1.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Chapter 1 The Role of Financial Management

1.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. After studying Chapter 1, you should be able to: 1. Explain why the role of the financial manager today is so important. 2. Describe "financial management" in terms of the three major decision areas that confront the financial manager. 3. Identify the goal of the firm and understand why shareholders' wealth maximisation is preferred over other goals. 4. Understand the potential problems arising when management of the corporation and ownership are separated (i.e., agency problems). 5. Demonstrate an understanding of corporate governance. 6. Discuss the issues underlying social responsibility of the firm. 7. Understand the basic responsibilities of financial managers and the differences between a "treasurer" and a "controller."

1.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Finance vs Accounting u In Finance, we are concerned with transactions that are cash, or affect cash flows, only. u Accounting deals with transactions that affect both cash and non-cash activities.

1.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Key Points u Financial management is concerned with achieving the goal of the firm – maximising the wealth of its owners (the shareholders). u This is achieved through careful and wise control of the acquisition, financing and management of its assets and involves three decision functions: u Investment decisions u Financing decisions u Asset management decisions

1.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Course Map u Introduction - Chapters 1, 2, 6, 7 u SubjectInvestment Financing Asset Mgt u Time ValueCh3Ch3 u ValuationCh 4 u RiskCh 5Ch 5 u Mgt Work Cap.Ch 11 Chs 8-11 u Capital Invest.Chs Ch 12 u Cost of CapitalCh 15 u Lev. & Cap. Struct.Chs 16-17

1.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Definition of Finance u Finance: u is about making decisions regarding what assets to buy/sell and when to buy/sell these assets. u its main objective is to make individuals and their businesses better off. overall goal u Thus, it concerns the buying/selling of, the financing of, and the managment of assets with some overall goal in mind.

1.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Three Decisions u Investment decision u Financing decision u Asset management decision

1.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Investment Decision What is the optimal firm size? What specific assets should be acquired? What assets (if any) should be reduced or sold? This is the most important of the three decisions.

1.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Financing Decision What is the best type of financing? What is the best financing mix? What is the best dividend policy (e.g., dividend-payout ratio)? How will the funds be obtained? Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).

1.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Asset Management Decision How do we manage existing assets efficiently? Financial Manager has varying degrees of operating responsibility over assets. Greater emphasis on current asset management than fixed asset management.

1.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. What is the Goal of the Firm? Maximisation of Shareholder Wealth! Value creation occurs when we maximise the share price for current shareholders.

1.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. What is the Goal of the Firm? u Maximising shareholder wealth: u The goal of the firm, its managers and employees u Measured by share price

1.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Shortcomings of Alternative Goals Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills (treasury bills), etc.). Ignores changes in the risk level of the firm. Can manipulate profits by changing accounting policies Profit Maximisation Maximising a firm’s earnings after taxes.Problems

1.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Shortcomings of Alternative Goals Does not specify timing or duration of expected returns. Ignores changes in the risk level of the firm. Calls for a zero payout dividend policy. Earnings per Share Maximisation Maximising earnings after taxes divided by number of shares on issue.Problems

1.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Strengths of Shareholder Wealth Maximisation Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors. Thus, share price serves as the best indicator of business performance.

1.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. The Modern Corporation There exists a SEPARATION between owners and managers. Modern Corporation ShareholdersManagement

1.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. The Agency Model u Agency relationship (between the owners (shareholders) and managers of the business) u Agency conflict u Why does it arise? u How can it be minimised? u Principal-agent problem u Agency theory u Agency costs

1.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Role of Management agent An agent is an individual authorised by another person, called the principal, to act in the principal’s behalf. agent Management acts as an agent for the owners (shareholders) of the firm.

1.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Agency Theory Agency Theory Agency Theory is a branch of economics relating to the behavior of principals and their agents.

1.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Agency Theory company car, expense account Incentives include, stock options, perquisites (company car, expense account), and bonuses. incentives monitor Principals must provide incentives so that management acts in the principals’ best interests and then monitor results.

1.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Corporate Social Responsibility socially responsible Wealth maximization does not stop the firm from being socially responsible at the corporate level. Assume we view the firm as producing both private and social goods. shareholder wealth maximisation Then shareholder wealth maximisation remains the appropriate goal in governing the firm.

1.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Corporate Governance Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. Then shareholder wealth maximisation remains the appropriate goal in governing the firm.

1.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Board of Directors Typical responsibilities: Set company-wide policy; Advise the CEO and other senior executives; Hire, fire, and set the compensation of the CEO; Review and approve strategy, significant investments, and acquisitions; and Oversee operating plans, capital budgets, and financial reports to common shareholders. CEO/Chairman roles commonly same person in US, but separate in Britain (US moving in this direction).

1.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Sarbanes-Oxley Act of 2002 Sarbanes-Oxley Act of 2002 (SOX): addresses corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. Arose as a result of major US corporate scandals and accounting fraud in the late 1990s and early 2000s (e.g Enron, WorldCom, and other corporations) Imposes new penalties for violations of securities laws. Established the Public Company Accounting Oversight Board (PCAOB) to adopt auditing, quality control, ethics, disclosure standards for public companies and their auditors, and policing authority. Generally increasing the standards for corporate governance.

1.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Organisation of the Financial Management Function Board of Directors President (Chief Executive Officer) Executive Vice President (Operations) Executive Vice President (Marketing) Executive Vice President (Finance - CFO )

1.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited Created by Gregory Kuhlemeyer. Vice President (Treasurer) Capital Investment Cash Management Commercial/investment banking relationships Credit Management Dividend Disbursement Financial Analysis/Planning Investor Relations Mergers and Acquisitions Pension Management Insurance/Risk Management Tax Analysis/Planning Organisation of the Financial Management Function EVP of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Financial Statements Preparing Budgets Preparing Forecasts