session 01 introduction to management accounting...• interaction with the financial markets •...

Session 01

Introduction to Financial Management

Programme : Executive Diploma in Accounting, Business & Strategy

(EDABS 2017)

Course : Corporate Financial Management (EDABS 202)

Lecturer : Mr. Asanka Ranasinghe

MBA (Colombo), BBA (Finance), ACMA, CGMA

Contact : [email protected]

Learning Outcomes

• Describe alternative views on the purpose of the business an

show the importance to any organization of clarity on thispoint;

• Describe the impact of the divorce of corporate ownership from

day-to-day managerial control;

• Explain the role of the financial manager;

• Detail the value of financial intermediaries;

• Show an appreciation of the function of the major financial

institutions and markets.

Asanka Ranasinghe MBA (Colombo), BBA (Finance), ACMA, CGMA2

What is Finance

• Finance can be defined as the science and art of managing

money.

• At the personal level, finance is concerned with individuals’

decisions about how much of their earnings they spend, how

much they save, and how they invest their savings.

• In a business context, finance involves the same types of

decisions: how firms raise money from investors, how firms

invest money in an attempt to earn a profit, and how they

decide whether to reinvest profits in the business or distribute

them back to investors.Asanka Ranasinghe MBA (Colombo), BBA (Finance), ACMA, CGMA

3

Financial Management Decisions

• Capital budgeting

– What long-term investments or projects should the

business take on?

• Capital structure

– How should we pay for our assets?

– Should we use debt or equity?

• Working capital management

– How do we manage the day-to-day finances of the firm?


Introduction

• ‘In whose interests is the firm run?’


FIRM

Creditors

Employees

Customers

Society

Shareholders

Managers

Possible Objectives of Firms

• Achieving a target market share

• Keeping employee agitation to a minimum

• Survival

• Creating an ever-expanding empire

• Maximisation of profit

• Maximisation of long-term shareholder wealth

6Asanka Ranasinghe MBA (Colombo), BBA (Finance), ACMA, CGMA

Shareholder Wealth

Dividends

• Shareholder Return

Capital gains

– Maximizes the net present value of a course of action to

shareholders.

– Accounts for the timing and risk of the expected benefits.

– Benefits are measured in terms of cash flows.

Fundamental objective—maximize the market value of the firm’s shares.


Shareholder Wealth vs Profits


Maximizing the Rupee Income of Firm

– Resources are efficiently utilized

– Appropriate measure of firm performance

– Serves interest of society also

• It Ignores the Timing of Returns

• It Ignores Risk

• In new business environment profit maximization is

regarded as

– Unrealistic

– Difficult

– Inappropriate

– Immoral

Corporate Governance

• A divorce, of ownership and control

Modern corporation has a very diffuse and fragmented set of shareholders and control often lies in the

hands of directors

• Principal–Agent problem

The separation of ownership and control raises worries that the management team may pursue

objectives attractive to them, but which are not necessarily beneficial to the shareholders

• Agency Costs

- Monitor managers’ behavior

- Create incentive schemes and controls for managers to encourage the pursuit of shareholders’ wealth

maximisation

• Corporate governance

The system by which companies are managed and controlled


Role of a Financial Manager

• Interaction with the financial markets

• Investment

• Treasury management

• Risk management

• Strategy and value based management


Financial System


Financial System

Financial Institutions

Financial Markets

Financial Instruments

• Banks

• Finance

Companies

• Insurance Firms

• Pension Funds

• Shares

• Bonds

• Mortgages

• Bills of Exchange

• Stock Market

• Money Market

• Forex Market

• Government

Securities Market

Role of the Financial System


Role of the Financial Intermediaries


1. Risk reduction – By lending to a wide variety of individuals and businesses, FI’s

reduce the risk of a single default

1. Aggregation – By pooling many small deposits, FI’s are able to make much larger

advances than would be possible for most individuals

1. Maturity transformation – Most borrowers wish to borrow in the long term

whilst savers are unwilling to lock up their money for the long term. FI’s, by

developing a floating pool of deposits are able to satisfy both the needs of

lenders and borrowers

1. Financial intermediation – FI’s bring together lenders and borrowers through a

process known as financial intermediation

Time Value of Money

“A rupee in hand today is worth more than a rupee promised

at sometime in future”

• Impatience to consume

• Inflation

• Risk


Simple Interest

Interest paid only on the initial principal

Example: Rs. 1,000 is invested to earn 6% per year, simple

interest.


-Rs. 1,000 Rs. 60Rs. 60 Rs. 60

0 21 3

Compound Interest

Interest paid on both the initial principal and on interest that

has been paid & reinvested.

Example: Rs. 1,000 is invested to earn 6% per year,

compounded annually.


-Rs. 1,000 Rs. 63.60Rs. 60 Rs. 67.42

0 21 3

Future Value

The value of an investment at a point in the future, given

some rate of return.

FV = future value

PV = present value

i = interest rate

n = number of periods


Future ValueSuppose a stock currently pays a dividend of $1.10, which is

expected to grow at 40% per year for the next five years.

What will the dividend be in five years?


Present Value

What a future sum of money is worth today, given a particular

interest (or discount) rate.

FV = future value

PV = present value

i = interest (or discount) rate

n = number of periods


Present Value

How much would an investor have to set aside today in order to

have Rs. 20,000 five years from now if the current rate is 15%?


Annuities

The payment or receipt of an equal cash flow per period, for a

specified number of periods.

Examples:

Student Loan Payments

Car Loan Payments

Insurance Premiums

Mortgage Payments

Retirement Savings


Annuities• Ordinary annuity: cash flows occur at the end of each period

• Annuity Due: cash flows occur at the beginning of each period

• Future value of an annuity


Annuities


What is the future value of a three year ordinary annuity with a cash

flow of Rs.100 per year, earning 6%?

What is the future value of a three year annuity due with a cash flow of

Rs.100 per year, earning 6%?

Annuities


The present value of an annuity is the sum of the present values of all

individual cash flows.

Perpetuities


Financial instrument that pays an equal cash flow per period into the

indefinite future (i.e. to infinity).

Frequent Compounding


Effective Annual Interest Rate (AER)


The actual rate of interest earned (paid) after adjusting the nominal

rate for factors such as the number of compounding periods per year

Asanka Ranasinghe BBA (Finance), ACMA, CGMA28

session 01 introduction to management accounting...• interaction with the financial markets •...

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