M01_GITM.4133_12_SE_C01.QXD 10/24/07 4:29 PM Page 2 1 The Role and Environment of Managerial Finance Why This Chapter Learning Goals Matters to You LG Define finance, its major areas and In Your Professional Life 1 opportunities, and the legal forms Accounting: You need to understand the relationships between the of business organization. firm’s accounting and finance functions; how the financial statements you prepare will be used; business ethics; agency costs and why the LG Describe the managerial finance firm must bear them; and how to calculate the tax effects of proposed 2 function and its relationship to transactions. economics and accounting. Information systems: You need to understand the organization of the firm; why finance personnel require both historical and projected data; LG Identify the primary activities of the and what data are necessary for determining the firm’s tax liability. 3 financial manager. Management: You need to understand the legal forms of business LG Explain the goal of the firm, organization; the tasks that will be performed by finance personnel; 4 corporate governance, the role of the goal of the firm; management compensation; ethics in the firm; the agency problem; and the role of financial institutions and markets. ethics, and the agency issue. Marketing: You need to understand how the activities you pursue LG Understand financial institutions will be affected by the finance function, such as the firm’s cash and 5 and markets, and the role they play credit management policies; ethical behaviors; and the role of financial in managerial finance. markets in raising capital. Operations: You need to understand the organization of the firm and LG Discuss business taxes and their of the finance function in particular; why maximizing profit is not the 6 importance in financial decisions. main goal of the firm; the role of financial institutions and markets in financing; and ethics and the agency problem. In Your Personal Life Many of the principles of managerial finance apply to your personal life: to making purchase and sale transactions, borrowing money, and saving and investing to achieve financial goals. These actions require you to interact with financial institutions and markets. You also need to consider the impact of taxes on your financial plans. Learning the basics of mana- gerial finance can help you manage your personal finances effectively. 2 M01_GITM.4133_12_SE_C01.QXD 10/24/07 4:29 PM Page 3 Starbucks A Taste for Growth ometimes it seems that there’s a Starbucks Son every corner—and now in supermarkets and hospitals too. The company that revolutionized the way we think about coffee now has more than 13,000 retail locations worldwide. Expansion in the international market is a key element in the company’s long-term goal of reaching 40,000 (20,000 U.S. and 20,000 international) retail out- lets. By early 2007, Starbucks had retail outlets in 39 countries and plans to open its first stores in Russia and China. The chain’s success is tied to somewhat unusual business strategies. Its mission statement emphasizes, first, creating a better work environment for employees. (Starbucks was one of the first companies to offer part-time employees health benefits.) Next in the mission statement are the goals of satisfying customers and promoting good corporate citizenship within its communi- ties. Profits are among the last of the company’s stated guiding principles. Starbucks’ bond with employees and customers has translated into sales and earnings as strong as its coffee. Sales growth for the 5-year period 2002 to 2006 averaged more than 24 percent compounded per year, and growth in earnings averaged more than 25 percent per year. A share of Starbucks’ stock purchased at the start of 1997 increased in value by 25.7 percent per year over the next 10 years, easily beating the S&P 500 return of 6.7 percent per year. Accomplishing its business objectives while building shareholder value requires that Starbucks practices sound financial management—raising funds to open new stores and build more roasting plants, deciding when and where to put them, managing cash collections, reducing pur- chasing costs, and dealing with the fluctuations in the value of One potential drawback to foreign currency and other risks as it buys coffee beans and a growth strategy is market expands overseas. saturation and slower same- Like Starbucks, every company must deal with many store sales growth. How different issues to keep its financial condition solid. Chapter 1 might Starbucks combat these potential problems? introduces managerial finance and its key role in helping an organization meet its financial and business objectives. 3 M01_GITM.4133_12_SE_C01.QXD 10/24/07 4:29 PM Page 4 4 PART ONE Introduction to Managerial Finance LG 1 1.1 Finance and Business The field of finance is broad and dynamic. It directly affects the life of every person and of every organization. There are many areas and career opportunities in the field of finance. Basic principles of finance, such as those you will learn in this text- book, can be universally applied in business organizations of different types. In addition, many of these principles are applicable to your personal financial life. What Is Finance? finance Finance can be defined as the art and science of managing money. Virtually all The art and science of individuals and organizations earn or raise money and spend or invest money. managing money. Finance is concerned with the process, institutions, markets, and instruments involved in the transfer of money among individuals, businesses, and govern- ments. Most adults will benefit from an understanding of finance, which will enable them to make better personal financial decisions. Those who work in non- financial jobs will benefit by being able to interact effectively with the firm’s financial personnel, processes, and procedures. Major Areas and Opportunities in Finance The major areas of finance can be summarized by reviewing the career opportu- nities in finance. These opportunities can, for convenience, be divided into two broad areas: financial services and managerial finance. Financial Services financial services Financial services is the area of finance concerned with the design and delivery of The area of finance concerned advice and financial products to individuals, business, and government. It with the design and delivery involves a variety of interesting career opportunities within the areas of banking of advice and financial products to individuals, and related institutions, personal financial planning, investments, real estate, and business, and insurance. Career opportunities available in each of these areas are described at government. this textbook’s website. Managerial Finance managerial finance Managerial finance is concerned with the duties of the financial manager in the Concerns the duties of the business firm. Financial managers actively manage the financial affairs of any financial manager in the type of businesses—financial and nonfinancial, private and public, large and business firm. small, profit-seeking and not-for-profit. They perform such varied financial tasks financial manager as planning, extending credit to customers, evaluating proposed large expendi- Actively manages the tures, and raising money to fund the firm’s operations. In recent years, changing financial affairs of any type of business, whether financial economic, competitive, and regulatory environments have increased the impor- or nonfinancial, private or tance and complexity of the financial manager’s duties. Today’s financial man- public, large or small, profit- ager is more actively involved in developing and implementing corporate seeking or not-for-profit. strategies aimed at “growing the firm” and improving its competitive position. As a result, many top executives have come from the finance area. Another ongoing trend has been the globalization of business activity. U.S. corporations have dramatically increased their sales, purchases, investments, and M01_GITM.4133_12_SE_C01.QXD 10/24/07 4:29 PM Page 5 CHAPTER 1 The Role and Environment of Managerial Finance 5 fund raising in other countries, and foreign corporations have likewise increased their corresponding activities in the United States. These changes have increased the need for financial managers who can manage cash flows in different curren- cies and protect against the risks that naturally arise from international trans- actions. Although these changes make the managerial finance function more complex, they can lead to a more rewarding and fulfilling career. Legal Forms of Business Organization The three most common legal forms of business organization are the sole propri- etorship, the partnership, and the corporation. Other specialized forms of business organization also exist. Sole proprietorships are the most numerous. However, corporations are overwhelmingly dominant with respect to business receipts and net profits. Corporations are given primary emphasis in this textbook. Sole Proprietorships sole proprietorship A sole proprietorship is a business owned by one person who operates it for his A business owned by one or her own profit. About 75 percent of all business firms are sole proprietorships. person and operated for his The typical sole proprietorship is a small business, such as a bike shop, personal or her own profit. trainer, or plumber. The majority of sole proprietorships are found in the whole- sale, retail, service, and construction industries. Typically, the proprietor, along with a few employees, operates the propri- unlimited liability etorship. He or she normally raises capital from personal resources or by bor- The condition of a sole rowing and is responsible for all business decisions. The sole proprietor has proprietorship (or general partnership) allowing the unlimited liability; his or her total wealth—not merely the amount originally owner’s total wealth to be invested—can be taken to satisfy creditors. The key strengths and weaknesses of taken to satisfy creditors. sole proprietorships are summarized in Table 1.1 (see page 6).