This document provides an overview of principles of corporate finance. It discusses three areas of finance: money and capital markets, investments, and financial management. Financial managers are responsible for forecasting and planning, investment and financing decisions, coordination and control, dealing with financial markets, and risk management. The primary goal of a corporation is shareholder wealth maximization through maximizing share price. Key principles of financial management include risk-return tradeoffs, time value of money, cash flow over profits, incremental cash flows, effects of competition, efficient capital markets, agency problems, impact of taxes, diversifiable vs. non-diversifiable risk, and ethics.
This document provides an overview of principles of corporate finance. It discusses three areas of finance: money and capital markets, investments, and financial management. Financial managers are responsible for forecasting and planning, investment and financing decisions, coordination and control, dealing with financial markets, and risk management. The primary goal of a corporation is shareholder wealth maximization through maximizing share price. Key principles of financial management include risk-return tradeoffs, time value of money, cash flow over profits, incremental cash flows, effects of competition, efficient capital markets, agency problems, impact of taxes, diversifiable vs. non-diversifiable risk, and ethics.
This document provides an overview of principles of corporate finance. It discusses three areas of finance: money and capital markets, investments, and financial management. Financial managers are responsible for forecasting and planning, investment and financing decisions, coordination and control, dealing with financial markets, and risk management. The primary goal of a corporation is shareholder wealth maximization through maximizing share price. Key principles of financial management include risk-return tradeoffs, time value of money, cash flow over profits, incremental cash flows, effects of competition, efficient capital markets, agency problems, impact of taxes, diversifiable vs. non-diversifiable risk, and ethics.
This document provides an overview of principles of corporate finance. It discusses three areas of finance: money and capital markets, investments, and financial management. Financial managers are responsible for forecasting and planning, investment and financing decisions, coordination and control, dealing with financial markets, and risk management. The primary goal of a corporation is shareholder wealth maximization through maximizing share price. Key principles of financial management include risk-return tradeoffs, time value of money, cash flow over profits, incremental cash flows, effects of competition, efficient capital markets, agency problems, impact of taxes, diversifiable vs. non-diversifiable risk, and ethics.
In this part of the Lesson, we will learn the following:
1. Areas in Finance 2. Financial Managers Functions 3. Goals of the Corporation 4. Principles that Form the Foundations of Financial Management
Areas in Finance
The field of finance is broad and dynamic. It directly affects every person and every organization, financial or non-financial institution, private or public, large or small, profit seeking or not-for-profit.
Finance can be defined as the art and science of managing money. It concerns with the process that institutions, markets, and instruments involved in the transfer of money among and between individuals, businesses, and governments.
Finance consists of three interrelated areas:
• Money and Capital markets
Money markets are the financial markets in which funds are borrowed or loaned for short periods (less than one year). In other words, money market is where you put your cash if you have surplus funds.
On the other hand, capital markets are the financial markets for stocks and for intermediate-or-long-term debt (one year or longer). In other words, capital market is where you sell or buy financial instruments.
• Investments Investment area focuses on the decisions made by both individual and institutional investors as they choose securities for their investment portfolio. The three main functions in the investments area are sales, analyzing individual securities, and determining the optimal mix of securities for a given investor.
• Financial Management Financial management is the broadest of the three areas and is important in all types of businesses including banks, financial institutions, industrial, retail firms as well as governmental operations.
Financial management involves various decision-making ranging from how to finance the company operation, determine the most appropriate types of financing for the specific projects, and costs of each type of financing. It also involves management of current asset such as cash, account receivables, and inventories as well.
Financial Managers Functions
The financial managers are responsible to the financial activities in a company and help to employ resources to maximize the value of the firm.
Activities performed by financial manager can be grouped into five categories:
1. Forecasting and Planning
Financial data is analyzed and transformed into a form that can be used to monitor and forecast the firm's financial condition. The firm position in the market is evaluated and financial analysis is carried out to determine whether additional or reduced financing is required. The managers concerned must interact with people from other departments as they look ahead and lay the plans that will shape the firm's future.
2. Investment and Financing Decisions
A successful firm normally has a high volume of sales shown in financial statements. An increase in sales requires additional investments in plant, equipment and inventory. In this case, the managers concerned need to determine the optimum sales growth rate, decide what specific assets to acquire, and then choose the best way to finance those assets according to the firm's financial position. Principles of Corporate Finance
3. Coordination and Control
The managers concerned must interact with other personnel to ensure that the firm is operated as efficiently as possible. Coordination of different activities in the firm is important to produce the required results, for example the preparation of financial statements. All business decisions have financial implications, and all managers need to take this into account.
4. Dealing with Financial Markets
Financial managers deal with the money and capital markets for investments and raising capital expenditures. This is the result of the firm's activities and objectives that must be satisfied. The financial markets where funds are raised affect the firm, securities are traded, and where investors either make or lose money.
5. Risk Management All businesses face certain kind of risks such as natural disasters, uncertainties in commodity and security market, volatile interest rates, and fluctuating foreign exchange rates. Financial manager analyzes and evaluates the business activities and the risks associated with it.
Goals of the Corporation
Shareholders are the owners of a corporation and they elect directors, who then hire managers to run the corporation daily. Since managers are working on behalf of shareholders, they should pursue policies that enhance shareholder value. Consequently, the primary goal of a corporation is shareholder wealth maximization through the maximization of share price.
Besides stockholder wealth maximization, there are other objectives that a corporation would pursue such as personal satisfaction, employee welfare and good of community. It relates to the concept of social responsibility
Principles that Form the Foundations of Financial Management
1. The Risk-Return Trade-off We won’t take on additional risk unless we expect to be compensated with additional return.
2. The Time Value of Money
A dollar received today is worth more than a dollar received in the future.
3. Cash—Not Profits—Is King
Cash Flow, not accounting profit, is used to measure wealth.
4. Incremental Cash Flows
The incremental cash flow is the difference between the projected cash flows if the project is accepted, versus what they will be, if the project is not accepted. Only what changes that counts.
5. The Curse of Competitive Markets
If an industry is generating large profits, new entrants are usually attracted. The additional competition and added capacity can result in profits being driven down to the required rate of return.
6. Efficient Capital Markets
The markets are quick, and the prices are right. Thus the values of all assets and securities at any instant in time fully reflect all available information.
7. The Agency Problem
Managers won’t work for the owners unless it is in their best interest
8. Taxes Bias Business Decisions
When a new project is evaluated, the after-tax incremental cash flows are considered.
9. All Risk is Not Equal
Some risk can be diversified away, and some cannot.
10. Ethical Behaviour Is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance Each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing to do - End of this topic -
