Introduction to Financial Management

The Importance of Finance

Finance involves the evaluation, disclosure, and management of economic activity and is crucial to the successful operation of firms and markets.

Learning Objectives

Differentiate between managerial finance and corporate finance

Key Takeaways

Key Points

  • The primary goal of corporate finance is to maximize shareholder value and it deals with the monetary decisions that business enterprises make.
  • Managerial finance is interested in the internal and external significance of a firm’s financial figures.
  • The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate a company’s financial needs and raise the appropriate type of capital that best fits those needs.
  • Sound financial management creates value and organizational ability through the allocation of scarce resources.

Key Terms

  • dividends: Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.

The Importance of Finance

Finance involves the evaluation, disclosure, and management of economic activity and is crucial to the successful and efficient operation of firms and markets.

Managerial Finance

Managerial finance concerns itself with the managerial significance of finance. It is focused on assessment rather than technique. For instance, in reviewing an annual report, one concerned with technique would be primarily interested in measurement. They would ask: is money being assigned to the right categories? Were generally accepted accounting principles (GAAP) followed?

A person working in managerial finance would be interested in the significance of a firm’s financial figures measured against multiple targets such as internal goals and competitor figures.They may look at changes in asset balances and probe for red flags that indicate problems with bill collection or bad debt as well as analyze working capital to anticipate future cash flow problems.

Sound financial management creates value and organizational ability through the allocation of scarce resources amongst competing business opportunities. It is an aid to the implementation and monitoring of business strategies and helps achieve business objectives.

Corporate Finance

Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make those decisions. The primary goal of corporate finance is to maximize shareholder value. Although it is in principle different from managerial finance, which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to financial problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, short-term decisions deal with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, short-term borrowing, and lending (such as the terms on credit extended to customers).

The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company’s financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms “corporate finance” and “corporate financier” may be associated with transactions in which capital is raised in order to create, develop, grow, or acquire businesses.

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Wall St.: Wall Street is the symbol of American and global finance.

The Role of Financial Managers

Financial managers ensure the financial health of an organization through investment activities and long-term financing strategies.

Learning Objectives

Outline the various roles played by financial managers

Key Takeaways

Key Points

  • Financial managers perform data analysis and advise senior managers on profit -maximizing ideas.
  • The role of the financial manager, particularly in business, is changing in response to technological advances that have significantly reduced the amount of time it takes to produce financial reports.
  • Types of financial managers include controllers, treasurers, credit managers, cash managers, risk managers and insurance managers.

Key Terms

  • net present value: The present value of a project or an investment decision determined by summing the discounted incoming and outgoing future cash flows resulting from the decision.

The Role of Financial Managers

Overview

Financial managers perform data analysis and advise senior managers on profit-maximizing ideas. Financial managers are responsible for the financial health of an organization. They produce financial reports, direct investment activities, and develop strategies and plans for the long-term financial goals of their organization. Financial managers typically:

  • Prepare financial statements, business activity reports, and forecasts,
  • Monitor financial details to ensure that legal requirements are met,
  • Supervise employees who do financial reporting and budgeting,
  • Review company financial reports and seek ways to reduce costs,
  • Analyze market trends to find opportunities for expansion or for acquiring other companies,
  • Help management make financial decisions.

The role of the financial manager, particularly in business, is changing in response to technological advances that have significantly reduced the amount of time it takes to produce financial reports. Financial managers’ main responsibility used to be monitoring a company’s finances, but they now do more data analysis and advise senior managers on ideas to maximize profits. They often work on teams, acting as business advisors to top executives.

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Financial Statements: This is an example of a financial statement that financial managers are responsible for preparing and interpreting.

Financial managers also do tasks that are specific to their organization or industry. For example, government financial managers must be experts on government appropriations and budgeting processes, and healthcare financial managers must know about issues in healthcare finance. Moreover, financial managers must be aware of special tax laws and regulations that affect their industry.

Capital Investment Decisions

Capital investment decisions are long-term corporate finance decisions relating to fixed assets and capital structure. Decisions are based on several inter-related criteria. Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate in consideration of risk. These projects must also be financed appropriately. If no such opportunities exist, maximizing shareholder value dictates that management must return excess cash to shareholders (i.e., distribution via dividends ). Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision.

Management must allocate limited resources between competing opportunities (projects) in a process known as capital budgeting. Making this investment decision requires estimating the value of each opportunity or project, which is a function of the size, timing and predictability of future cash flows.

Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. The sources of financing are, generically, capital self-generated by the firm and capital from external funders, obtained by issuing new debt or equity.

Types of Financial Managers

There are distinct types of financial managers, each focusing on a particular area of management.

Controllers direct the preparation of financial reports that summarize and forecast the organization’s financial position, such as income statements, balance sheets, and analyses of future earnings or expenses. Controllers also are in charge of preparing special reports required by governmental agencies that regulate businesses. Often, controllers oversee the accounting, audit, and budget departments. Treasurers and finance officers direct their organization’s budgets to meet its financial goals and oversee the investment of funds. They carry out strategies to raise capital and also develop financial plans for mergers and acquisitions.

Credit managers oversee the firm’s credit business. They set credit-rating criteria, determine credit ceilings, and monitor the collections of past-due accounts. Cash managers monitor and control the flow of cash that comes in and goes out of the company to meet the company’s business and investment needs. Risk managers control financial risk by using hedging and other strategies to limit or offset the probability of a financial loss or a company’s exposure to financial uncertainty. Insurance managers decide how best to limit a company’s losses by obtaining insurance against risks such as the need to make disability payments for an employee who gets hurt on the job or costs imposed by a lawsuit against the company.

Important Skills for Financial Managers

Analytical skills. Financial managers increasingly assist executives in making decisions that affect the organization, a task for which they need analytical ability.

Communication. Excellent communication skills are essential because financial managers must explain and justify complex financial transactions.

Attention to detail. In preparing and analyzing reports such as balance sheets and income statements, financial managers must pay attention to detail.

Math skills. Financial managers must be skilled in math, including algebra. An understanding of international finance and complex financial documents also is important.

Organizational skills. Financial managers deal with a range of information and documents. They must stay organized to do their jobs effectively.