Summary
Summary - Financial Management 244
- Course
- Financial Management 244
- Institution
- Stellenbosch University (SUN)
Summary of Financial Management 244 at Stellenbosch University.
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FINANCIAL MANAGEMENT:All businesses are guided by corporate financial principles
Financial function: flow of capital to and from businesses
Decisions: financing, investment, relationship between acquisition and
application of capital
Process of creating value in organisation
Planning, organising, directing, and controlling financial activities
Value created = increase in the wealth of the shareholders
Financial management ≠ Accounting
Accounting: a historical perspective (report)
Financial managers: Focus on value creation. Use information from accountants to make
decisions
Repo rate = 3,5%
Prime rate = 7% (when you borrow from bank)
CPI = 4,9%
FINANCIAL MANAGEMENT DECISIONS:
1. What long-term assets should the business invest in (CAPITAL BUDGETING
DECISION)
Involves the acquisition and management of non-current assets
Only invest in value-adding non-current assets
Determine cash flows
Size: how much initial investment is required (cash outflow) and how much
income will be received (cash inflows)
Timing: when and for how long income will be received
Risk: the likelihood of receiving the income
If the present value of an asset’s cash inflows (sum of the discounted operating cash flows) exceeds
its cost = positive NPV
Positive vs negative NPVs
2. Where will they get the long-term financing to pay for the new investment
(CAPITAL STRUCTURE)
The combination of debt and equity that a company uses to fund the firm
Three options available:
Borrow long-term funds (debt) – risk increase
Use savings of the company (retained earnings)
Issue more shares (equity) – ownership implications
Which form of financing is the cheapest?
3. How will the business manage its day-to-day financial activities
Working capital = current assets and current liabilities
How will you approach the day-to-day financial management?
§ Will you sell new product for cash, credit or both?
§ Who will receive credit and who will not?
§ How many days until debtors must pay?
§ Will you pay expenses in cash or on credit?
All these decisions are important to ensure:
§ Firms function efficiently; and
§ sufficient resources to remain profitable and liquid.
,GOALS OF FINANCIAL MANAGEMENT:
1. PROFIT MAXIMISATION:
Increase revenue and decrease operating and other expenses
More effective marketing campaigns, increased productivity, reduce waste, streamline production
processes and using most cost-effective sources of debt funding
Main flaws:
• Manipulated through malpractice
• Ignores the issue of timing and risk
2. MAXIMISING THE RATE OF RETURN
Ratio of net profit after tax to total assets to overcome the shortcomings of the profit maximization
goal
Rate of return: percentage that offers the advantage that several investments can be
compared with one antoher
Same risks associated with profit maximization as well as the timing and risk associated with
generating the profit are also ignored
3. MAXIMISING SHAREHOLDERS’ WEALTH:
Shareholder’s wealth influenced by number of shares and current share price
Only engage in activities that will positively influence the current share price
Forward looking goal
Profit and rate of return maximization = short-term goals
Share price maximization: Short-term and long-term goal
Links to environmental, social and corporate governance (ESG) aspects
Main flaws:
• Created a fixation on short-term results, fuelling inequality, environmental degradation and
excessive executive remuneration
4. STAKEHOLDER CONSIDERATIONS
People involved in the business and/or on whom the business has an impact
Shareholders
Employees
Suppliers
Customers
Why is it important to also consider the interests of other stakeholders of a company and not just
shareholders' interests?
• BOYCOTT
• Struggle to get customers, suppliers or employees
• Get fines
CORPORATE FORMS OF BUSINESS:
SOLE PROPRIETORSHIP: easy entry into the market from a legal perspective
No continuality
Unlimited liability
PARTNERSHIP: 2-20 partners
Easy entry
COMPANIES:
• Non-profit: don’t have to comply with:
• Capitalisation of profit companies
• Securities registration and transfer
• Certain provisions related to directors,
appointment of company secretatires
• Public offerings of company securities
, • Takeovers, offers and fundamental
transactions
• Rights of shareholders to approve a
business rescue plan
• Dissenting shareholders’ approval rights
• Personal liability: meets criteria for private company.
Directors and past directos are jointly
and severally liable during their
respective periods of office
• Public: minimum of 7 members
• State owned
AGENCY PROBLEMS:
The shareholders (principals) appoint managers (agents) to look after their interests
Agency relationship: The relationship between the principal and the agent
Agency problem: When the agent does not make decisions in the best interest of the principal.
Managers make decisions for the protection of their own best interest instead of focusing on what is best
for the shareholders
Agency costs: costs that arise due to the agent not taking decisions to maximize the wealth of the
shareholders
Can be controlled if managers have financial motivation
Managerial compensation plans:
• Performance linked to share price and often includes share options
• Performance assessed by profitability measures, incentives include cash
bonuses
FINANCIAL MARKETS AND INSTITUTIONS:
Financial markets: Brings together the suppliers and seekers of funds.
A meeting place where economic units with excess funds can transact with
economic units in need of funds
• Money market:
§ short-term securities (marketable securities);
§ no physical location; and
§ maturity of one year or less
, § main purpose is to enable participants that temporarily have extra funds to earn interest on
those funds
• Capital market:
§ long-term securities (shares and bond exchanges);
§ maturity of more than one year
• Primary market:
Sells securities for the first time
• Secondary market:
Securities traded after being sold in the primary market
Price determined by supply and demand
• Auction markets:
• Broker brings buyer and seller together
• Physical location with trading floor
• Example: NYSE. JSE was one until 1996
• Dealer market:
• Traders offer to buy or sell securities
• Automated exchange
• Example: NASDAQ and JSE
ETHICS AND ESG CONSIDERATIONS:
• “Ethics” refers to the character and guiding beliefs of a person, group, or institution.
• Ethical decisions refer to decisions based on what is good, right, just and fair when interacting with
others
• Morality refers to the customs that are defined by society at a specific point in time
• Unethical behaviour:
§ Creative accounting, discrimination, price fixing
• King IV Report offers corporate governance guidelines
CHAPTER 2:
OBJECTIVE OF FINANCIAL REPORTING:
• Listed firms prepare financial reports according to International Financial Reporting Standards
(IFRS) - type and nature of the information
• 3 main aspects:
• Directed towards potential external-capital providers
• Information about economic resources, claims on these resources and changes in resources
and claims
• Other useful information (non-financial related aspects)
INFORMATION PROVIDED BY FINANCIAL REPORTING:
• Information about a company’s economic resources (assets) and claims on these resources (equity
and liabilities)
• Three main aspects:
§ Provide summary of financial position (influenced by the economic resources available to it
and the capital structure used to finance these resources)
§ Financial performance (can it generate an income with its assets)
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