Introduction to Financial
Management
P.V. Viswanath
Based partly on slides from
Fundamentals of Corporate Finance
Brealey, Myers and Marcus, 4th ed.
Key Concepts and Skills
Know the basic types of financial management
decisions and the role of the financial manager
Know the goal of financial management
Know the financial implications of the different
forms of business organization
Understand the conflicts of interest that can
arise between owners and managers
P.V. Viswanath
2
Chapter Outline






Finance: A Quick Look
Forms of Business Organization
Business Finance and The Financial Manager
The Goals of the Corporation
The Agency Problem and Control of the
Corporation
Financial Markets and the Corporation
P.V. Viswanath
3
Organizing a Business
Sole
Partnership
Proprietorship
Corporation
Who owns the
business?
The manager
Partners
Shareholders
Are managers
and owners
separate?
What is the
owner’s
liability?
Are the owner
& business
taxed
separately?
No
No
Usually
Unlimited
Unlimited
Limited
No
No
Yes
P.V. Viswanath
4
Corporation
 Advantages





 Disadvantages
Limited liability
Unlimited life
Separation of ownership and
management
Transfer of ownership is easy
Easier to raise capital
P.V. Viswanath


Separation of ownership and
management
Double taxation (income taxed
at the corporate rate and then
dividends taxed at personal
rate)
5
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 and profitability
 Personal finance

Budgeting, retirement planning, college planning, day-to-day cash
flow issues
P.V. Viswanath
6
The Role of The Financial Manager
(2)
Firm's
operations
Real assets
(1)
Financial
Manager
(4a)
Investors
(4b)
(3)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
P.V. Viswanath
7
What questions does finance answer?
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
investment?
How will we manage the everyday financial activities of
the firm?
P.V. Viswanath
8
Financial Managers
The top financial manager within a firm is usually
the Chief Financial Officer (CFO). Under the CFO,
we have:


Treasurer – oversees cash management, credit
management, capital expenditures and financial planning
Controller – oversees taxes, cost accounting, financial
accounting and data processing
P.V. Viswanath
9
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?
P.V. Viswanath
10
Goal Of Financial Management
What should be the goal of a corporation?




Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the company’s stock?
General guide: Maximize shareholder wealth,
keeping in mind the effects on firm value.
Does this mean we should do anything and
everything to maximize owner wealth?
P.V. Viswanath
11
The Agency Problem
Agency relationship


Principal hires an agent to represent their interest
Stockholders (principals) hire managers (agents) to run the
company
Agency problem

Conflict of interest between principal and agent
Management goals and agency costs
P.V. Viswanath
12
Managing Managers
1 - Compensation plans: Incentives can be used to
align management and stockholder interests
2 - Board of Directors
3 – Takeovers: The threat of a takeover may result in
better management
4 - Specialist Monitoring
5 - Auditors
P.V. Viswanath
13
Financial Markets
Money
Primary
OTC
Markets
Markets
Secondary
Markets
P.V. Viswanath
14
Funding Sources & Financial Markets
Internally Generated Cash flows

Cash generated by the business is retained and reinvested
as long as positive value-adding projects can be found.
Primary and secondary markets


Dealer vs. auction markets
Listed vs. over the counter securities


NYSE
NASDAQ
P.V. Viswanath
15
Funding Sources & Financial Markets
Financial Intermediaries – raise money from investors and
provide financing for companies.
Mutual Funds – raise money by selling shares to
investors
Financial Institutions – raise financing in special ways
Banks – raise financing by accepting deposits; they also
provide other financial services.
Insurance Companies – they raise money by selling
insurance policies.
P.V. Viswanath
16
Functions of Financial Markets and
Intermediaries





Transporting Cash across time
Liquidity
Payment Mechanism (e.g. checks)
Reducing Risk
Providing Information, which firms use to



Hedge
Make financing decisions
Align employee goals with stockholder goals.
P.V. Viswanath
17