Finance Chapter 1

Topics: Asset, Corporation, Corporate finance Pages: 24 (11476 words) Published: November 13, 2014
1.1  
The Role of The Financial Manager 

LEARNING OBJECTIVE 1
Identify the key financial decisions facing the financial manager of any business firm.

The financial manager is responsible for making decisions that are in the best interests of the firm's owners, whether the firm is a start-up business with a single owner or a billion-dollar corporation owned by thousands of stockholders. The decisions made by the financial manager or owner should be one and the same. In most situations this means that the financial manager should make decisions that maximize the value of the owners' stock. This helps maximize the owners' wealth. Our underlying assumption in this book is that most people who invest in businesses do so because they want to increase their wealth. In the following discussion, we describe the responsibilities of the financial manager in a new business in order to illustrate the types of decisions that such a manager makes. Stakeholders

Before we discuss the new business, you may want to look at Exhibit 1.1, which shows the cash flows between a firm and its owners (in a corporation, the stockholders) and various stakeholders. Astakeholder is someone other than an owner who has a claim on the cash flows of the firm: managers, who want to be paid salaries and performance bonuses; other employees, who want to be paid wages;suppliers, who want to be paid for goods or services; the government, which wants the firm to pay taxes; and creditors, who want to be paid interest and principal. Stakeholders may have interests that differ from those of the owners. When this is the case, they may exert pressure on management to make decisions that benefit them. We will return to these types of conflicts of interest later in the book. For now, though, we are primarily concerned with the overall flow of cash between the firm and its stockholders and stakeholders.

EXHIBIT 1.1   
Cash Flows Between the Firm and Its Stakeholders and Owners (Stockholders)

A.   
Making business decisions is all about cash flows, because only cash can be used to pay bills and buy new assets. Cash initially flows into the firm as a result of the sale of goods or services. The firm uses these cash inflows in a number of ways: to pay wages and salaries, to buy supplies, to pay taxes, and to repay creditors.

B.   
Any cash that is left over (residual cash flows) can be reinvested in the business or paid as dividends to stockholders.

It's All about Cash Flows
To produce its products or services, a new firm needs to acquire a variety of assets. Most will be long-term assets, which are also known as productive assets. Productive assets can be tangible assets, such as equipment, machinery, or a manufacturing facility, or intangible assets, such as patents, trademarks, technical expertise, or other types of intellectual capital. Regardless of the type of asset, the firm tries to select assets that will generate the greatest cash flows. The decision-making process through which the firm purchases long-term productive assets is called capital budgeting, and it is one of the most important decision processes in a firm. Once the firm has selected its productive assets, it must raise money to pay for them. Financing decisions are concerned with the ways in which firms obtain and manage long-term financing to acquire and support their productive assets. There are two basic sources of funds: debt and equity. Every firm has some equity because equity represents ownership in the firm. It consists of capital contributions by the owners plus cash flows that have been reinvested in the firm. In addition, most firms borrow from a bank or issue some type of long-term debt to finance productive assets. After the productive assets have been purchased and the business is operating, the firm will try to produce products at the lowest possible cost while maintaining quality. This means buying raw materials at the lowest possible cost,...
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