The Goals and Activities of Financial Management

Finance

• fits between economics and accounting

• closely tied to accounting

• forward thinking

Economics

• provides a picture of the business environment

• consider consumers and producers

Accounting

• provides financial data (income statements, balance sheets, cash flow statements)

• measures business activity results.

Financial manager

• needs to know how to understand and interpret financial statements

• cannot directly control firm’s stock price.

• can act in consistent way with shareholder desires.

Chief Financial Officer (CFO)

Often in charge of financial planning, accounting, and tax systems

Investments

• Investors use investment principles to value stocks and bonds of companies.

• Investors choose which to purchase.

• The portfolio includes securities by multiple companies.

Corporate finance

Principles used to determine which assets the firm should develop or buy.

Financial management

• Term can be used interchangeably with corporate finance.

• Related to various investment topics.

• Include how outside investors evaluate the company.

• Corporate financial officer

• Banker

• Stockbroker

• Financial analyst

• Portfolio manager

• Investment banker,

• Financial consultant

• Personal financial planner

Career opportunities in studying finance

Chief Executive Officer (CEO)

Reports directly to the board of directors.

Marketing managers

Interested in the return on investment of marketing initiatives

• Monitor cash balances

• Manage credit decisions

• Monitor inventory levels

• Collect and distribute cash

Daily activities of financial manager

• Negotiations with banks for loans

• Sale of stocks and bonds

• Establishment of capital budgeting and dividend plans

Less routine activities of financial manager

Risk-return trade-off

• determined to maximize the market value

• influences the operational side (capital versus labor or Product A versus Product B).

• influences financial mix (stock versus bonds versus retained earnings).

1. Sole proprietorship

2. Partners

3. Corporation.

Forms of organization

Sole Proprietorship

• Represents single-person ownership

• Profits and losses taxed belong to individual owner.

Advantages

• Simplicity of decision-making.

• Low organizational and operational costs.

Drawback

• Unlimited liability to owner.

Advantages and Drawbacks of Sole Proprietorship

Partnership

• Similar to sole proprietorship except with two or more owners

• Carries unlimited liability for the owners

1. Ownership interest

2. Methods for distributing profits

3. Means of withdrawing from the partnership

Articles of partnership

Limited liability partnership

• One or more partners designated as general partners and

have unlimited liability for debts of the firm.

• Other partners designated limited partners and liable only

for initial contribution.

• Not all financial institutions extend funds to these firms.

Corporation

• Unique legal entity unto itself

• May sue or be sued, engage in contracts, and acquire

  property

• Formed through articles of incorporation, which specify rights and limitations of the entity

• Owned by shareholders who enjoy limited liability

• Has a continual life

• Key feature—easy divisibility of ownership interest by issuing shares of stock.

Double taxation of earnings.

Disadvantage of Corporation

S corporation

Income taxed as direct income to stockholders, thus taxed only once as normal income.

Limited liability company (LLC)

• Provides limited liability for the owners

• Can be taxed as a sole proprietorship, partnership, corporation, or S corporation, depending upon elections made by owners.

Sarbanes-Oxley Act

• Response to scandals and audit failures.

• Created legally binding standards for public companies.

Dodd-Frank Act

• Wall Street Reform and Consumer Protection Act of 2010

• First major financial regulatory change since great

Depression.

• Goal to reduce systemic risks that undermine financial system in the U.S.

Agency theory

• Examines relationship and potential conflict between

owners and managers of the firm.

• Management operates versus owners focused on

shareholders.

Institutional investors

• Have more to say about how publicly owned companies are managed.

• Able to vote large blocks of shares for election of board of

directors.

• often control enough shares in large companies that they are able to influence the board to unseat managers who are not responsive to shareholders’ interests.

Time Value of Money (TVM)

• The idea that a dollar received today is worth more than

a dollar that we expect to receive in the future.

• Future value of a dollar is greater than a dollar.

• Present value is today’s dollar value.

Maximization of profit

Primary goal of financial management

• Change in profit may also represent change in risk.

• Fails to consider timing of benefits.

• Impossible task of accurately measuring key variable

“profit”.

• Problems with inflation and international currency

transactions further complicate the issue.

Drawbacks of Achieving FM goal

Valuation Approach

Ultimate measure of performance—how earnings are valued

by the investor.

Residual claim

value of their claims is not fixed

Board of Directors

align management’s incentives and those of shareholders

Social Responsibility and Ethical

Behavior 1

Adopting policies that maximize values in market.

Attract capital.

Provide employment.

Offer benefits to society.

Socially desirable action like pollution control, equitable hiring

practices, and fair pricing standards may be inconsistent with

achieving maximum valuation in the market.