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 business environment in the Middle East Understand the conflicts of interest that can arise between owners and managers Understand the various types of financial markets 1-2
Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Business Environment in the Middle East – An Additional Aspect The Agency Problem and Control of the Corporation Financial Markets and the Corporation 1-3
Corporate 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 investment? –How will we manage the everyday financial activities of the firm? 1-4
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) who coordinates the activities of: –Treasurer – oversees cash management, credit management, capital expenditures, and financial planning –Controller – oversees taxes, cost accounting, financial accounting and data processing 1-5
Financial Management Decisions (1) Capital budgeting –“The process of planning and managing a firm’s long-term investments.” –The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. –Evaluating the size, timing and risk of future cash flows is the essence of capital budgeting. 1-6
Financial Management Decisions (2) Capital structure –“The mixture of debt and equity maintained by a firm.” –The mixture chosen will affect both the risk and the value of the company. –What are the least expensive sources of funds for the firm?
Financial Management Decisions (3) Working capital management –“A firm’s short-term assets and liabilities.” –Managing the firm’s working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions.
Forms of Business Organization Three major forms in the United States –Sole Proprietorship (owned by one person) –Partnership (owned by 2 or more) General Limited –Corporation Joint stock company Public limited company Limited Liability Company 1-9
Sole Proprietorship Advantages –Easiest to start –Least regulated –Single owner keeps all 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 1-10
Partnership All partners share in gains or losses as described in the “partnership agreement” which can be informal oral agreement or lengthy, formal written agreement In a limited partnership, 1 or more general partners will run the business and have unlimited, but there will 1 or more limited partners who will not actively participate in the business.
Partnership In a general partnership, general partners have unlimited liability for partnership debts and the partnership terminates when a general partner wishes to sell out or dies.
Partnership Advantages –Two or more owners –More capital available –Relatively easy to start –Income taxed once as personal income Disadvantages –Unlimited liability General partnership Limited partnership –Partnership dissolves when one partner dies or wishes to sell –Difficult to transfer ownership 1-13
Corporation “A business created as a distinct legal entity composed of one or more individuals or entities.” Forming a corporation involves preparing articles of incorporation (or a charter) and a set of bylaws. They should include the corporation’s name, its intended life, its business purpose and the number of shares that can be issued.
Corporation The bylaws are rules describing how the corporation regulates its existence. They can be amended or extended from time to time by the stockholders.
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 –Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate) 1-16
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? Does this mean we should do anything and everything to maximize owner wealth? 1-17
Goal of Financial Management The goal of financial management is to maximize the current value per share of the existing stock. Corporate finance could be defined as the study of the relationship between business decisions (identify investments and financing arrangements) and the value of the stock in the business.