Risks Faced by a Firm

Risks Faced by a Firm

• Risks can be categorized into two types: peculiar to a firm and all-pervasive risks that affect all firms in an industry
• Peculiar risks include unsuccessful product launch, labor problems, material supply problems, and cyclical demand fluctuations
• All-pervasive risks include exchange rate fluctuations, interest rate fluctuations, sudden price rises, shifts in government policies, and environmental risks

Financial Risk

• Financial risk refers to the chance that an investment's actual return will be different than expected
• Types of financial risks include credit risk, concentration risk, interest rate risk, currency risk, market risk, equity risk, refinancing risk, liquidity risk, legal risk, model risk, operational risk, political risk, and valuation risk

Corporate Organization

• The size and importance of the managerial finance function depend on the size of the firm
• In small companies, the finance function may be performed by the company president or accounting department
• As the business expands, finance typically evolves into a separate department linked to the president

The Managerial Finance Function: Relationship to Economics

• Financial managers must understand the economic framework and be alert to the consequences of varying levels of economic activity and changes in economic policy
• The primary economic principle used by financial managers is marginal cost-benefit analysis, which says that financial decisions should be implemented only when added benefits exceed added costs

The Managerial Finance Function: Relationship to Accounting

• The firm's finance (treasurer) and accounting (controller) functions are closely-related and overlapping
• One major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method, while in finance, the focus is on cash flows

Goal of the Firm

• The goal of the firm is to maximize shareholder wealth
• Decision rule for managers: only take actions that are expected to increase the share price

Ethics and Share Price

• Ethics programs seek to reduce litigation and judgment costs, maintain a positive corporate image, build shareholder confidence, and gain the loyalty and respect of all stakeholders
• The expected result of such programs is to positively affect the firm's share price

Financial Institutions & Markets

• Firms that require funds from external sources can obtain them through banks or other financial institutions, financial markets, or private placements
• Financial institutions are intermediaries that channel savings into loans or investments
• Financial markets provide a forum in which suppliers of funds and demanders of funds can transact business directly