1.3 How Finance Fits into Business Management

Marketing is responsible for selling a product or service. They do this through market research, advertising, promotions, etc. Frankly, anyone who has attempted to start their own company quickly realizes that marketing really is paramount. If you cannot sell your product or service, you do not have a company! As one of our marketing colleagues reminded us over lunch one day, "You have to have a top line to have a bottom line." By this, he meant that marketing is responsible for generating the top line of the income statement: sales. Finance has a lot of control over what happens between the top line (sales) and the bottom line (net income). Without a top line, you can't generate a bottom line.

When we think of marketing, we often think of slick print ads, funny TV commercials, or well-polished car salesmen. However, this is only one aspect of marketing. Another facet of marketing is very quantitatively-based and relies on heavy research and statistics.

Operations is typically in charge of the actual production of the product or the supplying of the service. The operations group determines the optimal way to structure the factory for optimal efficiency. Operations management is a highly quantitative field that uses math to figure out these optimalities. Within operations is a sub-field that has quickly grown in the past decade known as supply chain management (SCM). SCM is responsible for ordering the materials necessary for building the product and then shipping the product to the next player in the chain. SCM involves building networks of suppliers and customers to create value through the value chain. Wal-Mart is famous for their outstanding supply chain management, which has allowed them to be so successful. Wal-Mart continually uses cutting-edge inventory techniques to rule the retailing sector. Here are a couple of great quotes that stress the importance of SCM:

"As the economy changes, as competition becomes more global, it's no longer company vs. company but supply chain vs. supply chain."—Harold Sirkin, VP Boston Consulting Group

"Great firms will fight the war for dominance in the marketplace not against individual competitors in their field but fortified by alliances with wholesalers, manufacturers, and suppliers all along the supply chain. In essence, competitive dominance will be achieved by an entire supply chain, with battles fought supply chain versus supply chain."—Roger Blackman, Professor of Marketing, Ohio State, quoted in his book, From Mind to Market

Accounting has the job of recording what has happened in the past and formatting the historical data in the company balance sheet, income statement, and statement of cash flows. Accountants are essentially historians who use numbers as their language. Within the firm, accountants may specialize as tax experts, managerial accountants (aka cost accounting), or financial accountants (aka audit). Most business schools offer these three different tracks for their accounting students. The intent of most accounting students is to become a Certified Public Accountant (CPA) by passing a state CPA exam and fulfilling the other educational and work requirements. Within a smaller firm, it is not unusual for the accounting and finance departments to be combined. As such, the line between the two disciplines is very blurry and the finance/accounting department will wear both hats. In large corporations, accounting is almost always its own department as a form of protection-- separating the internal auditors from the finance function.

Organizational behavior/human relations is responsible for the firm's people. You may have heard the often-quoted phrase "Our employees are our greatest asset." While this quote may only be a recruiting tool at some firms, we can at least hope that companies value their employees. OB/HR has the job of recruiting and retaining the firm's employees. Often, when you're newly hired, you will work with the HR folks the first week or so as you get situated in your new job. They will help you set up your 401K plan, explain the company's various other benefits (for example, health insurance), and go over the company's various regulations and policies.

Strategic management (also known as "management" at some schools) typically provides internal consulting at large firms. Many firms outsource the strategy initiatives to management consulting firms such as Bain, McKinsey, and Monitor. Most schools have an emphasis or major in strategy.

Now that we've reviewed the various functions in the typical firm, the next time you watch "The Office" you may understand how accounting (Angela, Kevin, and Oscar) fits in with sales (Jim, Andy, Dwight, and others) and HR (Toby) and how they all fit in with management (Michael) a bit better! Now we can discuss how finance fits into the firm.

Suppose your firm has a new initiative to launch a video game console (think Microsoft launching the Xbox years ago). The operations team has come up with the design and manufacturing plan for the console. They have proposed how the production line in the factory will be set up from start to finish. The supply chain folks have contacted the suppliers for all of the parts necessary to manufacture the console. They have also modeled the distribution of the completed product to their down-chain customers. Marketing has performed the marketing analysis and has deemed there is a strong demand for the product despite the existence of competitors, such as Nintendo and PlayStation. HR has estimated how much it would cost to hire the additional people to carry out the plan. The head office has been employing an external consulting firm to provide strategic management throughout the process. Accounting is prepared to record the financial information, after the product is launched, to create the various financial statements.

Given this scenario, the financial management team is up to bat. Finance will take all of the information provided by the other departments and will conduct a cost-benefit analysis to see if it makes sense to launch the gaming console. First, a forecast will be made to determine if the benefits will outweigh the costs. As part of this forecast, the finance group will determine how to finance the project. Are there enough retained earnings in the company to finance the project? If not, should the firm seek debt or equity investors? Having the forecast, the financial management team can compute the free cash flows for the project. Knowing the form of financing, they can also compute the cost of capital for the project. Having these two inputs will allow them to use discounted cash flow analysis to determine if the company should go ahead with the launch.

Generally, a company survives and maximizes owner value by constantly investing in projects. Finance is used to determine which projects will add the most value to the firm. Along with the investing decision, finance also determines which form of financing is optimal. This capital budgeting decision is just one function of finance. By the time you make it through all of the topics in this course, you'll know the other functions as well.

The flow of the remainder of this course will focus on the responsibilities of the financial manager as follows:

1. Learn to measure the health of the firm via financial statement analysis. Using ratio analysis and free cash flow measures, we will understand how to assess if our firm is doing well and in what areas we can improve. We will also learn how to use ratios as goals for the firm.

2. Learn to prepare financial forecasts through pro forma financial statements.

3. Use discounted cash flows to value stocks, bonds, and other cash-flow generating assets.

4. Learn how to think about and quantify risk in a financial setting.

5. Learn how to estimate the various components of the weighted average cost of capital (WACC) and why the WACC is important to the firm.

6. Use a portfolio of capital budgeting tools to determine which investments will add value to our firm.

7. Learn several methods for valuing the company as an entity.