Summary
Summary The ultimate test 1 summaries of Financial management
- Course
- Institution
In-depth lecture and textbook summaries that will save you for test 1!
[Show more]
Seller
Follow
Theresapoala
Content preview
Week 1: Financial ManagementChapter 1: The Financial Manager and the firm
The role of the Financial Manager
- To use a blend of quantitative tools and analyses to make financial decisions that create
value for the owners of the firm
- Corporate finance is about maximizing firm value or shareholder value/wealth
- Maximizing firm value is all about cash flows
Cashflows
- Firm generates cash inflows by selling the goods and services produced by its productive
assets and human capital
- A firm is successful in creating value when these cash inflows exceed the cash outlaws
needed to pay operating expenses, creditors and taxes.
- The firm can pay the remaining cash (residual cash flows) to the owners as a cash
dividend, or reinvest the cash in the business
- Failure to generate sufficient cash flows may result in the firm being bankrupt or
insolvent (requiring either a business rescue plan or liquidation)
- The value of any asset is determined by the future cash flows it will generate
Liquidation = When you have to give all assets to bank
Insolvent = Liabilities > Assets
The role of the Financial Manager
Cash flows between firm and its owners and stakeholders
,Fundamental decisions financial managers make to create firm value
1. The capital budgeting decision
- Known as capital expenditure (CAPEX) decision
- It involves deciding what productive assets to buy (tangible and intangible)
Eg: Plant, machines, patents, trademarks
- The decision rule: Accept investment project if the value of future cash inflows exceeds
the costs of the project (creating value)
Why is the capital budgeting decision considered the most important decision?
- It is the productive assets that generate most of the firm’s cash inflows
- CAPEX decisions are long-term = any mistake lasts a long time
- CAPEX involve huge cash outlays = mistakes result in financial loss
2. The financing decision or capital structure decision
- How productive assets are financed
- Involves trade-offs between advantages and disadvantages of debt and equity financing
- 2 ways of raising equity finance are -> Share issue and reinvesting residual cash flow
- Firm value comes mainly from the investment rather than the financing decision
- Debt comes with higher risk
- Cost of capital includes cost of debt and cost of equity
- If internal rate of return is less > reject
3. The working capital management (WCM) decision
- Determines how current assets and current liabilities are managed
- Seeks to maximize value creation and to minimize or avoid destroying value
- Mismanagement can cause a firm to go into bankruptcy even though the firm is
profitable
- Net working capital is the difference between current assets and current liabilities
Examples:
Ø Deciding on the level of inventory
Ø Whether to sell inventory on credit
Ø Where to invest idle cash
Failed Investment example
- Daimler-Berz bought Chrysler: 40 Bil (investment decision)
- Struggled to sell both luxury and economy-prices cars
- In 2003 merger failed resulting in drop in share price
- Chrysler was eventually sold for $6 Bil, 34$ less than cost
,How the financial managers decisions affect the balance sheet
Forms of Business Organizations
Sole proprietorship (sole-trader business):
An unincorporated owner-managed business
ADVANTAGES:
Ø Easy and cheap to form
Ø Least regulated
Ø All business income taxed once as personal income of owner
Ø All the profits belong to you
DISADVANTAGES:
Ø No perpetual succession
Ø Unlimited liability
Ø Equity capital limited to wealth of the owner
Ø Difficult to sell ownership interest
, Partnership
Formed by 2 or more persons who operate in terms of an agreement
ADVANTAGES:
Ø Business income taxed once as personal income of partners
Ø Ability to raise more equity capital
Ø Ability to share expertise and duties
DISADVANTAGES:
Ø No perpetual succession
Ø Partners are jointly and severally liable for partnership debt
Ø Possible nasty disputes
Ø Difficulty to sell ownership interest
Company
An incorporated legal entity that is separate from its owners and is governed by the
Companies Act
ADVANTAGES:
Ø Owners have limited liability
Ø Company has perpetual succession
Ø More equity capital can be raised
Ø Easy to sell ownership interest
DISADVANTAGES:
Ø Separation of ownership and management gives rise to the agency problem
Ø Double tax of company profits
Ø More regulated
Types of companies
Private company (Pty; Ltd)
Prohibits sell of its securities to the public and restricts transferability of its securities
Public company (Ltd)
Can either be listed or unlisted
Ø Shareholders elect the board of directors at an AGM
Ø The board is the most important governing body in a company and its main roles are to
represent shareholders and to appoint the CEO
Ø The CEO is responsible for the day-to-day management of the company and reports to
the board
Ø An audit committee is a key sub-committee of the board
Ø The CFO or the financial director reports to the CEO and is responsible for managing the
financial function
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller Theresapoala. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $2.84. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
70055 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now