FINANCIAL MANAGEMENT

Financial Performance: Control and

Measurement
 Learning Objectives

1. Describe the cycle of money, the participants in the

cycle, and the common objective of borrowing and
lending.
2. Distinguish the four main areas of finance and briefly
explain the financial activities that each encompasses.
3. Explain the different ways of classifying financial
markets.
4. Discuss the three main categories of financial
management.
5. Identify the main objective of the financial manager and
how that objective might be achieved.
 Learning Objectives (continued)

6. Explain how the finance manager interacts with both internal and
external players.
7. Delineate the main types of business organizations and their
respective advantages and disadvantages.
8. Illustrate agency theory and the principal-agent problem.
9. Review issues in corporate governance and business ethics.
 Definition of Finance:
• Finance is the art and science of managing
wealth.
– It is about making decisions regarding what assets
to buy/sell and when to buy/sell these assets.
– Its main objective is to make individuals and their
businesses better off.
 Definition of financial management

• Financial management is generally defined as

those activities that create or preserve the
economic value of the assets of an individual,
small business, or corporation.
– Financial management comes down to making
sound financial decisions.
 Overview of Finance Areas
4 main interconnected and interrelated areas.

1. Corporate Finance
2. Investments
3. Financial Institutions and Markets
4. International Finance.
 Financial Markets
• Forums where buyers and sellers of financial assets and
commodities meet.
• Financial markets can be classified by:
– Type of asset traded
– Maturity of the financial asset
• money market
• capital market

– Owner of the financial asset

• primary market
• secondary market

– Nature of transaction
• dealer markets
• auction markets
 The Finance Manager and Financial
Management
Finance manager
– Has to determine the best repayment structure for borrowed funds
– Makes sure that debt obligations are met on time
– Ensures that sufficient funds are available for carrying out daily
operations.
 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
 The Finance Manager and Financial
Management (continued)
Financial management involves 3 main functions
• Capital Budgeting
• Capital Structure
• Working Capital Management
 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?
 Objective of the Finance Manager

To make investment and financing decisions that

increase the cash flow of the firm, thereby
maximizing the current stock price

Profit maximization vs. Stock price maximization

Why are they not the same?

Which one is more important?
 Internal and External Players

• Financial managers have to interact with

various internal and external stakeholders
– Internal players include all the departmental
managers and other employees
– External parties include:
• Customers
• Suppliers
• Government
• Creditors
 The Cycle of Money
• Financial intermediaries assist in the
movement of money, from lenders to
borrowers and back again.
– This process is termed the cycle of money and its
main objective is to make all the participants
better off
The Corporation and the
Financial Market
 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

securities
reinvest
Secondary
markets
Cash flow dividends,
etc.

tax

Government
 The Money Cycle
• Example: A mutual fund issues shares which are bought by
individuals
• The pooled funds are invested by the mutual fund company in
shares that are issued by firms
• The firms pay dividends periodically which are received by the
mutual fund and passed through to their shareholders, or
reinvested in additional shares and the cycle of money starts
again.
– The mutual fund managers earn fees;
– the firms whose securities are bought are able to raise capital for
growth and future returns; and
– the mutual fund shareholders earn dividends and capital gains.
• Thus, all participants are generally better off.
 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.
 The Agency Problem
• Agency relationship
– Principal hires an agent to represent his/her
interests
– Stockholders (principals) hire managers (agents)
to run the company
• Agency problem
– Conflict of interest between principal and agent
• Management goals and agency costs
A Basic Organizational Chart for a Company
 The Legal Forms of Business
• There are three main legal categories of business
organizations:
1. Sole proprietorship
2. Partnership
3. Corporation

• Besides these 3 main forms some other forms of

business organizations include:
Hybrid Corporations
Not-for-Profit Corporations
 The Legal Forms of Business
(continued)
Sole Proprietorship
• Advantages
1. Simplest and easiest form of business.
2. Least amount of legal documentation.
3. Least regulated.
4. Owner keeps all profits

• Disadvantages
1. Owner pays personal tax rate on profits
2. Obligations of the business are sole responsibility of owner, and personal assets may be
necessary to pay obligations (personal and business assets are commingled).
3. Business entity limited to life of owner.
4. Can have limited access to outside funding for the business.
 The Legal Forms of Business
(continued)
Partnership
• Advantages
1. Agreements between partners may be easily formed
2. Involves more individuals as owners and therefore usually more
expertise
3. Larger amount of capital usually available to the business (compared
to proprietorship)
• Disadvantages
1. Assets of general partners are commingled with assets of the
business
2. Profits treated as personal income for tax purposes
3. Difficult to transfer ownership
 The Legal Forms of Business
(continued)
Corporation
• Advantages
1. Business is legal, separate entity from owners
2. Owners have limited liability to obligations of the business
3. Easy to transfer ownership
4. Usually greater access to capital for business
5. Owners do not have any personal liability for default
• Disadvantages
1. Most difficult business operation to form
2. Double taxation of company profits
3. Most regulated.
 The Financial Management Setting:
The Agency Model
• Agency relationship
• Agency conflict
– Why does it arise?
– How can it be minimized?
• Principal-agent problem
• Agency theory
• Agency costs
 Corporate Governance and Business
Ethics
• Corporate governance deals with….
– how a company conducts its business and implements controls to
ensure proper procedures and ethical behavior.

• The Sarbanes-Oxley Act, enacted in 2002, requires that

– The CEO and CFO attest to the fairness of the financial reports.
– The company maintains an effective internal control structure around
financial reporting.
– The company and its auditors assess the effectiveness of the controls
over the most recent fiscal year.
 Financial Management Axiom
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.