Chapter 1 - An Overview of Financial Management

Chapter 1- An overview of
Financial Management
Financial Management Fundamentals 12th ed., Eugene Brigham and Joel Houston
The Role of Corporate Finance in Business
 Successful financial managers must be able to creatively manage both people and
money.
 Finance is an allocation of money.
 Skills needed for finance managers;
 Good written and verbal communication skills
 Ability to work in teams
 Proficiency with computers and the internet
Career Opportunities in Finance
 Corporate finance- corporate or managerial finance is concerned with duties of

financial manager in a business. Financial affairs in business. Tasks like budgeting,
financial forecasting, cash management, credit administration, investment analysis
and funds procurement.
Commercial banking- remains a fertile training ground for managers.
Investment banking- involves three types
Helping customers to obtain funding by selling securities such as stocks or
bonds to investors.
Career Opportunities in Finance
Providing advice to corporate clients on strategic transactions such as

mergers and acquisitions
Trading debt and equity securities for customers.
Money management- acts as fiduciary. Someone who invests and manages
money on someone else’s behalf.
Consulting- to analyze firm’s business process and strategies and
recommend how practices should change and make firms competitive
The Five Basic Corporate Finance Functions
 External financing- raising capital to support operations and investment programs

 Capital budgeting- selecting best projects based on perceived risks and return
 Financial management function- cash flows, working, mix of debt and equity
financing.
 Corporate governance function- behave ethically and make decision that benefit
shareholders.
 Risk- management function- managing firms in exposure of risks
LEGAL FORMS OF BUSINESS
ORGANIZATION
 Sole Proprietorship- a business with a single owner

Advantages
No legal distinction between the business and owner
Bears personal liability
Most common type of business
ORGANIZATION
 Sole Proprietorship- a business with a single owner

Dis- advantages
Limited life- ceases to exit when the owner dies or retires
Limited access to capital- Reinvested profits and owner’s personal
borrowings
Unlimited personal liability- personally liable for all debts of
business including any judgments to plaintiffs.
ORGANIZATION
 (General) Partnerships- a proprietorship with two or more owners who

have joined skills and personal wealth.
Advantages
Unless there is an agreement, each partner shares equally in business
income and each has management authority
Taxed only once
Allow a number of people to pool their capital and expertise to form
larger enterprises. Enjoy more flexibility
ORGANIZATION
 (General) Partnerships
Dis- advantages
Joint and several liability- a legal concept that makes each partner in a
partnership legally liable for all debts of partnership. If one partner
makes unwise or illegal decision all partners have to pay.
In the absence of agreements, the business dissolves whenever one of
the partners dies or retires.
Each partner shares equally in business income and each has
management authority
ORGANIZATION
 Limited Partnerships- combine the best features of the general

partnership and the corporate organizational forms. Most investors
(limited partners) in the partnership have limited liability of corporate
shareholders, but their share of profits from the business is taxed as
partnership income.
ORGANIZATION
 Limited partners- one or more totally passive participants in a

limited partnership who do not take any active role in the operation
of the business and do not face personal liability for the debts of the
business.
 They contribute capital but cannot have their names associated in the
business
 They can lose their equity in the business but plaintiffs cannot look
after them for payment of claims.
ORGANIZATION
 Corporation- is a separate legal entity with many of same economic

rights and responsibilities as those of individuals.
Advantages
Contracting. Can own property and execute contracts in their own
names with managers, suppliers, ordinary employees .
Unlimited or perpetual life unless explicitly terminated.
Limited Liability. Shareholders cannot be held personally liable for the
firm’s debts.
Unlimited access to capital. The company itself can borrow money from
ORGANIZATION
 Public Company- has the shares listed for trading on a public security market.
 Board of directors- elected by the shareholders to be responsible for hiring and
firing managers and setting overall corporate policies.
 Corporate Charter- legal document created at the corporation’s inception to
govern its operations.
 Shareholders- owners of common and preferred stock of a corporation.
ORGANIZATION
 Equity claimants- owners of corporation’s equity securities.

 Disadvantages
 Can sue and be sued, can be tries and convicted for crimes committed by their
employees.
What should a Financial Manager try to
maximize?
 Profit- Financial managers have to take action to increase revenues and reduce
cost and translates that to the maximization of earnings per share or the earnings
available for common stockholders divided by the number of shares of common
stock outstanding.
 Maximize shareholders wealth- measured by the market price of the firm’s stock.
Firm’s stock price reflects timing to generate over time. Focus on cash flows. If
not, investors would have little incentive to accept the risks. As residual claimant.
 Focus on Stakeholders- the interest of their employees, customers, tax authorities
and the communities.
How can agency costs be controlled in
Corporate Finance?
 Control rests on the non- owner manager who acts as agents of the owner. A part of
manager’s aim to maximize owner’s wealth is his personal wealth like cars, prestige, style.
 Financial economists recognize agency problems are costs when there is a conflict of
goals between the shareholder’s interest and managers.
 Control can be; relying on market forces to exert managerial discipline by giving pressure
of replacement to new ones like the hostile takeover.
 Incurring monitoring and bonding costs necessary to supervise managers( Bonded)like
security guards or agency personnel.
 Structuring compensation packages like incentive compensation plans and contracts by
tieing the good managers to the firm.
Hostile Take over and Business Ethics
 Hostile Takeover- acquisition of one firm by another firm through an

open market bid for a majority of the target’s shares, If senior
managers do not support the acquisition. By replacing an incumbent
manager.
 Business ethics- a company’s attitude and conduct toward its
employees, customers, community, and stockholders.
Why is Ethics important in Corporate Finance?
 to motivate business people and investors alike to adhere to both the

letter and the spirit of laws and regulations concerned with all aspects
of business and professional practice.
 END

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Chapter 1- An overview of

 Corporate finance- corporate or managerial finance is concerned with duties of

Providing advice to corporate clients on strategic transactions such as

 External financing- raising capital to support operations and investment programs

 Sole Proprietorship- a business with a single owner

 Sole Proprietorship- a business with a single owner

 (General) Partnerships- a proprietorship with two or more owners who

 Limited Partnerships- combine the best features of the general

 Limited partners- one or more totally passive participants in a

 Corporation- is a separate legal entity with many of same economic

 Equity claimants- owners of corporation’s equity securities.

 Hostile Takeover- acquisition of one firm by another firm through an

 to motivate business people and investors alike to adhere to both the

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