Functions of Financial Manager

Functions of financial Manager

Finance works as a blood for an organization, without finance it is not possible to run any business. Every business organization requires managing and ensuring effective use of funds and financial resources. But question is who will manage these funds. It is financial manager’s responsibility to manage funds (collection and proper use of funds). Managing funds is the main functions of financial manager.

role of financial manager

Financial Manager:

Financial Managers are those who mainly deal with financial resources and make decision about financial matters. Every decision taken by financial managers is concerning with investing and financing.

Basically the functions of financial manager can be categorized into three main functions. These are:
•    Capital structure decision
•    Investing and Financing Decision
•    Decision about dividend policy

functions of financial manager
Capital Structure Decision:

The main function of financial manager is to form an optimal capital structure for the organization. Optimal capital structure depends on the type of company and its financial capability. Capital structure means the ratio of debt and equity. Financial manager set the proportion of debt and equity for a company. It can be 50/50 ratio or 60/40, or 70/30, or 55/45, or others according to the decision of managers.

Investing and Financing Decision:

Financial managers always concern about the cost of collecting funds and the return on the invested capital. Where cost is less, fund should be collected from there. And where return is maximized with lower or moderate level of risk, funds should be invested there. So it’s financial manager’s responsibilities to make the right choice which can brings profit for the company.

Dividend Policy:

When companies make profit, a question arise there that whether profit will be distributed or not. If distributed then what proportion of profit will be distributed among the shareholders and what will be kept as a retained earnings. As a function of managing funds financial manager make decision about dividend policy.

In addition to these there are many functions/ roles that financial manager does. Some of these functions are given below:

  • Identifying what amount of funds is required for the company.
  • Managing working capital which is mainly deals with short tern asset and liabilities.
  • Cash forecasting that is forecasting of cash inflow and outflows.
  • Provides required fund to every departments of the company.
  • Ensuring optimal use of the financial resources.
  • Ensuring substantial growth of the company.
  • Buying and selling of financial assets.
  • Valuation of company’s stock.
  • Maximizing the wealth of the company by increasing the stock price in the  market.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Agency Cost

What is Agency Cost and who bears them?

An agency cost is the cost of reducing agency conflict among the owner/ principal (stockholders) and managers (agent). We can also say the cost which is bears by the company to reduce the agency conflict is basically known as agency cost and this cost must be maintained by the respective parties or by the company. To reduce agency conflict some effective measure can be taken which is cost worthy.

Managers can be encouraged to act in the stockholders best interests through incentives, constraints, and punishments. But these tools are effective only if shareholders can observe all of the actions taken by managers. A moral hazard problem, defined here as a situation in which agents take unobserved actions in their own interests, arises because it is virtually impossible for shareholders to monitor all managerial actions. To reduce agency conflicts and the moral hazard problem, stockholders must incur agency costs, which include all costs designed to encourage managers to maximize shareholder wealth rather than act in their own self-interests.

agency cost

Agency Cost

There are three major categories of agency costs:

  1. Expenses to monitor managerial actions, such as audit cost,
  2. Expenditures to structure the organization in a way that will limit undesirable managerial behavior, such as appointing outside investors to the board of directors, and
  3. Opportunity costs which are incurred when restrictions, such as requirements for stockholders to vote on certain issues, limit the ability of managers to take timely actions that would contribute to shareholder wealth.

 Agency costs must bear by shareholders. In the absence of any effort whatever to affect managerial behavior, and hence with zero agency costs, there will almost certainly be some loss of shareholder wealth due to improper managerial actions. Conversely, agency costs would be very high if shareholders attempted to ensure that every single managerial action coincided exactly with shareholder interests. Thus, the optimal amount of agency costs to be borne by shareholders should be viewed like any other investment decision.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Conflict Between Shareholders and Creditors

What kind of agency conflict between share holders and creditors may exist?

Conflict between shareholders and creditors is common for the company which use debt capital to form an optimum capital structure. Agency relation exist when one party works as an agent of the principal. In an organization management works as a agent of owner or share holders. When managers work for the company they can be influenced by the own interest so that they prefer their own interest rather than the interest of the company, on the other hand creditors interest is to provide credit and get the principal amount and interest timely. For ensuring their credit return creditor always concerned whether the company is doing business in the right manner or not. By monitoring the financial performance of the company creditors actually want to ensure their interest. So if there is any dispersion then creditors works to resolve the issue by taking necessary steps.

Conflict between Shareholders and creditors

Conflict between Shareholders & Creditors

Creditors have a claim on part of the firm’s earnings stream as well as a claim on the firm’s assets in the event of bankruptcy. However, the stockholders have control through the firm’s managers of the decision that affect the profitability and risk of the firm. Creditors lend funds at an specific rate which is based on the several factors. These are:

  1. On the riskiness of the firm’s existing assets,
  2. On expectations concerning the riskiness of future asset additions,
  3. On the firm’s existing capital structure (that is, the amount of debt financing used), and
  4. On expectations concerning future capital structure decision.

These are the primary determinants of the riskiness of a firm’s cash flows and hence its debt, so creditors base their required rates of return on these factors.

 Now suppose the stockholders, acting through management, have the firm take on a large new project that has a greater risk than was anticipated by creditors. This increased risk will cause the required rate of return on the firm’s debt to increase, which in turn will cause the value of the outstanding debt to fall. If the risky capital investment is successful, all of the benefits will go to the firm’s stockholders, because creditors’ returns are fixed at the old, low-risk rate. However, if the project is unsuccessful, the bondholders will have to share in the losses.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Agency Conflict

What is agency conflict?

Agency conflict is a common problem we face in an organization, this problem arises because of difference in interest of management, owner and other related parties. An agency relationship arises whenever one or more individuals hire other individuals to perform some service and also delegate decision making authority to the agents. Here the hiring parties is principal and hired individuals are agent.

agency conflict

Agency Conflict

A potential agency conflict exists whenever a manager owns less than 100 percent of the firm’s common stock. If the firm is a proprietorship manager by the owner, the owner-manager will take actions to maximize his or her own welfare, or utility. The owner-manager will probably measure utility primarily by personal wealth, but other factors, such as leisure time and perquisites, will be considered. However, if the owner-manager sells some of the firm’s stock to outside investors, a potential conflict of interest, called an agency conflict, arises. For example, the owner-manager may now decide to lead a more relaxed life and not work as strenuously to maximize shareholder wealth because less of this wealth will accrue to him or her. Also, the owner-manager may decide to take more “business trips” to fun locations because some of the cost will now be borne by the outside shareholders.

 In most large corporations, potential agency conflicts are quite important, because managers generally own only a small percentage of the firm’s stock. In this situation, shareholder wealth maximization could take a back seat to any number of possible managerial goals.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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What is a Bond

What is a Bond?

A bond is a financial instrument used by the government or corporate to collect money from the market. It provides a fixed benefit to the bond holders periodically and also at the time of maturity. Although the use of bond as a financing instrument used in developed countries and is very popular around the world, but in Bangladesh the use of the bond not getting enough popularity yet.

By selling bond, borrowers make a contract with the buyer to pay interest and principal at the time of maturity. All provisions, terms & conditions are written in the bond indenture. Bond indenture is the written document where all terms are clearly mentioned which actually helps ensuring the right of the bond holders.

Basically a bond pays interest semi-annually to the bond holders at specific rate which is mentioned in bond indenture.

Bonds with the maturity of 10 years or more are considered as long term bond. The interest of bond is set on the basis of market interest rate. Every bond has coupon rate (except zero coupon bonds), maturity date, and face value (basically tk 1000). Some may have call provision and convertible features.

There is an inverse relationship between interest rate (market interest) and the price of the bond. Higher the interest rates lower the price of the bond and vice versa. We get the price of the bond through discounting the cash and capital gain received from the bond by the required rates of return. Normally large companies issue bond for the purpose of collecting long term funds from the market.

Basic Characteristics of Bond:

what is a bond

Characteristics of a Bond

From above mentioned issues we can draw some basic characteristics of bond, these are:

  • Bond is a long term financial instrument issued by the large companies to collect long term funds.
  • Every bond must have face value, maturity value, and coupon rate and maturity period.
  • It provides periodical benefit to the holders (basically for interval of six months).
  • The terms and conditions are written in the bond indenture.
  • Zero coupon bonds do not provide any coupon/interest. It provides benefit at the maturity where bond is issued at discount.
  • There is an inverse relationship between interest and price of the bond.
  • Callable or convertible feature is common for a bond.

Actually the characteristics of a bond is depends upon the types of bond which is being issued and where it is issued. Country to country the type and features of bond varies.

Basic Types of Risk

What are the Basic Types of Risk?

We know that future is uncertain, because of uncertainty; involvement of risk can be traced to our every part of life. When we talk about any investment we have to think about risk and return, higher the risk higher the rates of return and lower the risk lower the rates of return. Our life is directly related with economic activities where risk is the considerable element that cannot be overlooked.

To minimize the risk people go for savings and some people take the help of insurance companies/ agencies by paying insurance premium. Risk can be categories into different perspective but here we only discuss about the business risk.

Before discussing the types of risk, let’s have some idea of risk. Risk is the deviation between the actual outcome and expected outcome. Some risk can be minimized and some risk cannot be minimized. Some risk arisen from the micro economic factor and some from macro economic factors.

Basic types of risk that we may found are:

Basic Types of Risk

Basic Types of Risk

Unsystematic Risk

Unsystematic risk is that portion of risk which can be minimize through diversification of the investment by forming portfolio. If we form a portfolio using the negatively correlated investment securities then it would be possible to minimize the risk at lower level. This types of risk is known as diversiable risk Theoretically it is possible to eliminate the portion of unsystematic risk but in real sense it is not possible to eliminate the risk through diversification.

Systematic Risk

Systematic risk is that portion of risk which cannot minimize through diversification of the investments. Systematic risk is mainly arisen from the macro economic variables which are beyond our control. Beta is the measure of the systematic risk. Sometimes this risk is also known as systematic market risk. Sources of systematic risk are given below with short explanation.

Business Risk

Business risk is the risk which mainly arise when a firm or business organization unable to generate sufficient revenue to maintain its operating expenditure through providing service or selling products, that is risk is directly related with the operation of the firm.

Financial Risk

When a firm is unable to pay off its fixed financial obligation then this type of risk may arise. This type of risk is involved with the levered firm which uses debt capital for business. In some cases this risk can lead a lead a company to bankruptcy.

Liquidity Risk

This risk is involved with the marketability of a security or investment that is the capacity to generate asset into cash as much quicker as possible. If an investment is takes less time to convert into cash then it is liquid asset or investment.

Country Risk

Unstable political condition of a country is responsible for this type of risk. If this risk is more than an economy definitely fall, so does business. In our Bangladesh this type of risk is higher.

Exchange Rate Risk

Exchange of currency is required when a country is involved with import and export. For importing product or services foreign currency basically dollar is used. So if there is more fluctuation of the exchange rate frequently then a business may incur loss. This probable loss is the risk for the business.

Although every economic activity is involved with risk, we need to be more cautious to minimize the risk. If we can minimize the risk of doing business then it will be possible to generate profit for the company/ business organization.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Perfect Capital Market

What is meant by a perfect capital market?

If a capital market has the following characteristics then it would be considered as perfect capital market. In perfect capital market case, assuming complete markets, perfect rationality of agents and under full information, the equilibrium occurs where the interest rates clear the market, with the supply of funds equal to the demand.

  1. There are no transaction (brokerage) costs.
  2. There are no taxes.
  3. There are large numbers of buyers and sellers, so the actions of no one buyer or seller affect the price of the traded security.
  4. Both individuals and firms have equal access to the market.
  5. There is no cost to obtain information, so everyone has the same information.
  6. Everyone has the same (homogeneous) expectations.
  7. There are no costs associated with financial distress.

What role does the perfect capital market assumption play in financial theory?

perfect capital marketRoles of perfect capital market assumption

Clearly most of these assumptions do not hold in the real world-taxes and brokerage costs exist, individuals often do not have the same access to markets as corporations, managers often have more information about their firms’ prospects than do outside investors and so on. Still, a theory should not be judged on the reality of its assumption, but rather on how consistent its predictions are with actual behavior. If a theory seems reasonable and is consistent with behavior, then the theory will generally be accepted, regardless of the realism of its assumption. Often the assumptions do not limit the ability of the theory to explain real world phenomena.

For example, although taxes certainly exist, there may be enough tax exempt institutions with sufficient capital to produce the results predicted by a theory that assumes zero taxes.

Standard Deviation is Better Measurement

Why standard deviation is better measurement for risk?

In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard deviation is also known as historical volatility and is used by investors as a measure for the amount of expected volatility. Basically standard deviation is used to see whether the project has less or high risk.

standard deviation

Formula of standard deviation

A measure of the variation in a distribution, equal to the square root of the arithmetic mean of the squares of the deviations from the arithmetic mean, the square root of the variance.

The reasons behind standard deviation as a better measurement for risk are given below:

 The most commonly used measure of risk for assets or securities is a measure known as the standard deviation. The larger the standard deviation the greater the dispersion and hence the greater the distribution’s stand alone risk. On the other hand the lower the standard deviation the lower the risky-ness of the project.

 If you want to know how `risky’ a fund/ a project is, there are other ways of assessing it. For instance, you can compare the annual returns of a fund over the past several years. You can analyze how the fund has done in bull markets and in bear markets. Or you can compare compound returns for several time periods. Using compound returns has one problem though. Compound returns can be affected by one year’s exceptional performance. To correct for this, Fund Counsel suggests dropping the exceptional year and re-computing the compound rate of return.

 But from above mentioned measures standard deviation is consider as a better measurement of risk because by using standard deviation we can easily identify whether the project is risky or not. If the rate of standard deviation is high then the project is risky and if the rate of standard deviation is low then the project is less risky.

Asymmetric Information

In financial market what is meant by asymmetric information?

When a manager knows more about his or her firm’s future than do the analysts and investors who follow the company then a situation of asymmetric information exists. In this situation a firm’s managers may correctly conclude that its securities are undervalued or overvalued depending on whether the inside information is favorable or unfavorable. Of course there are degrees of asymmetry management is almost always better informed about a firm’s prospects than are outsiders but in some situations this informational difference is too small to influence managerial actions. In other circumstances such as prior to a merger announcement or when a drug company has made a major research breakthrough managers may have information that will significantly alter the prices of the firm’s securities when it becomes public. In most situations the degree of information asymmetry lies between the two extremes.

asymmetric information

The potential impact of asymmetric information on markets was analyzed by George Ackerlof in a paper titled “The market for Lemons”

The only convincing way for a seller to convey potential buyers that the product is good to take some action that buyer can unambiguously interpret as a sign that the product is not defective. Such actions are called signals and the act of providing signals is called signaling.

 Since manager’s primary goal is to maximize shareholders wealth managers are generally motivated to convey favorable inside information to the public as rapidly as possible. The easiest way would be to issue a press release announcing the favorable development. However outsider would have no way of knowing whether the announcement was true or how important it really was. Therefore such announcements have limited value. But if managers could signal information concerning favorable prospects in some truly credible way then the information would be taken seriously by investors and reflected in security prices.

 Example: Dividend announcements are the classic example of managers providing information through signaling. If a firm announces a significant increase in cash dividend this is its managers signal that the firm has good future earnings and cash flow prospects. If dividend increase is widely anticipated but then is not forthcoming this is negative signal.

 The presence of effective management signals plays an important role in financial management.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Facebook: Ördïnärÿ Böÿ

Principles of Finance

Principles of Finance

Principles act as a guideline for the investment and financing decision. Financial managers take operating, investment and financing decisions, some of this related with short term and some long term.

Before discussing about principles of finance let’s have some idea about finance, is the process of collecting funds and ensures proper utilization of funds. Many people say that finance is the management of funds and those are responsible for managing this fund are financial managers.

There are six basic principles of finance, these are:

  • Principles of risk and return
  • Time value of money
  • Cash flow principle
  • Profitability and liquidity
  • Principles of diversity
  • Hedging principle
six principles of finance

principles of finance

Principle of Risk & Return

This principles indicates that investors have to conscious both risk and return, because higher the risk higher the rates of return and lower the risk, lower the rates of return. For business financing we have to compare the return with risk. To ensure optimum rates of return investors need to measure risk and return by both direct measurement and relative measurement.

Time Value of Money

This principles is concerned about the value of money, that value of money is decreased when time pass. The value of dollar 1 of present time is more than the value of dollar 1 after some time or years. So before investing or taking fund we have to think about the inflation rate of the economy and required rate of return must be more than the inflation rate so that return can compensate the loss incurred by the inflation.

Cash Flow Principle

This principle mainly talk about the cash inflow and outflow, more cash inflow in the earlier period is preferable than later cash flow by the investors. This principle also follow the time value principle that’s why it prefers earlier more benefit rather than later years benefits.

Profitability & Liquidity Principle

This principle is very important from the investor’s perspective, because investor have to ensure both profitability and liquidity. Liquidity indicates the marketability of the investment i.e. how much easy to get cash by selling the investment. On the other hand investors have to invest in a way that can ensure maximization of profit with moderate or lower level of risk.

Principles of diversity

This principle helps to minimize the risk through building an optimum portfolio. Never put all your eggs in the same basket because if it falls then all of your eggs will broke, so put eggs by separating in different basket so that your risk can be minimize. To ensure this principle investors have to invest in risk free investment and some risky investment so that ultimately risk can be lower. Diversification of investment ensures minimization of risk.

Hedging Principle

Hedging principle indicates us that we have to take loan from appropriate sources, for short term fund requirement we have to finance from short term sources and for long term fun requirement we have to manage fund from long term sources. For fixed asset financing is to be done from long term sources.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Facebook: Ördïnärÿ Böÿ