Chapter 1

Introduction to Financial Management

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 Chapter Outline

Field of Finance: An Overview

What is Financial Management?

Differences Between Accounting and Finance

Types of Business Organizations

Goal for the Financial Manager

What is Agency Problem?

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Field of Finance: An Overview
E c o n o m ics A c co u n tin g

F in a n ce

F in a n cia l F in a n cia l In v e s tm e n ts
M an a ge m e nt M a rk e ts

1) Financial Management (Insiders)

Investment Decisions – Assets (Using Funds); Financing Decisions - Debt and
Equity (Acquiring Funds)

2) Financial Markets:
Money and Capital Markets; Primary and Secondary Markets; Financial
Institutions: Banks, Insurance Companies, Credit Unions, Mutual Funds, etc…

3) Investments (Outsiders)
Security Analysis; Portfolio Management; etc…
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 Cont…
•The purpose of this course is to provide an
introduction to financial management.
•The financial management function is an important
part of every organization.
•Financial management is used to make key
decisions involving expansion, renovation, choice of
location, and many others.

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What is Financial Management?
• Financial – procuring sources of money supply and
allocation of these sources on the basis of
forecasting monetary requirements of the firm.
• Management – planning, organizing, coordinating
and controlling human activities and physical
resources for achieving the objectives of the firm.
 Financial Management is that managerial activity which is
concerned with the planning and controlling of firm’s
Financial Resources.
 The focus of Financial Management is on raising financial
assets and their effective utilization towards achieving the
organizational goals.
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 Cont…

• Financial management is used to help make three

major decisions:
1. Which assets should we invest in?... Investment
decision, Using Funds
2. How will we pay for these assets?... Financing
decision, Acquiring Funds
3. What should we do with the earnings generated
by the assets?... Dividend decision

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 Cont…

 Investment Decisions
Most important investment decision functions include:
• What is the optimal firm size?
• What specific assets should be acquired?
• What assets (if any) should be reduced or
eliminated?
• Should the firm operations be expanded by
introducing new products or services?

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 Cont…

 Financing Decisions
Determine how the assets will be financed:
• What is the best type of financing (debt or equity)?
• What is the best financing mix?
• What is the best dividend policy (e.g., dividend-
payout ratio)?
• How will the funds be physically acquired?

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 Cont…

Other Finance Functions

 Asset Management Decisions. Ensuring that funds are used
efficiently and effectively by the parties to whom they have
been allocated in the pursuit of organizational objectives.
 Risk management. The key task here is to minimize the
firm’s exposure to risks, for financial risk and business risk.
 Tax management. The financial manager’s objective will be
to minimize the firm’s tax liabilities.
 Financial public relations. This involves the management of
the firm’s financial image and its relationships with the
financial community.

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Differences Between Accounting and Finance
• Financial accounting involves recording and classifying
financial information, and preparation of financial
statements.
• Managerial accounting applies tools to financial
information to generate new information, especially for
management.
• Financial management involves a number of
different areas such as Stock/Bond valuation, Asset
diversification, Property valuation, and Working
capital management.
 Question!
Identify the major interference of Finance with other Functional Areas.
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Types of Business Organizations

• Sole proprietorship
A single owner
Unlimited liability
Taxed at personal income tax rates
Easiest and least expensive to establish
Market value of firm difficult to estimate
Difficult to raise equity capital

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 Cont…

• Partnership
Two or more owners
Unlimited liability
Taxed at personal income tax rates
Not too costly to establish
Market value of firm difficult to estimate
Difficult to raise equity capital
• Easier to raise capital compared to a sole
proprietorship, however.

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 Cont…

• Corporation (Publicly Traded)

Unlimited life
Legal entity
Easy to transfer ownership
Limited liability of stockholders
Double taxation (Corporate earnings taxed PLUS
Stockholders’ dividends taxed)
Most attractive form for raising capital
Market Value easy to determine
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 Cont…

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Goal for the Financial Manager
• The goal is to maximize the wealth of the owners.
• For a corporation, this means increasing the stock
price (Market Value of the firm’s common stock) to
its highest possible level.
 What Affects the Stock Price?
• The stock price is the sum of present and future
dividends (or earnings).
• Future dividends are affected by three major factors:
– The amount of the dividends (EPS)
– When the dividends are received (timing of EPS)
– The risk associated with the dividends
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 Cont…

 Question!
• What do managers do to create value for the
owners?
• Maximizing revenues does not necessarily mean
maximizing wealth. Do you agree? Why?

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What is Agency Problem?
• Agency relationships involve a principal (e.g., owner)
and an agent (e.g., manager).
• Agency problems arise when an agent does not act in
the best interest of the principal.
• Managers, in light of their self interest, may at times
make decisions that are not oriented towards
maximizing stockholder wealth. This does not,
however, invalidate the goal itself.
 Question!
What incentives may exist for management to act in
the stockholders’ best interest?
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• End of chapter Notes!

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