Business Finance 1

5/11/2018 Prof.
Kwame Adom-Frimpong 1
LEARNING OBJECTIVES
After studying this session, you should have achieved the following
learning objectives:
An understanding of the principles of the financial system.
The role of a Finance Manager
Types of business
An appreciation of the financial and non-financial objectives of

a company.
An understanding of the reasons why shareholder wealth

maximization is the primary financial objective of a company.
5/11/2018 Prof. Kwame Adom-Frimpong 2

Imagine you were to start your own business. No matter what type you started, you
would
have to answer the following three questions in some form or another:
1. What long-term investments should you take on? That is, what lines of
business will
you be in and what sorts of buildings, machinery, and equipment will you need?
2. Where will you get the long-term financing to pay for your investment? Will
you
bring in other owners or will you borrow the money?
3. How will you manage your everyday financial activities such as collecting
from
customers and paying suppliers?
These are not the only questions, but they are among the most important. Business
finance, broadly speaking, is the study of ways to answer these three questions. We’ll be
looking at each of them in the chapters ahead.

What Is Business Finance?
 Business Finance is concerned with all aspects of how
the business deals with its financial resources in order
to maximize profit over the long term.
 A business is any organization that strives for profit by
providing goods and services that meet customer
needs. It is an exchange of products and services for
money.

THE PARTICIPANTS IN BUSINESS
 Owners/Shareholders – are those people who have
invested money into the business and hope to receive
returns for their investment.
 Managers – are the decision makers for the business.

The Manages may or may not be owners.
 Stakeholders – These are the people or groups who

have some claim on or expectation of how the business
should operate.
FORMS OF BUSINESS OWNERSHIP
 Every business is owned by someone and exists in one
of a very few forms. There are three traditional terms
of ownership. They are
 Sole Proprietorship
 Partnership
 Company

SOLE PROPRIETORSHIP
 It is a business that is totally owned by a single person. This is the most
common form of business ownership in Ghana. One person owns not
only the business but all the assets and liabilities of the business.
 Sole proprietorships do not have to be run by one person working

alone.
 ADVANTAGES AND DISADVATAGES OF SOLE PROPRIETORSHIP
 Advantages Disadvantages
 It is easy to form 1. Owner is liable for debts

 Owner has discretion 2. Funds are limited
 Owner controls profit 3. Business ceases when the
owner dies.

PARTNERSHIP
 Is a business owned by two or more individuals. The
maximum lawful number of parties is twenty. However
the limit is increased in certain cases: - Banking,
Professional firms.
 How a partnership is formed – Partnership – by
agreement, express or implied.

TYPES
 Active Partner / working partners
 Dormant Partner / silent partners
 Limited

Partnership agreement
 It is important for the partners to establish a partnership
agreement at the inception of the business. The
Partnership agreement is a document that prescribes the
responsibilities and privileges of each partner.
 The agreement must specify the following:
 The percentage of ownership of each partner

 How the profits (and losses) will be shared
 How the partnership may be dissolved.

Advantages and Disadvantages of
Partnership
 Advantages
 It is easy to form
 Additional talents help in running the business
 More sources of financing are available
 Partners have claim to profits
 Disadvantages
 Partners have financial liabilities

 Dissolves upon death of one partner
 Inter personal conflicts between partners may arise.
 Partner’s action commit other partners

A COMPANY
 Is a business entity owned by shareholders. The

minimum number of individuals is normally two and
there is no maximum. Sec 8 of Company Act 1963 (Act
179)” Any one or more persons may form an
incorporated company by complying with the
provision of the act in respect of registration

TYPES OF COMPANIES (SECTION 9)
 Limited Liability Company – a company having the liability of its
members limited to the amount, unpaid on shares respectively
held by them – it is referred to as a Company Limited by
Shares.
 A company having the liability of its members limited to such

amount as the members may respectively undertake to
contribute to the assets of the company in the event of its being
wound up. It is referred to as a company limited by guarantee.
 A company not having any limit on the liability of its members is

referred to as unlimited company.
PRIVATE OR PUBLIC COMPANY
 A company of any of the forgoing types may either be a
private company or public company.
 A private company shall be a company which by its
Regulation
 Restricts the right to transfer its shares, if any
 Limits the total member of its members and debenture
holders to fifty
 Prohibits the company from making invitation to the
public to acquire shares or debenture of the company and
 Prohibits the company from making any invitation to the
public to deposit money for fixed period.

REGISTERED COMPANIES PARTNERSHIPS
1. Formation is by registration of certain 1. Formation is by agreement, express or
documents as required by the Companies Act implied, without any special formality.
1963 A179. (Though limited partnerships do require
registration).
2. Separate personality. A registered company has
a separate, corporate personality distinct from 2. A partnership has no separate legal
the human personalities of its members : personality, and is merely an association of
Salomon v. Salomon & Co Ltd (1897) several human persons.
3. Number of members: (i) In a private company 3. A partnership cannot have more than 20
there can be from 1 to 50 members (not members.
counting past employees): (ii) In a public
company there can be formed by one person. 4. In a partnership the liability of members is
unlimited (except for any rare limited
4. Limited liability. In a registered company the partners: see chapter VI).
liability of every member can be limited.
5. Creditors can sue partners jointly or
5. Creditors usually have no rights of action individually, in the firm’s name or in their own
against members of a registered company, names.
providing the company is not in breach of
certain rules; 6. Powers of a firm and its internal regulations
are fixed by the Partnership Articles (if any),
6. Powers. A company’s powers are fixed by its or by the Partnership Act 1962, and can be
Memorandum of Association, and its internal altered at any time by agreement among the
regulations by the Articles of Association (both partners
of which can be altered only as permitted by the
Companies Act 1963)

REGISTERED COMPANIES PARTNERSHIPS
7. Public documents. The Memorandum and Articles of
a registered company are open to inspection by the
7. The Partnership Articles are not
public, and all outsiders dealing with the company open to public inspection, and
are legally presumed to have notice of their contents.
outsiders are not presumed to
8. Agency. No member of a company has any implied have any knowledge of their
agency to contract for the company, i.e. agents must
be expressly appointed. contents.
9. Transfer of shares. In a public company, shares are
freely transferable without consent of other
8. Every general partner has
members. (Consent is usually necessary in private implied authority to act as agent
companies)
for the firm in the conduct of its
10. Transferees of shares have full rights as members business. (Limited partners have
immediately they register their transfer.
no such authority.)
11. Liquidation. Companies are wound-up in the manner
provided by the Companies Acts, either by the Court 9. Partners cannot transfer their
or by a Liquidator appointed by member or creditors.
shares without the agreement of
12. Dissolution. A company remains in existence until
the Registrar of Companies cancels its registration. the other partners.
13. Alteration of capital can be effected only in
accordance.
10. Transferees of shares can share
profits, but have usually no
further rights unless the other
partners consent.

ROLE OF FINANCIAL MANAGER
 Financial Management covers all the functions concerned in

attempting to ensure that financial resources are obtained and
used in the most effective way to secure attainment of the
objectives of the organisation.
The role of the financial manager is separated into three main
areas:
 The raising of finance / financing decisions.
 The efficient allocation of resources / Investment decision.
 Decides whether to pay dividend or not / Dividend decisions
 Maintenance control over the resources to ensure objectives are
met

Raising Finance/Financing decision
 The process of selecting suitable funds to finance long term
means and working capital.
 The Manager must know:
 Where additional funds can be obtained from and at what cost.
 The effect on a company’s profitability and value of using any

particular source of funds.
 The effect on financial risk of using any particular sources of

funds.

Sources of Fund
 Internally generated surpluses.
 Externally funds – 1 Equity

2 Debt finance

Investments
Broadly speaking, the investments area deals with
financial assets such as stocks and bonds. Some of the
more important questions include:
1. What determines the price of a financial asset such as
a share of stock?
2. What are the potential risks and rewards associated
with investing in financial assets?
3. What is the best mixture of the different types of
financial assets to hold?

Capital Budgeting
 The first question concerns the firm’s long-term
investments.
 The process of planning and managing a firm’s long-
term investments is called capital budgeting.
 In capital budgeting, the financial manager tries to
identify investment opportunities that are worth more
to the firm than they cost to acquire. Loosely speaking,
this means that the value of the cash flow generated by
an asset exceeds the cost of that asset.

As a Stockbrokers
 Stockbrokers often work for large companies such
 advising customers on what types of investments to
consider and helping
 them make buy and sell decisions. Financial advisers
play a similar role, but are not necessarily brokers.

Portfolio Management
 Portfolio management is a second investments-related
career path. Portfolio managers,
 as the name suggests, manage money for investors. For
example, individual investors
 frequently buy into mutual funds. Such funds are simply a
means of pooling money that is then invested by a portfolio
manager.
 Portfolio managers also invest and manage money for
pension funds, insurance companies, and many other types
of institutions.

Security Analysis
 Security analysis is a third area. A security analyst
researches individual investments, such as stock in a
particular company, and makes a determination as to
whether the price is right.
 To do so, an analyst delves deeply into company and
industry reports, along with a variety of other
information sources.
 Frequently, brokers and portfolio managers rely on
security analysts for information and
recommendations.

Dividend Decisions
ordinary shareholders expect to earn dividends and the
value of a company’s shares will be related to the amount
of dividend that a company has been paying, and also
to prospects of what the dividend might be in the future.

Working Capital Management
 The term working capital refers to a firm’s short-term
assets, such as inventory, and its short-term liabilities,
such as money owed to suppliers.
 Managing the firm’s working capital is a day-to-day

activity that ensures the firm has sufficient resources
to continue its operations and avoid costly
interruptions. This involves a number of activities
related to the firm’s receipt and disbursement of cash.

Why Study Finance?
Marketing and Finance
 If you are interested in marketing, you need to
know finance
 because, for example, marketers constantly work with
budgets, and they need to understand how to get the
greatest payoff from marketing expenditures and
programs

WHY STUDY FINANCE CONT’D
 Accounting and Finance
 For accountants, finance is required reading. In smaller
businesses in particular, accountants are often required to make
financial decisions as well as perform traditional accounting
duties.
 Further, as the financial world continues to grow more complex,
accountants have to know finance to understand the
implications of many of the newer types of financial contracts
and the impact they have on financial statements.
 Beyond this, cost accounting and business finance are
particularly closely related, sharing many of the same subjects
and concerns
WHY STUDY FINANCE CONT’D
 Management and Finance
 One of the most important areas in management is
strategy.
 Thinking about business strategy without
simultaneously thinking about financial strategy is an
excellent recipe for disaster,
 and, as a result, management strategists must have a
very clear understanding of the financial implications
of business plans

Why Study Finance cont’d
 You and Finance
 Perhaps the most important reason to know finance is

that you will have to make financial decisions that will
be very important to you personally. Today, for
example, when you go to work for almost any type of
company, you will be asked to decide how you want to
invest your retirement funds.

Objectives of Stakeholders in a Firm
Stakeholders are individuals or groups who have
an interest in the performance of a firm.
Stakeholders may include among others:
Shareholders;
Managers;
Employees;
Unions
Government;
Society at large.
Each of these groups may have its own objective(s)
for the firm:

Each of these groups may have its own
objective(s) for the firm:
 Shareholders may be interested in the dividends they
receive and the price of their shares. They are normally
assumed to be interested in wealth maximization.
Shareholders as a group may be interested in profit
maximization. They may also be interested in the
welfare of their employees, or the environmental
impact of the company’s operations.
 Managers may be interested in their salary, perks (e.g.
office size), relative power, etc;
 Employees may be interested in their pay, security of
employment, working conditions, etc;
 Unions tend to have the same objectives as employees;
 Government may be interested in ensuring that firms do
nothing illegal, pay appropriate taxes, etc;
 Society at large may be interested, for example in
ensuring that pollution levels are kept to a minimum
CONFLICT OF INTEREST
Managerial objectives
 As noted above, the managers (or directors) of a firm will
have their own objectives which could conflict with those
of the shareholders and other interested parties.
 For example, managers could be interested in
 maximizing the sales revenue of the firm or
 the number of employees so as to increase their own
prestige and improve their career prospects.
 Alternatively, they could be interested in maximizing their
short-term financial returns by increasing salaries or
managerial perks.
 It is also important to note that different groups of
managers may be following differing objectives. Marketing
management may be interested in maximizing sales
revenue, while production managers may be more
interested in developing the technological side of the firm
as far as possible.
Although the firm is owned by the shareholders,
the day-to-day control is in the hands of the
managers/directors (the divorce of ownership and
control) and they are in an ideal position to follow
their own objectives at the expense of other
parties. Although in theory shareholders can
replace the management of a company by voting
out the directors at the annual general meeting
(AGM), in practice the fragmented nature of
shareholdings makes this unlikely

Objectives of the Public Sector
 Private sector financial objectives are
comparatively easy to state and measure:
the aim is to maximize shareholder wealth, and
a measure of achievement is the amount of
profit a company generates. Public sector
objectives are more complex. Public sector
organizations can be defined as organizations
which have a goal other than that of earning a
profit for their owners.
Their primary purpose is to provide services to
the public which would not otherwise be
available, or not provided within the financial
means of all the members of the public.
Types of Financial Objectives of Public Sector
Public sector organizations and their financial
objectives can be divided into three types:
 those which are run in order to make a profit and which
should be financed entirely from the charges they make
for their goods or services. These include, nationalized
industries and organizations like the Post Office.
 Organizations which are not run to create a profit (for
example the NHIS);
 Organizations which are service based, meeting their
needs mainly from charges for their services, but which
also are subsidized from taxation.

 Organizations which run for profit in the public
sector are similar to organizations in the private
sector. They usually have to meet government-set
targets in the form of a percentage returns on capital
employed, or are required to break even. However
unlike private organizations public ones are obliged
to supply their product or to provide service to all
part of the country continuously, which can
obviously hamper profitability.
In compensation though, many public sector
organizations enjoy a monopoly situation.

NON-PROFIT AND SERVICE BASED
ORGANISATIONS
 The position of public non-profit making
organizations and service based organizations is
different. The financial objective of these two classes
is to provide ‘value for money’, by using the money
allocated to them efficiently to allow the
organization to discharge its designated purposes
well.

Value for money
The public sector aim of achieving ‘value for money’ can
be defined as the pursuit of economy, efficiency and
effectiveness.
 Economy – this is the obtaining of the appropriate quality
resources at the least cost. The measure is a relative one
and can be assessed in two ways: are costs more than
expected, or are costs more than the comparable inputs?
 Effectiveness – this is concerned with ensuring that the
output of the organization achieves its objectives.
 Efficiency – this links together inputs and outputs, and
measures the amount output per unit of input. To be
efficient the maximum amount of outputs should be
achieved from the resources put in, or only the minimum
level of resources should be used to achieve a given level of
output
Constraints on Financial Objectives
 Social factors
 Is impossible to ignore the social implications of business both
externally and internally.
 The age of democratic . It is impossible to ignore the social implications
of business both externally and internally. The age of democratic ideals
is one which affects the whole of society and cannot be excluded from
the organizations in which people work. The development of education,
the concern for people’s needs and a ‘higher’ overall standard of living
have led us to the point where social aspects cannot be ignored.
 The growth of Trade Unions has had a profound effect on the way A
company takes account of employee welfare and needs. The Unions have
and continue to, make managers more aware of conditions for the
employees.
 In these modern times of high unemployment, the organizations are
much more aware of ‘laying people off’, and causing community unrest.
However, with the increasing place of modern technologies, many
industries, such as electronics, often require less labour compared with
the traditional heavy industries of thirty to forty years ago.
 All firms are now acutely aware of their strong social responsibility
regarding unemployment, and it can often be good for their social
‘image’ if a firm creates new jobs. Deals is one which affects the whole of
society and cannot be excluded from the organizations in which people
work.
Environmental Factors
 The awareness of the effect of business activities on the
environment has grown rapidly in recent years, to the
extent where we even have a political party devoted to the
ecology. Many environmental constraints have been
imposed on firms since the effect of pollution has become
evident; such acts as dumping of waste into rivers or
emission of fumes into the atmosphere are being
controlled.
 More protests may be in the form of the effect of a new
factory on the local landscape, particularly in rural areas.
Often it is much cheaper for a new business to be set up in
rural areas, but they will meet stiff opposition, both from
the effect on the environment and social factors. However,
these ‘negative’ elements must always be weighed against
the positive social factors of increasing or creating further
employment, particularly in rural areas. There will often be
a divergence of interest from the protestors in this matter.

Non-financial objectives
The influence of the various parties with interests
in the firm results in the firm adopting many non-
financial objectives, e.g.
growth
diversification
survival maintaining a contented workforce
becoming research and development leaders
providing top quality service to customers
maintaining respect for the environment

Agency theory
 The relationships between the various interested
parties in the firm are often described in terms of
agency theory.
 Agency relationships occur when one party, the
principal, employs another party, the agent, to
perform a task or a set of tasks, on his behalf. In many
of these principal/agent relationships conflicts of
interest can arise.

Shareholders and Managers Conflict
 In the context of business finance, the most important of
these potential conflicts is between shareholders
(principals) and managers (agents). Though both of these
parties tend to have similar objectives for the firm, there
can be differences. With some firms, shareholders insist
that part of the directors’ remuneration is linked to the
extent to which shareholders’ wealth is enhanced. For
instance, directors are sometimes given long-term share
option schemes. Sometimes management audits are used
to monitor the actions of the directors. These
arrangements have a cost to the shareholders, often
referred to as agency costs.

Why does Agency exist?
Three important features that contribute to the
existence of the agency problem within public limited
companies are as follows:
 there exists a divergence of ownership and control whereby those who
own the company (shareholders) do not manage it, but appoint agents
(management) to run the company on their behalf;
 the goals of the management differ from those of the owners
(shareholders). Human nature being what it is, managers are likely to
look to maximizing their own wealth rather than the wealth of
shareholders;
 asymmetry of information exists between the two parties.
Management, as a consequence of running the company on a day-to-
day basis, has access to both management accounting data and
financial reports, while shareholders only receive annual reports, which
may, themselves, be subject to manipulation by the management.

Dealing with the Agency problem between
Shareholders and Managers
 Monitoring
The first way is for shareholders to monitor the actions of
management. There are number of possible monitoring
devices that can be used, although they all incur costs in
terms of both time and money. These monitoring devices
include:
 The use of independently audited financial statements
and additional reporting requirements,
 The shadowing of senior managers, and the use of
external analysts

Clauses
 An alternative to the monitoring approach is for
shareholders to incorporate clauses into managerial
contracts which encourage goal congruence. Such clauses
may formalize constraints, incentives and punishments.
When shareholders are formulating managerial contracts,
the ‘optimal’ contract will be one which minimizes all of
the costs associated with agency.
These costs include:
 financial contracting costs, such as transaction and legal
costs;
 the opportunity cost of any contractual constraints;
 the cost of managers’ incentive and bonus fees;
 monitoring costs, such as the cost of reports and audits;
 the loss of wealth due to sub-optimal behaviour by the
agent.
Performance-related pay
 Managerial remuneration can be linked to performance
indicators such as profit, earnings per share and return on
capital employed. The major problem here is the difficulty
in finding an accurate measure of managerial performance.
There are a number of difficulties associated with using the
performance measures mentioned since, being accounting
measures, they may be subject to manipulation by
management and may not be good indicators of
shareholder wealth in the first place.

Executive share option schemes
 Due to the problems associated with performance-related

pay, share option schemes now represent the most
frequently used incentive to encourage goal congruence
among senior management. Share options allow managers
to purchase a specified number of their company’s shares at
a fixed price over a specified time period. The share options
only have value when the market price of the company’s
shares exceeds the price at which they can be bought by
using the option. The aim of share option schemes is that,
by giving managers share options and making them
potential

Voting
Shareholders, in addition to using monitoring and
managerial incentives, have other ways of keeping
managers ‘on their toes’. They can exercise their
right to remove directors by voting them out of
office at the company’s annual general meeting.
Whether this represents a viable ‘threat’ to
management or not depends heavily upon the
ownership structure of the company’s share
capital, i.e. whether there are a few large
influential shareholders holding over half of the
company’s shares.

Sale of Shares
Alternatively, shareholders can ‘vote with their
feet’ and sell their shares on the capital markets.
This has the effect of depressing the company’s
share price, making it a possible target for take-
over. The fact that target company management
usually lose their jobs after a take-over may
provide an incentive for managers to run their
company more in the interests of shareholders.

Business Finance 1

Caricato da

Informazioni sul documento

Titolo originale

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Business Finance 1

Caricato da

Copyright:

Formati disponibili

5/11/2018 Prof.

An understanding of the principles of the financial system.

The role of a Finance Manager

An appreciation of the financial and non-financial objectives of

An understanding of the reasons why shareholder wealth

5/11/2018 Prof. Kwame Adom-Frimpong 2

5/11/2018 Prof. Kwame Adom-Frimpong 3

5/11/2018 Prof. Kwame Adom-Frimpong 4

 Managers – are the decision makers for the business.

 Stakeholders – These are the people or groups who

5/11/2018 Prof. Kwame Adom-Frimpong 6

 Sole proprietorships do not have to be run by one person working

 ADVANTAGES AND DISADVATAGES OF SOLE PROPRIETORSHIP

 It is easy to form 1. Owner is liable for debts

5/11/2018 Prof. Kwame Adom-Frimpong 7

5/11/2018 Prof. Kwame Adom-Frimpong 8

5/11/2018 Prof. Kwame Adom-Frimpong 9

 The agreement must specify the following:

 The percentage of ownership of each partner

5/11/2018 Prof. Kwame Adom-Frimpong 10

 Partners have financial liabilities

5/11/2018 Prof. Kwame Adom-Frimpong 11

 Is a business entity owned by shareholders. The

5/11/2018 Prof. Kwame Adom-Frimpong 12

 A company having the liability of its members limited to such

 A company not having any limit on the liability of its members is

5/11/2018 Prof. Kwame Adom-Frimpong 14

5/11/2018 Prof. Kwame Adom-Frimpong 15

5/11/2018 Prof. Kwame Adom-Frimpong 16

 Financial Management covers all the functions concerned in

5/11/2018 Prof. Kwame Adom-Frimpong 17

 The Manager must know:

 Where additional funds can be obtained from and at what cost.

 The effect on a company’s profitability and value of using any

 The effect on financial risk of using any particular sources of

5/11/2018 Prof. Kwame Adom-Frimpong 18

 Externally funds – 1 Equity

5/11/2018 Prof. Kwame Adom-Frimpong 19

5/11/2018 Prof. Kwame Adom-Frimpong 20

5/11/2018 Prof. Kwame Adom-Frimpong 21

5/11/2018 Prof. Kwame Adom-Frimpong 22

5/11/2018 Prof. Kwame Adom-Frimpong 23

5/11/2018 Prof. Kwame Adom-Frimpong 24

5/11/2018 Prof. Kwame Adom-Frimpong 25

 Managing the firm’s working capital is a day-to-day

5/11/2018 Prof. Kwame Adom-Frimpong 26

5/11/2018 Prof. Kwame Adom-Frimpong 27

5/11/2018 Prof. Kwame Adom-Frimpong 29

 Perhaps the most important reason to know finance is

5/11/2018 Prof. Kwame Adom-Frimpong 30

5/11/2018 Prof. Kwame Adom-Frimpong 31

5/11/2018 Prof. Kwame Adom-Frimpong 34

5/11/2018 Prof. Kwame Adom-Frimpong 36

5/11/2018 Prof. Kwame Adom-Frimpong 37

5/11/2018 Prof. Kwame Adom-Frimpong 38

5/11/2018 Prof. Kwame Adom-Frimpong 41

5/11/2018 Prof. Kwame Adom-Frimpong 42

5/11/2018 Prof. Kwame Adom-Frimpong 43

5/11/2018 Prof. Kwame Adom-Frimpong 44

5/11/2018 Prof. Kwame Adom-Frimpong 45

5/11/2018 Prof. Kwame Adom-Frimpong 46

5/11/2018 Prof. Kwame Adom-Frimpong 48

 Due to the problems associated with performance-related