Chapt

er

The Goals and Functions of

Financial Management

Prepared by:
Terry Fegarty
Seneca College

McGraw-Hill Ryerson

2003 McGraw-Hill
Ryerson
Limited
2003 McGraw-Hill
Ryerson
Limited

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Chapter 1 - Outline
Definition of Financial Management
The Field of Finance
The Economic Environment
The Evolution of Finance
The Goals of Financial Management
A Risk-Return Trade-Off
Functions and Activities of Financial Management
Forms of Organization
Financial Markets
Interest Rates
Summary and Conclusions

2003 McGraw-Hill Ryerson Limited

PPT 1-3

What is Financial
Management?

The business function

involving:
Managing

daily financial
activities-cash inflows and
outflows
Choosing long-term
investments of value and
obtaining the funds to pay
for them
Managing the risks taken
by the firm
2003 McGraw-Hill Ryerson Limited

The Field of Finance

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Finance is related to:

Accounting, which provides information in
financial statements
Economics, which provides
decision-making tools such as pricing
theory (supply and demand), risk analysis,
comparative return analysis
information on the economic and financial
environment in which the company operates

2003 McGraw-Hill Ryerson Limited

The Economic Environment

The financial manager
considers many economic
factors, such as
inflation
unemployment
industrial production
domestic and international
competition
foreign trade statistics
international capital flows

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exchange rates
changes in
technology
consumer and
investor attitudes
the state of financial
markets
changes in
government policy
etc. etc.

2003 McGraw-Hill Ryerson Limited

The Evolution of Finance

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Some milestones in Canadian finance:

1870s:
early 1900s:

1920s:
1930s:

1950s:

1990s on:

Stock exchanges open in Canada

Financial securities and institutions
are developed
Emphasis on raising capital
Depression era: capital
preservation, bankruptcy and
reorganization, securities regulation
Shift to analytical decision-making,
capital budgeting.
Focus on market efficiency, capital
structure, diversification
Focus on core businesses, growth in
use of derivatives, e-commerce
2003 McGraw-Hill Ryerson Limited

PPT 1-7

The Goals of Financial

Management
Primary

goal is to maximize the wealth of the

companys shareholders (owners) by increasing the
market value (price) of their shares
May conflict with
social / ethical goals (for example, pollution control)
interests of management (for example, short-term
compensation)

Management

can encourage an increase in share

price by earning an attractive return at an
acceptable level of risk
2003 McGraw-Hill Ryerson Limited

PPT 1-8

Profitability Risk
Profitability Risk
ex.,

investing in stocks vs.savings accounts

Stocks may be more profitable but are riskier
Savings accounts are less profitable and less risky (or
safer)

Financial manager must choose appropriate

combination of potential profit (return) and
level of risk (safety)
2003 McGraw-Hill Ryerson Limited

Functions and Activities

of Financial Management

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Functions involve:

raising funds for the firm at minimal cost and acceptable risk
investing those funds in company assets so as to earn an
attractive return given acceptable risks

Activities include:

Working Capital Management

Capital Budgeting

short-term (S/T) financial decisions (<1 year)

ex., managing cash and other current assets
long-term (L/T) financial decisions (>1 year)
ex., purchasing a new machine in the future

Financing decisions (capital structure)

how to raise money: loans? leases? shares? bonds?

2003 McGraw-Hill Ryerson Limited

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Figure 1-1

Functions of the Financial

Manager
Daily
Cash management
(receipt and disbursement of funds)
Credit management
Inventory control
Short-term financing
Exchange and interest rate hedging
Bank relations

Occasional
Intermediate financing
Bond issues
Leasing
Stock issues
Capital budgeting
Dividend decisions
Forecasting

Profitability
Goal:
Maximize
Trade-off
shareholder
wealth
Risk

2003 McGraw-Hill Ryerson Limited

PPT 1-11

Forms of Organization:
Sole Proprietorships
Advantages
Freedom
Simplicity

Disadvantages
Unlimited
Liability
Lack of Continuity

Low Start Up
Difficulty in
Costs
A business owned by Raising Money
one person
Tax Benefits
Reliance on One Person
2003 McGraw-Hill Ryerson Limited

Forms of Organization:
Partnerships
Disadvantages

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Advantages

Unlimited Liability
Lack of Continuity
Ownership
Transfer
Difficult
Possibility of
Conflict

More Capital
Greater Talent Pool
Ease of Formation
Tax Benefits

A business venture with two or more owners

2003 McGraw-Hill Ryerson Limited

Forms of Organization:
Corporations
Advantages
Limited Liability
Continuity
Greater Likelihood
of Professional
Management
Easier Access to
Money

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Disadvantages
Potential Shareholder
Revolts
Higher Start-Up
Costs
Regulation
Double Taxation

A corporation
is a separate legal entity

2003 McGraw-Hill Ryerson Limited

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Public and Private Corporations

Public corporations shares are
available for purchase on the
market for the general public

The shares in a private

corporation are held by a small
group of individuals and are not
sold to the public

2003 McGraw-Hill Ryerson Limited

Financial Markets

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Global network of corporations, financial institutions,

governments and individuals that either need money or have
money to lend or invest
Money markets deal in short-term securities (<1 year)

Ex.; Treasury Bills, commercial paper

Capital markets deal in long-term securities

Ex.; common stock, preferred stock, corporate bonds, government

bonds

Financial markets determine value and allocate capital to the

most productive use on a risk-return basis
Financial market characteristics

reliance on debt, and low but volatile interest rates

internationalization
2003 McGraw-Hill Ryerson Limited

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Stocks vs. Bonds

Stock

(Share)= ownership or equity

Shareholders own the company
Bond = debt or liability
Bondholders are owed $ by company
Capital raised in primary markets
Securities traded in secondary markets
2003 McGraw-Hill Ryerson Limited

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Figure 1-2

Prime rate versus percent change

in the CPI
Consumer price index (average annual rate)
Prime rate (December)

20.00
18.00
16.00

Percent

14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00

Source: www.bank-banque-canada.ca;www.statcan.ca
2003 McGraw-Hill Ryerson Limited

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Summary and Conclusions

The financial manager:
controls the daily cash inflows
and outflows resulting from
business operations
makes the occasional investment
and financing decisions essential for
the future financial success of the
business
may work in a corporation or
other form of business organization
Their overriding goal is to maximize
the wealth of the owners by earning
an attractive return in the business
at an acceptable level of risk
2003 McGraw-Hill Ryerson Limited