This document provides an overview of key concepts in financial management including definitions, decision making, business intelligence, risk management, capital management, and financial planning. It discusses informed decision making using relevant metrics and accounting information. It describes the finance function's role in providing business performance data, accounting reports, and market information for decision making. It also summarizes various types of risks managed by finance like liquidity, market, and credit risk. Capital management and allocating capital to maximize shareholder value is covered. The importance of financial planning for monitoring performance and accountability is highlighted. Recommended reading and videos are included for further reference.
4. “Informed” Decision
Making
"Decision implies the end of deliberation and the beginning
of action."
Any Decision has an
associated risk, and it has
to be estimated
https://hbr.org/2006/01/a-brief-history-of-decision-making
6. Business Intelligence
Finance Function has become the central provider of
business information for the organization
1. Business Performance
2. Accounting (Mgmt. and Financial)
3. Market Information
7. BI 1 of 3 - Business
Performance
Finance departments ensure no deviation between internal
and externally provided information
Finance works with business to ensure metrics are relevant
and measures are accurate
Main data source for informed decision making process
8. BI 2 of 3 - Accounting,
Mgmt. and Financial
Daily / Monthly / Quarterly / Yearly
Measure both Business and Company performance
Mgmt. Accounts Examples: Cost accounting,
department accounting, business performance,
budget execution
Financial Accounts Examples: Profit and Loss
statement, statutory accounts
9. BI 3 of 3 - Market
Information
Used by the Business function
Finance ensure it is aligned with corporate objectives
and external measures
Examples: customer taxonomy and size, market
prices, market taxonomies and volumes, share of
market, competitors metrics ...
11. Risk Management
Finance has a role to managing a number of risks, this
may or not include:
- Liquidity Risk
- Market Risk
- Counterparty Credit Risk
- Funding Risk
The relationship between Risk and Return CAPM
We will look at those in details in sessions 3 and 4
13. Capital Management
How can we best allocate capital of the organization to
maximize the shareholder’s value? And ...
Which sources of long term funding should we use?
Investment vs. funding decisions paradigms
We will look at it in sessions 5 to 8
15. Financial Planning
A key finance function to ensure early identification of
problems and allow corrective actions
Allows monitoring both management performance as
well as corporate performance
Key element for incentive management and corporate
discipline through ACCOUNTABILITY
We will look at it in detail sessions 9 & 10
22. Maths and Finance
Key Concepts
Interest Rates
Future and Present Value
IRR Internal Rate of Return
Value and Price
23. Interest Rates
“Relationship between the amount of money that is
lent (Capital) and the amount that people are ready to
pay to use it (Interest)”
I = $ Interest / $ Capital
Used to calculate the IRR internal rate of return of an
investment (or the cost of debt)
Annualized interest rates
24. How many Interest
Rates ?
Zero Coupon
Discounted Interest
Compounded Interest
Zero Risk Rate
Money Market Rate
Prime Rate
Libor Rate
Euribor
30d / 360
Actual/Actual
Liquidity Premium
Credit Spread
Mortgage Rates
Fed Funds Rate
Swap Rate
27. Only one IRR
There is no single formula !
Normally Refers to the relation between a series of future cashflows and an initial
investment
28. Money and Value
In economics, money illusion refers to the tendency of people to think of currency in
nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of
money is mistaken for its purchasing power (real value). This is false, as modern fiat
currencies have no inherent value and their real value is derived from their ability to be
exchanged for goods and used for payment of taxes. The term was coined by John
Maynard Keynes in the early twentieth century. Almost everyone is subject to the "Money
Illusion" in respect to his own country's currency. This seems to him to be stationary while
the money of other countries seems to change. It may seem strange but it is true that we
see the rise or fall of foreign money better than we see that of our own.
- Irving Fisher “The Money Illusion”
Company’s number alone don’t mean much in a competitive environment. Looking at how competition is doing and allowing us to compare the performance of our business with the performance of other similar businesses is often the best way to discover opportunities.
But the problem arises when those numbers are wrong or just not usable. For example, measuring revenue without having correct information about the underlying costs may lead to situations in which one part of the company is undermining the efforts of another part.
Problems appear as well when the numbers are just not usable to make decisions. For example, measuring the output of a factory in Tons when probably measuring it by produced units would be more intelligent. Or when the production of a given service adds additional financial risks that may get the company our of business
One of the most typical problems we observe in finance is the stickiness to legacy issue: “It has always been done this way” . Think that in a changing environment past performance is usually the worst indicator of future performance.
We will devote a big part of the course to risk management. Not all risks are managed in the same way, not even all of them are managed by the same function within a corporate. We will take some examples, those that are typically managed by Finance, and we will learn how it is done.
I will give you practical examples on how risk limits are set and how they are monitored.
We will talk about how risks can be hedged and what are the responsibilities of Finance in that regards. We will discuss a little bit about treasury functions, one of the most relevant day to day functions within finance. All this will be extended in sessions 3 and 4
It is important that we understand what Liquidity Risk, Market Risk, Credit Risk and Funding risk is, as some of the typical risks that are monitored and managed by the Finance function.
An important part of this is to understand expected return, as a function of risk R = ( riskfree + some additional risk linked to the investment )
Capital is probably the most scarce resource in a corporate
Understanding the cost of capital and be able to compare it to alternatives gives a framework for capital management decisions
During 5 to 8 we will look at some of this principles and it will converge in capital budgeting matters that we will examine in the financial planning sessions
Financial planning is the foundation for the intereaction between the business and the finance function.
Challenging forecasts, monitoring budget execution, challeging investing decisions and explaning the numbers is a critical part of the finance function and the reason why it is responsible to produce the numbers for the organization