FINA1027
Revision notes
,Lecture 1 - Finance Function
Aim of finance manager:
Optimal allocation of scarce resources available to the company
Accounting vs Finance Function
Accounting Function: Makes use of the financial information and data from business activities, then translates this
information for management to analyse the performance and risk of the firm.
Finance Function (focuses on):
Management of a company's financial resources
Planning for the future
Making strategic decisions to ensure financial sustainability and growth.
It provides both a historical perspective and forward looking analysis. It relies on accurate financial information
provided by the accounting function.
Finance function has 3 key areas; 1. Capital Budgeting 2. Capital structure 3. Working Capital Management
1. Capital Budgeting
The planning and managing of a firms long term investments. Considering the size, timing and risk of cash flows.
2. Capital Structure
Deals with how the firm obtains and manages long term financing.
A firms capital structure is the mixture of long term debt and equity that it will use to finance its operations.
Long term debt: borrowing by the firm (>1 year) to finance its long term investments
Equity: Amount of money raised by the firm that comes from the shareholders investments
Expenses of the various options of financing should be evaluated.
3. Working capital management:
Deals with a firms short term assets and liabilities.
Questions to consider:
How much cash and inventory should be kept on hand?
Should you sell on credit?
How to obtain any short term financing?
Role of finance manager
Role is to create value from the firms capital budgeting, financing and net working capital activities.
By:
Buying assets that generate more cash than they cost
Selling bonds, stocks, and other financial instruments that raise more cash than they cost
,They're appointed by shareholders and oversee the finance function.
Responsible for three core financial decisions:
Investment decisions
o Such as allocation of funds in terms of the total amount of assets, composition of non-current and
current assets, and the risk profile.
Financing decisions
o Raising funds through short-term money markets and long-term capital markets
o Use of mixture of internal funds such as retained earnings and external funds such as bank loans
Dividend decisions
o Deciding how much to retain and how much to distribute to shareholders
Primary objective of corporate finance:
To maximise the value of the company for its owners - Shareholders Wealth Maximisation
How to maximise SW?
SW is increased by:
Dividends
Capital gains through increase of share price
Three factors:
The size of cash flows
The timing of cash flows
The risk associated with cash flows
Promote SW maximisation through actions such as:
Managing a company's working capital efficiently
Raising finance through a mixture of debt and equity to minimise a company's cost of capital
Using NPV to assess all potential investment projects, and accepting all projects with positive NPV
Adopting appropriate dividend policy
Maximisation of profit - difficulties
Companies making profit may not necessarily have cash.
Difficulties:
To use profit as a measure, it should be measured accurately
Profit is usually measured over a one-year period and therefore doesn’t consider the long term survival of
the company
Profit ignores the risk that the firm might incur from profit generating activity
Profit ignores the time value of money
Shareholders are paid with cash, not profits, therefore the timing and risk associated with dividend payments are
more important determinants.
Other objectives:
Sales Maximisation: A company only pursuing sales maximisation may start 'overtrading' and could go into
liquidation. Overtrading occurs if a company is trying to support large volumes of trade from a small working capital
base.
, Stakeholder's Theory
Under stakeholder approach, stakeholders that are affected by the operations of the company have interest in its
decisions.
The theory argues that a firm should create value for all stakeholders, not just shareholders, and in doing so, the
company will achieve true lasting success.
The Agency Problem
Agents Managers
Principals Shareholders
Agency problem occurs when managers make decisions that are not consistent with the objective of SWM.
It concerns the difficulties in motivating the managers (agents) to act in the best interest of the shareholders
(principals).
If managers act to serve their own objectives, shareholder wealth is not maximised.
Why does it arise?
Separation of ownership and control
Conflict of interests between shareholders and managers
Asymmetry of information between shareholders and managers
Separation of ownership and control
Refers to when the shareholders have little or no control over management decisions
Ownership:
o Owners are shareholders who provide capital
o Typically a one-share, one-vote standard
o Minority shareholders: hold a small proportion of the company's shares, resulting in limited ability to
exercise control
o Institutional shareholders: organisations who invest their own assets or those entrusted to them by
others. They can use their equity stake to exercise power on management to affect decisions.
Control:
o The shareholders will appoint executives to run the company on their behalf
o These executives manage the firm
Conflict of interest
Managers will follow their own objectives such as:
Entrenchment (investing funds in a way that benefit themselves and not the shareholders)
o Increasing managerial pay and rewards
o Extravagant offices
o Make investments that play into their strengths (eg pet projects)
Empire building : invest to increase their sphere of control and influence
Redemption: invest to redeem business losses due to fear of dismissal
Asymmetry of Information
When one party to a transaction has material information that another party lacks
Two types:
Revision notes
,Lecture 1 - Finance Function
Aim of finance manager:
Optimal allocation of scarce resources available to the company
Accounting vs Finance Function
Accounting Function: Makes use of the financial information and data from business activities, then translates this
information for management to analyse the performance and risk of the firm.
Finance Function (focuses on):
Management of a company's financial resources
Planning for the future
Making strategic decisions to ensure financial sustainability and growth.
It provides both a historical perspective and forward looking analysis. It relies on accurate financial information
provided by the accounting function.
Finance function has 3 key areas; 1. Capital Budgeting 2. Capital structure 3. Working Capital Management
1. Capital Budgeting
The planning and managing of a firms long term investments. Considering the size, timing and risk of cash flows.
2. Capital Structure
Deals with how the firm obtains and manages long term financing.
A firms capital structure is the mixture of long term debt and equity that it will use to finance its operations.
Long term debt: borrowing by the firm (>1 year) to finance its long term investments
Equity: Amount of money raised by the firm that comes from the shareholders investments
Expenses of the various options of financing should be evaluated.
3. Working capital management:
Deals with a firms short term assets and liabilities.
Questions to consider:
How much cash and inventory should be kept on hand?
Should you sell on credit?
How to obtain any short term financing?
Role of finance manager
Role is to create value from the firms capital budgeting, financing and net working capital activities.
By:
Buying assets that generate more cash than they cost
Selling bonds, stocks, and other financial instruments that raise more cash than they cost
,They're appointed by shareholders and oversee the finance function.
Responsible for three core financial decisions:
Investment decisions
o Such as allocation of funds in terms of the total amount of assets, composition of non-current and
current assets, and the risk profile.
Financing decisions
o Raising funds through short-term money markets and long-term capital markets
o Use of mixture of internal funds such as retained earnings and external funds such as bank loans
Dividend decisions
o Deciding how much to retain and how much to distribute to shareholders
Primary objective of corporate finance:
To maximise the value of the company for its owners - Shareholders Wealth Maximisation
How to maximise SW?
SW is increased by:
Dividends
Capital gains through increase of share price
Three factors:
The size of cash flows
The timing of cash flows
The risk associated with cash flows
Promote SW maximisation through actions such as:
Managing a company's working capital efficiently
Raising finance through a mixture of debt and equity to minimise a company's cost of capital
Using NPV to assess all potential investment projects, and accepting all projects with positive NPV
Adopting appropriate dividend policy
Maximisation of profit - difficulties
Companies making profit may not necessarily have cash.
Difficulties:
To use profit as a measure, it should be measured accurately
Profit is usually measured over a one-year period and therefore doesn’t consider the long term survival of
the company
Profit ignores the risk that the firm might incur from profit generating activity
Profit ignores the time value of money
Shareholders are paid with cash, not profits, therefore the timing and risk associated with dividend payments are
more important determinants.
Other objectives:
Sales Maximisation: A company only pursuing sales maximisation may start 'overtrading' and could go into
liquidation. Overtrading occurs if a company is trying to support large volumes of trade from a small working capital
base.
, Stakeholder's Theory
Under stakeholder approach, stakeholders that are affected by the operations of the company have interest in its
decisions.
The theory argues that a firm should create value for all stakeholders, not just shareholders, and in doing so, the
company will achieve true lasting success.
The Agency Problem
Agents Managers
Principals Shareholders
Agency problem occurs when managers make decisions that are not consistent with the objective of SWM.
It concerns the difficulties in motivating the managers (agents) to act in the best interest of the shareholders
(principals).
If managers act to serve their own objectives, shareholder wealth is not maximised.
Why does it arise?
Separation of ownership and control
Conflict of interests between shareholders and managers
Asymmetry of information between shareholders and managers
Separation of ownership and control
Refers to when the shareholders have little or no control over management decisions
Ownership:
o Owners are shareholders who provide capital
o Typically a one-share, one-vote standard
o Minority shareholders: hold a small proportion of the company's shares, resulting in limited ability to
exercise control
o Institutional shareholders: organisations who invest their own assets or those entrusted to them by
others. They can use their equity stake to exercise power on management to affect decisions.
Control:
o The shareholders will appoint executives to run the company on their behalf
o These executives manage the firm
Conflict of interest
Managers will follow their own objectives such as:
Entrenchment (investing funds in a way that benefit themselves and not the shareholders)
o Increasing managerial pay and rewards
o Extravagant offices
o Make investments that play into their strengths (eg pet projects)
Empire building : invest to increase their sphere of control and influence
Redemption: invest to redeem business losses due to fear of dismissal
Asymmetry of Information
When one party to a transaction has material information that another party lacks
Two types:
