Foundations of Financial Management Page 1

Chapter 1

Introduction

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The Goals and Functions of Financial Management

Financial Management (or Business Finance) is concerned with managing a corporations money
For example, a company must decide:
where to invest its money whether or not to replace an old asset when to issue new stocks and bonds whether or not to pay dividends
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I. The Role of Financial Management

A. Unpredictable changes B. Demand for financial management from different sectors

II. Finance Evolved in Response to Changing Business Management Needs

A. Related to Economics and Accounting B. Finance becomes a separate field at the turn of the century. C. More government intervention during the Great Depression

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II. Finance Evolved in Response to Changing Business Management Needs

D. Contemporary financial management
z Capital budgeting / Use of current assets z Capital structure / Dividend policy

III. Functions of Financial Management

FIGURE 1-1 Functions of the financial manager

E. Risk-return relationship F. Impact of new technology

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III. Functions of Financial Management

A. Sole Proprietorship (one owner) - largest in actual number but smallest in total sales revenue B. Partnership (two or more owners) C. Corporation (legal entity) - smallest in actual number but largest in total sales revenue
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IV. Corporate Governance

A. Agency problems B. Influence of institutional investors

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V. Goals of Financial Management

Earnings per Share Period One Alternative A Alternative B
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V. Goals of Financial Management

A. Maximize the overall valuation for the stockholders B. Agency theory self-interest vs stockholders interest C. Pressure from institutional shareholders D. Maximizing profits Not equal to maximizing shareholders wealth
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Period Two $2.00 1.50

Total $3.50 3.50

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V. Goals of Financial Management

E. Valuation approach F. Shareholder wealth maximization influenced by expectations and emphasis G. Consequence of managements fail on maximizing shareholder wealth H. Ethical standards
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VI. The Role of Financial Markets

A. Structure and functions of the financial markets
z

money markets / capital markets primary vs secondary market force restructuring

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B. Allocation of capital
z

C. Institutional investors
z

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VI. The Role of Financial Markets

D. Internationalization of the financial markets
z globalization of the capital markets

A Brief Look for the Content of the Remaining Chapters

E. Internet and technology

D. cost reduction for trading securities

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Short-Term vs. Long-Term Financing

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The Risk-Return Tradeoff

Profitability Risk Profitability Risk ex., investing in stocks vs.savings accounts A. Stocks are more profitable but riskier

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Working Capital is concerned with shortterm (S/T) financing decisions <1 year
ex., managing cash and other current assets

Capital Budgeting is concerned with longterm (L/T) financing decisions >1 year
ex., purchasing a new machine in the future
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B. Savings accounts are less profitable and less risky (or safer) C. Financial manager must choose appropriate combinations

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Financial capital vs. Real capital

Stocks vs. Bonds

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Financial Capital (or Accounting Capital) = money Real Capital (or Economic Capital) = plant and equipment
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Stock = ownership or equity Stockholders own the company Bond = debt or IOU Bondholders are owed $ by company

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