CHAPTER 1

An Overview of Financial
Management

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1-1 What Is Finance?
• Hard to define– the term has many facets

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1-1a Finance versus Economics
and Accounting
• Finance then grew out of and lies between
economics and Accounting
• Economists developed the notion that an asset’s
value is based on the future cash flows the asset
will provide,
• Accountants provided information regarding the
likely size of those cash flows.

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1-1b Finance within an Organization

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1-1c Corporate Finance, Capital
Markets, and Investments
• Finance as taught in universities is generally divided
into three areas:
(1) financial management(Corporate Finance),
(2) capital markets,
(3) investments.

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1-1c Corporate Finance, Capital
Markets, and Investments
• Corporate finance focuses on decisions relating to
how much and what types of assets to acquire, how
to raise the capital needed to buy assets, and how
to run the firm so as to maximize its value.

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1-1c Corporate Finance, Capital
Markets, and Investments
• Capital markets relate to the markets where
interest rates, along with stock and bond prices, are
determined.

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1-1c Corporate Finance, Capital
Markets, and Investments
• Investments relate to decisions concerning stocks
and bonds and include a number of activities:
(1) Security analysis
(2) Portfolio theory
(3) Market analysis

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1-2 Jobs In Finance
• Commercial Banking
• Corporate Finance
• Financial Planning
• Hedge Funds
• Insurance
• Investment Banking
• Money Management
• Private Equity
• Real Estate
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1-3 Forms of Business
Organization
• Sole proprietorship
• Partnership
• Corporation
• Limited liability companies(LLCs) and limited
liability partnerships(LLPs)

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1-3 Forms of Business
Organization
• Proprietorship
An unincorporated business
owned by one individual

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1-3 Forms of Business
Organization
• Partnership
An unincorporated business owned by two or more
persons.

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1-3 Forms of Business
Organization
• Sole proprietorships & Partnerships
• Advantages
• Ease of formation
• Subject to few regulations
• No corporate income taxes
• Disadvantages
• Difficult to raise capital
• Unlimited liability
• Limited life

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1-3 Forms of Business
Organization
• Corporation
A legal entity created by a state, separate and
distinct from its owners and managers, having
unlimited life, easy transferability of ownership, and
limited liability.

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1-3 Forms of Business
Organization
• Corporation
• Advantages
• Unlimited life
• Easy transfer of ownership
• Limited liability
• Ease of raising capital
• Disadvantages
• Double taxation
• Cost of set-up and report filing

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1-3 Forms of Business
Organization
• S Corporation
A special designation that allows small businesses
that meet qualifications to be taxed as if they were
a proprietorship or a partnership rather than a
corporation.

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1-3 Forms of Business
Organization
• Limited Liability Company (LLC)
A relatively new type of organization that is a hybrid
between a partnership and a corporation.

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1-3 Forms of Business
Organization
• Limited Liability Partnership (LLP)
Similar to an LLC but used for professional firms in
the fields of accounting, law, and architecture. It
has limited liability like corporations but is taxed
like partnerships.

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1-4 Stock Prices And Shareholder
Value
• The primary financial goal is shareholder wealth
maximization, which translates to maximizing
stock price.

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1-5 Intrinsic Values, Stock Prices,
And Executive Compensation

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1-5 Intrinsic Values, Stock Prices,
And Executive Compensation
• Intrinsic Value
An estimate of a stock’s “true” value based on
accurate risk and return data. The intrinsic value
can be estimated but not measured precisely.

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1-5 Intrinsic Values, Stock Prices,
And Executive Compensation

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1-6 Important Business Trends
• First, the points discussed in the preceding section
have led to profound changes in business practices.
• Sarbanes-Oxley Act
A law passed by Congress that requires the CEO and
CFO to certify that their firm’s financial statements
are accurate.

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1-6 Important Business Trends
• A second trend is the increased globalization of
business.
Developments in communications technology have
made it possible for Wal-Mart, for example, to
obtain real-time data on the sales of hundreds of
thousands of items in stores from China to Chicago
and to manage all of its stores from Bentonville,
Arkansas.

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1-6 Important Business Trends
• A third trend that’s having a profound effect on
financial management is ever-improving
information technology (IT).

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1-6 Important Business Trends
• A fourth trend relates to corporate governance, or
the way the top managers operate and interface
with stockholders.

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1-7 Business Ethics
• Business Ethics
A company’s attitude and conduct toward its
employees, customers, community, and
stockholders.

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1-7a What Companies Are Doing
• When conflicts arise involving profits and ethics:
• Do firms have any responsibilities to society at
large?
• Is stock price maximization good or bad for society?
• Should firms behave ethically?

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1-7b Consequence of Unethical
Behavior
• Over the past few years, ethical lapses have led to a
number of bankruptcies.
• These frauds also severely damaged other
companies and even whole industries.
• These and other improper actions caused many
investors to lose faith in
American business and to turn away from the stock
market

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1-7c How Should Employees
Deal with Unethical Behavior?
• If questionable things are going on, who should
take action and what should that action be?
• Should the lower-level employees obey their boss’s
orders; refuse to obey those orders; or report the
situation to a higher authority, such as the
company’s board of directors, the company’s
auditors, or a federal prosecutor?

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1-8 Conflicts Between Managers,
Stockholders, And Bondholders
• Managers versus Stockholders
• Stockholders versus Bondholders

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1-8a Managers versus
Stockholder
• 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

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1-8b Stockholders versus
Bondholders
• Bondholders generally receive fixed payment
regardless of how well the company does, while
stockholders do better when the company does
better. This situation leads to conflicts between
these two groups.

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