Introduction to Financial Management

Introduction to Financial Management

• Financial management is the art and science of managing money and assets.
• It's a process to effectively and efficiently obtain and allocate financial resources to achieve a firm's objectives.
• The primary goal of a firm is to maximize shareholder wealth by maximizing share price.

Objectives and Goals of a Firm

• Maximize sales
• Minimize costs
• Maximize profits
• Achieve consistent and steady earnings growth
• Ensure survival
• Avoid financial distress and bankruptcy
• Outperform competitors

Wealth Maximization vs. Profit Maximization

• Wealth maximization considers the timing of returns and the time value of money.
• Profit maximization is usually a short-term approach.
• Wealth maximization takes into account the owners' desires to receive dividends rather than just maximizing profit.
• Profit maximization often overlooks the risk associated with potential returns

Financial Management Functions

• Planning: Developing and evaluating firm goals and strategies to achieve stated objectives.
• Controlling: Analyzing causes and responsibilities related to the activities of the firm.
• Investment decisions: Determining the asset structure of a firm.
• Financing decisions: Determining the financial structure of a firm.

Financial Management Decisions

• Capital budgeting: Determining which long-term investments or projects a business should undertake.
• Capital structure: Determining how much to borrow to pay for assets, and the optimal mix of debt and equity.
• Working capital management: Managing the day-to-day finances of the firm.

Financial Market

• Facilitates allocation of financial resources within the economy.
• Financial intermediaries (e.g., banks, credit unions) reduce transfer costs and risk for investors and borrowers.

Investment Process

• Individuals are typically suppliers of funds.
• Businesses are typically demanders of funds.

Financial Market Components

• Money market: Handles marketable securities that mature within one year or less. Characterized by low default risk, short maturities, high liquidity and marketability.
• Capital market: Handles long-term securities such as bonds, common stocks, and preferred stocks.
• Primary market: Deals with newly issued securities.
• Secondary market: Deals with previously issued securities.

Forms of Business Organization

• Three major forms: Sole Proprietorship, Partnership (General and Limited), and Corporation (Limited Liability Company & Limited Liability Partnerships).

Corporation Advantages and Disadvantages

• Advantages: Limited liability, unlimited life, easy transfer of ownership, and easier to raise capital.
• Disadvantages: Separation of ownership and management, potential for double taxation (in some jurisdictions).

Agency Problem

• Agency problems relate to the control of a corporation when ownership and management are separate.