4-1 Business Finance (MGT 232) Lecture 2

4-2 Business Finance Introduction Introduction (Role of Financial management (Cont..))

4-3 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

4-4 Role of Management agent principal An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. agent Management acts as an agent for the owners (shareholders) of the firm.

4-5 Agency Theory Agency Theory Agency Theory is a branch of economics relating to the behavior of principals and their agents. agency theory u Jensen and Meckling developed a theory of the firm based on agency theory.

4-6 Agency relationship Agency conflict Agency cost Agency Theory

4-7 Agency Theory stock options, perquisites, bonuses Incentives include stock options, perquisites, and bonuses. Examples incentives monitor Principals must provide incentives so that management acts in the principals’ best interests and then monitor results.

4-8 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.

4-9 Social Responsibility socially responsible Wealth maximization does not preclude the firm from being socially responsible. Assume we view the firm as producing both private and social goods. shareholder wealth maximization Then shareholder wealth maximization remains the appropriate goal in governing the firm.

4-10 Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Vice President Operations Vice President Marketing VP of Finance

4-11 Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning Organization of the Financial Management Function VP of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts

4-12 The Business and Financial Environments The Business Environment The Financial Environment

4-13 The Business Environment Sole Proprietorships Partnerships Corporations Limited Liability Corporation There are FOUR basic forms of business organization:

4-14 Sole ProprietorshipAdvantages Simplicity (single owner) Low setup cost Quick setup Single tax filing on individual formDisadvantages Unlimited liability Hard to raise additional capital Transfer of ownership difficulties

4-15 Unlimited liability means that owners can be held personally accountable for a business's debt Unlimited Liability

4-16 Partnership Partnership Partnership - A business form in which two or more individuals act as owners. There are two types of partnerships: General Partnership Limited partnership

4-17 Types of Partnerships Limited 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. General Partnership General Partnership -- All partners have unlimited liability and are liable for all obligations of the partnership.

4-18 Summary for Partnership Advantages Can be simple Low setup cost, higher than sole proprietorship Relatively quick setup Limited liability for limited partnersDisadvantages Unlimited liability for the general partner Difficult to raise additional capital, but easier than sole proprietorship Transfer of ownership difficulties

4-19 The Business Environment An artificial entity that can own assets and incur liabilities. Business income income tax form of the corporation Business income is accounted for on the income tax form of the corporation. Corporation Corporation - A business form legally separate from its owners.

4-20 Summary for Corporation Advantages Limited liability Easy transfer of ownership Unlimited life Easier to raise large quantities of capitalDisadvantages Double taxation More difficult to establish More expensive to set up and maintain

4-21 Limited Liability Company (LLC) 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. Generally, LLC will possess only the first two of the following four standard corporation characteristics

4-22 Summary for LLC Advantages Limited liability Eliminates double taxation No restriction on number or type of owners Easier to raise additional capitalDisadvantages Limited life (generally)

4-23 Financial Environment financial markets. Businesses interact continually with the financial markets. Financial Markets Financial Markets are composed of all institutions and procedures for bringing buyers and sellers of financial instruments together.

4-24 Summary Role of Management Agency Theory Social Responsibility Organization of the Financial Management Business Environment Tax Environment Financial Environment