Introduction to Financial Management

1
Introduction to Financial Management

• P.V. Viswanath
• Based partly on slides from
• Fundamentals of Corporate Finance
• Brealey, Myers and Marcus, 4th ed.

2
Key Concepts and Skills

• Know the basic types of financial management
  decisions and the role of the financial manager
• Know the goal of financial management
• Know the financial implications of the different
  forms of business organization
• Understand the conflicts of interest that can
  arise between owners and managers

3
Chapter Outline

• Finance A Quick Look
• Forms of Business Organization
• Business Finance and The Financial Manager
• The Goals of the Corporation
• The Agency Problem and Control of the Corporation
• Financial Markets and the Corporation

4
Organizing a Business
5
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 personal rate)

6
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 and
  profitability
• Personal finance
• Budgeting, retirement planning, college planning,
  day-to-day cash flow issues

7
The Role of The Financial Manager
Firm's
Financial
operations
Investors
Manager
Real assets
8
What questions does finance answer?

• 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?

9
Financial Managers

• The top financial manager within a firm is
  usually the Chief Financial Officer (CFO). Under
  the CFO, we have
• Treasurer oversees cash management, credit
  management, capital expenditures and financial
  planning
• Controller oversees taxes, cost accounting,
  financial accounting and data processing

10
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?

11
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 companys
  stock?
• General guide Maximize shareholder wealth,
  keeping in mind the effects on firm value.
• Does this mean we should do anything and
  everything to maximize owner wealth?

12
The Agency Problem

• Agency relationship
• Principal hires an agent to represent their
  interest
• Stockholders (principals) hire managers (agents)
  to run the company
• Agency problem
• Conflict of interest between principal and agent
• Management goals and agency costs

13
Managing Managers

• 1 - Compensation plans Incentives can be used to
  align management and stockholder interests
• 2 - Board of Directors
• 3 Takeovers The threat of a takeover may
  result in better management
• 4 - Specialist Monitoring
• 5 - Auditors

14
Financial Markets
Money
Primary Markets
OTC Markets
Secondary Markets
15
Funding Sources Financial Markets

• Internally Generated Cash flows
• Cash generated by the business is retained and
  reinvested as long as positive value-adding
  projects can be found.
• Primary and secondary markets
• Dealer vs. auction markets
• Listed vs. over the counter securities
• NYSE
• NASDAQ

16
Funding Sources Financial Markets

• Financial Intermediaries raise money from
  investors and provide financing for companies.
• Mutual Funds raise money by selling shares to
  investors
• Financial Institutions raise financing in
  special ways
• Banks raise financing by accepting deposits
  they also provide other financial services.
• Insurance Companies they raise money by selling
  insurance policies.

17
Functions of Financial Markets and Intermediaries

• Transporting Cash across time
• Liquidity
• Payment Mechanism (e.g. checks)
• Reducing Risk
• Providing Information, which firms use to
• Hedge
• Make financing decisions
• Align employee goals with stockholder goals.