1. Chapter 1
Financial Management

2. Explain the different ways of classifying financial markets.
LEARNING OBJECTIVES
Describe the cycle of money, the participants in the cycle, and the common objective of borrowing and lending.
Distinguish the four main areas of finance and briefly explain the financial activities that each encompasses.
Explain the different ways of classifying financial markets.
Discuss the three main categories of financial management.

3. LEARNING OBJECTIVES
5. Identify the main objective of the finance manager and how that objective might be achieved.
6. Explain how the finance manager interacts with both internal and external players.
7. Delineate the three main types of business organizations and their respective advantages and disadvantages.
8. Illustrate agency theory and the principal-agent problem.
9. Review issues in corporate governance and business ethics.

4. Definition of Finance
Finance is the art and science of managing wealth.
It is about making decisions regarding what assets to buy/sell and when to buy/sell these assets.
Its main objective is to make individuals and their businesses better off.

5. Definition of Financial Management
Financial management is generally defined as those activities that create or preserve the economic value of the assets of an individual, small business, or corporation.
Financial management comes down to making sound financial decisions.

6. 1.1 The Financial Intermediary Function
Financial intermediaries assist in the movement of money from lenders to borrowers and back again.
This process is termed the cycle of money and its main objective is to make all the participants better off

7. FIGURE 1.1 The money cycle

8. 1.1 The Cycle of Money
The movement of money from lender to borrower and back to lender from borrower (see page 4 of textbook)
Example: You invest money in a venture capital group that invests in new business ventures (this is typically a very risky investment)
The pooled funds are used to support a variety of business ventures at the early start up of the company
As the new start ups take hold, they are able to generate cash flow with their business ideas and “payback” the venture capital firm (usually the liquidation event enables the venture capital firm to make a sizeable gain in its initial investment)
All participants are generally better off from this cycle of money

9. 1.2 Overview of Finance Areas
Four main interconnected and interrelated areas:
Corporate Finance
Investments
Financial Institutions and Markets
International Finance

10. 1.3 The Financial Markets
Forums where buyers and sellers of financial assets and commodities meet.
Financial markets can be classified by:
The Type of Asset Traded
The Maturity of the Financial Asset
money market
capital market
The Issuer of the Financial Asset
primary market
secondary market
The Owner vs. Seller of the Financial Asset
dealer markets
auction markets

11. 1.4 The Finance Manager and Financial Management
Determines the best places to borrow money
Determines the best repayment structure for the borrowed funds
Ensures that financial obligations are met on time
Ensures that sufficient funds are available for carrying out daily operations

12. 1.4 The Finance Manager and Financial Management
Financial management involves three main functions:
Capital Budgeting (Use of funds)
Capital Structure (Source of funds)
Working Capital Management (Timing of funds)

13. 1.5 Objective of the Finance Manager
To make investment and financing decisions that increase the cash flow of the firm, thereby maximizing the current stock price
Profit maximization
vs.
Stock price maximization
Why are they not the same?
Which one is more important?
Sprinter versus Distance Runner

14. 1.6 Internal and External Players
Financial managers have to interact with various internal and external stakeholders
Internal players include all the departmental managers and other employees
External parties include:
Customers
Suppliers
Government
Creditors

15. 1.7 The Legal Forms of Business
There are three main legal categories of business organizations:  
Sole proprietorship
Partnership
Corporation
Besides these three main forms, some other forms of business organizations include:
Hybrid Corporations
Not-for-Profit Corporations

16. 1.7 The Legal Forms of Business
Sole Proprietorship
Advantages
Simplest and easiest form of business
Least amount of legal documentation
Least regulated
Owner keeps all profits
Disadvantages
Owner pays personal tax rate on profits
Obligations of the business are sole responsibility of owner, and personal assets may be necessary to pay obligations (personal and business assets are commingled)
Business entity limited to life of owner
Can have limited access to outside funding for the business

17. 1.7 The Legal Forms of Business
Partnership
Advantages
Agreements between partners may be easily formed
Involves more individuals as owners and therefore usually more expertise
Larger amount of capital usually available to the business (compared to proprietorship)
Disadvantages
Assets of general partners are commingled with assets of the business
Profits treated as personal income for tax purposes
Difficult to transfer ownership

18. 1.7 The Legal Forms of Business
Corporation
Advantages
Business is legal, separate entity from owners
Owners have limited liability to obligations of the business
Easy to transfer ownership
Usually greater access to capital for business
Owners do not have any personal liability for default
Disadvantages
Most difficult business operation to form
Double taxation of company profits
Most regulated 

19. 1.8 The Financial Management Setting: The Agency Model
Agency relationship
Agency conflict
Why does it arise?
How can it be minimized?
Principal-agent problem
Agency theory
Agency costs

20. 1.9 Corporate Governance and Business Ethics
Corporate governance deals with….
how a company conducts its business and implements controls to ensure proper procedures and ethical behavior.
The Sarbanes-Oxley Act, enacted in 2002, requires that
The CEO and CFO attest to the fairness of the financial reports.
The company maintains an effective internal control structure around financial reporting.
The company and its auditors assess the effectiveness of the controls over the most recent fiscal year.

21. 1.10 Why Study Finance?
Understand how and why financial decisions are made in large and small companies
Helps individuals increase their own compensations
Improves your personal contributions to the success of your company
Understand the tradeoffs we face in making personal financial choices and help us to select the most appropriate action