Introduction to Financial Management Flashcards
What are the two main components of finance?
1) Corporate Finance: Focuses on asset selection, financing decisions, and dividend policy from the company’s perspective.
2) Investment Analysis: Focuses on the risk-return trade-off, portfolio theory, and asset pricing from the investor’s perspective.
What is the primary financial objective of a company?
To maximize shareholder’s long-term value, often represented as maximizing the share price.
What is an agency relationship in finance?
- Occurs when one party (the principal, usually shareholders) delegates decision-making authority to another party (the agent, usually managers).
- Managers may prioritize their own interests over shareholders, creating potential conflicts.
How can agency conflicts be mitigated?
- Monitoring managers via the Board of Directors.
- Aligning manager incentives with shareholder interests, e.g., performance-based remuneration.
What are the three main types of business entities?
- Sole Proprietorship: Single ownership, unlimited liability, simple setup.
- Partnership: Joint ownership, shared responsibilities, joint liability.
- Corporation: Legally distinct, limited liability, perpetual existence, easier to raise capital.
What are the key advantages and disadvantages of corporations?
- Advantages: Limited liability, unlimited life, easy transfer of ownership, access to capital.
- Disadvantages: Double taxation, agency relationship issues.
What are the four rules of finance?
- Money has a time value: A dollar today is worth more than a dollar in the future.
- Risk-Return Trade-off: Higher risk demands higher returns.
- Cash Flow is King: Cash flow is prioritized over accounting profits.
- Market prices reflect information: Market prices incorporate available information efficiently.
What is the time value of money?
Money today has more value due to earning potential and inflation. It is a foundational concept for financial decision-making.
What is the risk-return trade-off?
Investors expect higher returns as compensation for taking on higher risk
What are the core functions of finance?
- Capital Budgeting: Evaluate long-term investment opportunities.
- Capital Structure: Decide on the mix of debt and equity financing.
- Working Capital Management: Manage day-to-day financial operations like cash flow and credit.
- Financial Reporting: Prepare financial statements and manage tax compliance.
What are the key focus areas for long-term and short-term finance?
- Long-term: Capital budgeting, CAPEX, and raising capital.
- Short-term: Cash and bank management, credit control, and working capital.
What does the phrase “Cash Flow is King” mean?
Cash flow reflects the actual liquidity of a company and is crucial for survival and growth, unlike accounting profits which include non-cash items.
What is risk aversion in finance?
The preference for lower risk while ensuring adequate compensation for taking risks.
What is the impact of market efficiency on financial decision-making?
In efficient markets, prices reflect all available information, making it hard to achieve consistently higher returns without taking on additional risk.
Why is the separation of ownership and management in corporations both an advantage and a disadvantage?
- Advantage: Professional management with specialized expertise.
- Disadvantage: Potential for agency conflicts between managers and shareholders.
