Introduction to Financial Management

Introduction to Financial Management

Dec 3, 2021 | Business & Finance - Financial markets | 0 comments

Introduction to Financial Management

Finance 5th Edition

Cornett, Adair, and Nofsinger

Finance in Business and in Life

Money flows from individuals who want to improve their financial future to businesses that want to expand the scale or scope of their operations

These financial exchanges lead to

A more productive economy

The growth of individuals wealth

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Economic Participants

Two dimensions

Participants with extra investment money

Participants with economically viable ideas

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Economic Participants Type 1

Type 1 participants

Do not lend significant sums of money or spend much in business context

No direct role in financial markets

Play an indirect role by providing labor to economic enterprises or by consuming their products

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Economic Participants Type 4

Type 4 participants

Use financial tools to evaluate their own business concepts and then choose the ideas with the most potential

Self-funded, so have no need for financial markets

Financial tools used and types of decisions made are narrowly focused to their own purposes

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Economic Participants Types 2 and 3

Types 2 and 3 participants

Use financial institutions and financial markets for mutually beneficial exchange

Type 2 participants make temporary loans to type 3 participants, who put that money to use with their good business ideas

Usually individual investors

Type 3 participants are idea generators, typically companies with research and development (R&D) departments

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Where Does the Cash Go?

Economically successful projects repay money (plus profit) to investors

Sources of friction arise, thereby reducing the amount of capital returned to investors

Retained earnings are funds the firm keeps for its ongoing operations

Taxes are imposed on corporations and individuals by the government to help fund public services

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Subareas of Finance

Investments

Subarea of finance that involves methods and techniques for making decisions about the following:

What kinds of securities to own (e.g., bonds or stocks)

Which firms securities to buy

How to pay the investor back in the form that the investor wishes (e.g., the timing and certainty of the promised cash flows)

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Subareas of Finance (continued)

Financial management

Subarea of finance that deals with a firms decisions in acquiring and using the cash that is received from investors or from retained earnings

How to organize the firm in a manner that will attract capital

How to raise capital (e.g., bonds versus stocks)

How to minimize taxation

Which projects to fund

How to pay back capital providers

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Subareas of Finance (concluded)

Financial institutions and markets

Facilitate flow of capital between investors and companies

International finance

The use of financial theory in a global business environment

Decisions are complicated by the uncertainty about future exchange rates, political risk, and changing business laws across the globe

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Application and Theory

Risk

Uncertainty of future cash flows due to timing and size

Financial asset

Something worth money, such as a stock or bond

Should depend on the cash flows you expect to receive from that asset in the future

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Application and Theory (continued)

Real assets

Physical property like gold, machinery, equipment, or real estate

Real markets

Places/processes that facilitate the trading of real assets

Time value of money (TVM)

Theory and application of valuing cash flows at various points in time

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Finance vs. Accounting

Accounting

Tracks what happened to firms money in the past

Financial management

Combines historical figures and current information

Determines what should happen with firms money now and in the future

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The Financial Manager

Chief Financial Officer

Highest level financial officer

Controller

Oversees accounting function

Treasurer

Responsible for managing cash, credit, financing, capital budgeting, and risk management

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Finance in Other Business Functions

CFO and treasurer positions tend to be the most visible finance-related positions

Finance permeates the entire business organization

Provides guidance for both strategic and day-to-day decisions of the firm and collecting information for control and feedback about the firms financial decisions

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Finance in Your Personal Life

Help you make good personal financial decisions

Borrowing money for a new car

Refinancing home mortgage at lower rate

Making credit card or student loan payments

Saving for retirement

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Business Organization

The number of owners is the key to how business structures are classified

Single owners, partners, and corporations operate businesses

Advantages and disadvantages related to

Controls and ownership of firm

Owners risks

Access to capital and tax ramifications

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Organizational Forms of Business

Sole Proprietorships

General Partnerships

Corporations

Hybrids

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Sole Proprietorships

Most common type of business in the U.S.

Advantages

Easy to start

Light regulatory and paperwork burden

Owner receives all the firms profits and is solely responsible for all losses

Disadvantages

Unlimited liability

Limited access to capital

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General Partnerships

Partners own the business together

Advantages

Relatively easy to start

Profits are added to each partners personal income and taxed at personal income tax rates

Disadvantages

Partners jointly share unlimited liability

Personally liable for legal actions and debts of firm

Partners may need to give up some ownership and control in the firm to raise more equity capital

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Public Corporations

Legally independent entity entirely separate from its owners

Advantages

Limited liability for owners

Can raise large amounts of capital

Easy to transfer ownership

Disadvantages

Double taxation (corporate level and personal level)

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Hybrid Organizations

Combine some attributes of corporations and some of proprietorships/partnerships

Advantages

Offer single taxation and limited liability to all owners

S Corporations

Limited Liability Partnerships (LLPs)

Limited Liability Companies (LLCs)

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Firm Goals

Owners perspective says the appropriate goal is to maximize shareholder wealth

Stakeholders perspective emphasizes social responsibility over profitability

Managers must maximize total satisfaction of all stakeholders in a business (e.g., owners, shareholders, customers, employees, etc.)

Practitioners and academics believe primary responsibility is to maximize shareholder wealth

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Corporate Goals

Maximize value of owners equity

Increase current value per share (stock price) of existing shares

Common alternatives to maximizing the value of owners equity

Maximize net income or profit

Minimize costs

Maximize market share

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Agency Problem

Stockholders hire managers to run the company, but managers may be tempted to act in their own best interests

The agency problem states that problems arise when a principal (shareholder) hires an agent (manager) and cannot carefully monitor the agents actions

Managers interest may not be aligned with shareholder goals

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Agency Problem (continued)

Three approaches to minimizing this conflict of interest

Ignore it

Research suggests allowing the manager a certain amount of perks might enhance owner value because it may boost managers productivity

Monitor managers actions

Make the managers owners

E.g., award options on the firms stock, allow purchase through an ESPO, etc.

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Corporate Governance Defined

The process of monitoring managers and aligning their incentives with shareholder goals is known as corporate governance

Corporate governance involves the set of laws, policies, incentives, and monitors designed to handle the issues arising from the separation of ownership and control

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Corporate Governance Inside

Inside monitors

Board of Directors

Hires the CEO

Evaluates management

Design compensation contracts to tie managements salaries to firm performance

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Corporate Governance Outside

Outside monitors

Auditors examine the firms accounting systems and comment on whether financial statements fairly represent the firms financial position

Investment analysts follow a firm, conduct their own evaluations, and report to the investment community

Investment banks help firms access capital markets

Credit rating agencies examine a firms financial strength for its debt holders

The government monitors activities via the SEC and the IRS

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Corporate Governance Monitors

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Corporate governance balances the needs of stockholders and managers. Inside the public firm, the members of the board of directors monitor how the firm is run. Outside the firm, auditors, analysts, investment banks, and credit rating agencies act as monitors.

Ethics

Financial professionals manage other peoples money

Corporate managers

Bankers

Investment advisors

Ethical dilemmas of corporate agency relationship

Stealing from firms = stealing from shareholders

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Financial Markets and Intermediaries

Financial markets and financial intermediaries

Facilitate flow of capital from investors to firms and back to investors

Earn very high profits because of specialized expertise and assets

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Financial Institutions Cash Flows

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The unique services and products that financial institutions provide allow them to make money.

Big Picture Environment

One of the biggest recent factors affecting the business environment in the U.S. is the Tax Cuts and Jobs Act (TCJA) of 2017

Reduces the amount of debt interest that can be deducted from tax bill

Companies are, therefore, likely to use more equity financing and less debt financing in the future

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Tax Cuts and Jobs Act (TCJA) of 2017

Reductions in individual income tax rates

Corporate tax rates reduced

New deduction for pass-through business income

Liberalized asset expensing and depreciation provisions

New limits on business interest deductions

Stricter rules for deducting losses

Reduced or eliminated deductions for business entertainment and some employee fringe benefits

Change to R&D expense deduction

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Introduction to Financial Management

Introduction to Financial Management

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