As you pursue your study of financial management, you should keep in mind that financial management is not a totally independent area in business administration. Instead, it draws heavily on related disciplines and fields of study. The most important of these are accounting and economics; in the latter discipline, both macroeconomics and microeconomics are significant. Marketing, production, human resources management, and the study of quantitative methods also have an impact on the financial management field. Each of these is discussed here.
Financial managers play the game of managing a firm’s financial and real assets and securing the funding needed to support these assets.Accountants are the game’s scorekeepers. Financial managers often turn to accounting data to assist them in making decisions. Generally a company’s accountants are responsible for developing financial reports and measures that assist its managers in assessing the past performance and future direction of the firm and in meeting certain legal obligations, such as the payment of taxes. The accountant’s role includes the entrepreneurial ISSUES
Shareholder Wealth Maximization
Entrepreneurial finance deals with the financial issues facing small businesses an important sector of the U.S. economy. Small business firms may be organized as sole proprietorships, partnerships, or corporations. According to criteria used by the Small Business Administration, over 95 percent of all business firms are considered small.
These firms account for the majority of private sector employment and nearly all of the recent net growth in new jobs. It is difficult to arrive at a precise definition of a small, or entrepreneurial, business; however, the characteristics of small business firms can be identified. In general, small businesses are not the dominant firm in the industries in which they compete, and they tend to grow more rapidly than larger firms. Small firms have limited access to the financial markets, and they often do not have the depth of specialized managerial resources available to larger firms. Small firms also have a high failure rate.
In our discussion of the goals of the firm, we concluded that the predominant goal of financial managers is to maximize shareholder wealth, as measured by the price of the firm’s stock. Many entrepreneurial corporations are closely held, and their stock trades infrequently, if ever. Other entrepreneurial firms are organized as sole proprietorships or partnerships. In these cases, there is no readily accessible external measure of performance. Consequently, these firms often rely more heavily on accounting based measures of performance to track their progress.
Accounting based measures of performance are discussed in Inspite of the lack of an objective, readily available measure of performance, the fundamental decisions made by entrepreneurs are unaltered.That is, the firm should invest resources in projects expected to earn a rate of return at least equal to the required return on those projects, considering the project’s risk. However, because many entrepreneurs are poorly diversified with respect to their personal wealth (that is, they have a large proportion of their personal wealth tied up in the firm), these owners are often more concerned about avoiding risks that could lead to financial ruin than are managers of public corporations.
As discussed earlier, in the large modern corporation, there is a concern that a firm’s managers may not always act in the interests of the owners (the agency problem). This problem is less severe in many entrepreneurial businesses because managers and owners are one and the same. An entrepreneur who consumes “excessive” perks is merely reducing his or her ability to withdraw profits from the firm. But to the extent that the manager is the owner, there is no owner manager agency problem. Of course, the potential for agency related conflicts between entrepreneurs and lenders still exists and may be greater in the closely held firm. As a consequence, many small firms find it difficult to acquire capital from lenders without also giving the lender an option on a part of the ownership in the firm or having the entrepreneur personally guarantee the loan.
Throughout this book, we will identify situations where the entrepreneurial financial management of small businesses poses special challenges. In general, we find that small firms often lack the depth of managerial talent needed to apply sophisticated financial planning techniques. Also, because significant economies of scale are often associated with using sophisticated financial management techniques, these techniques are frequently not justified on a cost benefit analysis basis in many entrepreneurial companies.
Development of financial statements, such as the balance sheet, the income statement, and the statement of cash flows.
Financial managers are primarily concerned with a firm’s cash flows, because they often determine the feasibility of certain investment and financing decisions. The financial manager refers to accounting data when making future resource allocation decisions concerning long -term investments, when managing current investments in working capital, and when making a number of other financial decisions (for example, determining the most appropriate capital structure and identifying the best and most timely sources of funds needed to support the firm’s investment programs).
In many small and medium-sized firms, the accounting function and the financial management function may be handled by the same person or group of persons. In such cases, the distinctions just identified may become blurred.
There are two areas of economics with which the financial manager must be familiar: micro-economics and macroeconomics.Microeconomics deals with the economic decisions of individuals, households, and firms, whereas macroeconomics looks at the economy as a whole.
The typical firm is heavily influenced by the overall performance of the economy and is dependent upon the money and capital markets for investment funds. Thus, financial managers should recognize and understand how monetary policies affect the cost of funds and the availability of credit. Financial managers should also be versed in fiscal policy and how it affects the economy. What the economy can be expected to do in the future is a crucial factor in generating sales forecasts as well as other types of forecasts.
The financial manager uses microeconomics when developing decision models that are likely to lead to the most efficient and successful modes of operation within the firm. Specifically, financial managers use the microeconomic concept of setting marginal cost equal to marginal revenue when making long-term investment decisions (capital budgeting) and when managing cash, inventories, and accounts receivable (working capital management).
Marketing, Production, Quantitative Methods, and Human Resources Management
We depicts the relationship between financial management and its primary supportive disciplines.Marketing, production, quantitative methods, and human resources management are indirectly related to the key day-to-day decisions made by financial managers. For example, financial managers should consider the impact of new product development and promotion plans made in the marketing area because these plans will require capital outlays and have an impact on the firm’s projected cash flows.
Similarly, changes in the production process may necessitate capital expenditures, which the firm’s financial managers must evaluate and then finance. The tools of analysis developed in the quantitative methods area are frequently helpful in analyzing complex financial management problems. Compensation policies may impact the extent of agency problems in a firm.
Financial Management Related Interview Questions
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