Finance Chapter 1

The financial manager is responsible
for making decisions that are in the best interests of the firm’s owners.
The financial manager should make decisions that
maximize the value of the owners’ stock.
Maximizing the value of the owners’ stock helps
maximize the owners’ wealth
Wealth is the
economic value of the assets the owner possesses
A stakeholder is someone
other than an owner who has a claim on the cash flows of the firm
To produce its products or services
a new firm needs to acquire a variety of assets
Long-term assets 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 for the firm’s owners
. The decision-making process through which the firm purchases productive assets is called
capital budgeting
Capital budget is
one of the most important decision processes in a firm.
Financing decisions determine
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.
Equity consists of
capital contributions by the owners plus cash flows that have been reinvested in the firm.
After the productive assets have been purchased and the business is operating, the managers of the firm will try to
produce products at the lowest possible cost while maintaining quality
Day-to-day finances must be managed so that the firm
will have sufficient cash on hand to pay salaries, purchase supplies, maintain inventories, pay taxes, and cover the myriad of other expenses necessary to run a business
The management of current assets, such as money owed by customers who purchase on credit, inventory, and current liabilities, such as money owed to suppliers, is called
working capital management.
A firm is successful when these cash inflows exceed the cash outflows, the managers of the firm can pay the remaining cash, called residual cash flows , to
the owners as a cash dividend, or reinvest the cash in the business.
The reinvestment of cash flows (earnings) is
the most fundamental way that businesses grow in size
A firm is unprofitable when it
fails to generate sufficient cash inflows to pay operating expenses, creditors, and taxes.
Three Fundamental Decisions in Financial Management
1. Capital budgeting decisions
2. Financing decisions
3. Working capital management decisions
Capital budgeting decisions
identify the productive assets the firm should buy
Financing decisions
determine how the firm should finance or pay for assets
Working capital management decisions
Determine how day-to-day financial matters should be managed so that the firm can pay its bills, and how surplus cash should be invested.
A firm’s capital budget is
a list of the productive (capital) assets that management wants to purchase over a budget cycle, typically one year.
The capital budgeting decision process addresses
which productive assets the firm should purchase and how much money the firm can afford to spend.
The fundamental question in capital budgeting is
Which productive assets should the firm purchase?
Productive assets, which are long term in nature, are financed by
long-term borrowing, equity investment, or both.
A major advantage of debt financing is that
debt payments are tax deductible for many corporations.
Equity has no
The mix of debt and equity on the balance sheet is known as
a firm’s capital structure .
The dollar difference between a firm’s total current assets and its total current liabilities is called its
net working capital