Financial management

Financial management, sometimes called business finance, is the specialty area of finance concerned with financial decision-making within a business entity. Often, we refer to financial management as corporate finance. However, the principles of financial management also apply to other forms of business and to government entities. Moreover, not all non-government business enterprises are corporations. Financial managers are primarily concerned with investment decisions and financing decisions within business organizations, whether that organization is a sole proprietorship, a partnership, a limited liability company, a corporation, or a governmental entity.
In Chapter 9, we provide an overview of financial management. Investment decisions are concerned with the use of funds—the buying, holding, or selling of all types of assets: Should a business purchase a new machine? Should a business introduce a new product line? Sell the old production facility? Acquire another business? Build a manufacturing plan? Maintain a higher level of inventory? Financing decisions are concerned with the procuring of funds that can be used for long-term investing and financing dayto- day operations. Should financial managers use profits raised through the firms’ revenues or distribute those profits to the owners? Should financial managers seek money from outside of the business? A company’s operations and investment can be financed from outside the business by incurring debt—such as though bank loans or the sale of bonds—or by selling ownership interests. Because each method of financing obligates the business in different ways, financing decisions are extremely important. The financing decision also involves the dividend decision, which involves how much of a company’s profit should be retained and how much to distribute to owners.
A company’s financial strategic plan is a framework of achieving its goal of maximiz ing shareholder wealth. Implementing the strategic plan requires both long-term and short-term financial planning that brings together forecasts of the company’s sales with financing and investment decision-making. Budgets are employed to manage the information used in this planning; performance measures, such as the balanced scorecard and economic value added, are used to evaluate progress toward the strategic goals. In Chapter 10, we focus on a company’s financial strategy and financial planning.
The capital structure of a firm is the mixture of debt and equity that management elects to raise in funding itself. In Chapter 11, we discuss this capital structure decision. We review different economic theories about how the firm should be financed and whether an optimal capital structure (that is, one that maximizes a firm’s value) exists. The first economic theory about firm capital structure was proposed by Franco Modigliani and Merton Miller in the 1960s. We explain this theory in the appendix to Chapter 11.
There are times when financial managers have sought to create financial instruments for financing purposes that cannot be accommodated by traditional products. Doing so involves the restructuring or repacking of cash flows and/or the use of derivative instruments. Chapter 12 explains how this is done through what is referred to as financial engineering or as it is more popularly referred to as structured finance.
In Chapters 11 and 12, we cover the financing side of financial management, whereas in Chapters 13, 14, and 15, we turn to the investment of funds. In Chapters 13 and 14, we discuss decisions involving the long-term commitment of a firm’s scarce resources in capital investments. We refer to these decisions as capital budgeting decisions. These decisions play a prominent role in determining the success of a business enterprise. Although there are capital budgeting decisions that are routine and, hence, do not alter the course or risk of a company, there are also strategic capital budgeting decisions that either affect a company’s future market position in its current product lines or permit it to expand into a new product lines in the future.
In Chapter 15, we discuss considerations in managing a firm’s current assets. Current assets are those assets that could reasonably be converted into cash within one operating cycle or one year, whichever takes longer. Current assets include cash, marketable securities, accounts receivable and inventories, and support the long-term investment decisions of a company.
In Chapter 16 we look at the risk management of a firm. The process of risk management involves determining which risks to accept, which to neutralize, and which to transfer. After providing various ways to define risk, we look at the four key processes in risk management: (1) risk identification, (2) risk assessment, (3) risk mitigation, and (4) risk transferring. The traditional process of risk management focuses on managing the risks of only parts of the business (products, departments, or divisions), ignoring the implications for the value of the firm. Today, some form of enterprise risk management is followed by large corporation. Doing so allows management to align the risk appetite and strategies across the firm, improve the quality of the firm’s risk response decisions, identify the risks across the firm, and manage the risks across the firm.