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This document provides an overview of managerial finance. It defines key terms like finance, financial services, and managerial finance. It describes the main legal forms of business organization like sole proprietorships, partnerships, and corporations. It explains the strengths and weaknesses of each form. It also outlines the roles and responsibilities of financial managers in a corporation. The goal of financial management is to maximize shareholder wealth rather than just profits. Financial managers should accept actions that are expected to increase share price over the long run by considering return, risk, and the interests of all stakeholders.
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Chapter 1 the Role and Environment of Managerial Finance
This document provides an overview of managerial finance. It defines key terms like finance, financial services, and managerial finance. It describes the main legal forms of business organization like sole proprietorships, partnerships, and corporations. It explains the strengths and weaknesses of each form. It also outlines the roles and responsibilities of financial managers in a corporation. The goal of financial management is to maximize shareholder wealth rather than just profits. Financial managers should accept actions that are expected to increase share price over the long run by considering return, risk, and the interests of all stakeholders.
This document provides an overview of managerial finance. It defines key terms like finance, financial services, and managerial finance. It describes the main legal forms of business organization like sole proprietorships, partnerships, and corporations. It explains the strengths and weaknesses of each form. It also outlines the roles and responsibilities of financial managers in a corporation. The goal of financial management is to maximize shareholder wealth rather than just profits. Financial managers should accept actions that are expected to increase share price over the long run by considering return, risk, and the interests of all stakeholders.
FINANCE -the art and science of managing money FINANCIAL SERVICES -design and delivery of advice and financial products to individuals, business, and government MANAGERIAL FINANCE - duties of the financial manager in the business firms manage the financial affairs of any type of business - financial and nonfinancial LEGAL FORMS OF BUSINESS ORGANIZATION owned by one person who operates it for his or her own profit. SOLE PROPRIETORSHIP consists of two or more owners doing business together for profit. PARTNERSHIP artificial being created by law often called as legal entity and has the powers of an individual that it can sue and be sued, make and be party to contracts, and acquire property in its own name. CORPORATION PROPRIETOR PARTNERS Articles of partnership stock non-stock STOCKHOLDERS MEMBERS preferred common TABLE 1.1a STRENGTHS OF THE COMMON LEGAL FORMS OF BUSINESS ORGANIZATION SOLE PROPRIETORSHIP owner receives all profits (sustains all losses) low organizational costs income included and taxed on proprietors personal tax return independence secrecy ease of dissolution PARTNERSHIP can raise more funds than sole proprietorship borrowing power enhanced by more powers more available brain power and managerial skill income included and taxed on partners personal tax return CORPORATION owners have limited liability can achieve large size via sale of ownership (stock) ownership is transferrable long life of firm can hire professional managers Has better access to financing Can offer attractive retirement plans Table 1.1b WEAKNESSES OF THE COMMON LEGAL FORMS OF BUSINESS ORGANIZATION SOLE PROPRIETORSHIP Owner has unlimited liability total wealth can be taken to satisfy debts limited fund-raising power tends to inhibit growth proprietor must be jack-of- all trades Difficult to give employees run career opportunities lacks continuity when proprietor dies PARTNERSHIP Owners have unlimited liability Partnership is dissolved when a partner dies Difficult to liquidate or transfer partnership CORPORATION taxes generally higher, dividends are taxed at a maximum of 15% more expensive to organize Subject to greater government regulation Lacks secrecy (stockholders must receive FS) Stockholders Figure 1.1 CORPORATE ORGANIZATION elect Board of Directors hires President (CEO) VP Human Resource VP Manufacturing VP Finance (CFO) VP Marketing VP Info Resources Treasurer Controller Financial Planning & Fund Raising Manager Capital Expendit ure Manager Cash Manager Credit Manager Pension Fund Manager FOREX Manager Corporate Accounting Manager Tax Manager Financial Accounting Manager Cost Accounting Manager OWNERS MANAGERS Why study Managerial Finance? Because most business decisions are measured in financial terms!!!! FINANCIAL MANAGER CAREER OPPORTUNITIES IN MANAGERIAL FINANCE Prepares financial plans and budgets Financial forecasting, financial comparisons, working closely with accounting. FINANCIAL ANALYST Involved in the financial aspects of implementing approved investments. CAPITAL EXPENDITURE MANAGER Arranges financing for approved asset investments. Coordinates consultants, investment bankers, and legal counsel. PROJECT FINANCE MANAGER CAREER OPPORTUNITIES IN MANAGERIAL FINANCE Maintains and controls the firms daily cash balance. CASH MANAGER Administers credit policy by evaluating credit application, extending credit, and monitoring and collecting A/R. CREDIT ANALYST/ MANAGER Oversees the assets and liabilities of the employees pension fund. PENSION FUND MANAGER CAREER OPPORTUNITIES IN MANAGERIAL FINANCE Manages specific foreign and the firms exposure to fluctuations. FOREIGN EXCHANGE MANAGER 1.2 THE MANAGERIAL FINANCE FUNCTION VP FINANCE (CFO) PRESIDENT TREASURER Financial Manager external CONTROLLER Chief Accountant internal RELATIONSHIP OF FINANCIAL MANAGEMENT TO OTHER FIELDS OF BUSINESS ECONOMICS efficient allocation of scarce means of production toward the satisfaction of human needs and wants.
Marginal cost-benefit analysis - The financial decisions should be made and actions taken only when the added benefits exceed the added costs.
Example: Decide whether to replace the old with a new computer using the following data:
NEW COMPUTER purchase would require cash outlay of $80,000 but will have benefits of $100,000.
OLD COMPUTER can be sold to net of $28,000 and will have benefits of $35,000 if still be used.
Benefits with new computer $ 100,000 Less: Benefit with old computer 35,000 (1) Marginal (added) benefits $ 65,000 Cost of new computer $ 80,000 Less: Proceeds from sale of old computer 28,000 (2) Marginal (added) costs 52,000 Net benefit [(1) (2)] $ 13,000 Applying the marginal cost-benefit analysis.. Since the marginal added benefits of $65,000 exceed the marginal added costs of $52,000, the firm should purchase the new computer and experience a net benefit of $13,000!!!!! ACCOUNTING a service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities, that is to be useful in making economic decisions. Basic difference between FINANCE and ACCOUNTING Emphasis on CASH FLOW accrual basis in accounting. - recognizes revenue when earned and expenses when incurred. cash basis in financial management. - recognizes revenue and expenses only with respect to inflows and outflows of cash. DECISION MAKING In accounting, accountants focus on collection and presentation of financial data. In financial management, financial managers evaluate accounting statements, develop data, and make decisions on the basis of their assessment of the associated returns and risks. Figure 1.2 PRIMARY ACTIVITIES OF A FINACIAL MANAGER Current Asset Current Liabilities Fixed Asset Long- Term Funds BALANCE SHEET Making Investment Decisions Making Financing Decisions 1.3 GOAL OF THE FIRM We need to maximize profit by means of increasing the earnings per share!!! Total earnings available to common stockholders number of common shares outstanding No way! Our objective should be to maximize shareholder wealth !!! What should I do? Sample case: A financial manager is choosing between two investments with expected earnings per share as shown below:
Earnings per share Investment Year 1 Year 2 Year 3 Total ROTOR $ 1.40 $ 1.00 $ 0.40 $ 2.80 VALVE 0.60 1.00 1.40 3.00 If answered on the point of view of profit maximization the choice would be VALVE. Yahoo!!! My answer is correct! But if answered on the point of view of shareholder wealth maximization the choice would be ROTOR. Of course! !! I have the correct answer! Hey!!! Im the finance manager here! Now Im confused! Which is correct?... Is profit maximization a reasonable goal? No! It fails for the following reasons: (1) timing of returns, (2) cash flows available to stockholders, and (3) risk. TIMING. The receipt of funds sooner than later is preferred. Though the total earnings of ROTOR is lower than VALVE, still, ROTOR has larger returns in year 1 and therefore could be reinvested to provide greater future earnings. CASH FLOWS. Earnings or Profits does not necessarily means cash inflow to stockholders. RISK. Actual outcomes may differ from those expected. There must be a trade-off between return (cash flow) and risk. Therefore, I should definitely invest in ROTOR using the point of view of shareholder wealth maximization!!! The correct answer should be shareholder wealth maximization.
Financial managers should accept only those actions that are expected to increase share price Figure 1.3 Share Price Maximization Financial Managers Financial Decision Alternatives Return? Risk? Increase the Share Price? Yes Accept No Reject Other concerns of financial management: 1. Focus also on the stakeholders wealth. employees, customers, suppliers, creditors, owners, and others who have a direct economic link to the firm. 2. Establish good corporate governance The system used to direct and control a corporation. Defines the rights and responsibilities of key corporate participants, decision making procedures, and the way in which the firm will set, achieve, and monitor its objectives.
The boards first responsibility is to the shareholders with broad classes of: a. Individual investors who buy relatively small quantities of shares. b. Institutional investors investment professionals such as insurance companies, mutual funds, and pension funds, that are paid to manage other peoples money.
has greater influence over corporate governance Issues arose from numerous corporate misdeeds: (1) false disclosures in financial reporting and other information releases (2) undisclosed conflicts of interests [between corporations and their analysts, auditors, and attorneys and between corporate directors, officers and shareholders.]
SARBANES- OXLEY ACT OF 2002 (SOX) An act aimed at eliminating corporate disclosure and conflict of interest problems. Other concerns of financial management: 3. Considering the role of ethics. Standards of conduct or moral judgment. Example of cases wherein the ethics became a major media issue:
- when energy company Enron Corps key executives failed to disclose to employees and shareholders of its bankruptcy.
- when auditing firm KPMG failed in their audit work with a company Lernout and Hauspie Speech Products that forced the auditing firm to pay $115 million to settle a shareholder lawsuit. Develop an effective ethics program Other concerns of financial management: 4. Solving the agency issue. There must be a clear cut indication of separation of the owners and managers The Agency Problem is the likelihood that managers may place personal goals ahead of corporate goals. Factors that serve to prevent or minimize agency problems: Market Forces - some large institutional investors tend to exercise their voting rights to influence the management. Agency Costs - costs borne by stockholders to maintain a governance structure Agency costs explained Structure management compensation the objective was to give managers incentives to act in the best interests of the owners. Incentive plans tend to tie management compensations to share price; the most popular incentive plan involves the grant of stock options. Performance plan plans tie management to measures such as EPS, growth in EPS, and other ratios of return. Cash bonuses cash paid to management for achieving certain performance goals. 1.4 FINANCIAL INSTITUTIONS AND MARKETS FINANCIAL INSTITUTIONS FINANCIAL MARKETS serve as intermediaries by channeling the savings of individuals, businesses, and governments into loans or investments forums in which suppliers of funds and demanders of funds can transact business directly. Money market Capital market Money Market vs. Capital Market marketable securities bonds money market stocks capital market SHORT-TERM DEBT INSTRUMENTS LONG-TERM DEBT INSTRUMENTS HOW TO RAISE MONEY THROUGH THE FINANCIAL MARKETS?... Securities Exchanges provide the marketplace in which firms can raise funds through the sale of new securities and purchases of securities can easily resell them when necessary. The two key types of securities exchanges are: ORGANIZED SECURITIES EXCHANGE tangible organizations that act as secondary markets where outstanding securities are resold. Example: New York Stock Exchange OVER-THE-COUNTER EXCHANGES an intangible market for the purchase and sale of securities not listed by the organized exchanges. OTC traders, known as dealers, are linked with the purchasers and sellers of securities through the National Association of Securities Dealers Automated Quotation (Nasdaq) system.