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 GM’s 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
Treasurer
VP: Operations
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 owner’s 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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