Financial management

• financial management in a nutshell

  • endeavors to reduce the cost of finance
  • ensures the sufficiency of funds
  • deals with planning, organizing, and controlling of financial activities, like procurement and utilization of funds
• "financial management is the activity concerned with planning, raising, controlling and administering of funds used in business" - Guthman and Dougal
• "Financial Management is the area of business management devoted to a judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals." -- J.F Brandley
• "financial management is an operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations" -- Massle
• Several financial accounting theories are

  1. acquisition of assets
  2. finance is concerned with everything the company does
  3. financial management encompasses both the effective use of funds
• many companies can easily raise capital in a developed market. the real issue is maximizing capital through successful financial planning and control.
• Scope of financial management

  • financing decision
  • investment decision
  • dividend decision
• Investment Decision: determine the amount of investment available from existing funds, both long term and short term.

  • Capital Budgeting - long term
  • Working Capital management - short term
• Capital Management (Long-term investment decision) - implies committing funds for a long time, similar to a fixed asset. These decisions are normally irreversible and involve those involving the purchase of a building and/or property. These choices influence a company's financial goals and result.
• Working capital management (Short term Investment decision) - committing funds for a short period of time, such as current assets. They have a direct impact on a company's liquidity and profitability.
• Financing Decision - decisions on raising funds from long term (Capital structure) and short term (Working Capital) sources. There are two kinds of them

  • Capital Structure decisions
  • Financial Planning decisions
• Financial Planning decisions - include estimating the origins and applications of funds. it entails anticipating a company's financial needs in order to ensure that sufficient funds are available. The primary goal of financial planning is to prepare ahead of time to ensure that funds are available when needed.
• Capital structure decisions - include locating funding resources. They also include decisions on whether to raise funds from external sources such as selling shares, bonds, or borrowing from banks, or from internal sources such as retained earnings.
• Dividend Decisions - these are decisions over how much of a company's earnings will be paid as dividends.
• A mission statement is a precise statement that defines what a company does and what purpose it serves
• characteristics of an objective:

  • Specific
  • Measurable
  • Attainable
  • Realistic
  • Timebound
• Most companies are owned by shareholders and are originally set up to make money for those shareholders. The primary objective of a company is to maximize shareholder wealth.
• many other objectives (aside from shareholder wealth maximization) are also suggested for companies including:

  • profit maximization
  • growth
  • market price
  • social responsibilities
• to address the issue on meeting the goals of many stakeholders at the same time, distinction between

  • maximising - seeking the best possible outcome
  • satisficing - finding a merely adequate outcome
• not-for-profit organizations include charities, state health services, and police forces, which are run for the purpose of providing a service rather than profit.
• value for money is descrived as obtaining the best possible combination of services by using the fewest resouces possible.
• the degree to which stated objectives/goals are met is referred to as effectiveness.
• the relationship between inputs and outputs is known as efficiency.
• stakeholders are people who are interested in a company's operations or success because they have a stake or an interest in what happens.
• most common type of stakeholder groups in an organization:

  • Internal (directors, employees)
  • Connected (shareholders, leaders, customers, suppliers, labor unions)
  • External (government, society as a whole)
• agency problem - conflict of interests between different stakeholders of a corporation
• moral hazard - a boss has a vested interest in reaping the rewards of his or her job. all of the perks that come with status, such as a company vehicle, use of company plane, lunches and so on, are included.
• effort level - managers could put in less effort than if they were the company's owners. in a large corporation, the issue would occur at both the middle and senior management levels.
• earnings retention - rather than earnings, the size of the business is also used to determine the remuneration of directors and senior managers. rather than paying out dividends, management is more likely to want to reinvest profits in order to grow the business.
• risk aversion - executive directors and senior managers typically receive the majority of their profits from the organization for which they work. as a result, they care about the company's stability because it will secure their job and future earnings.
• time horizon - shareholders are concerned about their company's long term financial prospects because the value of their shares is based on long-term assumptions. management, on the other hand, could be only concerned with short term. this is part;ly due to the fact that they may be paid annual bonuses based on short-term results, and partly due to the fact that they may have not plan to stay with the organization for more than a few years.
• Agency costs include direct and indirect costs

  • direct costs - include remuneration and audit fees
  • indirect costs - include the cost of lost opportunity because of agency problems.
• several methods of reducing agency problems:

  • creating a compensation plan
  • having a sufficient number of qualified non-executive directors on the board
  • Non-executive directors may be in charge of remuneration
  • the possibility of hostile takeover
• Three components of remuneration package (incentive schemes)

  • basic salary - needs to be high enough to attract and retain individuals with the required skills and talent
  • annual performance incentive - the performance target might be stated as profit or earnings growth
  • long-term performance incentive - linked in some way to share price growth. usually provided in the form of share rewards or share options of the company.
• corporate governance


  the collection of procedures, customs, rules, laws, and institutions that regulate how a corporation (or company) is guided, managed, or regulated.
• key elements in corporate governance

  • risk management
  • good organizational frameworks and management practice
  • execute its policy in an ethical and efficient way
  • apply the spirit and letter of the law (legalities)
  • accountability
• characteristics of successful companies include

  • have skilled people
  • have strong relationships
  • have enough funding
• provider


  person or organization with cash flow
• user

  person or organization with opportunities to convert cash now into cash later
• proprietorship


  an unincorporated business owned by one individual