1. Managerial Finance

Managerial FinanceManagerial FinanceFIN 745FIN 745

Dr Catherine S F HoDr Catherine S F Ho 11

Professor Dr Catherine S F HoProfessor Dr Catherine S F HoAC 5019AC 501955445544--47924792

[email protected]@salam.uitm.edu.my

The Scope of The Scope of Managerial FinanceManagerial Finance


Learning GoalsLearning Goals

1.1. Define finance and its major areas.Define finance and its major areas.

2.2. Describe the managerial finance function and its Describe the managerial finance function and its relationship to economics and accounting.relationship to economics and accounting.

3.3. Identify the primary activities of the Identify the primary activities of the financial manager.financial manager.


financial manager.financial manager.

4.4. Explain the goal of the firm, corporate Explain the goal of the firm, corporate governance, the role of ethics, and governance, the role of ethics, and the agency issue.the agency issue.

What is Finance?What is Finance?

�� Finance can be defined as the art and Finance can be defined as the art and science of managing money.science of managing money.

�� Finance is concerned with the process, Finance is concerned with the process, institutions, markets, and instruments institutions, markets, and instruments


institutions, markets, and instruments institutions, markets, and instruments involved in the transfer of money among involved in the transfer of money among individuals, businesses, and governments.individuals, businesses, and governments.

�� Enable managers to make effective Enable managers to make effective financial decisionsfinancial decisions

Major Areas & Opportunities in Major Areas & Opportunities in Finance: Financial ServicesFinance: Financial Services

�� Financial ServicesFinancial Services is the area of finance is the area of finance concerned with the design and delivery of concerned with the design and delivery of advice and financial products to advice and financial products to


individuals, businesses, and government.individuals, businesses, and government.

��Career opportunitiesCareer opportunities include banking, include banking, personal financial planning, investments, personal financial planning, investments, real estate, and insurance.real estate, and insurance.

Major Areas & Opportunities in Major Areas & Opportunities in Finance: Managerial FinanceFinance: Managerial Finance

�� Managerial financeManagerial finance is concerned with is concerned with the duties of the financial manager in the the duties of the financial manager in the business firm.business firm.

�� The The financial managerfinancial manager actively manages the actively manages the


�� The The financial managerfinancial manager actively manages the actively manages the financial affairs of any type of business, whether financial affairs of any type of business, whether private or public, large or small, profitprivate or public, large or small, profit--seeking or seeking or notnot--forfor--profit.profit.

�� They are also more involved in developing They are also more involved in developing corporate strategy and improving the firm’s corporate strategy and improving the firm’s competitive position.competitive position.

Major Areas & Opportunities in Major Areas & Opportunities in Finance: Managerial Finance (cont.)Finance: Managerial Finance (cont.)

�� The recent global financial crisis and subsequent The recent global financial crisis and subsequent responses by governmental regulators, increased global responses by governmental regulators, increased global competition, and rapid technological change also competition, and rapid technological change also increase the importance and complexity of the financial increase the importance and complexity of the financial manager’s duties.manager’s duties.


manager’s duties.manager’s duties.

�� Increasing globalization has complicated the financial Increasing globalization has complicated the financial management function by requiring them to be proficient management function by requiring them to be proficient in managing cash flows in different currencies and in managing cash flows in different currencies and protecting against the risks inherent in international protecting against the risks inherent in international transactions.transactions.

�� Changing economic and regulatory conditions also Changing economic and regulatory conditions also complicate the financial management function.complicate the financial management function.

Legal Forms of Business Legal Forms of Business OrganizationOrganization


Corporate OrganizationCorporate Organization


Other Limited Liability Other Limited Liability OrganizationsOrganizations


The Managerial Finance FunctionThe Managerial Finance Function

�� The size and importance of the managerial The size and importance of the managerial finance function depends on the size of the firm.finance function depends on the size of the firm.

�� In small companies, the finance function may In small companies, the finance function may be performed by the company president or be performed by the company president or


be performed by the company president or be performed by the company president or accounting department.accounting department.

�� As the business expands, finance typically As the business expands, finance typically evolves into a separate department linked to the evolves into a separate department linked to the president as was previously described in president as was previously described in Figure 1.1.Figure 1.1.

Major Functional Areas of Financial Major Functional Areas of Financial ManagementManagement

�� Planning and Forecasting Planning and Forecasting -- appropriate goals, appropriate goals,

objectives, and strategiesobjectives, and strategies

��Controlling and Coordinating Controlling and Coordinating -- analyzing financial analyzing financial

statements, cash flows, causes of problems and responsibilities statements, cash flows, causes of problems and responsibilities


�� Investment and Financing Decisions Investment and Financing Decisions --appropriate mix of assets and liabilitiesappropriate mix of assets and liabilities

��Understanding Financial Markets Understanding Financial Markets –– understand understand

the external financial environment to negotiate efficiently and the external financial environment to negotiate efficiently and effectivelyeffectively

��Managing Price Risk Managing Price Risk -- diversification and hedgingdiversification and hedging

The Managerial Finance Function: The Managerial Finance Function: Relationship to EconomicsRelationship to Economics

•• The field of finance is closely related to The field of finance is closely related to economics.economics.

•• Financial managers must understand the Financial managers must understand the economic framework and be alert to the economic framework and be alert to the


economic framework and be alert to the economic framework and be alert to the consequences of varying levels of economic consequences of varying levels of economic activity and changes in economic policy. activity and changes in economic policy.

•• They must also be able to use economic They must also be able to use economic theories as guidelines for efficient business theories as guidelines for efficient business operation.operation.

The Managerial Finance Function: The Managerial Finance Function: Relationship to Economics (cont.)Relationship to Economics (cont.)

�� The primary economic principal used by The primary economic principal used by financial managers is financial managers is marginal costmarginal cost--benefit analysisbenefit analysis which says that financial which says that financial


benefit analysisbenefit analysis which says that financial which says that financial decisions should be implemented only decisions should be implemented only when added benefits exceed added costs.when added benefits exceed added costs.

��Nord Department Stores is applying marginalNord Department Stores is applying marginal--

cost benefit analysis to decide whether to cost benefit analysis to decide whether to

replace a computer:replace a computer:


The Managerial Finance Function: The Managerial Finance Function: Relationship to AccountingRelationship to Accounting

�� The firm’s finance (treasurer) and The firm’s finance (treasurer) and accounting (controller) functions are accounting (controller) functions are closelyclosely--related and overlapping.related and overlapping.


closelyclosely--related and overlapping.related and overlapping.

�� In smaller firms, the financial manager In smaller firms, the financial manager generally performs both functions.generally performs both functions.

The Managerial Finance Function: The Managerial Finance Function: Relationship to Accounting (cont.)Relationship to Accounting (cont.)

��One major difference in perspective and One major difference in perspective and emphasis between finance and accounting emphasis between finance and accounting is that accountants generally use the is that accountants generally use the accrual method while in finance, the focus accrual method while in finance, the focus


accrual method while in finance, the focus accrual method while in finance, the focus is on is on cash flowscash flows..

�� The significance of this difference The significance of this difference can be illustrated using the following can be illustrated using the following simple example.simple example.


�� The Nassau Corporation experienced the The Nassau Corporation experienced the following activity last year:following activity last year:

Sales $100,000 (1 yacht sold, 100% still uncollected)


��Now contrast the differences in Now contrast the differences in performance under the accounting method performance under the accounting method versus the cash method.versus the cash method.

Sales $100,000 (1 yacht sold, 100% still uncollected)

Costs $ 80,000 (all paid in full under supplier terms)


INCOME STATEMENT SUMMARY

Now contrast the differences in performance under the accounting method

(accrual basis) versus the financial view (cash basis):


ACCRUAL CASH

Sales $100,000 $ 0

Less: Costs (80,000) (80,000)

Net Profit/(Loss) $ 20,000 $(80,000)


�� Finance and accounting also differ with respect Finance and accounting also differ with respect to to decisiondecision--makingmaking..

�� While accounting is primarily concerned with the While accounting is primarily concerned with the presentation of financial data, the financial presentation of financial data, the financial


presentation of financial data, the financial presentation of financial data, the financial manager is primarily concerned with manager is primarily concerned with analyzing analyzing and interpretingand interpreting this information for decisionthis information for decision--making purposes.making purposes.

�� The financial manager uses this data as a vital The financial manager uses this data as a vital tool for making decisions about the financial tool for making decisions about the financial aspects of the firm.aspects of the firm.

��Finance and accounting also differ with respect Finance and accounting also differ with respect to decisionto decision--making:making:

�� Accountants devote most of their attention to the Accountants devote most of their attention to the collection and presentation of financial data.collection and presentation of financial data.

Financial managers evaluate the accounting Financial managers evaluate the accounting �� Financial managers evaluate the accounting Financial managers evaluate the accounting statements, develop additional data, and statements, develop additional data, and make make

decisionsdecisions on the basis of their assessment of the on the basis of their assessment of the associated returns and risks.associated returns and risks.


Primary Activities of Primary Activities of the Financial Managerthe Financial Manager


Goal of the Firm: Maximize Profit?Goal of the Firm: Maximize Profit?

Investment Year 1 Year 2 Year 3 Total (years 1-3)

Rotor 1.40$ 1.00$ 0.40$ 2.80$

Valve 0.60$ 1.00$ 1.40$ 3.00$

Earnings per share (EPS)

Which Investment is Preferred?


Valve 0.60$ 1.00$ 1.40$ 3.00$

•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.

Goal of the Firm: Goal of the Firm: Maximize Shareholder Wealth!Maximize Shareholder Wealth!

�� Why?Why?�� Because maximizing shareholder wealth Because maximizing shareholder wealth properly considers cash flows, the timing of properly considers cash flows, the timing of these cash flows, and the risk of these cash these cash flows, and the risk of these cash flows.flows.


flows.flows.�� This can be illustrated using the following simple This can be illustrated using the following simple stock valuation equation: stock valuation equation:

Share Price = Future Dividends

Required Return

level & timing of cash flows

risk of cash flows

Goal of the Firm: Goal of the Firm: Maximize Shareholder Wealth! (cont.)Maximize Shareholder Wealth! (cont.)

�� The process of shareholder wealth The process of shareholder wealth maximization can be described using the maximization can be described using the following flow chart:following flow chart:


Goal of the Firm: Maximize Profit?Goal of the Firm: Maximize Profit?

Which Investment is Preferred?

��Profit maximization may not lead to the highest possible Profit maximization may not lead to the highest possible share price for at least three reasons:share price for at least three reasons:

1.1. Timing is importantTiming is important——the receipt of funds sooner rather than later the receipt of funds sooner rather than later is preferredis preferred

2.2. Profits do not necessarily result in cash flows available to Profits do not necessarily result in cash flows available to stockholdersstockholders

3.3. Profit maximization fails to account for riskProfit maximization fails to account for risk


Goal of the Firm: Goal of the Firm: What About Other Stakeholders?What About Other Stakeholders?

�� Stakeholders include all groups of individuals Stakeholders include all groups of individuals who have a direct economic link to the firm who have a direct economic link to the firm including employees, customers, suppliers, including employees, customers, suppliers, creditors, owners, and others who have a direct creditors, owners, and others who have a direct economic link to the firm.economic link to the firm.


economic link to the firm.economic link to the firm.

�� The "Stakeholder View" prescribes that the firm The "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions that make a conscious effort to avoid actions that could be detrimental to the wealth position of its could be detrimental to the wealth position of its stakeholders.stakeholders.

�� Such a view is considered to be "socially Such a view is considered to be "socially responsible."responsible."

Corporate GovernanceCorporate Governance

�� Corporate Governance is the system used to Corporate Governance is the system used to directdirect and and controlcontrol a corporation.a corporation.

�� It defines the It defines the rights and responsibilities rights and responsibilities of key corporate of key corporate participants such as shareholders, the board of directors, participants such as shareholders, the board of directors, officers and managers, and other stakeholders and and officers and managers, and other stakeholders and and


officers and managers, and other stakeholders and and officers and managers, and other stakeholders and and rules and proceduresrules and procedures for making corporate decisions.for making corporate decisions.

�� Board of Directors sets policies that specify Board of Directors sets policies that specify ethical ethical practicespractices and and protect stakeholder interestsprotect stakeholder interests..

�� Presence of institutional investors exert greater influence Presence of institutional investors exert greater influence on CG through ability to affect stock priceson CG through ability to affect stock prices

Individual versus Institutional InvestorsIndividual versus Institutional Investors

�� Individual investors are investors who purchase Individual investors are investors who purchase relatively small quantities of shares in order to earn relatively small quantities of shares in order to earn a return on idle funds, build a source of retirement a return on idle funds, build a source of retirement income, or provide financial security.income, or provide financial security.

�� Institutional investors are investment professionals Institutional investors are investment professionals who are paid to manage other people’s money. who are paid to manage other people’s money.


who are paid to manage other people’s money. who are paid to manage other people’s money. They hold and trade large quantities of securities for They hold and trade large quantities of securities for individuals, businesses, and governments and tend individuals, businesses, and governments and tend to have a much greater impact on corporate to have a much greater impact on corporate governance.governance.

�� Unlike individual investors, institutional investors Unlike individual investors, institutional investors often monitor and directly influence a firm’s often monitor and directly influence a firm’s corporate governance by exerting pressure on corporate governance by exerting pressure on management to perform or communicating their management to perform or communicating their concerns to the firm’s board.concerns to the firm’s board.

•• Government regulation generally shapes Government regulation generally shapes the corporate governance of all firms. the corporate governance of all firms.

•• During the recent decade, corporate During the recent decade, corporate governance has received increased governance has received increased governance has received increased governance has received increased attention due to several highattention due to several high--profile profile corporate scandals involving abuse of corporate scandals involving abuse of corporate power and, in some cases, corporate power and, in some cases, alleged criminal activity by corporate alleged criminal activity by corporate officers.officers.


The Role of Ethics: Ethics DefinedThe Role of Ethics: Ethics Defined

�� EthicsEthics is the standards of conduct or is the standards of conduct or moral judgmentmoral judgment——have become an have become an overriding issue in both our society and overriding issue in both our society and the financial communitythe financial community


the financial communitythe financial community

�� Ethical violations attract widespread Ethical violations attract widespread publicitypublicity

��Negative publicity often leads to negative Negative publicity often leads to negative impacts on a firmimpacts on a firm

The Role of Business EthicsThe Role of Business Ethics

•• Business ethicsBusiness ethics are the standards of conduct are the standards of conduct or moral judgment that apply to persons or moral judgment that apply to persons engaged in commerce.engaged in commerce.

•• Violations of these standards in finance involve a Violations of these standards in finance involve a variety of actions: “creative accounting,” variety of actions: “creative accounting,” variety of actions: “creative accounting,” variety of actions: “creative accounting,” earnings management, misleading financial earnings management, misleading financial forecasts, insider trading, fraud, excessive forecasts, insider trading, fraud, excessive executive compensation, options backdating, executive compensation, options backdating, bribery, and kickbacks. bribery, and kickbacks.

•• Negative publicity often leads to negative Negative publicity often leads to negative impacts on a firmimpacts on a firm


The Role of Ethics: Considering EthicsThe Role of Ethics: Considering Ethics

�� Robert A. Cooke, a noted ethicist, suggests that Robert A. Cooke, a noted ethicist, suggests that the following questions be used to assess the the following questions be used to assess the ethical viability of a proposed action:ethical viability of a proposed action:

�� Does the action unfairly single out an individual Does the action unfairly single out an individual or group?or group?


or group?or group?

�� Does the action affect the morals, or legal rights of Does the action affect the morals, or legal rights of any individual or group?any individual or group?

�� Does the action conform to accepted Does the action conform to accepted moral standards?moral standards?

�� Are there alternative courses of action that are less Are there alternative courses of action that are less likely to cause actual or potential harm?likely to cause actual or potential harm?

The Role of Ethics: The Role of Ethics: Ethics & Share PriceEthics & Share Price

�� Ethics programs seek to:Ethics programs seek to:

�� reduce litigation and judgment costsreduce litigation and judgment costs

�� maintain a positive corporate imagemaintain a positive corporate image

build shareholder confidencebuild shareholder confidence


�� build shareholder confidencebuild shareholder confidence

�� gain the loyalty and respect of all stakeholdersgain the loyalty and respect of all stakeholders

�� The expected result of such programs is to positively The expected result of such programs is to positively affect the firm's share price.affect the firm's share price.

�� Ethical behaviour is necessary to achieve the goal Ethical behaviour is necessary to achieve the goal of shareholder wealth maximization.of shareholder wealth maximization.

The Agency ProblemThe Agency Problem

�� Conflict of interest between owners and managersConflict of interest between owners and managers

�� Agent Agent –– person given decisionperson given decision--making power on behalf making power on behalf of principal. Manager as agent of owners.of principal. Manager as agent of owners.

�� Whenever a manager owns less than 100% of the firm’s Whenever a manager owns less than 100% of the firm’s equity, a potential equity, a potential agency problemagency problem exists.exists.


equity, a potential equity, a potential agency problemagency problem exists.exists.

�� In theory, managers would agree with shareholder In theory, managers would agree with shareholder wealth maximization.wealth maximization.

�� However, managers are also concerned with their However, managers are also concerned with their personal wealth, job security, fringe benefits, and personal wealth, job security, fringe benefits, and lifestyle.lifestyle.

�� This would cause managers to act in ways that do not This would cause managers to act in ways that do not always benefit the firm shareholders.always benefit the firm shareholders.

•• A A principalprincipal--agent relationshipagent relationship is an arrangement in is an arrangement in which an agent acts on the behalf of a principal. For which an agent acts on the behalf of a principal. For example, shareholders of a company (principals) elect example, shareholders of a company (principals) elect management (agents) to act on their behalf.management (agents) to act on their behalf.

•• Agency problemsAgency problems arise when managers place personal arise when managers place personal goals ahead of the goals of shareholders.goals ahead of the goals of shareholders.

•• Agency costsAgency costs arise from agency problems that are arise from agency problems that are borne by shareholders and represent a loss of borne by shareholders and represent a loss of borne by shareholders and represent a loss of borne by shareholders and represent a loss of shareholder wealth.shareholder wealth.

•• In addition to the roles played by corporate boards, In addition to the roles played by corporate boards, institutional investors, and government regulations, institutional investors, and government regulations, corporate governance can be strengthened by ensuring corporate governance can be strengthened by ensuring that managers’ interests are aligned with those of that managers’ interests are aligned with those of shareholders. shareholders.

•• A common approach is to structure management A common approach is to structure management compensation to correspond with firm performancecompensation to correspond with firm performanceDr Catherine S F HoDr Catherine S F Ho 3636

•• Incentive plansIncentive plans are management compensation plans are management compensation plans that tie management compensation to share price; one that tie management compensation to share price; one example involves the granting of stock options.example involves the granting of stock options.

•• Performance plansPerformance plans tie management compensation to tie management compensation to measures such as EPS or growth in EPS. Performance measures such as EPS or growth in EPS. Performance shares and/or cash bonuses are used as compensation shares and/or cash bonuses are used as compensation under these plans.under these plans.

When a firm’s internal corporate governance structure is When a firm’s internal corporate governance structure is •• When a firm’s internal corporate governance structure is When a firm’s internal corporate governance structure is unable to keep agency problems in check, it is likely that unable to keep agency problems in check, it is likely that rival managers will try to gain control of the firm. rival managers will try to gain control of the firm.

•• The threat of takeover by another firm, which believes it The threat of takeover by another firm, which believes it can enhance the troubled firm’s value by restructuring its can enhance the troubled firm’s value by restructuring its management, operations, and financing, can provide a management, operations, and financing, can provide a strong source of external corporate governance. strong source of external corporate governance.


The Agency Issue: The Agency Issue: Resolving the ProblemResolving the Problem

��Market ForcesMarket Forces such as major such as major shareholders and the threat of a hostile shareholders and the threat of a hostile takeover act to keep managers in check.takeover act to keep managers in check.


��Agency Costs Agency Costs are the costs borne by are the costs borne by stockholders to maintain a corporate stockholders to maintain a corporate governance structure that minimizes governance structure that minimizes agency problems and contributes to the agency problems and contributes to the maximization of shareholder wealth.maximization of shareholder wealth.

Agency Issue:

Institutionalinvestors

Threat oftakeovers

MarketForces


Issue:

Resolving the Problem Management

Compensation

AgencyCosts

ExternalAudit Costs

IncentivePlans

PerformancePlans

Agency RelationshipAgency Relationship

�� Firms incur Firms incur agency costsagency costs to prevent or minimize to prevent or minimize agency problems. It is unclear whether they are agency problems. It is unclear whether they are effective in practice. effective in practice.

�� The four categories of agency cost are The four categories of agency cost are �� monitoring expendituresmonitoring expenditures incurred by the owners for incurred by the owners for audit and control procedures, audit and control procedures,


audit and control procedures, audit and control procedures, �� bonding expendituresbonding expenditures to protect against the potential to protect against the potential consequences of dishonest acts by managers, consequences of dishonest acts by managers,

�� structuring expendituresstructuring expenditures that use managerial that use managerial compensation plans to provide financial incentives for compensation plans to provide financial incentives for managerial actions consistent with share price managerial actions consistent with share price maximization, and maximization, and

�� opportunity costsopportunity costs resulting from the difficulties resulting from the difficulties typically encountered by large organizations in typically encountered by large organizations in responding to new opportunities.responding to new opportunities.


�� The agency problem and the associated agency The agency problem and the associated agency costs can be reduced by a properly constructed costs can be reduced by a properly constructed and followed corporate governance structure. and followed corporate governance structure.

�� The structure of the governance system should The structure of the governance system should


�� The structure of the governance system should The structure of the governance system should be designed to institute a system of checks and be designed to institute a system of checks and balances to reduce the ability and incentives of balances to reduce the ability and incentives of management to deviate from the goal of management to deviate from the goal of shareholder wealth maximization.shareholder wealth maximization.

The Agency Issue: The Agency Issue: Resolving the Problem (cont.)Resolving the Problem (cont.)

�� Examples would include bonding or Examples would include bonding or monitoring management behavior, and monitoring management behavior, and structuring management compensation to structuring management compensation to


structuring management compensation to structuring management compensation to make shareholders interests their own.make shareholders interests their own.

�� A A stock optionstock option is an incentive allowing is an incentive allowing managers to purchase stock at the market managers to purchase stock at the market price set at the time of the grant.price set at the time of the grant.


�� Structuring expendituresStructuring expenditures are currently the most are currently the most popular way to deal with the agency problempopular way to deal with the agency problem——and and also the most powerful and expensive. also the most powerful and expensive.

�� Compensation plans can be either Compensation plans can be either incentive incentive or or performance plansperformance plans. . Incentive plansIncentive plans tie management tie management performance to share price. performance to share price.

�� Managers may receive stock options giving them the Managers may receive stock options giving them the


�� Managers may receive stock options giving them the Managers may receive stock options giving them the right to purchase stock at a set price. right to purchase stock at a set price.

�� This provides the incentive to take actions that This provides the incentive to take actions that maximize stock price so that the price will rise above maximize stock price so that the price will rise above the option’s price level.the option’s price level.

�� This form of compensation plan has fallen from favor This form of compensation plan has fallen from favor recently because market behavior, which has a recently because market behavior, which has a significant effect on share price, is not under significant effect on share price, is not under management’s control. management’s control.


�� As a result, As a result, performance plansperformance plans are more popular are more popular today. today.

�� With these, compensation is based on With these, compensation is based on performance measures, such as earnings per performance measures, such as earnings per share (EPS), EPS growth, or other return ratios.share (EPS), EPS growth, or other return ratios.


share (EPS), EPS growth, or other return ratios.share (EPS), EPS growth, or other return ratios.

�� Managers may receiveManagers may receive performance sharesperformance shares

and/orand/or cash bonusescash bonuses when stated performance when stated performance goals are reached.goals are reached.

�� In practice, recent studies have been unable to In practice, recent studies have been unable to document any significant correlation between document any significant correlation between CEO compensation and share price.CEO compensation and share price.

The Agency Issue: The Agency Issue: Resolving the Problem (cont.)Resolving the Problem (cont.)

�� Performance plansPerformance plans tie management tie management compensation to measures such as EPS compensation to measures such as EPS growth; performance shares and/or cash growth; performance shares and/or cash bonuses are used as compensation under bonuses are used as compensation under


bonuses are used as compensation under bonuses are used as compensation under these plans.these plans.

��Recent studies have failed to find a strong Recent studies have failed to find a strong relationship between CEO compensation relationship between CEO compensation and share price.and share price.

LG1LG1 Define Define financefinance and the managerial finance function.and the managerial finance function.

�� FinanceFinance is the science and art of managing money. is the science and art of managing money. Managerial Managerial financefinance is concerned with the duties of the financial manager is concerned with the duties of the financial manager working in a business.working in a business.

LG2LG2 Describe the legal forms of business organization.Describe the legal forms of business organization.

�� The legal forms of business organization are the sole The legal forms of business organization are the sole proprietorship, the partnership, and the corporation.proprietorship, the partnership, and the corporation.

LG3LG3 Describe the goal of the firm, and explain why Describe the goal of the firm, and explain why maximizing the value of the firm is an appropriate goal maximizing the value of the firm is an appropriate goal for a business.for a business.for a business.for a business.

�� The goal of the firm is maximize its value, and therefore the The goal of the firm is maximize its value, and therefore the wealth of its shareholders. Maximizing the value of the firm wealth of its shareholders. Maximizing the value of the firm means running the business in the interest of those who own itmeans running the business in the interest of those who own it——the shareholders.the shareholders.

LG4LG4 Describe how the managerial finance function is related to Describe how the managerial finance function is related to

economics and accounting.economics and accounting.

�� The financial manager must understand the economic environment The financial manager must understand the economic environment

and rely heavily on the economic principle of marginal costand rely heavily on the economic principle of marginal cost––benefit analysis to make financial decisions. Financial managers benefit analysis to make financial decisions. Financial managers

use accounting but concentrate on cash flows and decision making.use accounting but concentrate on cash flows and decision making.Dr Catherine S F HoDr Catherine S F Ho 4646

LG5LG5 Identify the primary activities of the financial manager.Identify the primary activities of the financial manager.

�� The primary activities of the financial manager, in addition to The primary activities of the financial manager, in addition to

ongoing involvement in financial analysis and planning, are ongoing involvement in financial analysis and planning, are

making investment decisions and making financing decisions.making investment decisions and making financing decisions.

LG6LG6 Describe the nature of the principleDescribe the nature of the principle--agent relationship agent relationship

between the owners and managers of a corporation, and between the owners and managers of a corporation, and

explain how various corporate governance mechanisms explain how various corporate governance mechanisms

attempt to manage agency problems.attempt to manage agency problems.attempt to manage agency problems.attempt to manage agency problems.

�� This separation of owners and managers of the typical firm is This separation of owners and managers of the typical firm is

representative of the classic principalrepresentative of the classic principal--agent relationship, where the agent relationship, where the

shareholders are the principles and mangers are the agents. A shareholders are the principles and mangers are the agents. A

firmfirm’’s corporate governance structure is intended to help ensure s corporate governance structure is intended to help ensure

that managers act in the best interests of the firmthat managers act in the best interests of the firm’’s shareholders, s shareholders,

and other stakeholders, and it is usually influenced by both and other stakeholders, and it is usually influenced by both

internal and external factors.internal and external factors.


1. Managerial Finance

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