CHAPTER 1 An Overview of Financial Management

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CHAPTER 1An Overview of Financial Management

• Career Opportunities
• Forms of Businesses
• Goals of the Corporation
• Agency Relationships

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Career Opportunities in Finance

• Money and capital markets
• Investments
• Financial management

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Responsibility of the Financial Staff

• Maximize stock value by
• Forecasting and planning
• Investment and financing decisions
• Coordination and control
• Transactions in the financial markets
• Managing risk

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• Responsibilities of the Financial Manager
• One - Capital Budgeting (Investment) decision
• Two - Capital structure decision
• Three - Dividend policy decision
• All firms - individual proprietorships to large
  multinational corporations face these decisions
• Common tool to analyze all these decisions (and
  much more)
• These decisions are made within the context of
  financial markets

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Alternative Forms of Business Organization

• Sole proprietorship
• Partnership
• Corporation

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Sole proprietorships Partnerships

• Advantages
• Ease of formation
• Subject to few regulations
• No corporate income taxes
• Disadvantages
• Difficult to raise capital
• Unlimited liability
• Limited life

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Corporation

• Most important form of business organization
• Legal person
• Separate and distinct from owners
• Can borrow money
• Enter into contracts
• Own property
• Sue and be sued
• Can own stock in another corporation

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Corporation

• Requires articles of incorporation
• Name
• Intended life
• Business Purpose
• Authorized capital - May be amended by
  shareholders
• Rights to shareholders
• Number of directors on the board
• How directors are elected
• Filed in a given state
• Corporation is a resident of that state

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Corporation

• Stockholders elect board of directors
• Board of directors has the legal authority
• To declare a dividend
• Issue securities
• Commit large investment outlays
• Directors select senior management
• CEO, president
• To run corporation in interests of shareholders

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Corporation

• Advantages
• Unlimited life
• Easy transfer of ownership
• Limited liability
• Ease of raising capital
• Disadvantages
• Double taxation
• Cost of set-up and report filing

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Objective of the firm

• Individual owner
• Maximize profits
• Maximize the value of the business
• Corporation -
• Maximize the value of the firm
• Maximize shareholder value
• Maximize price per share
• These objectives are generally considered
  interchangeable

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Financial Goals of the Corporation

• The primary financial goal is shareholder wealth
  maximization, which translates to maximizing
  stock price.
• Do firms have any responsibilities to society at
  large?
• Is stock price maximization good or bad for
  society?
• Should firms behave ethically?

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Is stock price maximization the same as profit
maximization?

• No, despite a generally high correlation amongst
  stock price, EPS, and cash flow.
• Current stock price relies upon current earnings,
  as well as future earnings and cash flow.
• Some actions may cause an increase in earnings,
  yet cause the stock price to decrease (and vice
  versa).

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Role of Finance in a Typical Business Organization
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Corporation - Organization of financial officers

• Treasurer
• Capital budgeting
• Financing
• Cash management
• Recommending dividend policy
• Insurance
• Pension plans
• Controller
• Accounting
• Preparation of financial statements
• Preparing budgets
• Internal auditing

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Agency relationships

• An agency relationship exists whenever a
  principal hires an agent to act on their behalf.
• Within a corporation, agency relationships exist
  between
• Shareholders and managers
• Shareholders and creditors

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Shareholders versus Managers

• Managers are naturally inclined to act in their
  own best interests.
• But the following factors affect managerial
  behavior
• Managerial compensation plans
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover

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Shareholders versus Creditors

• Shareholders (through managers) could take
  actions to maximize stock price that are
  detrimental to creditors.
• In the long run, such actions will raise the cost
  of debt and ultimately lower stock price.

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Factors that affect stock price

• Projected cash flows to shareholders
• Timing of the cash flow stream
• Riskiness of the cash flows

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Factors that Affect the Level and Riskiness of
Cash Flows

• Decisions made by financial managers
• Investment decisions
• Financing decisions (the relative use of debt
  financing)
• Dividend policy decisions
• The external environment