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Finance > The Business Finance Environment > Flashcards

The Business Finance Environment Flashcards

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1
Q

What is the business finance environment?

A
  • 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
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2
Q

What is a sole proprietorship/sole trader-ship?

A

A business that is owned by a single individual and is not legally separate from the owner e.g newsagents/cornershops

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3
Q

What are the characteristics of a sole proprietorship?

A
  • Unlimited liability for debts

- Limited access to capital

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4
Q

What is a partnership?

A

A business with two or more owners who all share in the risks and profits of the entity

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5
Q

What are the characteristics of a partnership?

A
  • Often a group of professionals e.g solicitors, accountants
  • Partners liable for debts
  • Limited access to capital
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6
Q

What is a company?

A

A business incorporated under company law, with its own separate legal identity, and its own rights and obligations

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7
Q

What are the characteristics of a company?

A
  • 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
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8
Q

What are examples of stakeholders?

A
  • Investors/owners
  • Lenders
  • Suppliers/creditors
  • Employees
  • Customers
  • Government
  • The public
  • Managers
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9
Q

What is the primary objective of a firm’s financial management?

A

To maximise the wealth of its shareholders/maximise firm value

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10
Q

Why are stakeholders important?

A
  • 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
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11
Q

What is the difference between maximising profit and maximising wealth?

A

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.

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12
Q

What are alternative corporate objectives?

A
  • 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
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13
Q

What are long term sources of finance?

A
  • Ordinary and preference share capital
  • Reserves: retained profit and other reserves
  • Long term loans/bonds (secured or unsecured, fixed or variable interest rates)
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14
Q

What are medium term sources of finance?

A
  • Bank loans (usually for a specific project, security usually required)
  • Leasing/hire purchase
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15
Q

What are short term sources of finance?

A
  • Bank overdraft
  • Factoring and invoice discounting
  • Trade creditors
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16
Q

How do debt and equity differ in terms of regular servicing?

A

Debt involves a contractual obligation to pay periodic interest whereas with equity there is no contractual obligation to pay dividends

17
Q

How do debt and equity differ in terms of repayment?

A

Debt is repaid often as there is a contractual obligation to do so. Equity shares are always perpetual - non repayable

18
Q

How do debt and equity differ in terms of ownership interest?

A

A debt provider is a lender and doesn’t have ownership interest. An equity investor has a high ownership stake.

19
Q

How do debt and equity differ in their position in the queue for cash?

A

Debt is high in the queue whereas equity shares are low.

20
Q

How do debt and equity differ in terms of sanctions for non performance?

A

Legal action will occur in the form of an insolvency process for debt. Equity investors may remove directors or sell their shares.

21
Q

How do debt and equity shares vary in terms of variety?

A

There is a wide variety of debt but equity shared tend to be very standard.

22
Q

Who uses debt and equity?

A

Commercial organisation and governments use debt whereas companies use equity shares.

23
Q

How are debt and equity investments traded?

A

Debt is traded on bond markets and equity shares are traded on stock markets.

24
Q

What is the value of the firm?

A

The value of all the financing:

  • Value of equity
  • Value of other shares
  • Value of debt
25
Q

What are shareholders?

A

Owners of the company who get a dividend of profits. Losses are borne by them up to the amount they invested.

26
Q

What are directors?

A

May be appointed/removed by shareholders, may themselves be shareholders and sit on a board that comprises of both executive and non executive directors.

27
Q

What is agency theory?

A

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.

28
Q

What is the agency problem?

A
  • Conflict of interest between principle (shareholders) and agents (directors/managers) - self interest behaviour, redistribution/loss of wealth
  • Asymmetric information, bounded rationality, moral hazard
29
Q

What are agency costs?

A
  • Contracting costs (logistics, constraints, incentives) e.g
  • Monitoring costs
  • Bonding costs
  • Residual loss
30
Q

How are monitoring costs incurred?

A
  • Audit
  • Company general meetings
  • Analyst reports
31
Q

What do contracting costs consist of?

A
  • Directors’/managers’ contracts

- Director/manager incentive schemes (profit sharing bonuses, granting of share options)

32
Q

How do shareholders exert control on the organisation?

A
  • 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
33
Q

What is corporate governance?

A

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.

34
Q

What are some definitions of corporate governance?

A
  • 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)
35
Q

What is the importance of corporate governance?

A
  • 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)
36
Q

What is the UK Corporate Governance Code 2018?

A

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.

Finance (6 decks)

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