Brush up

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Brush up

• The Role of Financial Management

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The Role of Financial Management

• What is Financial Management?
• The Goal of the Firm
• Corporate Governance
• Organization of the Financial Management Function

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What is Financial Management?

• Concerns the investment, financing, asset and
  risk management with some overall goal in mind.

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The Balance-Sheet Modelof the Firm
The Net Working Capital Investment Decisions
Current Liabilities
Current Assets
Net Working Capital
Long-Term Debt

• Investment Decisions
• Capital Budgeting

• Financing Decisions
• Capital Structure

Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
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Financing Decisions
Determine how the assets (LHS of balance sheet)
will be financed (RHS of balance sheet).

• What is the best type of financing?
• What is the best financing mix?
• What is the best dividend policy (e.g.,
  dividend-payout ratio)?
• How will the funds be physically acquired?

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The Role of The Financial Manager
Financial
Firm's
Financial
managers
operations
markets
(5)
Government
Irwin/McGraw-Hill
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What is the Goal of the Firm?

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

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What companies say about their corporate goal

• Cadbury Schweppes governing objective is growth
  in shareowner value
• Credit Suisse Group achieve high customer
  satisfaction, maximize shareholder value and be
  an employer of choice
• Dow Chemical Company maximize long-term
  shareholder value
• ExxonMobil long-term, sustainable shareholder
  value
• Refer to text for additional details

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Shortcomings of Alternative Perspectives

• Profit Maximization
• Maximizing a firms 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.

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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.

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Strengths of Shareholder Wealth Maximization

• Takes account of current and future profits and
  EPS the timing, duration, and risk of profits
  and EPS dividend policy and all other relevant
  factors.
• Thus, share price serves as a barometer for
  business performance.
• Performance Measurement
• ABC, the Balanced Scorecard, EVA and VBM provide
  a decision framework and incentives to motivate
  management to create value.

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Performance Measurement

• ABC Activity-Based Costing can help managers
  understand the costs and capital impact of their
  decisions.
• The Balanced Scorecard broadens the view of
  performance to include financial and
  non-financial indicators of both a leading and
  lagging nature.
• EVA Economic Value Added provides a link between
  decisions, performance measures, and rewards,
  which focuses managers on creating value.
• VBM Value- Based Management is the systematic
  application of the corporate valuation model to
  all corporate decisions and strategic
  initiatives.
• The objective of VBM is to increase Market Value
  Added (MVA) Total corporate value of firm -
  total book value of firm

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MVA and the Four Value Drivers

• MVA is determined by four drivers MVA ?
• Sales growth ?
• Operating profitability (OPNOPAT/Sales) ?
• Capital requirements
  ? (CROperating capital / Sales)
• Weighted average cost of capital (WACC) ?

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Separation of Ownership and Control
The Modern Corporation
Board of Directors
Management
Debtholders
Shareholders
Debt
Assets
Equity
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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
  latters behalf.

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Agency Theory

• Jensen and Meckling developed a theory of the
  firm based on agency theory.

• Agency Theory is a branch of economics relating
  to the behavior of principals and their agents.

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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.
• There is a market for managerial talentthis may
  provide market discipline to the managersthey
  can be replaced.
• If the managers fail to maximize share price,
  they may be replaced in a hostile takeover.

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Social Responsibility

• Should firms behave ethically? YES!
• Do firms have any responsibilities to society at
  large? YES! Shareholders are also members of
  society.
• Wealth maximization does not preclude the firm
  from being socially responsible.
• Assume we view the firm as producing both private
  and social goods.

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Is maximizing stock price good for society,
employees, and customers?

• Employment growth is higher in firms that try to
  maximize stock price. On average, employment goes
  up in
• firms that make managers into owners (such as LBO
  firms)
• firms that were owned by the government but that
  have been sold to private investors

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• Consumer welfare is higher in capitalist free
  market economies than in communist or socialist
  economies.
• Fortune lists the most admired firms. In
  addition to high stock returns, these firms have
• high quality from customers view
• employees who like working there
• Then shareholder wealth maximization remains the
  appropriate goal in governing the firm.

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Corporate Governance

• Corporate governance represents the system by
  which corporations are managed and controlled.
• Includes shareholders, board of directors, and
  senior management.
• Then shareholder wealth maximization remains the
  appropriate goal in governing the firm.

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Organization of the Financial Management Function
Board of Directors
President (Chief Executive Officer)
VP of Finance
Vice President Operations
Vice President Marketing
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Organization of the Financial Management Function
VP of Finance
Treasurer Capital Budgeting Cash
Management Credit Management Dividend
Disbursement Fin Analysis/Planning Pension
Management Insurance/Risk Mngmt Tax
Analysis/Planning
Controller Cost Accounting Cost Management Data
Processing General Ledger Government
Reporting Internal Control Preparing Fin
Stmts Preparing Budgets Preparing Forecasts
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Career Opportunities in Finance

• Institutions and capital markets
• Investments
• Financial management

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CAPITAL MARKETS

• CommoditiesAgricultural (softs, pulps, grains,
  livestock)Energy and PowersProperty and
  insuranceMetals
• ExchangesStock exchangesDerivative
  ExchangesCommodity Exchanges
• EquitiesIndividual equitiesIndexes

• TradingExchange TradingOTC
• Fixed IncomeBondsLoans
• Corporate Reports
• Real Estate
• Currencies
• Derivatives

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RISK MANAGEMENT

• ExposuresCommoditiesFixed IncomeEquitiesCurren
  ciesInterest ratesCredit
• TechnologyTrading systemsBack office
  systemsData ManagementRisk Management Systems

• InstrumentsFutures/ForwardsSwapsOptionsStructu
  red Notes
• Theory Research/Training
• Boutiques
• Regulators
• Trading

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Careers in Finance