Financial Management for Businesses

Prof. dr. Anamaria Ciobanu

For you, to reflect upon..

The future is for those which are coming out in front in the periods when the others are staying.
(Nordstrom & Ridderstrale Funky Business Forever)

The greatest power that a person possesses is the power to choose.

J. Martin Kohe (Hal Urban - Life's Greatest Lessons)

Lectures themes
Basics in Financial Management and the Business Plan Ratio analysis and Break Even Analysis Working Capital Management Cash Budgeting Financial Statements Forecasting Analysis of long term financing decisions. Cost of equity Cost of credits (loans and bonds). Cost of leasing. Capital optimal structure and the company value

The final exam and the final mark

you can get 60% of the final mark at the final exam
Exam structure: 3 problems (3 point each). 1 point is granted by delivering the exam paper .

.and 40% depends on the marks youll get at seminar (attendance (10%), project (20%) and 1 test(10%))

Suggested Readings
R. Brealey, S. Myers. Principles of corporate finance McGraw-Hill New York, 2003, (658.15 BREm, Nicolae Iorga reading room) R.A. Brealey, S.C. Myres, A.J. Marcus Fundamentals of Corporate Finance, Mc Graw Hill, 2004, (658.15 BREm, Nicolae Iorga reading room) S. Ross, R. Westerfield, J. Jaffe Corporate Finanace, Irwin, 2005 (658.15 ROSc2005, Nicolae Iorga reading room) Sulock J.M, Dunkelberg J.S. Cases in Financial Management, 2nd ed., John Wiley & Sons, 1997

The Decisions that Create Shareholder Value

CORPORATE INVESTMENT DECISIONS

CORPORATE FINANCING CHOICES

CORPORATE PAYOUT POLICIES

CORPORATE RISK MANAGEMENT

CREATING CORPORATE ECONOMIC VALUE

The Goal of Financial Management

What are firm decision-makers hired to do?
General Motors is not in the business of making automobiles. General Motors is in the business of making money. Alfred P. Sloan

Possible goals: Size, market share, profits Three equivalent goals of financial management:
Maximize shareholder wealth Maximize share price Maximize firm value

The Goal of Financial Management

Value-based management drives our performance targets and incentives. We have set ambitious short and medium-term financial and operating targets and, to help meet these, have aligned the interests of management and employees with those of our shareholders and customers. Our incentive systems are linked to key aspects of shareholder value, such as margins and asset productivity. Our strategic focus is centered on profitable growth, better margins through innovation and higher productivity, improved asset management, and turnarounds in operations whose past performance has not been world class.

One companys statement

Principles of Corporate Finance

Which are the question we can answer with the help of corporate finance? Brainstorm session: 5 minutes!

Corporate Finance
By studying corporate finance we get answers to these four important questions for a financial manager: What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment? How will we manage the everyday financial activities of the firm? How much annual companys profit we should distribute as dividends?

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?

Four important corporate finance principles!

Make good investments! Find the right resources to finance your business! Distribute well the companys profits! Manage efficiently your assets!

Corporate finance principles ..make good investments!

In which investment projects we should invest? How we substantiate our investment decision? Brainstorm session: 5 minutes!

Corporate finance principles ..make good investments!

Investment Principle: Invest in projects that yield a return greater than the minimum acceptable hurdle rate (required rate of return)
Returns on projects should be measured in terms of cash flows generated and the timing of these cash flows The hurdle rate should be higher for riskier projects and reflect the financing mix used (debt or equity)

Corporate finance principles ..make good investments!

Buy real assets that are worth more than they cost
Investment return have to be higher than the cost of funds we use to finance them!

Corporate finance principles Find the right resources to finance your business!
How we substantiate our financing decision? Which are the factors we have to take into account we choose between various types of funds (resources)?

Brainstorm session: 5 minutes!

Corporate finance principles Find the right resources to finance your business
The Financing Principle: Choose a financing mix that minimizes the hurdle rate (required rate of return) and matches the assets being financed
Is there an optimal financing mix and, if so, what is it? Debt is beneficial as long as the marginal benefits exceed the marginal costs

Corporate finance principles Manage efficiently your assets!

What means an efficient management of the companys assets? Give some examples of assets for which an efficient management it is crucial for the companys activity! Brainstorm session: 5 minutes!

Corporate finance principles Manage efficiently your current assets!

An efficient management of the companys assets imply:
The companys resources are tide up in its current assets for a short period of time! A higher return of the companys current assets than the cost of funds used to buy them! Types of current assets: Raw materials Accounts receivables Cash and bank accounts

Corporate finance principles Distribute well the companys profits!

How we substantiate our dividend decision? When we should reinvest the companys annual profit? When we should distribute the companys annual profit to its shareholders? Brainstorm session: 5 minutes!

Corporate finance principles Distribute well the companys profits!

The Dividend Principle: If there are not enough investment projects that earn the hurdle rate (the rate of return the investors demand), return the cash to stockholders (distribute dividends!)

Goal Of Financial Management

What should be the goal of a corporation? Maximize profit? Maximize cash flows? Minimize costs? Maximize market share? Maximize the current value of the companys stock? Employee well-being? Protect interests of all stakeholders?

Goals of the Corporate Firm

The traditional answer is that the managers of the corporation are obliged to make efforts to maximize shareholder wealth.

Goals of the Corporate Firm

In traditional corporate finance, the objective in decision making is to maximize the value of the firm. A narrower objective is to maximize stockholder wealth. When the stock is traded and markets are viewed to be efficient, the objective is to maximize the stock price. All other goals of the firm are intermediate ones leading to firm value maximization, or operate as constraints on firm value maximization.

Maximizing shareholder wealth vs. maximizing profits

Maximizing shareholder wealth is better than maximizing profits for three reasons: Maximizing profits does not take the time value of money into account (a dollar today is worth more than a dollar tomorrow) Maximizing profits does not take risks into account (a riskless dollar is worth more than a risky one) Accounting numbers, such as profits, can easily be manipulated

Goals of the Corporation

Market-oriented economies
Anglo-Saxon countries (Canada, U.S., U.K., Ireland, Australia etc.) Emphasis on shareholder value maximization

Network-oriented economies
Emphasis on interests of all stakeholders

Goals of the Corporation

Does this mean we should do anything and everything to maximize owner wealth? Does a firm have responsibilities to society at large? Is the goal of maximizing shareholder wealth good or bad for society at large?

The Criticism of Firm Value Maximization

Maximizing stock price is not incompatible with meeting employee needs/objectives. In particular:
- Employees are often stockholders in many firms - Firms that maximize stock price generally are firms that have treated employees well.

Maximizing stock price does not mean that customers are not critical to success. In most businesses, keeping customers happy is the route to stock price maximization. Maximizing stock price does not imply that a company has to be a social outlaw.

Why Maximize Stockholder Wealth?

Stock price is easily observable and constantly updated (unlike other measures of performance, which may not be as easily observable, and certainly not updated as frequently). If investors are rational (are they?), stock prices reflect the wisdom of decisions, short term and long term, instantaneously. The objective of stock price performance provides some very elegant theory on:
how to pick projects how to finance them how much to pay in dividends

The role of Financial Manager

I will get my money back?

Creditors
How performing is the investment we made in the stocks of this company?

How performing is the company we run?

Shareholders

Management

The Role of The Financial Manager

Capital Budgeting Decisions Financing

(2)

(1)

Firm's operation s
Real assets

Financial Manager
(3)

(4a)

Investors

(4b)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors

The Financial Manager

To create value, the financial manager should: Try to make smart investment decisions. Try to make smart financing decisions.

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

Increased growth and size are not necessarily the same thing as increased shareholder wealth.

The Agency Problem

Agency problem
Conflict of interest between principal and agent

Will managers work in the shareholders best interests?

Agency costs Direct agency costs:Management compensation Indirect agency costs: monitoring managers and suboptimal decisions.

Managing Managers
Managerial compensation
Incentives can be used to align management and stockholder interests The incentives need to be structured carefully to make sure that they achieve their goal

Corporate control
The threat of a takeover may result in better management

Takeovers as a Solution to Agency Problems

There is a conflict of interest between shareholders and managers of a target companyEg poison pill defenses Individual owners do not have suffcient incentive to monitor managers The threat of a takeover helps to keep managers on their toesoften precipitates restructuring.

As a result.

We need to know how to analyze a company in terms of financial performance and creditworthiness!

 Questions?

Thank you for your attention!