FINANCIAL MANAGEMENT

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 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

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 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
• Financial Markets and the Corporation
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Basic Areas Of Finance
Investments
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02 Financial institutions

03 International finance

04 Corporate finance

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 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

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 Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ
• IDX

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 Financial Institutions
• Companies that specialize in financial
matters
– Banks – commercial and investment, credit
unions, savings and loans
– Insurance companies
– Brokerage firms
• Job opportunities

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 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

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 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, day-
to-day cash flow issues

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 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?

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 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

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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?

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 Forms of Business Organization
• Three major forms of Business
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• S-Corp
• Limited liability company

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 Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all owner’s personal wealth
of the profits – Unlimited liability
– Taxed once as personal – Difficult to sell
income ownership interest

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 Partnership
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
• Limited partnership
– Relatively easy to start
– Income taxed once as – Partnership dissolves
personal income when one partner dies
or wishes to sell
– Difficult to transfer
ownership

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 Corporation
• Advantages • Disadvantages
– Limited liability – Separation of ownership
– Unlimited life and management
– Separation of ownership (agency problem)
and management – Double taxation (income
– Transfer of ownership is taxed at the corporate
easy rate and then dividends
taxed at personal rate,
– Easier to raise capital while dividends paid are
not tax deductible)

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 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?
• Sarbanes-Oxley Act
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 the Goal of the Firm

Maximization of
Shareholder Wealth!
Value creation occurs when we
maximize the share price for current
shareholders.
Shortcomings of Alternative Perspectives

Profit Maximization
 Maximizing a firm’s earnings after taxes.
Problems

• Could increase current profits while harming firm

(e.g., defer maintenance, issue common stock to
buy T-bills, etc.).
• Ignores changes in the risk level of the firm.
 Shortcomings of Alternative
Perspectives
Earnings per Share Maximization
 Maximizing earnings after taxes divided by
shares outstanding.
Problems
• Does not specify timing or duration of expected
returns.
• Ignores changes in the risk level of the firm.
• Calls for a zero payout dividend policy.
 Strengths of Shareholder Wealth
Maximization
• Takes account of: current and future profits and
EPS;
EPS the timing, duration, and risk of profits and
EPS;
EPS dividend policy;
policy and all other relevant
factors.
• Thus, share price serves as a barometer for
business performance.
 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

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 The Modern Corporation

Modern Corporation

Shareholders Management

There exists a SEPARATION between owners

and managers.
 Role of Management

Management acts as an agent for

the owners (shareholders) of the
firm.
• An agent is an individual authorized by
another person, called the principal, to
act in the latter’s behalf.
 Agency Theory

 Jensen and Meckling developed a

theory of the firm based on agency
theory.
theory
• Agency Theory is a branch of economics
relating to the behavior of principals and
their agents.
 Agency Theory

 Principals must provide incentives so

that management acts in the
principals’ best interests and then
monitor results.
• Incentives include, stock options, perquisites,
and bonuses.
bonuses
 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 goal
• Corporate control
– The threat of a takeover may result in better
management
• Other stakeholders

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 Example: Work the Web
• The Internet provides a wealth of
information about individual companies
• One excellent site is finance.yahoo.com.
• Click on the web surfer to go to the site,
choose a company and see what
information you can find!

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 Quick Quiz
• What are the four basic areas of finance?
• What are the three types of financial
management decisions, and what questions are
they designed to 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?

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