Financial Management Overview

Goals and Activities of Financial Management

• Financial management is the field that covers the concepts of finance, recognizing firms can have various organizational structures.
• The relationship between risk and return is a core focus of finance.
• Financial managers aim to maximize wealth through daily activities (like credit and inventory management) and long-term decisions (like raising funds).
• Future and present values are crucial concepts that relate to the time value of money.

The Field of Finance

• Finance bridges economics and accounting.
• Economics provides a picture of the business environment, encompassing consumers and producers.
• Accounting supplies financial data, including income statements, balance sheets, and cash flow statements.
• Financial managers need knowledge of financial statements.
• Finance is forward looking, while accounting focuses on past business activity results

Investments vs. Corporate Finance

• Investments use principles to value stocks and bonds of companies, enabling investors to choose which to purchase from multiple companies.
• Their portfolios include securities.
• Corporate finance determines which assets a firm should develop or buy.
• Financial management can be used interchangeably with corporate finance and is related to investment topics.
• Outside investor evaluations of companies are part of financial management.

The Value of Studying Finance

• Career options include corporate financial officer, banker, stockbroker, financial analyst, portfolio manager, investment banker, financial consultant, and personal financial planner.
• CEOs report directly to boards of directors.
• Marketing managers are interested in return on investment of marketing initiatives.

Activities of Financial Management

• Financial managers perform numerous activities.
• Daily activities involve monitoring cash balances, managing credit decisions, tracking inventory levels, and managing cash collections and distributions.
• Less routine tasks include negotiations with banks (for loans), selling stocks and bonds, and creating capital budgeting and dividend plans.

Figure 1-1 Functions of the Financial Manager

• A visual representation (Figure 1-1) shows daily and occasional activities of financial managers, and how they contribute towards achieving the goals, emphasizing the trade-off between profit and risk, with the ultimate goal of maximizing shareholder wealth.

Activities of Financial Management Continued

• Risk-return trade-offs are made to maximize the market value of firms.
• Financial decisions impact the operational side (e.g., capital vs. labor/Product A vs. Product B) and financial mix. (e.g., stock vs. bonds vs. retained earnings).

Forms of Organization

• Organizations include sole proprietorships, partnerships, and corporations, varying in the number of people, owner liability, and regulatory complexities.
• Sole proprietorships involve single-person ownership, simple decision-making with low costs and operational expenses, but with unlimited owner liability and single-taxation.
• Partnerships resemble sole proprietorships but involve more than one owner with articles of partnership.
  • They also have unlimited owner liability and are taxed as an individual unit. Limited liability partnerships have some partners with unlimited liability, differentiating them from general partners.
• Corporations are unique legal entities, separate from their owners (shareholders), enabling them to own property, sue or be sued, and engage in contracts.
• They have continuous life and easily divisible ownership interests through issuing stock. Corporations face potential for double taxation; however, tax rates have changed based on tax laws. S corporations and limited liability companies (LLCs) provide unique tax and liability alternatives.

Corporate Governance

• The Sarbanes-Oxley Act of 2002 responded to scandals and audit failures, establishing binding standards for public companies.
• The Dodd-Frank Act of 2010, a major financial regulatory change since the Great Depression, targets systemic risks that harm the financial system.
• Agency theory explores the relationship between owners and managers of a firm, highlighting potential conflicts and how management decisions sometimes differ from shareholder interests.
• Institutional investors are influential in publicly owned companies, often holding significant voting shares to influence management and board elections.

The Time Value of Money

• The time value of money (TVM) concept holds that a dollar today is valuable than a dollar in the future.
• Future value of money is greater than current value when considering interest rates and duration(number of periods).
• Present Value calculations use formulas (FV = PV * (1+i)^n) to determine today's worth of future funds.

Goals of Financial Management

• Profit maximization is a common, though flawed, goal.
• Profit changes often indicate changes in risk and ignore benefits timing, alongside difficulties in measuring variables like profit due to inflation and international transactions.

A Valuation Approach

• Performance is measured based on how investors value earnings.
• Present value valuations are key.
• Businesses are valued in the present, though most cash flows are realized over many years.
• Investors seek future earnings and long-term perspectives.

Maximizing Shareholder Wealth

• Shareholder wealth maximization, achieved by increasing firm value, is the key goal.
• Residual claims and stock prices aren't directly controllable by financial managers. Consistent actions aligning with shareholders' needs are preferred.
• Long-term shareholder value generally outweighs daily value matters.
• Management must be responsive to shareholders’ needs to maintain long-run power.

Social Responsibility and Ethical Behavior

• Policies maximizing market values in a way that includes attracting and providing employment to society are preferred.
• Socially desirable policies may not always align with maximizing market values.
• Ethical behavior is important, and unethical acts like insider trading should be avoided, as they negatively impact the long-run value of a company and shareholders.

Role of the Financial Markets

• Financial markets serve as a meeting place for people, corporations, and institutions. Participants also include national, state, and local governments who may borrow or lend money.
• Corporate participants raise funds in financial markets.

Structure and Functions of the Financial Markets

• Financial markets are structured into domestic/international, corporate/government, and money/capital markets.
• Money markets handle short-term securities (less than one year). Commercial paper and certificates of deposit are examples. - Capital markets handle long-term securities (more than one year). Common stock, preferred stock, and corporate/government bonds are some examples.

Allocation of Capital

• Primary market involves corporations issuing new securities to raise funds through IPOs.
• Secondary markets involve securities trading among investors. Financial reports reflecting firms’ performance are provided by secondary market trading activity.

Allocation of Capital Continued

• Firms aim for return maximization and risk minimization.
• Investors have objectives and can choose risk tolerances based on their needs.
• Companies with high-valued securities can raise funds more easily than competitors.

Internationalization of Financial Markets

• Companies seek international capital, and international financial markets are impacted by global affairs and technology
• Understanding international capital flows, computerized financial systems, and foreign exchange strategies is important.

Format of The Text

• This document is segmented into chapters (Introduction, Financial Analysis/Planning, Working Capital/Management, The Capital Budgeting process, Long-Term Financing, and Expanding Corporate Finance perspective)