What is Financial

Management?
Concerns the acquisition,
financing, and
management of assets
with some overall goal in
mind.
What is the optimal firm size?
Most important of the three
decisions.
What specific assets should be
acquired?
What assets (if any) should be reduced
or eliminated?
Investment Decisions
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?
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
Maximization of
Shareholder
Wealth!
What is the Goal
of the Firm?
Value creation occurs when
we maximize the share
price for current
shareholders
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.
Shortcomings of
Alternative Perspectives
Profit Maximization
Maximizing a firms earnings after
taxes.
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.
Earnings per Share Maximization
Maximizing earnings after taxes
divided by shares outstanding.
Problems
Shortcomings of
Alternative Perspectives
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.
Strengths of Shareholder
Wealth Maximization
Cadbury Schweppes: governing objective is
growth in shareowner value
Credit Suisse Group: achieve high customer
satisfaction, maximize shareholder value and
be an employer of choice
Dow Chemical Company: maximize long-
term shareholder value
ExxonMobil: long-term, sustainable
shareholder value
What companies say about
their corporate goal*
There exists a SEPARATION between
owners and managers.
Modern Corporation
Shareholders Management
The Modern Corporation
An agent is an individual
authorized by another person,
called the principal, to act in the
latters behalf.
Role of Management
Management acts as an
agent for the owners
(shareholders) of the firm.
Incentives include, stock options,
perquisites, and bonuses.
Agency Theory
Principals must provide
incentives so that management
acts in the principals best
interests and then monitor
results.
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.
Social Responsibility
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.
Corporate Governance
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.
CEO/Chairman roles commonly same person in
US, but separate in Britain (US moving this
direction).
Board of Directors
Sarbanes-Oxley Act of 2002
Sarbanes-Oxley Act of 2002 (SOX): addresses
corporate governance, auditing and accounting,
executive compensation, and enhanced and timely
disclosure of corporate information
Imposes new penalties for violations of
securities laws
Established the Public Company Accounting
Oversight Board (PCAOB) to adopt auditing,
quality control, ethics, disclosure standards for
public companies and their auditors, and
policing authority
Generally increasing the standards for
corporate governance
Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President
Operations
Vice President
Marketing
VP of
Finance
Treasurer
Capital Budgeting
Cash Management
Credit Management
Dividend Disbursement
Fin Analysis/Planning
Pension Management
Insurance/Risk Mngmt
Tax Analysis/Planning
Organization of the Financial
Management Function
VP of Finance
Controller
Cost Accounting
Cost Management
Data Processing
General Ledger
Government Reporting
Internal Control
Preparing Fin Stmts
Preparing Budgets
Preparing Forecasts
The Business
Environment
Sole Proprietorships
Partnerships (general and limited)
Corporations
Limited liability companies
The U.S. has four basic forms
of business organization:
The Business
Environment
Oldest form of business
organization.
Business income is accounted for on
your personal income tax form.
Sole Proprietorship -- A business
form for which there is one
owner. This single owner has
unlimited liability for all debts of
the firm.
Summary for
Sole Proprietorship
Advantages
Simplicity
Low setup cost
Quick setup
Single tax filing
on individual
form
Disadvantages
Unlimited liability
Hard to raise
additional capital
Transfer of
ownership
difficulties
The Business
Environment
Business income is accounted for
on each partners personal income
tax form.
Partnership -- A business form
in which two or more
individuals act as owners.
Types of Partnerships
Limited Partnership -- limited partners
have liability limited to their capital
contribution (investors only). At least
one general partner is required and
all general partners have unlimited
liability.
General Partnership -- all partners
have unlimited liability and are liable
for all obligations of the partnership.
Summary for Partnership
Advantages
Can be simple
Low setup cost,
higher than sole
proprietorship
Relatively quick setup
Limited liability for
limited partners
Disadvantages
Unlimited liability for
the general partner
Difficult to raise
additional capital,
but easier than sole
proprietorship
Transfer of
ownership
difficulties
The Business
Environment
An artificial entity that can own
assets and incur liabilities.
Business income is accounted for
on the income tax form of the
corporation.
Corporation -- A business form
legally separate from its
owners.
Summary for Corporation
Advantages
Limited liability
Easy transfer of
ownership
Unlimited life
Easier to raise large
quantities of capital
Disadvantages
Double taxation
More difficult to
establish
More expensive
to set up and
maintain
The Business
Environment
Business income is accounted for on
each members individual income
tax form.
Limited 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.
Limited Liability
Company (LLC)
Limited liability
Centralized management
Unlimited life
Transfer of ownership without other
owners prior consent
Generally, an LLC will possess only
the first two of the following four
standard corporation characteristics
Summary for LLC
Advantages
Limited liability
Eliminates double
taxation
No restriction on
number or type of
owners
Easier to raise
additional capital
Disadvantages
Limited life
(generally)
Transfer of
ownership
difficulties
(generally)
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.
Financial Environment
The market for short-term (less than
one year original maturity)
government & corporate debt
securities is known as Money
Market
The market for relatively long-term
(greater than one year original
maturity) financial instruments (e.g.
bonds & stocks) is known as Capital
Market
Financial Environment
The market where new securities are
bought & sold for the first time (a
new issues market is known as
Primary Market
The market for (used) securities
rather than new issues is known as
Secondary Market