MBA: FINANCIAL
MANAGEMENT
LECTURE 1
Chara Charalambous
1
PART A
 What Is A Corporation?
PART B
 The Role of The Financial Manager
 Who Is The Financial Manager?
PART C
 Separation of Ownership and Management
AGENTA
Chara Charalambous
2
PART A
Chara Charalambous
3
Alternative Forms of
Business Organization
There are three main forms of business
organization :
Proprietorship
Partnership
Corporation
Chara Charalambous
4
Sole proprietorships: Small enterprises are
owned and managed by a single individual.
 Partnership: Two or more people join to own
and manage partnership.
 Corporations: is a legal entity created by a
status.
It is separate and distinct from its
owners and managers. As such can have a name
and enjoy many of the legal powers of natural
persons. For e.g. can acquire and exchange
property, enter contracts, sue and be sued.

What Is A Corporation?
Chara Charalambous
5
Sole Proprietorship
 Advantages:
It is easy and inexpensively formed but in most cases
must be licensed by the municipality
in which it
operates. Is the cheapest business to form.
Subject to few government regulations
No corporate income taxes, it is taxed like an individual
 Limitations:
The owner has unlimited personal liability on business
debts which can result in losses that exceed the money
the owner has invested in the company.
Difficult to raise capital because the firm’s financial
strength is based on the financial strength of the sole
trader. The equity money are limited to the owner’s
personal wealth.
Transferring ownership is difficult – selling
of the
business is similar to selling a house and the proprietor
has to seek out and negotiate with a potential buyer.
6
Limited life of the business equal Chara
to Charalambous
the life of the
individual who created it.
Partnership
A
partnership has roughly the same advantages
and limitations as a proprietorship.
 Partners are ‘jointly and severally’ liable for
any losses that the business might make.
Regarding liability the partners can lose all of
their personal assets even those not invested in
the business because under partnership law all
each partner is liable for the business’ debts.
Thus if any partner is unable to meet his or her
prorate claim in the event the partnership goes
bankrupt, the remaining partners must cover the
unsatisfied claims.
Chara Charalambous
7



Every general partner is jointly liable with the
other partners for the debts and obligations of
the firm incurred while he is a partner. Although
the liability is joint, each partner is individually
liable for the whole amount due by the firm.
Traditionally the big accounting firms have been
partnerships.
Legally, the partnership is dissolved if one of the
partners dies or withdraws.
Chara Charalambous
8
Corporation
 Advantages:
Unlimited life: it can continue after its original
owners are dead.
Easy transfer of ownership: ownership can be
divided into shares of stock which in turn can be
transferred far more easily than the other two
form of organizations.
Limited liability: the loss of a shareholder in case
of bankruptcy is limited to the amount he/she
initially invested
Ease of raising capital in the financial markets for
the above reasons (sell shares e.t.c), because
investors will have limited liability and since many
will invest funds can be invested in growth
opportunities which will increase the value of the
firm.
Chara Charalambous
9
There are two main disadvantages for the
corporations:
 Disadvantages:
Double taxation of earnings: the earnings of the
corporation are taxed and then the earnings
paid as dividends are taxed again as income to
the stockholders
Setting up a corporation and filing required
lawyer to prepare
regulations and rules
regarding the management of the company and
reports given to the government , is more
complex and time consuming than the other
two forms of organizations.
Chara Charalambous
10
Sole Proprietorships
 Partnerships


Specific and Unlimited
Liability
Personal tax on profits
Corporations
Can be endless (separation of
ownership and management)
Limited Liability Corporate tax on
profits + Personal tax on dividends
Corporation: ‘An ingenious device for obtaining
individual profit without individual responsibility.’
—AMBROSE BIERCE
The Devil’s Dictionary
Corporate Structure
Chara Charalambous
11
It can raise money by selling new shares
to investors and it can buy those shares
back.
 One corporation can make a takeover bid
for another and then merge the two
business.

Things that a corporation can do
and a partnership can’t
Chara Charalambous
12

In
a
limited
partnership,
limited
partners
contribute capital and have liability limited to
that amount of capital; they cannot lose more than
they put in. There must, however, be at least one
general partner in the partnership, whose
liability is unlimited. Limited partners do not
participate in the operation of the business; this is left
to the general partner(s). The limited partners are
strictly investors, and they share in the profits or
losses of the partnership according to the terms of
the partnership agreement. This type of arrangement
is frequently used in financing real estate ventures.
Chara Charalambous
13

Corporations: Issue shares. In the beginning,
the shares may all be held by a small group of
investors, perhaps the company’s manager and a
few sponsors. In this case the shares are not
publicly traded and the company is closely held.
Eventually, when the firm grows and new shares
are issued to raise additional capital, its shares
will be widely traded. Such corporations are
known as public companies.
Chara Charalambous
14


People that hold only a few shares: have a
few number of votes and receive a tiny
proportion of profits and dividends.
Giant
pension
funds
and
Insurance
companies that hold a huge number of
shares: have a large number of votes,
and a large proportion of profits and
dividend.
Who are the shareholders?
Chara Charalambous
15
Sole Proprietorship
Who owns the
business
The manager
Are managers
and owners
separate?
No
What is the
owner’s
liability?
Unlimited
Are the owner
& business
taxed
separately?
No
Partnership
Partners
No
Corporation
Shareholders
Usually
Unlimited
Limited
No
Yes
Organizing a Business
Chara Charalambous
16

A partnership, like a proprietorship, pays no
income taxes. Instead, individual partners
include their share of profits or losses from the
business as part of their personal taxable
income.
Chara Charalambous
17



The board of directors is elected by the
shareholders in order to represent the
shareholders and manage the corporation →
Separation of ownership and management
Some of these directors are executive and
others are non-executive directors who are
not employed by the firm.
The board of directors appoints top management
and its role is to ensure that managers act in
the best interest of the shareholders.
Board of directors
Chara Charalambous
18

Essentially the role of a non-executive director is to provide what
could be called a “creative contribution” to the board of
directors by giving objective criticism and advice. Today it is
widely accepted that non-executive directors have an important
contribution to make to the effective running of many companies.
As “The Cadbury Report”, produced in 1992, stated “they should
bring an independent judgment to bear on issues of strategy,
performance and resources including key appointments and
standards of conduct”.(behaviour) There is no legal distinction
between executive and non-executive directors. As a result, in
the UK unitary board structure, non-executive directors
essentially have the same legal duties, responsibilities and
potential liabilities as their executive colleagues. Although it is
understood non-executive directors cannot and do not give the
same continuous attention to the business of the company, it is
important that they show the same commitment to its success as
the executive directors.
The Role of the
Non-Executive Director
Chara Charalambous
19

A non-executive director (NED) typically
does not engage in the day-to-day
management of the organization, but is
involved in policy making and planning
exercises. In addition, non-executive
directors' responsibilities include the
monitoring of the executive directors, and
to act in the interest of any stakeholders.
Also called external director, independent
director and outside director.
The Role of the
Non-Executive Director
Chara Charalambous
20
” Of genuine importance is their independence from
the management of the company and any of its
“interested parties’’.
 As a first point we would note that the great majority
of private limited companies in the UK have not in the
past appointed non-executive directors to their
boards. In the main this was only relevant for publicly
quoted companies and much larger private companies
where, perhaps, there were very good reasons to
make such appointments. This may have been to
represent a finance house or a powerful minority
shareholder. However, over the last few years we
have seen an increasing trend for medium size and
larger private companies to appoint non-executive
directors.
 The functions of non-executive directors:
(a) independence
(b) wide experience
(c) specialist knowledge
(d) personal merits.

Chara Charalambous
21
PART B
Chara Charalambous
22


Financial Decisions
Investment Decisions
A successful firm generally has rapid growth in sales which
requires investment in plant, equipment and inventory. The
financial manager must help decide on the specific assets to
acquire and the best way to finance those assets. For example
should the firm raise funds by borrowing (debt) or by selling stock
(shares)? If the firm uses debt should be long term or short term?




Forecasting and planning
Dealing with Financial markets
Monitor, coordination and control
Asset Management: Once assets
have been acquired
(investment) and appropriate financing provided, these assets
must still be managed efficiently. The financial manager is more
concerned with the management of current assets than with that
of fixed assets. A large share of the responsibility for the
management of fixed assets would reside with the operating
managers who employ these assets.
The Role of Financial Manager
Chara Charalambous
23
Firm's
Operations
- purchase
real assets
(2)
(3)
(1)
Financial
Manager
(4a)
(4b)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
Financial
Markets
(Investors
hold the
Financial
assets
issued by
the firm)
Role of The Financial Manager
Chara Charalambous
24


The fundamental financial objective of the firm is
to maximize the value of the cash invested
in the firm by its stockholders.
Stockholders are happy to contribute cash at
arrow (1) only if the decisions made at arrow (2)
generate at least adequate returns at arrow
(3), i.e. the returns generated are at least
equal to the returns that stockholders could
earn by investing in financial markets
Role of The Financial Manager
Chara Charalambous
25
…………………………common titles



CFO: Chief Financial Officer
TREASURER
CONTROLLER
………………………..…….regular tasks



FINANCIAL POLICY
CORPORATE PLANNING
CAPITAL BUDGETING PROCESS
Who is the Financial Manager
Chara Charalambous
26
BOARD OF DIRECTORS
PRESIDENT
(Chief Executive Officer)
VICE PRESIDENT
Operations
VICE PRESIDENT
of Finance
(or Chief Financial
Officer)
Treasurer
Cash management
Raising Capital and capital
budgeting
Banking relationships
Investors relations
Insurance/risk management
Tax analysis and planning
Dividend payment
Making financial plans
VICE PRESIDENT
Marketing
Controller
Cost Accounting
Cost Management
Preparing of Financial statements
General Ledger (payroll, accounts
receivable/payable)
Internal Control
Government reporting
Data processing
Who is The Financial Manager?
Chara Charalambous
27
As the head of one of the three major functional areas of the firm,
the vice president of finance, or chief financial officer (CFO),
generally reports directly to the president, or chief executive
officer (CEO). In large firms, the financial operations overseen by
the CFO will be split into two branches, with one headed by a
treasurer and the other by a controller.
 The controller’s responsibilities are primarily accounting in
nature. Cost accounting, as well as budgets and forecasts,
concerns internal consumption. External financial reporting is
provided to the stockholders.
 The treasurer’s responsibilities fall into the decision areas most
commonly associated with financial management: investment
(capital budgeting, pension management), financing (commercial
banking and investment banking relationships, investor relations,
dividend payment), and asset management (cash management,
credit management).
 The organization chart may give you the false impression that a
clear split exists between treasurer and controller responsibilities.
In a well-functioning firm, information will flow easily back and
forth between both branches. In small firms the treasurer and
controller functions may be combined into one position, with a
Chara Charalambous
28
resulting commingling of activities.


In the job of Managerial Finance you have to
deal with tasks such as: make decisions
regarding business expansions and choosing what
types of securities to issue to finance expansion,
deciding the credit terms under which customers
can buy, how much inventory the firm should
keep, how much cash to keep on hand, whether to
acquire other firms and how much of the firm’s
earnings to keep into the business and reinvest
versus pay out as dividends. (retain earnings)
Managerial Finance
29
‘What
role does finance play
successful operation of a firm’.
in
the
Answer:
Proper
financial
management
(managerial finance) will help any business to
provide better products to its customers at lower
prices , pay higher salaries to its employees and
still provide greater returns to its investors who
put up the funds needed to form and operate the
business. Because the national and worldwide
economy consists of consumers , employees and
investors, good financial management contributes
to the well being of both individuals and the
general population.
30

Managerial Finance is the broadest of the
three categories and the one with the
greatest job opportunities because it is
important in all types of business weather
they are public or private ,deal with
financial services or are manufacturers
Chara Charalambous
31
Common Finance Terminology
–Real assets
–Financial assets / Securities
–Capital markets and financial markets
–Investment / capital budgeting –finance
Common Finance Terminology
Chara Charalambous
32
 Real
assets: tangible (machinery, factories,
offices,cars,buildings
etc),
intangible
(technical expertise, trademarks, patents,
etc)
 Financial assets or Securities: bank loans,
stocks (common stock and preference stock),
bonds.
 Capital markets / Money Markets /
Financial Markets: refer to all sources of
financing.
 Investment/capital budgeting - financing
Common Finance Terminology
Chara Charalambous
33
Financial assets exist in an economy because the savings of
various individuals, corporations, and governments during a period
of time differ from their investment in real assets. If savings
equalled investment in real assets for all economic units in an
economy over all periods of time, there would be no external
financing, no financial assets, and no money or capital markets.
Each economic unit would be self-sufficient. Current expenditures
and investment in real assets would be paid for out of current
income. A financial asset is created only when the investment of
an economic unit in real assets exceeds its savings, and it finances
this excess by borrowing or issuing stock. Of course, another
economic unit must be willing to lend.
 This interaction of borrowers with lenders determines interest
rates.
 In the economy as a whole, savings-surplus units (those whose
savings exceed their investment in real assets) provide funds to
savings-deficit units (those whose investments in real assets
exceed their savings).
 This exchange of funds is confirmed by investment instruments, or
securities, representing financial assets to the holders and
financial liabilities to the issuers.

Why Financial Markets exist?
Chara Charalambous
34
A market is a place where goods and
services are exchanged.
 A financial market is a place where
individuals and organizations wanting to
borrow funds are brought together with
those having a surplus of funds.
 Financial markets are mechanisms by
which borrowers and lenders get
together

Why Financial Markets exist?
Chara Charalambous
35
Source of funding
 Investor liquidity
 Risk management
 Source of information

Financial Market Functions
Chara Charalambous
36




Financial markets can be broken into two classes – the
money market and the capital market. The money market
is concerned with the buying and selling of shortterm (less than one year original maturity) government
and corporate debt securities. The capital market, on the
other hand, deals with relatively long-term (greater
than one year original maturity) debt and equity
instruments (e.g., bonds and stocks).
Primary market: a market where new securities are
bought and sold for the first time (a “new issues” market).
Secondary market: a market for existing (used)
securities rather than new issues.
Financial intermediaries: Financial institutions that
accept money from savers and use those funds to make
loans and other financial investments in their own name.
They include commercial banks, savings institutions,
insurance companies, pension funds, finance companies,
and mutual funds
Chara Charalambous
37
PART C
Chara Charalambous
38
Goals of the Corporation
Business decisions are not made without
objectives: the primary goal is
stockholder
wealth maximization maximizing the value
of the firm - the value of stock price – current
value per share of the existing stock. This the
most important job of financial manager.
Maximizing market price per share
39

The short answer is that the firm should
create more cash flow than it uses. The cash
flows paid to bondholders and stockholders
should be greater than the cash flows put
into the firm by the bondholders and
stockholders. From the stockholders point of
view what is a good financial management
decision? If we assume that stockholders buy
stock because they seek to gain financially
then; good decisions increase the value
of the stock and poor decisions do the
opposite.
How do financial managers create
value?
Chara Charalambous
40
 Managers
make decisions → advantages and
disadvantages
 Advantages:
I.
Practical necessity
II.
III.
due to the large number of
shareholders →no way all of them to be
actively involved in management.
It allows share ownership to change without
interfering with the operation of the business.
It allows the firm to hire professional
managers.
SEPARATION OF OWNERSHIP AND
MANAGEMENT
Chara Charalambous
41
Do managers operate for the best interest of the
stockholders or they are taking advantage of
them?
Managers of course have also other objectives:
Personal satisfaction – high salaries, employees
welfare – safe working environment and in the
good of the community and of society at large –
avoid polluting the air or water, produce safe
products e.t.c.
It is difficult to know how managers act!
Chara Charalambous
42
Disadvantages: Agency costs
Different objectives between:
o Management Vs Shareholders
o Shareholders Vs banks and other lenders
o Top management Vs. operating management
SEPARATION OF OWNERSHIP AND
MANAGEMENT
Chara Charalambous
43
Agency Relationships
An agency relationship exists whenever a
principal (person) hires an agent to act on
their behalf.
 Within corporations, agency relationships
exist between:

◦ Stockholders and managers, and
◦ Stockholders and creditors.
◦ Top Management Vs Operational Management
44
The agency problem occurs when financial managers
make decisions which are not consistent with the
objectives of the company’s stakeholders.
It arises because:
 1. There is a separation of ownership and control:
agents (financial managers) are given the power to
manage and control the company by the principals
(stakeholders: shareholders, creditors and
customers).
 2. The goals of agents are different from those of the
principals.
 3. Principals do not get full information about their
company from the agent or the market (asymmetric
information).

The agency problem
Chara Charalambous
45
Stockholders versus Managers
Managers are naturally tending to
act in their own best interests.
 But the following factors affect
managerial behavior:

◦ The threat of firing
◦ The threat of takeover. In an antagonistic
takeover the managers of the acquired firm
generally are fired and any who are able to
stay on ,lose the power they had prior to the
acquisition.
◦ Structuring managerial incentives: Firms are
tying managers compensation to the
company’s performance and this motivates
managers to operate in a manner consistent
with stock price maximization.
46
o
Some people suggest that the primary
monitoring of managers comes not from the
owners but from the managerial labour
market. They argue that efficient capital
markets provide signals about the value of a
company’s securities, and thus about the
performance of its managers. Managers with
good performance records should have an easier
time finding other employment (if they need to)
than managers with poor performance records.
Chara Charalambous
47
Top Management Vs Operational
Management

Senior management has to think of ways
to motivate junior management and all
other employees for the benefit of the
firm. (e.g. bonuses)
Chara Charalambous
48
Stockholders versus Creditors

Creditors decide to loan money to a corporation
based on the riskiness of the company, its
capital structure (how mush debt and how
much own funds) and expectations of the
future riskiness and future capital structure. All
of these factors will affect creditors when
determining the level of the interest rate they
will charge in the company. Stockholders,
however, have control of such decisions through
the managers
.
Since stockholders will make decisions based on
their best interest, a potential agency problem
exists between the stockholders and creditors.
They might try to take on new projects that are
risky.
49

But the following factors hold on stockholders
from unethical decisions:
If creditors see that a firm will try to take
advantage of them in unethical ways they will
either refuse to deal with the firm or else
will require a much higher than normal
rate of interest to compensate for the risks of
such ‘tricky’ actions. Thus firms that try to deal
unfairly with creditors either lose access to the
debt markets or are charged with higher
interest rates, both of which decreases the long
run value of the stock.
50
Managers as agents of both the
creditors and the stockholders must
act in manner that is fairly balanced
between the interest of these two
classes of security holders.
51
Do you now understand the task of
Financial Manager?
Thank you
Chara Charalambous
52