chapter 1 financial management (1)

7/24/2019 Chapter 1 Financial Management (1)

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Chapter 1

The Role and Environment

of Managerial Finance

CFEA 2123 Financial Management


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Learning Goals

1. Defne fnance, its major areas andopportunities available in this feld, andthe legal orms o business organization.

2. Describe the managerial fnance unctionand its relationship to economics andaccounting.

. !denti" the primar" activities o the

fnancial manager.#. $%plain the goal o the frm, corporate

governance, the role o ethics, and theagenc" issue.


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Learning Goals &cont.'

(. )nderstand fnancial institutions andmar*ets, and the role the" pla" inmanagerial fnance.

+. Discuss business ta%es and theirimportance in fnancial decisions.


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hat is -inance

-inance can be defned as the art andscience o managing mone".

-inance is concerned /ith the process,institutions, mar*ets, and instruments

involved in the transer o mone" amongindividuals, businesses, and

governments.


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0ajor reas 3pportunities in-inance4 -inancial 5ervices Financial Servicesis the area o

fnance concerned /ith the design anddeliver" o advice and fnancial products

to individuals, businesses, andgovernment.

Career opportunitiesinclude ban*ing,

personal fnancial planning, investments,real estate, and insurance.


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0ajor reas 3pportunities in-inance4 0anagerial -inance Managerial fnanceis concerned /ith

the duties o the fnancial manager in thebusiness frm.

6he fnancial manageractivel" managesthe fnancial a7airs o an" t"pe obusiness, /hether private or public, largeor small, proft8see*ing or not8or8proft.

6he" are also more involved in developingcorporate strateg" and improving thefrm9s competitive position.


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0ajor reas 3pportunities in-inance4 0anagerial -inance

&cont.' !ncreasing globalization has complicatedthe fnancial management unction b"re:uiring them to be profcient in

managing cash ;o/s in di7erentcurrencies and protecting against theris*s inherent in internationaltransactions.

Changing economic and regulator"conditions also complicate the fnancialmanagement unction.


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Table 1.1 5trengths and ea*nesseso the Common Legal -orms o


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Figure 1.1 Corporate

3rganization


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Ta!le 1"2 Other Limited LiabilityOrganizations


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Table 1.3 Career3pportunities in 0anagerial-inance


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6he 0anagerial -inance-unction6he size and importance o the

managerial fnance unction depends onthe size o the frm.

!n small companies, the fnance unctionma" be perormed b" the compan"president or accounting department.

s the business e%pands, fnancet"picall" evolves into a separatedepartment lin*ed to the president as/as previousl" described in -igure 1.1.


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6he 0anagerial -inance-unction4 =elationship to

$conomics6he feld o fnance is actuall" anoutgro/th o economics.

!n act, fnance is sometimes reerred to

as fnancial economics. -inancial managers must understand the

economic rame/or* /ithin /hich the"

operate in order to react or anticipate tochanges in conditions.


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$conomics &cont.'6he primar" economic principal used b"fnancial managers is marginal cost-beneft analysis/hich sa"s that

fnancial decisions should beimplemented onl" /hen added beneftse%ceed added costs.


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ccounting6he frm9s fnance &treasurer' andaccounting &controller' unctions areclosel"8related and overlapping.

!n smaller frms, the fnancial manager

generall" perorms both unctions.


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ccounting &cont.' 3ne major di7erence in perspective andemphasis bet/een fnance andaccounting is that accountants generall"

use the accrual method /hile in fnance,the ocus is on cash ows.

6he signifcance o this di7erence can be

illustrated using the ollo/ing simplee%ample.


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#ale$ %1& '1 (acht $old& 1) $till *ncollected+

,o$t$ % 8& 'all aid in f*ll *nder $*lier term$+


ccounting &cont.'6he >assau Corporation e%perienced theollo/ing activit" last "ear4

>o/ contrast the di7erences in

perormance under the accountingmethod versus the cash method.


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./,0ME #TTEME/T #MMR

,,R ,#

#ale$ %1& %

e$$ ,o$t$ '8&+ '8&+

/et rofit'o$$+ % 2& %'8&+


ccounting &cont.'


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ccounting &cont.' -inance and accounting also di7er /ithrespect to ecision-ma!ing.

hile accounting is primaril" concerned

/ith the presentation o fnancial data, thefnancial manager is primaril" concerned/ith analy"ing an interpretingthisinormation or decision8ma*ing purposes.

6he fnancial manager uses this data as avital tool or ma*ing decisions about thefnancial aspects o the frm.


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Figure 1.# -inancialctivities


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Goal o the -irm4 0a%imize?roft

?roft ma%imization ails to account or di7erences in thelevel o cash ;o/s &as opposed to profts', the timing othese cash ;o/s, and the ris* o these cash ;o/s.


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Share Price = Ftre !i"idends

#e$ired #etrn

level timingof ca$h flo:$

ri$; of ca$hflo:$

Goal o the -irm40a%imize 5hareholder

ealth@@@ h"


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Goal o the -irm40a%imize 5hareholder ealth@@@

&cont.'6he process o shareholder /ealthma%imization can be described using theollo/ing ;o/ chart4

Figure 1.3 Share Price Maximization


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Goal o the -irm4hat bout 3ther

5ta*eholders 5ta*eholders include all groups o individuals /hohave a direct economic lin* to the frm includingemplo"ees, customers, suppliers, creditors,o/ners, and others /ho have a direct economic

lin* to the frm.

6he A5ta*eholder Bie/A prescribes that the frmma*e a conscious e7ort to avoid actions that couldbe detrimental to the /ealth position o its

sta*eholders.

5uch a vie/ is considered to be Asociall"responsible.A


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Corporate Governance

Corporate Governance is the s"stemused to direct and control a corporation.

!t defnes the rights and responsibilitieso *e" corporate participants such asshareholders, the board o directors,ocers and managers, and other

sta*eholders.6he structure o corporate governance

/as previousl" described in -igure 1.1.


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!ndividual versus !nstitutional!nvestors !ndividual investors are investors /ho purchase

relativel" small :uantities o shares in order toearn a return on idle unds, build a source oretirement income, or provide fnancial securit".

!nstitutional investors are investment proessionals/ho are paid to manage other people9s mone".

6he" hold and trade large :uantities o securities

or individuals, businesses, and governments andtend to have a much greater impact on corporategovernance.


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6he 5arbanes83%le" ct o22 6he 5arbanes83%le" ct o 22 &commonl"

called 53E' eliminated man" disclosure andcon;ict o interest problems that suracedduring the earl" 2s.

53E4 established an oversight board to monitor the

accounting industr"F tightened audit regulations and controlsF

toughened penalties against e%ecutives /hocommit corporate raudF

strengthened accounting disclosure re:uirementsF established corporate board structure guidelines.


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6he =ole o $thics4 $thicsDefned $thicsis the standards o conduct or

moral judgmenthave become anoverriding issue in both our societ" and

the fnancial communit" $thical violations attract /idespread

publicit"

>egative publicit" oten leads tonegative impacts on a frm


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6he =ole o $thics4 Considering$thics =obert . Coo*e, a noted ethicist, suggests

that the ollo/ing :uestions be used to assessthe ethical viabilit" o a proposed action4 Does the action unairl" single out an individual

or group Does the action a7ect the morals, or legal rights

o an" individual or group Does the action conorm to accepted moral

standards re there alternative courses o action that are

less li*el" to cause actual or potential harm


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6he =ole o $thics4Considering $thics &cont.' Coo*e suggests that the impact o a proposed decision

should be evaluated rom a number o perspectives4

re the rights o an" sta*eholder being violated

Does the frm have an" overriding duties to an"sta*eholder

ill the decision beneft an" sta*eholder to thedetriment o another sta*eholder

! there is a detriment to an" sta*eholder, ho/ should itbe remedied, i at all

hat is the relationship bet/een stoc*holders andsta*eholders


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6he =ole o $thics4$thics 5hare ?rice $thics programs see* to4

reduce litigation and judgment costs

maintain a positive corporate image

build shareholder confdence gain the lo"alt" and respect o all

sta*eholders

6he e%pected result o such programs isto positivel" a7ect the frmHs share price.


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6he genc" !ssue46he genc" ?roblem henever a manager o/ns less than 1I o

the frm9s e:uit", a potential agency probleme%ists.

!n theor", managers /ould agree /ithshareholder /ealth ma%imization.

Jo/ever, managers are also concerned /iththeir personal /ealth, job securit", ringe

benefts, and liest"le.

6his /ould cause managers to act in /a"s thatdo not al/a"s beneft the frm shareholders.


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6he genc" !ssue4=esolving the ?roblem Mar!et Forcessuch as major

shareholders and the threat o a hostileta*eover act to *eep managers in chec*.

%gency Costs are the costs borne b"stoc*holders to maintain a corporategovernance structure that minimizes

agenc" problems and contributes to thema%imization o shareholder /ealth.


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6he genc" !ssue4=esolving the ?roblem &cont.' $%amples /ould include bonding or

monitoring management behavior, andstructuring management compensation

to ma*e shareholders interests theiro/n.

stoc! optionis an incentive allo/ing

managers to purchase stoc* at themar*et price set at the time o the grant.


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6he genc" !ssue4=esolving the ?roblem &cont.' &er'ormance planstie management

compensation to measures such as $?5gro/thF perormance shares andKor cash

bonuses are used as compensationunder these plans.

=ecent studies have ailed to fnd a

strong relationship bet/een C$3compensation and share price.


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-inancial !nstitutions 0ar*ets -irms that re:uire unds rom e%ternal

sources can obtain them in three /a"s4

through a ban* or other fnancial institution

through fnancial mar*ets

through private placements


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-inancial !nstitutions 0ar*ets4 -inancial !nstitutions -inancial institutions are intermeiaries

that channel the savings o individuals,businesses, and governments into loans orinvestments.

6he *e" suppliers and demanders o undsare iniviuals, businesses, andgovernments.

!n general, individuals are net suppliersounds, /hile businesses and governments arenet emanerso unds.


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-inancial !nstitutions 0ar*ets4 -inancial 0ar*ets Financial mar!etsprovide a orum in

/hich suppliers o unds and demanderso unds can transact business directl".

6he t/o *e" fnancial mar*ets are themoney mar!etand the capital mar!et.

6ransactions in short term mar*etable

securities ta*e place in the mone" mar*et/hile transactions in long8term securitiesta*e place in the capital mar*et.


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-inancial !nstitutions 0ar*ets4 -inancial 0ar*ets

&cont.' hether subse:uentl" traded in themone" or capital mar*et, securities arefrst issued through the primary mar!et.

6he primar" mar*et is the onl" one in/hich a corporation or government isdirectl" involved in and receives theproceeds rom the transaction.

3nce issued, securities then trade on theseconary mar!etssuch as the >e/or* 5toc* $%change or >5DM.


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Figure 1.( -lo/ o -unds


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6he 0one" 0ar*et

6he money mar!ete%ists as a result o theinteraction bet/een the suppliers anddemanders o short8term unds &thosehaving a maturit" o a "ear or less'.

0ost mone" mar*et transactions are madein mar!etable securities /hich are short8term debt instruments such as 68bills andcommercial paper.

0one" mar*et transactions can be e%ecuteddirectl" or through an intermediar".


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6he 0one" 0ar*et &cont.'

6he international e:uivalent o the domestic&).5.' mone" mar*et is the $urocurrencymar!et.

6he $urocurrenc" mar*et is a mar*et orshort8term ban* deposits denominated in).5. dollars or other mar*etable currencies.

6he $urocurrenc" mar*et has gro/n rapidl"

mainl" because it is unregulated andbecause it meets the needs o internationalborro/ers and lenders.


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6he Capital 0ar*et

6he capital mar!et is a mar*et that enables suppliersand demanders o long8term unds to ma*etransactions.

6he *e" capital mar*et securities are bons &long8term

debt' and both common an pre'erre stoc!&e:uit"'.


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6he *e" di7erence bet/een bro*er and dealermar*ets is a technical point dealing /ith the/a" trades are e%ecuted.

hen a trade occurs in a bro*er mar*et, bu"ersand sellers are brought together and the tradeta*es place on the ;oor o the e%change.

!n contrast, bu"ers and sellers are neveractuall" brought together in a dealer mar*et Ntransactions are e%ecuted b" securities dealersthat ma*e mar*ets in certain securities.


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6he >e/ or* 5toc* $%change &>5$' isthe most amous o all bro*er mar*ets andaccounts or about +I o the value oshares traded in the ).5. stoc* mar*ets.

6rading is conducted through an auctionprocess /here specialists Oma*e amar*etP in selected securities.

s compensation or e%ecuting orders,specialists ma*e mone" on the sprea&bid price N as* price'.


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6he over-the-counter )*TC+mar*et is anintangible mar*et or securitiestransactions.

)nli*e organized e%changes, the 36C is botha primary mar*et and a seconary mar*et.

6he 36C is a computer-basemar*et/here ealers ma*e a mar*et in selected

securities and are lin*ed to bu"ers andsellers through the ,%S%5"stem.

Dealers also ma*e mone" on the Ospread.P


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!nternational Capital 0ar*ets

!n the $urobon mar!et, corporations andgovernments t"picall" issue bondsdenominated in dollars and sell them toinvestors located outside the )nited 5tates.

6he 'oreign bon mar!etis a mar*et ororeign bonds, /hich are bonds issued b" aoreign corporation or government that is

denominated in the investor9s homecurrenc" and sold in the investor9s homemar*et.

i l i l *


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!nternational Capital 0ar*ets&cont.' -inall", the international e/uity

mar!etallo/s corporations to sellbloc*s o shares to investors in a number

o di7erent countries simultaneousl".6his mar*et enables corporations to

raise ar larger amounts o capital than

the" could raise in an" single nationalmar*et.

h l i i


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6he =ole o 5ecurities$%changes

Figure 1.5 Supply and Demand


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E "34 '%8& - %75&+Ta< = %15&45


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E


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E


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s the e%ample sho/s, the use o debtfnancing can increase cash ;o/ and $?5,and decrease ta%es paid.

6he ta% deductibilit" o interest and othercertain e%penses reduces their actual&ater8ta%' cost to the proftable frm.

!t is the non8deductibilit" o dividendspaid that results in double ta%ation underthe corporate orm o organization.


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chapter 1 financial management (1)

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