CHAPTER 1A_P1 Introduction to Financial Mangement - K36.pptx

Introduction to Financial Management

1. MODULE 1: INTRODUCTION TO FINANCIAL MANAGEMENT Business Finance FMDFINA 1st Trimester, A.Y. 2021-2022

2. LEARNING OBJECTIVES (1/2) Explain the major role of financial management and the different individuals involved Distinguish a financial institution from financial instrument and financial market Enumerate the varied financial institutions and their corresponding services

3. LEARNING OBJECTIVES (2/2) Compare and contrast the varied financial instruments Explain the flow of funds within an organization – through and from the enterprise –and the role of the financial manager

4. What is the MAIN OBJECTIVE of any business? MAIN OBJECTIVE of a Business

5. MAXIMIZE SHAREHOLDER VALUE MAIN OBJECTIVE of a Business

6. Main Objective of A Firm What is the MAIN objective of a business entity? Maximize Profits? Satisfy customers? 6

7. Customer Satisfaction Customer Satisfaction - one of the strongest indicators of customer loyalty Leads to the following activities: Repurchasing Cross selling Reducing price-sensitivity Generate positive word of mouth

8. Planning Duration Wealth Maximization  Management generally focuses on long-term effects of discretionary expenditures such as advertising, research, and maintenance, training and thus “invests” in them Profit Maximization Immediate increase of profits is paramount Management may elect not to pay discretionary for  discretionary expenditures,

9. Risk Management Wealth Maximization  A wealth-focused company would work on risk mitigation, so its risk of loss is reduced Profit Maximization Management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization's risk profile.

10. Pricing Strategy Wealth Maximization  A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term. Profit Maximization Prices products/ services as high as possible in order to increase margins

11. Capacity Planning Wealth Maximization  A wealth-oriented business will spend more heavily on capacity  in order to meet its long-term sales projections. Profit Maximization A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast

12. Triple Bottom Line (3P’s, 3E’s) https://www.reptrak.com/ ESG (ENVIRONMENT, Social, Governance)

13. What is Finance?

14. What is FINANCE? A branch of economics concerned with RESOURCE ALLOCATION as well as resource management, acquisition and management. Simply, finance deals with matters related to money (Investorworld.com)

15. What is FINANCE? Art and science of managing money . It is concerned with the processes, institutions, markets and instruments involved in the transfer of money among individuals, businesses and governments ( Gitman ) Concerned with the maintenance and creation of economic value or wealth ( Keown )

16. What is Corporate Finance? What others think: Extension of accounting backward looking, it’s job is to record what happened in the past Financial modelling Subsector of banking Covers any decision that involves the use of money Everything is in service of Finance – Marketing, Operations, HR, Accounting, IT

17. What is Corporate Finance? Every decision that a business makes has financial implications , and any decision which affects the finances of a business is a corporate finance decision. Defined broadly, everything that a business does fits under the rubric of corporate finance. 17

18. Principles of Financial Management

19. First Principles Every discipline has first principles that govern and guide everything that gets done within it. All of corporate finance is built on three principles: Investment principle Financing principle Dividend principle

20. First Principles – 1/3 Investment Principle Determines where businesses invest their resources Invest in assets and projects that yield a return greater than the minimum acceptable hurdle rate . The hurdle rate should be higher for riskier projects and should reflect the financing mix used—owners’ funds (equity) or borrowed money (debt).

21. Determines where businesses invest their resources Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects. First Principles – 1/3 Investment Principle

22. First Principles – 2/3 Financing Principle Financing strategy is essential to the continuity of the business over the long term Choose a financing mix (debt and equity) that maximizes the value of the investments made and match the financing to the nature of the assets being financed. Ensure access to a constant inflow of capital since the savings margin will not allow operations to continue for much longer without the support of additional liquidity.

23. First Principles – 3/3 Dividend Principle Dividend Distribution - one of the most important financial decisions that a Financial Manager must make It concerns how much of the company’s earnings will be paid out to shareholders , or reinvested in the company to improve operations

24. First Principles – 3/3 Dividend Principle If there are not enough investments that earn the hurdle rate (WACC), return the cash to the owners of the business. In the case of a publicly traded firm, the form of the return —dividends or stock buybacks—will depend on what stockholders prefer.

25. First Principles These core corporate finance principles can be stated as follows: Finance, at its core, is managing the employment of those funds within the organization, including the decision to reinvest or distribute any subsequent profits generated .

26. First Principles and the Big Picture

27. Maximize the Value of the Firm The FINANCE Function

28. Corollary Principles Cash flow is king - Requires that the investment as well as its future benefits be measured in cash T ime Value of Money – money has cost Risk and Return – the higher the assumed risk, the higher the required return Market forces – efficient market hypothesis Agency Problem

29. Corollary Principles Amount of expected cash flows Bigger is Better Timing of the cash flow stream Sooner is better Risk of the cash flows Less risk is better

30. Foundational Principles of Finance Principle 1: CASH is KING

31. Foundational Principles of Finance Principle 1: CASH FLOW is what matters Accounting profit ≠ Cash flow Cash flow drives the value of business Incremental cash flow needs to be determined in making financial decisions

32. Foundational Principles of Finance Principle 2: Time Value of Money

33. Foundational Principles of Finance Principle 2: MONEY has time value One PESO received today is worth more than one received in the future Interest on money can earn interest also, thus better to receive money NOW than one year from now

34. Foundational Principles of Finance Principle 3: Risk and Return Principle

35. Foundational Principles of Finance Principle 3: RISK requires a reward NO additional risk is taken unless it is compensated with additional returns Investors expect to be compensated for “delaying consumption” and “taking on risk”

36. Foundational Principles of Finance Principle 4: Market Prices are Generally Right

37. Foundational Principles of Finance Principle 4: Market prices are generally right The prices of trades assets like stocks and bonds fully reflect all available information about the asset ( a.k.a efficient market hypothesis) Thus stock prices are a useful indicator of the value of a firm Good decisions → Increase in stock price → Increase in expected CFs Note there are inefficiencies in the market that may distort the prices https://ph.investing.com/equities/philippines

38. Foundational Principles of Finance Principle 5: Conflicts of interest cause Agency Problems

39. Corporate Finance Theme 1: It ‘s “common sense” Nothing earth shattering here in the obvious statements below: Taking investments that make 12% with funds that cost 11% (investment decision) Noting that it is better to find a funding mix which costs 12% instead of 13% (financing decision) Positing that if most of your investment opportunities generate returns less than your cost of funding, it is best to return the cash to the owners of the business and shrink the business 39

40. Corporate Finance Theme 2: It is focused… Singular objective – to maximize SHV As a result of this singular objective, we can Choose the right investment decision rule to use, given a menu of such rules. Determine the right mix of debt and equity for a specific business Examine the right amount of cash that should be returned to the owners of a business and the right amount to hold back as a cash balance. 40

41. Corporate Finance Theme 3: It is u niversal … Every business, small or large, public or private, mature or emerging market, has to make investment, financing and dividend decisions. The objective in corporate finance for all of these businesses remains the same: maximizing value. 41

42. Corporate Finance Theme 3: It is u niversal … While the constraints and challenges that firms face can vary dramatically across firms, the first principles do not change. a) A publicly traded firm, with its greater access to capital markets and more diversified investor base, may have much lower costs of debt and equity than a private business, but they both should look for the financing mix that minimizes their costs of capital. 42

43. Corporate Finance Theme 3: It is u niversal … b) A firm in an emerging markets may face greater uncertainty, when assessing new investments, than a firm in a developed market, but both firms should invest only if they believe they can generate higher returns on their investments than they face as their respective (and very different) hurdle rates. 43

44. The Business Environment Today 44