Reading 1

The Role of Financial

Management
Learning Goals
Explain why the role of the financial
manager today is so important.
Explain why the role of the financial
manager today is so important.
Explain why the role of the financial
manager today is so important.

Reading 1 The Role of Financial Managment

Financial Mangament:
acquisition,
financing,and
management of assets.

1.1 What is Financial Management?

Concerns the acquisition, financing, and management of assets with
some overall goal in mind.

1.2 Finanacial Mangaer Decisions: Most important of the

Investment Decisions :
a determination of the
total amount of assets
needed to be held by
the firm.

Finance Decisions :
firms have
relatively large
amounts of debt,
whereas others are
almost debt free
(100% equity).

three decisions.
1.Investment Decision: The investment decision is the most
important of the firms three major decisions when it comes to value
creation. It begins with a determination of the total amount of assets
needed to be held by the firm. Picture the firms balance sheet in your
mind for a moment.
The financial manager needs to determine the dollar amount that
appears above the double lines on the left-hand side of the balance
sheet that is, the size of the firm. Even when this number is known,
the composition of the assets must still be decided. For example, how
much of the firms total assets should be devoted to cash or to
inventory?

2.Finance Decision: Here the financial manager is concerned with the

makeup of the right-hand side of the balance sheet. If you look at the mix
of financing for firms across industries, you will see marked differences.
Some firms have relatively large amounts of debt, whereas others are
almost debt free. Does the type of financing employed make a
difference? If so, why? And, in some sense, can a certain mix of
financing be thought of as best?

Reading 1 The Role of Financial Managment

3.Asset Management Decision: Once assets have been acquired

and appropriate financing provided, these assets must still be
managed efficiently. The financial manager is charged with varying
degrees of operating responsibility over existing assets. These
responsibilities require that the financial manager be more
concerned with the management of current assets than with that of
fixed assets. A large share of the responsibility for the management
of fixed assets would reside with the operating managers who
employ these assets.

Asset Management
Decisions : assets
must still be
managed efficiently.
The financial
manager is charged
with varying degrees
of operating
responsibility over
existing assets.

1.3 The Goal of The Firm:

Efficient financial management requires the existence of some
objective or goal, because judgment as to whether or not a financial
decision is efficient must be made in light of some standard.
Although various objectives are possible, we assume the goal of the
firm is to maximize the wealth of the firms present owners. Shares
of common stock give evidence of ownership in a corporation.
Shareholder wealth is represented by the market price per share of
the firms common stock, which, in turn, is a reflection of the firms
investment, financing, and asset management decisions. The idea is
that the success of a business decision should be judged by the
effect that it ultimately has on share price.

The Goal Of the

Firm : the goal of
the firm is to
maximize the wealth
of the firms present
owners.

Reading 2
Financial Environment
Learning Goals
The Business Environment.
The Financial Environment.
Allocations Funds (External
Sources).

Reading 2 Financial Environment

Sole Proprietorships: A
business form one owner.
Has unlimited liability for
all debts.

2.1 The Business Environment

The U.S. has three basic forms of business organization:
2.1.1 Sole Proprietorships: A business form for which there is one
owner. This single owner has unlimited liability for all debts of
the firm. Oldest form of business organization. Business income is
accounted for on the owners personal income tax form.

Advantages
Simplicity
Low setup cost
Quick setup
Single tax filing on individual form
Partnerships: A business
form two or more
individuals act as owners.
Two types: General and
Limited.

Disadvantages
Unlimited liability
Hard to raise additional capital
Transfer of ownership difficulties

2.1.2 Partnerships: A business form in which two or more

individuals act as owners. Business income is accounted for on each
partners personal income tax form.
Types of Partnerships
General Partnership: All partners have unlimited liability and
are liable for all obligations of the partnership.
Limited Partnership: Limited partners have liability limited to
their capital contribution (investors only). At least one general
partner is required and all general partners have unlimited liability.

Advantages
Can be simple
Low setup cost, higher than sole
proprietorship
Relatively quick setup
Limited liability for limited partners

Disadvantages
Unlimited liability for the general
partner
Difficult to raise additional capital, but
easier than sole proprietorship
Transfer of ownership difficulties

Reading 2 Financial Environment

2.1.3 Corporations: A business form legally separate from its

owners. An artificial entity that can own assets and incur
liabilities. Business income is accounted for on the income tax
form of the corporation
Advantages
Limited liability
Easy transfer of ownership
Unlimited life
Easier to raise large quantities of
capital

Corporations: A business
form legally separate
from its owners.

Disadvantages
Double taxation
More difficult to establish
More expensive to set up and maintain

Reading 2 Financial Environment

2.2 Financial Environment

Businesses interact continually with the financial markets.
Financial Markets are composed of all institutions and procedures for bringing
buyers and sellers of financial instruments together.
The purpose of financial markets is to efficiently allocate savings to ultimate users.

Reading 2 Financial Environment

Reading 2 Financial Environment

2.3 Allocation of Funds: Funds will flow to economic units that are willing to
provide the greatest expected return (holding risk constant).
In a rational world, only those economic units with the most promising investment
opportunities will offer the highest expected returns.
Result: Savings tend to be allocated to the most efficient uses.
Risk-Expected Return Profile

Reading 2 Financial Environment

2.4 Firms that require funds from external sources can obtain them in three
ways:
through a financial institution
through financial markets
through private placements
2.4.1 Financial institutions are intermediaries that channel the
savings of individuals, businesses, and governments into loans or
investments. The key suppliers and demanders of funds are
individuals, businesses, and governments. In general, individuals
are net suppliers of funds, while businesses and governments are
net demanders of funds.

Financial institutions: are

intermediaries that
channel the savings of
individuals, businesses,
and governments into
loans or investments.
Individuals are net
suppliers of funds, while
businesses and
governments are net
demanders of funds.

through a financial institution

Commercial banks: are institutions that provide savers with a secure place to invest
their funds and that offer loans to individual and business borrowers.
Investment banks: are institutions that assist companies in raising capital, advice
firms on major transactions such as mergers or financial restructurings, and engage
in trading and market making activities.

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Reading 2 Financial Environment

through financial markets

Financial markets: are forums in which suppliers of funds and demanders of funds
can transact business directly.
Transactions in short term marketable securities take place in the money
market while transactions in long-term securities take place in the capital
market.
A private placement involves the sale of a new security directly to an investor or
group of investors.
Most firms, however, raise money through a public offering (IPO) of securities,
which is the sale of either bonds or stocks to the general public.
The primary market is the financial market in which securities are initially issued;
the only market in which the issuer is directly involved in the transaction.
Secondary markets are financial markets in which pre-owned securities (those
that are not new issues) are traded.
The money market is created by a financial relationship between suppliers and
demanders of short-term funds.
Most money market transactions are made in marketable securities which are shortterm debt instruments, such as U.S. Treasury bills, commercial paper, and negotiable
certificates of deposit issued by government, business, and financial institutions,
respectively.
Investors generally consider marketable securities to be among the least risky
investments available.

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Reading 2 Financial Environment

The capital market is a market that enables suppliers and demanders of long-term
funds to make transactions.
The key capital market securities are bonds (long-term debt) and both common
and preferred stock (equity, or ownership).
Bonds are long-term debt instruments used by businesses and government to raise
large sums of money, generally from a diverse group of lenders.
Common stock are units of ownership interest or equity in a corporation.
Preferred stock is a special form of ownership that has features of both a bond and
common stock.
Broker markets are securities exchanges on which the two sides of a transaction,
the buyer and seller, are brought together to trade securities.
Dealer markets are markets in which the buyer and seller are not brought together
directly but instead have their orders executed by securities dealers that make
markets in the given security.

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