ACC 2023BASIC FINANCE

What is finance?

Who involve in finance?

Where do finance took place?

Chapter 1- Financial Background

Every organization wheter it is a government agency, private firm or even a non profit organization requires money to operate.

Normal individu also requires money in order to have a comfortable living.

Since almost everything we do involves money, the handling or the management of money should be given the highest prority.

Introduction

Example of finance application:

Encik ahmad owes CIMB bank RM10,000. The bank charges him 10% annual interest on the amount owned to him. If he plans to pay the amount he owes to the bank in 10 years of time, how much must he save from his salary each year in order for him to have sufficient amount to settle his debt?

FV = PV + KPV FV = PV(1+K)

Where: ◦ FV= future value◦ PV = present value◦ KPV = the interest earned on the money◦ n= year invest/interest

General equation

n

solution:

◦ The total debt he would accumulated to RM 25,937.4 in ten years of time.

◦ He need to save RM 2,593.74 each year for the next ten years in order to repay his debt.

◦ Without an in deepth knowledge in finance, he maybe would have just save RM1,000 instead of more because the element of interest charges would never come to his knowledge.

Some other examples of finance application can also be found in private businesses and government agencies.

Investment◦ For those who seek employment in this area, they

could work in finance institutions like Stock broking house, investment banking firms, banks and the mutual funds organization.

Finance and employment opportunity

Financial Management◦ Financial management offers the most job

opportunities among the three finance areas.◦ Almost all firms, big or small require a financial

manager◦ Financial manager job tasks:

Making strategic decision on how the firm should invest, raise funds to finance firm’s expansion.

Monitoring firm’s daily cash inflow and outflow Evaluating client’s financial and demographic status

for the purpose of extending credit

Insurance and Risk Management◦ Basically, the main role of insurance and risk

management manager, is to determine the type of risks that the firm is exposed to and once that has been determined the overall firm risk level is measured.

◦ Formulate a strategy that could minimize the impact of such risk on the firm’s well being

In Malaysia, business entity may be classified into three basic types:1. Sole proprietorship2. Partnership3. Company

Forms of Business Organization

In finance, we believe that the primary goal of management is to maximizing shareholder’s wealth or the wealth of the firm owners.

This is accomplished through maximizin the company’s share price.

Share price on the other hand could only be maximized if there is a continuous increase in the price itself.

The primary goal of management is maximizing shareholder’s wealth

For example, if the price of a share continuoues to increase, the shareholder’s who have initially purchased those shares at a lower price, will experience capital gain when they sell those shares.

Thus,the wealth of the owners in the form of share prices are maximized.

If by maximizing the firm share price will help the managers to maximize the shareholder wealth, then, it is equally important for them also to understand factors that can cause the share price to appreciate.

Previous researches in finance reveal that main factor that could cause the share price to go up is the company’s profit

Internal factor◦ Managerial actions which influence the firm’s long

run profitability level that bring affect the value of stock price.

External factor◦ Social responsibilities, legal constrains, the

general level of economic activity, tax laws, interest rates and the conditions in the stock market

Constrains to shareholder’s profit maximizations process

Externals constrains• Antitru

st law• Enviro

nmental regulations

• Employment practices rules

• Federal reserve policy

• International rule

Strategic policy decisions controlled by management• Types

of product or services produce

• Produce method used

• Researched and development efforts.

• Relative use of debt financing

Level of EconomicExpected cash flowsTiming of cash flowsPerceeved riskiness of cash

flow

Stock Market condition• Stock

price

Figure 1: Major factors affecting stock price

An agency relationship is created when a person hires another and gives him or her decision-making auhority over something.

Example:◦ Kamal hires Dollah to run his business. Dollah is

the agent of Kamal, whereas Kamal is called the principal.

◦ If Kamal hires Dollah to sweep the floor, no agency relationship is created .

Agency relationship and problems

Within the financial management context, the primary agency relationships are those;

1. Between managers and stockholders2. Between managers and creditors (debt holders)

The agency relationship can create an opportunity for the agent who has control over the assets of the principal to abuse his power.

Such abuse is known as agency problem.

Agency problems between managers and stockholders

◦ An example of the problems is when managers with the approval of the B.O.D pay top executive excessive compensation (salary and bonuses).

◦ Conflict will arise with the stockholders because the excess pay would otherwise be profits which belong to stockholder.

Agency problem between stockolders and creditors◦ Example:

Encik Ahmad starts a business with RM 10,000 of his money and convinces Yusof to lend the business another RM 10,000 without any personal guarantee. The business now has RM 20,000 cash.(Ahmad = sole owner and Yusof = creditor).Now, let us suppose that Ahmad decide to use the money for a risky business, which has high probability of failure (50%). If it fails, all the invested funds would be lost. However, if it succeeds, the business will double the invested fund’s in a few month.

Solution: In the event failure, both investor will have equally

lost(RM10,000 yusoff and RM 10,000 Ahmad) If the venture succeeds and the company will have RM

40,000 in cash for example. Yusof’s claims will still be RM 10,000 balance (plus little interest)

The remaining RM 30,000 will belong entirely to Ahmad. This is very unfair deal between Ahmad and yusof. This is considered as an abuse the creditor by the

stockholder The losses are shared equallybetween them but all the

profits belong to the stockholder alone. That is not a very good deal to the creditor.