Chapter (1) An Overview Of Financial

Management.

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 Learning Objectives

1. Understand the importance of finance in

your personal and professional lives and
identify the three primary business
decisions that financial managers make.

2. Identify the key differences between three

major legal forms of business.
 Learning Objectives (cont.)

Understand the role of the financial

manager within the firm and the goal for
making financial choices.

Explain the four principles of finance that

form the basis of financial management for
both businesses and individuals.
 Key Concepts and Skills:

Know the basic types of financial

management decisions and the role of the
financial manager
Know the financial implications of the
different forms of business organization
Know the goal of financial management
Understand the conflicts of interest that
can arise between owners and managers
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 Introduction

Give examples of financial decisions faced

by corporations and individuals.
 Chapter Outline:

Finance: A Quick Look

Business Finance and The Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the
Corporation

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 What is Finance?

Finance is the study of how people and

businesses evaluate investments and raise
capital to fund them.
 Finance is the art and science of managing
wealth.
It is about making decisions regarding
what assets to buy/sell and when to
buy/sell these assets.
Its main objective is to make individuals
and their businesses better off.

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 Three Questions Addressed by
the Study of Finance:
1. What long-term investments should the
firm undertake? (capital budgeting
decisions)
2. How should the firm fund these
investments? (capital structure decisions)
3. How can the firm best manage its cash
flows as they arise in its day-to-day
operations? (working capital management
decisions)
 Why Study Finance?

Knowledge of financial tools is critical to

making good decisions in both professional
world and personal lives.
Finance is an integral part of corporate world
How will GMs strategic decision to invest $740
million to produce the Chevy Volt require the
expertise of different disciplines within the
business school such as marketing,
management, accounting, operations
management, and finance?
 Why Study Finance? (cont.)

Many personal decisions require financial

knowledge (for example: buying a house,
planning for retirement, leasing a car)
 Basic Areas Of Finance:

Financial Management and Corporate

Finance.
Investments
Financial institutions
International finance

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 What is Financial
Management?

Concerns the acquisition,

financing, and management
of assets with some overall
goal in mind.
 Financial Management

Financial management is planning, directing,

monitoring, organizing, and controlling of the
monetary resources of an organization.

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 Investments:

Work with financial assets such as stocks and

bonds
Value of financial assets, risk versus return, and
asset allocation
Job opportunities
Stockbroker or financial advisor
Portfolio manager
Security analyst
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 Investment Decisions

Most important of the three

decisions.
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be reduced
or eliminated?
 Financing Decisions

Determine how the assets (LHS of

balance sheet) will be financed (RHS of
balance sheet).
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g.,
dividend-payout ratio)?
How will the funds be physically
acquired?
 Financial Institutions:

Companies that specialize in financial matters

Banks commercial and investment, credit
unions, savings and loans
Insurance companies
Brokerage firms

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 International Finance:

It may allow you to work in other countries or

at least travel on a regular basis
Need to be familiar with exchange rates and
political risk
Need to understand the customs of other
countries.

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 Why Study Finance?
Marketing
Budgets, marketing research, marketing financial
products
Accounting
Dual accounting and finance function, preparation
of financial statements
Management
Strategic thinking, job performance, profitability
Personal finance
Budgeting, retirement planning, college planning
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 Business Finance:

Some important questions that are answered

using finance
What long-term investments should the firm
take on?
Where will we get the long-term financing to
pay for the investments?
How will we manage the everyday financial
activities of the firm?
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 Financial Manager:

Financial managers try to answer some, or all,

of these questions
The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
Treasurer oversees cash management, credit
management, capital expenditures, and financial
planning
Controller oversees taxes, cost accounting,
financial accounting, and data processing

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 Role of Finance in a Typical Business
Organization:

Board of Directors

President

VP: Sales VP: Finance VP: Operations

Treasurer Controller

Credit Manager Cost Accounting

Inventory Manager Financial Accounting

Capital Budgeting Director Tax Department

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 Responsibility of the Financial Staff:

Maximize stock value by:

Forecasting and planning
Investment and financing decisions
Coordination and control
Transactions in the financial markets
Managing risk

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 Financial Management Decisions:
Capital budgeting:
What long-term investments or projects should the
business take on?
Capital structure:
How should we pay for our assets?
Should we use debt or equity?
Working capital management:
How do we manage the day-to-day finances of the
firm?
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 Forms of Business Organization:

Sole proprietorship
Partnership
Corporation

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 Sole Proprietorship:
Advantages
Easiest to start
Least regulated
Single owner keeps all of the profits
Taxed once as personal income
Disadvantages
Limited to life of owner
Equity capital limited to owners personal wealth
Unlimited liability
Difficult to sell ownership interest

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 Partnership:
Advantages:
Two or more owners
More capital available
Relatively easy to start
Income taxed once as personal income
Disadvantages:
Unlimited liability
Partnership dissolves when one partner dies or
wishes to sell
Difficult to transfer ownership

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 Corporation:
Advantages:
Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages:
Separation of ownership and management (agency
problem)
Double taxation (income taxed at the corporate rate
and then dividends taxed at personal rate)
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 The Agency Problem:

Agency relationship
Principal hires an agent to represent its interests
Stockholders (principals) hire managers (agents) to
run the company
Agency problem
Conflict of interest between principal and agent
Management goals and agency costs

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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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 Financial Goals of the Corporation:

The primary financial goal is shareholder wealth

maximization, which translates to maximizing stock
price.
Do firms have any responsibilities to society at
large?
Is stock price maximization good or bad for
society?
Should firms behave ethically?

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 End of Chapter 1:

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