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CHAPTER 1An 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 businessowned 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 ValueAn 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.