Now we proceed to define business finance and the financial manager's job.

What Is Business Finance?

Imagine you were to start your own business. No matter what type you started, you would have to answer the following three questions in some form or another:

1. What long-term investments should you take on? That is, what lines of business will you be in and what sorts of buildings, machinery, and equipment will you need?
2. Where will you get the long-term financing to pay for your investment? Will you bring in other owners or will you borrow the money?
3. How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

The Financial Manager

The financial management function is usually associated with a top officer of the firm, often called the chief financial officer (CFO) or vice president of finance. Figure 1.1 is a simplified organizational chart that highlights the finance activity in a large firm. As shown, the vice president of finance coordinates the activities of the treasurer and the controller. The controller's office handles cost and financial accounting, tax payments, and management information systems. The treasurer's office is responsible for managing the firm's cash and credit, its financial planning, and its capital expenditures. These treasury activities are all related to the three general questions raised above, and the chapters ahead deal primarily with these issues. Our study thus bears mostly on activities usually associated with the treasurer's office. In a smaller firm, the treasurer and controller might be the same person, and there would be only one office.

FIGURE 1.1	A simplified organizational chart.  The exact titles and organization differ from company to company.
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Financial Management Decisions

As our discussion above suggests, the financial manager must be concerned with three basic types of questions. We consider these in greater detail next.

Capital Budgeting   The first question concerns the firm's long-term investments. The process of planning and managing a firm's long-term investments is called capital budgetingThe process of planning and managing a firm's long-term investments.. In capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. Loosely speaking, this means that the value of the cash flow generated by an asset exceeds the cost of that asset.

Regardless of the specific investment under consideration, financial managers must be concerned with how much cash they expect to receive, when they expect to receive it, and how likely they are to receive it. Evaluating the size, timing, and risk of future cash flows is the essence of capital budgeting. In fact, whenever we evaluate a business decision, the size, timing, and risk of the cash flows will be, by far, the most important things we will consider.

Capital Structure   The second question for the financial manager concerns how the firm obtains the financing it needs to support its long-term investments. A firm's capital structureThe mixture of debt and equity maintained by a firm. (or financial structure) refers to the specific mixture of long-term debt and equity the firm uses to finance its operations. The financial manager has two concerns in this area. First: How much should the firm borrow? Second: What are the least expensive sources of funds for the firm?

In addition to deciding on the financing mix, the financial manager has to decide exactly how and where to raise the money. The expenses associated with raising long-term financing can be considerable, so different possibilities must be carefully evaluated. Also, businesses borrow money from a variety of lenders in a number of different ways. Choosing among lenders and among loan types is another job handled by the financial manager.

Working Capital Management   The third question concerns working capitalA firm's short-term assets and liabilities. management. The term working capital refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. Managing the firm's working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. This involves a number of activities related to the firm's receipt and disbursement of cash.

Some questions about working capital that must be answered are the following: (1) How much cash and inventory should we keep on hand? (2) Should we sell on credit to our customers? (3) How will we obtain any needed short-term financing? If we borrow in the short term, how and where should we do it? This is just a small sample of the issues that arise in managing a firm's working capital.

Conclusion   The three areas of corporate financial management we have described—capital budgeting, capital structure, and working capital management—are very broad categories. Each includes a rich variety of topics, and we have indicated only a few of the questions that arise in the different areas. The chapters ahead contain greater detail.