This is a complete and comprehensive summary of modules 1, 2 and 3 of the FTX 2024 - Financial Management course. It contains everything you need to know to fully understand these sections, which are the building blocks for the rest of the course. Ideal for keeping up during the semester and for te...
Role of the Financial Manager
• Uses quantitative tools and analyses to make financial decisions that create
value for the firm’s owners (maximise firm value or shareholder value/wealth).
• Maximising firm value is about cash-flows:
- Firm generates cash inflows by selling goods and services produced by its
productive assets and human capital.
- Firm is successful in creating value when cash inflows > cash outflows
needed to pay operating expenses, creditors and taxes.
- Firm pays the residual cash flows (remaining cash) to the owners as cash
dividends or reinvests them in the business.
- Failure to generate sufficient cash flows results in bankruptcy or insolvency.
Firm then requires business rescue or liquidation.
- The value of any asset is determined by the future cash flows it will
generate, through use or sale.
• Stakeholders = Any person with a financial claim or interest in the firm.
• Shareholders = Stakeholders who have an ownership claim in the firm.
• To create firm value, financial managers make 3 fundamental decisions.
• Capital budgeting or investment decision:
- Also known as capital expenditure (CAPEX) decision.
- Involves deciding what productive assets to buy (tangible and intangible).
- The decision rule = Accept investment project if the value of future cash
inflows exceeds the cost of the project.
- Considered the most important decision because:
(1) Productive assets generate most of the firm’s cash inflows (firm value).
(2) Decisions are long-term.
, (3) Decisions involve huge cash outlays. Mistakes mean huge financial
losses. E.g. Daimler-Benz and Chrysler’s “worst merger of all time”.
- Affects non-current assets in the SOFP.
• Financing or capital structure decision:
- Determines how productive assets are finance.
- Involves trade-offs between the advantages (interest on debt is a tax
deductible expense) and disadvantages (more debt comes with greater
risk) of debt and equity financing – the optimal mix must be selected.
- Ways of raising equity finance:
(1) Share issue.
(2) Reinvesting residual cash flow.
- Bad financing decisions can destroy firm value, especially if the firm faces
liquidation if it is unable to meet its financial obligations.
- Affects non-current liabilities and shareholder’s equity in the SOFP.
• Working capital management (WCM) decision:
- Determines how day-to-day financial matters, current assets (inventory,
accounts receivable, cash) and current liabilities in the SOFP are managed.
- Seeks to maximise firm value creation (investing idle cash to earn interest)
and minimise destroying value.
- Mismanagement can cause bankruptcy, even if the firm is profitable.
- Net working capital = Current assets – Current liabilities.
Forms of Business Organisations
• Sole proprietorship or sole-trader business:
- Unincorporated (legally, the business does not exist separately from the
owner, both entities are treated as one and the same).
- Owner-managed.
- Most common type of business.
- Advantages:
(1) Easy and cheap to from.
(2) Least regulated.
(3) Business income is taxed once as the personal income of the owner.
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