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Foundations of Financial Management • Page 1
Chapter 1
The Goals and Functions of
Financial Management
McGraw-Hill/Irwin 1-2
Introduction LT 1-2
Financial Management (or Business Finance) isconcerned with managing a corporation’smoney
For example, a company must decide:
–where to invest its money – whether or not to replace an old asset
– when to issue new stocks and bonds
– whether or not to pay dividends
McGraw-Hill/Irwin 1-3
I. The Role of Financial Management
A. Unpredictable changes
B. Demand for financial management from
different sectors
McGraw-Hill/Irwin 1-4
II. Finance Evolved in Response to
Changing Business Management Needs
A. Related to Economics and Accounting
B. Finance becomes a separate field at theturn of the century.
C. More government intervention during the
Great Depression
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Foundations of Financial Management • Page 2
McGraw-Hill/Irwin 1-5
II. Finance Evolved in Response to
Changing Business Management Needs
D. Contemporary financial management
z Capital budgeting / Use of current assets
z Capital structure / Dividend policy
E. Risk-return relationship
F. Impact of new technology
McGraw-Hill/Irwin 1-6
III. Functions of Financial
Management
FIGURE 1-1
Functions of the
financial manager
McGraw-Hill/Irwin 1-7
III. Functions of Financial
Management
A. Sole Proprietorship (one owner) - largestin actual number but smallest in total sales
revenue
B. Partnership (two or more owners)
C. Corporation (legal entity) - smallest inactual number but largest in total salesrevenue
McGraw-Hill/Irwin 1-8
IV. Corporate Governance
A. Agency problems
B. Influence of institutional investors
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Foundations of Financial Management • Page 3
McGraw-Hill/Irwin 1-9
V. Goals of Financial Management
3.501.502.00Alternative
B
$3.50$2.00$1.50
Alternative
A
TotalPeriod
Two
Period
One
Earnings per Share
McGraw-Hill/Irwin 1-10
V. Goals of Financial Management
A. Maximize the overall valuation for the
stockholders
B. Agency theory – self-interest vs
stockholders’ interest
C. Pressure from institutional shareholders
D. Maximizing profits Not equal to
maximizing shareholders’ wealth
McGraw-Hill/Irwin 1-11
V. Goals of Financial Management
E. Valuation approach
F. Shareholder wealth maximizationinfluenced by expectations and emphasis
G. Consequence of managements fail on
maximizing shareholder wealth
H. Ethical standards
McGraw-Hill/Irwin 1-12
VI. The Role of Financial Markets
A. Structure and functions of the financialmarkets
z money markets / capital markets
B. Allocation of capital
z primary vs secondary market
C. Institutional investors
z force restructuring
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Foundations of Financial Management • Page 4
McGraw-Hill/Irwin 1-13
VI. The Role of Financial Markets
D. Internationalization of the financial
markets
z globalization of the capital markets
E. Internet and technology
D. cost reduction for trading securities
A Brief Look for the Content
of the Remaining Chapters
McGraw-Hill/Irwin 1-15
Short-Term vs. Long-Term
Financing LT 1-3
Working Capital is concerned with short-term (S/T) financing decisions <1 year
ex., managing cash and other current assets
Capital Budgeting is concerned with long-term (L/T) financing decisions >1 year
ex., purchasing a new machine in the future
McGraw-Hill/Irwin 1-16
The Risk-Return Tradeoff LT 1-4
↑ Profitability → ↑ Risk
↓ Profitability → ↓ Risk
ex., investing in stocks vs.savings accounts
A. Stocks are more profitable but riskier
B. Savings accounts are less profitable and less risky
(or safer)
C. Financial manager must choose appropriate combinations
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Foundations of Financial Management • Page 5
McGraw-Hill/Irwin 1-17
Financial capital vs.
Real capital LT 1-5
Financial Capital (or Accounting Capital) =
money
Real Capital (or Economic Capital) =
plant and equipment
McGraw-Hill/Irwin 1-18
Stocks vs. Bonds LT 1-6
Stock = ownership or equity
Stockholders own the company
Bond = debt or IOU
Bondholders are owed $ by company
