Week 2 Flashcards
Proprietorship
Owned by an Individual
All risks and liabilities lie with the individual
it may have employees
Simplest from of business organisation
Suitable for small/micro businesses/shops etc
Drawbacks:
Unlimited liability
Limited ability to raise money to expand business
Managerial skill and time – limited by the owner’s ability
Easy to manage details of transaction
Partnership
Owned by more than one individual/entity
All risks lie with the individuals/entities
It may have employees
Simple form of business organisation
Suitable for relatively larger micro businesses / shops, etc
Drawbacks
Unlimited liability
Limited ability to raise money to expand business – up to the partners only or borrowing
Managerial skill and time – limited by the partners’ ability
Easy to manage details of transaction
Easy Accounting and Financial Management
However, sharing of profits makes it somewhat complex
Limited Companies
Separate ‘Legal Entity’, Owned by Shareholders
Managers run the company on behalf of the shareholders
More complex structure
Drawbacks
Complexity and cost to engage accountants – so a minimum threshold size of business needed to justify cost
Need to pass on information from Managers to Owners
(Shareholders) – Detailed Accounting Reports needed
More strict laws and regulation to follow – Agency Problem
Benefits
Ability to raise significant capital
Can hire managers as needed – Skill can be rewarded as required
Not dependent on owners for success / continuity
Private Limited Companies vs Public (Listed) Limited Company
Private Limited
Mostly Small businesses – Shares are not ‘listed’ on stock exchanges and cannot be bought and sold in the open market
Large private companies also exist. E.g., Vitol, Poundland, Wilko, Aldi, Bose, IKEA
As few shareholders made up of close family/associates
Regular contact with managers – Financial Reporting is not too much of an issue
Public Limited
Large businesses – Shares are ‘listed’ on stock exchanges and can be bought and sold in open market. E.g., Volkswagen, Tesco, Apple, Barclays
Large number of small shareholders made up of a diverse unrelated group of entities – Need to pass on information – Financial Reporting very important issue – Regulated by government and stock exchanges
Typical Board Structure in the UK
Executive Directors: Directors from the Management team involved in the day-to-day management of the company
Non-Executive (Independent) Directors: Directors appointed from outside, not involved with the day-to-day management of the company
Chairman of Board: Heads the board of the directors, can be a non-executive Director
CEO: Heads the management team of the company
(CEO and Chairman can be the same person)
CFO (Chief Financial Officer)- a senior executive who manages a company’s financial operations and initiatives. Responsibilities include risk management, strategic decision making and financial reporting.
Prevention of the Dominant CEO
There should be a clear division between the head of
the company in control of the Board and the executive responsible for running the company’s business
The Board should monitor the CEO and senior
management actions to protect the interests of the
shareholders
The Board should be willing to challenge the CEO and not bow down to pressure from senior management
However, the CEO generally gets their own way, as their is not much challenge when power is concentrated on one individual.
Agency Theory (Ross 1973)
The separation of ownership and control.
Management as agent of shareholder alone
Management’s aim is to maximise shareholders’ wealth
Undertake productive investment with a return greater than that available in financial markets for equivalent
risk
Ross explained that there are costs involved with managing the behaviour of agents:
Monitoring Costs- financial reporting and corporate governance
Bonding Costs- profit bonuses, dividend policy.
Stakeholder Theory (Freeman 1984)
Company should act in the stakeholders’ interest
This includes shareholders but with fairness to other stakeholders
Business operates with sanction of society, so should be responsible to society as well.
Emergence of concept of corporate social responsibility.
External Provision of Information
Accounting Reports – Mandatory by Regulation Quarterly / Annually
Annual Reports with various message and/or statements – Not Mandatory – Also acts as part of PR by Management
Press releases – For one-time relevant information
Most of the stakeholders are expected to make decisions based on this information – provided to external stakeholders
Their decision will be only as good as the quality
of information
Principal-Agent Problem (Agency Problem)
Shareholders do not involve with the day-to-day operations of the firm.
Managers work as “agents” of owners to run the firm and to maximise the shareholders’ wealth
However, Shareholders normally have fragmented (different) set of interests and lack the technical knowledge and are passive. Managers have their own specific set of interests and have more information about the company
Therefore, managers could employ privileged information to their own benefit, to the detriment of shareholders.
Principal-Agent Problem is not exclusively the conflict in interests of owners and managers, it applies to a conflict in the interests of any groups.
Agency Problem Examples
Inflated sales/revenue to earn bonus
Short-term focus on profitability vs long-term wealth maximisation.
Tesco bought a corporate jet valued at $50m in 2014 immediately after the revelation that its profits were
overstated by up to £250 million.
Overcoming Agency Problem
Some popular mechanisms are:
Corporate Governance Regulations
Companies Act, FCA, Accounting bodies
Linking Compensation Plans to shareholders’ wealth – provision of stock options to managers
Shareholder Pressure / Dismissal
Sell of shares to create takeover threat
Force firms to improve information flow
Non-Financial Objectives
Some Examples
Employee Welfare – Safety, Mental Health, Career Progression
Provision of a service – Telephone, Gas, Water, health, National Security
Environmental Protection – CO2, Pollutants, Deforestation
Social Welfare – Addiction, Inequality
These are extremely important
But very difficult to measure in an objective
manner
Not captured in normal accounting and finance set
Not-for-Profit Organisations
Some organisations do not have profits as primary objective – examples – Government departments, Universities, Hospitals, NHS, Charities
These organisations are very important in promoting welfare of general public.
But their effectiveness is very difficult to measure in an objective manner
Not captured in normal accounting and finance set up
Value for Money – Getting the best possible combination of services from the least resources
Economy – Spending less money to provide same service
Efficiency – Using same money to provide additional service
Effectiveness – Using the planned amount of money to deliver planned amount of service
Whats the difference in Accounting and Finance
In simple terms, accounting focuses on reporting where finance looks at prices, markets and risk.
