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CHAPTER 1An Overview of Managerial Finance

Concept of Finance and Managerial Finance Types of Finance Functions of Managerial Finance Forms of Businesses Goals of the Corporation Principles of Finance Agency Relationship Business Ethics Multinational vs Domestic Managerial

Finance

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Concept of Finance

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 the minimum cost

source andallocating the collected fund in such a way

that maximizes the target is called finance.

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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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Differences among Business, Public and Private Finance

1. Definition2. Objective3. Sources of fund4. Issuing new notes and coins5. Foreign borrowings6. Confidentiality7. Bankruptcy8. Income & expenditure decision

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Definition of Managerial Finance

The process of determining the required fund for a business purpose, identifying the available sources for raising the fund, calculating the cost of fund, collecting the fund from the minimum cost source and allocating the collected fund in such a way that maximizes the profit and achieving the target of the manager is called managerial finance.

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Definition of Managerial Finance

The assessment of finance techniques to determine how they affect the business internally and externally. Managerial finance takes into consideration how to improve financial techniques to better the company and where changes can be made to prevent loss. This approach is a mixture between basic corporate financing and managerial.

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Functions of Managerial Finance

1. Procurement of funds: There are alternative sources of fund like a company can take loan or it can issue common stock, preferred stock, debenture or bond to raise the fund required based on cost minimization is the goal of financing. Finance managers need to select the best possible sources of funds among the different alternatives called Capital structure Decision.

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Functions of Managerial Finance

2. Utilization of funds: Capital Budgeting decision. Long term investment decision is made on the basis of risk and return. The goal is profit maximization. This is the most important and challenging function of finance. 3. Short term asset management: Working capital management by considering liquidity and profitability.4. Distribution of funds: Dividend policy decision. Dividend policy, repurchase of shares and amortization of debt.

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Alternative Forms of Business Organization Sole proprietorship Partnership Corporation

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Goals of the Corporation The conventional goal of a firm is

profit-maximization. However, since profit is reported by the management so it can be manipulated. Moreover, accounting profit is not estimated on cash basis. So, the modern goal of firm is shareholders’ wealth maximization, which refers to maximizing stock prices at the market.

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A graphical approach to wealth maximization

D1

S1

D2

P1

P2

Quantity of stock

Market P

rice of S

hares

Q1

W2= P2Q1

W1= P1Q1

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Why is Wealth Maximization?

For the following favorable reasons wealth maximization is considered as ultimate goal:

Clearness in definition It is an long-term concept It cann’t be manipulated by the management Risk consideration Time value of money consideration This leads to better and true evaluation of

business It emphasis more on cash flows rather than

profitability.

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Agency Relationship

Stockholders vs Managers: managerial compensation, threat of firing, shareholder intervention and threat of takeover

Stockholders vs Creditors: long term investment is risky projects, payment to employees, shareholders and financing from others.

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MNCs and Multinational vs Domestic Managerial Finance

Different currency denominations Economic and legal ramifications Language differences Cultural differences Role of governments Political risk

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Principles of Managerial Finance

Return and risk Time value of money Cash flow Profitability vs liquidity Diversification Hedging