Financial Management

Financial Management

Financial Management

Abstract

Considers whether financial risk management is value-adding. Although risk management can reduce total risk, this may not affect the cost of capital or firm value. Well-diversified investors have already eliminated all of the specific risk, and risk-management may be seen as a zero NPV activity at best, and at worst, a value-reducing activity. However, there is a role for risk management. Reduction of total risk may reduce the expected costs of financial distress, hence increasing expected cashflows. This increases firm value. Presents a method of investment appraisal that takes account of total risk through expected financial distress costs. Such a method can result in three possible decisions relating to a new project; reject the project invest in the project; and risk-manage; or invest in the project but do not risk-manage. Finally, presents worked examples.

Introduction

Financial management in government as well as in industry is becoming more mechanized as we develop sophisticated electronic equipment that produces information, assembles it, edits it, analyzes it, and in many cases stimulates action guided by artificial intelligence. Other non-personal devices and operations conceivably replicate the ideal in each of these processes.

These mechanical systems, however, are at the beck and call of government financial managers who, in the long run, are charged with the responsibility of efficient, compliant and effective operations. Their constituents are not content with sophistication in decision-making unless it produces good governmental operations and benefits for the customers, the electorate. We must also keep in mind that government today has a visibility unheard of a decade or two ago.

The result of this state-of-the-art management information process must be evaluated by human financial managers and arrayed against their arsenal of experience, professional expertise, judgment, and instincts. These qualities in the end are based on underlying behavioral relationships resulting from education, background, and basic human reactions to stimulants introduced by the situations and environmental conditions described by the sophisticated devices of the accounting and management information systems. Thus, the government financial manager is a captive of a mass of information and mechanical guidance on one hand and of his or her basic instincts and his or her experiential patterns of operations on the other hand.

The basic concept of psychology is that it is the relationship between an individual and his or her environment. This relationship is based on a series of reactive attitudes to stimulus, in this case, supplied by the grist of the information systems. So, no matter how hard we try to mechanize the government financial management system, in the end it has to transverse the human interpretive tunnel that is permeated with the basic behavioral climate and structure that is present in all mankind - though admittedly, to differing degrees.

Thus, we hope to see how these basic behavioral phenomena serve to filter out the mass of information, and to help indicate the direction to which the government should proceed. Much of the material is taken from two basic governmental works. The Application of Government Accounting Principles and Applying Government Auditing ...