The Role and Environment of

Managerial Finance

Based from
Various Financial Management
Accounting Books

Presented by

CANDIDO M. PEREZ, PhD, CPA

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Objectives: The learner should be able to:
1. Explain the importance of role of the financial manager today.

2. Describe "financial management/ managerial finance " in terms of

the three major decision areas that confront the financial manager.

3. Identify the goal of the firm and understand why shareholders'

wealth maximization is preferred over other goals.

4. Understand the potential problems arising when management of

the corporation and ownership are separated (agency problems).

5. Demonstrate an understanding of corporate governance.

6. Discuss the issues underlying social responsibility of the firm.

7. Understand the basic responsibilities of financial managers and

the differences between a "treasurer" and a "controller.

8. Understand the axioms of finance

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Why should I care about Financial
Management/ Managerial finance ?

Prepare for the workplace of tomorrow.

Broadening expectations of financial knowledge
and skills.
Use and understand financial terminology and
concepts in team communication.
Developing cross-functional capabilities.
Critical thinking.

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 What is Finance
Finance deals with about money that is, how
money is raised and used by companies and
individuals. How money is raised and used
(as decision making for business and for
personal).

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 What is Financial Management/
Managerial Finance?

Concerns the acquisition,

financing, and
management of assets with
some overall goal in mind.

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 The Role of The Financial Manager

(2) (1)
Firm's
Financial
operations (4a) Investors
Manager

Real assets
(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
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 Investment Decisions

Most important of the three

decisions.
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be reduced
or eliminated?

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 Financing Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS of
balance sheet).
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g.,
dividend-payout ratio)?
How will the funds be physically
acquired?
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 Asset Management Decisions
(Operations)
How do we manage existing assets
efficiently?
Financial Manager has varying degrees of
operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.

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What is the Goal of the Firm?

Maximization of
Shareholder Wealth!
Value creation occurs when we
maximize the share price for
current shareholders.

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 Shortcomings of
Alternative Perspectives
Profit Maximization
Maximizing a firms earnings after taxes.
Problems
Could increase current profits while harming
firm (e.g., defer maintenance, issue common
stock to buy T-bills, etc.).
Ignores changes in the risk level of the firm.

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 Shortcomings of Alternative
Perspectives
Earnings per Share Maximization
Maximizing earnings after taxes divided
by shares outstanding.
Problems
Does not specify timing or duration of expected
returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.
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 Strengths of Shareholder
Wealth Maximization
Takes account of: current and future profits
and EPS; the timing, duration, and risk of
profits and EPS; dividend policy; and all
other relevant factors.
Thus, share price serves as a barometer for
business performance.

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 Role of Management
Management acts as an agent for
the owners (shareholders) of the
firm.

An agent is an individual authorized

by another person, called the
principal, to act in the latters behalf.

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 Agency Theory

Jensen and Meckling developed a

theory of the firm based on agency
theory.
Agency Theory is a branch of
economics relating to the behavior of
principals and their agents.

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 Agency Theory

Principals must provide incentives so

that management acts in the
principals best interests and then
monitor results.
Incentives include, stock options,
perquisites, and bonuses.

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The Modern Corporation
Modern Corporation

Shareholders Management

There exists a SEPARATION between

owners and managers.
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 Corporate Governance

Corporate governance: represents the

system by which corporations are
managed and controlled.
Includes shareholders, board of
directors, and senior management.
Then shareholder wealth maximization
remains the appropriate goal in governing
the firm.
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 Board of Directors
Typical responsibilities:
Set company-wide policy;
Advise the CEO and other senior executives;
Hire, fire, and set the compensation of the CEO;
Review and approve strategy, significant
investments, and acquisitions; and
Oversee operating plans, capital budgets, and
financial reports to common shareholders.
CEO/Chairman roles commonly same person in
US, but separate in Britain (US moving in this
direction).

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 Sarbanes-Oxley Act of 2002
Sarbanes-Oxley Act of 2002 (SOX):
addresses corporate governance, auditing
and accounting, executive compensation,
and enhanced and timely disclosure of
corporate information.
Imposes new penalties for violations of securities
laws.
Established the Public Company Accounting
Oversight Board (PCAOB) to adopt auditing, quality
control, ethics, disclosure standards for public
companies and their auditors, and policing authority.
Generally increasing the standards for corporate
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 Corporate
Social Responsibility
Wealth maximization does not preclude
the firm from being socially responsible
at the corporate level.
Assume we view the firm as producing
both private and social goods.
Then shareholder wealth maximization
remains the appropriate goal in governing
the firm.
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 Corporate Social
Responsibility Discussion
Class Discussion: What role should CSR
and/or sustainability have on living the goal
of the firm?
Corporate Social Responsibility (CSR): A business
outlook that acknowledges a firms responsibilities to
its stakeholders and the natural environment.
Sustainability: Meeting the needs of the present without
compromising the ability of future generations to meet
their own needs.
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Importance of Finance
in NonFinance Areas

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 Organization of the
Financial Management
Function
Board of Directors

President
(Chief Executive Officer)

Executive Vice Executive Vice Executive Vice

President President President
(Operations) (Finance - CFO) (Marketing)

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 Who is the Financial
Manager?
Chief Financial Officer

Treasurer Controller

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 Organization of the Financial
Management Function

EVP of Finance
Vice President (Treasurer) Controller
Capital Investment Cost Accounting
Cash Management Cost Management
Commercial/investment banking Data Processing
relationships General Ledger
Credit Management Government Reporting
Dividend Disbursement Internal Control
Financial Analysis/Planning Preparing Financial Statements
Investor Relations Preparing Budgets
Mergers and Acquisitions Preparing Forecasts
Pension Management
Insurance/Risk Management
Tax Analysis/Planning Powerpoint Templates
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 Careers in Finance
Career Annual Salary
Commercial Banking
Loan Officer $ 60,000 +
Department Manager $ 100,000 +

Corporate Finance
Financial Analyst $ 38 - 47,000
Credit Manager $ 30 - 63,000
Chief Financial Officer $ 232 - 295,000

Investment Banking (bulge bracket)

First Year Analyst $ 30 - 110,000
First Year Associate $ 125 - 235,000
Assistant Vice President $ 200 - 600,000
Director/Principal $ 300k - 1.2 mil
Managing Director/Partner $ 400k - 20 mil
Department Head $ 750k - 70 mil

Money Management
Portfolio Manager $ 500,000 +
Bank Trust Department $ 100,000 +
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 CEO Pay
CEO Compensation 2001 ($ millions)

Total Earnings from

CEO Name Company Earnings Stock Options
Philip Condit Boeing 2.90 0.00
Sanford Weill Citigroup 34.60 15.90
Gordon Bethune Continental Airlines 4.70 0.00
Michael Dell Dell Computer 201.30 198.70
Michael Eisner Walt Disney 1.00 0.00
Lee Raymond Exxon Mobil 32.70 24.30
Ray Irani Occidental Petroleum 10.90 1.70
Robert Ulrich Target 6.60 2.20
David Bernaner Walgreen 2.20 0.79
Donald Graham Washington Post 1.10 0.00
Steven Rogel Weyerhauser 2.10 0.00

source: www.forbes.com/ceos

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 Ten Axioms of Financial
Management

1. The risk-return trade-off: We wont take on

additional risk unless we expect to be
compensated with additional return. The greater
the risk, the greater the expected return.

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Ten Axioms of Financial
Management
2. The time value of money: A dollar received
today is worth more than a dollar received in
the future. A dollar received today is worth
more than a dollar received tomorrow
because a dollar received today can earn a
days interest by tomorrow.

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 Ten Axioms of Financial
Management

3. Cash- not profits- is king. Accounting profit or loss

frequently does not coincide with the actual transfer of
money. The first rule of running any business: Do not run
out of cash.

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 Ten Axioms of Financial
Management

4. Incremental cash flows: Its only what

changes that counts. Think
incrementally. How will a decision
change the cash flow of the company?

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 Ten Axioms of Financial
Management
5.The curse of competitive markets: Why its hard to find
exceptionally profitable projects. Success attracts
competition. Competition lowers profits.

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 Ten Axioms of Financial
Management

6. Efficient capital markets: The markets are quick and the

prices are right. Security prices adjust very quickly and
appropriately to new information.

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 Ten Axioms of Financial
Management
7. The agency problem: Managers wont work
for owners
unless its in their best interest. Most
people will work harder for themselves than
they will for someone else.

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 AGENCY Problems

Existence of Divergent Objectives between

Stockholders and managers
Stockholders and Creditors

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 Ten Axioms of Financial
Management
8. Taxes bias business decisions. Decisions using cash flows
must always use after-tax cash flows.

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 Ten Axioms of Financial
Management
9. All risk is not equal. Some risk can be diversified away
and some cannot. Total risk is a combination of firm-
specific risk, which can be diversified away, and market
risk, which cannot be diversified away. (But see the
futures markets.)

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 Ten Axioms of Financial
Management
10. Ethical behavior is doing the right thing,
and ethical dilemmas are everywhere in
finance. Businesses that are not trusted by
other businesses or by customers will not
maximize the wealth of stockholders.
Perhaps the primary goal of firms should
address stakeholders and not just
stockholders.
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 References:
Van Horne, J.C. Wachowicz, J.M. Fundamentals of
Financial Management
Brealey, R.A. Principles of Corporate Finance
Brigham, E.F. Financial Mgmt. fundamentals.
Block, C. and Stanley B. Foundations of Financial Mgmt.
Gitman, L. Principles of Managerial Finance
Keown, Arthu r J. et al. Basic Financial Management
Shim, Jae K. Schaums Outline of Financial
Management.
Ross, S. Modern Financial Management
Cabrera, M.E.B Management Accounting: Concepts &
Applications
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Thank You

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