CHAPTER 1: OVERVIEW OF FINANCIAL MANAGEMENTJune 17, 2015 - University of St. La SalleFIN1 (Sources: Harcourt, Inc., Brigham & Houston, Gitman)

OBJECTIVES

Explain the role of finance and the different types of jobs in finance (LO1)

Identify the advantages and disadvantages of the different forms of business organisations (LO2)

Discuss the importance of business ethics and the consequences of unethical behaviour (LO3)

OBJECTIVES

Identify the potential conflicts that arise within the firm between stock holders and managers, and discuss the techniques that firms can use to mitigate these potential conflicts. (LO4)

(LO1) F.A.M.E.

Finance is the art and science of managing money.

Grew out of economics and accounting

Finance is forward looking

Economics focus on cause and effect

Accounting is backward looking

F.A.M.E.

Investor will look at financial performance of a company in the past. (Accounting)

Determine the economic environment in the future and how the company will interact with it. (Economics)

He will use finance to determine wether the company is worth the investment. (Finance)

F.A.M.E.

Marginal cost–benefit analysis is the economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs

F.A.M.E.

Finance and accounting also differ with respect to decision-making:

Accountants devote most of their attention to the collection and presentation of financial data.

Financial managers evaluate the accounting statements, develop additional data, and make decisions on the basis of their assessment of the associated returns and risks.

FINANCE IN AN ORGANISATION

Role of Finance in a Typical Business Organization

Board of Directors

President

VP: Sales VP: Finance VP: Operations

Treasurer Controller

Credit Manager

Inventory Manager

Capital Budgeting Director

Cost Accounting

Financial Accounting

Tax Department

FINANCIAL MANAGEMENT

Corporate finance

How to maximize value of the firm

Planning, organizing, directing, and controlling the financial activities of the firm

Financial decisions, investment decisions, management decisions

CAPITAL MARKETSWhere interest rates, along with stock and bond prices, are determined.

Financial institutions that supply capital to business

Markets for buying and selling equity and debt instruments.

Serve as a bridge between investors/suppliers of capital AND businesses, government, and individuals

Primary markets, secondary markets

INVESTMENTS

On stocks and bonds

Security analysis - valuation

Portfolio theory - diversify risks

Market analysis - for example: market is bullish/bearish; S&P500

CAREERS IN FINANCE

(LO2) FORMS OF BUSINESS ORGANISATION

Proprietorship

Partnership

Corporation (S Corporations; C Corporations)

Limited liability companies and partnerships

PROPRIETORSHIP

Advantages:Ease of formationSubject to few regulationsNo corporate income taxes

Disadvantages:Limited lifeUnlimited liabilityDifficult to raise capital

PARTNERSHIP

A partnership has roughly the same advantages and disadvantages as a sole proprietorship.

CORPORATION

Advantages:Unlimited lifeEasy transfer of ownershipLimited liabilityEase of raising capital

Disadvantages:Double taxationCost of set-up and report filing

(LO2) FORMS OF BUSINESS ORGANISATION

(LO3) ETHICS

The primary goal is shareholder wealth maximization, which translates to maximizing stock price.Do firms have any responsibilities to society at

large?Is stock price maximization good or bad for society?Should firms behave ethically?

(LO3) ETHICS

Primary goal of an entity: shareholder wealth maximisation

Decisions should be made to maximize the long-run value of the firm’s common stock

Shareholders vs stakeholders

(LO3) BUSINESS ETHICSCompany’s attitude and conduct toward its employees, customers, community, and stockholders

Written codes, training programs

SEATWORK

Make a reaction paper on either of the following issues

(1) Enron (fraudulent reporting)

(2) 2008 global financial crisis (subprime mortgages)

(3) Raj Rajaratnam (insider trading)

(LO3) BUSINESS ETHICS

ASSIGNMENTDoes profit maximization equal stock price maximization?

Explain.

(LO4) MANAGERS, STOCKHOLDERS, BONDHOLDERS An agency relationship exists whenever a

principal hires an agent to act on their behalf.

Within a corporation, agency relationships exist between:Shareholders and managersShareholders and creditors

SHAREHOLDERS VS MANAGERS Managers are naturally inclined to act in their

own best interests. But the following factors affect managerial

behavior:Managerial compensation plansDirect intervention by shareholdersThe threat of firingThe threat of takeover

SHAREHOLDERS VS CREDITORS

Shareholders (through managers) could take risky actions to maximize stock price, but are detrimental to creditors.

In the long run, such actions will raise the cost of debt and ultimately lower stock price.

REFERENCES FOR SEATWORK

Enron

http://content.time.com/time/specials/packages/0,28757,2021097,00.html

2008 global financial crisis

https://www.youtube.com/watch?v=Q-zp5Mb7FV0

REFERENCES FOR SEATWORK

Raj Rajaratnman

http://www.vanityfair.com/news/business/2013/06/steve-cohen-insider-trading-case