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Summary Financial Management 244 - Chapter 1-11,13
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Financial Management 244Chapter 1: Introduction to Financial Management
Introduction
The financial function is one of the key business functions, along with manufacturing/operations,
marketing, human resources and information technology. The financial function is primarily
concerned with the flow of capital to and from the business. More specifically, it relates to financing
decisions, investment decisions and the relationship between the acquisition and application of
capital. It is important to increase the wealth of the shareholders.
Defining Financial Management
Financial management can be described as the process of creating value in an organisation. This
process consists of planning, organising, directing and controlling the financial activities of a
business. Value is created when the wealth of the owner increases over time.
Financial management is not accounting.
Accountants record activities in a business by means of financial statements.
Financial management focuses on value creation.
Financial managers must make decisions within a constantly changing economic
environment.
Economic indicators: GDP, inflation, interest and exchange rates are necessary to make
informed, educated decisions.
Businesses have limited resources and financial managers are responsible for using these
resources in the best possible way, to increase shareholders’ wealth.
The Financial Manager
The Roles and Responsibilities of the Financial Manager
The financial manager is responsible for an organisations financial management activities. The
financial manager is in charge of managing the business’s treasury, finance and human resources
divisions.
Financial-management decisions
o In which non-current assets should the firm invest? (capital budgeting)
o Where will the owner obtain the necessary long-term financing to fund the purchase of the
new asset? (capital structure)
o How will the owner mange the organisations day-to-day financial activities? (working capital
management)
Capital budgeting
The acquisition and management of non-current assets also called capital projects or investments.
Financial managers should only invest in value-adding non-current assets.
Determine cash flows
Size
Timing
Risk
, Capital Structure
These decisions concern the mix of debt and equity that the business uses to fund its activities.
Three options available:
Borrow long-term funds
Use savings of the company
Issue more shares
The options the owner chooses for obtaining finances will have an effect on the business, both from
a risk and value perspective.
Working-capital management
Working capital refers to the short-term assets and liabilities of a firm and typically includes
inventory, cash, trade receivables and trade payables.
How will you approach the day-to-day financial management?
Will you sell the product for cash, credit or both?
Who will receive credit and who won’t?
How many days until debtors have to pay?
Will you pay expenses in cash or on credit?
All these decisions are important to ensure that the firms function efficiently and that there are
sufficient resources to remain profitable and liquid.
The Goals of Financial Management
Financial management needs goals to guide and motivate them when making decisions on behalf of
the organisation.
1. Profit Maximization
Financial managers should increase the firm’s turnover and decrease its operating and other
expenses. This can be obtained by increasing productivity, reducing waste, stream lining production
processes and using the most cost-effective sources of debt-financing.
2. Maximizing the Rate of Return
The aim is to maximise the ratio to net profit after tax to total sales, instead of merely maximising net
profit after tax.
3. Maximising Shareholders’ Wealth
A shareholder’s wealth is influenced by the number of shares that the shareholder owns and the
current share price. Financial managers should only engage in activities that will have a positive
influence on the current share price. The focus on shareholder wealth maximisation considers both
risk and return. Profit and rate of return maximisation are regarded as short-term goals.
,The Corporate Forms of Business in South Africa
Sole Proprietorship
A single person has the controlling interest in the business.
Main characteristics of a sole proprietorship:
Easy entry into the market.
The life span of the business is limited to the owner’s lifespan.
The owner is generally also the manger.
The business is not a separate entity from the owner.
Partnership
A private agreement with a maximum of 20 partners, who contribute to the business with skills and
equity.
The key characteristics of a partnership:
o Easy entry into the market.
o The lifespan of the business is limited.
o The business is not a separate entity from the partners.
o Profits and debts are the liability of the partners in proportion to their contribution to
capital.
Company
A company is a separate legal entity from the owners of the business. This means that the company
can be sued and taxed separately from the owners, and the owners have limited liability.
Non-Profit Companies
Non- profit companies will not be required to comply with the provisions pertaining to:
Capitalisation of profit companies
Securities registration and transfer
Public offerings of company securities
Takeovers, offers and fundamental transactions
Rights of shareholders to approve a business rescue plan
Dissenting shareholders’ appraisal rights
The name of a non-profit company should be followed by the letters “NPC”. A non-profit company
must be incorporated by three or more persons.
For-Profit Companies
The four types of profit companies:
Private company (Pty (Ltd)): Its memorandum of incorporation prohibits offering any of its
securities to the public and restricts the transferability of its shares.
Personal liability company (Inc.): Meets the criteria for a private company but all the
directors are jointly responsible for the debts of the company.
Public company (Ltd): Offering of shares to the public in order to obtain equity.
State-owned enterprise: An enterprise registered as a company and is owned by a
municipality.
, Close Corporation
A close corporation is a business form that has the same advantages as a company, but is simpler and
less expensive than a company in terms of legislation. A close corporation can have between 1 and
10 members.
The main characteristics of a close corporation are:
A less complicated entry into the market compared to a company.
A close corporation is a separate entity and provides limited liability to the members.
Transfer of interest is uncomplicated and simple.
The Agency Problem and Agency Costs
Managers become agents and are obligated to maximise the interests of those who appointed them.
Managers often run the business to protect their own interests rather than the interests of the
shareholders (agency problem).
Agency costs
Any costs that can arise due to the agent not taking decisions to maximise the wealth of the
shareholders.
Direct agency cost: Any measurable amount incurred as a result of the agency problem. Examples
are management spending money on luxuries such as holidays.
Indirect agency cost: Mostly relate to missed opportunities. An example is offering a new product,
whose outcome is unknown, that could possibly have a negative effect on the price of shares.
Managerial Compensation plans:
Incentive plans: If manager’s performance increases the share price, they receive shares in
the company and therefore will make decisions that benefits shareholders.
Performance plans: Performance is assessed by profitability measures. Incentives include
cash bonuses and performance shares.
Financial Markets and Institutions
Starting and growing a business requires funding: financial markets and institutions are necessary to
ensure that funds flow between borrowers and lenders. These markets act as intermediaries
between buyers and sellers of financial securities.
Financial Markets
A meeting place where economic units with excess funds can transact with economic units in need of
funds. Financial markets thus bring together the suppliers of funds and those seeking funds.
1. Money Markets
A market where short-term debt securities are bought and sold (within a year). Money markets do
not have a physical location, but participants are connected electronically. The main purpose of a
money market is to enable participants that temporarily have extra funds to earn interest on those
funds. The debt securities available from money markets are called marketable securities.
2. Capital Markets
A market where long-term debt securities are bought and sold (more than one year). The main
securities bought and sold are bonds and shares.
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