An Overview of Managerial

Finance

What is Finance?
Finance is concerned with decisions about
money (Cash Flows)
Finance decisions deal with how money is
raised and used
Everything else being equal:
More value is preferred to less
The sooner cash is received the more value it has
Less risky assets are more valuable than riskier
assets

General Areas of Finance

Financial Markets and Institutions
Banks, Insurance Companies, Saving & Loans, Credit Unions etc.

Investments
Stock Brokerage firms, Financial Institutions, Investment Companies, Insurance
Companies etc.

Financial Services
Financial Consultants, Auditing Firms etc

Managerial Finance
All type of Firms making Financial Decisions concerning cash flows.

The types of duties

encountered
Managerial
Finance

in managerial

finance:

making decisions about plant expansions to

choosing what types of securities to issue to
finance such expansions.
deciding the credit terms under which customers
can buy, how much inventory the firm should
carry, how much cash to keep on hand, whether
to acquire other firms (merger analysis), and how
much of the firms earnings to reinvest in the
business and how much to pay out as dividends.

FINANCE IN NONFINANCE AREAS

Management
Strategic planning cannot be accomplished without
considering how such plans impact the overall financial wellbeing of the firm.
Personnel decisions as setting salaries, hiring new staff, and
paying bonuses must be coordinated with financial decisions
to ensure that any needed funds are available.

Marketing
Four Ps of marketingproduct, price, place, and promotion
determine the success of products. Clearly, the price that
should be charged for a product and the amount of
advertising a firm can afford for the product must be
determined in consultation with financial managers.

FINANCE IN NONFINANCE AREAS

(Cont.)
Accounting

Financial managers rely heavily on accounting information

because making decisions about the future requires
information about the past. As a consequence, accountants
must understand how financial managers use accounting
information in planning and decision making so that it can
be provided in an accurate and timely fashion.

Information Systems
information system specialists work with financial managers
to determine what information is needed, how it should be
stored, how it should be delivered.

Economics
economic activity and policy impact financial decisions, and
vice versa
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Finance in the Organizational

Structure of the Firm
Board of Directors
President (CEO)

Vice-President:
Sales

Credit
Manager

Vice-President:
Operations (COO)

Inventory
Manager

Director of
Capital
Budgeting

Vice-President:
Finance (CFO)

Treasurer

Manage cash & Marketable Securities

Plan how the firm is financed
Manage Risk
Oversee pension fund

Controller

Vice-President:
Information Systems (CIO)

Financial
Tax
and Cost
Department
Accounting

Activity of accounting and tax

department

Alternative Forms of
Business Organization
Proprietorship
Partnership
Corporation

Proprietorship
Advantages:
Ease of formation
Subject to few government regulations
No corporate income taxes

Limitations:
Unlimited personal liability
Limited life
Transferring ownership is difficult
Difficult to raise capital

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Partnership
Like a proprietorship, except two or
more owners
A partnership has roughly the
same advantages and limitations
as a proprietorship

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Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital

Disadvantages:
Cost of set-up and report filing
Double taxation

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Hybrid Forms of Business

Limited

Liability

Partnership

(LLP)

A
partnership wherein one (or more) partner is designated the
general partner(s) with unlimited personal financial liability and
the other partners are limited partners whose liability is limited
to amounts they invest in the firm.

Limited Liability Company (LLC)

Offers the
limited personal liability associated with a corporation, but the
companys income is taxed like a partnership

S Corporation

A corporation with no more than 75

stockholders that elects to be taxed the same as proprietorships
and partnerships so that business income is taxed only once.

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Business Organized as a
Corporation: Value Maximized
Limited liability reduces risk increasing
market value
Ease of raising capital allows taking
advantage of growth opportunities
Ownership can be easily transferred
thus investors would be willing to pay
more for a corporation

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Goals of the Corporation

Primary goal:stockholder wealth
maximizationtranslates to
maximizing stock price.
Managerial incentives
Provide valuable incentives to keep the interest of management alive
and inline with stockholder wealth maximization.

Social responsibility
The concept that businesses should be actively concerned with the
welfare of society at large.

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Goal of stock price maximization: is this

good or is this bad for society?
it is good.
First, stock price maximization requires efficient, lowcost plants that produce high quality goods and services
that are sold at the lowest possible prices.
Second, stock price maximization requires the
development of products that consumers want and
need, so the profit motive leads to new technology, new
products, and new jobs.
Finally, stock price maximization necessitates efficient
and courteous service, adequate stocks of merchandise,
and well-located business establishments.

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Managerial Actions to
Maximize Stockholder Wealth
Capital Structure Decisions
Decision about how much and what types of debt and equity
should be used to finance the firm.

Capital Budgeting Decisions

Decision as to what types of assets should be purchased to
help generate future cash flows.

Dividend Policy Decisions

Decisions as to how much of current earnings to pay out as
dividends rather than to retain for reinvestment in the firm.

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Value of the Firm

Market Factors/Considerations
Economic Conditions
Government Regulations and Rules
Competitive Environment
Firm Factors/Considerations
Normal Operations (Revenues and
Expenses)

Financing Policy
Investing Policy
Dividend Policy

(Capital Structure)
(Capital Budgeting)

Investor Factors/Considerations
Income/Savings
Age/Lifestyle
Interest Rates
Risk Attitude

Net Cash Flows, CF

Rates of Return, r

^
N
CF 1
CF 2
CFN
CFt

...

1
2
N
t
(1 r) (1 r)
(1 r)
(1 r)
t 1
^

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Factors Influenced by Managers

thatProjected
Affect Stock
Price
earnings
per share
Timing of earnings streams
Risk of projected earnings

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Agency Relationships
An agency relationship exists whenever a
principal hires an agent to act on his or her
behalf.
An agency problem results when the agent
makes decisions that are not in the best
interest of principals.
Two types of Agency Relationship:
Stockholders Vs. Managers
Stockholders Vs. Creditors

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Stockholders versus Managers

Managers are naturally inclined to act in their own
best interests.
Mechanisms to motivate managers to act in
shareholders best interest
Managerial compensation (incentives)
Performance shares awarded on basis of EPS, executive
stock purchased at future time at given price, restricted
stock grants to employees for some time in future.
1. Performance share
2. Executive stock option: An incentive plan that
allows the managers to purchase stock at some future time at a
given price.

3. Restricted stock grants: Stock is granted to

employees based on performance but does not have the right to
ownership of the stock untill some period in the future.
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Stockholders versus Managers

Cont.
The threat of firing
Possible now due to ownership by few large institutions like
pension fund, mutual funds etc.

Shareholder intervention
Big Funds now closely monitor firms and influence
management decisions when ever needed.

Threat of takeover
Hostile takeovers, management is fired.
Poison pill
Green Mail

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Stockholders Vs. Creditors

Stockholders through management cause
the firm to take new ventures that have
much greater risk than the creditors
anticipated. That causes the value of
outstanding debt to fall. If the venture
become successful, all benefits will go to
stockholders. If things go wrong, the
bondholders will have to share the losses.

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Business Ethics
Webster: A standard of conduct
and moral behavior.
Business Ethics: A companys
attitude and conduct toward its
employees, customers,
community, and stockholders

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Is being ethical good for profit and firm

value?
There is a positive correlation between
ethics and long-run profitability because
ethical behavior
(1) prevents fines and legal expenses,
(2) builds public trust,
(3) attracts business from customers who appreciate
and support ethical policies,
(4) attracts and keeps employees of the highest
caliber,
(5) supports the economic viability of the communities
where these firms operate.

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Corporate Governance
The set of rules that a firm follows
when conducting business
Good corporate governance generates
higher returns to stakeholders
Those who are associated with a business;
stakeholders
include
mangers,
employees,
customers, suppliers, creditors, stockholders, and
other parties with an interest in the firm.

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Multinational Corporations
Five reasons firms go
international
1. To seek new markets
2.

To seek raw materials

3.

To seek new technology

4.

To seek production efficiency

5.

To avoid political and regulatory

hurdles

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Factors Distinguishing Domestic

Firms from Multinational Firms
Different currency denominations
Economic and legal differences
Language differences
Cultural differences
Role of governments
Political risk

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Chapter 1 Essentials
What is finance?
Finance deals with decisions about money
What are the forms of business organization?
Proprietorship, partnership, corporation
What goals should firms pursue?
Maximize stockholders wealth
What is the role of ethics in business?
Ethical firms survive; non-ethical firms do
not

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Thank you

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