Chapter 1 Introduction to Financial Management

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Chapter 1 Introduction to Financial Management

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

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