Chapter 01

The Role and

Environment
of Managerial
Finance

What is Finance?
Finance can be defined as the art and science
of managing money.
The process of determining the required fund
for an activity or a purpose, identifying the
available sources for raising the fund,
calculating the cost of each source, collecting
the fund from optimal source and allocating
the collected fund in such a way that
maximizes the wealth of shareholders is
called finance.
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FINANCE (Continue.)
According to R. C. Osborn
The Finance function is the process of acquiring and utilizing funds of a business.
According to Bonneville and Dewey
Financing consists of raising , providing , managing of all the money , capital or funds of
any kind to be used in connection with the business.
a. Investment Decision
b. Financial Decision

Functions?

c. Dividend Decision
d. Liquidity Decision

Finance Department

Calculating funds requirement of organization Means how much money we require to run the
business
Finding sources of finance It means to check from where we can raise money & out of that which
source of finance is suitable for our organization
Utilization of funds It means utilization of profits which a company earns during a financial year

Functions/Activities/Roles of
Financial Manager

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Key Activities of The Financial Manager

Primary Activities
Performing
Financial Analysis
and Planning

1.

Making Investment Decisions

Determine both the mix and the type of assets found on the firms balance sheet
The left-hand side of the balance sheet

Making Financing Decision

Balance Sheet
Current
Assets

Current
Liabilities

Fixed
Assets

Long-Term
Funds

Deals with The right-hand side of the balance sheet and involves two major area:
1. Most appropriate mix of short-term and long-term financing must be established
2. Which individual short-term or long-term sources of financing are the best at given point in time

Making Financing
Decision

2.
3.

Transforming financial data into a form that can be used to monitor

the firms financial condition
Evaluating the need for increased (or reduced) productive capacity
Determining what additional (or reduced) financing is required

Making Investment Decision

Performing Financial Analysis and Planning

Types of Finance
1. Business finance:

The process of determining the required fund for

an activity or a purpose by a business enterprise, identifying the available
sources for raising the fund, calculating the cost of each source, collecting
the fund from the minimum cost source and utilizing the collected fund in
such a way that maximizes the profit is called finance.

2. Public/Government finance:

The process of determining the

required fund for an activity or a purpose by the government of a particular
country, searching the available sources for collecting the required fund,
estimating the cost of each source, raising the fund from the minimum cost
source and disbursing the collected fund in such a way that maximizes the
welfare of the common people of the country is called public finance.

3. Personal/Private finance:

The process of determining the required

fund for an activity or a purpose by an individual, identifying the available
sources for raising the fund, calculating the cost of each source separately,
collecting the fund from the minimum cost source and using the fund for
maximizing personal and family benefit is called personal finance.
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Major Areas & Opportunities in

Finance: Financial Services

Financial Services is the area of finance concerned with

the design and delivery of advice and financial products to
individuals, businesses, and government.

Career opportunities include banking, personal financial

planning, investments, real estate, and insurance.
Managerial finance is concerned with the duties of the
financial manager in the business firm.
The financial manager actively manages the financial
affairs of any type of business, whether private or public,
large or small, profit-seeking or not-for-profit. They are also
more involved in developing corporate strategy and
improving the firms competitive position.

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Legal Forms of Business Organization

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Corporate Organization

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The Managerial Finance Function

Since
most
business
decisions are measured in
financial terms, the financial
manager plays a key role in
the operation of the firm

Managerial Finance is closely related to,

but quite different from, Economics and
Accounting.

Organizational View
The size and importance of the managerial finance depend on the
size of the firm.
In small firm the finance function generally performed
by the accounting department
In medium-to-large-size firm
Financial
Manager

Separate department, vice-president of finance (CFO),

Treasurer, Controller

The officer responsible for the firms financial

activities: financial planning and fund raising, managing
cash, making capital expenditure decision, managing credit
activities and managing the investment portfolio

08/05/15

The officer responsible for the firm

accounting
activities:
tax
management, data processing, and cost
and financial accounting

The Managerial Finance Function

Relationship to Economics
The Financial Manager must understand the economic framework, and be alert
to the consequences of varying levels of economic activity and changes in
economic policy

ust be able to use economic theories as guidelines for efficient busineness operation
Supply-demand analysis

Profit-Maximazing strategies

Marginal Analysis

Economic principle which states

that financial decisions should be
made and actions taken only
when the added benefit exceed
the added costs

Price Theory

Example
Benefits with new computer
BDT100.000
Less: Benefits with old computer
35.000
(1) Marginal (Added) benefits
BDT 65.000
Cost of new computer
BDT 80.000
Less: Proceeds from sale of old com
28.000
(2) Marginal (added) costs
52.000
Net Benefit [(1) (2)]

BDT
BDT 13.000

The Managerial Finance Function

Relationship to Accounting
The finance and accounting function are closely related and generally overlap; indeed, managerial
finance and accounting are not often easily distinguishable. In small firm the controller often carries
out of the finance function, and in large firms many accountants are intimately involved in
various finance activities

Two Basic Differences

Emphasis of cash flows

Accrual Method

vs.

Cash Method

Recognizes revenue at the

point of sale and recognized
expenses when incurred

Recognized
revenues
and
expenses only with respect to
actual inflow and outflows of cash

Accounting View

Financial View

Income statement
ABC Corporation
For the year xxxx
Sales Revenue
100.000
Less: Costs
80.000
Net Profit

BDT

BDT 20.000

Income statement
ABC Corporation
For the year 2015
Cash inflow
Less: Cash Outflow
Net Profit

BDT

0
80.000
($80.000)

Decision Making
The accountant devotes the majority of
attention
to
the
collection
and
presentation of financial data
The
financial
manager
evaluates
the
accountants statements, develops additional
data, and makes decisions based on
subsequent analyses
This does not mean that accountant
never make decision, or that financial
manager never gather data

Goal of the Firm: Maximize

Profit or Wealth Maximization
Source:
Reference Materials

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Goal of the Firm: Maximize Profit or

Wealth Maximization
EPS:
The amount earned during
the
period
on
each
outstanding
share
of
common stock

Maximize Profit?

Some people believe that the owners objective is always to maximize profits
The Financial Manager are expected to make a major contribution to the firms
overall profit
For Corporation, profit are commonly measured in terms of Earnings per Share (EPS)

Earning per share (EPS)

Investment
X
Y

year 1
1.40
0.60

1.00
1.00

year 2
0.40
1.40

Profit maximization fails for reason:

1. Timing of return
2. Cash flow available to
stockholder
3. Risk
Stockholder are risk-averse ?

(IN BDT)
year 3
2.80
3.00

periods total earnings avaliable

for the firms common stock
holders
The number of shares of
common stock outstanding

total
The chance that actual outcomes
may differs from those expected
Basic primises in managerial finance
is that trade-off exist between
return (cash flow) and risk
Return and risk are in fact the key
determinant of share price
which represents the wealth of the
owners in the firm

Goal of the Firm: Maximize Profit or

Wealth Maximization
Maximizing Shareholder Wealth
The goal of the financial manager is
to maximize the wealth of the
owners for whom the firm is being
managed

Timing of return (cash flow)

Measured by the share

price of the stock

magnitude

Risk
Financial decisions and share price
Financial
Manager

Financial Decision
Alternative or action

Return?
Risk?

Increase
Share
Price ?

Yes

Reject

Yes

Acept

Goal of the Firm: What About Other

Stakeholders?
Stakeholders include all groups of individuals who
have a direct economic link to the firm including
employees, customers, suppliers, creditors, owners,
and others who have a direct economic link to the
firm.
The "Stakeholder View" prescribes that the firm make
a conscious effort to avoid actions that could be
detrimental to the wealth position of its stakeholders.
Such a view is considered to be "socially responsible."

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The Agency Issue:

The Agency Problem
The Agency Issue
The goal of the financial manager
should be to maximize the wealth
of the owners of the firm

Management can be viewed as agents of

the owners who have hired them and
given them decision-making authority to
manage the firm for the owners benefit

In theory

In practise

Most financial managers would agree

with
the
goal
of
owner
wealth
maximization
Agency problem

However, managers also concern with

their personnel wealth, job security,
lifestyle, and privilege

To prevent or minimize problem

The likelihood that managers may place
personnel goals ahead of corporate goals

Audit & control

Agency Cost
Monitoring expenditure

Fidelity bond

Bonding expenditure

Managerial compensation
Stock option, performance share, cash bonuses

Structuring expenditure
Opportunity cost

The Role of Ethics: Ethics

Defined
Ethics is the standards of conduct or moral
judgmenthave become an overriding issue in
both our society and the financial community
Ethical violations attract widespread publicity
Negative

publicity

often

leads

to

negative

impacts on a firm

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Ethics & Corporate Governance

The Role of Ethics

Ethics Standard
judgement

of

conduct

or

moral example

Responsibility

Corporate Ethics Guidelines and Policies

Fairness

Ethics and share price

Transparency

Issues Update

Accountability
Good Corporate Governance

Corporate Social Responsibility

Certified Financial Analyst

Financial Institutions &

Markets

Firms that require funds from external sources can obtain

them in three ways:
through a bank or other financial institution
through financial markets
through private placements
Financial institutions are intermediaries that channel the savings of
individuals, businesses, and governments into loans or investments.
The key suppliers and demanders of funds are individuals, businesses,
and governments.
In general, individuals are net suppliers of funds, while businesses and
governments are net demanders of funds.
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Types of Financial Market

Types of Financial Market

Financial markets are differentiated according to the
types of investment, maturity of investment, trading
structures, types of lender & Borrower, location of the
market & types of transactions.

Classification by the Nature of Maturity: Money Vs Capital Market

Classification by the seasoning of Claim: Primary Vs Secondary

Market

Classification by the Nature of Claim: Debt Vs Equity Market

Classification by the Immediate Delivery: Spot Vs Derivative Market

Classification by Organizational Structure: Auction Vs OTC Market

Other types: Private Vs Public Market

Particulars

Difference between Money &

Capital Market

Definition

Money Market

Capital Market

Money market s a component of the financial markets where Capital market is a component of financial markets where
short-term borrowing takes place

long-term borrowing takes place

Maturity Period

For one year or less than one year

For more than one year

Instruments

The main credit instruments of the money market are call

The main instruments used in the capital market are

money, T-Bill, Commercial Paper, Bankers Acceptance,

stocks, shares, debentures, bonds, securities of the

REPO, Reserve REPO, Certificates of Deposit etc.

government.

Homogenous. A lot of variety causes problems for investors.

Heterogeneous. A lot of varieties are required.

Short-term credit required for small investments.

Long-term credit required to establish business, expand

Nature of Credit
Instruments
Purpose of Loan

business or purchase fixed assets.

Basic Role

Liquidity adjustment

Putting capital to work

Institutions

Central banks, Commercial banks, Acceptance houses,

Stock exchanges, Commercial banks and Nonbank

Nonbank financial institutions, Bill brokers, etc.

institutions, such as Insurance Companies, Mortgage

Banks, Building Societies, etc.

Purpose of Loan

The money market meets the short-term credit needs of

The capital market, on the other hand, caters the long-term

business; it provides working capital to the industrialists.

credit needs of the industrialists and provides fixed capital

to buy land, machinery, etc.

Risk

The degree of risk is small in the money market.

The risk is much greater in capital market.

Market Regulation

Money market is regulated by central bank of Bangladesh

Capital Market is regulated by Bangladesh Security &

(Bangladesh Bank).

Exchange Commission (BSEC).

Closely related to the central banks of the country.

Indirectly related with central banks and feels fluctuations

Relation with Central

Bank

depending on the policies of central banks.

Difference between Primary Market & Secondary Market

The Primary market refers to the market where new securities are issued
for the purpose of obtaining capital. Firms and public or government
institutions can raise funds from the primary market through making a new
issue of stock (to obtain equity financing) or bonds (to obtain debt
financing).

The secondary market refers to the market where securities that have
already been issued are traded. Instruments that are usually traded on the
secondary market include stocks, bonds, options and futures.

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