the payback period, the less risky the project, and the greater the liquidity.

Net Present Value (NPV) is the excess of the present value (PV) of cash inflows generated by the project over the amount of the initial investment ( I ): NPV = PV I The present value of future cash flows is just discounting. Decision Rule: If NPV is positive, accept the project. Otherwise, reject it. Example: Consider the following investment: Initial Investment $12,950 Estimated life 10 years Annual cash inflows $ 3,000 Required Rate of Return 12%

PV = Annual cash inflows (PVIFAi,n) PV = $3,000(PVIFA 12,10) = $3,000 (5.6502) = $16,950 NPV = PV - I NPV = $16,950 - $12,950 = $4,000 Since the NPV of the investment is positive, the investment should be accepted.

Internal Rate of Return (IRR) is defined at the rate of interest that equates Initial Investment (I) with the Present Value (PV) of future cash inflows. In other words, at IRR, I = PV or NPV = 0 Decision Rule: Accept the project if the IRR exceeds the required rated of return (RRR) or the cost of capital. Otherwise, reject it.

Using the same data: I = $12,950, PV = $3,000(PVIFA?,10) I = PV 2,950 = $3,000 (PVIFA?,10) $12,950/$3,000 = (PVIFA?,10) (PVIFA?,10) = 4.317 4.317 stands somewhere between 18% and 20% in the 10-year line of PVIFA table. By interpolation, IRR is 19.17%. Since IRR of 19.17% is greater than the cost of capital of 12%, accept the investment.

Profitability Index (Benefit/Cost Ratio) is the ratio of the total PV of future cash inflows to the initial investment, that is, PV/I. If the profitability index is greater than 1, then accept the project. This is used as a means of ranking projects in descending order of attractiveness. Using the same data: PV/I = $16,950/$12,950 = 1.31 Since the project generates $1.31 for each dollar invested, accept the project.

Financial Decisions
1. Short-term financing financing that will be repaid in 1 year or less. It may be used to meet seasonal and temporary fluctuations in a companys funds positions as well as to meet permanent needs of the business. It may be used to provide extra net working capital, finance current assets, or provide interim (temporary) financing for a long-term project. Examples: trade credit, bank loans, bankers acceptance, finance company loans, commercial papers, receivable financing and inventory financing

2. Long-term debt financing financing that will be repaid in more than one year. Sources of long-term debt financing include mortgages (notes payable that have as collateral real assets) and bonds (certificate indicating that a company has borrowed a given sum of money that it agrees to repay it a future date). 3. Equity financing is financing through issuance of preferred and common stocks.

In choosing the type of financing, the cost of capital is a critical consideration. Cost of capital is defined as the rate of return that is necessary to maintain the market value of the firm (price of the firms stock). The cost of capital is computed as a weighted average of the various capital components, which are debt, preferred stock, common stock and retained earnings (right-hand side of the balance sheet).

Always remember the techniques in choosing the right investment. The investment must earn a return more than its cost, and be guided by the ten maxims of financial management in making financial and investment decisions.

SALAMAT PO

Vous aimerez peut-être aussi