ch 1 financial management introduction brooks

8/13/2019 Ch 1 Financial Management Introduction Brooks

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Chapter 1

Financial

Management


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2013 Pearson Education, Inc. All rights reserved.1-2

1. Describe the cycle of money, the participants in thecycle, and the common objective of borrowing andlending.

2. Distinguish the four main areas of financeand briefly

explain the financial activities that each encompasses.3. Explain the different ways of classifying financial

markets.

4. Discuss the three main categories of financial

management.5. Identify the main objective of the financial manager

and how that objective might be achieved.

Learning Objectives


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Learning Objectives(continued)

6. Explain how the finance manager interacts withboth internal and external players.

7. Delineate the main types of business organizationsand their respective advantages and disadvantages.

8. Illustrate agency theoryand the principal-agentproblem.

9. Review issues in corporate governance andbusiness ethics.


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Definition of Finance:

Financeis the art and science of managingwealth.

It is about making decisions regarding whatassets to buy/sell and when to buy/sell these

assets.

Its main objective is to make individuals andtheir businesses better off.


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Definition of financialmanagement

Financial managementis generally definedas those activities that create or preservethe economic value of the assets of anindividual, small business, or corporation.

Financial management comes down to makingsound financial decisions.


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1.1 The Cycle of Money

Financial intermediaries assist in themovement of money, from lenders toborrowers and back again.

This process is termed the cycle of money and itsmain objective is to make all the participantsbetter off


7/22 2013 Pearson Education, Inc. All rights reserved.1-7

Figure 1.1 The money cycle


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9/22 2013 Pearson Education, Inc. All rights reserved.1-9

1.2 Overview of Finance Areas

4main interconnected and interrelated areas.

1. Corporate Finance

2. Investments3. Financial Institutions and Markets

4. International Finance


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1.3 Financial Markets

Forums where buyers and sellers of financial assetsand commodities meet.

Financial markets can be classified by: Type of asset traded

Maturity of the financial asset Money market

capital market

Owner of the financial asset primary market

secondary market

Nature of transaction dealer markets

auction markets


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1.4 The Finance Manager andFinancial Management

Finance manager Has to determine the best repayment structure for

borrowed funds

Makes sure that debt obligations are met on time

Ensures that sufficient funds are available for carrying outdaily operations.


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1.4 The Finance Manager andFinancial Management (continued)

Financial management involves 3mainfunctions

Capital Budgeting

Capital Structure

Working Capital Management


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1.5 Objective of the FinanceManager

To make investment and financing decisionsthat increase the cash flow of the firm,thereby maximizing the current stock price

Profit maximization vs. Stock pricemaximization

Why are they not the same?

Which one is more important?


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1.6 Internal and External Players

Financial managers have to interact withvarious internal and external stakeholders

Internal players include all the departmentalmanagers and other employees

External parties include:

Customers

Suppliers

Government

Creditors


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Figure 1.2 A Basic OrganizationalChart for a Company


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1.7 The Legal Forms of Business

There are three main legal categories ofbusiness organizations:

1. Sole proprietorship

2. Partnership

3. Corporation

Besides these 3main forms some other

forms of business organizations include:Hybrid Corporations

Not-for-Profit Corporations


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1.7 The Legal Forms of Business(continued)

Sole Proprietorship Advantages

1. Simplest and easiest form of business.

2. Least amount of legal documentation.

3. Least regulated.

4. Owner keeps all profits

Disadvantages

1. Owner pays personal tax rate on profits

2. Obligations of the business are sole responsibility of owner, andpersonal assets may be necessary to pay obligations (personal andbusiness assets are commingled).

3. Business entity limited to life of owner.

4. Can have limited access to outside funding for the business.


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Partnership Advantages

1. Agreements between partners may be easily formed

2. Involves more individuals as owners and therefore usuallymore expertise

3. Larger amount of capital usually available to the business(compared to proprietorship)

Disadvantages

1. Assets of general partners are commingled with assets ofthe business

2. Profits treated as personal income for tax purposes

3. Difficult to transfer ownership


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Corporation Advantages

1. Business is legal, separate entity from owners2. Owners have limited liability to obligations of the

business

3. Easy to transfer ownership4. Usually greater access to capital for business5. Owners do not have any personal liability for

default Disadvantages

1. Most difficult business operation to form2. Double taxation of company profits3. Most regulated.


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1.8 The Financial ManagementSetting: The Agency Model

Agency relationship

Agency conflict

Why does it arise?

How can it be minimized?

Principal-agent problem

Agency theory

Agency costs


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1.9 Corporate Governance andBusiness 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 financialreports.

The company maintains an effective internal control

structure around financial reporting.

The company and its auditors assess the effectiveness ofthe controls over the most recent fiscal year.


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1.10 Why Study Finance?

Understand howand whyfinancial decisions aremade in large and small companies.

Helps individuals increase their own compensations,

Improves contributions to the success of the

companies that people work for. Understand the tradeoffs we face in making

personal financial choices and help us to select themost appropriate action.

ch 1 financial management introduction brooks

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