You are on page 1of 31

PowerPoint slides to accompany

Corporate Finance: A South African Perspective


by Gideon Els, Elda du Toit, Pierre Erasmus, Liezel Kotze, Sam Ngwenya, Kevin
Thomas and Suzette Viviers

Ancillary material
ISBN 978 019 904100 8

Oxford University Press Southern Africa (Pty) Ltd


Vasco Boulevard, Goodwood, Cape Town, Republic of South Africa

P O Box 12119, N1 City, 7463, Cape Town, Republic of South Africa


All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
without the prior permission in writing of Oxford University Press Southern Africa (Pty) Ltd,
or as expressly permitted by law, or under terms agreed with the appropriate
designated reprographics rights organization. Enquiries concerning reproduction
outside the scope of the above should be sent to the Rights Department,
Oxford University Press Southern Africa (Pty) Ltd, at the address above.
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCIAL MANAGEMENT
Chapter outline
Introduction
What is corporate finance?
The goals of financial management
The corporate forms of business
The agency problem
Financial markets and institutions
Corporate governance and ethics
Conclusion
Learning outcomes
By the end of this chapter you should be able to:
Explain the role of corporate financial management and
the role and responsibilities of the financial manager
Review the types of corporate financial management
decisions and identify the main goal of financial
management
Describe the different corporate forms of business
Describe the agency problem and agency cost
Understand the functions of financial markets and
institutions and the role of corporate governance and
business ethics
Introduction
Both big and small businesses are guided by
the same corporate financial principles
Bigger businesses are run by managers
These managers are selected by the
shareholders (owners of the business)
It is important to increase the wealth of the
shareholders
The role of corporate financial
management
The process of creating value in a business by
making the best decisions
Ultimate measure to increase the wealth of
the shareholders
Financial management Accounting
Accounting: a historical perspective (report)
Financial managers: use information from
accountants to make decisions
Position of the financial manager
in the corporate structure
The Financial Manager
Responsible for:
Managing the businesss cash and credit
Financial planning
Corporate expenditure
Record-keeping
Corporate financial management
decisions
3 basic decisions:
What should the business invest in?
CAPITAL-BUDGETING DECISION
Where will the business get long-term
financing to pay for the new investment?
CAPITAL-STRUCTURE DECISION
How will the business manage its day-to-day
financial activities?
WORKING-CAPITAL MANAGEMENT DECISION
Capital budgeting
Financial manager should aim to create value
Will do that by identifying investments that will
create value
Determine cash flows
Size how much initial investment is needed and
how much income will be received
Timing when and for how long income will be
received
Risk the likelihood of receiving the income
Will income from investment exceed the cost?
Capital structure
The mix of debt and equity a company uses to
fund new investments/projects
Three choices available:
Borrow long-term funds (debt) risk increase
Use savings of the company (retained earnings)
Issue more shares (equity) ownership declines
Whichever option will have an effect (risk and
value)
Which form of financing is the cheapest?
Working-capital management
Working capital = short-term assets and
liabilities
How will you approach the day-to-day financial
management?
Will you sell new product for cash, credit or both?
Who will receive credit and who wont?
How many days until debtors have to pay?
Will you pay expenses in cash or on credit?
All these decisions are important to ensure
business functions efficiently
There must be sufficient resources for adequate
liquidity
Three financial management
decisions
The goals of financial
management
Most people believe main goal is maximising profit:
Increasing sales
Increasing market share
Minimising costs
Increasing growth in profits
Avoiding insolvency
Surviving
BUT focusing on profitability ignores risk
Higher risk should correspond with higher return
Need more basic goal shareholders wealth
maximisation
Shareholders wealth
maximisation
Number one goal = increase the wealth of the
shareholders
How can that be done?
Shareholders can receive dividends
Increase in the share price
If a financial manager focuses on shareholders wealth
maximisation, then both risk and return are taken into
account
Profit maximisation: short-term goal not looking at long-
term effects
Share price maximisation: short-term and long-term
Every decision in the best interest of the shareholders
The corporate forms of business
Sole proprietorship
Partnership
Companies
Private companies
Public companies
Close corporations
Sole proprietorship
A single person has the controlling interest
(one-person business)
Success/failure is entirely in the hand of one
person
Main characteristics:
Easy entry into the market
Lifespan of business = owners lifespan
Owner is generally also the manager (shareholders
wealth maximisation)
Business not a separate legal entity from owner
Partnership
Private agreement between partners (max 20)
All contribute to business with skills and equity
Partners can raise more capital and have
greater creditworthiness
Main characteristics:
Easy entry into the market
Lifespan of the business is limited
Business not a separate legal entity from partners
Profits and debts are the liability of the partners in
proportion to their contribution to capital
Companies
Separate legal entity from the owners
Owners (shareholders) have limited liability
Company must comply with legislation
Two kinds of companies:
Private companies
Public companies
PRIVATE COMPANIES PUBLIC COMPANIES
Must have between 1 and Minimum of 7 (unlimited
50 shareholders number of shareholders)
At least one director At least two directors
Transferability of shares is Transferability of shares
restricted. No offer can be not restricted. Public are
made to the public to buy. invited to purchase and
sell shares at any time
Financial statements only Financial statements are
available to the directors available to the public
and shareholders
Proprietary Limited - (Pty) Limited (Ltd) after the
Ltd after the name of the name of the company
company
Companies
Main characteristics:
Complicated entry into the market
Lifespan of the company is unlimited
Company is a separate legal entity from the owners
Unlimited access to capital
Separation of ownership and management
Close corporations
Same advantages of a company, but simpler
and less expensive
Between 1 - 10 members (not shareholders)
Members interest (not shares) percentage
share in the business
Main characteristics:
Less complicated market entry than a company
A separate legal entity and limited liability to
members
Transfer of interest uncomplicated and simple
The agency problem
Goal of financial management: increase shareholders
wealth
Sole proprietorship = easy; owners are generally also
the managers of the business
Big companies = difficult; owners/shareholders not
directly involved in business
The shareholders (principals) appoint managers
(agents) to look after their interest
Agency relationship: the relationship between the
principal and the agent
Agency problem: when the agent does not make
decisions in the best interest of the principal
Agency costs
Management and shareholders goals can differ
Agency cost: Any costs (both direct and
indirect) that can arise due to the agency
problem
Direct agency cost: measurable amount
Indirect agency cost: not physical, lost
opportunity
Control agency cost:
Incentive plans
Performance plans
Financial markets and institutions
Financial market: place where anyone with funds can
transact with anyone in need of funds
Money Market: short-term debt securities (no physical location)
Capital Market: long-term debt securities (stock and bond
exchanges)
Primary market: sell securities for the first time
Secondary market: securities traded after being sold in the
primary market
Auction market: broker brings buyer and seller together
(NYSE)
Dealer market: traders offer to buy or sell securities (JSE)
Financial institutions: bring savers and lenders together to
efficiently allocate funds (financial intermediary)
Flow of funds
Corporate governance
Laws, policies, processes and organisations that
influence business and the business environment
Ensures that needs of shareholders & stakeholders are
served
Main role players: shareholders, board of directors,
management
Other stakeholders: employees , creditors, customers,
community
Accepted principles of corporate governance:
Rights & equitable treatment of shareholders
Interests of other stakeholders
Role & responsibility of the board
Integrity & ethical behaviour
Disclosure & transparency
King III Report
Business ethics
Moral principles and values applied in a business
setting
Ethical companies conduct themselves by
distinguishing between right and wrong
Unethical behaviour: creative accounting, insider
trading, gender, race & religious discrimination, price
fixing
Certain behaviour might be legal, but still unethical
For example: child labour might be legal in certain
countries, but is it ethical to buy products from
companies using children as cheap labour?
Conclusion
Corporate financial management is the process of
creating value in a business.

The financial manager needs to make the following


three decisions to create value:
What should a business invest in?
Where will the business get the long-term financing to fund the
investment?
How will the business manage its day-to-day financial
activities?

The most important financial management goal is to


increase the wealth of the shareholders by increasing
the current share price.
Conclusion (cont.)

The four forms of a business organisation are:


Sole proprietorship
Partnership
Company
Close corporation

Shareholders are the owners of a business and they


appoint managers to act as their agents. If the
managers do not act in the shareholders best interests,
the business is faced with the problem of agency.
Conclusion (cont.)

Financial markets act as a platform to bring together


buyers and sellers of securities. There are two forms of
financial markets, namely money and capital markets.
Capital markets are also divided into primary and
secondary markets.

Financial institutions act as intermediaries to bring


together suppliers of funds (savers) and demanders of
funds (borrowers).

Corporate governance and ethics are necessary to


manage a business in a moral and lawful manner.