Topic 1 - Business Finance Introductory Concepts

From Uni Study Guides
Jump to: navigation, search

This article is a topic within the subject Business Finance.

Contents

Required Reading

Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010., pp. 2-20.

Forms Of Business Organisation

[1]

  • Sole ProprietorshipsOwned & operated by an individual, profits taxed as personal income (PTPI)
    • Advantages - Simple to establish, least regulated, few regulations, owner receives all profits
    • Disadvantages - Difficult to raise funds, unlimited liability, limited to life of owner, difficult ownership transfer
  • PartnershipsOwned & operated by 2+ individuals/entities. Formed by an informal or legally binding agreement. PTPI
    • Advantages - Cheap to establish & run, owners receive all profits
    • Disadvantages - unlimited liability, hard to raise funds, difficult ownership transfer, life limited to partners
  • CorporationA legally registered entity. Corporate taxation.
    • Advantages - Easily transferable ownership, unlimited life, limited liability, able to raise large amounts of $
    • Disadvantages - Legal formalities & disclosure requirements, 2x taxation unless dividend imputation system

Financial Management Decisions And The Financial Manager

  • Investment Decision – How funds are used in productive activities, Capital Budgeting – planning long term investment
  • Financing Decision – Capital Structure, mix of debt & equity financing,
    • Working Capital Management – ensure firm has enough funds to run daily operations,
  • Dividend Decision – How much to distribute as dividends
  • Restructuring Decision – Corporate actions that will benefit the firm

The financial manager needs to raise cash (debt & equity) & decide how to invest the cash. Hopefully, operations will generate cash & the manager will need to decide if it should be reinvested, distributed or paid to government as taxes.

Goals of Financial Management

[2] The Primary Goal of a business is to maximise the (current) value of the firm for existing shareholders . Intermediate goals include social & ethical responsibilities e.g. protecting environment, ensuring the welfare of employees/customers & donations.

Agency Conflicts

[3] Agency problems between managers & shareholders, due to the separation of ownership & control, give rise to agency costs (not maximising s’holder value by overpaying). Direct agency costs occur if managers act in their own self interest. Monitoring costs (e.g. contracts) to control managers are used to ensure their actions are in the owner’s best interests. Indirect Costs occur when investment opportunities are not pursued. Corporate Governance is the system by which corporations are controlled & directed. It outlines remuneration, risk mgmt & disclosure requirements for the benefit of stakeholders. There are mechanisms to resolve the manager-shareholder agency problem.

Internal Mechanisms

  • Board of Directors. Not always effective is managers appoint a director who is ‘easy
  • Shareholder Meetings & Voting Rights. Proxy fight – group of shareholders solicit proxy votes to replace existing management.
  • Managerial Compensation. Stock options to align interests

External Mechanisms

  • Managerial Labour Market. Disciplinary mechanism, bad managers won’t be hired, better performers will be promoted
  • Debt & Legal Restraints. Legally required to act in the best interest of owners. Debt can restrict activities
  • M&A. Shareholders can threaten to sell in hostile takeovers, a greater profit potential exists for poorly run companies

Agency conflicts can occur between shareholders & debt holders. E.g. if a firm elects a project that increases risk, the required rate of return on the debt should rise, decreasing the value of existing debt. If the project is a success debt holders receive no extra benefits. Increasing borrowings on the same assets & distributing more dividends may cause conflict. To protect themselves they may demand restrictive covenants to restrict the firms behaviour, charge higher rates or refuse to lend.

Financial Markets & the Firm

[4] The Financial System functions to facilitate the flow of funds between deficit & surplus units through the interaction of financial institutions, instruments & markets. It brings together buyers & sellers of debt & equity.

  • Primary Markets - Individual, Government or Firm creates/issues a new financial instrument for funds.
  • Secondary Markets - Trading of existing financial instruments. Enhances marketability of primary issued instruments
    • Dealer (OTC) Market. Decentralised market, dealers facilitate trade via personal inventory. Profit = spread E.g. Debt mkt
    • Auction Market. Centralised market where buy/sell orders are matched by brokers or electronically e.g. Equity ASX

End

This is the end of this topic. Click Business Finance to go back to the main subject page for Business Finance

References

Textbook refers to Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010.

  1. Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010., pp. 7-10
  2. Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010., pp. 10-12
  3. Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010., pp. 12-16
  4. Essentials of Corporate Finance (2nd Australian and New Zealand edition), by Stephen A. Ross, Rowan Traylor, Ron Bird, Randolph W. Westerfield and Bradford D. Jordan, McGraw Hill Irwin, 2010., pp. 16-20
Personal tools
Namespaces

Variants
Actions
Navigation
Toolbox