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The Role of Financial Management


The financial manager plays a dynamic role in a modern company's development. This has not always been the case. Until around the first haif of the 1900s financial managers primarily raised funds and managed their firms' cash positions - and that was pretty much it. In the 1950s, the increasing acceptance of present value concepts encouraged financial managers to expand their responsibilities and to become concerned with the selection of capital investment projects.

Today, external factors have an increasing impact on the financial manager. Heightened corporate competition, technological change, volatility in inflation and interest rates, worldwide economic uncertainty, fluctuating exchange rates, tax law changes, environmental issues, and ethical concerns over certain financial dealings must be dealt with almost daily. As a result, finance is required to play an ever more vital strategic role within the corporation.


What Is Financial Management?

Financial management is concerned with the acquisition, financing, and management of assets with some overall goal in mind. Thus the decision function of financial management can be broken down into three major areas: the investment, financing, and asset management decisions.

lnvestment Decision

The investment decision is the most important of the firm's three major decisions when it comes to value creation. It begins with a determination of the total amount of assets needed to be held by the firm. Picture the firm's balance sheet in your mind for a moment. Imagine liabilities and owners' equity being listed on the right side of the balance sheet and its assets on the left. The financial manager needs to determine the dollar amount that appears above the double lines on the ieft-hand side of the balance sheet - that is, the size of the firm. Even when this number is known, the composition of the assets must still be decided. For example, how much of the firm's total assets should be devoted to cash or to inventory? Also, the flip side of investment - disinvestment - must not be ignored. Assets that can no longer be economically justified may need to be reduced, eliminated, or replaced.


The Goal of the Firm

Efficient {inancial management requires the existence of some objective or goal, because judgment as to whether or not a financial decision is effrcient must be made in light of some standard. Although various objectives are possible, we assume in this book that the goal of the firm is to maximize the wealth of the firm's present owners.

Shares of common stock give evidence of ownership in a corporation. Shareholder wealth is represented by the market price per share of the firm's common stock, which, in turn, is a reflection of the firm's investment, financing, and asset management decisions. The idea is that the success of a business decision should be judged by the effect that it ultimately has on share price.


Virtue Rewarded

Companies are suddenly discovering the profit potential of social responsibility.

What's going on. As it turns out, Gore was invited to visit the retailer in July to introduce a screening ofhis documentary about global warming, An Inconyenient Truth. An odd-couple pairing - Gore and a company known for its giant parking lots? Certainly. But also one of the many recent signs that "corporate social responsibility", once seen as the purview of the hippie fringe, has gone mainstream.

In the 1970s and 19g0s, companies like Ben & Jerry's and The Body Shop pushed fair_labor practices and environmental awareness as avidly and effectively as Cherry Garcia ice cream and cocoa-butter hand cream.

They were widely admired but rarely imitated. Today, more than 1,000 companies in 60 countries have published sustainability reports proclaiming their concern for the environment, their employees, and their iocal communities. Giant corporations from Bp to General Electric have launched marketing campaigns emphasizing their focus on alternative energy. Wal-Mart, too, has announced new environmental goals - hence the Gore visit. The retailer has pledged to increase the efficiency of its vehicle fleet by 25% over the next three years, cut the amount of energy used in its stores by at least 25%, and reduce solid waste from US stores by the same amount.


Sustainability: Why CFOs Need to Pay Attention

No longer just the right thing to do, sustainability can affect an organization's reputation, brand and longterm profitability.

The surging interest in sustainable developments is I d.irr..r by the recognition that corporations, more than any other organizations (including national governments), have the power, the influence over financial, human and natural resources, the means and arguably the responsibility to promote a corporate agenda that considers not only the economics of growth but also the health of the environment and society at large.

Most early sustainability efforts fell under the umbrella of corporate social responsibility, which corporations practiced with a sense that it was the right thing to do. The concept has changed since then, and its evolution has serious implications for the way financial professionals do their work. Sustainability has emerged as a business strategy for maintaining long-term growth and performance and to satis$r corporate obligations to a range ofstakeholders including shareholders.


Corporate Governance

Corporate governance refers to the system by which corporations are managed and controlled. It encompasses the relationships among a company's shareholders, board of directors, and senior management. These relationships provide the framework within which corporate objectives are set and performance is monitored. Three categories of individuals are, thus, key to corporate governance success: first, the common shareholders, who elect the board of directors; second, the company's board of directors themselves; and, third, the top executive officers led by the chief executive officer (CEO).

The board of directors - the critical link between shareholders and managers - is potentially the most effective instrument of good governance. The oversight of the company is ultimately their responsibility. The board, when operating properly, is also an independent check on corporate management to ensure that management acts in the shareholders' best interests.


More Rules, Higher Profits

New research shows that good governance practices may reduce your cost of capital.

All too often, the drive for corporate-governance -6.reform feels like a costly exercise in wishful thinking. After all, can you really find a strong correlation between a mandatory retirement age for directors and a bigger net profit margin?


Organization of the Financial Management Function

Whether your business career takes you in the direction of manufacturing, marketing, finance, or accounting, it is important for you to understand the role that financial management plays in the operations of the firm. Figure 1.1 is an organization chart for a tlpical manufacturing firm that gives special attention to the finance function.

As the head of one of the three major functional areas of the firm, the vice president of finance, or chief financial officer (CFO), generally reports directly to the president, or chief executive officer (CEO). In large firms, the financial operations overseen by the CFO will be split into two branches, with one headed by a treasurer and the other by a controller.