© 2003 McGraw-Hill Ryerson Limited 1 1 Chapter Prepared By: P Chua Slides Based on: Terry Fegarty Seneca College Book References: 1.Block, Short and Hirt 2.Gitman and Hennessey The Goals and Functions of Financial Management McGraw-Hill Ryerson©2003 McGraw-Hill Ryerson Limited

Chapter 1 - Outline  Definition of Finance  Areas of Finance  Career Opportunities in Finance  Finance as related to Accounting and Economics  The Goal of the Financial Manager  Agency issue as it relates to owner wealth maximization  Stakeholder focus, and ethical behaviour relate to firm’s goal.  Activities of Financial Management  Forms of Organization PPT 1-2

© 2003 McGraw-Hill Ryerson Limited  Finance is the study of financial planning, asset management, and fund raising for businesses and financial institutions.  Financial management can be described using a balance sheet. What is Finance? PPT 1-3

© 2003 McGraw-Hill Ryerson Limited Working Capital Working Capital Investment Decisions Financing Decisions Macro Finance

© 2003 McGraw-Hill Ryerson Limited Areas of Finance 1. Financial Markets - Markets of users and savers of funds. - Money markets deal in short-term securities (<=1 year) Ex.; Treasury Bills, commercial paper - Capital markets deal in long-term securities Ex.; common stock, preferred stock, corporate bonds, government bonds 2. Financial Services - Design and delivery of financial advice and products to individuals, businesses, government. 3. Managerial Finance - Financial management of business firms. - Financial management involves the efficient use of financial resources in the production of goods  A well-developed financial system is a hallmark and essential characteristic of any modern developed nation.

© 2003 McGraw-Hill Ryerson Limited Career Opportunities in Finance  Financial Analyst – prepares and analyze firm’s financial plans and budgets; other duties include financial forecasting, financial ratio analysis.  Capital budgeting analyst/manager – evaluation/recommendation of proposed asset investments, implementation of approved projects.  Project finance manager –arranges financing for approved asset investments; coordinates with investment bankers and legal counsel.  Cash manager - maintain and control firm’s daily cash balances; manages cash collection, short-term investment/borrowing, disbursement activities and banking relationships.  Credit analyst/manager – administers firm’s credit policy by analyzing/managing the evaluation of credit applications, extending credit, monitoring/collecting A/R’s.

© 2003 McGraw-Hill Ryerson Limited Finance as related to Accounting and Economics Finance is related to:  Accounting, which provides information in financial statements  Economics, which provides:  analysis tools such as pricing theory through supply and demand analysis, cost-benefit analysis etc.  information on the economic and financial environment in which the company operates for sound financial decisions. These include inflation rate, exchange rate, international capital flows, unemployment rate, etc.  All of these factors must fit into the financial decisions PPT 1-4

© 2003 McGraw-Hill Ryerson Limited Difference Between Finance and Accounting  Recognition of Revenue and Expenses  Accrual Basis: recognizes sales revenue and expenses incurred to make sale at time of sale.  Cash Basis: recognizes revenues and expenses as they occur. Accounting vs Financial View Accounting View (Accrual Basis) Income Statement Peakes Quay, Inc. For year ended 12/31 Financial View (Cash Basis) Cash Flow Statement Peakes Quay, Inc. For year ended 12/31 Sales revenue $100,000 Less: Costs 80,000 Net Profit $ 20,000 Cash inflow $ 0 Less: Cash outflow 80,000 Net cash flow ($80,000)

© 2003 McGraw-Hill Ryerson Limited Goal of the Financial Manager Should it be Profit Maximization?  Corporations commonly define profit as “Earnings per Share” (EPS).  EPS ignores at least 2 critical factors:  the timing of the returns.  risk factors facing the firm.  Profitability   Risk  Profitability   Risk  ex., investing in stocks vs. savings accounts  Stocks may be more profitable but are riskier  Savings accounts are less profitable and less risky (or safer)

© 2003 McGraw-Hill Ryerson Limited Goal of the Financial Manager Or should it be Shareholder Wealth Maximization?  Shareholder Wealth Maximization considers factors of EPS timing, and risk ignored by the EPS.  Therefore, Maximizing Shareholder Wealth is a more comprehensive goal for the firm, its managers and employees.

© 2003 McGraw-Hill Ryerson Limited Goal of the Financial Manager  Also, shareholder wealth maximization is in general, consistent with the social responsibility of the firm. Adopting policies that will improve the share price can attract capital and provide employment.  But could conflict with  social / ethical goals (for example, pollution control)  interests of management (for example, short-term compensation)  Management can encourage an increase in share price by earning an attractive return at an acceptable level of risk PPT 1-7

© 2003 McGraw-Hill Ryerson Limited Agency Theory: The Principal-Agent Problem  Agency Theory is about the conflict that may arise between management and owners whenever owners are not also the managers.  Management may not always act in the best interest of the owners because management has interest of its own, like personal wealth, job security, lifestyle, and benefits. Thus, these concerns may conflict with shareholder interests.  The pursuit of socially or ethically acceptable goals may have to come at the expense of shareholder’s wealth.

© 2003 McGraw-Hill Ryerson Limited Importance of Ethics to Stakeholders  Stakeholders are those groups that have direct economic links to the firm.  Stakeholders include not only owners, but also employees, customers, suppliers, unions, and creditors.  Honesty, trustworthiness, fair dealing are foundations of sustainable business relations with these stakeholders.  Ethical behaviour is necessary to achieve the goal of maximizing shareholder wealth.  Maintaining positive stakeholder relationships helps maximize long-term benefits to shareholders.

© 2003 McGraw-Hill Ryerson Limited Financial Manager – Key Activities Activities include:  Short-Term Financial Decisions  Working Capital Management - ex., careful monitoring of cash position on a day-to-day basis  Financial Analysis and Planning  Investment Decisions (Capital Budgeting)  long-term (L/T) financial decisions (>1 year) - ex., purchasing a new machine in the future  Financing decisions (capital structure)  how to raise money: loans? leases? shares? bonds? PPT 1-9

© 2003 McGraw-Hill Ryerson Limited A business owned by one person Freedom Freedom Simplicity Low Start Up Costs Tax Benefits UnlimitedLiability Lack of Continuity Lack of Continuity Difficulty in Raising Money Reliance on One Person Reliance on One Person Advantages Disadvantages Forms of Organization: Sole Proprietorships PPT 1-11

© 2003 McGraw-Hill Ryerson Limited Greater Talent Pool Greater Talent Pool More Capital Ease of Formation Ease of Formation Tax Benefits Unlimited Liability Unlimited Liability Lack of Continuity OwnershipTransferDifficult Possibility of Conflict A business venture with two or more owners A business venture with two or more owners Advantages Disadvantages Disadvantages Forms of Organization: Partnerships PPT 1-12

© 2003 McGraw-Hill Ryerson Limited Limited Liability Limited Liability Continuity Continuity Greater Likelihood Greater Likelihood of Professional of Professional Management Management Easier Access to Easier Access to Money Money Potential Shareholder Revolts Revolts Higher Start-Up Costs Costs Regulation Double Taxation Double Taxation A corporation is a separate legal entity Advantages Disadvantages Forms of Organization: Corporations PPT 1-13

© 2003 McGraw-Hill Ryerson Limited Summary and Conclusions The financial manager:  controls the daily cash inflows and outflows resulting from business operations  makes the occasional investment and financing decisions essential for the future financial success of the business  may work in a corporation or other form of business organization Their overriding goal is to maximize the wealth of the owners by earning an attractive return in the business at an acceptable level of risk PPT 1-18