Overview of Business Finance PDF

Overview of Business Finance  Outline Business Finance Definition of Financial Management Objectives of the Firm Financial Management Decisions Importance of Financial Management Forms of Business Organizations Agency Problems and the Control of Corpora...

Overview of Business Finance  Outline Business Finance Definition of Financial Management Objectives of the Firm Financial Management Decisions Importance of Financial Management Forms of Business Organizations Agency Problems and the Control of Corporations  Business Activities Generally , business activities are centered around; Production Marketing Finance Business Finance Functions The finance function is performed by the Finance Manager. Business finance is that business activity which concerns with the acquisition and conversation of capital funds in meeting financial needs and overall objectives of a business  Financial Management involves: The management of the finances of an organization in order to achieve the financial objectives of the organization. FM covers all activities directed at ensuring that financial resources both short and long term are obtained and used in the most efficient and effective way to achieve organizational objective. FM is also all the processes associated with the efficient acquisition and deployment of both short and long term financial resources to achieve organizational objectives  Financial Management Decisions The financial manager and indeed business finance is mainly concerned with four basic business decision areas namely: Investment Decisions Financing Decisions Dividend Policy decisions Working Capital Management Decisions The Role of Finance Manager or Chief Finance Officer (CFO) 1. Investment Decisions: The investment decision is the most important of the firm’s four major decision areas for value creation. It is about determining the types, numbers and composition of assets the firm should invest in (acquire) to achieve business goals (i.e. value creation). 2. Financing Decisions: The next major decision of the firm is the financing decision. It is concerned with where and how the firm can source funds to finance the investment decision. Will the financing be sourced by means of equity or debt or a fix of both? This decision is also referred to as capital structure decision. Once the mix of financing has been decided, the financial manager must still determine how best to physically acquire the needed funds. The mechanics of getting short-term and long-term funds or the issue of equity and bonds must be understood. 7 3. Working capital management decision: The third important decision of the firm is working capital (asset) management decision. Once the assets have been acquired they must still be managed efficiently by providing appropriate working capital (operating or current assets) and properly managing same efficiently to meet the day-to-day working capital needs of the firm. The operating assets include stock, cash, debtors, and creditors. 4. Dividend policy decision: This is concerned with decisions regarding the optimum sharing of the firm’s net earnings between the firm and its shareholders. In deed dividend policy is often viewed as an integral part of the firm’s financing decision. Because dividend policy determines the amount of earnings that can be retained in the firm. Retaining a greater amount of current earnings in the firm means that fewer amount will be available for current dividend payments. 8  Financial Objectives of the Firm The shareholders’ view Other Stakeholders’ view  Financial Objectives of the Firm Cont’d 1. Shareholders’ View Profit Maximization Wealth Maximization  Financial Objectives of the Firm Cont’d Profit Maximization Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern.  Financial Objectives of the Firm Cont’d Profit Maximization Drawbacks of Profit Maximization It is vague : profit is not defined precisely or correctly It is short term It ignores the time value of money It ignores risk Creative accounting may influence profit Has no bearing on cash flows It assumes perfect competition  Financial Objectives of the Firm Cont’d Wealth Maximization The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern Wealth maximization is also known as value maximization or net present worth maximization. This objective is universally accepted as the “GOAL of the Firm”.  Financial Objectives of the Firm Cont’d 2. Other Stakeholders’ View Employees Community Suppliers Government Customers Non-Financial Objectives of the Firm Cont’d 1. Growth 2. Diversification 3. Survival 4. Maintaining contended workforce 5. Becoming research and development leader 6. Providing top quality service to customers 7. Maintaining respect for the  Forms of Business Organisation Sole Proprietorship A sole proprietorship is an unincorporated business owned by one individual. Going into business as a sole proprietor is easy—one merely begins business operations. However, even the smallest business normally must be licensed by a governmental unit. Advantages: It is easily and inexpensively it is subject to few government regulations, and the business avoids corporate income taxes.  Forms of Business Organisation Limitations It is difficult for a proprietorship to obtain large sums of capital; the proprietor has unlimited personal liability for the business’s debts, which can result in losses that exceed the money he or she invested in the company; and the life of a business organized as a proprietorship is limited to the life of the individual who created it.  Forms of Business Organisation Partnership A partnership exists whenever two or more persons associate to conduct a non corporate business. Partnerships may operate under different degrees of formality, ranging from informal, oral understandings to formal agreements filed with the secretary of the state in which the partnership was formed. Advantages low cost and ease of formation.  Forms of Business Organisation Disadvantages unlimited liability, limited life of the organization, difficulty transferring ownership, and Difficulty raising large amounts of capital. Corporation A corporation is a legal entity created by a state, and it is separate and distinct from its owners and managers.  Forms of Business Organisation Advantages Unlimited life Easy transferability of ownership Limited liability. Disadvantages Corporate earnings may be subject to double taxation Setting up a corporation, and filing the many required state and federal reports, is more complex and time-consuming  Agency Problems The thousands, or more, investors who own public firms could not collectively make the daily decisions needed to operate a business. Therefore: The shareholders are owners of the firm The officers (or executives) control the firm  Agency Problems Agency relationship – Principal hires an agent to represent its interests – Stockholders (principals) hire managers (agents) to run the company Principal-Agent Problem Principal-shareholders Agent –managers  Agency Problems Agency problem – Conflict of interest between principal and agent Management goals and agency costs Principal –agent problem represents the conflict of interest between management and owners. For example if shareholders cannot effectively monitor the managers’ behaviour, then managers may be tempted to use the firm’s assets for their own ends, all at the expense of shareholders. Reasons for existence of Agency Problem 1. Separation of ownership The thousands, or more, investors who own public firms could not collectively make the daily decisions needed to operate a business. 2. Asymmetry of information 3. Goals of management may differ from the goals of shareholders Entrench managerial power by creating job security for themselves – empire building Increasing managerial rewards Pursing social objectives, eg travelling ostentatiously Page 24 Taking sub-normal decisions, eg I takeovers  Solving Agency Problems 1. Managerial Incentives – Incentives can be used to align management and stockholder interests – The incentives need to be structured carefully to make sure that they achieve their goal Bonus Stock Stock options 2. Monitoring/ Corporate Control Inside the corporate structure – BOD Outside the structure- auditors, bankers, credit agencies and attorneys In government- SEC, IRS  Solving Agency Problems 3. Other Monitors Market forces Creditors Employees Society Government/Regulators