Ch.

1 - An Introduction to
Financial Management

 2002, Prentice Hall, Inc.

• What is Finance?
• Perspective of Finance
– Past – Financial Statement Analyses
– Present – Short-Term Financial Management
– Future – Capital Budgeting
• Goals of the Firm
• Ten Basic Principles of Finance
 Goal of the Firm

1) Profit Maximization?
this goal ignores:
a) TIMING of Returns
(Time Value of Money - Ch. 5)
b) UNCERTAINTY of Returns
(Risk - Ch. 6)
 Goal of the Firm

2) Shareholder Wealth
Maximization?
this is the same as:
a) Maximizing Firm Value
b) Maximizing Stock Price
 GOALS OF THE CORPORATION
1. Maximize Shareholder’s Wealth
2. Optimum Cash Flow Management
3. Optimum Investment Management
4. Optimum Inventory Level Management
5. Optimum Debt-Equity Ratio
6. Optimum Risk-Return Trade-Off
7. Optimum Dividend Payout Ratio
8. Minimize Interest & Capital Cost
9. Minimize Tax Burden
10. Effective & Efficient Financial Control
11. Effective & Efficient Financing of Growth
12. Optimize Social & Societal Welfare
13. Avoiding Bankruptcy
14. Maximize Distribution of Wealth
15. Maximize Distribution of Ownership
 Legal Forms of Business
1) Sole Proprietorship
• A business owned by a single individual.
• Owner maintains title to the firm’s assets.
• Owner has unlimited liability.

2) Partnership
• Similar to a sole proprietorship, except
that there are two or more owners.
 Legal Forms of Business
2a) General Partnership
• All partners have unlimited liability.

2b) Limited Partnership

• Consists of one or more general partners,
who have unlimited liability, and
• One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
 Legal Forms of Business
3) Corporation
• A business entity that legally functions
separate and apart from its owners.
• Owners’ liability is limited to the amount
of their investment in the firm.
• Owners hold common stock certificates,
and ownership can be transferred by
selling the certificates.
The Corporation and Financial
Markets
 The Corporation and Financial
Markets

Corporation
 The Corporation and Financial
Markets

Corporation Investors
 The Corporation and Financial
Markets

Corporation Investors

Government
 The Corporation and Financial
Markets

Corporation cash Investors

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets
Cash flow

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets
Cash flow

tax

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities
reinvest
Secondary
markets
Cash flow

tax

Government
 The Corporation and Financial
Markets
Corporation cash Investors
Debt & equity
securities
reinvest
Secondary
markets
Interest,
Cash flow dividends,
etc.
tax

Government
BUSINESS

INVESTMENT
 The Corporation and Financial
Markets
• Primary Market
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
– Market in which previously issued
securities are traded.
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
– A new stock offering by a firm that
already has stock that is traded in
the secondary market.
 FINANCIAL MARKETS, INSTITUITION & INSTRUMENTS

 Primary Markets

 Secondary Markets

 Money Markets
o T-Bills
o Federal Agency Discount Notes
o Short Term Munis
o Federal Funds
o Negotiable Certificate of Deposits
o Commercial Paper
o Bankers Acceptance
o Repos

 Mortgage Markets
 FINANCIAL MARKETS, INSTITUITION & INSTRUMENTS

 Capital Markets
o Debt
o Equity
o Common Shares
o Preferred Shares
 Bond Markets
o T-Bonds
o Agency Debt
o Munis Bonds
o Corporate Bonds
 Futures Market, i.e., real or financial assets
o Options
o Forwards
o Derivatives
 Financial Management Axioms
• 1) Risk - return trade-off
• 2) Time value of money
• 3) Cash - not profits - is king
• 4) Incremental cash flows count
• 5) The curse of competitive markets
• 6) Efficient capital markets
• 7) The agency problem
• 8) Taxes bias business decisions
• 9) All risk is not equal
• 10) Ethical dilemmas are everywhere in finance
 BUSINESS
INVESTMENT
ASSETS Ξ FINANCE
S/T INV + L/T INV Ξ S/T FINANCE + L/T FINANCE

C A + F A = C L + LTD + EQUITY

Cash Plant & Equipment Short Term Loan Long Term Preferred
Marketable Securities Current Maturities Debt Share
Machinery Accounts Payable Bank Loans Ordinary Share
Accounts Receivables Capital WIP Notes Share Premium Notes Treasury Stock
Inventory Land Accrued Expenses Bonds Retained Earnings
Others Investments (Land) Proposed Dividend Reserves

• S/T= SHORT TERM, L/T=LONG TERM, INV= INVESTMENT

• CA= CURRENT ASSETS, FA= FIXED ASSETS, CL= CURRENT LIABILITY
• CM= CURRENT MATURITY, WIP= WORK IN PROGRESS