UNDERSTANDING WEALTH AND

BUSINESS

An Overview of Financial
Management

A Basic Finance Presentation

Lourdes College
June 2011 1-1
 Learning Objectives

1. Understand what financial management is

all about;

2. Learn how business enterprises are

organized;

3. Know the role of financial management in

the growth of a company’s wealth.
1-2
 Why Study Finance?
• Marketing
– Budgets, marketing research, marketing financial products

• Accounting
– Dual accounting and finance function, preparation of financial
statements

• Management
– Strategic thinking, job performance and profitability

• Personal finance
– Budgeting, retirement planning, college planning, day-to-day cash
flow issues

 1.3 1-3
 Business Finance

• Some important questions that are answered

using finance

–What long-term investments should the firm take

on?
–Where will we get the long-term financing to pay
for the investment?
–How will we manage the everyday financial
activities of the firm?
 1.4 1-4
 Financial Manager

• Financial managers try to answer some or all of

these questions
• The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
–Treasurer – oversees cash management, credit
management, capital expenditures and financial
planning
–Controller – oversees taxes, cost accounting,
financial accounting and data processing
 1.5 1-5
 What is Financial Management
• Financial – money, funds, capital
• Management – administration, control and
skillful managing

Financial Management is the skillful managing

of funds

1-6
 3 Areas of Finance

• Personal Finance

• Corporate Finance

• Public Finance

1-7
 3 Areas of Finance
• Money and capital markets
• Securities market & financial institutions

• Investments
• Investment decisions

• Financial management
• Involves decisions with firms

1-8
 Financial Management Decisions
• Capital budgeting
– What long-term investments or projects should the
business take on?

• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?

• Working capital management

– How do we manage the day-to-day finances of the
firm?

 1.9 1-9
 Forms of Organization

• Three major forms in the United States

–Sole proprietorship
–Partnership
• General
• Limited
–Corporation
• S-Corp
• Limited liability company

 1.10 1-10
 Sole Proprietorship

• Advantages • Disadvantages
–Easiest to start –Limited to life of
–Least regulated owner
–Single owner keeps –Equity capital
all the profits limited to owner’s
–Taxed once as personal wealth
personal income –Unlimited liability
–Difficult to sell
ownership interest1-11
 1.11
 Partnership

• Advantages • Disadvantages
–Two or more owners –Unlimited liability
• General partnership
–More capital
available • Limited partnership
–Partnership dissolves
–Relatively easy to when one partner dies
start or wishes to sell
–Income taxed once –Difficult to transfer
as personal income ownership
 1.12 1-12
 Corporation

• Advantages • Disadvantages
–Limited liability –Separation of
–Unlimited life ownership and
–Separation of management
ownership and –Double taxation
management (income taxed at the
–Transfer of ownership corporate rate and
is easy then dividends taxed at
personal rate)
–Easier to raise capital
 1.13 1-13
 Goal Of Financial Management

• What should be the goal of a corporation?

–Maximize profit?
–Minimize costs?
–Maximize market share?
–Maximize the current value of the company’s
stock?
• Does this mean we should do anything and
everything to maximize owner wealth?

 1.14 1-14
 The Agency Problem

• Agency relationship
–Principal hires an agent to represent their interest
–Stockholders (principals) hire managers (agents) to
run the company
• Agency problem
–Conflict of interest between principal and agent
• Management goals and agency costs

 1.15 1-15
 Managing Managers

• Managerial compensation
–Incentives can be used to align management and
stockholder interests
–The incentives need to be structured carefully to
make sure that they achieve their goal
• Corporate control
–The threat of a takeover may result in better
management
• Other stakeholders

 1.16 1-16
 Work the Web Example
• The Internet provides a wealth of information
about individual companies
• One excellent site is finance.yahoo.com
• Click on the web surfer to go to the site,
choose a company and see what information
you can find!

 1.17 1-17
 Figure 1.2

 1.18 1-18
 Financial Markets

• Cash flows to the firm

• Primary vs. secondary markets
–Dealer vs. auction markets
–Listed vs. over the counter securities
• NYSE
• NASDAQ

 1.19 1-19
 Financial Markets
• Financial markets bring together the buyers and
sellers of debt and equity securities.

• Money markets involve the trading of short-term

debt securities.

• Capital markets involve the trading of long-term debt

securities.

Copyright 2004 McGraw-

• Primary markets involve the original sale of
Hill Australia Pty Ltd
PPTs t/a Fundamentals of
securities.
Corporate Finance 3e
Ross, Thompson,

Christensen, Westerfield and

Jordan • Secondary markets involve the continual buying and
Slides prepared by Sue
Wright selling of issued securities.
 1-20 1-20
 Structure of Financial Markets
Financial Markets

Money Market Capital Market

Primary Market Secondary Market Primary Market Secondary Market

 Copyright 2004 McGraw-Hill Australia

Pty Ltd
PPTs t/a Fundamentals of Corporate
Finance 3e
Ross, Thompson, Christensen,
Westerfield and Jordan
Slides prepared by Sue Wright
1-21
1-21

 Quick Quiz

• What are the four basic areas of finance?

• What are the three types of financial
management decisions and what questions are
they designed to answer?
• What are the three major forms of business
organization?
• What is the goal of financial management?
• What are agency problems and why do they
exist within a corporation?
1-22
 Financial Management Issues of the
New Millennium
• The globalization of business

Factors
– Improvements in
transportation &
communication cost
– Increasing political clout of
consumers
– Increase in cost of developing
new products
– Ability to shift production to
wherever cost are lowest

1-23
 Percentage of Revenue and Net Income from
Overseas Operations for 10 Well-Known
Corporations, 2001
Company % of Revenue % of Net Income
from overseas from overseas
Coca-Cola 60.8 35.9
Exxon Mobil 69.4 60.2
General Electric 32.6 25.2
General Motors 26.1 60.6
IBM 57.9 48.4
JP Morgan Chase & Co. 35.5 51.7
McDonald’s 63.1 61.7
Merck 18.3 58.1
3M 52.9 47.0
Sears, Roebuck 10.5 7.8
1-24
 Financial Management Issues of the
New Millennium

• The effect of changing

technology
• Linking of networks of PCs
• Immediate access to shared
information
• Face-to-face meeting thru video
teleconferencing

1-25
Financial Goals of the Corporation

• The primary financial goal is shareholder

wealth maximization, which translates to
maximizing stock price.
– Do firms have any responsibilities to society
at large?
– Is stock price maximization good or bad for
society?
– Should firms behave ethically?

1-26
 Agency relationships
• An agency relationship exists whenever a
principal hires an agent to act on their behalf.
• Within a corporation, agency relationships
exist between:
– Stockholders and managers
– Stockholders and creditors

1-27
 Stockholders versus Managers
• Managers are naturally inclined to act in their
own best interests.
• But the following factors affect managerial
behavior:
– Managerial compensation plans
– Direct intervention by shareholders
– The threat of firing
– The threat of takeover

1-28
 Stockholders versus Creditors
• Stockholders (through managers) could take
actions to maximize stock price that are
detrimental to creditors.
• In the long run, such actions will raise the cost
of debt and ultimately lower stock price.

1-29
Factors that affect stock price
• Projected cash flows
to shareholders
• Timing of the cash
flow stream
• Riskiness of the cash
flows

1-30
 Factors that Affect the Level and
Riskiness of Cash Flows
• Decisions made by financial managers:
– Investment decisions
– Financing decisions (the relative use of debt
financing)
– Dividend policy decisions

• The external environment

1-31
 The long and short of it….

Business is wealth creation and sound and

prudent financial management is critical to
ensuring business success and continuity.

Thank you all!

1-32