1. Introduction To Financial Management
Chapter 1
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2. Topics
The basics of corporate financial management decisions and the role of the financial manager
The goal of corporate financial management
The financial implications of the different forms of business organizations
The conflicts of interest that can arise between managers and owners
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3. The Basics Of Corporate Financial Management Decisions
Define Asset:
Examples: Cash, UPS Trucks, Buildings
“Provide probable future economic benefit”
Definition of Finance:
How to allocate scarce resources across assets over time in order to earn a return
What should we invest in?
Should we incur debt?
How do we as individuals make investments, conduct banking activities, incur debt?
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4. The Basics Of Corporate Financial Management Decisions
Four basic areas of finance:
Corporate finance
How corporations allocate scarce resources across assets over time
Investments
Stocks and Bonds, Risk and Return
Financial institutions
Banks, Exchanges, Insurance Co.
International Finance
All of the above but more than one country
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5. Why do you need to know finance?
Student Loans
Credit cards
Investments
Retirement Savings
Banking
Careers in:
Finance
Accounting
Marketing
Sole proprietorship
Security Analyst
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6. Why Study Finance? Marketing Accounting Management Personal finance
Budgets, marketing research, marketing financial products
Accounting
Dual accounting and finance function, preparation of financial statements
Management
Strategic thinking, job performance, profitability
Personal finance
Budgeting, retirement planning, college planning, day-to-day cash flow issues
Since this course is generally required of all business majors, it is important to emphasize that everyone needs to have a basic understanding of financial concepts so that they can communicate effectively within an organization. This is the same reason that everyone is required to take marketing courses, management courses, etc. It is important to speak the language of business, and that includes finance.
Marketing
Have to work within a budget
Marketing research is often very important to financial analysts, those doing the research need to understand what information the analysts need so that they ask the right questions
Marketing financial products – including entire companies through IPOs and seasoned equity offerings, as well as insurance and other basic financial products
Accounting
In smaller businesses, accountants often perform both the accounting and finance functions
Prepare the financial statements that financial analysts rely on for information
Management
Business strategy – have to understand the goals of the business and how cash flow works
Understand how job performance affects profitability
Personal Finance
For many students, emphasizing the personal finance issues whenever possible can make the material more relevant
Decisions about 401K plans, saving for houses, cars, kids college, etc. can be discussed throughout the course
Day-to-day decisions about consumption vs. saving can also be discussed within a finance framework

7. The Role Of The Financial Manager
Business Finance Questions
What long-term investments should you make
Examples: equipment, buildings
Where will you get the long-term financing?
Profits? Equity? Debt?
Short-term cash management
How will you collect from customers and pay your bills?
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8. Financial Management Decisions
Capital Budgeting
The process of planning and managing a firm’s long-term investments
Evaluating the size, timing, and risk of the future cash flows
Use NPV finance tool to decide (chapter 8)
Capital Structure
The mixture of debt and equity
Working Capital
The firm’s short-term assets and liabilities
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9. The Role Of The Financial Manager
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10. Forms of Business Organization
Three major forms in the united states
Sole proprietorship
Partnership
General
Limited
Corporation
S-Corp
Limited liability company
www: Clicking on the “web surfer” will take you to a web site that will provide a discussion about which form of business may be appropriate for an entrepreneur. The following pages will provide links to specific pages on the web site that provide additional information about the legal aspects of each form of business, as well as a discussion of the advantages and disadvantages. The address is:

11. Sole Proprietorship Advantages Disadvantages Easiest to start
Least regulated
Single owner keeps all the profits
Taxed once as personal income
Disadvantages
Limited to life of owner
Equity capital limited to owner’s personal wealth
Unlimited liability
Difficult to sell ownership interest
www: Click on the “web surfer” for more information about sole proprietorships. If you click on the “--Sole Proprietorship” link, you will be taken to an index that will provide a link to information about husband and wife sole proprietorships.

12. Partnership Advantages Disadvantages Two or more owners
More capital available
Relatively easy to start
Income taxed once as personal income
Disadvantages
Unlimited liability
General partnership
Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
www: Click on the “web surfer” for more information about partnerships. If you click on the “—Partnerships” link, you will go to an index that provides links to additional information about limited partnerships, partnership agreements and buy-sell agreements.
Note that unlimited liability applies to all partners in a general partnership but only to the general partners in a limited partnership
Written agreements are essential due to the unlimited liability.
Limited partners cannot be involved in the business or else they may be deemed general partners.

13. Corporation Advantages Disadvantages Limited liability Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages
Separation of ownership and management (agency problem)
Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate)
www: Click on the “web surfer” to go to a page that discusses corporations. If you click on the “—Corporations” link it will take you back to an index that provides links to additional information on corporations as well as limited liability corporations.
Discuss how separation of ownership and management can be both an advantage and a disadvantage:
Advantages
You can benefit from ownership in several different businesses (diversification)
You can take advantage of the expertise of others (comparative advantage)
It is easier to transfer ownership
Disadvantage
Agency problems if management goals and owner goals are not aligned
The instructor’s manual provides additional discussion of limited liability companies and S-corporations

14. Figure 1.2

15. Forms of Business Organization
Sole proprietorships
Partnerships
Corporations
Fewest in number
Account for more business transactions than the other two types combined
Limited Liability Company (LLC)
Benefit of single taxation and limited liability
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16. Forms of Business Organization
Sole Proprietorship (one person)
Easy to set up
No double taxation
No liability insulation to deflect outside claims (unlimited liability)
When owner dies, business ends
Difficult to transfer ownership
Hard to raise capital (money to invest)
Partnerships (More than one person)
General partners fully liable
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17. Forms of Business Organization
Corporations
Legal “person” separate from owners
Can owe property, sue, be sued, enter into contracts
Limited Liability (owners only lose up to investment, debt responsibility of corp.)
Continuity of existence (Stock transferable – when owner dies, corporation does not die)
Separation of owner and manager
Allows continual existence, however it creates agency problem
Easier to get external financing (equity & debt)
Double taxation
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18. Corporations Issue stock to stockholders Issue bonds to bondholders
Carry out business activities for the purpose of making profits
Not-for-profit corporations carry out charitable, educational, or other philanthropic purposes and are beyond the scope of this chapter
Distribute the profits to their owners
Pay interest to bondholders
Reinvests earnings to buy more assets
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19. Advantages of the Corporate Form
Limited liability
The corporation is responsible for its own debt
The stockholder can only lose up to the amount of his or her investment
Ease of raising capital
A corporation can issue stock to raise capital
A corporation can have over a million stockholders
A corporation can issue bonds to raise capital
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20. Advantages of the Corporate Form
Ease of transferring ownership rights
Ownership rights in a corporation are represented by shares of stock
Stock can readily be transferred from one person to another without the permission of other stockholders
With partnerships, other partners have to give permission for changes in ownership in order for the business to continue
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21. Advantages of the Corporate Form
Continuous existence
The length of life of a corporation is stipulated in its charter
When the charter expires, it may be renewed
The death, incapacity, or withdrawal of an owner does not affect the life of the corporation
No mutual agency
Stockholders who are not officers do not have the power to bind the corporation to contracts
Owners need not participate in management
The corporation is free to employ the managerial talent it believes can best accomplish its objectives
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22. Disadvantages of the Corporate Form
Additional taxation
“Double taxation”
Taxation of corporate income at two separate points
First, the net income of the corporation is taxed because the corporation is a separate entity
When the net income is distributed as dividends to stockholders, it becomes part of the personal income of the individual stockholder and is taxed a second time
The corporation must pay charter fees (fees paid for the corporation's right to exist)
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23. Disadvantages of the Corporate Form
Government regulation
States often regulate
The amount of net income that a corporation may retain
The extent to which it may buy back its own stock
The amount of real estate it may own
Securities And Exchange Commission (SEC) requires that corporations file financial statements quarterly and yearly
Sarbanes-Oxley Act
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24. The Financial Implications Of The Different Forms Of Business Organizations
The corporate form is superior when it comes to raising cash:
Ease of transferring ownership
Business does not end each time stock is sold
Unlimited life
When owners die, the business does not end
Limited liability for business debts
Owners can only loose up to the amount they have invested
For good ideas to be implemented which in turn creates profits for owners, cash is required. Thus the business form which can raise cash more easily is more beneficial
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25. Page 10 In Textbook Link to: www.buisnessfinancemag.com
Is filled with ads…
Better to go to and click on News
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26. The Goal Of Corporate Financial Management
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27. The Goal Of Corporate Financial Management
Presume:
The stockholders elect the BofD
The BofD hire the managers
The managers work for the stockholders
Goal:
The financial managers have a fiduciary duty to identify goods and services that add value to the firm because they are desired and valued in the free marketplace, which in turn increases current and future revenues, which in turn increases stock price/equity value
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28. The Goal Of Corporate Financial Management
The goal of financial management is to maximize the current value per share of existing stock (market value of equity)
This is theoretically a good goal
Do some managers employ creative accounting so that it looks like stock value goes up?
Financial managers should not take illegal or unethical actions to increase stock value
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29. The Goal Of Corporate Financial Management
Managers commit assets in a particular direction in order to earn a return
Capital budgeting using NPV model (ch.9)
Cash Flow is what the managers will use to make decisions (ch.5)
Goal is to maximize returns at a given risk level (risk and return are considered together) (ch.11)
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30. The Goal Of Corporate Financial Management
Corporation must continually get cash to acquire assets to earn a return
Corporation acquires cash from financial markets through equity or debt
Corporation reinvests earnings (remaining amount paid to owners)
More assets, more sales, higher return, higher stock value (theoretically)
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31. The Goal Of Corporate Financial Management
All this is done to increase the current stock price
Owners’ stock value is increased
Managers salaries should be based on stock value and so their salaries increase (theoretically)
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32. Goal Of Financial Management
What should be the goal of a corporation?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the company’s stock?
Does this mean we should do anything and everything to maximize owner wealth?
Sarbanes-Oxley Act
Makes managers personally responsible for financial statements
Try to have the students discuss each of the goals above and the inherent problems of the first three goals:
Maximize profit – Are we talking about long-run or short-run profits? Do we mean accounting profits or some measure of cash flow?
Minimize costs – We can minimize costs today by not purchasing new equipment or delaying maintenance, but this may not be in the best interest of the firm or its owners.
Maximize market share – This has been a strategy of many of the dot.com companies. They issued stock and then used it primarily for advertising to increase the number of “hits” to their web sites. Even though many of the companies may have huge market share (i.e. Amazon) that still does not guarantee positive earnings, so their owners may not be happy.
Maximize the current value of the company’s stock
There is no short run vs. long run here. The stock price should incorporate expectations about the future of the company and consider the trade-off between short-run profits and long-run profits.
The purpose of a for-profit business should be to make money for its owners. Maximizing the current stock price increases the wealth of the owners of the firm.
This is analogous to maximizing owners’ equity for firms that do not have publicly traded stock.
Not for profits can also follow the same principle, but their “owners” are the constituencies that they were created to help.
The instructors manual provides a letter to stockholders that was written by former Coca-Cola CEO Roberto Goizueta. There is also a brief discussion of an article that appeared in Fortune magazine that discusses Coke vs. Pepsi and their different philosophies on business in the early 1990s.
Ethics Note: See the instructor’s manual for a discussion of Dow-Corning, silicone breast implants and the ethics involved with pursuing owners’ wealth at all costs.

33. The Conflicts Of Interest That Can Arise Between Managers And Owners
Creative accounting so that it looks like stock value goes up?
Enron:
Former Enron CFO Andrew Fastow, the alleged mastermind behind Enron's complex network of offshore partnerships and questionable accounting practices*
World Com:
Former CEO, Bernard Ebbers was convicted (2005) of fraud and conspiracy in the largest (to date) accounting scandal in U.S. history, as a result of WorldCom's false financial reporting, and subsequent 11 billion dollar loss to investors*
Andrew and Bernard were agents that were supposed to be serving the stockholders
*Wikipedia
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34. Agency Problem
How do you get managers inside the firm (managers have custody of assets that belong to owners) to act in the best interest of the owners?
We must incur agency costs to minimize problems
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35. Agency Costs
Direct
Pay managers based on stock value (aligns managers’ and owners’ interests)
Allow external auditor to examine the financial statements
Have internal controls over assets and accounting
Have internal auditors report to BofD
Sarbanes-Oxley Act
Makes managers personally responsible for financial statements
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36. Agency Costs
Indirect
A profitable project that is risky may benefit owners, but may put the manager’s job at risk
If manager does not take on project Cost to owner
Managers may create ways to pay themselves great deals of money (accounting or other)
Cost to owner
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37. Financial Markets Primary Markets Secondary Markets
Original sale of equity or debt
Corporation issues security
Secondary Markets
After original sale of equity or debt
You sell/buy security
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38. Financial Markets Secondary Markets:
Dealer Markets (Over-the-counter markets (OTC))
Dealers buy and sell for themselves
(think of car lot)
Most debt is sold this way
Example: NASDAQ
Auction Markets (Exchanges)
Brokers and agents match buyers and sellers
(think of real estate agent)
Most of the large firms’ equity is sold this way
Example: NYSE
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39. Summary Slide The Basics Of Corporate Financial Management Decisions
Why do you need to know finance?
The Role Of The Financial Manager
Financial Management Decisions
Forms of Business Organization
The Financial Implications Of The Different Forms Of Business Organizations
The Goal Of Corporate Financial Management
The Conflicts Of Interest That Can Arise Between Managers And Owners
Agency Problem
Agency Costs
Financial Markets
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