Chapter 1

Introduction to
Financial
Management

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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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Key Concepts and Skills

• Know the basic types of financial
management decisions and the role of
the financial manager
• Know the financial implications of the
different forms of business organization
• Know the goal of financial management
• Understand the conflicts of interest that
can arise between owners and
managers
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Chapter Outline
• Finance: A Quick Look
• Business Finance and The Financial
Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Problem and Control of the
Corporation
• Financial Markets and the Corporation
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Basic Areas Of Finance

• Corporate finance
• Investments
• Financial institutions
• International finance

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Corporate Finance
• Corporate Finance is the division of the company that
deals with financial and investment decisions.
• Corporate finance is primarily concerned with
maximizing shareholder value through long-term and
short term financial planning and the implementation
of various strategies.
• Corporate finance activities range from capital
investment decisions to investment banking.

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Investments
• Work with financial assets such as
stocks and bonds
• Value of financial assets, risk versus
return, and asset allocation
• Job opportunities
– Stockbroker or financial advisor
– Portfolio manager
– Security analyst

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Financial Institutions
• Companies that specialize in financial
matters
– Banks – commercial and investment, credit
unions, savings and loans
– Insurance companies
– Brokerage firms
• Job opportunities

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International Finance
• This is an area of specialization within each of
the areas discussed so far
• It may allow you to work in other countries or
at least travel on a regular basis
• Need to be familiar with exchange rates and
political risk
• Need to understand the customs of other
countries; speaking a foreign language
fluently is also helpful

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International Finance
• Sometimes known as international macroeconomics
– is a section of financial economics that deals with
the monetary interactions that occur between two or
more countries.
• This section is concerned with topics that include
foreign direct investments and currency exchange
rates.
• It also involves issues pertaining to financial
management, such as political and foreign exchange
risk that comes with managing multinational
corporations.

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Multinational Corporation
• A multinational corporation (MNC) has facilities and
other assets in at least one country other than its
home country. Such companies have offices and/or
factories in different countries and usually have a
centralized head office where they coordinate global
management.
• Multinational corporations are sometimes referred to
as transnational, international or stateless
corporations.

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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, profitability
• Personal finance
– Budgeting, retirement planning, college planning,
day-to-day cash flow issues
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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 investments?
– How will we manage the everyday financial
activities of the firm?

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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

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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?

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Forms of Business Organization

• Three major forms in the United States
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• S-Corp
• Limited liability company

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Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all owner’s personal
of the profits wealth
– Taxed once as – Unlimited liability
personal income – Difficult to sell
ownership interest

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Partnership
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
– Relatively easy to • Limited partnership

start – Partnership dissolves

– Income taxed once as when one partner dies
personal income or wishes to sell
– Difficult to transfer
ownership

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Corporation
• Advantages • Disadvantages
– Limited liability – Separation of
– Unlimited life ownership and
– Separation of management (agency
ownership and problem)
management – Double taxation
– Transfer of ownership (income taxed at the
is easy corporate rate and
– Easier to raise capital then dividends taxed
at personal rate, while
dividends paid are not
tax deductible)

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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?
• Sarbanes-Oxley Act
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The Agency Problem

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

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The Agency Problem

Agency problems occur between the stockholders and corporate
managers. While the stockholders call on the managers to take
care of the company, the managers may look to their own needs
first.

• The Fall of Enron – The collapse of energy giant Enron in 2001

showed how catastrophic the agency problem can be. The
company’s officers and board of directors, including Chairman
Kenneth Lay, CEO Jeffrey Skilling and CFO Andy Fastow, were
selling their Enron stock at higher prices due to false accounting
reports that made the stock seem more valuable than it truly
was. After the scandal was uncovered, thousands of
stockholders lost millions of dollars as Enron share values
plummeted.

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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

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Example: Work the Web

• The Internet provides a wealth of information
about individual companies
• One excellent site is finance.yahoo.com
• www.bloomberg.com
• Click on the Web surfer to go to the site,
choose a company and see what information
you can find!

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Figure 1.2

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Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ

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