1. Corporate Finance: A South African Perspective
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Corporate Finance: A South African Perspective
by Gideon Els, Elda du Toit, Pierre Erasmus, Liezel Kotze, Sam Ngwenya, Kevin Thomas and Suzette Viviers
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2. INTRODUCTION TO CORPORATE FINANCIAL MANAGEMENT
CHAPTER 1
INTRODUCTION TO CORPORATE FINANCIAL MANAGEMENT 2

3. Chapter outline Introduction What is corporate finance?
The goals of financial management
The corporate forms of business
The agency problem
Financial markets and institutions
Corporate governance and ethics
Conclusion

4. Learning outcomes By the end of this chapter you should be able to:
Explain the role of corporate financial management and the role and responsibilities of the financial manager
Review the types of corporate financial management decisions and identify the main goal of financial management
Describe the different corporate forms of business
Describe the agency problem and agency cost
Understand the functions of financial markets and institutions and the role of corporate governance and business ethics

5. Introduction
Both big and small businesses are guided by the same corporate financial principles
Bigger businesses are run by managers
These managers are selected by the shareholders (owners of the business)
It is important to increase the wealth of the shareholders

6. The role of corporate financial management
The process of creating value in a business by making the best decisions
Ultimate measure – to increase the wealth of the shareholders
Financial management ≠ Accounting
Accounting: a historical perspective (report)
Financial managers: use information from accountants to make decisions

7. Position of the financial manager in the corporate structure

8. The Financial Manager Responsible for:
Managing the business’s cash and credit
Financial planning
Corporate expenditure
Record-keeping

9. Corporate financial management decisions
3 basic decisions:
What should the business invest in?
Where will the business get long-term financing to pay for the new investment?
How will the business manage its day-to-day financial activities?
CAPITAL-BUDGETING DECISION
CAPITAL-STRUCTURE DECISION
WORKING-CAPITAL MANAGEMENT DECISION

10. Capital budgeting Financial manager should aim to create value
Will do that by identifying investments that will create value
Determine cash flows
Size – how much initial investment is needed and how much income will be received
Timing – when and for how long income will be received
Risk – the likelihood of receiving the income
Will income from investment exceed the cost?

11. Capital structure
The mix of debt and equity a company uses to fund new investments/projects
Three choices available:
Borrow long-term funds (debt) – risk increase
Use savings of the company (retained earnings)
Issue more shares (equity) – ownership declines
Whichever option will have an effect (risk and value)
Which form of financing is the cheapest?

12. Working-capital management
Working capital = short-term assets and liabilities
How will you approach the day-to-day financial management?
Will you sell new product for cash, credit or both?
Who will receive credit and who won’t?
How many days until debtors have to pay?
Will you pay expenses in cash or on credit?
All these decisions are important to ensure business functions efficiently
There must be sufficient resources for adequate liquidity

13. Three financial management decisions

14. The goals of financial management
Most people believe main goal is maximising profit:
Increasing sales
Increasing market share
Minimising costs
Increasing growth in profits
Avoiding insolvency
Surviving
BUT focusing on profitability ignores risk
Higher risk should correspond with higher return
Need more basic goal – shareholders’ wealth maximisation

15. Shareholders’ wealth maximisation
Number one goal = increase the wealth of the shareholders
How can that be done?
Shareholders can receive dividends
Increase in the share price
If a financial manager focuses on shareholders’ wealth maximisation, then both risk and return are taken into account
Profit maximisation: short-term goal not looking at long- term effects
Share price maximisation: short-term and long-term
Every decision in the best interest of the shareholders

16. The corporate forms of business
Sole proprietorship
Partnership
Companies
Private companies
Public companies
Close corporations

17. Sole proprietorship
A single person has the controlling interest (one-person business)
Success/failure is entirely in the hand of one person
Main characteristics:
Easy entry into the market
Lifespan of business = owner’s lifespan
Owner is generally also the manager (shareholders’ wealth maximisation)
Business not a separate legal entity from owner

18. Partnership Private agreement between partners (max 20)
All contribute to business with skills and equity
Partners can raise more capital and have greater creditworthiness
Main characteristics:
Easy entry into the market
Lifespan of the business is limited
Business not a separate legal entity from partners
Profits and debts are the liability of the partners in proportion to their contribution to capital

19. Companies Separate legal entity from the owners
Owners (shareholders) have limited liability
Company must comply with legislation
Two kinds of companies:
Private companies
Public companies

20. PRIVATE COMPANIES PUBLIC COMPANIES
Must have between 1 and 50 shareholders
Minimum of 7 (unlimited number of shareholders)
At least one director
At least two directors
Transferability of shares is restricted. No offer can be made to the public to buy.
Transferability of shares not restricted. Public are invited to purchase and sell shares at any time
Financial statements only available to the directors and shareholders
Financial statements are available to the public
Proprietary Limited - (Pty) Ltd after the name of the company
Limited (Ltd) after the name of the company

21. Companies Main characteristics: Complicated entry into the market
Lifespan of the company is unlimited
Company is a separate legal entity from the owners
Unlimited access to capital
Separation of ownership and management

22. Close corporations
Same advantages of a company, but simpler and less expensive
Between members (not shareholders)
Member’s interest (not shares) – percentage share in the business
Main characteristics:
Less complicated market entry than a company
A separate legal entity and limited liability to members
Transfer of interest uncomplicated and simple

23. The agency problem
Goal of financial management: increase shareholders’ wealth
Sole proprietorship = easy; owners are generally also the managers of the business
Big companies = difficult; owners/shareholders not directly involved in business
The shareholders (principals) appoint managers (agents) to look after their interest
Agency relationship: the relationship between the principal and the agent
Agency problem: when the agent does not make decisions in the best interest of the principal

24. Agency costs Management and shareholders goals can differ
Agency cost: Any costs (both direct and indirect) that can arise due to the agency problem
Direct agency cost: measurable amount
Indirect agency cost: not physical, lost opportunity
Control agency cost:
Incentive plans
Performance plans

25. Financial markets and institutions
Financial market: place where anyone with funds can transact with anyone in need of funds
Money Market: short-term debt securities (no physical location)
Capital Market: long-term debt securities (stock and bond exchanges)
Primary market: sell securities for the first time
Secondary market: securities traded after being sold in the primary market
Auction market: broker brings buyer and seller together (NYSE)
Dealer market: traders offer to buy or sell securities (JSE)
Financial institutions: bring savers and lenders together to efficiently allocate funds (financial intermediary)

26. Flow of funds

27. Corporate governance
Laws, policies, processes and organisations that influence business and the business environment
Ensures that needs of shareholders & stakeholders are served
Main role players: shareholders, board of directors, management
Other stakeholders: employees , creditors, customers, community
Accepted principles of corporate governance:
Rights & equitable treatment of shareholders
Interests of other stakeholders
Role & responsibility of the board
Integrity & ethical behaviour
Disclosure & transparency
King III Report

28. Business ethics
Moral principles and values applied in a business setting
Ethical companies conduct themselves by distinguishing between right and wrong
Unethical behaviour: creative accounting, insider trading, gender, race & religious discrimination, price fixing
Certain behaviour might be legal, but still unethical
For example: child labour might be legal in certain countries, but is it ethical to buy products from companies using children as cheap labour?

29. Conclusion
Corporate financial management is the process of creating value in a business.
The financial manager needs to make the following three decisions to create value:
What should a business invest in?
Where will the business get the long-term financing to fund the investment?
How will the business manage its day-to-day financial activities?
The most important financial management goal is to increase the wealth of the shareholders by increasing the current share price.

30. Conclusion (cont.) The four forms of a business organisation are:
Sole proprietorship
Partnership
Company
Close corporation
Shareholders are the owners of a business and they appoint managers to act as their agents. If the managers do not act in the shareholders’ best interests, the business is faced with the problem of agency.

31. Conclusion (cont.)
Financial markets act as a platform to bring together buyers and sellers of securities. There are two forms of financial markets, namely money and capital markets. Capital markets are also divided into primary and secondary markets.
Financial institutions act as intermediaries to bring together suppliers of funds (savers) and demanders of funds (borrowers).
Corporate governance and ethics are necessary to manage a business in a moral and lawful manner.