THE BASICS OF FINANCIAL
MANAGEMENT
Rien Brouwers MSc. & Wim Koetzier MSc.
Third Edition | Noordhoff Uitgevers
Part 1 Financial management in business
Chapters 1-4
, 1 Businesses and their role in the economy
1.1 Consumers and manufacturers
- All products and services have to be manufactured (made)
- Enterprises/production companies manufacture products/services and offer those to consumers
A company is a production organization
Operates between the supplier market (resources obtained) and the retail market (goods sold)
- Economics study the relationship between consumers and companies & their mutual interactions
Microeconomics: among others, theory of markets (price mechanism in particular market)
Macroeconomics: economic problems that affect the society as a whole (inflation)
Business economics: economic behavior in a production organization
- Tangible assets/non-current assets = remain for a long period of time; machines and buildings
- Resources = commodities/nature (raw materials), machines/buildings or labor
- Capital = raw material and tangible assets used by company
- Formal nature: all rights and obligations written down on paper
- Enterprise produce goods/service without a profit target – company; seeks maximum profit
- Effectiveness = focus on production process: meeting target objectives and end product (sales)
- Efficiency = focus on producing a certain amount at minimal cost: cost-effectiveness (process)
- Maximizing a profit means maximum effectiveness and efficiency
Sometimes want to maximize sales or see continuity as more important
- Mission statement = outlining their targets – environmental issues, job satisfaction, etc.
1.2 Profit and non-profit organizations
- Profit organization = focus on maximizing profit: companies
- Non-profit organizations
Target to provide facilities, activities are linked to social objective
Not economically independent, depend on gifts such as contributions/subsidies/inheritances
Profit cannot be used as indicator of success of organization
- Non-profit organization can be either public or private
Public: the State, provinces, municipalities and regional water authorities
Private: amateur sports clubs, charitable organizations and fund-raising institutions
- Government provides mainly public goods and services, like infrastructure and safety
Budget mechanism = compulsory contributions (tax)
Privatizing = separating activities from government: e.g. public transport and mail delivery
1.3 Business activities
- Four sectors with each a different way of transforming resources into goods or services
1) Agriculture and mining
Wealth of nature: turn small quantity of commodities into large quantity of end product
Use of minerals such as gold or copper for example
2) Industry
Create a physical, tangible product that did not exist before production
Job production = each product tailored to customers’ requirements, sale before production
Mass production = one type of product produced in large quantities, build-up of inventory
Batch-job production process = produce a series of identical products
3) Trade
No new products produced, solve imbalance between production and consumption
Imbalance in scale, product range, time or location of production and consumption
, Retail trade = final link in chain – supply to end user: consumer
Wholesale trade = purchases from manufacturer and redistributes to retail trade
Business-to-business
4) Services
Provide service without manufacturing or redistributing a product
Can be: financial services (banks), hospitals, transport, IT-services and facility services
Almost no raw materials purchased from suppliers
Tangible assets (buildings) and labor costs almost always very important
1.4 Legal forms of businesses
- Companies can be divided into two categories:
With legal entity: considered as independent in legal agreements – nv, bv and cooperative
No legal entity: agreements in the name of the owner – sole proprietorship or partnership
- Non-profit organizations can be foundation and association – both legal entities
1) Sole proprietorship
- The owner is also the management, company depends entirely on the entrepreneur
- Can be financed with own capital of owner (equity) or loans (liabilities)
- Often limited size due limited availability of equity
- Owner is liable for debts incurred by the company
- Owner pays income tax on profits made by sole proprietorship – income tax box 1
In the Netherlands, the more you earn, the more tax you have to pay
- Accounting obligations = legal obligation to maintain administration
- Not obligated to disclose any financial information, no disclosure requirements
2) The partnership
- Two or more persons working together in business without a legal entity
E.g. doctors, lawyers, accountants, etc.
- Joint partners control business – all own qualities and also own opinions
- Jointly and severally liable for debts: creditor can demand full payment from either partner
- Partnership is not acknowledged by the tax authorities: income tax based on each profit share
- Limited partnership = partial separation of ownership and control – way to attract extra capital
General partners are both own and control – several liability
Pay income tax on their share of the profit – income tax box 1
Limited partners owners since they invested capital but no control
Not liable with their private assets, for the debts of the business
Pay income tax on their share of the profit, however no tax advantages
3) Joint-share companies
- Legal entity with limited liability, legal separation between ownership and control
- Equity of joint-share company is divided into shares
Annual general meeting of shareholders is the highest authority
Shareholders have limited liability – not obligated to compensate debts with private assets
Shareholders pay income tax on their share of the profit
- Board of directors handles daily management
- could also be third party: Supervisory Board (SVB) – supervises the board of the directors
- Limited Liability Company (LLC): shareholder(s) involved in daily business
- Public limited Company (PLC): purpose of gathering large capital
- Corporate tax is charged on profit of both the LLC and PLC
shareholders pay income tax on the dividend – therefor dividends paid will be taxed twice
- Dividend = net profit payed to shareholders, instead of added to the equity of the company
- LLC and PLC have both disclosure requirements: financial reports to office of Trade Register
4) Differences between LLC and PLC
- LCC: always registered shares, PLC could issue bearer shares; can easily change legal ownership
Stock exchange listed companies are always PLCs
