Chapter 1

Introduction to Financial
Management
 Key Concepts and Skills
• Know the basic types of financial management
decisions and the role of the financial manager
• Know the financial implications of the different forms of
business organization
• Know the goal of financial management
• Understand the conflicts of interest that can arise
between owners and managers
 Chapter Outline
• Finance: A Quick Look
• Business Finance and The Financial Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Problem and Control of the Corporation
• Financial Markets and the Corporation
 What is finance?
• Finance can be defined as the art and science of
managing money.
– At personal level, think about your earnings, savings and investments
– In business, think about raise money from investors, investing money
for profit, deciding to reinvest profits or distribute to shareholders

• Understanding the dynamics of how to manage your

money is of the utmost importance when running any firm.
• Consider the situation in which you need to purchase a
machine? How would you go about doing this?
 What is finance?
• There are numerous ways to evaluate a project. One
such way is the Net Present Value method.
• This means that you evaluate the cost of the machine you
buy, how much it costs to run it and if it can be resold...
• All of this must be done within comparable timeline! You
CANNOT compare a 5 year machine to a 3 year machine
if you do not make adjustments…
• But more on this later…
 What is finance?
• What is my firm’s financial health? (Financial Statements)

• Is my firm efficient in the use of its assets? Can I pay

back my debt? (Ratios)

• How much credit should I obtain? How much capital

should be my own? (Capital Structure)
 Areas and Opportunities
• Financial Services is the area of finance
concerned with the design and delivery of advice
and financial products to individuals, businesses,
and government.
• Career opportunities include banking, personal
financial planning, investments, real estate, and
insurance.
 Areas and Opportunities
• Chartered Financial Analyst – offered by CFA
Institute. Graduate level, focus on investments.
High prestige. 3 levels to pass.
• Certified Treasury Professional - pass a single
exam on knowledge relating to working on the
corporate treasury department.
• Certified Financial Planner - pass a ten hour
exam covering wide topics on personal financial
planning
 Investments
• Work with financial assets such as stocks and bonds
• Value of financial assets, risk versus return, and asset
allocation
• Job opportunities
– Stockbroker or financial advisor
– Portfolio manager
– Security analyst
– Quants
 Financial Institutions
• Companies that specialize in financial matters
– Banks – commercial and investment, credit unions,
savings and loans
– Insurance companies
– Brokerage firms
 Why Study Finance?
• Marketing
– Budgets, marketing research, marketing financial
products
• Accounting
– Dual accounting and finance function, preparation
of financial statements
• Management
– Strategic thinking, job performance, profitability
• Personal finance
– Budgeting, retirement planning, college planning,
day-to-day cash flow issues
 Managerial Finance
• Some important questions that are answered using
finance
– What long-term investments should the firm take
on?
– Where will we get the long-term financing to pay
for the investments?
– How will we manage the everyday financial
activities of the firm?
 Financial Manager
• Financial managers try to answer some, or all, of
these questions
• The top financial manager within a firm is usually the
Chief Financial Officer (CFO)
– Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning
– Controller – oversees taxes, cost accounting,
financial accounting, and data processing
Financial Management Decisions
• Capital budgeting
– What long-term investments or projects should the
business take on?
• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?
• Working capital management
– How do we manage the day-to-day finances of the
firm?
 Forms of Business Organization
• Three major forms of Business Organisations
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• S-Corp
• Limited liability company
 Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all owner’s personal
of the profits wealth
– Taxed once as – Unlimited liability
personal income – Difficult to sell
ownership interest
 Partnership
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
– Relatively easy to • Limited partnership

start – Partnership dissolves

– Income taxed once as when one partner dies
personal income or wishes to sell
– Difficult to transfer
ownership
 Corporation
• Advantages • Disadvantages
– Limited liability – More regulation
– Unlimited life – More expensive to set
– Separation of up
ownership and – Double taxation
management (income taxed at the
– Transfer of ownership corporate rate and
is easy then dividends taxed
– Easier to raise capital at personal rate, while
dividends paid are not
tax deductible)
Goal Of Financial Management
 Goal Of Financial Management
• What should be the goal of a corporation?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company’s
stock?
• Does this mean we should do anything and
everything to maximize owner wealth?
 The Agency Problem
• Agency relationship
– Principal hires an agent to represent its interests
– Stockholders (principals) hire managers (agents)
to run the company
• Agency problem
– Conflict of interest between principal and agent
– Excessive bonuses
– Making emotional investment decisions which
eventually causes company to leak money
 Managing Managers
• Managerial compensation
– Incentives can be used to align management and
stockholder interests
– The incentives need to be structured carefully to
make sure that they achieve their goal
• Corporate control
– The threat of a takeover may result in better
management
• Other stakeholders
Financial Institutions, Financial
Markets and the Firm
 Financial Markets
Two types:
1. Money Market: Short-term debt securities bought and sold in
money market such as:
Treasury bills of SA government
Bankers’ acceptances notes

2. Capital Market: Long-term securities issued and traded in

capital market such as:
Ordinary shares
Preference shares
Bonds
Debentures
 Financial Markets....Continues
Financial markets function both as primary and secondary markets.
1. Primary market refers to original sale (issue) of securities by
governments and companies.
2. Secondary market refers to where securities are bought and sold
AFTER original sale
Side note:
3. Equities (ordinary shares) issued solely by a company
4. Preference shares (debt security) issued solely by a company
5. Debt securities issued by both government and company
 Financial Markets....Continues
Primary Market transaction
Who Transaction Types of primary market
Company raise money for 1. Public offering i.e.
company selling to general public
2. Private offering i.e.
negotiated sale to specific
Government raise money for buyer
government 1. Public offering
 Financial Markets....Continues
1. Merchant bank acts as intermediary between company and public.
2. Will underwrite publicly offered securities.
3. Underwriter guarantees (for a fee) to take up securities not bought by public.
Advantage: Company achieves new capital input it initially seeked out.
4. Underwriters have option to purchase initial issue and market it to public.
Advantage: Profit by reselling issue at higher price to public.
Prospectus, registered with Registrar of Companies, must accompany public
offerings.
Company must disclose a significant amount of info before selling securities to
public
 Financial Markets....Continues
Secondary Market transaction
Who transaction Types of secondary market
Owner or lender Transferring 1. Dealer market:
ownership a) referred to as over the counter
(OTC) markets
b) Buying and selling done by a dealer.
2. Auction markets:
a) Has physical address. Eg JSE
b) Economic forces of demand and
supply dictate prices