Yarmouk University Chapter 01 - Information...

Faculty of Economics and Business Administration

Department of Finance and Banking Sciences

B. F. 210

Principles of Financial Management (1)

Yarmouk University

Chapter 01

First Semester 2013/2014

Done by: Osama Alkhoun Mobile 01: 0796484613 Mobile 02: 0785764063

Website: infoTechYU.weebly.com Osama Alkhoun

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Chapter 01:

The Role and Environment of Managerial

Finance


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Finance and Business

Finance: is the art and science of managing money of cash flows.

All individuals and organizations earn or raise money and spend or

invest money.

Finance is concerned with the processes, institutions, markets and

instruments involved in the transfer of money among individuals,

businesses and governments.

Major Areas and Opportunities in Finance:-

The major area of finance can be summarized by reviewing the career

opportunities in finance.

1. Financial services:

Financial advice and financial products.

2. Managerial financial:

Is concerned with the financial manager's duties

a. Financial manager: the person that manages the financial

affairs of business


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Legal forms of business organizations

1. Sole proprietorships:

A business owned by one person and operated for his own profit.

Strengths:

1. Owners receive all profits.

2. Low organization cost.

3. One taxation.

4. Independent.

5. Secrecy.

6. Ease of dissolution.

Weaknesses:

1. Unlimited liability.

2. Limited fund raising power.

3. Limited life.

4. Difficult transfer of ownership.

5. Proprietor must be jack of all trades.

2. Partnerships:

A business owned by two or more people and operated for profit.

Articles of partnership:

the written contract used formally establish a business

partnership.

Strengths:

1. Can raise more funds than sole proprietorship.

2. Borrowing power because of more owners.

3. More available managerial skills.

Weaknesses:

1. Unlimited liability.

2. Difficult transfer of ownership.

3. Limited life.


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3. Corporations:

An artificial being created by the law [called legal entity]; owners

of corporations are separated from its manager.

Strengths

1. Limited liability.

2. Large capital.

3. Easy transfer ownership.

4. Unlimited life.

5. Professional management.

6. Better access to financing (borrowing).

7. Attractive retained plans.

Weaknesses

1. Double taxation.

2. Expensive to organize.

3. Subject to greater government regulation.

4. Lacks secrecy.

The owners of corporation are its stockholders whose ownership of equity

is evidenced by either common stock or preferred stock.

Common stock (CS)

The purest and most basic form of corporate ownership,

stockholders are expected earn a return:

1. By receiving dividends periodic distributions of earnings or

2. By realizing again through increases in share pairs.

The common stockholder have voting rights, they use these voting

rights to vote periodically to elect members of the board of

directors (BoD) who is responsible for developing the goals and

plans for the corporation affairs, hiring and firing and monitoring

managers of the firm.


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Corporate Organization.

Board of Directors (BoD)

a ground elect by stock owner.

CEO

President

Chief Executive Officer

CFO

Chief Financial Officer

Treasure

for Accounting Activities

Controller

for Financial Activities

• Treasure for Accounting Activities

• Capital expenditure manager.

• Credit manager.

• Foreign exchange manager.

• Financial planning and fund raising manager.

• Cash manager.

• Pension fund manager.

• Controller for Financial Activities

• Tax manager.

• Cost accounting manager.

• Corporate accounting manager.

• Financial accounting manager.


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Other limited liability organization:

1. Limited partnership (LP):

one or more partners have limited liability called limited

partners the others are unlimited partners.

2. S corporation (S Corp):

have 100 stockholders or less and its income is taxed only

one [like the partnership].

3. Limited liability corporation (LLC):

corporation with limited liability and one tax.

4. Limited liability partner (LLP):

partnership with limited liability and one tax.

Primary activities of financial managers:

1. Investment decisions:

decisions regarding the types and mix of investments (Assets)

used in the firm.

2. Financing decisions:

decisions about the types and mix of financing (liability, equity)

used to finance the investments (assets) of the firm.

The decisions are made on the basis of their cash flow effects on the

overall value of the firm.

NOTE:

Assets:

1. Current assets.

2. Fixed assets.

Liability:

1. Current liability.

2. Long term debt.


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Goal of the Firm:

Financial Managers should achieve the goals of the owners.

1. Maximize Profit ?:

corporations measure profits in terms of Earning Per Share (EPS)

the periods income divided on the number of common stocks of

the firm.

Example:

Suppose firm reported a net income of 200,000$ for the year ended 2012

find its EPS if it has 100,000 common stocks.

Net Income = 200,000$ # Of common stocks =100,000 # of CS

= 2 $ per share.

EPS is not a reasonable condition as a goal of the corporation

Because:

1. It ignores the timing of earnings.

2. It ignores the cash flows.

3. It ignores the risk.

EPS is an indicate to a firm's success or profit but not a goal to the

owners.

Net Income EPS=

# Of common stocks (CS)

Net Income EPS=

# of common stocks (CS)

200,000 $ EPS=

100,000 # (CS)


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The make a rational investing decision, the investor concern the

followings:

1. Timing of earnings.

the sooner cash is received the better.

2. Cash flows.

higher cash flows is preferred.

3. Risk.

less risk is preferred.

2. Maximize shareholder's wealth:

the wealth of corporate owners is measure by the stock price which is

based on:

1. Timing of earnings.

2. Magnitude.

3. Risk.

Wealth: [# of stocks * market price]

Stakeholders: groups such as employees, customers, suppliers,

creditors, owners, who have a direct economic relationship to the firm.

3. Corporate governance

the system used to direct and control a corporation, rights, and

responsibility of the corporate participants, decision making procedures,

and ways to set, achieve and monitor the firm's objectives.


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The agency Issue:

Owners of the corporations [Principals] hire managers [Agents]

and give them the authority of decision making, this called an

agency relationship.

Managers should work to achieve the goal of owners [stock price

maximization, owner's wealth maximization] but the managers are

also concerned with their own benefit.

The agency problem:

the likelihood that managers may place their personal goals a head

of the owner's or corporate goals.

Two factors are used to minimize the agency problem.

1. Market Forces:

a. Major stockholders [have a large portion of the company's

stocks] exert pressure on management to perform by

communicating their concerns to the firm's Board of Director

(BoD) [by their voting right], and if the BoD doesn't respond

to them, they can liquidate their stocks.

b. Threat of takeover: takeover by another firm that believes it

can enhance this firm by restructuring its managements or

operations or financing…. etc.

so this motivate the managers to act in the best interest of the

owners.


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2. Agency Cost:

costs of monitoring a corporate governance structure that

monitors management behavior this prevent the dishonest acts of

management and give them the financial incentives of maximize

share price.

Structure management:

correspond with share price maximization to motivate them to

act in the best interests of owners.

Key types of compensation plans:

1. Incentive plans:

tie management compensation to share price.

Stock options: allow managers to purchase stocks of the

market price set at the time of grant and they have the

choice to sell them when their prices increase.

2. Performance plans:

tie management compensation to a certain measure such as

EPS, Revenue, etc….

Performance share: shares of stocks given to management

as a result of achieving stated performance goals.

Cash bonuses: cash paid to management for achieving

certain performance goals.


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Financial institutions and Markets

Financial Institutions:

an intermediary that channels the savings of individuals, businesses

and governments into loans or investments.

Key customers of financial institutions:

1. Individuals Saving (supply of money).

Borrowings (Demand of money).

NET saving > Borrowing, then suppliers.

2. Businesses Saving (supply of money).


NET saving < Borrowing, then Demander.

3. Governments Saving (supply of money).


NET saving < Borrowing, then Demander.

Financial market:

Forums in which suppliers of funds and demanders of funds can

transact business directly.

Ways to raise money:

1. Private placement:

the sale of a new security issues, bonds or preferred stocks, to

an investor or group of investors.

2. Public offering:

nonexclusive sale of either bonds or stocks to the general

public.


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Financial market can divided into:

1. Money Market VS Capital or deficit.

o Money Market: Financial relationship between suppliers and

demanders of short term funds [one year or less]

o Seasonal or temporary surplus or deficit of funds.

Examples:

Marketable securities:

Short term debt securities such as:

Treasury bills, commercial papers, and negotiable certificate of

deposit.

o Capital Market:

the market that enables suppliers and demanders of long term funds

to make transactions key securities in the capital market.

Bonds: long term debt instruments issued by businesses and

governments to raise large sums of money.

Bonds pay periodic interest, long term securities of 10 -30

years, and have a par of face value of 1000$.

Stocks: ownership or equity instruments issued to raise money.

It pays dividends, long term [have no maturity], it can realize

gain through the sale of stocks.

Preferred stocks: a special form of ownership having a fixed

periodic dividend to common stocks.

NOTE:

Treasury bills: short terms.

Treasury bonds: long terms.


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Another classification for financial markets:

2. Primary VS Secondary Market.

Primary market: financial market in which securities are

initially issued, the only market in which the issuer is directly

involved in the transaction. The instruments issued in this

market are new [not used] , the issuer receive the proceeds from

the sale of securities.

Secondary market: financial market in which powered [used,

not new] securities are traded among investors, the issuing firm

is not involved in the transactions that are done in secondary

market.

An example of secondary market is Amman stock exchange.

Note:

Two type of stocks:

1. Common Stock:

2. Preferred Stock: a special form of ownership having a fixed

periodic dividend to common stocks.

Definition of:

Limited liability

Dividends

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