Introduction to Financial Management Chapter 1 Introduction to Financial Management
Key Concepts and Skills Know the basic financial management decisions and the financial manager’s 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
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
Areas of Finance Corporate finance Investments Financial Institutions International finance
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
Financial Institutions Banks: commercial banks, credit unions, savings and loans Insurance companies Brokerage houses Schwab Merrill Lynch Scottrade, Etrade
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)
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
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?
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
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)
Sole Proprietorship Advantages Disadvantages 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 owner’s personal wealth Unlimited liability Difficult to sell ownership interest
Partnership Advantages Disadvantages 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
Corporation Advantages Disadvantages 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)
Goal of Financial Management The goal of a corporation is to maximize the value of the firm’s stock Sarbanes-Oxley Act Adopted in 2002 in response to corporate mismanagement Scandals involved Enron, WorldCom, Tyco, and Adelphia
Agency Issues The agency relationship Agency problem 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
Managerial Compensation and Control 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
Managerial Compensation and Control (continued) Employees, customers, suppliers, and the government (stakeholders) have a financial interest in the firm
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
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
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
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?
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?