AN OVERVIEW OF MANAGERIAL FINANCE CHAPTER 1 AN OVERVIEW OF MANAGERIAL FINANCE N. ALSALEH: FIN220-CH1 11/14/2018

Finance is the Science and Art of Managing Money What is Finance? Finance is the Science and Art of Managing Money Finance Deals with Decisions about How to: Raise Money Invest Money Spend Money N. ALSALEH: FIN220-CH1 11/14/2018

Finance is important For every body (How): When you want to borrow to buy a car or a house retire ( the amount of payment you receive) start your own business invest your money N. ALSALEH: FIN220-CH1 11/14/2018

Finance and other disciplines: Finance is closely related to: Management Marketing: Information Systems Accounting Economics N. ALSALEH: FIN220-CH1 11/14/2018

Differences between Finance & Accounting: Accounting Finance Gathering & Presenting Decision Making Accounting Information Accrual Concept Cash Concept N. ALSALEH: FIN220-CH1 11/14/2018

On December 20, 2006, Gulf Co. generated sales of $1,000,000 on credit to be paid after 30 days ( Jan , 19, 2007). Dec,20,2006 Account Receivables $1,000,000 Sales $1,000,000 January 19,2007 Cash $1,000,000 Account Receivables $,1000,000 N. ALSALEH: FIN220-CH1 11/14/2018

Finance consists of three interrelated areas Financial Markets and Institutions Investments Managerial Finance) Role of Finance within a Business Organization ( N. ALSALEH: FIN220-CH1 11/14/2018

Forms of Business Organizations (Proprietorship, Partnership, Corporation) Proprietorship A business owned by one Individual. Partnership A business owned by two or more than two persons. N. ALSALEH: FIN220-CH1 11/14/2018

A corporation is a legal entity created By law. it is separate and distinct from its owners and managers. Money contributed to start a corporation is called capital stock and is divided into shares. The owners of the corporation are called stockholders or shareholders. N. ALSALEH: FIN220-CH1 11/14/2018

Corporation enjoys four major advantages: 1. Limited Liability 2. Permanency 3. Liquidity 4. Ability to Raise Capital N. ALSALEH: FIN220-CH1 11/14/2018

Role of Finance in a typical Business Organization N. ALSALEH: FIN220-CH1 11/14/2018

Stockholders BOD President (CEO) VP-Marketing VP- Finance VP-Production Treasurer Controller Accounting Functions N. ALSALEH: FIN220-CH1 11/14/2018

Marketable Securities Treasurer Capital Budgeting Managing Cash & Marketable Securities Managing Risk Capital Structure Managing Inventory N. ALSALEH: FIN220-CH1 11/14/2018

Responsibilities & Functions of the Financial manager Forecasting & Planning Investment & Financing Decisions Coordination & Control Dealing with Financial Markets N. ALSALEH: FIN220-CH1 11/14/2018

The goals of the Corporation The management primary goal is: stockholder wealth maximization This is translated into maximizing the value of the firm as measured by the price of the firm’s common stock. N. ALSALEH: FIN220-CH1 11/14/2018

Stockholder Wealth Maximization Stock Price Maximization The Goals of the Corporation Stockholder Wealth Maximization Stock Price Maximization N. ALSALEH: FIN220-CH1 11/14/2018

Social Responsibility The concept that businesses should be Actively concerned with the welfare of society at large. Businesses are responsible for the welfare of their employees, customers, and the communities in which They operate? N. ALSALEH: FIN220-CH1 11/14/2018

Stock Price Maximization and Social Welfare Actions that maximize stock prices are consistent with social welfare. STPM requires: Company to produce high quality goods and services at the lowest possible cost. The development of products that consumers want and need. Requires efficient and courteous services, adequate stocks of merchandise and good location. N. ALSALEH: FIN220-CH1 11/14/2018

Wealth maximization (Value) Management must consider the following factors in its attempt to maximize wealth: Projected earnings per Share (EPS) rather than profit maximization, Timing of the earnings stream, Riskiness of the projected earnings, N. ALSALEH: FIN220-CH1 11/14/2018

Management must consider the following factors in its attempt to maximize wealth Projected earnings per Share (EPS) rather than profit maximization, b. Timing of the earnings stream, c. Riskiness of the projected earnings, N. ALSALEH: FIN220-CH1 11/14/2018

Gulf Star reported net income of $200,000 for 2005. Gulf has 100,000 shares outstanding. You own 100 shares. So your share of the earnings is $200. During 2006, the company issued 25,000 more shares and reported net income of $220,000. The earnings per share is: $220,000/125,000 = $1.76/share. Your share of the earnings is $1.76x100= $176 N. ALSALEH: FIN220-CH1 11/14/2018

Timing of the earnings stream ( increase in profits Million) YEAR1 YEAR2 TOTAL Project A 5 2 7 Project B 2 5 7 N. ALSALEH: FIN220-CH1 11/14/2018

Riskiness of the projected earnings Project A- very safe project and is expected to raise earnings by $1.0 per share. Project B - very risky project and is expected to raise earnings by $2.00 per share. N. ALSALEH: FIN220-CH1 11/14/2018

Agency Relationships Exist between: Stockholders and managers and Agency relationship exists when one or more people ( the principals) hire another person (the agent) to perform a service and then Delegate decision-making authority to that agent. Agency Relationships Exist between: Stockholders and managers and Stockholders and creditors N. ALSALEH: FIN220-CH1 11/14/2018

Stockholders versus Managers Agency relationship that exist between stockholders and mangers gives rise to what so called agency problem. Agency problem: the likelihood that mangers place personal goals ahead of corporate goals. N. ALSALEH: FIN220-CH1 11/14/2018

Mechanisms available to make mangers to act in the shareholders’ Best interest? 1. Structuring Managerial Incentives . Performance shares . Executive stock option 2. Shareholder intervention (The threat of firing) 3. The threat of takeover N. ALSALEH: FIN220-CH1 11/14/2018

Stockholders versus Creditors Conflicts between stockholders and Creditors result from: Actions taken by stockholders that jeopardize the interest of the creditors N. ALSALEH: FIN220-CH1 11/14/2018

Creditors lend funds to the firm at rates that are based on the following factors: The riskiness of the firm’s existing assets The riskiness of future asset additions Firm’s existing capital structure Future capital structure N. ALSALEH: FIN220-CH1 11/14/2018

The goal of wealth maximization requires fair play with creditors Stockholder wealth depends on continued access to capital market and abiding by both the letter and the sprit of credit agreements. Managers as agents of both the creditors and the stockholders, must act in a manner that is fairly balanced between the interests of these two parties N. ALSALEH: FIN220-CH1 11/14/2018

Stakeholders Individuals or entities that have an interest in the well-being of a firm, including: a. Stockholders, b. Creditors, c. Employees d. Customers and ,e. Suppliers Maximizing shareholder wealth requires the fair treatment of all stakeholders N. ALSALEH: FIN220-CH1 11/14/2018