ACCOUNTING AND FINANCE

FOR MANAGERS

MAF605
Overview of Corporate Finance
 What Is Corporate Finance?
 Let’s assume, you have decided to start a firm to make netball balls. To do this, you hire
managers to buy raw materials, and you assemble a workforce that will produce and
sell finished netball balls. In the language of finance, you make an investment in assets
such as inventory, machinery, land and labor. The amount of cash you invest in assets
must be matched by an equal amount of cash raised by financing. When you began
to sell netball balls, your firm will generate cash. This is the basis of value creation. The
purpose of the firm is to create value for you, the owner. The firm must generate more
cash flow than it uses. The value is reflected in the framework of the simple balance-
sheet model of the firm that will be illustrated in this chapter. It is normal if you have
some interest in money. As such finance is an integral part of life. Understanding
finance can empower you and help you to use your money efficiently and create
more money. For example, if you want to make money through your talent and new
idea, how will you go about it? The first thing you will need is money but if you do not
have enough money you’ll need financing to start a business. Among other things,
you’ll need to understand finance that could help you to manage your money to put
your business operation in a good financial position.
 The study of finance can benefit anyone. Finance is not
complex as some might think. In fact it is a daily activities and
concern of individual and organizations, such as business in
the private and public sector. The study of finance also could
help us to understand the position of world economic events
before thinking about investing some money into the variety
instruments in the financial market. For example, let say you
just graduate from the university and decide to start business
on your own business. No matter what type of business you
started, you would have to answer the following four
questions in some form or another.
 Broadly specking a study of corporate finance is the study of
ways to answer these four questions. Therefore, studies of
finance discipline are concern with determining value and
making decisions. The finance function allocates resources,
which includes acquiring, investing and financing the
resources. The financial decision firms make and the tools and
analysis used to make decisions. Therefore, Corporate finance
principle is different from managerial finance which studies the
financial decisions of all firms, rather than corporations alone.
As such, the main concepts in the study of corporate finance
are applicable to the financial problems of all kinds of firms.
 Thediscipline can be divided into long-term and short-term
decisions and techniques. Capital investment decisions are long-
term choices about which projects receive investment, whether to
finance that investment with equity or debt, and when or whether
to pay dividends to shareholders. On the other hand, the short term
decisions can be grouped under the heading “Working capital
management”. This subject deals with the short-term balance of
current assets and current liabilities; the focus here is on managing
cash, inventories and short-term borrowing and lending (such as the
terms on credit extended to customers). The terms corporate
finance and corporate financier are also associated with
investment banking. The primary goal of corporate finance is to
maximize corporate value while reducing the firm’s financial risks.
1.1.2 Goal of the Firm
 The goal of the firm should be maximization of shareholders wealth, by which we
mean maximization of the value of the existing common stock that lead to the most
benefits to the society. As such, the issue of scarce resources are directed the most
productive use by the business competing to create wealth.
(a) Profit Maximization
Profit maximization is a microeconomic course that stresses the efficient
use of capital resources, but it is not specific with respect to the time
frame over which profits are to be measured. In macroeconomic, profit
maximization functioned largely as theoretical goal. Unfortunately, it
ignores many real world complexities that financial managers must
address in their decision. Therefore, on the more applied discipline of
financial management, firm must deal every day with two factors namely
uncertainty and timing.
In reality, all projects differ a great deal with respect to risk characteristics
that ignore in microeconomics course, and to disregard these difference
in the practice of financial management can result in incorrect decisions.
This module ahead will in detail cover a very definite relationship between
risk and expected return that is investors demand a higher expected
return for taking on added risk.
1.2 : Financial Management
Decisions
1.2.1 Capital Budgeting Decision

This section will focus on financial management and

how an organization can create and maintain financial
value through an application of financial principles for
decision making and proper resource management.
The function is usually associated with a top officer of
the firm; such as a vice president of finance or some
other chief financial officer (CFO).
Figure 1.2:
Financial
Organizati
on Chart.
Figure 1.2 is simplified organizational chart that highlights
the finance activity in a large firm. As, shown the vice
president of finance coordinates the activities of the
treasures’ and the controller. The controller’s office
handles cost and financial accounting, tax payments, and
management information system. The treasurer’s office is
responsible for managing the firm’s cash and credit, its
financial planning, and its capital expenditure. These
treasury activities are all related to the four questions
raise earlier, and this module ahead deal primary with
these issues. Our module thus mostly on activities usually
associated with the treasurer’s department.
 1.2.1 Capital Budgeting Decision

The first concern of the firm’s is long-term investment. The process of planning and
managing a firm’s long-term investments is called capital budgeting. In capital
budgeting, the financial manager tries to identify investment opportunities that are worth
to the firm than they cost to acquire

Logically, this means that the value of the cash flow generated by assets exceeds the
cost of the assets. There are many types of investment opportunities that would typically
be considered depend in part on the nature of the firm’s business. For example, a
decision not to open a new branch would be an important capital budgeting decision.

However, regardless of the specific nature of an opportunity under consideration,

financial managers must be concerned not only with how much cash they expect to
received, but also with when they expect to receive it and how likely they are to receive
it. Evaluating the size, timing, and risk of future cash flows is the essence of capital
budgeting. In fact, as we will see in the chapter ahead, whenever we evaluate a
business decision, the size, timing, and risk of get cash flows ‘s will be, by far, the most
important things we will discussed.
Figure 1.3: The Capital Budgeting Decision.
1.2.2 Capital Structure Decision
The understanding of capital structure by the manager is important in which
the firm will manages the long –term it needs to support its long-term
investment. A firm’s capital structure (or financial structure) in is the specific
mixture of long-term debt and equity the firm uses to finance its operations, the
financial manger ha two concerns in this area. First, how much should the firm
borrow? That is, what mixture of debt and equity is best?

The mixture chosen will affect both the risk and the value of the firm. Secondly,
what are the less expensive sources of funds foe the firms? The flexibility in
choosing a financial structure has great deal for the firm to rise up the funds
either by issuing equity or debt financing. However, in choosing what is the
best percentage should the capital structure apply in financing activity, is still
debating issues.
Figure 1.4: The Capital Structure Decision.
1.2.3 Working Capital Management Investment Decision

Understanding the working capital management is useful that are

concerned with managing the firm’s liquidity. This entails, emerging
two related aspects of the firms’ operations.

Managing the firm’s working capital is important since the business

is day –to – day activities that ensures that the firm’s has sufficient
resources to continue it operations and avoid costly interruptions.
This involves a number activities related to the firm’s receipt and
disbursement of cash. To ensure firm’s working capital is not
interrupt, the manager should concern the important questions?
Such as:
1. What is the right amount of cash and inventory
should be kept on hand?
2. What is the term of selling the product?
3. Is it selling on credit or cash and to whom
4. How should the firm acquire if they need a short-
term financing?
5. Should firm borrow in short-term, is yes, how
much and where to borrow?
 Figure 1.5: Two related aspects of the firms’ operations.

The above areas of corporate financial management (capital budgeting, capital structure and
working capital management is a very broad categories and each included variety of topics that
the module will ahead discuss in detail. Next section will discuss the various forms of business
organization.
Figure 1.6: The Net Working Capital Investment Decision.
 1.3 : The Economic and Value Wealth Maximization
This section, we will continue to look at the maximization of shareholders wealth and discuss profit maximization as an
ultimate goal for the firm.
(a) Profit Maximization
In economic courses, profit maximization is usually referred as the goal of the firm. Profit
maximization focused the efficient use of capital resources, but it is not specific with the
respects the time frames over which profits are to be measured.
For example, are we only measure profit over the current year of business? Or profit
maximization for over some over longer period. As a financial manager, you could easily
misinterpretation of the business activities and tailor your financial goals to increase
profit by cutting down some routine maintenance. However, the financial decision on a
goals that must be precise, and not allow for misinterpretation, and deal with all the
window dressing and complexity of the real world.

In other word, financial management applies uncertainty and risk theory that was ignoring by
microeconomic courses. The project and investment alternatives are calculate, compared and
examining their expected value or weighted average profits. For example one project might riskier
than another, and in reality project differ a great deal with respect to risk characterizes.
Another issues with profit maximization, it ignores the timing of the
project’s returns. If this goal is only concerned with this year’s profits,
therefore it is inappropriately ignores profit in future years. If we interpret it
to maximize the average of future profits, it is also incorrect. Inasmuch
investment opportunities are available for money in hand; we are no
indifferent to the timing of the returns. Given equivalent cash flows from
profit of course we want those cash sooner rather than later. Therefore, the
financial manager is taking factors uncertainty and timing as a goal of profit
maximization as decision criterion.

Profit maximization is usually referred:

•Goal of the firm
•Focused the efficient use of capital
resources
•Ignores the timing of the project’s returns
The maximization of shareholders is nothing more about
maximization of the market value of the existing shareholders’
of common stock, because the effect of all financial decisions
are thereby included. Investor react to poor investment or
dividend decision by causing the total value of the firm’s stock
to fall, and they react to good decision by pushing up the price
of the stock. In effect, under this goal good decisions are those
that create wealth to the stockholder. However, we should keep
in mind that over the long run price equals value and our
decision should have on the stock price if everything else were
held constant. The market price of the firm’s stock reflects the
value of the firm as seen by its owners and keep in mind that
the shareholders are the legal owners of the firm.
1.4 : Legal Forms of Business Organization
Legal forms of business organization are diverse and
numerous. However, there are three categories: the sole
proprietorship, the partnership and the corporation. To
understand the basic difference between each form, we
need to define each form and understanding its
advantages Dan disadvantaged. We will see, as the firm
grows, the advantages of the corporation begin to
dominate. As a result, most large firms take on the
corporate from.
(a) Sole Proprietorship:
A business owed by a single person and which has
a minimum amount of legal structure.
Table 1.1: Advantages and disadvantages of sole
proprietorship.
(b) Partnership:
It is an association of two or more individuals
coming together as co-owners to operate a
business.
(c) The corporation:
It is an “Impersonal “legal entity having the power to
purchase. Sell, and own assets and tom incur liabilities
while existing separately and apart from its owners.

(d) Federal Income Tax:

The objective of the federal income
taxation is to:
•Provide government income
•Achieve socially desirable goals
•Stabilize the economy
1.5.1 Why Financial Markets Exits?
The financial market is a place for the corporation raise cash in the capital market. As
discuss above, when the financial manager decide to raise cash in the capital market, they
have to consider what type of financing vehicle is most suitable to their types of investment
project. For example, a firm could decide to make a long–term capital commitment such
corporate bonds. In such event, they might consider the corporate debt markets in which
clearly dominate the corporate equity markets when the new (external) funds are being
raised.

The market environment consists of security markets, investment banking services, private
placement and security market regulation. Theoretically the market rate of interest is an
indicator of which is the instrument that less expensive to the investment cost. The financial
management viewpoint is concern if the interest raise that could cause them opportunity cost of
funds to rise. This means the firm’s cost capital funds rose, which in turn made it more difficult
for real capital project to be financed and be included in the firm’s capital budgeting with cost of
funds. Figure 1.9 shows, as financial manager, they have to concern and understand three
important things that are likely effects on your firm’s ability in doing a business.
1.5.1 Why Financial Markets Exits?
Businesses, individuals, and governments often need to raise capital. For example, suppose
Telekom Malaysia forecasts an increase in the demand for electricity in Northern Regions, and
the company decides to build a new power plant. Because Telekom Malaysia almost certainly
will not have the RM1 billion or so necessary to pay for the plant, the company will have to
raise this capital in the financial markets. People and organizations who want to borrow money
are brought together with those with surplus funds in the financial markets. There are many
different financial markets. Each deals with a somewhat different type of instruments in terms of
the instruments maturity and the assets backing it. Also, different markets serve different types
of customers or operate in different parts of the country.
As a financial manager you have to understand the critical roles of financial intermediaries
by looking at the flow of money in the economy. As businesses and households spend
their income, these funds provide still other business and households with income in the
following period. By not spending all their income, some of these units become ‘surplus”
units which, as savers, lend their unspent funds for various periods of time to “deficit” units
that want to spend more than they earned. Deficit –spending units –government, business
and households which acquire borrowed funds quickly use them, and then return them to
the spending system. Figures 1.10 clarify the important of the financial markets that
contributes the wealth of the economy.
1.5.2 Real Assets vs Financial Assets
Refer the Figure 1.11 shows a balance sheet as a business
transaction of a firm. The figure shown only real assets exist in the
hypothetical economy. Real assets are tangible assets like house,
equipment, and inventories. They are distinguished from financial
assets, which represent claims for future payment on other economic
units. Common and preferred stocks, bonds, bills, and notes all re
types of financial assets. If only real assets exist, then savings for
given economic unit, such as a firm, must be accumulated in the form
of real assets. If the firm has a great idea for a new product hat new
product can be developed, produced, and distributed only out of
company savings (retained earnings). Furthermore, all investment in
the new product must occur simultaneously as the saving are
generated .if you have the idea, and we have the savings, there no
mechanism to transfer our saving to you, this is not a good situation.
1.5.3 Financing Business
In the financing process, financial institutions play a major role in bridging
the gap between savers and borrowers in the economy. In a normal year,
the household sector is the largest net supplier of funds to the financial
markets. We call the households sector, then a saving-surplus sector. In
contrast, the non-financial business sector is saving-deficit sector. In
resent years, the federal government has become a “quasi permanent”
saving deficit sector. All in all, within the domestic economy, the non-
financial business sector is dependent on household sector to finance it
investment needs. Therefore, the financial market is involved with the
unit surplus and deficit as discussed above where some economic units
spend more during a given period of time than they earn. On the other
hand, some economic units spend less than they earn.
Accordingly, a mechanism is needed to facilitate the transfer of saving from
those economic units that have a savings surplus to those that have a saving
deficit. Financial markets provide such a mechanism. Therefore, the function
financial markets, then is to allocate savings in an economy to the ultimate
demander (user) of the savings. Imagine if there were no financial markets,
the wealth of an economy would be lessened. Saving could not be transferred
to economic units, such as business firms, which are most in need of those
funds. The movement of savings through the economy occurs in three distinct
ways.
•The direct transfer of funds
•Indirect transfer using the investment banker
•Indirect transfer using the financial intermediary
1.5.4 Public Offering and Private Placements
The public (financial) market is an impersonal market in which
both individual and institutional investors have the opportunity to
acquire securities.
•A public offering takes place in the public market
•The security –issuing firm does not meet (face to face) the
actual investor in the business.

In a private placement of securities, on a limited number of

investors have the opportunity to purchase a portion of the issue.
•The market for private placement is more personal than its
public counterpart.
•The specific details of the issue may actually be developed on a
face-to-face basis among the potential investors and the issuer.
1.5.5 Primary Markets vs Secondary Markets
The securities are first offered for sale in a primary market.
For example, the sale of a new bond issue, preferred stock
issue, or common stock issue takes place in eh primary
market. These transactions increase the total stock of
financial assets in existence in the economy. On the other
hand, trading in currently existing securities takes place in
the secondary market. The total stock of financial assets is
unaffected by such transactions.
1.5.6 The Money Market vs Capital Market
The money markets consist of the institution and procedures that
provide for transactions in short-term debt instruments which are
generally issued by borrowers who have very high credit ratings.
Short-term means that the securities traded in the money market
have maturity periods of not more than 1 year. On the other hand,
equity instruments are not traded in the money market. Typical
example of money market is instruments are treasury bills, Bankers’
acceptance, negotiable certificates of deposits, and commercial
paper. The capital market consists of the institutions and procedures
that provide for transactions in log –term financial instruments. Thus
market encompasses those securities that have maturity periods
extending beyond 1 year.
1.5.7 Organized Security Exchanges over the Counter Markets
The business activity of the firm could also organized security
exchanges using tangible entities whose activities are governed by a
set of bylaws. Security exchanges physically occupy space, and
financial instruments are traded on such premises. The process of
organized and counter market must be complying with the Exchange
Commission regulations. For example, major stock exchange must
comply with a strict set of reporting requirements established by the
Securities and Exchange Commission (SEC), these exchanges have
said to be registered.
The organized security exchanges provide several
benefits to both corporations and investors.
•Provide a continuous market.
•Establish and publicize fair security prices, and
•Help businesses raise new financial capital.
1.5.8 The Role of the Investment Banker
Is a financial specialist who acts as an intermediary in the selling of securities. He or she
works for an investments banking firm (house). For the corporate issuers, investment bankers
perform services such as formulating the method used to issues the securities, pricing the
new securities, and selling the new securities.

There are two basic methods of issuing, pricing, and selling the securities:
1.Firm commitment that comprise of investment or group of investments banks buy securities
for lower than the offering price and accepts the risk of not being able to sell them. The
investment banker assume that the risk of selling a new security issue at a satisfactory
(profitable) price. This is called underwriting. Typically, the investment banking house along with
the underwriting syndicate, actually buys the news issue from the firm that is raising funds. To
minimize the risk, investment bankers combine to form an underwriting call the syndicate
group. In such a group, one or more managers arrange or co-manage the deal. The lead
manager typically has responsibility for all aspects of the issue. The syndicate group of
investment banking firms’ then sells the issue to the investing public hoping that a new security
will be higher price than it paid for it. It is the role of investment banker for the distribution of the
securities to the investing public. At the same time, they also advise the firms on the details of
selling securities.
2. Best efforts methods. The underwriter is committed to bear the
risk because it buys the entire of securities issued by the
company. Conversely, the syndicate avoids this risk under a
best-efforts offering because it does not purchase the shares.
Instead, it merely acts as an agent, receiving a commission for
each share sold. The syndicate is legally bound to issue it best
efforts to sell the shares at the agreed-upon offering price. If
there is no buyer at the offering prices it is usually withdrawn.
This method is more common for initial public offerings than
seasoned new issues.
1.5.9 Methods for Placing New Securities
In a negotiated purchase, the firm in need of funds contacts an investment banker and begins the
sequence of steps leading to the financial distribution of the securities that will be offered. The price
that the investment banker pays for the securities is “negotiates” with the issuing firm.
•In a competitive-bid purchase, the investment banker and underwriting
syndicate are selected by an auction process. The syndicate willing to
pay the greatest dollar amount per new security to the issuing firms wins
the competitive bid. This means that it will underwrite and distribute the
issue. In this situation, the price paid to the issuer is not negotiated;
instead it is determined by a sealed-bid process much on the order of
construction bids.
•In a commission, the investment banker does not act as an underwriter.
They attempt to sell the issue in return for fixed commission on each
security that is actually sold. Unsold securities are simply returned to the
firm hoping to raise funds.
•In a privileged subscription, the new issue is not offered to the investing
public. It is sold to a definite and limited group of investor. Current
stockholders are often the privileged group.
•In a direct sale, the issuing firm sells the securities to the investing
public without involving an investment banker in the process. This is not
a typical procedure.
The steps of negotiated purchase and the distribution

•The security-issuing firm selects an investment banker

•A series of the pre-underwriting conferences takes place. Discussions center on
a) the amount of capital to be raised,
b) the possible receptiveness of the capital markets to a specific mode of financing, and
c) the proposed use of the new funds. Hess conferences are consumed by the signing of a
tentative underwriting agreement/ the approximate price to be paid for each security is identified in this
agreement.
•An underwriting syndicate is formed. The syndicate is a temporary association of investment bankers
formed to purchase the security issue from the corporation. The syndicate’s objective is to resell the
issue at a profit.
•The new public issues must be registered with the SEC before they can be sold to final investors. This
involves filing a lengthy technical document called a registration statement with the SEC. This
document is aims to disclose relevant facts about the issuing firm and the related security to potential
investors. Another document is the prospectus that is also filed with the SEC for examination. It is s
shortened version of the official registration statement. One both documents are approved; the
prospectus becomes the official advertising vehicle for the security offering.
•A selling group is formed to distribute the new securities to final investors. Securities dealers who are
part of the selling group are permitted to purchase a portion of the new issue at a price to the public. A
selling-group agreement binds the syndicate and the members of the selling group.
•A due diligence meeting is held to finalize all details prior to taking the
offering to the public. The price at which the issuing firm will sell the new
securities to the syndicate is settled. Usually, the offering is made to the
public on the day after this meeting.
•The syndicate manager from the investment banking house that
generated the business is permitted to mitigated downward price
movements in the secondary market for the subject offering. This is
accomplished by the syndicate managers placing buy orders for the
security at the agreed-upon public offerings price.
•A contractual agreement among the syndicate members terminates the
syndicate. In the most pleasant situations, this agreement is made when
the issue is fully subscribed.
1.5.10 Private Placements
In the private placement, a small number of
investor purchases the entire security
offering. Most private placements involve
debts instrument. Usually, the large
financial institutions are the major investor
in private placements, that include;
1. Life insurance firms
2. State and local retirement’s funds
3. Private pension funds
1.5.11 Floating Costs
The firm raising long-term capital typically incurs two types of floatation
cost:
1. The underwriter’s spread - is the difference between the gross and
net proceeds from s specific security is due. This absolute dollar
difference is usually expressed as a percent of the gross proceeds.
There are many components comprise issue costs. There are two most
significant are:
•Printing and engraving and
•Legal fees. For comparison purposes, these too, are usually expressed
as a percent of the issue’s gross proceeds
2. Issuing costs - as a percent of gross proceeds from common stock
exceed those of preferred stock, which exceed those of bonds. The
total flotation costs per dollar raised decrease as the dollars size of the
security issue increase.
1.6 : Summary And Conclusions
This chapter introduced you to some of the basics ideas in corporate finance. We learnt
about:
1. Corporate finance has three main areas of concerns:
•Capital budgeting and which of the long terms investments that should the firm take.
•Capital structure (or financial structure) is the specific mixture of long-term debt and
equity the firm uses to finance its operations.
•The choice of which mixture of debt and equity should the manager use to fund the
operation is still unsettled.
•Working capital management is managing financial activities for daily business operation.
•The goal of financial management is for profit in doing business and to make a right
decisions to increase the value of the firm’s stock, or generally to increase market value of
the equity.
•The advantaged and disadvantages of the corporate form are enhanced by the
•Existence of financial a markets. Financial markets functions as both primacy
and secondary markets for corporate securities and can be organized as either dealer or
auction markets.
•The role of the financial institutions in helping the financial market to grow is explained
through the financing process.
1. What are financial markets? What function do they perform? How would an economy be
worse off without them?
2. Distinguish between money and capital market
3. What do you mean by financial intermediary?
4. Why do you think most secondary-market trading in bonds takes place over the –counter?
5. Why is an investment –banking syndicate are formed?
6. As a recent business school graduate, you work directly for the corporation treasure. Your
corporation is going to issue a new security. Explain what are the steps that you should follow
and what is a floatation cost?
7. When the firm raise funds, what type of financing vehicle or instruments is most favored,
and why?
8. What are the three types of financial management decision? For each type of decision, give
an example of a business transaction that would be relevant.
9. What are three primary disadvantages of the role proprietorship and partnership forms of
business organization? What benefits are there to these types of business organization as
opposes to the corporate form?
10. Evaluate the following statement: Manager should not focus on the current stock value
because in doing so will to an overemphasis on short-term profits at the expenses of long
term profits.
11. What do you know about the KLSE and MESDEC? Q