Defining Managerial Finance and Ownership Types, Case Study Example

Mini Case-1

1. Financial Management (Managerial Finance), Investments and Financial Markets and Institutions are the three major areas under the umbrella of finance. According to the definition, “financial management is the study and practice of making dollar denominated decisions within a single firm”. Financial managers in any organisation are concerned with the allocation, distribution and use of financial resources in any company. They overlook the financial and investment decisions within that firm. In investments, most jobs are found in portfolio management, financial planning, sales and securities analysis. Almost every other large firm makes investments in bonds and sales. Financial Markets and institutions refer to money markets and capital markets from where business generates liquidity or facilitate the transfer between savers and borrowers.
2. It is difficult for someone to work in one area of finance when they do not have sound knowledge about the other two areas because towards the end of the day, all of them interact with each other. For example, an investment manager will have to consult with the financial manager in order to know the required rate of return, expected maturity period and liquidity requirements of the company. Financial institutions are actually financial intermediaries that help financial markets in financial transactions.
3. Corporate Finance is important to all managers because ultimately, the goal of the company is to earn return over its investments. All departments work towards the same goal. Companies only start operating when they have financial capital and they cease to exist when they fail to fulfill their financial obligations. Companies fire those managers and close those departments that are not financially sound.
4. The primary objective of manager should be to minimize costs within their control and generate the maximum possible revenue. Furthermore, controlling, assigning of tasks and leading their subordinates are also their primary tasks.
5. Financial markets, simply put, are markets where financial assets are traded. Different types of financial markets are dedicated for dealing with different types of financial assets. Financial markets differ from physical markets in a way that in the latter, tangible and real assets such as machinery, land and building are traded by in financial markets; “claim on assets” are traded. Money markets are a part of the broader financial markets, which deals with securities, and bonds that have a maturity period of less than a year.
6. Households and individuals are mostly the savers of capital and non-financial firms are classified as the borrowers of that capital. Governments also become the net borrowers but that is only when they have a deficit and need cash. Transfer of capital between savers and borrowers takes place through three methods. These are direct transfer of money and securities, through investment banks and through financial intermediary.
7. Shareholders have ownership in the company and they influence the major strategic and financial decisions that the company takes. Creditors are lenders who allow the company to borrow money and in return, they receive interest. They do not have any ownership. When the company is being liquidated, the claims of the creditors are fulfilled first and then shareholders get their money.
8. Sole proprietorship refers to type of organisation that is run by a single person under his full ownership. It also the person to have full control, avoid paperwork and decrease costs but it creates too much responsibility on that person, makes it harder to raise capital and the owner has unlimited liability. Partnership is when two or more people join hands to form an organization where they jointly share the ownership. Partners help each other, share capital, share experience and divide responsibilities, however, on the down side; the partnership may not last for long since problems and disagreements surface, it takes time to consult and on death of any partner, the partnership ends. Corporations are formed when companies grow big and need other people to raise capital. Limited companies have many shareholders, who many easily pass ownership, the business continues even after the death of any shareholders, the business becomes an independent entity, however, the ownership divides, many tax and formal liabilities arise and bureaucratic management may decrease efficiency.
9. According to the valuation model, the total value of any corporation at any given time is value of its operations, value of its fixed assets and the value of all growth options minus all the liabilities of the company. If there are any liabilities included then creditors are the first one to have claims on that value or else, shareholders have the claim on that value.
10. Shareholders want maximization of the share price and dividends, whereas, managers may engage in decisions that may lead to lower dividends and lower share price. Furthermore, managers may engage in dishonesty to hide earnings and fill their own pockets. Shareholders who have control on assets may refuse to pay the creditors on time. The shareholders may undertake projects that were more risky than the creditors predicted thus decreasing the rates on bonds.
11. Excess cash can be used to pay out the long-term debt, settle all the claims of the creditors and most importantly, pay dividends to the shareholders. If there is any more cash after that, then should be invested in projects that could the firm their required rate of return.
12. The three aspects of cash flows are known as operating, investing and financing.
13. The decrease in the value of assets is known as depreciation. It is also defined as the process in accounting through which the cost of assets is allocated to the asset over its lifetime. Including depreciation expenses in the financial statements allows the company to get a tax advantage since when tax is deducted on this non cash expense, the company actually saves taxes on that amount. Depreciation does not influence the firm’s cash flow since it is a non-cash expense.
14. Proforma statements help in planning for future, projecting the needs in terms of cash, assets and others, help in financial modeling and calculation of the project financial ratios, assessing the financial impact of anticipated changes and external reporting.
15. Financial forecasting could be understood through five steps. First, forecast the sales. Second, determine the assets that would be needed to generate those sales. Third, project the funds that could be generated internally. Fourth, determine the level of financing needed from the outside, if any. Fifth, decide on a method to generate those funds. Sixth and last, examine the impact of the same on financial ratios and share price, and revise the plans if needed.
16. Sales increase will require more assets; therefore, the AFN would increase. Reduction in payout ratio would decrease the AFN because more funds would be retained thus decreasing the need for external financing. Increase in profit margin will decrease the need for AFN because of additional funds generated internally. An increase in the capital intensity ratio, which is the ratio of required assets to total assets, will increase the AFN because you would need more money to generate every additional dollar of sales. Paying sooner will increase the need of external funds thus increasing the AFN.
17. Percent of sales approach forecasts elements of balance sheet and income statement based on the percentage with which sales vary. If sale double then they would forecast all other variable elements, such as costs, cash, accounts receivable, inventories, accounts payable, and accruals to increase with same proportion that is double. Debt, dividends and common stock may follow company policy. Interest expense would be based on the debt that you have during the year. Interest expense could be calculated with three approaches of debt at Dec 31, Debt at Jan 1 or average debt during the year.