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- 1. 1 Dr. Mazharul Islam FINA 252 FINA 252 Basics of Financial Management INTRODUCTORY CLASS
- 2. 2 Lesson Plan Lesson Plan Introduction – (Me and You)-15 minutes Subject Overview – 25 minutes Important Instructions- 10 Minutes Discussion on Topic 1: The role of Financial Management.
- 3. 3 Introduction Introduction Me – Personal – Education – Professional Now You – Background (Name, Home location) – Life goals – What do you want from this subject
- 4. 4 My Background- My Background- Work Work Associate Professor, KAU – (2013-current) Senior Lecturer, Swinburne University of Technology, Australia (2010-2012, currently on leave) Post Doctoral Research Fellow: RMIT University, Australia (2008-2010) Lecturer: Faculty of Business Administration, Universiti Tun Abdul Razak, (2004-2007) Research Assistant: National University of Malaysia and International Islamic University of Malaysia. Graduate Research Assistant: National University of Malaysia, Malaysia, (1997-2003)
- 5. 5 Introduction Introduction Now Your turn – Background (Name, Home location) – Life goals – What do you want from this subject?
- 6. 6 Subject Overview Subject Overview - Objectives - Objectives To familiarize the student with the concept of finance and the role financial managers. Recognize the ten different principles of financial management. To understand the concept of corporate world, time value of money, financial statements and cash flow, tradeoff between risk and return, difference between simple interest and compound interest, financial ratios and their limitations. How to calculate both present value and future value, the value of bonds, and the major financial ratios.
- 7. 7 Subject Overview Subject Overview- -Learning Methods Learning Methods Lectures (interactive). Tutorials (class exercise). – Problem solving Group (home work)
- 8. 8 Subject Overview - Subject Overview - Assessment Assessment Individual assignments – Class Participation Activities (10%) – 2 Quizzes (15%) – Mid-term exam (15%) – Final exam (40%) Group assignments – Homework (20%) Total = 100%
- 9. 9 Subject Overview – Subject Overview – Course Materials Course Materials Recommended textbook Ross/ Westerfield/ Jordan (2010), Fundamentals of Corporate Finance, 9th Edition, McGraw-Hill/ Irwin, NY, USA (any edition can be used). Other References; (Journals, Reports, Websites, E. Library…etc.) Lecture slides
- 10. 10 The Firm and the Financial Manager Dr. Mazharul Islam
- 11. 11 Chapter Objectives Chapter Objectives What is Financial Management? 10 principles of financial management. What are the Decisions that Financial Manager must be Concern? The Goal of the Firm. Organization of the Financial Management Function. Understand the agency problems. Dr. Mazharul Islam
- 12. 12 What is Financial What is Financial Management? Management? Financial Management means planning, organizing, directing and controlling the financial activities of the organization. ( يعني المالية اإلدارة التخطيط وال تنظيم ال و توجيه و السيطرة للمنظمة المالية األنشطة )على It refers the efficient and effective management of money (funds) in such a manner as to achieve the goals of the organization. Dr. Mazharul Islam
- 13. 13 “It is necessary to understand these principles in order to understand finance.” Ten Principles of Financial Management Ten Principles of Financial Management Dr. Mazharul Islam
- 14. 14 We won’t take on additional risk unless we expect to be compensated with additional return. Investment choices have different amounts of risk and expected returns. The more risk an investment has, the higher its expected return will be. Principle 1: The Risk- Principle 1: The Risk- Return Trade-off Return Trade-off Dr. Mazharul Islam
- 15. 15 A dollar received today is worth more than a dollar received in the future. Because we can earn interest on money received today, it is better to receive money earlier rather than later. Principle 2: The Time Principle 2: The Time Value of Money Value of Money Dr. Mazharul Islam
- 16. 16 Cash Flow, not accounting profit, is used as our measurement tool. Cash flows, not profits, are actually can be reinvested. Principle 3: Cash Principle 3: Cash— — Not Profits Not Profits— —Is King Is King Dr. Mazharul Islam
- 17. 17 The incremental cash flow is the difference between the projected cash flows if the project is selected, versus what they will be, if the project is not selected. Principle 4: Incremental Principle 4: Incremental Cash Flows Cash Flows Dr. Mazharul Islam
- 18. 18 It is hard to find exceptionally profitable projects If an industry is generating large profits, new entrants are usually attracted. The additional competition and added capacity can result in profits being driven down to the required rate of return. Product Differentiation, Service and Quality can separate products from competition Principle 5: The Curse of Principle 5: The Curse of Competitive Markets Competitive Markets Dr. Mazharul Islam
- 19. 19 The markets are quick and the prices are right. The values of all assets and securities at any instant in time fully reflect all available information. Principle 6: Efficient Principle 6: Efficient Capital Markets Capital Markets Dr. Mazharul Islam
- 20. 20 Managers won’t work for the owners unless it is in their best interest A agency problem resulting from conflicts of interest between the manager/agent and the stockholder/owners. Managers may make decisions that are not in line with the goal of maximization of shareholder wealth. Principle 7: The Principle 7: The Agency Problem Agency Problem Dr. Mazharul Islam
- 21. 21 The cash flows we consider are the after-tax incremental cash flows to the firm as a whole. Principle 8: Taxes Bias Principle 8: Taxes Bias Business Decisions Business Decisions Dr. Mazharul Islam
- 22. 22 Some risk can be diversified away, and some cannot The process of diversification can reduce risk, and as a result, measuring a project’s or an asset’s risk is very difficult. Principle 9: All Risk is Principle 9: All Risk is Not Equal Not Equal Dr. Mazharul Islam
- 23. 23 Each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing Principle 10: Ethical Behavior is Doing Principle 10: Ethical Behavior is Doing the Right Thing, and Ethical Dilemmas the Right Thing, and Ethical Dilemmas Are Everywhere in Finance Are Everywhere in Finance Dr. Mazharul Islam
- 24. 24 Investment Decisions (Capital Budgeting) (Investment decisions revolve around how to best allocate money to maximize their value.) Financing Decisions (Capital Structure) (Financing decisions revolve around how to pay for investments and expenses) Asset Management Decisions (Working Capital Management Decisions) Decisions of Financial Decisions of Financial Manager Manager
- 25. 25 Investment Decisions Investment Decisions how, when, where and how much money will be spent on investment opportunities. A firm has many options to invest their funds but firm has to select the most appropriate assets for investment which will bring maximum benefit for the firm. What specific assets should be acquired? What assets (if any) should be reduced or eliminated? Dr. Mazharul Islam
- 26. 26 Investment Decisions Investment Decisions What specific assets should be acquired? What assets (if any) should be reduced or eliminated? Dr. Mazharul Islam
- 27. 27 Financing Decisions Financing Decisions A company can raise finance from various sources such as by issue of shares, debentures or by taking loan and advances. These sources of finance can be divided into two categories: owners fund (no risk involve) and borrowers fund (risk involve). Find the least expensive sources of fund. Determine how the assets will be financed. Determine how the assets will be financed. Dr. Mazharul Islam
- 28. 28 Financing Decisions Financing Decisions What is the best type of financing? Mix type financing. What is the best financing mix? Mixer debt and equity. What is the best dividend policy? Paying a consistent percentage of net earnings. How will the funds be physically acquired? Dr. Mazharul Islam
- 29. 29 Asset Management Asset Management Decisions Decisions 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. Dr. Mazharul Islam
- 30. 30 1-30 Interrelationship of the decisions Interrelationship of the decisions made by a Financial Manager made by a Financial Manager
- 31. 31 What are the Goals of the What are the Goals of the Firm? Firm? (General Goals) (General Goals) Dr. Mazharul Islam Survival Avoid financial distress and bankruptcy Beat the competition Maximize sales or market share Minimize costs Maximize profits Maintain steady earnings growth.
- 32. 32 Shortcomings of these Shortcomings of these General Goals General Goals These goals are either associated with increasing profitability or reducing risk. Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy Treasury-bills, etc.). Does not specify timing or duration of expected returns. Calls for a zero payout dividend policy. They are not consistent with the long-term interests of shareholders. Problems Problems Dr. Mazharul Islam So it is necessary to find a goal that can encompass both profitability and risk.
- 33. 33 The Real Goal of The Real Goal of the Firm the Firm Maximization of Maximization of Shareholder Wealth! Shareholder Wealth! Shareholders’ wealth can be measured as the current value per share of existing shares. Dr. Mazharul Islam
- 34. 34 Strengths of Shareholder Strengths of Shareholder Wealth Maximization Wealth Maximization Takes account of: current and future current and future profits and EPS profits and EPS; the timing, the timing, duration, and risk of profits duration, and risk of profits; dividend dividend policy policy; and all other relevant factors. Thus, share price share price serves as a barometer for business performance. Dr. Mazharul Islam
- 35. 35 The Modern Organization The Modern Organization There exists a SEPARATION between owners and managers. Modern Organization Shareholders Management Dr. Mazharul Islam
- 36. 36 Role of Management Role of Management An agent agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. Management acts as an agent agent for the owners (shareholders) of the firm. Dr. Mazharul Islam
- 37. 37 Agency Theory Agency Theory Agency Theory Agency Theory is a branch of economics relating to the behavior of principals and their agents. Jensen and Meckling developed a theory of the firm based on agency theory agency theory. Dr. Mazharul Islam
- 38. 38 Agency Theory Agency Theory Incentives include stock options stock options, , perquisites perquisites, , and bonuses bonuses. Principals must provide incentives incentives so that management acts in the principals’ best interests and then monitor monitor results. Dr. Mazharul Islam
- 39. 39 Social Responsibility Social Responsibility Wealth maximization does not stop the firm from being socially responsible socially responsible. Assume we view the firm as producing both private and social goods. Then shareholder shareholder wealth wealth maximization maximization remains the appropriate goal in governing the firm. Dr. Mazharul Islam
- 40. 40 Organization of the Financial Organization of the Financial Management Function Management Function Board of Directors President (Chief Executive Officer) Vice President Operations Vice President Marketing Vice President Finance Dr. Mazharul Islam
- 41. 41 Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning Organization of the Financial Organization of the Financial Management Function Management Function Vice President of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts Dr. Mazharul Islam
Editor's Notes
- #25: A firm has many options to invest their funds but firm has to select the most appropriate assets for investment which will bring maximum benefit for the firm. how, when, where and how much capital will be spent on investment opportunities.
- #29: How much cash and inventory should be keep on hand? Should we sell on credit? If so, what terms will we offer, and to whom will we extend them? How will we obtain any needed short-term financing? If so, will we purchase on credit or will we borrow in the short-term and pay cash?
- #30: Adding depreciation and amortization expenses to earnings Funds from Operations = Net Income + Depreciation + Amortization - Gains on Sales of Property . Amortization Expenses: capital expenses for intangible assets over a specific period of time Example: Broadcast licenses, Copyrights, Patents, Taxi licenses, Trademarks
- #34: EPS = Earnings Per Share.
- #38: Perquisites are advantages (some monetary, some not e.g. free lunch, parking space, etc.) that come with a job. Bonus is usually a monetary compensation tied to performance An employee stock option is a contract issued by an employer to an employee to purchase a set amount of shares of company stock at a fixed price for a limited period of time.