Business Finance Lecture 1 part b

Functions of Finance Manager

• Ensures Company Has Adequate LiquidityKey focus on maintaining sufficient cash flow to meet operational needs. This includes forecasting cash flows to ensure expenses such as payroll, inventory purchases, and operational costs can be met without hindrance. For instance, if a company anticipates a slow sales month, a finance manager might recommend setting aside extra cash reserves.

• Involves Three Main Decisions:

  1. Capital Budgeting Decisions

     • This is the process of planning and managing a company's long-term investments. It evaluates potential major projects or investments like purchasing new equipment, launching a new product line, or building a new facility. For example, if a company considers investing in solar panels to reduce energy costs, the finance manager will analyze costs versus potential savings and returns over time.

  2. Capital Structure Decisions

     • Refers to determining the best mix of debt, equity, and internal financing. It involves balancing risk and return in financing decisions. For instance, a company may choose to finance a new project through taking a loan (debt), issuing new stock (equity), or using retained earnings (internal financing). Each option has its own risks and benefits, and a finance manager must analyze which structure best supports the company’s goals while maximizing shareholder value.

  3. Risk Management and Corporate Governance

     • Involves identifying, assessing, and prioritizing risks that could impact the organization. The finance manager implements strategies to minimize negative impacts, such as diversifying investments to enhance stability. Corporate governance is also essential, ensuring accountability and transparency throughout the organization.

Risk Management Strategies

• Importance of Determining Acceptable Levels of RiskCompanies must define what levels of risk are acceptable to maintain a balance between growth and security. A high-tech startup, for example, may take on higher risks compared to a traditional manufacturing business, which might prefer a conservative approach.

• Techniques for Managing Risk:

  • Risk Reduction

    • Implementing measures to decrease potential risks can include investments in technology for better security, or training employees on compliance to mitigate legal risks. For instance, a firm might invest in cybersecurity measures to protect against data breaches.

  • Risk Transfer

    • Selling some risk, such as through insurance, enables companies to manage liability effectively. For example, taking out liability insurance allows a company to transfer the financial risk associated with potential lawsuits to the insurance provider.

Insurance Types Explained

• Compulsory Insurance (Rego)Required to operate a vehicle legally. It typically covers third-party life but not property damage, meaning if you are at fault in an accident, it would cover medical expenses for the other party’s injuries but not damages to their vehicle.

  • Third-Party Property InsuranceCovers damages to another's vehicle in collisions, which is often a separate purchase for comprehensive coverage. For instance, if a driver accidentally crashes into another vehicle, this insurance would cover repair costs.

  • Comprehensive Insurance

    • Covers damages to both the insured and other parties, often requiring additional premiums. This insurance is beneficial for drivers of older cars who want to secure value protection without spending excessively on newer vehicle premiums.

Investment Overview

• Investments Involve Various Asset Classes:

  • Debt Instruments (e.g., bonds)

    • Companies raise money by issuing bonds instead of getting loans from a single bank. Bonds serve as a receipt for borrowed funds from multiple investors. For example, a corporation might issue bonds worth $1 million at a 5% interest rate to finance new manufacturing equipment.

  • Shares

    • Issuing shares raises capital by giving equity stake to shareholders. Each share represents ownership in the company, and potential profits are shared with shareholders in the form of dividends. For example, a tech company may offer shares to raise funds for its development projects, giving shareholders a chance to reap profits from the company's success.

Investment Analysis and Roles in Finance

• Roles in Finance

  • Stockbroker

    • Facilitates buying/selling shares on stock exchanges and offers different service levels, varying in fees and market advice. Some may provide extensive research, while others could offer basic trading services.

  • Security Analyst

    • Analyzes and evaluates securities to inform investment decisions, often providing buy/sell recommendations based on market trends and financial performance.

  • Financial Advisor

    • Provides personalized advice based on the client's financial goals and risk tolerance. Advisors may help clients allocate assets across various investments according to their specific profiles.

  • Portfolio Manager

    • Manages investments on behalf of wealthy clients or funds, strategizing asset distribution for optimal growth, and realigning portfolios based on market changes.

Understanding Market Dynamics

• Primary vs. Secondary Markets

  • Primary Market

    • The initial issuance of stocks/bonds where money goes directly to the issuing company, often seen during initial public offerings (IPOs).

  • Secondary Market

    • Trading of previously issued shares, with transactions occurring between investors, allowing them to buy and sell existing shares without affecting the issuing company directly. Market liquidity ensures quick sales of assets without significant loss of value, critical during times of financial instability when selling might be necessary.

Financial Ratios Summary

• Profit Margin

  • Net profit margin = Net income / Sales, indicating the profitability from sales. A high profit margin suggests effective management and cost control.

• Return on Assets (ROA)

  • Measures efficiency in using assets to generate profit. Companies with high ROA are better at converting investments into profit.

• Earnings Per Share (EPS)

  • Indicates company profitability per share; lower PE ratio indicates cost-effectiveness per dollar of profit, often sought by value investors.

• Market Capitalization

  • Represents total value of a company's equity in the market, influencing potential acquisition costs for investors. It’s calculated as share price multiplied by the total number of outstanding shares, and companies with larger market cap usually have more stability and influence in the market.