Week 1 Flashcards
The Firm
A firm is used to denote a business entity in literature. This can be a sole trader, a limited company, or a partnership. However, we generally talk about limited companies which are the most successful and prevalent form of business organisations or firms. This is because of limited liability (liability limited up to the amount invested), separate legal identity, continuity of existence and because they have the ability to gain from economies of scale.
What is the difference between accounting and finance?
Accounting is generally concerned with keeping record of transactions. There are two main types in the form of financial and management accounting. Financial accounting is mainly concerned with preparing financial reports as per laws and regulations. Management accounting is concerned with helping managers make decisions.
Finance’s main role is too manage transactions and money. The two main areas are financial management (day to day management such as debtors and choosing between two projects) and corporate finance (the management of transactions related to the capital structure of a firm, such as borrowing loans and issuing dividends).
Financial Management in More Detail
Financial Planning-
Short-term planning – matching cash receipts with cash
payments
Long-term planning – Strategy, markets, capital structure
Financial Control and Risk Management-
Is the business meeting its targets? Comparing actual with planned (forecasted) numbers, preventing misuse, fraud
Role of the Finance Manager-Interaction with Financial Markets
Shareholders-
Private Equity (investment into established businesses to provide opportunities for growth) vs Venture Capital (investment into start-ups to allow entrepreneurs to bring their product to market)
Initial Public Offering (first time a company sells shares to the public and raises money) vs Private Placement (selling securities to a select group of investors, rather than to the public)
Debt Holders-
Type of Debt
Terms of Debt
Alternative Options
Dividends
Very Dynamic Role
Role of the Finance Manager Cycle
Cash raised by selling financial assets e.g loan agreements, shares.
Cash used to purchase real assets.
The firms operation using real assets.
Cash generated by the firm’s operation.
Cash returns to investors, dividends/interest.
Capital Markets-financial claims held by investors
Role of the Finance Manager- Investment
Decisions regarding best use of cash to increase value
Which projects to undertake- project appraisal / capital budgeting
Need knowledge of both analytical techniques and relevant issues- corporate strategy-govt restrictions
Divestment (Disinvestment) Decisions- Assets or business lines which are no longer adding to shareholders’ wealth
Dividends Vs Retained Earnings
Borrowings vs retained profits
Role of the Finance Manager- Treasury Management
Management of Cash
* May also include Money Market activities for large corporates
Cash should not be kept idle
* This will reduce profitability and shareholders’ returns
* But the company also needs to maintain some cash to meet unexpected requirements
* Need to balance
Investing surplus cash in short term investments
* Generating cash by selling such investments when cash is needed
* Very dynamic transaction
Management of cash may also include
* Inventory Control
* Creditor and Debtor Management – Credit Policy
Role of the Finance Manager- Risk Management
Exchange rate movements in international trade
* Forwards, Swaps
Risk of default by debtors / Bankruptcy of debtors
* Credit policy
* Debt Management
Changes in interest rates
* Fixed vs Floating interest rates
* Covenants of loan contracts, inflation
Fluctuations in commodity prices – Input and Output
* Forward contracts vs stocking
Insurable risk and insurance
Role of the Finance Manager- Strategy and Value Based Judgement
Implementation of long-term strategy is more important than short-term profitability
* Clear the stock by selling on discount, e.g., NEXT
* Destroy stock to keep prices high, e.g., food items, luxury goods
Need to distinguish between the products and markets that generate value for the firm and those which do not
* Diversification decisions
* Divestment decisions
Value Based Management – The return generated by a
business/ product should be commensurate with the risk taken
Three Financial Decisions- The Financing Decision
How/where/when to raise funds for these investments?
What should be the mix of debt/equity and other sources of funds?
Three Financial Decisions- The Allocation Decision
Where to invest the scarce resources of the firm?
How to determine the worth of an investment?
Three Financial Decisions- The Dividend (Rewarding) Decision
How much of a firm’s funds should be reinvested and how much should be returned to the owners (shareholders)?
