Introduction to Financial Management

1
Chapter 1

• Introduction to Financial Management

2
Key Concepts and Skills

• Know the basic financial management decisions and
  the financial managers role
• Know the forms of business organization and the
  advantages/disadvantages of each
• Know the goal of financial management
• Know the conflicts of interest that may arise
  between owners and managers

3
Chapter Overview

• Finance An Overview
• Business Finance and the Financial Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Issue and Control of the Corporation
• Financial Markets

4
Areas of Finance

• Corporate finance
• Investments
• Financial Institutions
• International finance

5
Investments!

• Work with financial assets
• Value of financial assets, risk versus return,
  asset allocation
• Job opportunities
• Financial planner, stockbroker
• Portfolio manager
• Securities analyst
• CalPers and CalStrs

6
Financial Institutions

• Banks commercial banks, credit unions, savings
  and loans
• Insurance companies
• Brokerage houses
• Schwab
• Merrill Lynch
• Scottrade, Etrade

7
International Finance

• A specialized area within the other areas of
  finance
• Work in foreign countries and travel
• Requires knowledge of exchange rates and
  political risk
• Requires knowledge of other cultures and possibly
  the ability to speak foreign language(s)

8
Reasons to Study Finance

• Marketing
• Create budgets, perform marketing research,
  market financial products
• Accounting
• Preparation of financial statements, dual
  accounting/financial functions
• Management
• Strategic thinking, performance, and
  profitability
• Personal finance
• Retirement planning, investing, daily cash flow

9
Business Finance

• Questions the financial manager will answer
• What long-term investments should we make?
• How will we obtain long-term financing to pay for
  the investments?
• How will we manage the daily financial activities
  of the firm?

10
Financial Manager

• Chief Financial Officer (CFO), the highest-level
  financial manager within a firm
• Treasurer Oversees cash management, credit
  management, capital expenditures, financial
  planning functions
• Controller Oversees taxes, cost accounting,
  financial accounting, and data processing
  functions

11
Forms of Business Organization

• There are three major forms of business
  organization in the United States
• Sole proprietorship
• Partnership
• General partnership
• Limited partnership
• Corporation
• S-Corp
• Limited liability company (LLC)

12
Sole Proprietorship

• Advantages
• Easiest to start
• Least regulated
• Single owner retains profits
• Income taxed once at personal income tax rate

• Disadvantages
• Limited to the life of the owner
• Equity capital limited to owners personal wealth
• Unlimited liability
• Difficult to sell ownership interest

13
Partnership

• Advantages
• Two or more owners
• More available capital
• Easy to start
• Income taxed once at the personal income tax rate

• Disadvantages
• Unlimited liability
• Partnership dissolves when one partner dies or
  sells
• Difficult to transfer ownership

14
Corporation

• Advantages
• Limited liability
• Unlimited life
• Separation of ownership and management
• Ease of transfer of ownership
• Ability to raise capital

• Disadvantages
• Separation of ownership and management (agency
  problem)
• Double taxation
• (Income taxed at the corporate tax rate and
  dividends taxed at the personal tax rate)problem)

15
Goal of Financial Management

• The goal of a corporation is to maximize the
  value of the firms stock
• Sarbanes-Oxley Act
• Adopted in 2002 in response to corporate
  mismanagement
• Scandals involved Enron, WorldCom, Tyco, and
  Adelphia

16
Agency Issues

• The agency relationship
• An agency relationship occurs when a principal
  hires an agent to represent his/her interest
• Stockholders (principals) hire managers (agents)
  to represent their interests and manage the
  company
• Agency problem
• A potential conflict of interest between the
  owners and management of a firm
• Management interests and stockholders interests
  might differ - agency costs

17
Managerial Compensation and Control

• Managerial compensation
• Incentives can help to align management and
  stockholders interests
• Incentives must be carefully designed to ensure
  that they align management and stockholders
  interests
• Corporate Control
• A hostile takeover threat/attempt may result in
  better management

18
Managerial Compensation and Control (continued)

• Employees, customers, suppliers, and the
  government (stakeholders) have a financial
  interest in the firm

19
Financial Markets

• Cash flows to the firm
• Primary market
• The original sale of securities by governments
  and corporations
• Secondary market
• One owner or creditor selling to another
• Provide the means for transferring ownership of
  corporate securities

20
Financial Markets (continued)

• NASDAQ
• National Association of Securities Dealers
  Automated Quotations system
• A dealer market an over-the-counter (OTC)
  market
• Less stringent listing requirements than NYSE

21
Financial Markets (continued)

• New York Stock Exchange
• An auction market
• Has a physical location on Wall Street
• Accounts for more than 85 of all shares traded
  in auction markets

22
Quiz

• What are the major areas of corporate finance?
• What is the capital budgeting decision?
• What is the mixture of long-term debt and equity
  that a firm chooses to use called?
• What are the three forms of business
  organization?
• What is the difference between a general and a
  limited partnership?

23
Quiz (continued)

• What are the primary advantages and disadvantages
  of sole proprietorships and partnerships?
• What is the goal of financial management?
• What is a dealer market?
• What is the largest auction market in the United
  States?
• What does OTC stand for? What is the largest OTC
  market for stocks called?