Bme 5 Prelims

BME 5 PRELIMS
Overview of Financial Management Investments

- “the system that includes the circulation Investments relate to decisions concerning stocks
of money, the granting of credit, the and bonds and include a number of activities:
making of investments, and the provision
of banking facilities.” (1) Security analysis deals with finding the proper
values of individual securities (i.e., stocks and
ACTIVITIES IN BUSINESS ORGANIZATIONS bonds)
(2) Portfolio theory deals with the best way to

structure portfolios, or “baskets,” of stocks and
bonds.
(3) Market analysis deals with the issue of

whether stock and bond markets at any given
time are “too high,” “too low,” or “about right.”
Financial System
The financial system links the savers and users of
funds.
SAVERS
 Households
Areas of Finance  Individuals
Finance is generally divided into three areas:  Corporations/ Companies
 Government Agencies
Financial Management
Financial management, also called corporate FINANCIAL INTERMEDIARIES
finance, focuses on decisions relating to how  Banks
much and what types of assets to acquire, how to  Insurance Companies
raise the capital needed to purchase assets, and  Stock Exchange
how to run the firm so as to maximize its value.  Stock Brokerage Firms
 Mutual Funds
Capital Markets  Other financial institutions
Capital markets relate to the markets where
interest rates, along with stock and bond prices, USERS OF FUNDS
are determined. Also studied here are the (Borrowers/ Investors)
financial institutions that supply capital to  Households
businesses. Banks, investment banks,  Individuals
stockbrokers, mutual funds, insurance  Corporations/Companies
companies, and the like bring together “savers”  Government Agencies
who have money to invest and businesses,
individuals, and other entities that need capital Finance versus Economics and Accounting
for various purposes Finance, as we know it today, grew out of
economics and accounting.
Financing Decisions
Economists developed the notion that an asset’s One of the responsibilities of a financial manager
value is based on the future cash flows the asset is to find ways to provide money for the activities
will provide, and accountants provided of the firm. The manager needs to consider the
information regarding the likely size of those cash short-term or long-term debt or equity financing.
flows. People who work in finance need The manager assesses the best possible financing
knowledge of both economics and accounting. mix or capital structure for the company in order
to meet he expected return on investment.
Wealth Maximization – Creating Value for The main idea in financing decisions is to look for
Investors resources that will give the company the lowest
weighted average cost of capital.
Maximizing shareholders’ wealth through
maximization of stock price should be the Dividend Policy Decisions
overriding objective of management as it covers Dividend payouts is a sign that company is
the different facets of operating a company and profitable.
considers the different stakeholders in the
organization. A sound dividend policy is a good financial sign to
the market that continually assess a company.
Wealth Maximization as Compared to Companies with earnings retention have more
Profitability funds for investment; hence, it indicates the
growth potential of a business. This also equally
important to investors. Decisions to pay or not to
pay dividends are usually based on advice by the
finance manager to the board of directors.
Finance within and Organization
The Role of Financial Managers

The financial manager of the firm plays a crucial
role in the company’s goals, policies, and success.
Here are the responsibilities of the financial
managers:
 INVESTMENT DECISIONS
 FINANCING DECISIONS The common functions of the controller include:
 DIVIDEND POLICY DECISIONS  accounting and financial reporting
 internal audit
Investment Decisions  cost accounting
An investment proposal is evaluated by capital  tax accounting
budgeting techniques that considers time value  planning for control
of money (e.g. discounted payback period,  evaluating and consulting
internal rateof return, net present value and  government reporting
profitability index) or an evaluation that does not  protection of assets
use the time value of money (e.g., payback period  economic appraisal
and accounting rate of return).
Primary Agency Relationships
The treasurer’s common functions are: 1. Stockholders and managers.
 cash management 2. Stockholders and creditors.
 banking relationship
 finding sources of financing Misconceptions About Financial Management
 financial planning
 investment planning Financial management is accounting.
 capital budgeting
 risk management Financial management is a review of
 investor relations mathematics.
 credit and collection
Financial management is a branch of
Financial Decisions and Risk Return Trade-off statistics.
An increase in return is coupled by a

corresponding increase in risk. It cannot be
expected that whatever financial decision is
made will immediately favor the firm.
The financial manager’s obligation is to ascertain

that such risk present is tolerable. Risk is
common and ubiquitous. It could be credit,
financial, political, interest and social. The firm
must recognize the risk and must include this in
any financial decision it will make.
“The higher the return, the higher the risk.”
Agency Theory
The agency theory poses a potential conflict of

interest between the stockholders and the
managers. Such conflict starts when the
stockholders entrust to the managers the
authority to make decisions for the business. The
managers, with the power vested upon them,
may have personal goals that clash with the
stockholder’s wealth maximization.
The agency relationship is borne as soon as an

individual or group of people, called the
principals, hire the service of an individual or
organization called an agent, to perform a service
and exercise decision-making for the principal.

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Bme 5 Prelims

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BME 5 PRELIMS

Overview of Financial Management Investments

(2) Portfolio theory deals with the best way to

(3) Market analysis deals with the issue of

Finance within and Organization

The Role of Financial Managers

An increase in return is coupled by a

The financial manager’s obligation is to ascertain

“The higher the return, the higher the risk.”

The agency theory poses a potential conflict of

The agency relationship is borne as soon as an

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