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CHAPTER ELEVEN

Financial Management

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 LEARNING OUTCOMES

In this chapter, you will learn to:

 Explain what financial management is.
 Relate corporate finance to legal forms of business
organization.
 Discuss the goal of the firm.
 Explain the agency problem.
 Elaborate the firm’s capital structure and the cost of capital.
 Discuss capital raising and elaborate capital markets.
 Elaborate capital budgeting process.
 Discuss corporate costs control.
 Explain time value of money, present and future value.

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 Concept and Functions of Money

Barter System of Trade :

An ancient mode of goods exchange –
it involved the exchange of goods for
other good, without any use of money

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 Five Principle Disadvantages of
the Barter System of Trade

‘Double coincidence of wants’ dilemma

Lack of common measure of value
Lack of divisibility
Problem of storing wealth
Problem of transportation

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 Concept of Money

Money is any item that people will accept in

exchange for goods or services, in the belief that
they may turn exchange the money, now or later,
for other goods or services.

Gold, Silver, Copper, Iron bars , jewellery.

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 Functions of Money

A medium of exchange
A store of value
A unit of account

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 FINANCIAL MANAGEMENT

• Deals with the maintenance and creation of

economic value or wealth.
• Involves the dimensions of:
– Investment decision
– Financing decision

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 FINANCIAL MANAGEMENT
DECISIONS

• Investment decision
– Choose the most promising investment venture
that offers the highest expected return after
considering the risks involved.
• Financing decision
– Decide on how to raise funds (cheapest) to
finance the company’s investment ventures.

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 LEGAL FORMS OF
BUSINESS ORGANIZATIONS

• Each legal form of business organization has its

own unique characteristics in terms of:
– Legal identity
– Nature of ownership succession
– Business continuity
– Taxation implication on income generated

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 GOAL OF THE FIRM

• To maximize shareholders’ wealth.

• The management should manage the firm in such a
way to enhance the wealth of its owners, who are
the shareholders.
• Shareholders’ wealth will be enhanced if:
– The share price of the firm keeps increasing.
– They constantly receive dividend payments as a form
of return for their investment in the firm.

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 SHAREHOLDERS AND
MANAGERS

• Managers are the agents for their principals, who are

the shareholders of the firm.
• The concept of separation between management and
ownership roles in corporation may not always
result in an ideal outcome.
• Managers may run the business in such a way to
maximize their own wealth, instead of the
shareholders’ wealth.
• This situation is referred to as the agency problem.
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 THE TAX ENVIRONMENT

“There are two things in life that we cannot avoid:

death and paying taxes.”
• As an individual, each and every one of us has to pay
personal income tax on income generated.
• Similarly, a company or a corporation also has to pay
taxes.
• The corporation form of business is regarded as a legal
entity from the perspective of company law.
• When a corporation declares profits in its business
activities, it is subjected to taxes.
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 DOUBLE TAXATION

• When a corporation pays taxes, it is a cost to the

shareholders.
• If a corporation pays dividends to its shareholders,
the dividends are subject to personal income taxes.
• Therefore, the income that is generated by the
corporation is taxed twice; once at the corporation
level, the other at the shareholders’ level.
• This situation is referred to as double taxation.

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 CAPITAL STRUCTURE

• Capital is the money that the corporation uses to

fund the business investment activities and other
operating expenditures.
• Two sources of capital are:
– Equity
– Debt
– Preferred stock : hybrid instrument that has the
characteristic of both equity and debt.
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 CAPITAL STRUCTURE

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 • Cost of Capital :
• Equity = Dividend
• Debt = Interest
• Debt Instruments : Bond, bank term loans and inter-
company loans.
• When a corporation has a high level of debt in its
capital structure, it is said to be highly leverage

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 CAPITAL MARKETS

• Corporations raise funds (capital) by issuing financial

securities (equity and debt) and selling them to investors
in return for cash.
• These transactions take place in capital markets, i.e.
share market and bond market.
• When a corporation issues shares and sells them to the
investing public for the first time, it is called initial
public offering (IPO).
• Capital markets are further distinguished as:
– Primary market
– Secondary market
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 FINANCIAL INSTITUTIONS
AND REGULATORS

• Bursa Malaysia
• Stock broker
• Remisier
• Dealer
• Securities Commission
• Bank Negara

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 CAPITAL BUDGETING

• To decide on how best to utilize the capital funds

in order to generate income and create value for
the firm.
• Managers evaluate and decide on what
investment projects to undertake so that the
invested capital in the chosen project will yield
the highest possible return.

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