Financial Management NOTES

1.0 Introduction
Financial management is that managerial activity which is concerned with
the planning and controlling of the firm’s financial resources
It involves the decision of the three decisions of the firm i.e.

• Investment decision
• Financial decision
• Dividend decision

Together they determine the value of the firm to its shareholders. The
finance manager makes use of certain analytical tools in the analysis,
planning and control activities associated with the major decisions of
the firm.

1.1 Role of the Finance Manager

A financial manager is a person who is responsible in a significant way
to carry out the finance functions.

1. Interaction with the financial markets
   In order to raise finance knowledge is needed of the financial
   markets and the way in which they operate.
2. Investment
   Decisions have to be made concerning how much to invest in real
   assets and which specific projects to undertake (capital budgeting
   decisions).
3. Treasury management
   Many firms have large sums of cash which need to be managed properly
   too obtain a high return for shareholders. Other areas of
   responsibility might include inventory control, creditor management
   and issues of solvency and liquidity.
4. Risk management
   Exposures to interest rates changes and commodity price fluctuations
   can be reduced by using hedging techniques. These often employ
   instruments such as futures, options, swaps, and forward agreements.
5. Strategy
   Managers need to formulate and implement log term plans to maximize
   shareholders wealth. This means selecting markets and activities in
   which the firm given its resources has a competitive edge.

1.2 Functions of a Finance Manager

Financial manager is concerned with;

1. Investment decision or long term asset mix
   A firm’s investment decisions involve capital expenditures.
   Therefore referred to as capital budgeting decisions. It involves
   the decision of allocation of capital or commitment of funds to long
   term asset that would yield benefit (cash flows) inn the future.
2. Financing decision
   The mix of debt and equity is known as the firm’s capital structure.
   The finance manager must strive to obtain the best financing mix or
   the optimum capital structure for his/ her firm. Broadly he/ she
   must decide when, where from and how to acquire funds to meet the
   firm’s investment needs.
3. Dividend decision
   The finance manager must decide whether the firm should distribute
   all profits, or retain them, or distribute a portion and retain the
   balance. The proportion of profits distributed as dividend is called
   the dividend payout ratio and the retained portion is known as the
   retention ratio.
4. Liquidity decision.
   Investment in current assets affects the firm’s profitability and
   liquidity. Current assets should be managed efficiently for
   safeguarding the firm against the risk of illiquidity. The
   profitability liquidity trade off requires that the financial
   manager should develop sound techniques of managing current assets.

1.3 Objectives of a Firm.

Profit maximization
A company is an entity which invests its resources so as to gain maximum
profit –this is a traditional objective of business or cardinal
objective. The business must make profits;

• To give a return to its owners(shareholders)
  The return must be satisfactory i.e. higher than the bank rate on
  savings account. The owners may pull out of the company if it is
  making losses.
• It must give a reasonable reward to employees –good salaries and
  benefits.

The company must make profits some of which should contribute to social
causes. Nevertheless this objective cannot be fully achieved under
perfect competition as a number of firms will
compete for a limited number of customers; also maximization of profits
must not be done at the expense of customer welfare i.e. the firm should
not achieve this objective by exploiting its customers as it owes them a
duty of care.

Wealth maximization/maximization of the net worthiness of a business.
This is achieved through retention of earnings and subsequent
reinvestment of these earnings in the business or other viable ventures
.this will boost the value of the company’s share as shareholders or
owners will receive better returns from such ventures. In this case the
net worth should be taken to be the total assets less its liabilities.

Social responsibility

Maximization of the welfare of its employees
Happy (contented) body of employees will boost the company’s production
thus sales and profits. The company must provide its employees with:-

• Reasonable salaries commensurate with the employees’ qualification,
  competence, experience and nature of the job.
• Transport facilities for those people performing sensitive jobs i.e.
  jobs which can hold others E.g. cashiers, accountants, storekeepers
  etc.
• Medical facilities for employees and their families. (To the
  employee such facilities will
• facilitate a healthy employee who can work better and avoid
  absences). To their families this is an incentive for the employees.
• Assurance of terminal benefits e.g. pension schemes or other
  retirement benefits- to ensure steady employees and boost their
  morale towards the company.
• Recreation facilities e.g. playgrounds, clubs- lower grade employees
  enjoy mixing with management which facilitates unity and harmony in
  the company and facilitates attainment of the company’s goals.

Interest of customers
A business must be mindful of its customers and must seek to retain them
and for this reason a business should:-

• Provide quality products
• Fair prices for the goods purchased i.e. customers should get a good
  value for their money.
• Have an honest dealing with customers i.e. to avoid bouncing them/il
  l treatments of customers should be avoided as these contribute to
  the company’s profitability.

Welfare of the society
A business owes a social responsibility to the society in such forms as:-

• Maintaining sound industrial relations with the society around it
• Avoiding harmful production processes e.g. avoiding pollution of
  environment.
• The company should contribute to the social cause e.g. in form of:-
  harambee donations ,building public clinics, recreational centers
  ,schools e.t.c.
• The company must identify itself with the society in as much as it
  must understand the problems of the society around it e.g. be aware
  of the society’s development needs and contribute to its attainment
• Fair dealing with suppliers of goods and finance

The company must:-

• Meet its obligations as and when they fall due.
• Avoid dishonor of any obligation and also double dealings in
  procurement of goods.
• The creditors also need assurance of the company’s ability not only
  to service the current obligations but also to be able to raise more
  internal equity to back their finances.
• Duty to the government

The company must:-

• Pay corporation taxes as and when they fall due.
• Operate within the government development plans e.g. banks and
  financial institutions which should operate within boundaries
  required by the central bank so as to facilitate development.
• Operate within legal system i.e. adhere to industrial requirements
  and ensure safety standards to its employees.