Strategic Financial Management

Session -1
Functions & Objectives

Corporate Finance: Objectives?

What is Corporate Finance?

Corporate Finance addresses the following questions:
What long-term investments should the firm choose?
How should the firm raise funds for the selected
investments?
How should short-term assets be managed and financed?
How much short-term cash flow firm need to pay its bills?

What proportion of the funds should be reinvested in the

firm and what should be distributed to the shareholders?
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Balance Sheet Model of the Firm

Total Value of Assets:

Current Assets

Total Liabilities
Current
Liabilities
Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

Shareholders
Equity

The Capital Budgeting Decision

Current
Liabilities

Current Assets

Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

What long-term
investments
should the firm
choose?

Shareholders
Equity

The Capital Structure Decision

Current Assets

How should the

firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible
2 Intangible

Current
Liabilities
Long-Term
Debt

Shareholders
Equity

Short-Term Asset Management

Current Assets

Fixed Assets
1 Tangible
2 Intangible

Current
Liabilities
Net
Working
Capital

How should
short-term assets
be managed and
financed?

Long-Term
Debt

Shareholders
Equity

Risk and Return

Financial Management involves three decisions:
Investment Decisions
Financing Decisions
Dividend Decisions

Whenever a financial decision involves investment and/or

financing, it is also concerned with two specific factors:
expected return and risk.
Expected return is the difference between potential benefits and
potential costs.
Risk is the degree of uncertainty associated with these expected
returns.

Cash Flow Btw the Firm and the Financial Markets

Firm

Financial
markets

Retained
cash flows (F)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (E)

Long-term debt
Equity shares

Taxes (D)

FirmInvests
Receive
in generate
assets
Cash,
(B)
profits through
Current
assets
its
operations
Fixed assets
(B)

Firm issues securities (A)

Ultimately, the firm

must be a cash
generating activity.

Government

The cash flows from

the firm must exceed
the cash flows from
the financial markets.
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Corporations

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Forms of Business Organization

The Sole Proprietorship
The Partnership
General Partnership
Limited Partnership

The Corporation

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A Comparison
Corporation

Partnership

Liquidity

Shares can be easily

exchanged

Subject to substantial
restrictions

Voting Rights

Usually each share gets one

vote

General Partner is in charge;

limited partners may have
some voting rights

Taxation

Double

Partners pay taxes on

distributions

Reinvestment and
dividend payout

Broad latitude

All net cash flow is

distributed to partners

Liability

Limited liability

General partners may have

unlimited liability; limited
partners enjoy limited
liability

Continuity

Perpetual life

Limited life
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Role of Financial Managers

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Hypothetical Organization Chart

BoardofDirectors

ChairmanoftheBoardand
ChiefExecutiveOfficer(CEO)
PresidentandChief
OperatingOfficer(COO)
VicePresidentand
ChiefFinancialOfficer(CFO)

Treasurer

Controller

CashManager

CreditManager

TaxManager

CostAccounting

CapitalExpenditures

FinancialPlanning

FinancialAccounting

DataProcessing
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Accounting and Financial Management

The firms finance (treasurer) and accounting (controller)
functions are closely related and overlapping. In smaller firms
usually financial manager generally performs both functions.
One major difference is that accountants generally uses accrual
method while in finance, the focus is on cash flows.
Finance and accounting also differ with respect to decision
making. While accounting is primarily concerned with the
presentation of the financial data, financial manager is
primarily concerned with the analyzing and interpreting this
information for the decision making purposes.

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The Goal of Financial Management

Survive
Avoid financial distress and bankruptcy
Beat the competition
Maximize sales or market share
Minimize cost
Maximize profits
Maintain steady earning growth

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Role of Financial Managers

The financial managers are primarily
concerned with investment decisions and
financing decisions within business
organizations.
Financial Managers dilemma:
What goal(s) do managers have in mind when they
choose between financial alternativessay,
between distributing current income among
shareholders and investing it to increase future
income?
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Role of Financial Managers

The Financial Managers primary goal is to increase
the value of the firm by:
Selecting value creating projects
Making smart financing decisions
How to minimize the cost of capital

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Financial Objective
There is actually one financial objective:
The maximization of the economic wellbeing, or wealth, of
the owners.

Whenever a decision is to be made, management

should choose the alternative that most increases the
wealth of the owners of the business.
The market value of shareholders equity generally
measures the owners economic well being.

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How to maximize shareholders wealth?

Maximize profit?
Minimize costs?
Maximize market share?
Increase the stocks value

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How to maximize shareholders wealth?

If the stock market is efficient, the value of a share
should reflect investors expectations regarding the
future prospects of the corporation.
The value of a stock will change as investors
expectations about the future change.
For financial managers decisions to add value, the
present value of the benefits resulting from decisions
must outweigh the associated costs, where costs
include the costs of capital.

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How Stock Price Maximization Works?

Stockholders hire managers to run their firms
efficiently for them
Because stockholders have absolute powers to hire and fire
managers

Managers set aside their interest and maximize stock

prices
Because markets are efficient

Stockholder wealth is maximized

Because lenders are fully protected from the stockholders
action

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Finance Managers: Additional Issues

If there is a separation of the ownership and
management of a firmthat is, the owners are not the
managers of the firmthere are additional issues to
confront.
What if a decision is in the best interests of the firm,
but not in the best interest of the manager?
How can owners ensure that managers are watching
out for the owners interests?
How can owners motivate managers to make
decisions that are best for the owners?

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The Agency Relationship

An agent is a person who acts forand exerts
powers ofanother person or group of persons called
Principal.
Agency relationship
Stockholders (principals) hire managers (agents) to run the
company/ to represent his/her interest

Agency problem
Conflict of interest between principal and agent

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Managerial Goals
Managerial goals may be different from shareholder
goals
Expensive perquisites
Survival
Independence

Increased growth and size are not necessarily

equivalent to increased shareholder wealth

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Agency Cost
There are costs involved with any effort to
minimize the potential for conflict between the
principals interest and the agents interest.
These are:
Lost of opportunity
Monitoring Costs
Takeovers

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Questions
Which of following actions are the result of a
financing decision and which are the result of an
investment decision?
1.
2.
3.
4.
5.

A firm introduces a new product.

A firm issues new bonds.
A corporation issues new shares of stock.
A firm expands its existing manufacturing facilities.
A firm leases a new building to be used in its
manufacturing.

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Thank You!

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