Chapter 1: Key principles of Finance

• Real assets


  Assets used in the normal line of business to generate profits
• Financial assets 


  Stocks and bonds
• Tangible assets

  Assets that physically exist
• Examples of intangible assets


  Don't physically exist eg. goodwill, trademarks, brand names
• Shares are assets of the

  Capital providers
• The financial manager stands between 


  The firm operations and the financial markets
• Financial markets 


  Where investors hold the financial assets issued by the firm to obtain money
• Finance involves two basic issues

  what real assets should the firm invest in? How should the cash for investment be raised?
• The investment or capital budgeting decision


  What real assets should the firm invest in?
• The financing decision

  How should the cash for the investment be raised?
• Firms use real assets to undertake projects
• A firm is a collection of projects that

  Generate revenue and incur costs
• What complicates the capital budgeting decision?

  There may be more than one apparently profitable project. It is very difficult to estimate the future profitability
• what is the responsibilities of the CFO

  Capital budgeting decisions, tied into product development, production, marketing, etc.
• What is the responsibility of a treasurer?

  Looks after the company cash, raises new capital, maintains relationships with banks, shareholders and other investors.
• The CFO reports to the

  CEO
• The treasurer reports to the

  CFO
• Responsibilities for financial issues lies with

  The board of directors
• The importance of capital budgeting is due to

  the complexity of the analysis involved and the cost of poor decisions
• Investment in fixed capitals involved the choices

  Alternative capital assets, dates of commencement, methods of financing
• The purposes of financial analysis

  Identify the risks involved in the project, highlight salient factors, suggest methods to reduce risks
• Financial analysis

  Analysing the financial implications of different possible courses of action
• The use of a specialist finance function is

  an attempt to enforce impartiality and realism
• Companies aim to

  Increase the value of their shares, as they are owned by shareholders
• The extent to which increasing the share value is the company's aim depends on

  The extent to which shareholders control the business and other stakeholders are considered
• Groups involved in running a company

  Shareholders, managers, employees, lenders, suppliers, customers, government
• The shareholders elect ____ to run the company

  The board of directors
• Who does the board of directors elect to run the company?

  General managers, who are not shareholders but experts in their fields
• Advantages of separation of ownership and management

  Freedom of ownership to change without affecting operational activities, freedom to hire professional managers
• Disadvantages of separation of ownership and management

  If the interests of the owners and managers diverge
• Objectives of shareholders

  Obtain an income from their investments (dividends), make capital gain, maximise overall return
• Capital gains 


  Sell the shares for more than they cost
• Manager objectives

  Job security, good pay, benefits, prestige and power
• The managers may wish the company to aim for

  Growth, stability, satisfactory level of profit rather than max
• Employee objectives

  Pay at least market rate of pay, stay in business, safe working conditions, training, benefits
• Banks objectives

  For the company to: remain in business, pay a market rate of return on borrowed funds, meet payment deadlines
• Customer objectives

  Remain in business (after sale service), reasonable prices, good quality, produce goods ethically
• Government objectives

  Perform well to pay more corporation tax, provide jobs, act legally and morally
• Conflicting objectives of shareholders and managers

  Shareholders: high return on investment. Managers: pursue projects of interest over profit, take over other companies (business empire), luxurious working life, satisfactory return (and secure job prospects) over max return
• Conflicting objectives of providers of finance and the providers of equity capital

  Shareholders: high risk and high return projects. Finance: lenders have no interest in upside profits-rather they ensure they receive the promised interests and capital payments