Managing the finances of a corporation can be complex and involved and requires capable and experienced financial leadership and management. Corporations seek to provide a return on investment to stockholders and need money to finance daily operations and long term plans. Managerial finance is made up of the investment decisions financial managers make. These can be decisions about dividend policy, capital spending, funding of long and short term projects and managing long and short term debt. Financial managers also have to balance their decisions with the risk involved. Financial managers use specific tools and techniques to make investment decisions and evaluate and assess the appropriate techniques based on company strategy and current economic conditions.
Keywords Abandonment Option; Bankruptcy Risk; Debt; Debt Financing; Equity; Equity Financing; Finance; Financial Managers; Net Present Value; Pecking-order; Present Value; Working Capital
Finance: Managerial Finance
Finance looks at how businesses make, use and deploy financial resources. Managerial finance considers the challenges of the financial manager who must make decisions about the techniques used to manage company finances. The decisions that the financial manager makes affect the ability of the company to adequately use its cash and liquid assets, raise funds when needed and make investment moves that benefit stockholders.
Faulkender & Wang (2006, p 1957) note that investors and shareholders care about the amount of cash that a firm has because "corporate liquidity enables firms to make investments without having to access external capital markets." In this way, companies avoid transaction costs. Companies have an objective to produce a positive financial result to ensure the continuation of the company and to provide value to investors and stockholders. When a company is publicly owned, it is important that companies make decisions that are not simply in the interest of internal stakeholders but that consider the objectives of external stakeholders such as stockholders and financial analysts. These external stakeholders are interested in predicting the profitability of a company for investment reasons.
There are two techniques of financial analysis involved in security selection and valuation. These include fundamental analysis and technical analysis.
- Fundamental analysis involves researching industry information, financial statements and other factors to determine the true value of a firm.
- Technical analysis is tracking trends and patterns that might exist in stock price.
In order to make corporate investment decisions, financial managers must understand the time value of money, capital budgeting, capital structure and dividend policy. In addition, financial managers face the problem of dealing with and making decisions about risk and return. Risk is the chance that you will get a result other than the one you expected. Other topics financial managers consider include capital budgeting, raising capital, cash flow techniques, market efficiency and the capital asset pricing model (CAPM). One technique used by financial managers is that of discounted cash flow (DCF). French (2013) provides an overview of how the DCF model is used quarterly. This technique makes sure that companies examine the income produced by capital investments.
Market efficiency can refer to economic efficiency or information efficiency.
- Economic efficiency has to do with how funds are allocated or directed and what the transaction cost is for these positions.
- Information efficiency refers to the availability of critical information related to investments and transactions.
Besley & Brigham (2001) note three types of information efficiency: Weak, semi-strong, and strong. Each refers to the relative strength of information related to price, price movement and how useful that information is in relation to the return on investment. The capital asset price model (CAPM) relates risk to return when considering the value of a stock. Morgenson & Harvey (2002) noted that CAPM is a model for the pricing of risky securities.
Time Value of Money
The time value of money is a statement of how one feels about money. It is the notion that a dollar today is worth more than the promise of a dollar in the future. Financial managers must observe how money reacts over time in order to decide the best use of money and what investments make sense. If a company has money tied up in investments, there is a cost that the company incurs because that money is not available to do something else. There are certain benefits of capitalizing on time. "Equity market timing" is "issuing shares at high prices and repurchasing at low prices" (Baker & Wurgler, 2002).
Capital budgeting is the process of analyzing various investment alternatives in machinery and equipment and is used for planning long term acquisitions of capital assets. Although capital equipment may be useful for a company, the cost has to be balanced against the reward. For example, a manufacturing company may be in a position where old equipment is costing the company money because of high repair and maintenance costs and lost production. In addition, the older equipment might present a safety cost to employees and maintenance workers and may interfere with worker productivity because employees spend a lot of time dealing with equipment breakdowns. Similarly, a company may decide to invest in new equipment but it may be costly, there may be long lead times on the equipment and it may take a long time to get a return on the capital investment. Ghahremani, Aghaie, and Abedzadeh (2012) studied the effectiveness of various capital budgeting techniques over four decades and argue for the importance of adopting the real option approach to capital budgeting decisions.
Capital structure refers to the framework a company uses to generate financing for assets. Companies may choose to use debt or equity financing or some combination of the two. When raising capital, a financial manager has many options. Companies can use internal money for projects or can turn to venture capital firms or banks. Loans can be obtained either as short term, working capital loans or long term loans.
A dividend is money that is paid out of a company's profit to holders of stock. Dividend policy describes how a company will decide whether or not to pay dividends. Dividends are typically paid quarterly and can be paid out in cash or more stock to the stockholders. One of the measures of dividend policy used by financial managers is dividend yield. Dividend yield is a function of the annual dividend per share divided by the price per share (Morgenson & Harvey, 2002).
Cash Flow Analysis
An analysis of cash flow examines the in and outflows of cash and whether or not enough cash is available to meet company needs. Companies can breakeven, have a positive cash flow or net loss of cash. Projecting cash flow can prevent uncomfortable shortfalls which may result in borrowing or otherwise changing the company's financial position. However, excessive cash can uncover other signs of mismanagement. Financial managers may make changes in product prices or analyze where costs are coming from to identify the business units that generate the most in cost. Some companies find cash relief by improving their ability to collect on bills. That is why some companies employ collections agencies as an adjunct to their own accounts receivable personnel to collect stubborn, delinquent accounts. Other companies may look for ways to increase sales to bring in more cash. Financial managers also find ways to create cash reserve to prevent restrictions on company activities due to lack of cash flow.
The financial markets in which the marketplace invests, buys and sells fall into the categories of markets for goods and services, financial assets, money balances, and resources (Schenk, 1997). The financial manager may deal with external parties in the course of investing or seeking financing. These institutions include banks, insurance companies and investment brokerages.
Financial managers are responsible for acquiring needed funds for the company and positioning these funds so that they will be invested in projects that will maximize the return on investment and the enhance the value of the company.
It may sound as if the job of a managerial finance professional is an easy one and that each...
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