WHAT IS FINANCE ??? Finance is the science of funds management. Finance includes saving money and often includes lending money. The field of finance deals with the concepts of time, money, and risk and how they are interrelated. It also deals with how money is spent and budgeted.
WHAT IS BUSINESS FINANCE? Raising and managing of funds by business organizations.
THE ROLE OFFINANCIAL MANAGEMENT What is Financial Management? The Goal of the Firm Corporate Governance Organization of the Financial Management Function
WHAT IS FINANCIAL MANAGEMENT?Concerns the acquisition, financing, and management of assets with some overall goal in mind.
INVESTMENT DECISIONS Most important of the three decisions. What is the optimal firm size? What specific assets should be acquired? What assets (if any) should be reduced or eliminated? eg. How much of total cash is devoted to cash or inventory?
FINANCING DECISIONS Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet). What is the best type of financing? What is the best financing mix? What is the best dividend policy (e.g., dividend-payout ratio)? How will the funds be physically acquired? eg. Shortterm loan, long term lease arrangement, stocks or bonds.
ASSET MANAGEMENT DECISIONS How do we manage existing assets efficiently? Financial Manager has varying degrees of operating responsibility over assets. Greater emphasis on current asset management than fixed asset management.
WHAT IS THE GOAL OF THE FIRM?Maximization of Shareholder Wealth! Value creation occurs when we maximize the share price for current shareholders.
SHORTCOMINGS OF ALTERNATIVE PERSPECTIVES Profit Maximization Maximizing a firm’s earnings after taxes. Problems Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.). Ignores changes in the risk level of the firm. Decrease in each owners share of profits i.e earnings per share.
SHORTCOMINGS OF ALTERNATIVEPERSPECTIVES Earnings per Share Maximization Maximizing earnings after taxes divided by shares outstanding. Problems Does not specify timing or duration of expected returns. Ignores changes in the risk level of the firm. Calls for a zero payout dividend policy.
STRENGTHS OF SHAREHOLDERWEALTH MAXIMIZATION Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors. Thus, share price serves as a barometer for business performance
THE MODERN CORPORATION Modern Corporation Shareholders Management There exists a SEPARATION between owners and managers.
ROLE OF MANAGEMENTManagement acts as an agent for the owners (shareholders) of the firm. An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.
AGENCY THEORY Jensen and Meckling developed a theory of the firm based on agency theory. Agency Theory is a branch of economics relating to the behavior of principals and their agents.
AGENCY THEORY Principals must provide incentives so that management acts in the principals’ best interests and then monitor results. Incentives include, stock options, perquisites, and bonuses.
SOCIAL RESPONSIBILITY Wealth maximization does not preclude the firm from being socially responsible. Assume we view the firm as producing both private and social goods. Then shareholder wealth maximization remains the appropriate goal in governing the firm.
CORPORATE GOVERNANCE Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. Then shareholder wealth maximization remains the appropriate goal in governing the firm.
BOARD OF DIRECTORS Typical responsibilities: Set company-wide policy; Advise the CEO and other senior executives; Hire, fire, and set the compensation of the CEO; Review and approve strategy, significant investments, and acquisitions; and Oversee operating plans, capital budgets, and financial reports to common shareholders.
ORGANIZATION OF THE FINANCIALMANAGEMENT FUNCTION Board of Directors President (Chief Executive Officer) Vice President VP of Vice President Operations Marketing Finance
THE BUSINESS AND FINANCIALENVIRONMENTS The Business Environment The Financial Environment
THE BUSINESS ENVIRONMENT Sole Proprietorships Partnerships (general and limited) Corporations Limited liability companies
THE BUSINESS ENVIRONMENT Sole Proprietorship -- A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm. Oldest form of business organization. Business income is accounted for on the owner’s personal income tax form.
SUMMARY FOR SOLE PROPRIETORSHIP Advantages Disadvantages Simplicity Unlimited liability Hard to raise additional Low setup cost capital Quick setup Transfer of ownership Single tax filing on difficulties individual form
THE BUSINESS ENVIRONMENTPartnership -- A business form in which two or more individuals act as owners. Business income is accounted for on each partner’s personal income tax form.
SUMMARY FOR PARTNERSHIP Advantages Disadvantages Can be simple Unlimited liability for the Low setup cost, higher than general partner sole proprietorship Difficult to raise additional Relatively quick setup capital, but easier than sole proprietorship Limited liability for limited partners Transfer of ownership difficulties
THE BUSINESS ENVIRONMENTCorporation -- A business form legally separate from its owners. An artificial entity that can own assets and incur liabilities. Business income is accounted for on the income tax form of the corporation.
SUMMARY FOR CORPORATION Advantages Disadvantages Limited liability Double taxation Easy transfer of ownership More difficult to Unlimited life establish Easier to raise large More expensive to quantities of capital set up and maintain
THE BUSINESS ENVIRONMENTLimited Liability Companies -- A business form that provides its owners (called “members”) with corporate- style limited personal liability and the federal-tax treatment of a partnership. Business income is accounted for on each “member’s” individual income tax form.
LIMITED LIABILITY COMPANY (LLC)Generally, an LLC will possess only thefirst two of the following four standard corporation characteristics Limited liability Centralized management Unlimited life Transfer of ownership without other owners’ prior consent
SUMMARY FOR LLC Advantages Disadvantages Limited liability Limited life (generally) Eliminates double taxation Transfer of ownership No restriction on number or difficulties (generally) type of owners Easier to raise additional capital
FINANCIAL ENVIRONMENT Businesses interact continually with the financial markets. Financial Markets are composed of all institutions and procedures for bringing buyers and sellers of financial instruments together. The purpose of financial markets is to efficiently allocate savings to ultimate users.
TYPES OF FINANCIAL MARKETS Primary market: in which newly issued securities are traded. Secondary Market: in which previously issued securities are traded
TYPES OF FINANCIAL MARKETS Money Market: In which securities having maturity less than one year are traded Capital Market: In which securities having maturity more than a year are traded