Contemporary Financial
Management, 9th Edition
by
Moyer, McGuigan, Kretlow
Prepared by
Richard Gendreau
Bemidji State University
Copyright ©2003 South-Western/Thomson Lea
Chapter
1
The Role and Objective of
Financial Management
Copyright ©2003 South-Western/Thomson Learning
Introduction
• This chapter introduces the financial
management process of the typical
firm. It looks at the financial manager,
the field of finance, financial decisions
and their implications, and the daily
questions faced by the firm’s financial
management.
Questions Faced in Finance
• How is finance related to other fields of
study?
• What are financial managers’ goals
and objectives?
• How has the finance field evolved?
• How is the finance field changing
today?
• More questions are listed in the text.
Principal Forms of Business
Organizations
• Sole proprietorship
• Partnership
• Corporation
Sole Proprietorship
•
•
•
•
•
•
Owned by one person
Easy formation
advantage
Unlimited liability
disadvantage
Difficulty raising funds disadvantage
Represent 75 percent of all businesses
Account for less than 6% of the dollar
volume
• Check out small business info from the SBA
http://www.sba.gov/
Partnership
• Owned by two or more persons
• Classified as general or limited
• Partnership dissolves when a general
partner dies.
disadvantage
Liability of Partners
• General Partner
Has unlimited liability for all obligations of
the business disadvantage
• Limited Partner
Liability limited to the partnership
agreement
advantage
Corporation
• Limited liability
• Flexibility
• Permanency
• Legal entity
• Ability to raise capital • Easy marketability
of shares of
ownership
• Has a board of
directors
• Owners are
stockholders
All advantages
Board of Directors
• Stockholders elect a board of directors
• Board of directors then elect the officers
–
–
–
–
–
–
–
–
Chairman of the board
Chief executive officer (CEO)
Chief operating officer (COO)
President
Chief financial officer (CFO)
Vice presidents
Treasurer
Secretary
Management
Who Manages?
• Board of directors
deals with broad
policy
• Management makes
most of the decisions
• 3 to 5 year strategic
plan
• Day-to-day decisions
following the
strategic plan
Stockholder Rights
• Dividend
• Voting
• Asset
• Preemptive
Priority of Corporate Securities
Bonds
(highest)
Preferred stock
Common stock (C/S)
Major corporate Web sites
http://www.ford.com/
http://www.gm.com/
http://www.porsche.com/
(lowest)
Optimal Form of Organization
Influenced by
• Cost
• Complexity
• Liability
• Continuity
• Raising capital
• Decision making
• Tax considerations
Shareholder Wealth Maximization
Objective of
financial
management
Shareholder
Wealth
Maximization
(SWM)
Objective of the
financial manager
NOT
Profit maximization,
which does not consider the
time value of money
SWM
• Considers the timing and risk of the
benefits from stock ownership
• Determines that a good decision
increases the price of the firm’s
common stock (C/S)
• Is an impersonal objective
• Is concerned for social responsibility
Social Responsibility
• Ethical issues will constantly confront
financial managers as they achieve the
goal of the firm (SWM).
Managers Must
•
•
•
•
Avoid personal conflicts
Maintain confidentiality
Be objective
Act fairly
Check out http://www.ge.com/
Agency Relationships/Problems
• Problem
created by
separation of
Owners (shareholders)
Management and
Employees
• Management may maximize
its own welfare instead
of the owners’ wealth.
Job security
Job Security
• Management decisions based on
retaining management rather than SWM
• Example
– A decision to retain suppliers rather than
selecting new suppliers providing higher
quality and/or lower cost
– Why? If a change is made management
will be scrutinized, but if no change is
made, the issue will be ignored
Agency Costs
•
•
•
•
Management incentives
Monitor performance
Owners protection
Complex organization structures
Recent Trends
Flatten organization structures to cut costs
Problems
Problem created by
separation of
Owners
Management
Owners
A similar problem
Creditors
Protective covenants
in loan agreements
Examples of Protective Covenants
• Limitations on
– common stock dividends
– the type of investments
– divestitures
– additional debts
– poison puts
Shareholder Wealth Maximizing Is
a Market Concept and Results in
• Maximizing PV of E(R)
• Measured by Market Value of C/S
Three Basic Factors Determine
C/S Market Value
• 1) Amount of
• 2) Timing of
• 3) Risk of
Expected cash flows
Conditions Affecting Market Value
• Economic environment factors
• Decisions under management control
• Conditions in financial markets
• Expected cash flows
Cash Flow Concept Used for
• Financial analysis
• Planning
• Resource allocation
CF does not equal accounting profit
Internal sources
Cash
External sources
Competitive Forces Influencing
C/S Market Value
• New entrants
• Substitute products
• Bargaining power of buyers
• Bargaining power of suppliers
• Rivalry among current competitors
NPV of an Investment
• NPV = PV of future cash flows
minus cash outlays
The NPV of an investment
represents the contributions of
that investment to the value of
the firm and passes on to SWM.
Different Size Businesses
Small Business
vs.
Large Corporations
Fundamental concepts are the same
Small Business
•
•
•
•
•
•
•
•
Not the dominant firm in the industry
Tend to grow more rapidly
Limited access to financial market
Lack management resources
Have a high failure rate
Stock is not publicly traded
Poorly diversified
Owner/manager frequently the same
Controller’s Activities
• Financial accounting
• Cost accounting
• Taxes
• Data processing
Treasurer’s Activities
• Management of cash and marketable
securities
• Capital budgeting
• Financial planning
• Credit analysis
• Investors relations
• Pension fund management
Disciplines Impacting Finance
Economics
Accounting
Marketing
Production
Human Resources
Quantitative Analysis
MIS
Finance
Professional Organizations
• Financial Executive Institute
• Institute of Charted Financial Analysis
• Financial Management Association
• Institute of Management Accounting
Exciting Career Opportunities
• VP of Finance
• Financial Analyst
• Director Investor
Relations
• Account Executive
Security Broker
• Assistant Treasurer • Mortgage Analyst
• Tax Manager
• Banking
Check out http://www.careerpath.com/
How to get at least a C
• Read the chapters as the material is
covered in class.
• Mark/underline important parts of each
chapter.
• Read each chapter twice.
• Try to get all the bonus points you can.
• Actually learn TVM calculation methods
(Ch.4).
How to get at least a C (continued)
• Make thorough and concise notes for exams.
• Don’t rely on exam notes. Use them as a
learning exercise.
• Work all homework problems.
• Come by my office if you don’t understand
homework problem solutions.
• Review class notes, market portions of your
text, and problem solutions the night before
exams and quizzes.
How to Fail
•
•
•
•
•
“All I want is a D.”
Be a certified “non-worker.”
Don’t read the textbook.
Don’t do any homework.
Expect exam notes to be a substitute
for studying.
• Copy someone else’s exam notes.
How to Fail (continued)
• Cut class often.
• Wait until the last minute to study.
• Treat the first two exams like
throwaways.
• Expect to pass based on the final exam.
• Expect “extra work” to be given for
improving your grade.
• Expect a grading curve to save you.