Chapter

1Introduction to Financial Management

Basic Areas Of Finance

• Business finance• Investments• Financial institutions• (International Finance?)

Business Finance

Various duties within companiesEvaluating past investments, analyzing future

projectsJob opportunities

Entry level – cost accountingAdvanced – financial analyst

Investments

• Work with financial assets such as stocks and bonds

• Value financial assets and decide asset allocation• Job opportunities

• Stockbroker or financial advisor• Portfolio manager• Security analyst

Financial Institutions

Companies that specialize in financial mattersBanks – commercial and investment, credit unions,

savings and loansInsurance companiesBrokerage firms

Job opportunitiesLoan officerInsurance agentBrokerage agent

6

Why Study Finance?Marketing

Budgets, marketing research, marketing financial productsAccounting

Dual accounting and finance function, preparation of financial statements

Management Strategic thinking, job performance, profitability

Personal finance Budgeting, retirement planning, college planning, day-to-

day cash flow issues

Forms of Business Organization

Three major forms in the United StatesSole proprietorshipPartnership

GeneralLimited

CorporationLimited liability company

Sole Proprietorship

AdvantagesEasiest to startLeast regulatedSingle owner keeps all

the profitsTaxed once as personal

income

DisadvantagesLimited to life of

ownerEquity capital limited

to owner’s personal wealth

Unlimited liabilityDifficult to sell

ownership interest

Partnership

AdvantagesTwo or more ownersMore capital availableRelatively easy to startIncome taxed once as

personal income

DisadvantagesPartnership dissolves

when one partner dies or wishes to sell

Difficult to transfer ownership

Unlimited liability?General partnershipLimited partnership

Corporation

AdvantagesLimited liabilityUnlimited lifeSeparation of

ownership and management

Transfer of ownership is easy

Easier to raise capital

DisadvantagesSeparation of

ownership and management

Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate)

Goal Of Financial Management

What should be the goal of a sole proprietorship?

What should be the goal of a corporation?Maximize firm size?Maximize profits?Minimize costs?

Goal Of Financial Management

Goal of corporation =

maximize shareholder wealth (maximize stock price)

The Agency Problem

Agency relationshipPrincipal hires an agent to represent their interestStockholders (principals) hire managers (agents) to

run the companyAgency problem

Shareholders’ goals = stock price maximizationManagers’ goals = ???Conflict of interest between principal and agent

Management goals and agency costs

Managing Managers

Managerial compensationIncentives can be used to align management and

stockholder interestsCorporate control

The threat of a takeover may result in better management

Other stakeholders

Adam Smith’s “Invisible Hand”

Shareholder wealth maximization…

How a business succeeds: Produce a product consumers want Optimize quality/price for consumers Sell at a convenient location for consumers

Quick Quiz

What are the three basic areas of finance?What are the three major forms of business

organization?What is the goal of financial management?What are agency problems and why do they

exist within a corporation?