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Finance is concerned with resource allocation
as well as resource management, acquisition
and investment. Simply, finance deals with
matters related to money and the markets.
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Finance can be defined as the art and science
of managing money. All the individuals and
organization earn or raise money and spend
or invest money
Finance is concerned with the process,
institutions, markets and instruments
involved in the transfer of money among and
between individuals, businesses and
government
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Financing Decision
Investment Decision
Dividend Decision
Financial Analysis and Planning
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The primary goal is shareholder wealth
maximization, which translates to
maximizing stock price.
Other Goals include
◦ Profit Maximizing
◦ Preserving Stakeholders wealth
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The Primary responsibility of financial
managers is the acquisition of funds (cash)
needed by the firm and directing those funds
into projects that will maximize the value of
the firm to its owners.
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Raise funds from investors
Invest funds in value-enhancing projects
Manage funds generated by operations
Return funds to investors - dividends
Reinvest funds in new projects
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Financial Service
Managerial Finance
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Shareholders are the Principals
Managers are their Agents
An agency conflict arises when the goals of
these two parties are not congruent.
An agency conflict is generally costly to the
firm, I.e., it results in reduced value of the
total firm
There are ways of mitigating this conflict
but it cannot totally eliminated or reduced
to zero
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Shareholders can attempt to control
managers in a variety of ways
Market-value based compensation such as
stock options and bonus plans
Threat of firing
Threat of takeover
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Consider the evolution of a firm from a Sole
Proprietorship, I.e., a firm owned by a single
owner
The owner is the manager of the firm’s
operation manager, marketing manager,
finance manager, and everything else for the
firm
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A sole proprietorship has little conflict, low
taxation, but limited financing available, and
unlimited liability
The firm may eventually add more partners
(Partnership)and start to borrow from banks
to fuel its growth.
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At some stage the firm may choose to
incorporate and go public, I.e. becomes a
Corporation
An intangible business entity created by
law often called a legal entity
Individuals or firms who buy shares of
such a firm become equity participants and
may be quite active
Other individuals lending money on very
specific terms such as bondholders may
choose to be passive
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At the Corporation stage, new investment and
challenges face a firm, financing is abundant,
stockholders have limited liability, but
accountability is high as well
On or about this stage, the firm is likely to
hire finance professionals
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Strength
Sole Proprietorship
Partnership
Corporation
Owners receive all the
profits and losses
Can raise more funds
than sole proprietorship
Owners have limited
liability Which
guarantees that they
cannot lose more than
they invested
Low organizational
costs
Borrowing power
enhanced by more
owners
Ownership is readily
transferred
Income taxed as
personal income of
proprietor
Income taxed as
personal income of
partners
Long life of firm
Ease of dissolution
More available brain
power and managerial
skills
Can expand more easily
due to access capital
market
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Weaknesses
Sole Proprietorship
Partnership
Corporation
Owner has unlimited
liability
Owners have unlimited
liability
Taxes generally higher,
since corporate income is
taxed & dividends paid to
owners are again taxed
Limited fund raising
power
When partner dies,
partnership is dissolved
More expensive to
organize than other
business forms
Difficult to give
Difficult to achieve large
employees long run career scale operations
opportunities
Subject to greater
government regulation