Key terms in managerial finance

Financial Decision Making in Organizations

Many business choices in an organization are quantified in financial terms, making managerial finance critical to the organization’s operation. Managerial finance is thus primarily concerned with the governance of the financial affairs of any company, whether for profit or not. Financial managers are responsible for reviewing proposed significant expenditures, as well as planning and obtaining funds to fund the organization’s activities (Neveu, 1989).

Shareholder Value and its Measurement

In recent years, the economic and regulatory environments have changed, increasing the importance and complexity of the financial manager’s obligations. The purpose of this study is to highlight some key terms in managing finance. Shareholder value is the worth that is gained by shareholders resulting from the ability of the management to generate free cash flows, earnings and grow its sales (Kroncke, 1978). The management’s strategic decisions in making judicious investments and spawning high return on investments to a large extent determines the shareholder value. The organization is able to pay larger dividends due to increase I the share price as a result of increase in this value over time. The shareholders’ value is measured in terms of earnings per share which is basically defined as the earnings available to shareholder divided by the outstanding shares. The higher the earnings per share the more valuable is the shareholders worth.

Goals of a Firm: Profit Maximization and Shareholder Wealth Maximization

The shareholder value maximization is a fundamental goal for all managers in an organization. The wealth maximization objective takes care of the shareholders interest, lenders and workers interests as it ensures fair return to shareholders, building up reserves for growth ensuring financial discipline in management (Kroncke, 1978). The wealth is measured by the share price which is based on the timing of the cash flows, their magnitude and risk. Managerial finance is therefore concerned with those decisions that would yield the highest market value for common stock.

Managing the Agency Problem and Foregone Investment Opportunities

Managerial finance is also concerned with the goals of the firm. The two chief goals of a firm are profit maximization and shareholders wealth maximization. Profit maximization is often a short term to be achieved within a year where management mainly focus on effective utilization of resources to maximize returns (Neveu, 1989). It however has some drawbacks which include; ignorance of risk, does not consider timing of returns and its short term. Shareholder wealth maximization is the other goal which aims at yielding the highest market price for a common stock. It is achieved by considering the present and future earnings, timing of returns and other factors that affect market price of common stock. Unlike profit maximization, its often long term, applies principle of time value of money, incorporates the risk factor and directly leads to increase in the cash flows.

The Role of Risk and Required Return in Managerial Finance

Agency problem is commonly experienced in managerial finance. It usually refers to the conflict of interest between organization’s management and the stockholders where managers make decisions that maximize self-interest rather than shareholders interest. The problem can be minimized by altering the compensation structure to give managers sufficient compensation that eliminates an incentive to act on self-interest. Market capitalization foregone investment opportunity refers to the cost of an alternative given up when a decision is made (Kroncke, 1978). This implies that it is the difference in return between a chosen investment and one that is given up.

The Importance of Managerial Finance

In addition, managerial finance also considers level of risk and investor’s required return. The level of risk refers to mitigation of uncertainty in investment to an acceptable level by the investor (Neveu, 1989). Investor’s required return on the other hand is the minimum percentage gain from investment that will induce the investor to commit resources to the investment. In conclusion, managerial finance is of great importance because it is concerned with the governance and the assessment of financial techniques. Proper managerial finance enables institutions and companies achieve their goals, make good and optimum decisions and formulate well organized structures of operations.

Works Cited

Neveu, Raymond P. Fundamentals of Managerial Finance. Cincinnati: South-Western Pub., 1989. Print.

Kroncke, Charles O., Erwin Esser Nemmers, and Alan E. Grunewald. Managerial Finance: Essentials. St. Paul: West Pub., 1978. Print.