CHAPTER 1:

DR. DOAA AYMAN THE ROLE AND

ENVIRONMENT OF
CORPORATE
FINANCE
 LG1: Define finance, its major areas and opportunities
available in this field, and the legal forms of business
organization.
LG2: Describe the managerial finance function and its
relationship to economics and accounting.
LEARNING LG3: Identify the primary activities of the financial
GOALS: manager.
LG4: Explain the goal of the firm and the agency
issue.
LG5: Understand financial institutions and markets,
and the role they play in managerial finance.
 WHAT IS FINANCE?

• Finance can be defined as:

…….the art and science of managing money or the study of how people allocate
scarce resources

• Understanding finance helps you to take a decision about uncertain cash flows.
 At the personal level, finance is concerned with
individuals’ decisions about how much of their earnings
they spend, how much they save, and how they invest
their savings.

WHAT IS In a business context, finance involves the same types

FINANCE? of decisions: how firms raise money from investors, how
firms invest money in an attempt to earn a profit, and
how they decide whether to reinvest profits in the
business or distribute them back to investors.
 WHAT IS FINANCE? CONTINUED

Related to definition of finance , there are two main concepts that we should
illustrate:
A. Financial theory consists of: the set of concepts that help to organize one’s
thinking about how to allocate resources over time. – the set of quantitative models
used to help evaluate alternatives, make decisions, and implement them.
B. Financial Services: is the area of finance concerned with the design and delivery
of advice and financial products to individuals, businesses, and governments.
• Career opportunities include banking, investments, and insurance
 WHAT IS MANAGERIAL FINANCE?

Managerial finance is concerned with the duties of the financial manager

working in a business.

Financial managers administer the financial affairs of all types of businesses

—private and public, large and small, profit-seeking and not-for-profit.

They perform such tasks as developing a financial plan or budget, extending

credit to customers, evaluating proposed large expenditures, and raising money
to fund the firm’s operations
 WHAT IS MANAGERIAL FINANCE?

In sum the financial manager:

1. Determines the best repayment structure for borrowed funds.
2. Ensures that debt obligations are met on time.
3. Ensures that sufficient funds are available for carrying out daily
operations.
4. Evaluate the current position of the corporation
…..helps the corporation to take a decision about how to allocate its resources
efficiently keeping into mind the goals of achieving profits and met all its obligations
 WHAT IS THE FINANCIAL SYSTEM?

Any Financial System is composed of: Markets, Intermediaries, Financial

services firms and other institutions used to carry out the financial
decisions of households, business firms, and governments.
Funds may flow from the surplus unit to the deficit unit either:

Directly Indirectly
Through markets Through intermediaries
 FUNCTION OF FINANCIAL MARKETS

Perform the essential function of channeling funds from economic players that have
saved surplus funds to those that have a shortage of funds {see the figure}
Direct finance: borrowers borrow funds directly from lenders in financial markets by
selling them securities (also called financial instruments)
Indirect finance: borrowers borrow funds indirectly from lenders through financial
intermediaries (such as banks)
Note: Securities are assets for the person who buys them but liabilities (debts) for
individual or firm that sells (issues) them
 FLOWS OF
FUNDS
THROUGH THE
FINANCIAL
SYSTEM
 FLOW OF FUNDS: CONTINUED

Financial Intermediary: A firm whose primary business is to provide financial services

and financial products.
– Examples:
• bank (checking accounts, loans, CDs …)
• investment company (mutual funds …)
• insurance company (term life insurance …)
Financial Markets: Forums where buyers and sellers of financial assets meet.
 LEGAL FORMS OF BUSINESS ORGANIZATION

Sole Proprietorship Partnership Corporation

……is a business owned by ……is a business owned by two …….is an entity created by law and
or more people and operated for have the legal powers of an individual
one person (individual or a
profit and sharing the equity. in that it can make contracts, and
family) and operated for his
acquire property in its own name.
or her own profit. – A partnership agreement
– a legal entity, distinct from its
usually stipulates how decisions
- The assets and liabilities ownership.
and profits (losses) are shared.
are the personal assets and – may own property, borrow and
liabilities of the proprietor. – Changes in ownership enter into legal contracts
involve dissolving the old
- Unlimited liability – not dissolved when shares are
partnership and forming a new
transferred.
- Low administrative costs one
– pays corporate taxes, resulting in
double taxation of owner
 LEGAL
FORMS OF
BUSINESS
ORGANIZATION
 MANAGERIAL FINANCE FUNCTION
• The size and importance of the managerial finance function depends on the size of the
firm.

• In small firms, the finance function is generally performed by the accounting

department.

• As a firm grows, the finance function typically evolves into a separate department linked
directly to the company president or CEO through the chief financial officer (CFO)
 MANAGERIAL FINANCE FUNCTION: CONTINUED
1- Relationship to Economics:
• The field of finance is closely related to economics.
• Financial managers must understand the economic framework and be alert to the consequences of
varying levels of economic activity and changes in economic policy.
• They must also be able to use economic theories as guidelines for efficient business operation.
The primary economic principal used by financial managers is marginal cost-benefit analysis which says
that financial decisions should be implemented only when added benefits exceed added costs.
 MANAGERIAL FINANCE FUNCTION:
CONTINUED
2- Relationship to Accounting:
• The firm’s finance and accounting activities are closely related and generally overlap.
• In small firms accountants often carry out the finance function, and in large firms financial
analysts often help compile accounting information.
• 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.
 MANAGERIAL FINANCE FUNCTION:
RELATION TO ACCOUNTING CONTINUED
• The significance of this difference can be illustrated using the following simple example.
• The Nassima Corporation experienced the following activity last year:

Sales $100,000 (products 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.
 MANAGERIAL FINANCE FUNCTION:
RELATION TO ACCOUNTING CONTINUED

Income Statement Summary

Accrual Cash

Sales $100,000 $0

Less: Costs $80,000 $80,000

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

 MANAGERIAL FINANCE FUNCTION:
RELATION TO ACCOUNTING CONTINUED
Finance and accounting also differ with respect to decision-making:
– Accountants devote most of their attention to the collection and
presentation of financial data .

– Financial managers evaluate the accounting statements, develop

additional data, and make decisions on the basis of their assessment of the
associated returns and risks.
 THE GOAL OF THE FIRM
• In finance, the goal of the firm is always described as "maximization of shareholders' wealth".
• The question is” Why not maximize the profit”?, this is mainly because setting “profit maximization”
as firm`s objective is not accurate and is rarely used for these 3 reasons:
1-Timing is important—the receipt of funds as early as possible rather than later is preferred. So if 2
projects provide the shareholders with the same profits but project A provide it at the beginning of the
year but project B provide it at the end of the year we cannot tell that both projects are equally good
because actually project A is preferred than B
 THE GOAL OF THE FIRM: CONTINUED

2- Profits do not necessarily result in cash flows available to stockholders.

3- Profit maximization fails to account for risk: the managers should find the optimal
combination between risk and return that maximize the shareholders` wealth
 THE GOAL OF THE FIRM: CONTINUED
• Maximizing shareholders` wealth means that the management is supposed to
maximize the present value of the return that is expected to be received by the
shareholders in the future.
• Therefore; all problems related to the objective in maximizing profits can be
overcome when the manager set his priority to maximize the shareholders wealth,
as it take into account any difficulties in the real business world. In addition the
shareholders are the actual owners of the company.
 CLASS ACTIVITY

1) Financial managers actively manage the financial affairs of many types of business-
financial and non-financial, private and public, for-profit and not-for-profit.
2) Managerial finance is concerned with design and delivery of advice and financial
products to individuals, business, and government.
3) The wealth of corporate owners is measured by the share price of the stock.
 CLASS ACTIVITY

4) The profit maximization goal ignores the timing of returns, does not directly consider
cash flows, and ignores risk.

5)In partnerships, owners have unlimited liability and may have to cover debts of other
less financially sound partners.

6) The sole proprietor has unlimited liability; his or her total investment in the business,
but not his or her personal assets, can be taken to satisfy creditors.
 CLASS ACTIVITY

1) The part of finance concerned with design and delivery of advice and financial products to individuals,
business, and government is called
A) Managerial Finance.
B) Financial Manager.
C) Financial Services.
D) none of the above.
 CLASS ACTIVITY

2) Managerial finance
A) involves tasks such as budgeting, financial forecasting, cash management, and funds procurement.
B) involves the design and delivery of advice and financial products.
C) recognizes funds on an accrual basis.
D) devotes the majority of its attention to the collection and presentation of financial data.
 CLASS ACTIVITY

3) Finance can be defined as

A) the system of debits and credits.
B) the science of the production, distribution, and consumption of wealth.
C) the art and science of managing money.
D) the art of merchandising products and services.
 CLASS ACTIVITY
4) Which of the following legal forms of organization is most expensive to organize?
A) Sole proprietorships.
B) Partnerships.
C) Corporations.
D) Limited partnership.
 CLASS ACTIVITY
5) A major weakness of a partnership is
A) limited liability.
B) difficulty liquidating or transferring ownership.
C) access to capital markets.
D) low organizational costs.
Thank you