CHAPTER

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The Goals and Functions of Financial Management

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Figure 1-1 Functions of the Financial Manager

Daily
Cash management (receipt and disbursement of funds) Credit management Inventory control Short-term financing Exchange and interest rate hedging Bank relations

Occasional
Intermediate financing Bond issues Leasing Stock issues Capital budgeting Dividend decisions Forecasting

Profitability Goal: Maximize Trade-off shareholder wealth Risk

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Figure 1-2 Prime rate versus percent change in the CPI

Cons umer price index (average annual rate) Prime rate (December)

20.00 18.00 16.00 14.00

Percent

12.00 10.00 8.00 6.00 4.00 2.00 0.00 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999

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Sou rce : ww w.b ank-can ada .ca;www .statca n.ca

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Chapter 1 - Outline

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Definition of Financial Management The Field of Finance The Economic Environment The Evolution of Finance The Goals of Financial Management Functions and Activities of Financial Management Forms of Organization Financial Markets A Risk-Return Trade-Off
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Financial Management

Financial Management (or Business Finance) is concerned with managing a corporations money 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
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The Field of Finance

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Finance is related to: Accounting, which provides data in financial statements Economics, which provides decision-making tools such as pricing theory (supply and demand), risk analysis, comparative return analysis information on the economic and financial environment in which the company operates
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The Economic Environment The financial manager considers inflation unemployment industrial production domestic and international competition foreign trade statistics international capital flows

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exchange rates changes in technology consumer and investor attitudes the state of financial markets changes in government policy etc. etc.
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The Evolution of Finance The Exchanges develop 1920s: raising capital

1930s: capital preservation, bankruptcy and reorganization 1950s: shift to analytical decision-making, capital budgeting Markowitz, Modigliani and Miller, Sharpe, Merton, Scholes Agency Theory
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The Goals of Financial Management

Primary goal is to maximize the long-term wealth of the companys shareholders (owners) by increasing the market value (price) of their shares May conflict with social / ethical goals (for example, pollution control) interests of management (for example, short-term compensation) Management can encourage an increase in share price by earning an attractive return at an acceptable level of risk
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Functions and Activities of Financial Management

Functions involve:
raising funds for the firm at minimal cost and acceptable risk investing those funds in company assets so as to earn an attractive return given acceptable risks

Activities include:
Working Capital Management
short-term (S/T) financial decisions (<1 year) ex., managing cash and other current assets

Capital Budgeting
long-term (L/T) financial decisions (>1 year) ex., purchasing a new machine in the future
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Financing decisions
how to raise money loans? leases? shares? bonds?
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Forms of Organization

Sole Proprietorship
single owner with unlimited liability. limited access to capital

Partnership
2 or more owners (partners) greater access to capital

Corporation
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smallest in actual number but largest in total sales revenue and profits owned by the shareholders large corporation can raise money by selling more shares or bonds
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Financial Markets

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Global network of corporations, financial institutions, governments and individuals that either need money or have money to lend or invest Money markets deal in short-term securities (<1 year) Ex.; Treasury Bills, commercial paper Capital markets deal in long-term securities Ex.; common stock, preferred stock, corporate bonds, government bonds Financial markets determine value and allocate capital to the most productive use on a risk-return basis Financial market characteristics reliance on debt volatile interest rates corporate restructuring internationalization
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A Risk-Return Tradeoff

Profitability Risk Profitability Risk ex., investing in stocks vs.savings accounts Stocks may be more profitable but are riskier Savings accounts are less profitable and less risky (or safer)
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