Lecture No. 1 of Financial Management

: INTRODUCTION TO FINANCIAL MANAGEMENT

Learning Objectives
Understand the concept of FM and different concepts of a financial business environment. Understand the different definitions of Financial management The basic structure of the organization How we look at balance sheet from FM perspective what is internal or external environment of Financial markets Kinds of financial markets

INTRODUCTION TO FINANCIAL MANAGEMENT
FM is the management of financial resources – how to best find and use investments and financing opportunities in an ever-changing and increasingly complex environment.

Why should CS majors study FM

First of all, financial management is a core life skill; almost every one needs to understand some concepts of finance to manage his/her business & personal finances. It is generally and quite rightfully said, “Money makes the world go round”. Finance is like a life-blood for a company. Even the best of the companies and CEOs go out of the business because of poor financial management policies. Management Information Systems (MIS) and Information Technology (IT) are just a part of the overall corporate strategy which runs on finances, the major resource. So the computer sciences professionals need to have an understanding of the financial concepts to understand and contribute to the overall corporate strategy. Financial Engineering is an upcoming field that requires people with CS, math/science, and finance background. Financial engineering is the application of engineering methods to finance. One important area of study is the design, analysis, and construction of financial contracts to meet the needs of enterprises. This field is experiencing an increased demand for professionals, especially those who are trained in both the underlying mathematics/computer technologies and finance.

Definitions

Finance Finance is the science of managing financial resources in an optimal pattern i.e. the best use of available financial sources. MGT201 (Financial Management) Finance consists of three interrelated areas:1) Money & Capital markets, which deals with securities markets & financial institutions. 2) Investments, which focuses on the decisions of both individual and institutional investors as they choose assets for their investment portfolios. 3) Financial Management, or business finance which involves the actual management of firms.

Major Areas & Concepts of Financial Management

Following are some of the important areas and concepts of financial management, which would be discussed in detail in the lectures to come. Analysis of Financial Statements: Analysis of financial statement is one of the most common techniques of financial analysis, in which the financial performance and financial health of a company are analyzed based on its past performance. The following financial statements are used in the analysis process. • Profit & Loss Statement or Income Statement o Balance Sheet o Statement of Shareholders’ equity o Statement of Cash Flows Investment Decisions & Capital Budgeting: Capital budgeting is a term strictly related to investment in fixed assets; here, the term capital refers to the fixed assets that are used in production, while budget is a plan which details projected cash inflows and outflows over some future period. The following concepts and techniques are employed while analyzing investment decisions. o Interest rate formulas o Time Value of Money o Discounted Cash Flows o Net Present Value o Internal Rate of Return Risk & Return: Investors, individual or institutional, invest their money with the expectations of earning a return on their investment. How the risks and returns are related and how do investors make a choice of their portfolios is important for investment decision making. Following concepts and theories would be discussed while discussing the risk-return choices of the investor: o Uncertainty o Risk o Portfolio Theory o Capital Asset Pricing Model Corporate Financing & Capital Structure: When a firm plans to expand, it needs capital or funds. Acquisition of funds is considered to be a primary responsibility of a finance department in an organization. Financial experts attempt to find a combination of debt and equity that could increase the overall value of the company, i.e., they try to find the optimal capital structure. The following concepts would be used to understand how an optimal capital structure could be attained. o Cost of Capital o Leverage o Dividend Policy o Debt Instruments Valuation: Asset or company valuation is important not only for financial managers, but also for creditors and investors. It is important to know the value of the company or its assets to make important financing and investment choices. Different valuation techniques and factors that influence the value of a company or its financial instruments would be discussed in this section. o Share o Bond o Option o Corporate Working Capital & Inventory Management: Working capital and inventory management pertains to the effective management of current assets. As we will see, an optimal and effective utilization of working capital and inventory increases the operating efficiency of the firm. International Finance & Foreign Exchange: With the increasing importance of international trade and global markets, the role of international finance has increased manifold. In a global environment, the finance managers have more choices pertaining to investing and financing than ever before. However, it is important to understand the implications of working in a global environment, since fluctuations in the currency rates can convert a good financing or investment decision into a bad one. This section of the course would discuss the international financial environment and the financial implications of working in a global environment.

Organizational Structure

Business Legal Entities
Sole Proprietorship: It is an unincorporated business owned by one individual. Going into a business as a sole proprietor is simple – one merely has to begin business operations. Proprietorship consists of 80%of the total number of businesses worldwide. Partnership:A partnership exists whenever two or more persons associate to conduct a non-corporate business. It could be registered or unregistered. Corporation:A corporation is a limited company and a separate legal entity registered by the government. It is separate & distinct from its owners & managers. It Can be Private Limited (Pvt. Ltd.) or Public Limited (which may be listed on Stock Exchange). The businesses in the form of corporations control 80% of global sales of products and services. S-Type Corporation: S- Type corporations are Limited Liability Corporations without double taxation. In a regular corporation, the company itself is taxed on business profits. In addition, the owners pay individual income tax on money that they draw from the corporation as salaries, bonuses, or dividends. In contrast, in an S corporation, all business profits "pass through" to the owners, who report them on their personal tax returns (as in sole proprietorships, partnerships, and Limited Liability Companies). The S corporation itself does not pay any income tax, although a co-owned S corporation must file an informational tax return like a partnership or Limited Liability Companies – to tell the tax authorities what each shareholder's portion of the corporate income is.

Balance Sheet – An FM Perspective

Internal and External Business Environment

Internal Business Environment:             Internal environment of business normally consists of the following.                                              i.        Finance                                              ii.       Marketing                                             iii.       Human Resources                                             iv.       Operations (Production, Manufacturing)                                             v.        Technology                                             vi.        Other Functions (Logistics, Communications) External Business Environment:             The following business environment factors outside an organization have a profound effect on the functions and operations of an organization.                                              i.    Customers                                              ii.   Suppliers                                              iii.  Competitors                                              iv.  Government/Legal Agencies & Regulations                                              v.   Macro Economy/Markets:                                              vi.   Technological Revolution

Financial Markets
Capital Markets:   These are the markets for the long term debt & corporate stocks.  Stock Exchange:A stock exchange is a place where the listed shares, Term finance certificates (TFC) and national investment trust units (NIT) are exchanged and traded between buyers and sellers.  Long term bonds: Long term government & corporate bonds are also traded in capital markets. Money Markets: Money market generally is a market where there is buying and selling of short  term liquid debt instruments. (Short term means one year or less). Liquid means something which is easily en-cashable; an instrument that can be easily exchanged for cash. Following financial instruments are traded in money markets. Short term Bonds o         Government of Pakistan:  Federal Investment Bonds (FIB), Treasury-Bills (T-Bills) o         Private Sector: Corporate Bonds, Debentures Call Money, Inter-bank short-term and overnight lending & borrowing  Loans, Leases, Insurance policies, Certificate of Deposits (CD’s)  Badlah (money lending against shares), Road-side money lenders  Real Assets or Physical Asset Markets: Following are the active markets of real and physical assets in Pakistan o         Cotton Exchange, Gold Market, Kapra Market o         Property (land, house, apartment, warehouse) Computer hardware, Used Cars, Wheat, Sugar, Vegetables, etc