CHAPTER 1
The Role of
Managerial Finance
,FINANCE AND THE FIRM
finance: The science and art of how individuals and firms raise, allocate, and invest money.
managerial finance: Concerns the duties of the financial manager in a business.
WHAT IS A FIRM?
- a firm is a business organization that sells goods or services
- The goal is to satisfy customers
- Managers must inspire and motivate employees
earnings per share (EPS)
The amount earned during the period on behalf of each outstanding share of stock,
calculated by dividing the period’s total earnings available for the firm’s stockholders by
the number of shares of stock outstanding.
risk
The chance that actual outcomes may differ from those expected.
stakeholders
Groups such as employees, customers, suppliers, creditors, and others who have a direct
economic link to the firm but are not owners
business ethics
Standards of conduct or moral judgement that apply to persons engaged in commerce.
investment decisions
Decisions that focus on how a company will spend money on long-term projects that
ultimately determine whether the firm creates value for its owners.
financing decisions
Decisions that determine how companies raise the money they need to pursue
investment opportunities.
capital
The money that firms raise to finance their activities.
working capital decisions
Decisions that refer to the management of a firm’s short-term resources
treasurer
A key financial manager, who manages the firm’s cash, oversees its pension plans, and
manages key risks.
director of risk management
Works with the treasurer to manage risks that the firm faces related to movements in
exchange rates, commodity prices, and interest rates.
controller
The firm’s chief accountant, who is responsible for the firm’s accounting activities, such
as corporate accounting, tax management, financial accounting, and cost accounting
MARGINAL COST–BENEFIT ANALYSIS
marginal cost–benefit analysis Economic principle that states that financial decisions should be made
and actions taken only when the marginal benefits exceed the marginal costs
, accrual basis
Preparation of financial statements that recognizes revenues and expenses when they occur
(regardless of when cash actually exchanges hands).
matching principle
GAAP accrual accounting rule that says a firm should report expenses in the same period in
which it earns the related revenue, regardless of when the expenses are paid or the revenues
collected.
cash basis
Recognizes revenues and expenses only when actual inflows and outflows of cash occur.
LEGAL FORMS OF A BUSINESS:
sole proprietorship A for-profit business owned by one person.
unlimited liability The liabilities of the business are the owner’s responsibility, and creditors
can make claims against the owner’s personal assets if the business fails to pay its debts.
partnership A business owned by two or more people and operated for profit.
limited liability A legal provision that limits owners’ business liability to the amount they have
invested in the business.
corporation A legal business entity with rights and duties similar to those of individuals but
with a legal identity distinct from its owners
stockholders
The owners of a corporation, whose ownership, or equity, takes the form of common stock
or, less frequently, preferred stock.
stock
A security that represents an ownership interest in a corporation.
cash dividends
Periodic distributions of cash to the stockholders.
, marginal tax rate The tax rate that applies to the next dollar of income earned.
average tax rate The average tax rate paid per dollar of taxable income.
ordinary income Income earned by a business through the sale of goods or services.
capital gain Income earned by selling an asset for more than it cost.
AGENCY PROBLEMS AND AGENCY COSTS
agency costs The costs that shareholders bear due to managers’ pursuit of their own interests
principal–agent problem A problem that arises when the owners (principals) and managers (agents)
of a firm are not the same people, and the agents fail to act in the interest of the principals.
CORPORATE GOVERNANCE
corporate governance The rules, processes, and laws by which companies are operated, controlled,
and regulated.
stock options Securities that allow managers to buy shares of stock at a fixed price
restricted stock Shares of stock paid out as part of a compensation package that do not fully transfer
from the company to the employee until certain conditions are met.
EXTERNAL CORPORATE GOVERNANCE MECHANISMS
individual investors Investors who own relatively small quantities of shares to meet personal
investment goals.
institutional investors Investment professionals such as banks, insurance companies, mutual funds,
and pension funds that are paid to manage and hold large quantities of securities on behalf of others.
activist investors Investors who specialize in influencing management.
The Role of
Managerial Finance
,FINANCE AND THE FIRM
finance: The science and art of how individuals and firms raise, allocate, and invest money.
managerial finance: Concerns the duties of the financial manager in a business.
WHAT IS A FIRM?
- a firm is a business organization that sells goods or services
- The goal is to satisfy customers
- Managers must inspire and motivate employees
earnings per share (EPS)
The amount earned during the period on behalf of each outstanding share of stock,
calculated by dividing the period’s total earnings available for the firm’s stockholders by
the number of shares of stock outstanding.
risk
The chance that actual outcomes may differ from those expected.
stakeholders
Groups such as employees, customers, suppliers, creditors, and others who have a direct
economic link to the firm but are not owners
business ethics
Standards of conduct or moral judgement that apply to persons engaged in commerce.
investment decisions
Decisions that focus on how a company will spend money on long-term projects that
ultimately determine whether the firm creates value for its owners.
financing decisions
Decisions that determine how companies raise the money they need to pursue
investment opportunities.
capital
The money that firms raise to finance their activities.
working capital decisions
Decisions that refer to the management of a firm’s short-term resources
treasurer
A key financial manager, who manages the firm’s cash, oversees its pension plans, and
manages key risks.
director of risk management
Works with the treasurer to manage risks that the firm faces related to movements in
exchange rates, commodity prices, and interest rates.
controller
The firm’s chief accountant, who is responsible for the firm’s accounting activities, such
as corporate accounting, tax management, financial accounting, and cost accounting
MARGINAL COST–BENEFIT ANALYSIS
marginal cost–benefit analysis Economic principle that states that financial decisions should be made
and actions taken only when the marginal benefits exceed the marginal costs
, accrual basis
Preparation of financial statements that recognizes revenues and expenses when they occur
(regardless of when cash actually exchanges hands).
matching principle
GAAP accrual accounting rule that says a firm should report expenses in the same period in
which it earns the related revenue, regardless of when the expenses are paid or the revenues
collected.
cash basis
Recognizes revenues and expenses only when actual inflows and outflows of cash occur.
LEGAL FORMS OF A BUSINESS:
sole proprietorship A for-profit business owned by one person.
unlimited liability The liabilities of the business are the owner’s responsibility, and creditors
can make claims against the owner’s personal assets if the business fails to pay its debts.
partnership A business owned by two or more people and operated for profit.
limited liability A legal provision that limits owners’ business liability to the amount they have
invested in the business.
corporation A legal business entity with rights and duties similar to those of individuals but
with a legal identity distinct from its owners
stockholders
The owners of a corporation, whose ownership, or equity, takes the form of common stock
or, less frequently, preferred stock.
stock
A security that represents an ownership interest in a corporation.
cash dividends
Periodic distributions of cash to the stockholders.
, marginal tax rate The tax rate that applies to the next dollar of income earned.
average tax rate The average tax rate paid per dollar of taxable income.
ordinary income Income earned by a business through the sale of goods or services.
capital gain Income earned by selling an asset for more than it cost.
AGENCY PROBLEMS AND AGENCY COSTS
agency costs The costs that shareholders bear due to managers’ pursuit of their own interests
principal–agent problem A problem that arises when the owners (principals) and managers (agents)
of a firm are not the same people, and the agents fail to act in the interest of the principals.
CORPORATE GOVERNANCE
corporate governance The rules, processes, and laws by which companies are operated, controlled,
and regulated.
stock options Securities that allow managers to buy shares of stock at a fixed price
restricted stock Shares of stock paid out as part of a compensation package that do not fully transfer
from the company to the employee until certain conditions are met.
EXTERNAL CORPORATE GOVERNANCE MECHANISMS
individual investors Investors who own relatively small quantities of shares to meet personal
investment goals.
institutional investors Investment professionals such as banks, insurance companies, mutual funds,
and pension funds that are paid to manage and hold large quantities of securities on behalf of others.
activist investors Investors who specialize in influencing management.
