Introduction to Financial

Management

PhD Lecturer Maria Pascu-Nedelcu

 The final exam and the final mark
you can get 60% of the final mark at the final
exam
Exam structure: 6 problems (1,5 point each);
You are allowed with your own list of formulas and
with a scientific calculator (not your phone);
.and 40% depends on the marks youll get at
seminar (a test and activity during seminars,
delivering the group project);
project groups will contain 4-5 members only;
the deadline is the last week before Christmas
holidays;
you have 2 weeks time to form your groups and
another week to choose the company you want to
analyze;
 References:
Brealey R., Myers S. Principles of corporate finance, The McGraw
Hill Companies, 2003
Dragot, V.; Dragot, M.; Obreja, L.; u, L.; Ciobanu, A.; Raca,
A., Abordri practice n finanele firmei, Ed. IRECSON, Bucureti,
2005
Dragot, V., A. Ciobanu, L. Obreja, M. Dragot, Management
financiar (vol. I i II), Editura Economic, Bucureti, 2003
Damodaran, A. Applied Corporate Finance A Users Manual,
2nd ed, John Wiley & Sons, 2005
Ross, S., R. Westerfield, J. Jaffe Corporate Finance, Irwin, 2002
Sulock J.M, Dunkelberg J.S. Cases in Financial Management, 2nd
ed., John Wiley & Sons, 1997
 Key activities of the Financial
Manager:

1. Financial Analysis and Planning

2. Investment Decisions

3. Financing Decisions
Key Activities of the Financial
Manager
Corporate Organization
 Overview of Finance
Relationship to Accounting

Finance and Accounting functions are closely-

related and overlapping.
In smaller firms, the financial manager generally
performs both functions.
 Overview of Finance
Relationship to Accounting

Finance and accounting differ with respect to

decision-making.
While accountant - is primarily concerned with the
preparation and presentation of financial data,
the financial manager - is primarily concerned with
analyzing and interpreting this information for decision-
making purposes.
 What is Financial Management?

Financial Management is the study of decisions that

firms make

What is a firm?
Any business in any area of economic activity, large or
small, private or publicly traded

Firms own assets that generate earnings and seek

to invest and grow
 Legal Forms of Business Organization

Three key legal forms

Sole Proprietorship
Partnership
Corporation

The principles of finance apply to all three forms

of the business organizations.
 Sole Proprietorship
Proprietorship is a business that is owned by one person
No distinction between business & person

Advantages Disadvantages
Easiest to start Limited to life of owner
Least regulated Equity capital limited
Single owner keeps all to owners personal
the profits wealth
Taxed once as Unlimited liability
personal income Limited access to
capital
 Partnership
A Partnership has two or more business owners
Partners are liable for every other partners actions

Advantages Disadvantages
Two or more owners
More capital available
Relatively easy to start
Income taxed once as
personal income
Unlimited liability
General partnership
Limited partnership
Partnership dissolves
when one partner dies
or wishes to sell
Difficult to transfer
ownership
 Corporation
A corporation is a separate legal entity with all the economic
rights & responsibilities of a person

Advantages Disadvantages
Limited liability Separation of
Unlimited life ownership and
Separate contracting management
Transfer of ownership Double taxation
is easy (income taxed at the
corporate rate and
Easier to raise capital then dividends taxed
at personal rate)
 Sole
Proprietorship Partnership Corporation

Who owns The manager Partners Shareholders

the business?
Are managers
and owner No No Usually
separate?

What is
the owners Unlimited Unlimited Limited
liability?
Are the owners
& business No No Yes
taxed separately?
 Financial Management

Which are the question we can answer with

the help of financial management?
Brainstorm session: 5 minutes!
 Financial Management
By studying financial management we get answers to these
four important questions for a financial manager:

What long-term investments should the firm take on?

Where will we get the long-term financing to pay for the

investment?

How will we manage the everyday financial activities of the

firm?

How much annual companys profit we should distribute as

dividends?
 Four important financial
management principles!

Make good investments!

Find the right resources to finance your business!

Distribute well the companys profits!

Manage efficiently your assets!

 Financial management principles
..make good investments!
In which investment projects we should invest?
How we substantiate our investment decision?
Brainstorm session: 5 minutes!
 Financial management principles
..make good investments!
Investment Principle: Invest in projects that yield a
return greater than the minimum acceptable hurdle
rate (required rate of return)

Returns on projects should be measured in terms of

cash flows generated and the timing of these cash flows

The hurdle rate should be higher for riskier projects and

reflect the financing mix used (debt or equity)
 Financial management principles
..make good investments!

Buy real assets that are worth more than

they cost
Investment return have to be higher than the
cost of funds we use to finance them!
 Financial management principles
Find the right resources to finance your business!
How we substantiate our financing decision?
Which are the factors we have to take into account we
choose between various types of funds (resources)?
Brainstorm session: 5 minutes!
 Financial management principles
Find the right resources to finance your business
The Financing Principle: Choose a financing mix
that minimizes the hurdle rate (required rate of
return) and matches the assets being financed

Is there an optimal financing mix and, if so, what is it?

Debt is beneficial as long as the marginal benefits

exceed the marginal costs
 Financial management principles
Manage efficiently your assets!
What means an efficient management of the
companys assets?
Give some examples of assets for which an
efficient management it is crucial for the companys
activity!
Brainstorm session: 5 minutes!
 Financial management principles
Manage efficiently your current assets!
An efficient management of the companys assets
imply:
The companys resources are tide up in its current
assets for a short period of time!
A higher return of the companys current assets than
the cost of funds used to buy them!

Types of current assets:

Raw materials
Accounts receivables
Cash and bank accounts
 Financial management principles
Distribute well the companys profits!
How we substantiate our dividend decision?
When we should reinvest the companys annual
profit?
When we should distribute the companys annual
profit to its shareholders?
Brainstorm session: 5 minutes!
 Financial management principles
Distribute well the companys profits!

The Dividend Principle: If there are not enough

investment projects that earn the hurdle rate (the
rate of return the investors demand), return the
cash to stockholders (distribute dividends!)
 Goal Of Financial Manager
What should be the goal of a corporation?
Maximize profit?
Maximize cash flows?
Minimize costs?
Maximize market share?
Maximize the current value of the companys stock?
Employee well-being?
Protect interests of all stakeholders?
 Goal of Financial Manager
To Maximize Shareholders Wealth!
It can also be described using the following flow chart:
Maximizing shareholder wealth vs.
maximizing profits
Maximizing shareholder wealth is better than
maximizing profits for three reasons:
Maximizing profits does not take the time
value of money into account (a dollar today is
worth more than a dollar tomorrow)
Maximizing profits does not take risks into
account (a riskless dollar is worth more than a
risky one)
Accounting numbers, such as profits, can
easily be manipulated
 Goals of the Corporation
Market-oriented economies
Anglo-Saxon countries (Canada, U.S., U.K.,
Ireland, Australia etc.)
Emphasis on shareholder value maximization
Network-oriented economies
Emphasis on interests of all stakeholders
 Goals of the Corporation
Does this mean we should do anything and
everything to maximize owner wealth?

Does a firm have responsibilities to society at

large?

Is the goal of maximizing shareholder wealth

good or bad for society at large?
 Goal of Corporations
What About Other Stakeholders?
Stakeholders include all groups who have a direct
economic link to the firm including:
Employees - Creditors
Customers - Bankers
Suppliers

The stakeholders view that the firms should make a

conscious effort to avoid actions that could be
detrimental to the wealth position of its stakeholders.

Thus firms have to maintain a social responsibility

towards the stakeholders.
The role of Financial Manager

I will get my money back?

Creditors

How performing is
the investment
we made in the stocks
of this company? How performing is
the company we run?

Shareholders

Management
The Role of The Financial Manager
Capital Budgeting Decisions Financing

(2) (1)
Firm's
operation Financial
(4a) Investors
s 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
 The Agency Issue
The Problem
Within a corporation, agency relationship exists between
shareholders and managers.
In theory, managers would agree with shareholders wealth
maximization - where managers only act as an agent.
However, managers also concerned with their own personal
wealth, job security, fringe benefits, and lifestyle.
This would cause managers to act in ways that do not
always benefit the shareholders - lead to a conflict of
interest with the shareholders. For eg. managers may avoid
risk to safeguard their personal security and benefits.
 The Agency Problem

Agency problem
Conflict of interest between principal and agent

Will managers work in the shareholders best interests?

Agency costs
Direct agency costs:Management compensation
Indirect agency costs: monitoring managers and suboptimal decisions.
 Managing Managers
Managerial compensation
Incentives can be used to align management and
stockholder interests
The incentives need to be structured carefully to
make sure that they achieve their goal

Corporate control
The threat of a takeover may result in better
management
 Questions?

Thank you for your

attention!