FINANCIAL MANAGEMENT

Professor: Gheorghe Militaru / gheorghe.militaru@upb.ro

Assistant Professor: PhD student Ioanid Alexandra

Requirements:

1. The final grade will be determined by the final exam (written exam
max 50 points / % of the final grade = 50%

2. The attendance and class participation of each individual is essential

for assessment / The seminar performance (presence, test and activity
max 20 points) / % of the final grade = 20%

3. Each student will have to present two homework to be evaluated in

laborator classes / two homework 2 x (max 15) = 30 points / % of
the final grade = 30%
Minimum passing requirements:
Submission of two homework
Scoring 50% out of total points

INFORMATION ABOUT THE PROJECT

The two homework:

I. An analysis of financial ratios using the balance sheet and financial statement
(profit and loss account) of a company;

II. Capital budgeting decision criteria - Net Present Value (NPV), Internal Rate
of Return (IRR), Profitability Index (PI) and Payback Period (PP).

NPV is defined as the present value of the stream of expected net cah flows from
the project minus the projects net investment / A project is accepted if its NPV is
greater than or equal to zero

IRR the discount rate that equals the present value of the expected net cash
flows from a project with the present value of the net investment

PI the ratio of the present value of expected net cash flows over the life of the
project to the net investment / If a project has a PI equal to or greater than 1,0, it
is acceptable

PP is the period of time required for the cumulative cash inflows (net cash flows)
from a project to equal the initial cash outlay

MAIN TOPICS TO BE COVERED (half-year / semester)

Balance Sheet, Financial Statement and Cash Flow

Financial Statements Analysis and Long-Term Planning
Discounted Cash Flow Valuation
How to Value Bonds and Stocks
Net Present Value and Other Investment Rules
Risk Analysis, Cost of Capital and Capital Budgeting
Dividends and Other Payouts
Leasing
Option and Corporate Finance
Short-Term Finance and Planning
Mergers and Acquisitions
Financial Distress (Bankruptcy, Reorganization, The Marginal Firm)

BIBLIOGRAPHY (recommendations):
1. Ross, S.A., Westerfied, R.W, Jaffe, J., and Jordan, B.D., Modern Financial
Management, McGraw-Hill, 2008
2. Brealey, R.A., Fundamentals of Corporate Finance (Third Edition), McGrawHill, 2001
3. Militaru, Gh., Management financiar. Aplicatii, Ed. POLITEHNICA Press,
Bucuresti, 2013

FINANCE
Business Finance
Financial Management

FINANCE

Financial Economics

Corporate Finance
Financial Markets
Financial Institutions

Capital Markets
Money Markets

Financial Instruments
Investments

Securities Analysis
Portfolio Theory
Market Analysis

Personal Finance

Public Finance

Behavioral Finance
Finance has a strategic role within the company through raise
funds, invest in assets and manage them wisely. A firms value is
dependent on its growth opportunities, which in turn are
dependent on the firms ability to attract capital

IMPORTANCE OF FINANCIAL MANAGEMENT

Finance is about the efficient use of money for firms or individuals

Objective of Financial Management:

Maximization of shareholders/owners wealth, and this means maximizing the firms stock
price

Shareholders wealth is defined as the present value of the expected future returns
to owners of the firm (e.g., the market value of the shareholders common stock
holdings)

The market value of a firms stock is determined by the magnitude, risk, and timing
of the cash flows, the firms is expected to generate (investments, financing or
dividend)

Major areas of business finance:

Financial analysis and planning (forecasting the future - income and expenses)
Working capital management (short-term assets and liabilities)

Capital Budgeting ( what assets to buy)

Capital structure (how the firm finances its operations)

DIAGNOSING THE FINANCIAL HEALTH OF A BUSINESS

What will you learn?

How to evaluate the performance of a business with reference to its financial reports

How to conduct financial analysis by integrating information across its balance sheet,
income statement and cash flow statement

How to identify early warning signs of potential financial difficulties in a business

How to assess risks in a business by reference to its financial reports

How to identify the assumptions and estimates that are made by managers in
constructing their financial reports and assess the implications for interpreting the
performance of a business

How to measure and interpret the sustainable growth rate of a business

How to measure the operating cash cycle of a business and assess the implications for
the funding needs of the business

How to determine if a firm is generating appropriate returns on its assets and for its
owners

CONTEXT

The goal of financial management is to maximize the current

value per share of the existing sock

CONTEXT

ASSETS

Firms must manage four types of assets to be successful:

Physical assets buildings, land, furniture, computers, vehicles, equipment, and so on

Financial assets cash, financial resources, stocks, bonds or debts, and so on

Intellectual property assets - patents, operating processes, copyrights, trademarks,
information systems, designs, and so on
Human assets individuals with their talents, capabilities, experience, professional
expertise, relationships, and so on

Human capital is the collective value of the capabilities, knowledge, skills, life
exeprinces, and motivation of an organizational workforce

Intellectual capital reflects the thinking, knowledge, creativity, and decision

making that people in organization contribute

Real assets assets used to produce goods and services (tangible machinery,
equipments, other are intangible - trademarks, patents or technical expertise)

FINANCIAL ASSETS

Financial assets refers to the income generated by real assets (the

company sells financial assets to obtain the necessary money)
Example: If a company borrows money from the bank (the bank has a financial asset)
the financial assets gives it a claim to a stream/series of interest payments and to
repayment of the loan
The companys real assets need to produce enough cash to satisfy these claims !!!

Financial markets markets in which financial assets are traded / markets in

which the company raises cash
2
Firms
operations

4.

Financial
markets

Company

3
1.
2.
3.

The flow start when financial assets are sold to raise cash
The cash is used to purchase the real assets used in the firms operations
Later, if the company does well, the real assets generate enough cash inflow to more than
repay the initial investment
The cash is either reinvested or returned to the investors who contributed the money in
the first place

FINANCIAL ASSETS
CASH FLOW FROM THE FIRM TO THE FINANCIAL MARKETS AND
BACK AGAIN

Firm invests in
assets
Current assets
Fixed assets

Cash for securities

issued by the firm

Financial markets:
Retained
cash flows
Cash flow
from firm

Dividends
and debt
payments

Short-term debt
Long-term debt
Equity shares

Taxes

Total Value of Assets

Government

Total Value of the Firm

to Investors in the
Financial Markets

FINANCIAL DECISIONS
Financing decision how to raise the money to pay for investments in real assets
FINANCIAL DECISIONS:
I. Capital budgeting making and managing expenditures on long-lived assets
/ the firms investment (how much money should the firm invest/ which assets
to buy. and how to pay for them)

II. The firms capital structure represents the proportions of the firms
financing from current and long-term debt and equity

III. Net working capital is defined as current assets minus current liabilities.
There is often a mismatch between the timing of cash inflows and cash outflows
during operating activities. Financial managers must attempt to manage the gaps
in cash flow - short-term finance

Capital structure decision the choice of the long-term financing mix

Capital markets the markets for long-term financing

Capital refers to the firms sources of long-term financing

ORGANIZING A BUSINESS

The firm is a way of organizing the economic activity of many individuals.

A basic problem is how it raise cash

Form of business organization:

The sole proprietorship is a business owned by one person / all profits of the
business are taxed as individual income
Advantages: this business form is easy and inexpensive to establish

Disadvantages: (1) the owner of the firm has unlimited personal liability for all
debts, and (2) the owner has difficulty raising funds to finance growth (sole
proprietorships generally are small)

The partnership two or more people can get together/ each partner provide a
certain percentage of the funds necessary to run the business/ the partners share in
the profits (or losses) of the business:
Advantages: low cost and ease of formation
Disadvantages: (1) unlimited liability, (2) limited life of the organization, (3)
difficulty of transferring ownership, and (4) difficulty of raising large amounts of
capital

ORGANIZING A BUSINESS

The partners can potentially lose all of their personal assets, even assets not invested in the
business (each partner is liable for the businesss debts) !!!!!!!!!

Corporations is a legal entity created by a state, and it is separate and distinct

form its owners and managers
Advantages: (1) unlimited life (business can continues after its original owners and managers
are deceased), (2) easy transferability of ownership interest (e.g., shares of stock can be
transferred for more easily), (3) limited liability (losses are limited to the actual funds
invested)
Disadvantages: (1) corporate earnings may be subject to double taxation (the profit of the
corporation is taxed and then dividends are taxed again as income to the stockholders), (2)
setting up a corporation is more complex and time-consuming than for a proprietorship or
a partnership

The value of any business will be maximized if it is organized as a corporation for

the following reasons:
Limited liabilities reduces the risks borne by investors the lower the firms risk, the higher its value

A firms value is dependent on its growth opportunities, which in turn are dependent on the firms
ability to attract capital. Corporations can attract capital more easily than other kind of businesses.

ORGANIZING A BUSINESS

Hybrid forms of organization

1. Limited partnership limited partners are liable only for the amount of their investment in
the partnership, while the general partners have unlimited liability

2. Limited liability partnership (LLP) where partners enjoy limited liability with regard to the
businesss liabilities

LLP - general partnership all partners agree to provide some fraction of the work and cash
and share the profits and losses. Each partner is liable for all of the debts of the partnership/
general partners have unlimited for all debts

Agency problem

An agency relationship arises wherever one or more individuals, called principals, hire another
individual or organization, called an agent, to perform some services and delegate decision-making

An agency problem is a potential conflict of interests that can arise between a principal and an
agent. Two important agency relationships are (1) those between the owners of the firm and its
management and (2) those between the managers, acting for stockholders, and the debt-holders

SOURCES OF CAPITAL

How a company can obtain financing (financing methods):

Debt Financing / obtaining borrowed funds for the company (usually a loan) / debt
financing requires that some asset be used as collateral (e.g., car, house, or land) /
commercial banks
!

The entrepreneur need to pay back the amount of funds borrowed as well as a fee
expressed in terms of the interest rate (the funds are repaid from the resulting sales and
profit)

Equity Financing does not require collateral and offers the investor some form of
ownership position in the venture
! Usually, an entrepreneur meets financial needs by employing a combination of debt and

equity financing

Internally generated funds can come from several sources within the company : profits,
sale of assets (little-used assets), reduction in working capital, extended payment terms, and
accounts receivable
! A final method of internally generating funds is collecting bills (accounts receivable) more
quickly

SOURCES OF CAPITAL

Personal funds (new ventures) are the least expensive funds in terms of cost
and control. They are essential in attracting outside funding, particularly form
banks, private investors, and venture capitalists (entrepreneur need to be
committed to the venture)

Family and friends are a common source of capital for a new venture.
Family and friends provide a small amount of equity funding for new ventures (if
is in form of equity financing - the family and friends have an ownership position in
the new venture)

Venture capital is a long-term investment. In each investment, the venture

capitalist takes an equity participation through stock, warrants, and convertible
securities and has an active role in the monitoring of each portfolio company,
bringing investment, financing planning, and business skills to the firm (equity
participation taking an ownership position)

SOURCES OF CAPITAL

Business angels are entrepreneurial individuals who provide capital in return for a
proportion of the company equity. They take a high personal risk and provide not
only finance but experience and business skills

Crowdfunding is the practice of funding a project or venture by raising monetary

contributions from a large number of people, typically via the internet
The crowdfunding model includes: the project initiator who proposes the idea
to be funded, individuals/groups who support the idea, and a moderating
organization (the platform) that brings the parties together

Cash flow from operations depends largely on two factors: (1) accounts receivable
(money owed by customers) and accounts payable (money owed to suppliers)

FINANCIAL MARKETS

Firms offer two basic types of securities (certificates) to investors. Corporate securities
represent claims against the assets and future earnings of the firm:

(1) debt securities contractual obligations to repay corporate borrowing

(2) equity securities shares of common stock and preferred stock that represent noncontractual claims to the residual cash flow of the firm

Financial markets are vehicles through which financial assets are bought, sold, and traded.
They are composed of the money markets and the capital markets:
Money markets are for debt securities that will pay off in the short term (usually less than one
year)
Capital markets are for long-term debt (with a maturity of over one year) and for long-term
shares

The primary market is used when corporations and governments initially sell securities ( a
company sells securities to raise cash)

Secondary markets provide the means for transferring ownership of corporate securities /
one owner or creditor selling to another a security

Question and topics for discussion

Question: What are the differences between the operating income, capital
gains income, and dividend income of a corporation?

Application: During the past year , Star Inc., had sales of 3 million RON, cost
of goods sold of 1.8 million RON, operating expenses of 0.8 million RON, and
interest expenses of 0.2 million RON. Star Inc. paid common stock dividends of
0.1 million RON during the year. What is the gross profit margin, operating
earnings before interest and taxes and earnings before tax (taxable income)?