FINA 252 Basics of Financial Management INTRODUCTORY CLASS

FINA 252 Basics of Financial Management INTRODUCTORY CLASS 1 -1 Dr. Mazharul Islam

Lesson Plan u Introduction u Subject – (Me and You)-15 minutes Overview – 25 minutes u Important Instructions- 10 Minutes u Discussion on Topic 1: The role of Financial Management. 1 -2 Dr. Mazharul Islam

Introduction u. Me – Personal – Education – Professional u. Now You – Background (Name, Home location) – Life goals – What do you want from this subject 1 -3 Dr. Mazharul Islam

My Background- Work 1 -4 z Associate Professor, KAU – (2013 -current) z Senior Lecturer, Swinburne University of Technology, Australia (2010 -2012, currently on leave) z Post Doctoral Research Fellow: RMIT University, Australia (2008 -2010) z Lecturer: Faculty of Business Administration, Universiti Tun Abdul Razak, (2004 -2007) z Research Assistant: National University of Malaysia and International Islamic University of Malaysia. z Graduate Research Assistant: National University of Malaysia, (1997 -2003) Dr. Mazharul Islam

Introduction u. Now Your turn – Background (Name, Home location) – Life goals – What do you want from this subject? 1 -5 Dr. Mazharul Islam

Subject Overview - Objectives u To familiarize the student with the concept of finance and the role financial managers. u Recognize the management. u 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. u How to calculate both present value and future value, the value of bonds, and the major financial ratios. 1 -6 ten different principles of financial Dr. Mazharul Islam

Subject Overview-Learning Methods u. Lectures (interactive). u. Tutorials (class exercise). – Problem solving Group (home work) 1 -7 Dr. Mazharul Islam

Subject Overview - Assessment q Individual assignments – Class Participation Activities (10%) – 2 Quizzes (15%) – Mid-term exam (15%) – Final exam (40%) q Group assignments – Homework (20%) Total = 100% 1 -8 Dr. Mazharul Islam

Subject Overview – Course Materials u. Recommended textbook Ross/ Westerfield/ Jordan (2010), Fundamentals of Corporate Finance, 9 th Edition, Mc. Graw-Hill/ Irwin, NY, USA (any edition can be used). u. Other References; (Journals, Reports, Websites, E. Library…etc. ) u Lecture 1 -9 slides Dr. Mazharul Islam

The Firm and the Financial Manager 1 -10 Dr. Mazharul Islam

Chapter Objectives 1 -11 u What is Financial Management? u 10 principles of financial management. u What are the Decisions that Financial Manager must be Concern? u The Goal of the Firm. u Organization of the Financial Management Function. u Understand the agency problems. Dr. Mazharul Islam

What is Financial Management? Financial Management means planning, organizing, directing and controlling the financial activities of the organization. ( ﺍﻹﺩﺍﺭﺓ ﺍﻟﻤﺎﻟﻴﺔ ﻳﻌﻨﻲ ﺍﻟﺘﺨﻄﻴﻂ ﻭﺍﻟﺘﻨﻈﻴﻢ ﻭ ﺍﻟﺘﻮﺟﻴﻪ ﻭﺍﻟﺴﻴﻄﺮﺓ ﻋﻠﻰ ﺍﻷﻨﺸﻄﺔ ﺍﻟﻤﺎﻟﻴﺔ )ﻟﻠﻤﻨﻈﻤﺔ 1 -12 It refers the efficient and effective management of money (funds) in such a Dr. Mazharul Islam manner as to achieve the goals of the

Ten Principles of Financial Management “It is necessary to understand these principles in order to understand finance. ” 1 -13 Dr. Mazharul Islam

Principle 1: The Risk. Return Trade-off u We won’t take on additional risk unless we expect to be compensated with additional return. u Investment choices have different amounts of risk and expected returns. u The more risk an investment has, the higher its expected return will be. 1 -14 Dr. Mazharul Islam

Principle 2: The Time Value of Money u. A dollar received today is worth more than a dollar received in the future. u Because we can earn interest on money received today, it is better to receive money earlier rather than later. 1 -15 Dr. Mazharul Islam

Principle 3: Cash— Not Profits—Is King u. Cash Flow, not accounting profit, is used as our measurement tool. u. Cash flows, not profits, are actually can be reinvested. 1 -16 Dr. Mazharul Islam

Principle 4: Incremental Cash Flows u. 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. 1 -17 Dr. Mazharul Islam

Principle 5: The Curse of Competitive Markets u It is hard to find exceptionally profitable projects u 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. u Product 1 -18 Differentiation, Service and Quality can separate products from Dr. Mazharul Islam competition

Principle 6: Efficient Capital Markets u. The markets are quick and the prices are right. u. The values of all assets and securities at any instant in time fully reflect all available information. 1 -19 Dr. Mazharul Islam

Principle 7: The Agency Problem u Managers won’t work for the owners unless it is in their best interest u. A agency problem resulting from conflicts of interest between the manager/agent and the stockholder/owners. u 1 -20 Managers may make decisions that are not in line with the goal of maximization of shareholder wealth. Dr. Mazharul Islam

Principle 8: Taxes Bias Business Decisions u. The cash flows we consider are the after-tax incremental cash flows to the firm as a whole. 1 -21 Dr. Mazharul Islam

Principle 9: All Risk is Not Equal u. Some risk can be diversified away, and some cannot u. The process of diversification can reduce risk, and as a result, measuring a project’s or an asset’s risk is very difficult. 1 -22 Dr. Mazharul Islam

Principle 10: Ethical Behavior is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance u. Each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing 1 -23 Dr. Mazharul Islam

Decisions of Financial Manager u. Investment Decisions (Capital Budgeting) (Investment decisions revolve around how to best allocate money to maximize their value. ) u. Financing Decisions (Capital Structure) (Financing decisions revolve around how to pay for investments and expenses) u. Asset 1 -24 Management Decisions (Working Capital Management Decisions)

Investment Decisions 1 -25 u how, when, where and how much money will be spent on investment opportunities. u 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. Dr. Mazharul Islam

Investment Decisions 1 -26 u What specific assets should be acquired? u What assets (if any) should be reduced or eliminated? Dr. Mazharul Islam

Financing Decisions Determine how the assets will be financed. u. 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). u Find 1 -27 the least expensive sources of fund. Dr. Mazharul Islam

Financing Decisions u What is the best type of financing? Mix type financing. u What is the best financing mix? Mixer debt and equity. u What is the best dividend policy? Paying a consistent percentage of net earnings. u How will the funds be physically acquired? 1 -28 Dr. Mazharul Islam

Asset Management Decisions u How do we manage existing assets efficiently? u Financial Manager has varying degrees of operating responsibility over assets. u Greater emphasis on current asset management than fixed asset management. 1 -29 Dr. Mazharul Islam

Interrelationship of the decisions made by a Financial Manager 1 -30

What are the Goals of the Firm? (General Goals) u Survival u Avoid u Beat financial distress and bankruptcy the competition u Maximize sales or market share u Minimize costs u Maximize profits u Maintain 1 -31 steady earnings growth. Dr. Mazharul Islam

Shortcomings of these General Goals Problems u These goals are either associated with increasing profitability or reducing risk. 1 -32 Ø Could increase current profits while harming firm (e. g. , defer maintenance, issue common stock to buy Treasury-bills, etc. ). Ø Does not specify timing or duration of expected returns. Ø Calls for a zero payout dividend policy. Ø They are not consistent with the long-term interests of shareholders. So it is necessary to find a goal that can encompass both profitability and risk. Dr. Mazharul Islam

The Real Goal of the Firm Maximization of Shareholder Wealth! Shareholders’ wealth can be measured as the current value per share of existing shares. 1 -33 Dr. Mazharul Islam

Strengths of Shareholder Wealth Maximization u. Takes account of: current and future profits and EPS; EPS the timing, duration, and risk of profits; profits dividend policy; policy and all other relevant factors. u. Thus, share price serves as a barometer for business performance. 1 -34 Dr. Mazharul Islam

The Modern Organization Shareholders Management There exists a SEPARATION between owners and managers. 1 -35 Dr. Mazharul Islam

Role of Management acts as an agent for the owners (shareholders) of the firm. u 1 -36 An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. Dr. Mazharul Islam

Agency Theory u. Jensen and Meckling developed a theory of the firm based on agency theory u. Agency Theory is a branch of economics relating to the behavior of principals and their agents. 1 -37 Dr. Mazharul Islam

Agency Theory u. Principals must provide incentives so that management acts in the principals’ best interests and then monitor results. u. Incentives include stock options, perquisites, and bonuses 1 -38 Dr. Mazharul Islam

Social Responsibility u Wealth maximization does not stop the firm from being socially responsible u Assume we view the firm as producing both private and social goods. u Then shareholder wealth maximization remains the appropriate goal in governing the firm. 1 -39 Dr. Mazharul Islam

Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Vice President Operations 1 -40 Vice President Finance Vice President Marketing Dr. Mazharul Islam

Organization of the Financial Management Function Vice President of Finance Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning 1 -41 Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts Dr. Mazharul Islam