The Business Finance Environment Flashcards
What is the business finance environment?
- Different types of business entity
- Stakeholders
- Corporate objectives
- Sources of finance available to the firm
- Firm value and capital structure
- Shareholders and directors; agency theory
- Governance
What is a sole proprietorship/sole trader-ship?
A business that is owned by a single individual and is not legally separate from the owner e.g newsagents/cornershops
What are the characteristics of a sole proprietorship?
- Unlimited liability for debts
- Limited access to capital
What is a partnership?
A business with two or more owners who all share in the risks and profits of the entity
What are the characteristics of a partnership?
- Often a group of professionals e.g solicitors, accountants
- Partners liable for debts
- Limited access to capital
What is a company?
A business incorporated under company law, with its own separate legal identity, and its own rights and obligations
What are the characteristics of a company?
- Easier and wider access to sources of capital
- Transfer of share ownership without affecting the business
- Public access to financial information
- Public (UK plc) vs private (UK LTD)
Limited liability of their shareholders: only required to finance the business to an agreed capital amount
What are examples of stakeholders?
- Investors/owners
- Lenders
- Suppliers/creditors
- Employees
- Customers
- Government
- The public
- Managers
What is the primary objective of a firm’s financial management?
To maximise the wealth of its shareholders/maximise firm value
Why are stakeholders important?
- A fairly treated workforce is likely to be a productive workforce
- A reasonable environment approach avoids costly legislation and penalties
- Social contribution builds positive reputation and image
What is the difference between maximising profit and maximising wealth?
Maximising profit tends to be a short term objective, does not focus on cash generation, does not consider timing or risk.
Maximising wealth is a longer term and overriding objective, is focussed on cash flow and considers timing and risk.
What are alternative corporate objectives?
- Maximise profits
- Achieve a satisfactory level of profits
- Maximise sales
- Achieve a target market share
- Minimise employee turnover
- Maximise managerial income/prestige
- Technical innovation
- Limit environmental damage
- Provide gainful employment
- Contribute to society
What are long term sources of finance?
- Ordinary and preference share capital
- Reserves: retained profit and other reserves
- Long term loans/bonds (secured or unsecured, fixed or variable interest rates)
What are medium term sources of finance?
- Bank loans (usually for a specific project, security usually required)
- Leasing/hire purchase
What are short term sources of finance?
- Bank overdraft
- Factoring and invoice discounting
- Trade creditors
How do debt and equity differ in terms of regular servicing?
Debt involves a contractual obligation to pay periodic interest whereas with equity there is no contractual obligation to pay dividends
How do debt and equity differ in terms of repayment?
Debt is repaid often as there is a contractual obligation to do so. Equity shares are always perpetual - non repayable
How do debt and equity differ in terms of ownership interest?
A debt provider is a lender and doesn’t have ownership interest. An equity investor has a high ownership stake.
How do debt and equity differ in their position in the queue for cash?
Debt is high in the queue whereas equity shares are low.
How do debt and equity differ in terms of sanctions for non performance?
Legal action will occur in the form of an insolvency process for debt. Equity investors may remove directors or sell their shares.
How do debt and equity shares vary in terms of variety?
There is a wide variety of debt but equity shared tend to be very standard.
Who uses debt and equity?
Commercial organisation and governments use debt whereas companies use equity shares.
How are debt and equity investments traded?
Debt is traded on bond markets and equity shares are traded on stock markets.
What is the value of the firm?
The value of all the financing:
- Value of equity
- Value of other shares
- Value of debt
What are shareholders?
Owners of the company who get a dividend of profits. Losses are borne by them up to the amount they invested.
What are directors?
May be appointed/removed by shareholders, may themselves be shareholders and sit on a board that comprises of both executive and non executive directors.
What is agency theory?
A relationship as a contract under which one or more persons engage another person to perform some service on their behalf which involves delegating some decision making authority to the agent.
What is the agency problem?
- Conflict of interest between principle (shareholders) and agents (directors/managers) - self interest behaviour, redistribution/loss of wealth
- Asymmetric information, bounded rationality, moral hazard
What are agency costs?
- Contracting costs (logistics, constraints, incentives) e.g
- Monitoring costs
- Bonding costs
- Residual loss
How are monitoring costs incurred?
- Audit
- Company general meetings
- Analyst reports
What do contracting costs consist of?
- Directors’/managers’ contracts
- Director/manager incentive schemes (profit sharing bonuses, granting of share options)
How do shareholders exert control on the organisation?
- May appoint/remove directors
- Directors select management
- Competition in managerial labour market force directors/managers to perform in the best interest of shareholders to avoid replacement
What is corporate governance?
The way in which companies are controlled. Narrow view focuses on the relationship between company and shareholders. Broader view looks at relationship between company and a range of stakeholders.
What are some definitions of corporate governance?
- Supervision and control to ensure management acts in accordance with the interests of shareholders
- Giving overall direction, overseeing and controlling the actions of management, satisfying legitimate expectations of outsiders (Tricker, 1984)
What is the importance of corporate governance?
- CG has attracted attention in light of corporate scandals e.g BCCI, Barings, Enron, Guinness and Parmalat
- Now entrenched in regulation e.g UK Corporate Governance Code (2018) and US Sarbanes-Oxley Act (2002)
What is the UK Corporate Governance Code 2018?
Applies to accounting periods beginning after 1 Jan 2019. Emphasis on relationships between company and stakeholders. Must report in annual report how they have applied the code. Can lead to better trust.
