Chapter

The Goals and Functions of

1 Financial Management

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-2

Chapter 1 - Outline
 Definition of Financial Management
 The Field of Finance
 The Economic Environment
 The Evolution of Finance
 The Goals of Financial Management
 A Risk-Return Trade-Off
 Functions and Activities of Financial Management
 Forms of Organization
 Financial Markets
 Interest Rates
 Summary and Conclusions
© 2003 McGraw-Hill Ryerson Limited
 PPT 1-3

What is Financial Management?

The business function
involving:
Managing daily financial
activities-cash inflows and
outflows
 Choosing long-term
investments of value and
obtaining the funds to pay
for them
Managing the risks taken
by the firm

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-4

The Field of Finance

Finance is related to:
 Accounting, which provides information 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
© 2003 McGraw-Hill Ryerson Limited
 PPT 1-5

The Economic Environment

The financial manager

 exchange rates
considers many economic
 changes in
factors, such as
technology
 inflation
 consumer and
 unemployment
investor attitudes
 industrial production
 the state of financial
 domestic and international
markets
competition
 changes in
 foreign trade statistics
government policy
 international capital flows
 etc. etc.
© 2003 McGraw-Hill Ryerson Limited
 PPT 1-7

The Goals of Financial Management

 Primarygoal is to maximize the wealth of the

company’s shareholders (owners) by increasing the
market value (price) of their shares

 Management can encourage an increase in share

price by earning an attractive return at an
acceptable level of risk

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-8

 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)
Financial manager must choose appropriate
combination of potential profit (return) and
level of risk (safety) © 2003 McGraw-Hill Ryerson Limited
 PPT 1-9
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
 Financing decisions (capital structure)
 how to raise money: loans? leases? shares? bonds?

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-10
Figure 1-1
Functions of the Financial Manager

Daily Occasional Profitability

Cash management
(receipt and disbursement of funds)
Intermediate financing
Bond issues
Goal:
Credit management Leasing Maximize
Inventory control Stock issues Trade-off
Short-term financing
Exchange and interest rate hedging
Capital budgeting
Dividend decisions
shareholder
Bank relations Forecasting wealth

Risk

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-11
Forms of Organization:
Sole Proprietorships

Disadvantages
Advantages
Unlimited
Freedom Liability
Simplicity
Lack of Continuity
Low Start Up
Difficulty in
Costs A business owned by Raising Money
one person
Tax Benefits
Reliance on One Person
© 2003 McGraw-Hill Ryerson Limited
Forms of Organization: PPT 1-12

Partnerships
Disadvantages Advantages
Unlimited Liability
Lack of Continuity More Capital
Ownership
Greater Talent Pool
Transfer
Difficult
Ease of Formation
Possibility of Tax Benefits
Conflict
A business venture with two or more owners
© 2003 McGraw-Hill Ryerson Limited
 Forms of Organization: PPT 1-13

Corporations

Advantages Disadvantages
Limited Liability Potential Shareholder
Revolts
Continuity
Higher Start-Up
Greater Likelihood Costs
of Professional
Management Regulation
Double Taxation
Easier Access to A corporation
Money is a separate legal entity
© 2003 McGraw-Hill Ryerson Limited
 PPT 1-14

Public and Private Corporations

 Public corporations’ shares are
available for purchase on the
market for the general public

 The shares in a private

corporation are held by a small
group of individuals and are not
sold to the public

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-15
Financial Markets

 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, and low but volatile interest rates
 internationalization © 2003 McGraw-Hill Ryerson Limited
 PPT 1-16

Stocks vs. Bonds

 Stock(Share)= ownership or equity

 Shareholders own the company

Bond = debt or liability

 Bondholders are owed $ by company

Capital raised in primary markets

Securities traded in secondary markets

© 2003 McGraw-Hill Ryerson Limited

 PPT 1-18

Summary and Conclusions

The financial manager:
 controls the daily cash inflows and
outflows resulting from business
operations
makes the occasional investment
and financing decisions essential for
the future financial success of the
business
may work in a corporation or
other form of business organization

Their overriding goal is to maximize

the wealth of the owners by earning
an attractive return in the business
at an acceptable level of risk
© 2003 McGraw-Hill Ryerson Limited