higher profit by spending moreon labor and materials. For example, choosing the
lowest-cost supplier might result in using poor materials that lead to costly production
problems. Therefore, managers should understand supply chain management,which
often means developing long-term relationships with suppliers. Similarly, increased
employee training adds to costs, but it often pays off through increased productivity
and lower turnover. Therefore, the human resources staffcan have a huge impact on op-
erating profits.
The third factor affecting cash flows is the amount of money a company must in-
vest in plant and equipment. In short, it takes cash to create cash. For example, as a
part of their normal operations, most companies must invest in inventory, machines,
buildings, and so forth. But each dollar tied up in operating assets is a dollar that the
company must “rent” from investors and pay for by paying interest or dividends.
Therefore, reducing asset requirements tends to increase cash flows, which increases
the stock price. For example, companies that successfully implement just-in-timein-
ventory systems generally increase their cash flows, because they have less cash tied up
in inventory.
As these examples indicate, there are many ways to improve cash flows. All of them
require the active participation of many departments, including marketing, engineer-
ing, and logistics. One of the financial manager’s roles is to show others how their ac-
tions will affect the company’s ability to generate cash flow.
Financial managers also must decide how to finance the firm:What mix of debt and
equity should be used, and what specific types of debt and equity securities should be
issued? Also, what percentage of current earnings should be retained and reinvested
rather than paid out as dividends?
Each of these investment and financing decisions is likely to affect the level, tim-
ing, and risk of the firm’s cash flows, and, therefore, the price of its stock. Naturally,
managers should make investment and financing decisions that are designed to maxi-
mize the firm’s stock price.
Although managerial actions affect stock prices, stocks are also influenced by such
external factors as legal constraints, the general level of economic activity, tax laws, in-
terest rates, and conditions in the stock market. See Figure 1-1. Working within the set
of external constraints shown in the box at the extreme left, management makes a set of
The Primary Objective of the Corporation 11
External Constraints: Strategic Policy Decisions
Controlled by Management:
- Antitrust Laws
- Types of Products
or Services Produced - Production Methods
Used - Research and
Development Efforts - Relative Use of Debt
Financing - Dividend Policy
- Types of Products
- Product and Workplace
Safety Regulations - Employment
Practices Rules - Federal Reserve Policy
Level of Economic
Activity and
Corporate Taxes
Expected
Cash Flows
Timing of
Cash Flows
Perceived Risk
of Cash Flows
Stock
Price
- Environmental
Regulations - International Rules
Conditions in
the Financial
Markets
FIGURE 1-1 Summary of Major Factors Affecting Stock Prices