Chapter 1 INTRODUCTION TO FINANCE.pptx.PPT

Chapter 1 Introduction to Finance

1. Chapter 1 Financial Management Ms. Anne Savarimoothu George

2. Learning Outcomes

3. 1.0 Introduction to Financial Management Financial management involves determining value, making optimal financial decisions, and allocating resources efficiently. It plays a crucial role in businesses, individuals, and government financial transactions. The field is growing more complex due to a rapidly changing financial environment.

4. Purpose of Financial Management Ensuring the financial health of an organization. Allocating resources effectively. Managing investments and financial risks. Maximizing shareholder value.

5. The Role of Financial Management Making informed financial decisions. Balancing risk and profitability. Ensuring liquidity and financial stability. Planning for long-term financial success.

6. Key Responsibilities of a Financial Manager Investment Decisions: These decisions involve choosing whether or not to invest in a security. The manager analyzes financial securities from the perspective of investors and decides how to manage a portfolio of investments, either individually or institutionally. Financial Decisions: These decisions involve long-term financing and short-term financing. Long-term financing decisions include determining the amount of long-term debt and equity financing. Short-term financing decisions include working capital management and the management of short-term assets and liabilities. Management Decisions: These decisions involve matters such as dividend policy, using campaigns to attract customers, and planning the use of fixed assets. They also include decisions on converting current assets into cash. .

7. 1.2 Objectives of the Firm The modern theory of financial management states that the main goal of a firm is to maximize shareholder wealth. Shareholder wealth is represented by the market price of the company's stock, taking into account time and risk. A higher market price indicates good investments, stable financing, and higher dividend payouts.

8. Maximizing Profit and Maximizing Shareholder Wealth

9. 1.3 Financial Environment The financial environment is an economic system that connects borrowers (who need funds) with investors (who have surplus funds). Key Components: Investors – Individuals or entities providing capital for investment. Financial Markets – Platforms like stock exchanges and bond markets that facilitate the exchange of funds. Financial Instruments – Tools such as stocks, bonds, and loans used for borrowing and investing. Financial Managers – Professionals responsible for making financial decisions for businesses and individuals. Role of Financial Markets: Act as intermediaries, ensuring borrowers can access capital while investors earn returns. Support economic growth by efficiently allocating financial resources.

10. 1.4 The Basic Principles in Financial Management: The primary goal of financial management is to create and maintain economic value or wealth. This involves maximizing profits and shareholder wealth, which benefits both shareholders and the community.

11. a) Risk-Return Trade-Off: The text explains the principle of "High Risk, High Return" in business and investment. It states that higher returns should be expected for higher risks. This is illustrated with the example of a Formula 1 driver's salary being higher than a badminton player's salary due to the higher risk involved in Formula 1 racing.

12. b) Time Value of Money: The concept of time value of money states that money received today is worth more than the same amount received in the future. This is due to factors like inflation and the opportunity cost of not investing the money today. RM1 today can buy you a packet of Nasi Lemak, but in 5 years’ time, it may not able to.

13. c) Cash, Not Profit, is King: This principle emphasizes the importance of cash flow over accounting profit. Cash is essential for a business to operate and grow, while accounting profit may not always reflect the actual cash available.

14. d) Incremental Cash Flow: When evaluating investment projects, focus on the incremental cash flow. This means comparing the cash flow with the project to the cash flow without the project. Only the change in cash flow due to the project is relevant for decision-making.

15. e) The Curse of the Competitive Market: In competitive markets, it's challenging to consistently earn large profits. Competitors will react to successful strategies, reducing profit margins. Companies need to innovate and adapt to maintain a competitive edge Companies need to differentiate themselves through product innovation, service quality, or cost leadership to gain an advantage. Product differentiation involves creating unique features or benefits that attract customers. Cost leadership focuses on reducing production costs to offer lower prices.

16. f) Efficient Capital Market: In an efficient capital market, the market price of a company's stock reflects its true value. This means that investors cannot consistently earn above-average returns by exploiting market inefficiencies. The market price adjusts quickly to new information.

17. g) Agency Problem: The agency problem arises when there is a conflict of interest between the managers of a company (agents) and the shareholders (principals). Examples: Managers may make decisions that benefit them personally, such as excessive compensation or perks. Managers may avoid risky but potentially profitable projects to protect their jobs. Addressing Agency Problems: Market Forces: Large institutional investors (insurance agencies, pension funds) can exert pressure on managers to act in the best interests of shareholders. Threat of Takeover: The possibility of a hostile takeover can incentivize managers to perform well. Management Compensation Structures: Incentive Compensation: Linking manager compensation to share price, such as through stock options. Performance-Based Compensation: Rewarding managers based on performance metrics like earnings per share (EPS).

18. h) Tax-Biased Decisions Tax Considerations: Companies consider tax implications when making financial decisions. Debt vs. Equity Financing: The choice between issuing debt or equity can be influenced by tax considerations. Interest payments on debt are tax-deductible, while dividends on equity are not.

19. i ) Risk Management Diversification: Spreading investments across different assets or companies to reduce overall risk. "All Risk is Not Equal": The adage emphasizes that different types of risk have varying levels of severity and impact .

20. j) Ethical Behavior in Financial Management Ethical errors are more critical than mathematical errors. Mathematical errors can be corrected, but ethical errors can damage a person's career and reputation. Maintaining integrity and public trust is crucial in financial management.

21. 1.5 Functions of a Financial Manager Financial Analysis and Planning – Monitors the company’s financial position, collaborates with executives for future planning, and promotes cost efficiency to enhance profit margins. Investment Decisions – Determines the optimal sales growth rate, selects the right mix of assets, and manages current asset levels efficiently. Financing Decisions – Chooses the best combination of short-term and long-term financing, decides between debt and equity financing, and secures funds for operations. Maximizing Shareholder Value – Makes strategic financial decisions aimed at increasing shareholder wealth and ensuring long-term value creation. Monitoring and Control – Works with executives to maintain efficient operations while ensuring all business decisions align with financial goals. Dealing with Financial Markets – Engages in financial market transactions, understands market conditions, and manages funding sources to ensure financial stability and profitability.

22. True/False Questions 1. Agency problem is a potential conflict of interest between two groups of people, either shareholders versus managers or shareholders versus creditors. 2. Investment decisions involve financial markets and institutions, which deal with interest rates, stocks, bonds, government securities and other marketable securities. It also covers the Federal Reserve System and its policies. 3. Profit maximization usually ignores timing and risk of cash flows. 4. Financial managers can obtain funds from within and outside the company. Sources from outside the company come from the capital market, and may take the form of debt or company profits. 5. The main task of financial management includes making investment decisions, financing business activities and distribution of the dividends of a company, thus the task of financial managers is planning how to maximize the firm's profit. 6. The modern financial theory assumes that the primary objective of a firm is to maximize the firm's profit. 7. Dividend revenue is distributed to the shareholders of the company. 8. In managing the investment structure, financing, risk and return, financial managers are also responsible for the financial markets, and they interact with the markets to ensure the firm continues to grow. 9. "Cash Not Profit is the King" is a key concept in calculating the value of stocks, bonds, investment project proposals, and others. 10. Business profits are used to measure shareholders wealth.

23. True/False Questions 1. Agency problem is a potential conflict of interest between two groups of people, either shareholders versus managers or shareholders versus creditors. TRUE 2. Investment decisions involve financial markets and institutions, which deal with interest rates, stocks, bonds, government securities and other marketable securities. It also covers the Federal Reserve System and its policies. FALSE 3. Profit maximization usually ignores timing and risk of cash flows. TRUE 4. Financial managers can obtain funds from within and outside the company. Sources from outside the company come from the capital market, and may take the form of debt or company profits. FALSE 5. The main task of financial management includes making investment decisions, financing business activities and distribution of the dividends of a company, thus the task of financial managers is planning how to maximize the firm's profit. FALSE 6. The modern financial theory assumes that the primary objective of a firm is to maximize the firm's profit. FALSE 7. Dividend revenue is distributed to the shareholders of the company. TRUE 8. In managing the investment structure, financing, risk and return, financial managers are also responsible for the financial markets, and they interact with the markets to ensure the firm continues to grow. TRUE 9. "Cash Not Profit is the King" is a key concept in calculating the value of stocks, bonds, investment project proposals, and others. FALSE 10. Business profits are used to measure shareholders wealth. FALSE

24. THANK YOU