2003 McGraw-Hill Ryerson Limited

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The Goals and Functions of
Financial Management
McGraw-Hill Ryerson 2003 McGraw-Hill Ryerson Limited
Prepared by:

Terry Fegarty
Seneca College
2003 McGraw-Hill Ryerson Limited
Chapter 1 - Outline
Definition of Financial Management
The Field of Finance
The Economic Environment
The Evolution of Finance
The Goals of Financial Management
A Risk-Return Trade-Off
Functions and Activities of Financial Management
Forms of Organization
Financial Markets
Interest Rates
Summary and Conclusions


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2003 McGraw-Hill Ryerson Limited
The business function
involving:
Managing daily financial
activities-cash inflows and
outflows
Choosing long-term
investments of value and
obtaining the funds to pay
for them
Managing the risks taken
by the firm

What is Financial Management?

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The Field of Finance
Finance is related to:
Accounting, which provides information in
financial statements
Economics, which provides
decision-making tools such as pricing
theory (supply and demand), risk
analysis, comparative return analysis
information on the economic and
financial environment in which the
company operates

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2003 McGraw-Hill Ryerson Limited
The Economic Environment
The financial manager
considers many economic
factors, such as
inflation
unemployment
industrial production
domestic and international
competition
foreign trade statistics
international capital flows


exchange rates
changes in
technology
consumer and
investor attitudes
the state of financial
markets
changes in
government policy
etc. etc.

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2003 McGraw-Hill Ryerson Limited
The Evolution of Finance
Some milestones in Canadian finance:
1870s: Stock exchanges open in Canada
early 1900s: Financial securities and institutions
are developed
1920s: Emphasis on raising capital
1930s: Depression era: capital
preservation, bankruptcy and
reorganization, securities regulation
1950s: Shift to analytical decision-making,
capital budgeting.
Focus on market efficiency, capital
structure, diversification
1990s on: Focus on core businesses, growth in
use of derivatives, e-commerce
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2003 McGraw-Hill Ryerson Limited
The Goals of Financial Management
Primary goal is to maximize the wealth of the
companys shareholders (owners) by increasing the
market value (price) of their shares
May conflict with
social / ethical goals (for example, pollution control)
interests of management (for example, short-term
compensation)
Management can encourage an increase in share
price by earning an attractive return at an
acceptable level of risk



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Profitability Risk
Profitability Risk

ex., investing in stocks vs.savings accounts
Stocks may be more profitable but are riskier
Savings accounts are less profitable and less risky
(or safer)
Financial manager must choose appropriate
combination of potential profit (return) and
level of risk (safety)
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Functions and Activities
of Financial Management
Functions involve:
raising funds for the firm at minimal cost and acceptable risk
investing those funds in company assets so as to earn an
attractive return given acceptable risks
Activities include:
Working Capital Management
short-term (S/T) financial decisions (<1 year)
ex., managing cash and other current assets
Capital Budgeting
long-term (L/T) financial decisions (>1 year)
ex., purchasing a new machine in the future
Financing decisions (capital structure)
how to raise money: loans? leases? shares? bonds?

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Trade-off
Daily

Cash management
(receipt and disbursement of funds)
Credit management
Inventory control
Short-term financing
Exchange and interest rate hedging
Bank relations



Intermediate financing
Bond issues
Leasing
Stock issues
Capital budgeting
Dividend decisions
Forecasting
Profitability





Risk
Goal:
Maximize
shareholder
wealth
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Figure 1-1
Functions of the Financial Manager
Occasional
2003 McGraw-Hill Ryerson Limited
A business owned by
one person
Freedom
Simplicity
Low Start Up
Costs
Tax Benefits
Unlimited
Liability
Lack of Continuity
Difficulty in
Raising Money
Reliance on One Person
Advantages
Disadvantages
Forms of Organization:
Sole Proprietorships
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Greater Talent Pool
More Capital
Ease of Formation
Tax Benefits
Unlimited Liability
Lack of Continuity
Ownership
Transfer
Difficult
Possibility of
Conflict
A business venture with two or more owners
Advantages
Disadvantages
Forms of Organization:
Partnerships
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Limited Liability
Continuity
Greater Likelihood
of Professional
Management
Easier Access to
Money
Potential Shareholder
Revolts
Higher Start-Up
Costs
Regulation
Double Taxation
A corporation
is a separate legal entity
Advantages
Disadvantages
Forms of Organization:
Corporations
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Public and Private Corporations

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Public corporations shares are
available for purchase on the
market for the general public

The shares in a private
corporation are held by a small
group of individuals and are not
sold to the public
2003 McGraw-Hill Ryerson Limited
Financial Markets
Global network of corporations, financial institutions,
governments and individuals that either need money or have
money to lend or invest
Money markets deal in short-term securities (<1 year)
Ex.; Treasury Bills, commercial paper
Capital markets deal in long-term securities
Ex.; common stock, preferred stock, corporate bonds,
government bonds
Financial markets determine value and allocate capital to the
most productive use on a risk-return basis
Financial market characteristics
reliance on debt, and low but volatile interest rates
internationalization
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Stocks vs. Bonds

Stock (Share)= ownership or equity
Shareholders own the company
Bond = debt or liability
Bondholders are owed $ by company

Capital raised in primary markets
Securities traded in secondary markets
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Source: www.bank-banque-canada.ca;www.statcan.ca
P
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Consumer price index (average annual rate)
Prime rate (December)
Figure 1-2
Prime rate versus percent change in the CPI

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Summary and Conclusions
The financial manager:
controls the daily cash inflows and
outflows resulting from business
operations
makes the occasional investment
and financing decisions essential for
the future financial success of the
business
may work in a corporation or
other form of business organization

Their overriding goal is to maximize
the wealth of the owners by earning
an attractive return in the business
at an acceptable level of risk
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