Chapter 1

FIN2102 & FIN1100 FINANCIAL MANAGEMENT
CHAPTER 1
INTRO TO FINANCE, FINANCE OBJECTIVES AND ROLES OF

FINANCIAL MANAGEMENT
LEARNING OBJECTIVES
1. State the importance of finance in your personal and professional lives

and identify the three primary business decisions that financial
managers make.
2. Identify the key differences between three major legal forms of
business.
3. Describe the role of the financial manager within the firm and the goal
for making financial choices.
WHAT IS FINANCE?
 Finance can be defined as science and

art of managing money.
 A study of how people and corporate
evaluate investments and raise capital to
fund them.
 Finance is concerned with the process,
institutions, markets, and instruments
involved in the transfer of money among
individuals, business and government.
Further info: https://youtu.be/JEVirFX6goE

WHY STUDY FINANCE
Knowledge of financial tools is critical to make good decisions in both business
world and personal level.
BUSINESS CONTEXT PERSONAL LEVEL

• It involves the decisions: how • It is concerned with individuals’
firms raise money from investors, decisions about how much of their
how firms invest money in an earnings they spend, how much they
attempt to earn a profit, and how save, and how they invest their money.
they decide whether to reinvest • Example
profits in the business or • Borrowing money for a new car
distribute them back to investors.
• Refinancing home mortgage at
lower rate
• Making credit card or student loan
payments
• Saving for retirement.
CAREER OPPORTUNITIES IN FINANCE
5
WHAT IS FINANCIAL MANAGEMENT?
 Financial management is concerned with the efficient acquisition and

consumption of both short- and long-term financial resources, to ensure the
objectives of the company are achieved.
 Three questions addressed by the study of finance (corporation):

1. What long-term investments should the firm undertake? (capital budgeting
decisions)
2. How should the firm fund these investments? (capital structure decisions)
3. How can the firm best manage its cash flows as they arise in its day-to-day
operations? (working capital management decisions)
6
WHAT IS FINANCIAL MANAGEMENT? - (CONT.)
7
BUSINESS ORGANIZATIONAL FORMS
Sole-proprietorship
Partnership
Corporation
https://www.ssm.com.my/Pages/Home.aspx
8
SOLE PROPRIETORSHIP
 It is a business owned by a single

individual that is entitled to all the firm’s
profits and is responsible for all the firm’s
debt.
 There is no separation between the
business and the owner when it comes to
debts or being sued.
 Sole proprietorships are generally financed
by personal loans from family and friends
and business loans from banks.
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SOLE PROPRIETORSHIP (CONT.)
ADVANTAGES DISADVANTAGES
 Easy to start  Personally liable for the
 No need to consult others while business debts
making decisions  Ceases on the death of the
 Single taxation- personal tax proprietor
 Limited ability to raise funds
10
PARTNERSHIP
 A general partnership is an association of

two or more persons who come together as
co-owners for the purpose of operating a
business for profit.
 There is no separation between the
partnership and the owners with respect to
debts or being sued.
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PARTNERSHIP (CONT.)
 Relatively easy to start.  Partners jointly share unlimited
 Single taxation- personal tax liability.
 Access to funds from multiple  Partnership is dissolved when
sources or partners one partner die/withdraw.
12
CORPORATION
Corporation is “an artificial being, invisible,
intangible, and existing only in the
contemplation of the law.”
Corporation can individually sue and be sued,
purchase, sell or own property, and its personnel
are subject to criminal punishment for crimes
committed in the name of the corporation.
Corporation is legally owned by its current
stockholders.
The Board of directors are elected by the firm’s
shareholders. One responsibility of the board of
directors is to appoint the senior management of
the firm.
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CORPORATION (CONT.)
 Liability of owners limited to  Difficult to establish - greater
invested funds regulation
 Life of corporation is not tied to  Double taxation
the owner
 Easier to transfer ownership
 Easier to raise capital
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SUMMARY
Strengths and Weaknesses of the Common Legal Forms of

Business Organization
15
HOW DOES FINANCE FIT INTO THE FIRM’S
ORGANIZATIONAL STRUCTURE?
 In a corporation, the Chief
Financial Officer (CFO) is
responsible for managing the
firm’s financial affairs.
 Figure 1-2 shows how the
finance function fits into a
firm’s organizational chart.
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THE GOAL OF THE FIRM
 The goal of the financial manager must be consistent with the mission
of the corporation.
 What is the generally accepted mission of a corporation?
To maximize firm value or shareholder’s wealth

(as measured by share prices)
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GOAL OF THE FIRM: MAXIMIZE 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 stock valuation equation:
level & timing of

cash flows
Share Price = Future Dividends
Required Return risk of cash flows
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PROFITS VERSUS CASH
 It is possible for a firm to report profits but have no cash.

 For example, if all sales are on credit, the firm may report profits even
though no cash is being generated.
 Financial decisions in a firm should consider “incremental cash flow”
i.e. the difference between the cash flows the company will produce
with the potential new investment it’s thinking about making and what it
would make without the investment.
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CORPORATE MISSION
 “To achieve sustainable growth, we have established a vision with clear

goals: Maximizing return to shareholders while being mindful of our overall
responsibilities” (part of Coca-Cola’s mission statement)
 “Our final responsibility is to our stockholders …when we operate according
to these principles, the stockholders should realize a fair return” (part of
Johnson & Johnson’s credo)
 “Optimize for the long-term rather than trying to produce smooth earnings
for each quarter” (Google)
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CORPORATE MISSION (CONT.)
 While managers have to cater to all the stakeholders (such as consumers,

employees, suppliers etc.), they need to pay particular attention to the
owners of the corporation i.e. shareholders.
o Shareholders are the owners of the firm. Firms come into being due to
the contributions and risks taken on by the shareholders.
o Shareholders are protected by the provisions of the Companies Act,
1965.
o Finance managers owe some kind of allegiance to the ‘owners’ of the
firm.
 If managers fail to pursue shareholder wealth maximization, they will lose
the support of investors and lenders. The business may cease to exist and
ultimately, the managers will lose their jobs!
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Decision rule for managers: only take actions that are expected to increase the share
price.
THE ROLE OF ETHICS
 Ethics programs seek to:

o maintain a positive corporate image
o build shareholder confidence
o gain the loyalty and respect of all
stakeholders
 The expected result of such programs is to
positively affect the firm's share price.
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AGENCY CONSIDERATIONS IN CORPORATE FINANCE
Agency relationship exists when one or more persons

(known as the principal) contracts with one or more
persons (the agent) to make decisions on their behalf.
In a corporation, the managers are the agents and the
stockholders are the principal.
Agency problems arise when there is conflict of
interest between the stockholders and the managers.
Such problems are likely to arise more when the
managers have little or no ownership in the firm.
o Examples: Not pursuing risky project for fear of losing
jobs, stealing, expensive perks.
Agency costs arise from agency problems that are
borne by shareholders and represent a loss of
shareholder wealth.
Further info: https://www.youtube.com/watch?v=6-w3RY0tc7o
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HOW TO 1. Monitoring - Reports, Meetings, Auditors,
REDUCE board of directors, financial markets
bankers, credit agencies
AGENCY
PROBLEMS? 2. Compensation plans - Performance based
bonus, salary, stock options, benefits.
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FIN2102 & FIN1100 FINANCIAL MANAGEMENT

INTRO TO FINANCE, FINANCE OBJECTIVES AND ROLES OF

1. State the importance of finance in your personal and professional lives

 Finance can be defined as science and

Further info: https://youtu.be/JEVirFX6goE

BUSINESS CONTEXT PERSONAL LEVEL

 Financial management is concerned with the efficient acquisition and

 Three questions addressed by the study of finance (corporation):

 It is a business owned by a single

 A general partnership is an association of

Strengths and Weaknesses of the Common Legal Forms of

To maximize firm value or shareholder’s wealth

level & timing of

 It is possible for a firm to report profits but have no cash.

 “To achieve sustainable growth, we have established a vision with clear

 While managers have to cater to all the stakeholders (such as consumers,

 Ethics programs seek to:

Agency relationship exists when one or more persons

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