Copyright © 2003 Pearson Education, Inc. Slide 1-1 The Role and Environment of Managerial Finance
Dec 16, 2015
Copyright © 2003 Pearson Education, Inc. Slide 1-1
The Role and Environment of Managerial Finance
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Learning Goals1.Define finance, the major areas of finance, and the
career opportunities available in this field, and the
legal forms of business organization.
2.Describe the managerial finance function and its
relationship to economics and accounting.
3. Identify the primary activities of the financial manager
within the firm.
4.Explain why wealth maximization, rather than profit
maximization, is the firm’s goal and how the agency
issue is related to it.
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Learning Goals5.Understand the relationship between financial
institutions and markets, as well as the role and
operations of the money and capital markets.
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What is Finance?• At the macro level, finance is the study of financial
institutions and financial markets and how they
operate within the financial system in both the Thai
and global economies.
• At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions.
• Financial management can be described in brief using
the following balance sheet.
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What is Finance?
Assets: Liabilities & Equity:
Current Assets Current Liabilities
Cash & M.S. Accounts payable
Accounts receivable Notes Payable
Inventory Total Current Liabilities
Total Current Assets Long-Term Liabilities
Fixed Assets: Total Liabilities
Gross f ixed assets Equity:
Less: Accumulated dep. Common Stock
Goodw ill Paid-in-capital
Other long-term assets Retained Earnings
Total Fixed Assets Total Equity
Total Assets Total Liabilities & Equity
ABC CompanyBalance Sheet
As of December 31, 19xx
WorkingCapital
WorkingCapital
InvestmentDecisions
FinancingDecisions
Macro Finance
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What is Finance?• A well-developed financial system is a hallmark and
essential characteristic of any modern
developed nation.
• Financial markets, financial intermediaries, and
financial management are the important
components.
• Financial markets and financial intermediaries
facilitate the flow of funds from borrowers to savers.
• Financial management involves the efficient use of
financial resources in the production of goods.
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Financial Services
• 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.
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Managerial Finance• Managerial finance is concerned with the duties of the
financial manager in the business firm.
• The financial manager actively manages the financial
affairs of any type of business, whether private or
public, large or small, profit-seeking or not-for-
profit.
• Increasing globalization has complicated the
financial management function.
• Changing economic and regulatory conditions also
complicate the financial management function.
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Basic Forms of Business Organization
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Corporate Organization
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Career Opportunities
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The Managerial Finance Function
• The size and importance of the managerial finance
function depends on the size of the firm.
• In small companies, the finance function may be
performed by the company president or accounting
department.
• As the business expands, finance typically evolves
into a separate department linked to the president.
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The Managerial Finance Function
• The field of finance is actually an outgrowth of
economics.
• In fact, finance is sometimes referred to as financial
economics.
• Financial managers must understand the economic
framework within which they operate in order to react
or anticipate to changes in conditions.
Relationship to Economics
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The Managerial Finance Function
• The primary economic principal used by financial
managers is marginal analysis which says that
financial decisions should be implemented only when
benefits exceed costs.
Relationship to Economics
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The Managerial Finance Function
• The firm’s finance (treasurer) and accounting
(controller) functions are closely-related and
overlapping.
• In smaller firms, the financial manager generally
performs both functions.
Relationship to Accounting
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The Managerial Finance Function
• One major difference in perspective and emphasis
between finance and accounting is that accountants
generally use the accrual method while in finance, the
focus is on cash flows.
• The significance of this difference can be illustrated
using the following simple example.
Relationship to Accounting
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The Managerial Finance FunctionRelationship to Accounting
• The Nasau Corporation experienced the following
activity last year:
Sales $100,000 (1 yacht sold, 100% still uncollected)
Costs $ 80,000 (all paid in full under supplier terms)
• Now contrast the differences in performance under the
accounting method versus the cash method.
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The Managerial Finance FunctionRelationship to Accounting
INCOME STATEMENT SUMMARY
ACCRUAL CASH
Sales $100,000 $ 0
Less: Costs (80,000) (80,000)
Net Profit/(Loss) $ 20,000 $(80,000)
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The Managerial Finance Function
• Finance and accounting also differ with respect to
decision-making.
• While accounting is primarily concerned with the
presentation of financial data, the financial manager is
primarily concerned with analyzing and interpreting this
information for decision-making purposes.
• The financial manager uses this data as a vital tool for
making decisions about the financial aspects of the
firm.
Relationship to Accounting
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Key Activities of the Financial Manager
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Goal of the FirmMaximize Profit???
Investment Year 1 Year 2 Year 3 Total
A 2.80$ -$ -$ 2.80$
B -$ -$ 3.00$ 3.00$
EPS ($)
Which Investment is Preferred?
Profit maximization fails to account for differences in the level of cash flows (as
opposed to profits), the timing of these cash flows, and the risk of these cash flows.
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Goal of the FirmMaximize Shareholder Wealth!!!
• Why?
• Because maximizing shareholder wealth properly
considers cash flows, the timing of these cash flows,
and the risk of these cash flows.
• This can be illustrated using the following simple
valuation equation:
Share Price = Future Dividends
Required Return
level & timing of cash flows
risk of cash flows
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Goal of the FirmMaximize Shareholder Wealth!!!
• It can also be described using the following flow chart:
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Goal of the FirmEconomic Value Added (EVA)
• Economic value added (EVA) is a popular measure
used by many firms to determine whether an
investment - proposed or existing - positively
contributes to the owners wealth.
• EVA is calculated by subtracting the cost of funds
used to finance an investment from its after-tax
operating profits.
• Investments with positive EVAs increase shareholder
wealth and those with negative EVAs reduce
shareholder value.
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Goal of the FirmWhat About Other Stakeholders?
• Stakeholders include all groups of individuals who have a direct economic link to the firm including:
– Employees– Customers– Suppliers– Creditors– Owners
• The "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions that could be
detrimental to the wealth position of its stakeholders.• Such a view is considered to be "socially responsible."
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• Ethics is the standards of conduct or moral judgment -
have become an overriding issue in both our society
and the financial community
• Ethical violations attract widespread publicity
• Negative publicity often leads to negative impacts on a
firm
The Role of EthicsEthics Defined
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The Role of EthicsConsidering Ethics
• To assess the ethical viability of a proposed action,
ask:• Does the action unfairly single out an individual or
group?• Does the action affect the morals, or legal rights of
any individual or group?• Does the action conform to accepted moral
standards?• Are there alternative courses of action that are less
likely to cause actual or potential harm?
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• Ethics programs seek to:
• reduce litigation and judgment costs
• maintain a positive corporate image
• build shareholder confidence
• gain the loyalty and respect of all stakeholders
• The expected result of such programs is to positively
affect the firm's share price.
The Role of EthicsEthics & Share Price
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The Agency Issue
• Whenever a manager owns less than 100% of the
firm’s equity, a potential agency problem exists.
• In theory, managers would agree with shareholder
wealth maximization.
• However, managers are also concerned with their
personal wealth, job security, fringe benefits, and
lifestyle.
• This would cause managers to act in ways that do not
always benefit the firm shareholders.
The Agency Problem
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The Agency Issue
• Market Forces such as major shareholders and the
threat of a hostile takeover act to keep managers in
check.
• Agency Costs may be incurred to ensure management
acts in shareholders interests.
Resolving the Problem
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Financial Institutions & Markets
• Firms that require funds from external sources can
obtain them in three ways:
– through a bank or other financial institution
– through financial markets
– through private placements
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Financial Institutions & Markets
• Financial institutions are intermediaries that channel
the savings of individuals, businesses, and
governments into loans or investments.
• The key suppliers and demanders of funds are
individuals, businesses, and governments.
• In general, individuals are net suppliers of funds, while
businesses and governments are net demanders of
funds.
Financial Institutions
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Financial Markets
• Financial markets provide a forum in which suppliers
of funds and demanders of funds can transact
business directly.
• The two key financial markets are the money market
and the capital market.
• Transactions in short term marketable securities take
place in the money market while transactions in long-
term securities take place in the capital market.
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Financial Markets• Whether subsequently traded in the money or capital
market, securities are first issued through the primary
market.
• The primary market is the only one in which a
corporation or government is directly involved in and
receives the proceeds from the transaction.
• Once issued, securities then trade on the secondary
markets such as the New York Stock Exchange or
NASDAQ.
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The Relationship between Financial Institutions and Financial Markets
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• The money market exists as a result of the interaction
between the suppliers and demanders of short-term
funds (those having a maturity of a year or less).
• Most money market transactions are made in
marketable securities which are short-term debt
instruments such as T-bills and commercial paper.
• Money market transactions can be executed directly or
through an intermediary.
The Money Market
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• The capital market is a market that enables suppliers
and demanders of long-term funds to make
transactions.
• The key capital market securities are bonds (long-term
debt) and both common and preferred stock (equity).
• Bonds are long-term debt instruments used by
businesses and government to raise large sums of
money or capital.
• Common stock are units of ownership interest or equity
in a corporation.
The Capital Market
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Q: What are SECURITIES?
A: Financial Assets that Investors purchase
hoping to earn a high rate of return.
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Types of Securities
• Treasury Bills and Treasury Bonds
• Municipal Bonds• Corporate Bonds• Preferred Stocks• Common Stocks
Which of these are RISKY?Which promise HIGH RETURNS?Is there a relationship between
RISK and RETURN?
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Movement of Savings
• Direct Transfer of Funds
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Movement of Savings
• Direct Transfer of Funds
saver
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Movement of Savings
• Direct Transfer of Funds
saverfirm
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Movement of Savings
• Direct Transfer of Funds
cashcash
saverfirm
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Movement of Savings
• Direct Transfer of Funds
cashcash
securitiessecurities
saverfirm
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Movement of Savings
• Indirect Transfer using Investment Banker
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Movement of Savings
• Indirect Transfer using Investment Banker
investmentbanker
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Movement of Savings
• Indirect Transfer using Investment Banker
investmentbanker firm
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Movement of Savings
• Indirect Transfer using Investment Banker
fundsfunds
investmentbanker firm
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Movement of Savings
• Indirect Transfer using Investment Banker
fundsfunds
securitiessecurities
investmentbanker firm
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Movement of Savings
• Indirect Transfer using Investment Banker
fundsfunds
securitiessecurities
saver
investmentbanker firm
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Movement of Savings
• Indirect Transfer using Investment Banker
fundsfundsfundsfunds
securitiessecurities
saver
investmentbanker firm
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Movement of Savings
• Indirect Transfer using Investment Banker
securitiessecurities
fundsfundsfundsfunds
securitiessecurities
saver
investmentbanker firm
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Movement of Savings• Indirect Transfer using a Financial Intermediary
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Movement of Savings• Indirect Transfer using a Financial Intermediary
financialintermediary
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Movement of Savings• Indirect Transfer using a Financial Intermediary
financialintermediary firm
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Movement of Savings• Indirect Transfer using a Financial Intermediary
fundsfunds
financialintermediary firm
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Movement of Savings• Indirect Transfer using a Financial Intermediary
fundsfunds
firmfirmsecuritiessecurities
financialintermediary firm
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Movement of Savings• Indirect Transfer using a Financial Intermediary
fundsfunds
firmfirmsecuritiessecurities
financialintermediary firm
saver
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Movement of Savings• Indirect Transfer using a Financial Intermediary
fundsfunds fundsfunds
firmfirmsecuritiessecurities
financialintermediary firm
saver
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Movement of Savings• Indirect Transfer using a Financial Intermediary
fundsfunds
intermediaryintermediarysecuritiessecurities
fundsfunds
firmfirmsecuritiessecurities
financialintermediary firm
saver
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Financial Market Components
• Public Offering– Firm issues securities, which
are made available to both individual and institutional investors.
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Financial Market Components
• Public Offering– Firm issues securities, which
are made available to both individual and institutional investors.
• Private Placement
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Financial Market Components
• Public Offering– Firm issues securities, which are
made available to both individual and institutional investors.
• Private Placement– Securities are offered and sold
to a limited number of investors.