Finance Overview and Managerial Functions

Finance Definition

• Finance is about managing money, both personally and professionally
• Personal finance focuses on spending, saving, and investing decisions
• Business Finance mirrors the personal decisions, but involves raising funds, investing for profits, and reinvesting or distributing profits

Major Areas & Opportunities in Finance

• Managerial Finance is the focus of financial managers in businesses
• Financial managers oversee the financial affairs of any type of business, regardless of size or purpose
• Their role is to develop corporate strategies and improve competitive position

Legal Forms of Business Organization

• Sole proprietorships, partnerships, and corporations are the most common legal structures
• A corporation has legal rights, can sue, be sued, make contracts, and own property
• Corporations are owned by shareholders, whose ownership is evidenced by common or preferred stock

The Managerial Finance Function

• Financial managers are responsible for forecasting, planning, and controlling a firm's financial activities
• They analyze financial data, make investment decisions, and manage cash flow

Goal of the Firm

• The primary goal of a firm is to maximize shareholder wealth
• This means taking actions that increase the share price
• This goal considers cash flows, timing, and risk

Profit Maximization and Share Price

• Maximizing profits alone may not maximize share price because of factors such as:
  • Timing of funds received (sooner is better)
  • Profit does not always translate to cash available for stockholders
  • Profit maximization ignores risk

Goal of the Firm and Stakeholders

• Stakeholder focus refers to considering the well-being of groups like employees, customers, and suppliers, beyond just profit
• The aim is to preserve stakeholder interests, not maximize them
• This perspective is considered "socially responsible"

The Role of Business Ethics

• Business ethics are standards of conduct in commerce
• Ethical issues in finance include:
  • Creative accounting
  • Earnings management
  • Misleading forecasts
  • Insider trading
  • Fraud
  • Excessive executive compensation
  • Options backdating
  • Bribery
  • Kickbacks

Ethics and Share Price

• Strong ethical programs benefit the firm by:
  • Reducing litigation and judgment costs
  • Maintaining a positive corporate image
  • Building shareholder confidence
  • Gaining stakeholder loyalty and respect

Governance and Agency

• Corporate governance structures provide rules, processes, and laws for company operation
• They define responsibilities of stakeholders, including shareholders, board, officers, and managers
• The structure ensures fair and transparent corporate decisions

Individual and Institutional Investors

• Individual investors are individuals owning small quantities of shares for personal investment goals
• Institutional investors are professionals (banks, mutual funds, and pension funds) managing large amounts of securities
• Institutional investors exert influence on corporate governance by monitoring and communicating with management

Government Regulation

• Government regulations shape corporate governance and reduce the risk of scandals
• Corporate governance codes are implemented in many countries to strengthen transparency and accountability

The Agency Problem

• Managers, as agents of shareholders, may not always act in the best interests of the owners
• The potential conflict between owner and manager goals is the agency problem
• This can be resolved by aligning manager incentives with shareholder goals

Resolving the Agency Problem

• Market forces, such as major shareholders and the threat of takeovers, can act as checks on management
• Agency costs are incurred by shareholders to minimize agency problems and maximize shareholder wealth
• Incentive plans, such as stock options and performance plans, compensate managers based on share price or performance

Financial Institutions and Markets

• Financial institutions are intermediaries channeling savings into loans and investments
• The main players are individuals, businesses, and governments
• Individuals are typically net suppliers of funds, while businesses and governments are net demanders

Financial Markets

• Financial markets facilitate direct transactions between suppliers and demanders of funds
• The money market deals with short-term debt instruments, while the capital market handles long-term securities

Primary and Secondary Markets

• Securities are initially issued in the primary market, where the issuing entity receives the proceeds
• Once issued, securities are traded in secondary markets, such as stock exchanges

The Money Market

• The money market involves short-term (less than a year) debt instruments
• These instruments include Treasury bills and commercial paper

The Capital Market

• The capital market handles long-term debt and equity securities
• The most well-known stock market is the New York Stock Exchange
• Capital markets in the Arab world have grown rapidly but remain relatively small

Capital Market Securities

• Bonds are long-term debt instruments used for fundraising
• Common stock represents ownership interest or equity in a corporation