FIN2001

FINANCIAL MANAGEMENT

Topic 1
1

Introduction
2 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
3 Lecture 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
 Financial Markets and the Corporation
4 Basic Areas Of Finance

 Corporate finance
 Investments
 Financial institutions
 International finance

Finance: A Quick Look

5 Investments
 Work with financial assets such as stocks
and bonds
Determination of value of financial assets
Risk versus return associated with investing
in financial assets
The best mixture of different types of
financial assets to hold - asset allocation

Finance: A Quick Look

6 Financial Institutions

 Companies that specialize in financial

matters
 Banks – commercial and investment
 Insurance companies
 Brokerage firms

Finance: A Quick Look

7 International Finance

 This is an area of specialization within

each of the areas discussed so far
 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; speaking a foreign language
fluently is also helpful

Finance: A Quick Look

8 What is Corporate Finance?

$
Production of Sale of Goods
Goods & & Services
Services

$ Firm
$$
Issuance of
Dividends &
Securities
Debt Payments
Investors
$
Business Finance and the Financial Manager
9
What is Corporate Finance?
Corporate Finance addresses the
following three questions:
 What long-term investments should the firm
choose?
 How should the firm raise funds for the selected
investments?
 How should short-term assets be managed and
financed?

Business Finance and the Financial Manager

10 Balance Sheet Model of the Firm
Total Value of Assets: Total Firm Value to Investors:

Current
Liabilities
Current
Assets Long-Term

=
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity

Business Finance and the Financial Manager

11 The Capital Budgeting Decision

Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
What long-
1 Tangible term
investments Shareholders’
2 Intangible should the firm Equity
choose?

Business Finance and the Financial Manager

12 The Capital Structure Decision

Current
Liabilities
Current
Assets Long-Term
Debt
How should the
firm raise funds
Fixed Assets for the selected
investments?
1 Tangible
Shareholders’
2 Intangible
Equity

Business Finance and the Financial Manager

13 Short-Term Asset Management

Current
Liabilities
Current
Net
Assets Working Long-Term
Capital Debt

Fixed Assets How should

short-term assets
1 Tangible be managed
and financed? Shareholders’
2 Intangible Equity

Business Finance and the Financial Manager

14 The Financial Manager
The Financial Manager’s primary goal is to increase
the value of the firm by:

 Selecting value creating projects

 Making smart financing decisions

Business Finance and the Financial Manager

15 The Corporate Firm
 The choice of a corporate form of business is one
of the methods for solving the problems
encountered in raising large amounts of cash.
 Actually, businesses can take different forms.
1. The Sole Proprietorship
2. The Partnership
 General Partnership
 Limited Partnership
3. The Corporation

Forms of Business Organizations

 16 Sole Proprietorship
Business owned by one person
Advantages Disadvantages
Easiest to start Limited to life of owner
Least regulated Equity capital limited to
Single owner keeps all of the owner’s personal wealth
profits Unlimited liability
Taxed once as personal income Difficult to sell ownership
interest

Forms of Business Organizations

 17 Partnership
Business owned by two or more persons
Advantages Disadvantages
Two or more owners Unlimited liability
More capital available o General partnership
Relatively easy to start o Limited partnership
Income taxed once as personal Partnership dissolves when one
income partner dies or wishes to sell
Difficult to transfer ownership

Forms of Business Organizations

 18 Corporation
A legal “person” distinct from owners and a
resident of a state
Advantages Disadvantages
Limited liability Separation of ownership and
management (agency problem)
Unlimited life
Separation of ownership and Double taxation (income taxed
management at the corporate rate and then
dividends taxed at personal
Transfer of ownership is easy rate, while dividends paid are
Easier to raise capital not tax deductible)

Forms of Business Organizations

 The Goal of Financial
19
Management (1 of 2)
 What is the correct goal?
Maximize profit?
Minimize costs?
Maximize market share?

Maximize shareholder wealth,

i.e., the current stock value

The Goals of Financial Management

20
The Goal of Financial
Management (2 of 2)
 Does this mean we should do anything and
everything (even illegal or unethical) to
maximize owner wealth?

 A more modern goal is to maximize stakeholders’

benefits
Corporate social responsibility – other
stakeholders’ interests (such as employees,
customers and the communities) should not be
ignored

The Goals of Financial Management

21 The Agency Problem
Agency relationship
Principal hires an agent to represent his/her interest
Stockholders (principals) hire managers (agents) to run
the company i.e., separation of ownership and control
Agency problem
Conflict of interest between principal and agent

The Agency Problem and Control of Corporation

22 Managerial Goals
 Managerial goals may be different from
shareholder goals, E.g.
 Expensive perquisites (e.g., corporate jets)
 Survival (or job security)
 Independence
 Increased growth and size (e.g., empire building
through merger & acquisitions) are not necessarily
equivalent to increased shareholder wealth

The Agency Problem and Control of Corporation

23
Separation of Ownership and
Control
Board of Directors

Debtholders

Shareholders
Management
Auditor

Debt
Assets
Equity

The Agency Problem and Control of Corporation

24 Managing Managers
Managerial compensation
Incentives can be used to align management and
stockholder interests
The incentives need to be structured carefully to make
sure that they achieve their intended goal. E.g.
managerial compensation is tied to financial
performance, say, stock price of the firm
Market Discipline
Underperformed management can be replaced by the
board of directors
Corporate control
The threat of a takeover by other firms may result in
better management
The Agency Problem and Control of Corporation
25 Financial Markets
 Primary Market
 New issuance of securities such as stocks and bonds
 Secondary Markets
 Buying and selling of previously issued securities
 NYSE
 NASDAQ
 HKEx

Financial Markets and the Corporation

26 Financial Markets

Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money

Primary Market
Secondary
Market

Financial Markets and the Corporation

27 Lecture Summary

 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
 Financial Markets and the Corporation
28 Quick Quiz
What are the three basic questions Financial
Managers must answer?
What are the three major forms of business
organization?
What is the goal of financial management?
What are agency problems, and why do
they exist within a corporation?
What is the difference between a primary
market and a secondary market?