CHAPTER 1: INTRODUCTION TO CORPORATE FINANCE
Contents 1. Scope of financial management 5. Company stakeholders 2. Forms of business organization 6. Management‐Shareholders’ Relationship 3. The objectives of the firm 7. The Audit 4. Regulatory frameworks for companies 8. Public Sector Organisation Learning Outcomes When you have read and understand this chapter, you should be able to: Explain the key decisions in corporate financial management and their interrelationships Explain the different forms of business organization Differentiate between a Limited Liability Company and Public Limited Liability Company Explain the primary objective of a company and why management act to further the objective Identify the various stakeholders in a company and explain the nature of their interest Understand the principles of agency theory Explain the purpose of audit
1. INTRODUCTION Corporate financial management is the management of the financial resources of an organization in such a way as to create and maintain value in the organization. Value is created through the exercise of good judgement in taking the key three decisions involved in financial management. These are: Investment decision Financing decision Dividend decision
Investment Decision Investment decision involves issues relating to the nature of the projects a firm is to undertake. It involves the allocation of capital resources to long term assets that would yield benefits in the future. Two important aspects of the investment decision are (a) the evaluation of the prospective profitability of new investments and (b)the measurement of the cut‐off rate against that the prospective return of new investments could be compared1. Financing decision Financing decision concerns the source of finance that will be used to fund the projects that have been decided upon by the organization. This will involve the consideration of equity, preferential share capital and loan stock as a source of funding for the project. This is also a capital structure issue. Capital structure is the mixture of equity and debt the company is using to finance its operations. The finance manager should work towards an optimum capital structure2. Dividend Decision Given a profit making organization, dividend decision concerns the distribution of the residual profits after taking the investment and financing decision. An organization will decide whether to distribute or retain the profit or share the part and retain the balance. There is no hard and fast rule about dividend decision. The dividend being paid by a company cannot be used to judge if it is a profitable or less profitable company. It will dividend on the life cycle stage of the company (whether growing or matured) and the availability of investment opportunities. 2. FORMS OF BUSINESS ORGANISATION There are three basic forms of business organization namely: sole proprietorship, partnership and limited liability company. Sole Proprietorship Sole Proprietorship is a business organization where an individual owns the assets and liabilities of the business. The benefits of this form of business include: ease of decision‐making and full control. Its major drawback is unlimited liability of the individual owner of the business. His assets can be seized to liquidate the liabilities of the business. The sole proprietorship’s profit is taxed in the hand of the sole proprietor. 1
Partnership Partnership is an agreement between two or more parties to carry on a business for the benefits of the ...
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