Chapter 1
Introduction to Financial
Management
Key Concepts and Skills
Know the basic financial management
decisions and the financial manager’s role
Know the forms of business organization and
the advantages/disadvantages of each
Know the goal of financial management
Know the conflicts of interest that may arise
between owners and managers
Chapter Overview
Finance: An Overview
Business Finance and the Financial
Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Issue and Control of the
Corporation
Financial Markets
Areas of Finance
Corporate finance
Investments
Financial Institutions
International finance
Investments!
Work with financial assets
Value of financial assets, risk versus
return, asset allocation
Job opportunities
Financial planner, stockbroker
Portfolio manager
Securities analyst
CalPers and CalStrs
Financial Institutions
Banks: commercial banks, credit
unions, savings and loans
Insurance companies
Brokerage houses
Schwab
Merrill Lynch
Scottrade, Etrade
International Finance
A specialized area within the other
areas of finance
Work in foreign countries and travel
Requires knowledge of exchange rates
and political risk
Requires knowledge of other cultures
and possibly the ability to speak foreign
language(s)
Reasons to Study Finance
Marketing
Create budgets, perform marketing research,
market financial products
Accounting
Preparation of financial statements, dual
accounting/financial functions
Management
Strategic thinking, performance, and profitability
Personal finance
Retirement planning, investing, daily cash flow
Business Finance
Questions the financial manager will
answer:
What long-term investments should we
make?
How will we obtain long-term financing to
pay for the investments?
How will we manage the daily financial
activities of the firm?
Financial Manager
Chief Financial Officer (CFO), the
highest-level financial manager within a
firm
Treasurer: Oversees cash management,
credit management, capital expenditures,
financial planning functions
Controller: Oversees taxes, cost
accounting, financial accounting, and data
processing functions
Forms of Business
Organization
There are three major forms of business
organization in the United States
Sole proprietorship
Partnership
General partnership
Limited partnership
Corporation
S-Corp
Limited liability company (LLC)
Sole Proprietorship
Advantages Disadvantages
Easiest to start Limited to the life of
Least regulated the owner
Single owner retains Equity capital limited
profits to owner’s personal
Income taxed once wealth
at personal income Unlimited liability
tax rate Difficult to sell
ownership interest
Partnership
Advantages Disadvantages
Two or more owners Unlimited liability
More available Partnership dissolves
capital when one partner
Easy to start dies or sells
Income taxed once Difficult to transfer
at the personal ownership
income tax rate
Corporation
Advantages Disadvantages
Limited liability Separation of
Unlimited life ownership and
Separation of management
ownership and (agency problem)
management Double taxation
Ease of transfer of (Income taxed at the
ownership corporate tax rate
and dividends taxed
Ability to raise capital
at the personal tax
rate)problem)
Goal of Financial Management
The goal of a corporation is to maximize
the value of the firm’s stock
Sarbanes-Oxley Act
Adopted in 2002 in response to corporate
mismanagement
Scandals involved Enron, WorldCom, Tyco,
and Adelphia
Agency Issues
The agency relationship
An agency relationship occurs when a principal
hires an agent to represent his/her interest
Stockholders (principals) hire managers (agents)
to represent their interests and manage the
company
Agency problem
A potential conflict of interest between the owners
and management of a firm
Management interests and stockholders’
interests might differ - agency costs
Managerial Compensation and
Control
Managerial compensation
Incentives can help to align management
and stockholders’ interests
Incentives must be carefully designed to
ensure that they align management and
stockholders’ interests
Corporate Control
A hostile takeover threat/attempt may
result in better management
Managerial Compensation and
Control (continued)
Employees, customers, suppliers, and
the government (stakeholders) have a
financial interest in the firm
Financial Markets
Cash flows to the firm
Primary market
The original sale of securities by
governments and corporations
Secondary market
One owner or creditor selling to another
Provide the means for transferring
ownership of corporate securities
Financial Markets (continued)
NASDAQ
National Association of Securities Dealers
Automated Quotations system
A dealer market – an over-the-counter
(OTC) market
Less stringent listing requirements than
NYSE
Financial Markets (continued)
New York Stock Exchange
An auction market
Has a physical location on Wall Street
Accounts for more than 85% of all shares
traded in auction markets
Quiz
What are the major areas of corporate
finance?
What is the capital budgeting decision?
What is the mixture of long-term debt and
equity that a firm chooses to use called?
What are the three forms of business
organization?
What is the difference between a general and
a limited partnership?
Quiz (continued)
What are the primary advantages and
disadvantages of sole proprietorships and
partnerships?
What is the goal of financial management?
What is a dealer market?
What is the largest auction market in the
United States?
What does OTC stand for? What is the
largest OTC market for stocks called?
