FOUNDATIONS OF FINANCIAL MANAGEMENT PART 1 INTRODUCTION Lecturer: Renee, Ren Gu Financial Management. 2013. South China University of Technology 1 What is Corporation? 1.1 Forms of Organization Sole proprietorship Partnership Corporation First Type: Sole Proprietorship Advantages Disadvantages Easiest to start Owners must bear all costs Least regulated No others to share burden or add expertise Single owner keeps all the profits Unlimited liability for debts and malpractice Taxed once as personal income Difficult to sell ownership interest Second Type: Partnership Advantages Disadvantages Relatively easy to start Each partner has unlimited liability for debt and malpractice Pooled expertise and resources Partnership dissolves when one partner dies or wishes to sell More capital available Difficult to transfer ownership Income taxed once as personal income Share profits with partners Third type: Corporation Advantages Disadvantages Limited liability for debts and malpractice Separation of ownership and management Separation of ownership and management Double taxation (income taxed at the corporate rate; dividends taxed at personal rate) Easier to raise capital Responsible to shareholders Transfer of ownership is easy Requires and attorney to establish 2 What is FINANCIAL MANAGEMENT ? 2.1 Definition Taking a commercial business as the most common organizational structure. Financial management entails planning for the future of a person or a business enterprise with the aim of ensuring a positive cash flow. Corporations Financial Management 2.2 Structure of the KNOWLEDGE Corporate finance includes Corporate finance includes 2.3 Who is financial manager? Functions of financial manager:Functions of financial manager: to allocate funds to current and fixed assetsto allocate funds to current and fixed assets to obtain the best mix of financing alternativesto obtain the best mix of financing alternatives to develop an appropriate dividend policy within to develop an appropriate dividend policy within the context of the firms objectives. the context of the firms objectives. These functions are performed on a day-to-day basis as well as through infrequent use of the capital markets to acquire new funds. Financial managers try to answer some or all of these questions: Capital budgeting What long-term investments or projects should the business take on? Capital structure How should we pay for our assets? Should we use debt or equity? Working capital management How do we manage the day-to-day finances of the firm? Corporation Operations (Real Assets) Financial Managers Financial Markets (Investors) Trade-off The Risk-Return Tradeoff Credit management Inventory control Receipt and disbursement of fund Daily Stock issue Bond issue Capital budgeting Dividend decision Occasional Profitability Risk 2.4 Financial Managers Career Career opportunities: Financial market & institute Bankers Insurers Investment Stockbroker Financial analyst Portfolio manager Investment banker Financial consultant Personal financial planner Financial management Corporate financial officer TPO Financial Manager: Chief Financial Officer (CFO) The top financial manager within a firm is usually the Chief Financial Officer (CFO) Treasurer oversees cash management, credit management, capital expenditures and financial planning Controller oversees taxes, cost accounting, financial accounting and data processing Given the three basic forms of organization, we might wonder if the same goals exist? Sole proprietorship Partnership Corporation 3.1 Goals of Financial Management Profit Maximization There are some serious drawbacks to profit maximization as the primary goal of the firm. A change in profit may also represent a change in risk. The goal of maximizing profit fails to consider the timing of the benefits. The goal of maximizing profit suffers the impossible task of accurately measuring the profit. Economic Profit For a period the economic profit is the amount earned by a business after deducting the operating expenses and a charge for the opportunity cost of the capital employed. Maximizing Shareholder Wealth Corporations goal must cope with the Share holders goal: Share holders are the owners of a corporation, and they purchase stocks because they are looking for a financial return. Managers goal should be consistent with Shareholders: In most cases, shareholders elect the board of directors , who then hire managers to run the corporation on a day-to-day basis. Since managers are working on behalf of shareholders, so they should maximizing the shareholder wealth. Maximizing shareholder wealth is maximizing the price of the firms common stock. Drawbacks of the goal: Much of what affects stock price is beyond managements direct control. Stock prices are affected by many fa