Introduction to Financial Management
Organization of the Book
The Underpinnings
Part 1 Introduction to Financial Management
Part 2 Financial statements and analyze
Part 3, 4 & 6 Basic tools of financial analysis
Main content
Capital Budgeting Part 5
Capital Structure
Part 8 short term financing
Part 7 long term financing
Working capital management Part 8 in chapter 17
Part 9 international aspects of financial management
Key Concepts and Skills
The basic types of financial management decisions and the role of the financial manager.
The goal of financial management.
The financial implications of the different forms of business organization.
The conflicts of interest that can arise between managers and owners.
Chapter Outline
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
US Corporation Balance Sheet – Table 2.1
What is financial management?
Capital budgeting
Capital structure
Working capital management
Capital Budgeting
The process of planning and managing a firm’s long-term investments.
What long-term investments should the firm take?
How much cash they expect to receive, when they expect to receive it, and how likely they are to receive it? (size, timing and risk of future cash flow)
Capital Structure
The mixture of debt and equity maintained by a firm.
Where will you get the long-term financing to pay for your investment?
Does the firm issue equity or debt?
Should the firm issue short-term or long-term securities?
Working Capital Management
A firm’s short-term assets and liabilities
Net working capital
How much cash and inventory should we keep on hand?
Should we sell on credit to our customers?
How will we obtain any needed short-term financing? And where?
Conclusion…,
Financial management has three main areas of decisions: capital budgeting, capital structure, and working capital management.
Organization of the Financial Management Function
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
Vice President
Marketing
Vice President
Finance (CFO)
Vice President
Production
President and Chief
Operations Officer (COO)
Organization of the Financial Management Function
VP of Finance
Treasurer
Cash Manager
Credit Manager
Capital Expenditures
Financial Planning
Controller
Tax Manager
Cost Accounting Manager
Financial Accounting
Manage
Data Processing Manager
The Goal of Financial Management
Profit Maximization
Problems:
Put eyes on the present, ignore the firm’s development in the future.
Accounting net income or earning per share have little to do with what is good or bad for the firm.
The Goal of Financial Management
Maximize the current value per share of the existing stock
Shareholders buy stock because they seek to
gain financially, financial manager acts in the
shareholders’ best interests by making
Decisions that increase the value of the stock.
The Goal of Financial Management
Maximize the market value of the existing
owners’ equity
For-profit business, the total value of the stock in a
corporation is simply equal to the value of the
owners’ equity
Agency Problem
An agent is an individual authorized by
another person, called the principal, to act
on the latter’s behalf.
Management acts as an agent for the owners (shareholders) of the firm.
Agency Problem
The relationship between stockholders and
management is called an agency
relationship. Such a relationship exists
whenever someone ( the principal ) hires
another ( the agent) to represent his or her
interest.
Agency Problem
Agency problem: the possibility of conflict of interest between the owners and management of a firm.
How to control and reduce Agency Problem?
Managerial compensation: stock option; job prospects.
Control of the Firm: proxy fight; takeover
Business Organization
We examine the four legal forms
of business organization:
Sole Proprietorships
Partnerships (general and limited)
Corporations
Limited liability companies
Sole Proprietorship
A business owned by a single individual
Sole Proprietorship
Advantages
Simplest
Least regulated
Single tax for personal income
Disadvantages
Unlimited liability
Limited life
Insufficient capital
Transfer of ownership difficulties
Partnership
A business formed by two or more individuals or entities
Partnership
General partnership – all partners share in gains or losses, and all have unlimited liability for all partnership debts, not just some particular share.
Limited partnership – one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who do not actively participate in the business.
Partnership
Advantages
Easy and inexpensive
to form
Limited liability for limited partners
Single tax for personal income
Disadvantages
Unlimited liability for the general partner
Limited life for business
Transfer of ownership difficulties
Inability to raise additional cash for investment
Corporation
A legal “person” separate and distinct from its owners, and it has many of the rights, duties of actual person.
Corporation
Advantages
Limited liability
Easy transfer of ownership
Unlimited life
Easier to raise large quantities of capital
Disadvantages
Double taxation
More complicated to set up
Limited Liability Company (LLC)
This entity is to operate and be taxed like a partnership but retain limited liability for owners.
Financial Market
A financial market is just a way of bringing buyers and sellers together. It is debt and equity securities that are bought and sold.
Primary markets
Secondary markets ( dealer, auction market)
End of Chapter
The first example computing cash flows has a link to the information in this table. The arrow in the corner is used to return you to the example.
Here is an example of a simplified balance sheet. Many students make it through business school without ever seeing an actual balance sheet, particularly those who are not majoring in finance or accounting. I encourage you to bring in some annual reports and let the students see the differences between the simplified statements they see in textbooks and the real thing.
This is a good place to talk about some of the specific types of items that show up on a balance sheet and remind the students what accounts receivable, accounts payable, notes payable, etc. are.
Liquidity is a very important concept. Students tend to remember the “convert to cash quickly” component of liquidity, but often forget the part about “without loss of value.” Remind them that we can convert anything to cash quickly if we are willing to lower the price enough, but that doesn’t mean it is liquid.
Also, point out that a firm can be TOO liquid. Excess cash holdings lead to overall lower returns. See the IM for a more complete discussion of this issue.
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