FINANCIAL MANAGEMENT

Chapter 1 The Corporation

Financial Management
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How people in corporations make financial decisions? Financial decisions?

Where,

when, what, how much, howetc. Mostly concern with three decisions: _______decisions, _________ decisions and _________decisions. With one goal

The Role of the Financial Manager

Capital budgeting: decide which L-T assets to acquire; Financing: decide how to pay for S-T and L-T assets, Working Capital: decide how to manage S-T resources and obligations or Dividend decision: decide on the payout of dividend.

Cash Flows Between the Firm and Its Stakeholders and Owners

(Parrino et al., 2012)

How the Financial Managers Decisions Affect the Balance Sheet

(Parrino et al., 2012)

Learning Objectives
1. Identify the key financial decisions faced by the financial managers; 2. Identify the basic forms of business organisation; 3. Understand the rationale of firms goal of maximisation of shareholders wealth; 4. Understand the nature of the Stock Market.
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The Four Types of Firms

Sole Proprietorship

Partnership
Limited Liability Company Corporation

Legal forms of business organisation

Sole proprietorship
A

business owned by a single individual, unlimited liability, limited access to capital, lack of continuity, constraints of various skills.

Advantages
Easy

to create

Disadvantages
Unlimited

personal liability Limited life Difficult to transfer ownership

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Legal forms of business organisation

Partnership
An

association of two or more individuals joining together as co-owners to operate a business for profit, joint responsibility, involves partnership agreement, better access of capital/skills, continuity of business? partners are personally liable for all of the firms debts. A lender can require any partner to repay all of the firms outstanding debts. partnership ends with the death or withdrawal of any single partner.

All

The

The Four Types of Firms (cont'd) Partnership

Advantages:

limited protection of owners personal assets; more sources of equity & expertise. Disadvantages: hard to dissolve, shared control & profit.
Limited

Partnership has two types of owners.

Partners

General

Have the same rights and liability as partners in a regular partnership (personally liable for firms debt obligations.) Typically run the firm on a day-to-day basis

Limited

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Partners

Have liability limited to their investment Have no management authority and cannot legally be involved in the managerial decision making for the business The limited partners interest is transferable

The Four Types of Firms (cont'd)

Limited Liability Company (LLC)

All

owners have limited liability (not personally liable) but they can also run the business.
be private or public companies. as PLC in UK.

Can

Known

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The Four Types of Firms (cont'd)

Corporation
A

legal entity separate from its owners

many of the legal powers as individuals have, such as the ability to enter into contracts, own assets, and borrow money corporation is solely responsible for its own obligations. Its owners are not liable for any obligation the corporation enters into.

Has

The

An

entity that legally functions separately and apart from its owners, limited liability, good access of capital/skills, separation of management and ownership, ownership is dictated by the shareholdings and is transferable.

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The Four Types of Firms (cont'd) Corporation

Advantages:

protects personal assets, no shareholder liability for business, greater access to sources of funds.

Disadvantages? Formation
Corporations

must be legally formed. A legal document is created on formation of the corporation.

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The Four Types of Firms (cont'd)

Corporation
Ownership
Represented

by shares of stock Owner of stock is called

Shareholder Stockhoder Equity Holder

Sum

of all ownership value is called equity. There is no limit to the number of shareholders, and thus the amount of funds a company can raise by selling stock. Owner is entitled to dividend payments.
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Legal forms of business organisation

Comparison of organisational forms Consider:

Organisation requirements and costs Liability of owners Continuity of business Transferability of ownership Management control Ease of capital raising Income taxes

Ownership versus Control of Corporations

Corporate Management Team

In

a corporation, ownership and direct control are typically separate.

of Directors
Elected

Board

by shareholders Have ultimate decision-making authority

Chief

Executive Officer (CEO)

Board

typically delegates day-to-day decision making to CEO.

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Figure 1.2 Organizational Chart of a Typical Corporation

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Ownership versus Control of Corporations (cont'd)

Financial Manager
Responsible
Investment Financing Cash

for:

Decisions

Decisions

(Treasury) Management or Dividend Decisions

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Ownership versus Control of Corporations (cont'd)

Goal of the Firm

Shareholders

will agree that they are better off if management makes decisions that maximizes the value of their shares. of shareholders wealth; or firms
value.

Maximisation

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Goal of the firm

Profit maximisation?
Problems:
Timing

of returns, eg.

Uncertainty

of returns, (risk vs return, opportunity cost of capital) eg.

The Goal of the Firm

Do not Maximize Profit

Accounting
Cash

profit differs from cash flows Profit earned may not equal cash received
not received cant be used to pay bills
The

strategy ignores the timing of future cash flows The strategy ignores the risks associated with having to wait for cash flows

The Goal of the Firm

Maximize Shareholders Wealth!

Future

cash flows are considered The timing of future cash flows is considered The risks associated with having to wait to for cash flows are considered

The Goal of the Firm

Its All About Cash flow!

Positive

residual cash flow may be paid to firm owners as dividends or invested in the firm The larger the positive residual cash flow, the greater the value of a firm Negative residual cash flow over the long run leads to bankruptcy or closing a business

Goal of the firm

Maximisation of shareholder wealth?

How do we measure it?

Goal of the firm

Maximisation of shareholder wealth?

The maximisation of the price/market value of the existing ordinary shares which owned by the ultimate owners - who affects the movement of share prices.
refers to

Goal of the firm

Maximisation of shareholder wealth?

This goal is consistent with:

Maximising firm value Maximising share value

BUTits not without its difficulties!

Ownership versus Control of Corporations (cont'd)

Ethics and Incentives within Corporations

Agency

Problems

Managers

may act in their own interest rather than in the best interest of the shareholders. potential solution is to tie managements compensation to firm performance. (may encourage risk-taking)

One

How

should performance be measured?

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Ownership versus Control of Corporations (cont'd)

CEO Performance
If a CEO is performing poorly:

shareholders can express their dissatisfaction by selling their shares. This selling pressure will drive the stock price down.
shareholders could pressure the board to reappoint a new CEO. Hostile Takeover

or

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Low stock prices may entice a Corporate Raider to buy enough stock so they have enough control to replace current management. The stock price will rise after the new management team fixes the company.

Ownership versus Control of Corporations (cont'd)

Corporate Bankruptcy
Debt

holders vs equity holders

Reorganization Liquidation

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The Stock Market

The stock market provides liquidity to shareholders.

Liquidity
The

ability to easily sell an asset for close to the price you can currently buy it for is it important?

Why

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The Stock Market (cont'd)

Public Company
Stock

is traded by the public on a stock exchange.

Private Company
Stock

may be traded privately.

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The Stock Market (cont'd)

Primary Markets
When

a corporation itself issues new shares of stock and sells them to investors, they do so on the primary market.

Secondary Markets
After

the initial transaction in the primary market, the shares continue to trade in a secondary market between investors.

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The Stock Market (cont'd)

Largest Stock Markets

New

York Stock Exchange (NYSE)

Makers/Specialists
Each stock has only one market maker

Market

NASDAQ
Does

not meet in a physical location May have many market makers for a single stock
Bid

Price versus Ask Price

Spread

Bid-Ask

Transaction cost

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Getting A Stock Price

The stock price is the market price of a stock. Using the Bursa Malaysia website you can view the price for any listed stock. Getting a Price: There are many places you can find market news, eg: The financial section of the daily newspapers Bursa Malaysia Website. (www.bursamalaysia.com) Your broker website may have an up-to-date list of stock prices Your telephone company may be able to send you market updates via your mobile phone

The Essence of Share Prices

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What is the importance of share prices? Why are the news focused heavily on the movement of the share prices? What are the factors that driving the changes in the share prices?