Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-1 Chapter (1) An Overview Of Financial Management.
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.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-4 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
Introduction Give examples of financial decisions faced by corporations and individuals.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-6 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
What is Finance? Finance is the study of how people and businesses evaluate investments and raise capital to fund them.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-8 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.
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)
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Basic Areas Of Finance: Financial Management and Corporate Finance. Investments Financial institutions International finance
What is Financial Management? overall goal Concerns the acquisition, financing, and management of assets with some overall goal in mind.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Financial Management Financial management is planning, directing, monitoring, organizing, and controlling of the monetary resources of an organization.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Investment Decisions What is the optimal firm size? What specific assets should be acquired? What assets (if any) should be reduced or eliminated? Most important of the three decisions.
Financing Decisions 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? Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Financial Institutions: Companies that specialize in financial matters –Banks – commercial and investment, credit unions, savings and loans –Insurance companies –Brokerage firms
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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?
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Role of Finance in a Typical Business Organization:
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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?
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Forms of Business Organization: Sole proprietorship Partnership Corporation
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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)
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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
Copyright © 2006 Pearson Addison-Wesley. All rights reserved 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?
Copyright © 2006 Pearson Addison-Wesley. All rights reserved End of Chapter 1: