Introduction to Financial Management【Dr. Deric】

Summary

This video introduces the concept of Financial Management, defining it as the art and science of money management. It distinguishes between Personal and Corporate Finance, emphasizing the importance of creating economic value and wealth. The script clarifies the difference between Finance and Accounting, highlighting their unique focuses and roles within a company. It also discusses various company goals, from profit maximization to shareholder wealth and stakeholder well-being, advocating for a balanced approach that considers long-term value and social responsibility.

Takeaways

• 💰 Finance is defined as the art and science of managing money, blending both intuitive and analytical approaches.
• 🏦 Financial Management is crucial for companies as it involves the maintenance and creation of economic value or wealth.
• 📈 Wealth in a company is the market value minus the total investment by shareholders, representing the additional value created for investors.
• 🔍 Finance is divided into two broad areas: Personal Finance, which focuses on individual financial planning, and Corporate Finance, which deals with strategic allocation of a company's resources.
• 🏡 Personal Finance involves budgeting, saving, paying off debt, and investing to meet personal financial goals.
• 🏢 Corporate Financial Management is about making strategic decisions with a company's financial resources to achieve long-term goals and stay competitive.
• 🔄 While Finance and Accounting share some overlapping functions, they differ in focus, with Finance being more forward-looking and focused on investment and growth.
• 📊 Accounting is concerned with recording and reporting financial transactions using the accrual method, whereas Finance is more about managing resources and can use the cash method for certain analyses.
• 🎯 Profit maximization is not the only goal for a company; creating value and considering social responsibility are also important for long-term success.
• 📈 Shareholder wealth maximization is a goal that focuses on increasing the value of the company's stock or shares, considering timing, magnitude, and risk of returns.
• 🤝 A stakeholder view of a company's goals includes considering the well-being of all parties with an economic link to the firm, promoting Corporate Social Responsibility (CSR).

Q & A

What is the definition of finance according to the video?

Finance is defined as the art and science of managing money, which is a mix of both feeling-based activities and fact-based, experimental approaches to explain theories.

Why is financial management important for companies?

Financial management is important for companies because it is about maintaining and creating economic value or wealth, which is a key indicator of a company's success and attractiveness to investors.

How is wealth in a company calculated in the context of the video?

Wealth in a company is calculated by taking the market value of the company and subtracting the total investment made by the investors. For example, if the market value is $100 billion and the total investment is $30 billion, the wealth created for investors is $70 billion.

What are the two broad topics in finance mentioned in the video?

The two broad topics in finance mentioned are Personal Finance and Corporate Finance.

What does Personal Finance involve?

Personal Finance involves managing one's own money, which includes planning and managing personal financial resources to achieve short-term and long-term financial goals such as buying a house, saving for education, and retirement.

What is the main focus of Corporate Financial Management?

Corporate Financial Management focuses on making strategic decisions about how to allocate a company's financial resources to achieve its goals and objectives, staying competitive in the market.

How are accounting and finance related yet different in the video's explanation?

Accounting and finance are related in that they both deal with money, but they differ in focus, responsibilities, and goals. Accounting is about recording and reporting financial transactions, while finance is about managing and allocating financial resources.

What is the difference between the accrual method and cash method in accounting as explained in the video?

The accrual method recognizes sales and costs when transactions occur, regardless of when payment is received or made. The cash method, on the other hand, recognizes sales and costs only when cash is received or paid out.

What are the main goals of a company as discussed in the video?

The main goals discussed are profit maximization, shareholder wealth maximization, and the stakeholder view, which includes considering the well-being of all parties involved with the company.

Why might focusing solely on profit not be the best strategy for a company in the long run?

Focusing solely on profit can lead to decreased customer loyalty, lower sales, and a lack of consideration for the company's social responsibility, which are all important for long-term success and sustainability.

How does the concept of shareholder wealth maximization differ from profit maximization?

Shareholder wealth maximization focuses on increasing the value of the company's stock or shares, considering the timing, magnitude, and risk of returns, and is more concerned with long-term value creation rather than short-term profit.

What is the stakeholder view of a company's goals and why is it important?

The stakeholder view considers the interests of all parties connected to the company, such as employees, customers, and the environment. It is important because it promotes social responsibility and can contribute to the company's long-term success and reputation.

Outlines

00:00

💼 Introduction to Financial Management

Deric introduces the concept of financial management as an art and science of managing money, emphasizing its importance for companies in maintaining and creating economic value or wealth. He explains the difference between personal finance, which involves individual financial planning, and corporate finance, which is about strategic allocation of a company's resources. Deric also clarifies the distinction between finance and accounting, highlighting that while they overlap, they serve different functions with finance focusing on future investment and growth, and accounting on past transactions and financial reporting.

05:01

📊 Finance vs. Accounting: Distinctions and Company Goals

This paragraph delves into the differences between finance and accounting, particularly the accrual and cash methods of recording transactions. An example illustrates the contrast between recognizing sales and costs under each method. The section then discusses company goals, critiquing profit maximization for its short-term focus and lack of consideration for timing, magnitude, and risk of returns. It advocates for wealth maximization and creating value for the company, including social responsibility, over mere profit chasing. The paragraph concludes with the concept of shareholder wealth maximization, which considers long-term financial asset value and incorporates timing, magnitude, and risk assessment.

10:04

🌐 The Broader View: Value Creation and Stakeholder Interests

The final paragraph expands on the idea that profit is just a part of a company's overall value, which also includes quality, branding, market share, R&D, and company culture. It argues that while profit is important, creating value is more beneficial for long-term success. The paragraph introduces the stakeholder view, emphasizing the importance of considering all individuals with an economic link to the firm, such as employees and the community, not just shareholders. It promotes Corporate Social Responsibility (CSR) as a way to improve financial performance while contributing positively to society.

Keywords

💡Financial Management

Financial Management is the art and science of managing money. It is crucial for companies as it involves the maintenance and creation of economic value or wealth. In the video, it is described as managing money to increase a company's value and achieve financial goals.

💡Wealth

Wealth refers to the economic value created for investors. It is illustrated with an example in the video where a company's market value is significantly higher than the initial investment by shareholders, resulting in wealth creation.

💡Personal Finance

Personal Finance is the process of planning and managing individual financial resources to achieve personal financial goals, such as buying a house, saving for retirement, or managing debt. The video highlights its importance in making smart financial choices for a secure future.

💡Corporate Finance

Corporate Finance involves making strategic decisions about a company's financial resources to achieve its goals. It is compared to a game of chess where each move with financial resources impacts the company's success. The video explains its role in raising money, investing, and distributing profits.

💡Profit Maximization

Profit Maximization is the goal of making the most profit from business activities. The video discusses its short-term focus on increasing profits by cutting costs or raising prices, and contrasts it with long-term strategies that consider customer loyalty and overall value.

💡Shareholder Wealth Maximization

Shareholder Wealth Maximization focuses on increasing the value of a company's shares. It is a long-term approach that considers the timing, magnitude, and risk of returns. The video describes how companies invest in new projects and improve processes to enhance shareholder value.

💡Corporate Social Responsibility (CSR)

Corporate Social Responsibility (CSR) refers to a company's commitment to contribute positively to society. The video explains that CSR involves actions like donating to the community, preventing pollution, and caring for employees, which ultimately improve the company's financial performance.

💡Accounting

Accounting is focused on recording and reporting financial transactions. The video describes it as the controller function, providing historical financial data that finance managers use for decision-making. It contrasts with finance, which is more future-oriented and strategic.

💡Accrual Method

The Accrual Method in accounting recognizes revenues and expenses when they are incurred, regardless of cash flow. The video uses an example of a car sale to illustrate how the accrual method records sales and costs, even if the payment hasn't been received.

💡Cash Method

The Cash Method in finance records transactions only when cash is received or paid. The video contrasts this with the accrual method using the same car sale example, showing how the cash method can result in different profit or loss outcomes.

💡Stakeholders

Stakeholders are all groups or individuals with a direct economic link to a company, including employees, customers, suppliers, creditors, and the community. The video emphasizes the importance of preserving stakeholder well-being and engaging in CSR to ensure long-term success.

Highlights

Finance is defined as the art and science of managing money, blending both emotional and factual aspects.

Financial Management is crucial for companies as it involves the maintenance and creation of economic value or wealth.

Wealth is exemplified by the market value of a company minus the investment by shareholders, indicating created value.

Finance encompasses two broad topics: Personal Finance and Corporate Finance, each with distinct focuses.

Personal Finance involves planning and managing personal resources to achieve financial goals such as buying a house or saving for retirement.

Corporate Financial Management is about making strategic decisions on allocating a company's financial resources to meet its objectives.

The relationship between Finance and Accounting is complex, with some overlapping functions but distinct differences in focus and responsibilities.

Accounting focuses on recording and reporting financial transactions, while Finance is about managing and allocating resources based on that information.

Accounting uses the accrual method for recording transactions, whereas Finance may recognize the cash method for practical decision-making.

Company goals include profit maximization, which has limitations such as ignoring the timing, magnitude, and risk of returns.

Creating wealth is more important than just profit, as it considers long-term value creation for the company.

Shareholder wealth maximization is a long-term approach focusing on increasing the value of the company's stock or shares.

Profit is a subset of value, and creating value encompasses factors like profit, quality, branding, market share, R&D, and company culture.

A company's goal should also consider the stakeholder view, which includes taking care of all groups with an economic link to the firm.

Corporate Social Responsibility (CSR) is increasingly important for companies, as it can improve financial performance and societal impact.

The video concludes by emphasizing the importance of understanding the different aspects of financial management and its impact on a company's strategy.

Transcripts

Hey guys, I’m Deric, welcome to my  channel. In this video, I’m gonna  

make a short introduction to Financial Management.

The first question is, what is finance.

Finance can be defined as the art  and science of managing money.  

Art, is like dancing, singing and drawing,  something which is based on feeling.  

But science, is more about facts and figures, you  have to do experiment, come out with theories to  

explain what you believe. So, Finance is basically  a mix of art and science of managing money.  

The key word here is managing money.  That’s what we call Financial Management.

Financial management is a very important  aspect for companies. It is because  

financial management is about maintenance,  and creation of economic value, or wealth.

What is wealth? Let’s take an example.

Let say, the market value of  company A is $100 billion.

Investors of company A  altogether invested $30 billion.  

So taking $100 billion, minus $30  billion, you will get $70 billion.  

This amount of money is what we call wealth  created for investors. Shareholders only paid $30  

billion to buy the shares, but the company created  extra $70 billion for the shareholders. Of course,  

this is gonna be a good sign for investors,  as the value of the company has increased.

For Finance, it has two broad topics.  Personal Finance, and Corporate Finance.

Personal Finance is about managing your own money.

This is the process of planning and managing  your personal financial resources to achieve  

your short-term and long-term financial  goals. These goals may include, buying a  

house or a car, saving money for your child’s  education, saving for retirement, and so on.

Personal finance involves creating a budget,  saving for emergencies and future expenses,  

paying off debt, and investing for your future.  It's about making smart choices with your money,  

so that you can live the life you want  today, and have peace of mind for tomorrow.

It would answer the questions, such as,  how much you spend, how much you save,  

and how you invest your savings. In short, this  is about doing individual financial planning.

But for Corporate Finance, it is more  on how to manage company’s money.

Corporate Financial Management is the process  of making strategic decisions about how to  

allocate a company's financial resources, in  order to achieve its goals and objectives.  

It is like a game of chess, where each move you  make with your financial resources, like cash,  

investments, and credit, is a strategic  decision that can lead to a win or a loss.

So, it is about making smart  decisions with the firm’s money,  

in order to reach the firm’s long-term  goals, and stay competitive in the market.

It would answer the questions, such as,  how firms raise money from investors,  

how firms invest money to earn a profit,  whether to reinvest profits in the business,  

or distribute them back to investors.

Alright, another question, is Finance the  same as Accounting. The answer can be, yes,  

and no. Yes, because some functions of accounting  and finance are closely-related and overlapping.  

No, because they have some distinct differences in  terms of their focus, responsibilities, and goals.

Accounting people are the controllers, while  finance people are basically the treasurers.  

Finance people always focus on how to invest, and  how to make more money for the company. They’re  

just like the accelerator of a car. To make a  car move, you have to press on the accelerator.  

The harder you press, the faster the car can move.  But at the same time, you need to have a brake.  

This is the function of accounting,  which we call them the controllers.  

When finance people are moving too fast,  investing too much money in too many projects,  

accounting people, the brake, will slow them  down for safety purpose. One thing to take note,  

only in big corporations we will have two separate  Accounting and Finance departments. But in smaller  

firms, generally the financial manager will  perform both accounting and finance functions.

Another aspect, accounting is focused on  recording and reporting financial transactions,  

while finance is focused on managing  and allocating financial resources.  

Accounting involves the preparation  of financial statements, such as the  

balance sheet, income statement, and cash flow  statement. However, finance managers are using  

the information prepared by accounting  department to make business decisions,  

such as investing in new projects, or to  pay off the outstanding debt of the company.

On the other hand, accounting is focused on the  past and present, while finance is focused on  

the future. Accounting deals with historical  financial data, and provides information about  

what has happened in the past. However, finance  uses that information to make predictions about  

what will happen in the future, and to make  decisions about how to allocate resources.

In terms of information recording method,  accounting applies accrual method,  

while finance recognizes cash method.  How to differentiate these two methods?

Let’s take an example. Company A experienced  the following activity last year.

Company sales was $100,000, with 1 car sold,  

but customer has not made the payment yet,  that’s why it is 100% still uncollected.

The cost of the car is $80,000. The company has  already paid in full amount under supplier terms.

If you were to prepare an income  statement, under accounting record,  

which is using the accrual method, you would  recognize a sales of $100,000, costs of $80,000.  

So, the company made a profit of $20,000.

But under finance record, which is using the cash  method, since you had not received cash from the  

customer, you would recognize a sales of $0. But  you’d already paid the supplier, so there would  

be a cost of $80,000. Eventually, the company  made a net loss of $80,000 for selling the car.  

A loss position could happen when company  recognized the cash flows of the transaction.  

This example shows us the difference  between accounting and finance records.

Next, we will talk about the goals of a company.  

It is about what target a company wants to  achieve. The first one, profit maximization.

Profit maximization refers to how  much dollar profit the company makes.  

How to make the most profits from the business?

Some companies may focus on cutting costs  

and increasing prices in the  short-term to boost profits.

Such method is a short-term approach, mostly  concerned about short term benefits only.  

But in the long-term, this strategy may  lead to a decrease in customer loyalty,  

lower sales, and a decrease in overall profits.

Another problem with profit maximization  is that, it ignores the timing of returns,  

magnitude of returns, and risk. When will you  receive the money? How much money will you  

receive? How much is the risk? These questions are  not answered if companies only focus on profits.

Third, fulfilling objective of earning profit  may not help in creating wealth in the long run.  

Profit should not be the only target of a company.  

Rather, company should look  at how to create wealth.  

Wealth means value. In fact, company should  focus more on creating value for the company.

Lastly, it does not consider the social  responsibility. If the goal of a company  

is just to make profit, it may not make  donation, it may not care about air pollution.  

But nowadays, social responsibility is very  important for company to survive in the long run.

Another goal of a company is about  shareholder wealth maximization.

It focuses on maximizing the value of a company.  

When we say the value of a company, it  means the value of the stock or share.

So, it is a long-term approach, mostly  concerned about the value of financial assets.  

Financial assets include bonds, shares, and so on.

Next, it considers the timing of  returns, magnitude of returns, and risk.  

It will answer the following questions, like,  when will you receive the money? How much money  

will you receive? How much is the risk? These  are the important criteria of doing a business.

How to increase the value of a company? For  examples, company may invest in new projects,  

or it may think of how to improve the quality of  the products, not to cut the cost, but to control  

the cost by improving the production process.  Probably the old way of production is to take  

10 steps to manufacture a product. But, if you can  come out with a better way of production, reduce  

the process to 5 steps only, then you can control  the cost and create value. Another good example is  

Google. Initially Google offered its Gmail service  for free as it tried to grab the market share.  

This strategy has helped increase the  value, that is the share price of Google.

In short, shareholder wealth means  the share price or the firm’s value.  

Maximizing shareholder wealth means maximizing the  share price, and also maximizing the firm’s value.

In fact, some companies focus on profit,  whilst some companies focus on value.

Profit versus value, which one  is more important to company?

Well, profit is a subset of value, which means  that profit is only a small part of the value.

As shown in the graph, under value, we have  profit, quality, branding, market share, R&D,  

and culture of company. These are the factors  that contribute to the value of a company.  

That’s why, profit is not everything.  Profit is just a small part of the value.

In other words, creating  value will help create profit.  

But, making profit does not  necessarily create value for a company.

Another goal of a company is a stakeholder view.

Stakeholders, include all groups of individuals,  who have a direct economic link to the firm,  

such as, employees, customers, suppliers,  creditors, community, environment, and so on.  

Companies should not only take care  of the shareholders, but also others.

In the process of making profit, companies  should avoid actions that could harm the  

interest of their stakeholders. Taking care  of the stakeholders is not to maximize, but to  

preserve stakeholder well-being. For example,  to donate money to the community, to build  

schools or hospitals, to prevent pollution of  environment, to take good care of the employees.  

These are some examples of  taking care of the stakeholders.

Such a view is considered to be “socially  responsible”. We usually call this as  

Corporate Social Responsibility, CSR. More  and more companies are contributing in CSR,  

which they believe that, CSR would improve  the financial performance of the company.

Alright, that’s all for this video, thanks  for watching, see you in the next one, bye!