Business Finance

(MGT 232)

Lecture 2

4-1
 Business
Business Finance
Finance
Introduction
Introduction
(Role of Financial management (Cont..))

4-2
 Overview of the Last Lecture
• What is Finance? And interrelated areas
• Financial Management
• Three Important FM decisions
• Goal of a Firm (some alternatives)
• Structure of a Modern Corporation
• Role of Management
• Organization of the Financial Management

4-3
 Role of Management

Management acts as an agent for

the owners (shareholders) of the
firm.
• An agent is an individual authorized by
another person, called the principal,
principal to
act in the latter’s behalf.

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 Agency Theory

 Jensen and Meckling developed a

theory of the firm based on agency
theory.
theory
• Agency Theory is a branch of economics
relating to the behavior of principals and
their agents.

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 Agency Theory
• Agency relationship
• Agency conflict
• Agency cost

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 Agency Theory

• Principals must provide incentives so

that management acts in the principals’
best interests and then monitor results.

• Incentives include stock options, perquisites,

and bonuses.
bonuses
• Examples

4-7
 Social Responsibility

• Corporate Social Responsibility is the

integration of business operations and
values, whereby the interests of all
stakeholders including investors, customers,
employees, the community and the
environment are reflected in the company's
policies and actions.

4-8
 Social Responsibility

• Wealth maximization does not preclude the

firm from being socially responsible.
responsible
• Assume we view the firm as producing both
private and social goods.
• Then shareholder wealth maximization
remains the appropriate goal in governing the
firm.

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 Organization of the Financial
Management Function
Board of Directors

President
(Chief Executive Officer)

Vice President VP of Vice President

Operations Marketing
Finance
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 Organization of the Financial
Management Function

VP of Finance
Treasurer Controller
Capital Budgeting Cost Accounting
Cash Management Cost Management
Credit Management Data Processing
Dividend Disbursement General Ledger
Fin Analysis/Planning Government Reporting
Pension Management Internal Control
Insurance/Risk Mngmt Preparing Fin Stmts
Tax Analysis/Planning Preparing Budgets
Preparing Forecasts
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 The Business and Financial
Environments

• The Business Environment

• The Financial Environment

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 The Business Environment

There are FOUR basic forms of

business organization:
• Sole Proprietorships
• Partnerships
• Corporations
• Limited Liability Corporation

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 Sole Proprietorship

Advantages Disadvantages
• Simplicity • Unlimited liability
(single owner) • Hard to raise
• Low setup cost additional capital
• Quick setup • Transfer of
• Single tax filing on ownership difficulties
individual form
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 Unlimited Liability
• Unlimited liability means that owners can be
held personally accountable for a business's
debt

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 Partnership

Partnership - A business form in

which two or more individuals act
as owners.

There are two types of partnerships:

•General Partnership
•Limited partnership

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 Types of Partnerships

General Partnership -- All partners have

unlimited liability and are liable for all
obligations of the partnership.
Limited Partnership -- Limited partners have
liability limited to their capital contribution
(investors only). At least one general partner is
required and all general partners have
unlimited liability.
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 Summary for Partnership
Advantages Disadvantages
• Can be simple • Unlimited liability for the
• Low setup cost, higher general partner
than sole proprietorship • Difficult to raise
• Relatively quick setup additional capital, but
• Limited liability for limited easier than sole
partners proprietorship
• Transfer of ownership
difficulties
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 The Business Environment

Corporation - A business form legally

separate from its owners.
• An artificial entity that can own assets and
incur liabilities.
• Business income is accounted for on the
income tax form of the corporation.
corporation

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 Summary for Corporation

Advantages Disadvantages
• Limited liability • Double taxation
• Easy transfer of • More difficult to
ownership establish
• Unlimited life • More expensive to
• Easier to raise large set up and maintain
quantities of capital

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 Limited Liability Company (LLC)

Generally, LLC will possess only the first

two of the following four standard
corporation characteristics
• Limited liability
• Centralized management
• Unlimited life
• In Pakistan LLCs are known as private companies
that end with Pvt. Ltd. They should have at
least Rs. 100,000 as their minimum paid up capital.
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 Summary for LLC
Advantages Disadvantages
• Limited liability • Limited life
• Eliminates double (generally)
taxation
• No restriction on
number or type of
owners
• Easier to raise additional
capital
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 Financial Environment
• Businesses interact continually with the
financial markets.
• Financial Markets are composed of all
institutions and procedures for bringing
buyers and sellers of financial instruments
together.

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 Summary
• Role of Management
• Agency Theory
• Social Responsibility
• Organization of the Financial Management
• Business Environment
• Tax Environment
• Financial Environment

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