1

I. OVERVIEW

II. FORMS OF BUSINESS ORGANIZATION

III. THE GOAL OF FINANCIAL MANAGEMENT

IV. FINANCIAL INSTITUTIONS

V. FINANCIAL SECURITIES

VI. FINANCIAL MARKETS

VII. THE AGENCY RELATIONSHIP (PROBLEM)

2

3

4

“Finance is the art and science of

managing money”.

Khan and Jain‘management of

money’.

Oxford dictionary

“the Science on study of the management of funds’ and the

management of fund as the system that includes the circulation of money, the

granting of credit, the making of investments, and the provisionof

banking facilities.

Webster’s Dictionary

“It is the application of economic principles and

concepts to business decision-making and

problem solving.”

Jabossi & Peterson

1. Financial management (Business Finance)

Area of finance is concerned primarily with financial decision-making within a business entity.

Guthumann and Dougall, “Business finance can broadly be defined as the activity concerned with planning, raising, controlling, administering of the funds used in the business”.

2. Investments

Area of finance focuses on the behavior of financial markets and the pricing of securities

3. Financial institutionsArea of finance deals with banks and other firms that specialize in bringing the suppliers of funds together with the users of funds

5

Financial manager: analising and making financial decision :

1. Investment decisions--the use of funds; 2. Financing decisions--, the acquisition of funds to

be used for investing and financing day-to-day operations;

3. Decisions that involve both investing and financing.

expected return and risk

6

Financial Analysis

Financial analysis is a tool of financial management. It consists of the evaluation of the financial condition and operating performance of a business firm, an industry, or even the economy, and the forecasting of its future condition and performance. It is a means for examining risk and expected return.

7

1. Capital Budgeting The process of planning and managing a firm’s long-term investments. In capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire.

2. Capital Structure A firm’s capital structure (or financial structure) is the specific mixture

of long-term debt and equity the firm uses to finance its operations.

3. Working Capital ManagementThe term working capital refers to a firm’s short-term assets, such as

inventory, and its short-term liabilities, such as money owed to suppliers. Managing the firm’s working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. This involves a number of activities related to the firm’s receipt and disbursement of cash.

8

SOLE PROPRIETORSHIPA sole proprietorship is a business owned by one person. This is

the simplest type of business to start and is the least regulated form of organization

PARTNERSHIPA partnership is similar to a proprietorship except that there are

two or more owners (partners). a. A general partnership; all the partners share in gains or losses,

and all have unlimited liability for all partnership debts, not just some particular share.

b. A limited partnership; one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business.

9

CORPORATIONA corporation is a legal “person” separate and

distinct from its owners, and it has many of the rights, duties, and privileges of an actual person. Corporations can borrow money and own property, can sue and be sued, and can enter into contracts. A corporation can even be a general partner or a limited partner in a partnership, and a corporation can own stock in another corporation.

10

These three forms differ in a number of factors, of which those most important to financial decision-making are:

■ The way the firm is taxed. ■ The degree of control owners may exert on decisions. ■ The liability of the owners. ■ The ease of transferring ownership interests. ■ The ability to raise additional funds. ■ The longevity of the business.

11

Sole Proprietorship Advantages1. The proprietor is the sole business decision-maker.2. The proprietor receives all income from business.3. Income from the business is taxed once, at the individual taxpayer level. Disadvantages1. The proprietor is liable for all debts of the business (unlimited liability).2. The proprietorship has a limited life.3. There is limited access to additional funds.

General Partnership Advantages1. Partners receive income according to terms in partnership agreement.2. Income from business is taxed once as the partners’ personal income.3. Decision-making rests with the general partners only. Disadvantages1. Each partner is liable for all the debts of the partnership.2. The partnership’s life is determined by agreement or the life of the partners.3. There is limited access to additional funds.

12

CorporationAdvantages1. The firm has perpetual life.2. Owners are not liable for the debts of the firm; the

most that owners can lose is their initial investment.3. The firm can raise funds by selling additional

ownership interest.4. Income is distributed in proportion to ownership

interest.

Disadvantages1. Income paid to owners is subjected to double

taxation.2. Ownership and management are separated in larger

organizations13

POSSIBLE GOALS1. Survive.2. Avoid financial distress and bankruptcy.3. Beat the competition.4. Maximize sales or market share.5. Minimize costs.6. Maximize profi ts.7. Maintain steady earnings growth

The goal of financial management is to maximize stockholder wealth by means of maximizing the current value per share of the existing stock.

14

A. Investment Banks and Brokerage Activities Investment banking houses help

companies raise capital. (1) Advise corporations regarding the design

and pricing of new securities, (2) Buy these securities from the issuing

corporation, (3) Resell them to investors

15

Savings and Loan Associations (S&Ls)

Credit UnionsCredit unions are cooperative associations

whose members have a common bond, such as being employees of the same firm or living in the same geographic area.

Commercial BanksCommercial banks raise funds from depositors

and by issuing stock and bonds to investors

16

Mutual FundsMutual funds are corporations that accept money from

savers and then use these funds to buy financial instruments. These organizations pool funds, which allows them to reduce risks by diversification and achieve economies of scale in analyzing securities, managing portfolios, and buying/selling securities.

Hedge Funds Hedge funds raise money from investors and engage in a

variety of investment activities. Unlike typical mutual funds, which can have thousands of investors, hedge funds are limited to institutional investors and a relatively small number of high–net-worth individuals

17

Private Equity FundsPrivate equity funds are similar to hedge funds

in that they are limited to a relatively small number of large investors, but they differ in that they own stock (equity) in other companies and often control those companies, whereas hedge funds usually own many different types of securities.

18

Life insurance companies take premiums, invest these funds in stocks, bonds, real estate, and mortgages, and then make payments to beneficiaries. Life insurance companies also offer a variety of tax-deferred savings plans designed to provide retirement benefits.

Pension funds invest primarily in bonds, stocks, mortgages,hedge funds, private equity, and real estate.

19

Financial securities are simply pieces of paper with contractual provisions that entitle their owners to specific rights and claims on specific cash flows or values

DebtEquityThe value of an ownership interest in property, including shareholders' equity in a businessDerivativesSecurities whose values depend on, or are derived from, the values of some other traded assets.

20

Financial markets bring together people and organizations needing money with those having surplus funds.1.Physical asset & financial markets 2.Spot markets and futures markets: on- the- spot3.Money markets & capital market4.Mortgage markets (loans on residents, agri. Etc) & Consumer credit markets.5.World, national, regional, and local markets6.Private & Public Markets7.Primary markets and Secondary markets

21

Primary Markets In a primary market transaction, the corporation is the

seller, and the transaction raises money for the corporation.

Corporations engage in two types of primary market transactions:

Public offerings (IPO) and private placements. A public offering, as the name suggests, involves selling

securities to the general public, whereas a private placement is a negotiated sale involving a specific buyer.

Secondary Markets A secondary market transaction involves one owner or

creditor selling to another. Therefore, the secondary markets provide the means for transferring ownership of corporate securities

22

Dealers MarketsDealers buy and sell for themselves, at their own risk. A car

dealer, for example, buys and sells automobiles. In contrast, brokers and agents match buyers and sellers, but they do not actually own the commodity that is bought or sold.

The Nasdaq Stock Market

Auction marketsAuction markets differ from dealer markets in two ways. 1. An auction market or exchange has a physical location

(like Wall Street). 2. In a dealer market, most of the buying and selling is done

by the dealer. The primary purpose of an auction market, on the other hand, is to match those who wish to sell with those who wish to buy. Dealers play a limited role.

NYSE, BEI

23

agency relationshipThe relationship between stockholders and

management. Such a relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interests.

agency costs The costs of the conflict of interest between

stockholders and management1. An indirect agency cost is a lost opportunity2. A direct agency cost is an expense that arises

from the need to monitor management actions24

A. Managerial Compensation1. Managerial compensation, particularly at the

top, is usually tied to financial performance in general and often to share value in particular.

2. Incentive, Better performers within the firm will tend to get promoted

B. Control of the FirmControl of the firm ultimately rests with

stockholders. They elect the board of directors, who in turn hire and fire managers

25