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CHAPTER 1
An Overview of Financial Management
 Role of financial management
 Career opportunities
 Forms of business organization
 Goals of the corporation
 Issues of the new millenium
 Agency relationships
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What three questions does financial
management seek to answer?

 What causes a company to have a particular stock value?

 How can managers make choices that add value to their
companies?
 How can managers ensure that their companies don’t run
out of cash while executing their plans?

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Career Opportunities in Finance

 Institutions and capital markets

 Investments
 Financial management

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Alternative Forms of
Business Organization

 Sole proprietorship
 Partnership
 Corporation

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Sole Proprietorship

 Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
 Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital

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Partnership

 A partnership has roughly the same

advantages and disadvantages as a
sole proprietorship.

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Corporation

 Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
 Disadvantages:
Double taxation
Cost of set-up and report filing

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Goals of the Corporation

 The primary goal is shareholder wealth

maximization, which translates to
maximizing stock price.
Should firms behave ethically? YES!
Do firms have any responsibilities to
society at large? YES! Shareholders
are also members of society.

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Is maximizing stock price good for
society, employees, and customers?
 Employment growth is higher in firms
that try to maximize stock price. On
average, employment goes up in:
firms that make managers into
owners (such as LBO firms)
firms that were owned by the
government but that have been sold
to private investors
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 Consumer welfare is higher in capitalist

free market economies than in
communist or socialist economies.
 Fortune lists the most admired firms. In
addition to high stock returns, these
firms have:
high quality from customers’ view
employees who like working there

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Factors that Affect Stock Price

 Amount of cash flows expected by

shareholders
 Timing of the cash flow stream
 Risk of the cash flows

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Three Determinants of Cash Flows

 Sales
Current level
Short-term growth rate in sales
Long-term sustainable growth rate in
sales
 Operating expenses
 Capital expenses

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Factors that Affect the Level and
Risk of Cash Flows
 Decisions made by financial managers:
Investment decisions (product lines,
production processes, geographic
market, use of technology, marketing
strategy)
Financing decisions (choice of debt
policy and dividend policy)
 The external environment

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Financial Management
Issues of the New Millenium

 Use of computers and electronic

transfers of information
 The globalization of business

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Agency Relationships

 An agency relationship exists

whenever a principal hires an agent
to act on his or her behalf.
 Within a corporation, agency
relationships exist between:
Shareholders and managers
Shareholders and creditors

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Shareholders versus Managers

 Managers are naturally inclined to act

in their own best interests.
 But the following factors affect
managerial behavior:
Managerial compensation plans
Direct intervention by shareholders
The threat of firing
The threat of takeover
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Shareholders versus Creditors

 Shareholders (through managers)

could take actions to maximize
stock price that are detrimental to
creditors.
 In the long run, such actions will
raise the cost of debt and ultimately
lower stock price.

Copyright © 2002 by Harcourt, Inc. All rights reserved.