Chapter 1 Introduction To Financial Management

chapter 1 introduction 10 Fnancialmanagement The Five Basic Areas traditionally, Financial topics are grouped mto 5 main areas 1. corporate Finance 2. investments 3 Francial institutions 4 international Finance 5 what IS Business Finance? NO matter who type OF business you started you would have 10 answer the Fonouring will you need what long-term investments should you take on? that is what lines OF business Will you be n,3 what SOTIS OF bundings macrinery 3 equipment where will you get the long-term financing 10 Day FOR your investments will you oringin other owners. 01 WW you borrow the money ? HOW will you manage your everyday Financial activities such as comeaning From customers and paying suppliers? The Financial Manager Chief Financial officer the Financial management Function IS usually associated with a top OFFICER of the Firm,arien called 010 or vice president of finance The controtter's OFFICE handles DOS and accounting 100 payments and management information systems The treasurer musealso report 10 the CHO. Financial Management Decisions AS our preceding discussion suggests, the Financial manager must be concerned with three basic &ypes OF questions Capital Budgeting the FIRST question concerns the Firm's long-term investments The process OF planning and managing a rimm's long-term investments is called Capital Budgeting concer ned with making and managing expenditures on long-termasses Capital Structure A HIM'S capital structure (or financial structure) lefers to the Specific mixture at long term debt and equity the Form uses 10 finance its operations. working Capital The third question concerns working capital management 11 lefers 10 and short ccm nabité es, Such as money owed 10 suppliers

1.3 Forms OF Business organization sole proprietorsnip 0 A sole proprietorship IS 0 business owned by one person THIS IS the simplest IVDC or business 10 start and is the least required Form OF organization for this reason there are more proprietorships non any other iyoto business and many business that later become large corporations start out as small proprietors the owner OF 0 sole proprietorsmip keeps on the PIOFIES The bad news is that the owner has unumiled nobinity FOR business debts this means inal creditors can look 10 the proprietor's personal assets FOR payment. similarly there IS no distriction between personal and business income. so all business income is taxed as personal income. the nte 01 0 sole prople orship is united 10 the owner's me span and impor annly the amount 01 equity that can be raised IS anned to the propnetor's personal wealth This umitation other means and the business IS unable 10 explore new opportunities because OF insurance capital ownership OT a sale proprietorship may be difficult to transfer because MIS requires me sale OF the entire business 10 a new owner partnerships yahom 4097 0 I partnership is simmar 10 a proprietorsmip, except that there are two ST more owners (pariners) general partnership, all line pariners snare in gains or losses and all have unimited hability For all partnership debts, 1701 JUST some particular snare. 0 ina unned partnership one or more general partners will run the business and nave ununted liability but mere with-be one or more unlied partners who do na actively particdate in me business A limited partner's nobilly For business debts IS limited 10 the amount that partner 10 the pannership. This Form 01 organization is common in real estate versures Corporation The corporation IS the mas important FORM in terms OF size) OF business organization in the united states. A corporation is a legal "person" separate $ distinct FROM IS owners and 1 nas many OF me rights duries and privileges 0% an actual person. corporations can borrow money and our property can Sue and be sued and can enter into contacts I corporation canever be a general partner or 0 limited partnership and 0 corpor ation can own Stock in another corporation 4 1707 toming 0 corporation involves preparing articles OF incorporation (or a charter) and a set 01 Dylaws me articles 01 incorporation must contain a number 01 things, including the corporation's name ,It's intended are (which can be Forever) Its business purpose and the number 01 snares that can be issued This information must normally be supplied to the state in which the firm will incorporated For most regal purposes the corporation is 0 "resident" 01 that state . The onous arcrutes describing how me corporation requires noon existance FOR example the by laws describe now directors are elected me bylaws may ve amended or extended From time 10 time by stockholders in large corporation the stockholders and me managers are usually separate groups the stock nolders elect ine board of directors, whomen Select me managers Management is charged withouting the corporation's affairs in the stockholder's interest . in principle clockholders control the corporation because they elect the directors

ownership (represented by shares OF STOCK) can be readity transferred and the ute of the corporation therefore not united line car potation invest borrows money in is own name AS result the stockharters no corporation have limited mability for corporate debts the mastiney can rose is what my have Because a corporation IS a legal person it must pay taxes Marcover money paid out 10 stockmiders in the Form OF dividends IS taxed again as income to those stockholders This is double taxation meaning that corporate profits are taxed twice at the corporate level when are earned and again a the personal level when they are paid out A Corporation or Another name me corporate FOTH has many variations around the world exact laws and regulations airrer.or course. but the essential features of public ownership and limited liability remain These firms are often called JOIN stock companies public limited companies or limited hability companies international corporations company country OF origin Type OF company Transiation Bayerisone Motoren Germany Aktiengesellschaft corporation works (8MW) AG Gesellschaft mit Members GMbH Germany unner Liability beschrankier Haffing company Rolls-Royce PLC united kingdom public smalled company PUBLIC limited company Lid unlied Kingdom Limited corporation Unilever NV Netherlands Naamizze verinodischap Limited Liobitry company Fig SpA Italy societa per Azioni PUBLIC limited company Samb AB sweden JONES company Peugeon SA France SOCIETE Anonyme Joint-stock company Profit Maxmization (long run) Profit Marimization would probably be the most commonly cited business goal but this is not very precise objective The goal OF Financial Management in a corporation The goal OF Financial management is 10 maximize the current value per snare 01 the esising Stock A more General Financial Management Goal For each OF these good Financial decisions increase the market equity and poor Financial decisions decrease increase

Sarvanes Oxley Act in response +0 corporate scandais involving companies such as Enion worldcom Tyco,and Adelonia congress enacted me Sorbanes -oxley Act in 2002. The act which IS better known as "SOX" is intended 10 serengen projection against corporate accouning Fraudand Financial maloracnce 0211 "They must auest that the annual report does not contain cause statements or material omissions and that the financial statements Fairly represent the company's Financial results in essence, SOX makes management personally responsible FOR the accuracy OF a company's Financial statements Agency Relationships MILE and and 2010 1400 the relationship between stockholders and management is called an agency relationship Such a relationship exists whenever someone (the principle) nires another (ine agent) to represent his or her interest FOR example you might hire someone (anagemi to sell a car ma you own while you are away a school Management Goals TO see now management and stockholder interests might differ imagine that a corporation is considering a new investment the new investment is expected to Favorably affect the stock price, but If IS also a reallvely risky venure the owners 01 the arm will wish to take the investment (because the snare value will rise) but management may not because there is the possibility that inings will turn out badly and management jobs will be lost. IF management does not take the investment, then the Stocknolders may lose a valuable opportunity This is one example OF an agency cost. Manageria compensation First managerial compensation particularly a the top, IS usually lled 10 financial performance in general and ottenumes 10 snare value in particular For example, managers are frequently given the option 10 buy stock at a fixed price the more the stock IS worth the more valuable is thi S option 1 control OF the Firm control OF me arm minimately rests with stockholders They elect the board OF directors who, insure. nires and Fires management The mechanism by which unhappy stockholders canach 10 replace existing management is called 0 proxy Fight A proxy IS the authority to vote someone else's Stock A praxy Fight develops when a group SONCHIS proxies in order 10 replace the existing board and thereby re place existing managements Another way mal management can be replaced IS by takeover Firms that are poorly managed are more altrative as acquisitions than well-

managed Firms because a greater profit potential exists Thus avoiding a takeover by another Firm gives management another incentive to act in the stockholders interests Stakeholders Employees customers suppliers, and even the government an have a financial interests in the arm mese various groups are called stakeholders in the Firmin general a Stakeholder is someone other than a Stockholder or creditor who potentially nas a claim on the cashilious OF the firm cash FLOWS to and From the Firm suppose we start with the urm selling snares OF Stock and borrowing money 10 raise cash cash Flows 10 the arm From me Financial markets (A) The Firm invests the cash in current and Fixed (or long-term assets (Bl.ines assets generate some cash (c), some of which goes to pay corporate taxes (D) After taxes are paid some OF this cash flow IS reinvested in the firm (E) the rest goes back to the Financial markets as cash paid to creditors and snareholders (F) primary versus secondary Markets Financial markets Function as boin primary and secondary markets FOY debt and equity securities The term primary market leters to the original sale of securities by governments and corporations the secondary markets are mose in which these securities are brought and said other the original sale secondary Markets Dealer versus Auction markets There are two kinds OF secondary marketsauciionmarkers and dealer markets Generally speaking dealers buy and sell FOR inemselves at their own risk A cardedier for example, buys and sells automobiles in contrast blokers and agents match buyers and sellers, but they aonot actually own the commodity that is bought or sold. A real esiale agent for example does nonnormany buy and sell houses. Dealer markets in stroks and long-term debt are called over-int. counter (OIC) markets Most trading indebt securities takes place over the count er. The expression over the counter refers to days OF old when securities were literally bought and said a counters in officies around the country.Today a Signature reduction or the markets STOCKS am ammost 011 01 the market for long-term debt naveno central the many dealers are connected electronically Aucon markets direct from Dealer markets 1110 ways. HIST an aucuan market or exchange has 0 physical location (like wall sweet) Second in dealer market most of the buying and selling is done by the deater.The primary purpose of an auction market on the other hand is 10 maich those who wish to sell with those who wish 10 buy. Dealers play 0 invulled rate.