Bba 2204 fin mgt week 1 introduction

FINANCIAL MANAGEMENT:FINANCIAL MANAGEMENT:
IntroductionIntroduction
FINANCIAL MANAGEMENT:FINANCIAL MANAGEMENT:
IntroductionIntroduction
BBA 2204 FINANCIAL MANAGEMENTBBA 2204 FINANCIAL MANAGEMENT
by
Stephen Ong
Visiting Fellow, Birmingham City
University Business School, UK
Visiting Professor, Shenzhen

Today’s OverviewToday’s Overview

Learning GoalsLearning Goals
1.1. DefineDefine financefinance and the managerial finance function.and the managerial finance function.
2.2. Describe the legal forms of business organization.Describe the legal forms of business organization.
3.3. Describe the goal of the firm, and explain whyDescribe the goal of the firm, and explain why
maximizing the value of the firm is an appropriate goalmaximizing the value of the firm is an appropriate goal
for a business.for a business.
4.4. Describe how the managerial finance function is relatedDescribe how the managerial finance function is related
to economics and accounting.to economics and accounting.
5.5. Identify the primary activities of the financial manager.Identify the primary activities of the financial manager.
6.6. Describe the nature of the principle-agent relationshipDescribe the nature of the principle-agent relationship
between the owners and managers of a corporation, andbetween the owners and managers of a corporation, and
explain how various corporate governance mechanismsexplain how various corporate governance mechanisms
attempt to manage agency problems.attempt to manage agency problems.

What is Finance?What is Finance?
 Finance can be defined as the science and art ofFinance can be defined as the science and art of
managing money.managing money.
 At the personal level, finance is concerned withAt the personal level, finance is concerned with
individuals’ decisions about how much of theirindividuals’ decisions about how much of their
earnings they spend, how much they save, andearnings they spend, how much they save, and
how they invest their savings.how they invest their savings.
 In a business context, finance involves the sameIn a business context, finance involves the same
types of decisions: how firms raise money fromtypes of decisions: how firms raise money from
investors, how firms invest money in an attemptinvestors, how firms invest money in an attempt
to earn a profit, and how they decide whether toto earn a profit, and how they decide whether to
reinvest profits in the business or distributereinvest profits in the business or distribute
them back to investors.them back to investors.

Career Opportunities inCareer Opportunities in
Finance: Financial ServicesFinance: Financial Services
 Financial Services is the area ofFinancial Services is the area of
finance concerned with the design andfinance concerned with the design and
delivery of advice and financialdelivery of advice and financial
products to individuals, businesses,products to individuals, businesses,
and governments.and governments.
 Career opportunities include banking,Career opportunities include banking,
personal financial planning,personal financial planning,
investments, real estate, andinvestments, real estate, and
insurance.insurance.

Career Opportunities inCareer Opportunities in
Finance: Managerial FinanceFinance: Managerial Finance
 Managerial finance is concerned with theManagerial finance is concerned with the
duties of the financial manager working in aduties of the financial manager working in a
business.business.
 Financial managers administer the financialFinancial managers administer the financial
affairs of all types of businesses—privateaffairs of all types of businesses—private
and public, large and small, profit-seekingand public, large and small, profit-seeking
and not-for-profit.and not-for-profit.
 They perform such varied tasks asThey perform such varied tasks as
developing a financial plan or budget,developing a financial plan or budget,
extending credit to customers, evaluatingextending credit to customers, evaluating
proposed large expenditures, and raisingproposed large expenditures, and raising
money to fund the firm’s operations.money to fund the firm’s operations.

Career Opportunities in Finance: ManagerialCareer Opportunities in Finance: Managerial
Finance (cont.)Finance (cont.)
• The recent global financial crisis andThe recent global financial crisis and
subsequent responses by governmentalsubsequent responses by governmental
regulators, increased global competition, andregulators, increased global competition, and
rapid technological change also increase therapid technological change also increase the
importance and complexity of the financialimportance and complexity of the financial
manager’s duties.manager’s duties.
• Increasing globalization has increasedIncreasing globalization has increased
demand for financial experts who candemand for financial experts who can
manage cash flows in different currenciesmanage cash flows in different currencies
and protect against the risks that naturallyand protect against the risks that naturally
arise from international transactions.arise from international transactions.

Focus on PracticeFocus on Practice
 Professional Certifications in Finance:Professional Certifications in Finance:
 Chartered Financial Analyst (CFA)Chartered Financial Analyst (CFA) – Offered by– Offered by
the CFA Institute, the CFA program is a graduate-the CFA Institute, the CFA program is a graduate-
level course of study focused primarily on thelevel course of study focused primarily on the
investments side of finance.investments side of finance.
 Certified Treasury Professional (CTP)Certified Treasury Professional (CTP) – The CTP– The CTP
program requires students to pass a single examprogram requires students to pass a single exam
that is focused on the knowledge and skillsthat is focused on the knowledge and skills
needed for those working in a corporate treasuryneeded for those working in a corporate treasury
department.department.
 Certified Financial Planner (CFP)Certified Financial Planner (CFP) – To obtain CFP– To obtain CFP
status, students must pass a ten-hour examstatus, students must pass a ten-hour exam
covering a wide range of topics related tocovering a wide range of topics related to
personal financial planning.personal financial planning.

Focus on Practice (cont.)Focus on Practice (cont.)
 Professional Certifications in Finance:Professional Certifications in Finance:
 American Academy of Financial Management (AAFM)American Academy of Financial Management (AAFM)
– The AAFM administers a host of certification– The AAFM administers a host of certification
programs for financial professionals in a wide rangeprograms for financial professionals in a wide range
of fields. Their certifications include the Charterof fields. Their certifications include the Charter
Portfolio Manager, Chartered Asset Manager,Portfolio Manager, Chartered Asset Manager,
Certified Risk Analyst, Certified Cost Accountant,Certified Risk Analyst, Certified Cost Accountant,
Certified Credit Analyst, and many otherCertified Credit Analyst, and many other
programmes.programmes.
 Professional Certifications in AccountingProfessional Certifications in Accounting – Most– Most
professionals in the field of managerial finance needprofessionals in the field of managerial finance need
to know a great deal about accounting to succeed into know a great deal about accounting to succeed in
their jobs. Professional certifications in accountingtheir jobs. Professional certifications in accounting
include theinclude the Certified Public Accountant (CPA),Certified Public Accountant (CPA),
Certified Management Accountant (CMA), CertifiedCertified Management Accountant (CMA), Certified
Internal Auditor (CIA),Internal Auditor (CIA), and many programmes.and many programmes.

Legal Forms of BusinessLegal Forms of Business
OrganizationOrganization
• A sole proprietorship is a business owned byA sole proprietorship is a business owned by
one person and operated for his or her ownone person and operated for his or her own
profit.profit.
• A partnership is a business owned by two orA partnership is a business owned by two or
more people and operated for profit.more people and operated for profit.
• A corporation is an entity created by law.A corporation is an entity created by law.
Corporations have the legal powers of anCorporations have the legal powers of an
individual in that it can sue and be sued,individual in that it can sue and be sued,
make and be party to contracts, and acquiremake and be party to contracts, and acquire
property in its own name.property in its own name.

Table 1.1 Strengths and Weaknesses of theTable 1.1 Strengths and Weaknesses of the
Common Legal Forms of Business OrganizationCommon Legal Forms of Business Organization

Figure 1.1 CorporateFigure 1.1 Corporate
OrganizationOrganization

Table 1.2 Career OpportunitiesTable 1.2 Career Opportunities
in Managerial Financein Managerial Finance

Goal of the Firm:Goal of the Firm:
Maximize Shareholder WealthMaximize Shareholder Wealth
Decision rule for managers: only take actionsDecision rule for managers: only take actions
that are expected to increase the share price.that are expected to increase the share price.

Maximize Profit?Maximize Profit?
Profit maximization may not lead to the highestProfit maximization may not lead to the highest
possible share price for at least three reasons:possible share price for at least three reasons:
1.1. Timing is important—the receipt of funds soonerTiming is important—the receipt of funds sooner
rather than later is preferredrather than later is preferred
2.2. Profits do not necessarily result in cash flowsProfits do not necessarily result in cash flows
available to stockholdersavailable to stockholders
3.3. Profit maximization fails to account for riskProfit maximization fails to account for risk
Which Investment is Preferred?Which Investment is Preferred?

What About Stakeholders?What About Stakeholders?
• Stakeholders are groups such as employees,Stakeholders are groups such as employees,
customers, suppliers, creditors, owners, andcustomers, suppliers, creditors, owners, and
others who have a direct economic link to theothers who have a direct economic link to the
firm.firm.
• A firm with aA firm with a stakeholder focusstakeholder focus consciouslyconsciously
avoids actions that would prove detrimental toavoids actions that would prove detrimental to
stakeholders. The goal is not to maximizestakeholders. The goal is not to maximize
stakeholder well-being but to preserve it.stakeholder well-being but to preserve it.
• Such a view is considered to be "sociallySuch a view is considered to be "socially
responsible."responsible."

The Role of Business EthicsThe Role of Business Ethics
• Business ethics are the standards of conductBusiness ethics are the standards of conduct
or moral judgment that apply to personsor moral judgment that apply to persons
engaged in commerce.engaged in commerce.
• Violations of these standards in financeViolations of these standards in finance
involve a variety of actions: “creativeinvolve a variety of actions: “creative
accounting,” earnings management,accounting,” earnings management,
misleading financial forecasts, insider trading,misleading financial forecasts, insider trading,
fraud, excessive executive compensation,fraud, excessive executive compensation,
options backdating, bribery, and kickbacks.options backdating, bribery, and kickbacks.
• Negative publicity often leads to negativeNegative publicity often leads to negative
impacts on a firmimpacts on a firm

The Role of Business Ethics:The Role of Business Ethics:
Considering EthicsConsidering Ethics
Robert A. Cooke, a noted ethicist, suggestsRobert A. Cooke, a noted ethicist, suggests
that the following questions be used to assessthat the following questions be used to assess
the ethical viability of a proposed action:the ethical viability of a proposed action:
 Is the action arbitrary or capricious? Does theIs the action arbitrary or capricious? Does the
action unfairly single out an individual or group?action unfairly single out an individual or group?
 Does the action affect the morals, or legal rightsDoes the action affect the morals, or legal rights
of any individual or group?of any individual or group?
 Does the action conform to accepted moralDoes the action conform to accepted moral
standards?standards?
 Are there alternative courses of action that areAre there alternative courses of action that are
less likely to cause actual or potential harm?less likely to cause actual or potential harm?

The Role of Business Ethics:The Role of Business Ethics:
Ethics and Share PriceEthics and Share Price
Ethics programs seek to:Ethics programs seek to:
 reduce litigation and judgment costsreduce litigation and judgment costs
 maintain a positive corporate imagemaintain a positive corporate image
 build shareholder confidencebuild shareholder confidence
 gain the loyalty and respect of allgain the loyalty and respect of all
stakeholdersstakeholders
The expected result of suchThe expected result of such
programs is to positively affect theprograms is to positively affect the
firm’s share price.firm’s share price.

Focus on EthicsFocus on Ethics
 Will Google Live Up to Its Motto?Will Google Live Up to Its Motto?
 In January 2010, Google announced thatIn January 2010, Google announced that
the Gmail accounts of Chinese human-the Gmail accounts of Chinese human-
rights activists and a number ofrights activists and a number of
technology, financial, and defensetechnology, financial, and defense
companies had been hacked.companies had been hacked.
 The company threatened to pull out ofThe company threatened to pull out of
China unless an agreement on uncensoredChina unless an agreement on uncensored
search results could be reached.search results could be reached.
 Is the goal of maximization of shareholderIs the goal of maximization of shareholder
wealth necessarily ethical or unethical?wealth necessarily ethical or unethical?
 How can Google justify its actions in theHow can Google justify its actions in the
short run to its long run investors?short run to its long run investors?

Managerial Finance FunctionManagerial Finance Function
• The size and importance of the managerialThe size and importance of the managerial
finance function depends on the size of thefinance function depends on the size of the
firm.firm.
• In small firms, the finance function isIn small firms, the finance function is
generally performed by the accountinggenerally performed by the accounting
department.department.
• As a firm grows, the finance functionAs a firm grows, the finance function
typically evolves into a separate departmenttypically evolves into a separate department
linked directly to the company president orlinked directly to the company president or
CEO through the chief financial officer (CFO)CEO through the chief financial officer (CFO)
(see Figure 1.1)(see Figure 1.1)

Managerial Finance Function:Managerial Finance Function:
Relationship to EconomicsRelationship to Economics
• The field of finance is closely related toThe field of finance is closely related to
economics.economics.
• Financial managers must understand theFinancial managers must understand the
economic framework and be alert to theeconomic framework and be alert to the
consequences of varying levels of economicconsequences of varying levels of economic
activity and changes in economic policy.activity and changes in economic policy.
• They must also be able to use economicThey must also be able to use economic
theories as guidelines for efficient businesstheories as guidelines for efficient business
operation.operation.

Managerial Finance Function: RelationshipManagerial Finance Function: Relationship
to Economics (cont.)to Economics (cont.)
• Marginal cost–benefit analysis is theMarginal cost–benefit analysis is the
economic principle that states thateconomic principle that states that
financial decisions should be made andfinancial decisions should be made and
actions taken only when the addedactions taken only when the added
benefits exceed the added costsbenefits exceed the added costs
• Marginal cost-benefit analysis can beMarginal cost-benefit analysis can be
illustrated using the following simpleillustrated using the following simple
example.example.

to Economics (cont.)to Economics (cont.)
Nord Department Stores is applying marginal-Nord Department Stores is applying marginal-
cost benefit analysis to decide whether tocost benefit analysis to decide whether to
replace a computer:replace a computer:

Managerial Finance Function:Managerial Finance Function:
Relationship to AccountingRelationship to Accounting
• The firm’s finance and accounting activitiesThe firm’s finance and accounting activities
are closely-related and generally overlap.are closely-related and generally overlap.
• In small firms accountants often carry out theIn small firms accountants often carry out the
finance function, and in large firms financialfinance function, and in large firms financial
analysts often help compile accountinganalysts often help compile accounting
information.information.
• One major difference in perspective andOne major difference in perspective and
emphasis between finance and accounting isemphasis between finance and accounting is
that accountants generally use the accrualthat accountants generally use the accrual
method while in finance, the focus is on cashmethod while in finance, the focus is on cash
flows.flows.

to Accounting (cont.)to Accounting (cont.)
• Whether a firm earns a profit orWhether a firm earns a profit or
experiences a loss,experiences a loss, it must have ait must have a
sufficient flow of cash to meet itssufficient flow of cash to meet its
obligations as they come due.obligations as they come due.
• The significance of this differenceThe significance of this difference
can be illustrated using thecan be illustrated using the
following simple example.following simple example.

The Nassau Corporation experiencedThe Nassau Corporation experienced
the following activity last year:the following activity last year:
Sales $100,000 (1 yacht sold, 100% still uncollected)
Costs $ 80,000 (all paid in full under supplier terms)

Now contrast the differences in performanceNow contrast the differences in performance
under the accounting method (accrual basis)under the accounting method (accrual basis)
versus the financial view (cash basis):versus the financial view (cash basis):
Income Statement SummaryIncome Statement Summary
Accrual basisAccrual basis Cash basisCash basis
SalesSales $100,000$100,000 $ 0$ 0
Less: CostsLess: Costs ((80,00080,000) () (80,00080,000))
Net Profit/(Loss)Net Profit/(Loss) $ 20,000$ 20,000 $(80,000)$(80,000)

Finance and accounting also differ withFinance and accounting also differ with
respect to decision-making:respect to decision-making:
 Accountants devote most of their attentionAccountants devote most of their attention
to theto the collection and presentation ofcollection and presentation of
financial data.financial data.
 Financial managers evaluate theFinancial managers evaluate the
accounting statements, develop additionalaccounting statements, develop additional
data, anddata, and make decisionsmake decisions on the basis ofon the basis of
their assessment of the associated returnstheir assessment of the associated returns
and risks.and risks.

Personal Finance ExamplePersonal Finance Example

Figure 1.3 Financial ActivitiesFigure 1.3 Financial Activities

Governance and Agency:Governance and Agency:
Corporate GovernanceCorporate Governance
• Corporate governance refers to the rules,Corporate governance refers to the rules,
processes, and laws by which companies areprocesses, and laws by which companies are
operated, controlled, and regulated.operated, controlled, and regulated.
• It defines the rights and responsibilities ofIt defines the rights and responsibilities of
the corporate participants such as thethe corporate participants such as the
shareholders, board of directors, officers andshareholders, board of directors, officers and
managers, and other stakeholders, as well asmanagers, and other stakeholders, as well as
the rules and procedures for makingthe rules and procedures for making
corporate decisions.corporate decisions.
• The structure of corporate governance wasThe structure of corporate governance was
previously described in Figure 1.1.previously described in Figure 1.1.

Individual versus Institutional InvestorsIndividual versus Institutional Investors
• Individual investors are investors who own relativelyIndividual investors are investors who own relatively
small quantities of shares so as to meet personalsmall quantities of shares so as to meet personal
investment goals.investment goals.
• Institutional investors are investment professionals,Institutional investors are investment professionals,
such as banks, insurance companies, mutual funds, andsuch as banks, insurance companies, mutual funds, and
pension funds, that are paid to manage and hold largepension funds, that are paid to manage and hold large
quantities of securities on behalf of others.quantities of securities on behalf of others.
• Unlike individual investors, institutional investors oftenUnlike individual investors, institutional investors often
monitor and directly influence a firm’s corporatemonitor and directly influence a firm’s corporate
governance by exerting pressure on management togovernance by exerting pressure on management to
perform or communicating their concerns to the firm’sperform or communicating their concerns to the firm’s
board.board.

Government RegulationGovernment Regulation
• Government regulation generally shapes theGovernment regulation generally shapes the
corporate governance of all firms.corporate governance of all firms.
• During the recent decade, corporateDuring the recent decade, corporate
governance has received increased attentiongovernance has received increased attention
due to several high-profile corporatedue to several high-profile corporate
scandals involving abuse of corporate powerscandals involving abuse of corporate power
and, in some cases, alleged criminal activityand, in some cases, alleged criminal activity
by corporate officers.by corporate officers.

Government RegulationGovernment Regulation
 The Sarbanes-Oxley Act of 2002:The Sarbanes-Oxley Act of 2002:
• established an oversight board to monitor theestablished an oversight board to monitor the
accounting industry;accounting industry;
• tightened audit regulations and controls;tightened audit regulations and controls;
• toughened penalties against executives who committoughened penalties against executives who commit
corporate fraud;corporate fraud;
• strengthened accounting disclosure requirements andstrengthened accounting disclosure requirements and
ethical guidelines for corporate officers;ethical guidelines for corporate officers;
• established corporate board structure and membershipestablished corporate board structure and membership
guidelines;guidelines;
• established guidelines with regard to analyst conflicts ofestablished guidelines with regard to analyst conflicts of
interest;interest;
• mandated instant disclosure of stock sales by corporatemandated instant disclosure of stock sales by corporate
executives;executives;
• increased securities regulation authority and budgets forincreased securities regulation authority and budgets for
auditors and investigators.auditors and investigators.

The Agency IssueThe Agency Issue
• A principal-agent relationship is anA principal-agent relationship is an
arrangement in which an agent acts on thearrangement in which an agent acts on the
behalf of a principal. For example,behalf of a principal. For example,
shareholders of a company (principals) electshareholders of a company (principals) elect
management (agents) to act on their behalf.management (agents) to act on their behalf.
• Agency problems arise when managers placeAgency problems arise when managers place
personal goals ahead of the goals ofpersonal goals ahead of the goals of
shareholders.shareholders.
• Agency costs arise from agency problemsAgency costs arise from agency problems
that are borne by shareholders and representthat are borne by shareholders and represent
a loss of shareholder wealth.a loss of shareholder wealth.

The Agency Issue:The Agency Issue:
Management Compensation PlansManagement Compensation Plans
• In addition to the roles played by corporateIn addition to the roles played by corporate
boards, institutional investors, andboards, institutional investors, and
government regulations, corporategovernment regulations, corporate
governance can be strengthened by ensuringgovernance can be strengthened by ensuring
that managers’ interests are aligned withthat managers’ interests are aligned with
those of shareholders.those of shareholders.
• A common approach is to structureA common approach is to structure
management compensation to correspondmanagement compensation to correspond
with firm performance.with firm performance.

The Agency Issue:The Agency Issue:
Management Compensation PlansManagement Compensation Plans
• Incentive plans are managementIncentive plans are management
compensation plans that tiecompensation plans that tie
management compensation to sharemanagement compensation to share
price; one example involves theprice; one example involves the
granting of stock options.granting of stock options.
• Performance plans tie managementPerformance plans tie management
compensation to measures such ascompensation to measures such as
EPS or growth in EPS. PerformanceEPS or growth in EPS. Performance
shares and/or cash bonuses are usedshares and/or cash bonuses are used
as compensation under these plans.as compensation under these plans.

Matter of Fact—Forbes.comMatter of Fact—Forbes.com
CEO Performance vs. PayCEO Performance vs. Pay

The Agency Issue: The Threat ofThe Agency Issue: The Threat of
TakeoverTakeover
• When a firm’s internal corporate governanceWhen a firm’s internal corporate governance
structure is unable to keep agency problemsstructure is unable to keep agency problems
in check, it is likely that rival managers willin check, it is likely that rival managers will
try to gain control of the firm.try to gain control of the firm.
• The threat of takeover by another firm, whichThe threat of takeover by another firm, which
believes it can enhance the troubled firm’sbelieves it can enhance the troubled firm’s
value by restructuring its management,value by restructuring its management,
operations, and financing, can provide aoperations, and financing, can provide a
strong source of external corporatestrong source of external corporate
governance.governance.

Review of Learning GoalsReview of Learning Goals
 DefineDefine financefinance and the managerial finance function.and the managerial finance function.
 Finance is the science and art of managing money. ManagerialFinance is the science and art of managing money. Managerial
finance is concerned with the duties of the financial managerfinance is concerned with the duties of the financial manager
working in a business.working in a business.
 Describe the legal forms of business organization.Describe the legal forms of business organization.
 The legal forms of business organization are the soleThe legal forms of business organization are the sole
proprietorship, the partnership, and the corporation.proprietorship, the partnership, and the corporation.
 Describe the goal of the firm, and explain whyDescribe the goal of the firm, and explain why
maximizing the value of the firm is an appropriatemaximizing the value of the firm is an appropriate
goal for a business.goal for a business.
 The goal of the firm is maximize its value, and therefore theThe goal of the firm is maximize its value, and therefore the
wealth of its shareholders. Maximizing the value of the firmwealth of its shareholders. Maximizing the value of the firm
means running the business in the interest of those who own itmeans running the business in the interest of those who own it
——the shareholders.the shareholders.

(cont.)(cont.)
 Describe how the managerial finance functionDescribe how the managerial finance function
is related to economics and accounting.is related to economics and accounting.
 The financial manager must understand the economicThe financial manager must understand the economic
environment and rely heavily on the economicenvironment and rely heavily on the economic
principle of marginal cost–benefit analysis to makeprinciple of marginal cost–benefit analysis to make
financial decisions. Financial managers usefinancial decisions. Financial managers use
accounting but concentrate on cash flows andaccounting but concentrate on cash flows and
decision making.decision making.
 Identify the primary activities of the financialIdentify the primary activities of the financial
manager.manager.
 The primary activities of the financial manager, inThe primary activities of the financial manager, in
addition to ongoing involvement in financial analysisaddition to ongoing involvement in financial analysis
and planning, are making investment decisions andand planning, are making investment decisions and
making financing decisions.making financing decisions.

(cont.)(cont.)
 Describe the nature of the principle-agentDescribe the nature of the principle-agent
relationship between the owners and managersrelationship between the owners and managers
of a corporation, and explain how variousof a corporation, and explain how various
corporate governance mechanisms attempt tocorporate governance mechanisms attempt to
manage agency problems.manage agency problems.
 This separation of owners and managers of the typicalThis separation of owners and managers of the typical
firm is representative of the classic principal-agentfirm is representative of the classic principal-agent
relationship, where the shareholders are the principlesrelationship, where the shareholders are the principles
and mangers are the agents. A firm’s corporateand mangers are the agents. A firm’s corporate
governance structure is intended to help ensure thatgovernance structure is intended to help ensure that
managers act in the best interests of the firm’smanagers act in the best interests of the firm’s
shareholders, and other stakeholders, and it is usuallyshareholders, and other stakeholders, and it is usually
influenced by both internal and external factors.influenced by both internal and external factors.

Bba 2204 fin mgt week 1 introduction

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