FMA101 TOPIC 1: The Role of Managerial Finance

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LEARNING OUTCOMES

After completing this topic, you should be able to:

• Describe the managerial finance function and its relationship with economics and accounting.
• Identify, list, explain and compare the different legal forms of business in South Africa.
• Explain the primary goal of a business entity.
• Explain the meaning, role, purpose and importance of good corporate governance and ethics in organisations.
• Distinguish between maximising shareholder wealth and maximising profit.
• Explain the agency issue and how its impact on business decisions can be overcome.

 

READING

Before continuing with this topic, please read the following:

• Gitman et al. (2015: Chapter 1)

Please make sure that you also read this study guide carefully as it contains additional information that is not in the prescribed textbook.

FINANCE AND BUSINESS

You should read this section in order to gain an understanding of what finance is all about and where this important function finds its place in the business organisation.

The key concepts that you must focus on are:

• how finance can be defined
• the role finance plays in both one’s personal life and in business entities
• the meaning and functions of managerial finance
• the different legal forms of business organisations found in South Africa

Study the different legal forms of business organisations found in South Africa. You must be able to compare these entities in terms of their similarities and differences.

• Sole proprietorship: Also referred to as “sole ownership” in South Africa but the characteristics of this form of ownership are the same for both countries mentioned.
• Partnerships: This form is also found in South Africa and characteristics mentioned in the textbook are the same in both
• In terms of the South African Companies Act 71 of 2008, business organisations fall into two main categories, namely:
  • Public companies – Listed on the JSE, with its name ending in “Limited” (Ltd), for example ABSA Bank Ltd. This type of organisation can trade its shares through the stock exchange to the general public.
  • Private companies – Not listed on the JSE, with its name ending in “Propriety Limited” (Pty Ltd). These organisations have a limited number of shareholders and their shares are not traded on the stock exchange and not available to the public.

 

Act 71 of 2008 also introduces an entirely new set of business structures, which are as follows:

• Non-profit companies (NPCs): They are similar to Section 21 companies and must have a “public benefit” objective or an objective relating to cultural or social activities or communal or group interests. Not all provisions of the Act apply to these companies and there are special provisions in section 1 of the Act that govern these companies.
• Private companies (Pty Ltd): Similar to private companies under the previous Act. They may not offer securities to the public or transfer their securities. Their membership is, however, no longer limited to 50 shareholders as has been the case.
• Personal liability companies: Indicated as “Incorporated” (Inc.). Directors and past directors are jointly and severally liable together with the company for debts and liabilities contracted during their period of office. Currently professional practices use “Inc.” in their representation.
• Public companies (Ltd) are similar to companies under the previous Act, although such a company now may have only one member as compared to the minimum of seven under the previous Act.
• State-owned companies (SOC Ltd): These are companies defined as a “state- owned enterprise” in terms of the Public Finance Management Act 1 of 1999, or owned by a municipality.

 

Further reading:

You can read the following publications about the provisions of the new Companies Act 71 of 2008:

• The Companies Act 71 of 2008 (advisory). KPMG. https://www.intergate-com/types-business-structures-south-africa.php, accessed 24 February 2020.
• http://www.acts.co.za/companies_act_2008/whnjs.htm, accessed 24 February 2020.

 

THE GOAL OF THE FIRM

Read this section very carefully as it is very important to understand that the financial objective of an organisation is not maximum profit but rather maximisation of shareholder wealth. There is a very distinct difference between these two concepts and you must be able to distinguish them as such.

Special attention should be paid to the reasons why maximising profits should not be the preferred goal (timing, cash flows and risk) of an organisation and why the maximisation of shareholders’ wealth is.

The key concepts that you must focus on are:

• maximising shareholders’ wealth
• maximising profit
• shareholders versus stakeholders
• the role of business ethics

Carefully consider the importance of other stakeholders, their influence on the objectives of an organisation and why stakeholders cannot be ignored in terms of the objectives of the organisation.

Pay attention to the importance of sound corporate governance and cite examples of actions taken by organisations that demonstrate good corporate governance and acceptance of organisational social responsibility.

Pay attention to the brief discussion concerning business ethics, as it is not very topical only in the rest of the world. South Africa is experiencing unprecedented levels of fraud and corruption, which clearly demonstrates that there is a serious disregard in the country for ethics in business.

THE MANAGERIAL FINANCE FUNCTION

The managerial finance function is discussed in a general manner and you must take note that the manner in which this discipline is structured within the organograms of organisations can differ quite significantly. To gain a more practical understanding of how a business organisation performs this function, you could look at your own employer organisation or organisations where you have access to the organisation structures.

Of importance are the relationships between managerial finance and economics, particularly in terms of how both disciplines use marginal cost-benefit analysis for decision-making purposes. You need to understand the fundamental difference in focus between accounting and finance in terms of the accrual accounting system and the cash basis approach. Pay particular attention to how these different approaches can affect decisions and decision-making.

You should be able to compare the two approaches and explain the reasons why the differences in approach can lead to different financial decisions.

You must also be able to demonstrate and explain the use of information contained in a statement of financial position to make financial or investment decisions.

GOVERNANCE AND AGENCY

The key concepts that you must focus on are:

• corporate governance
• the agency issue

The agency issue is a critical aspect of corporate governance and business ethics. All employees need to understand their responsibilities as agents of employer organisations and the effects of their actions on the image and status of a business. The agency issue can also significantly affect the financial standing of an organisation, its profitability and the value of its equity.

It frequently happens that there are fundamental differences between shareholders and managers about managing a particular organisation. These differences usually come to a head at annual shareholders meetings and can have a profound effect on the continued existence, image and business prospects of an organisation.

Note that ownership of an organisation rests with the shareholders, while managers are “appointed agents” of shareholders, tasked to manage the organisation on behalf of its shareholders. The manager, by implication, must therefore act in the best interests of the shareholders, although this may not always be the case.

The agency issue, however, applies to all employees although it mostly centres around the actions of managers.

ADDITIONAL SOURCES TO ACCESS

Read the following articles, as they are concise yet very informative about the status of corporate governance in South Africa:

• https://cdn.ymaws.com/www.iodsa.co.za/resource/collection/94445006- 4F18-4335-B7FB- 7F5A8B23FB3F/King_III_Code_for_Governance_Principles_.pdf, accessed 24 February 2020.
• https://www.pwc.co.za/en/publications/king3.html, accessed 24 February 2020.

 

Also read the following:

• Ethics Institute of South Africa: http://tei.org.za/, accessed 24 February 2020.
• Financial managers – what they do: https://study.com/academy/lesson/the- role-and-responsibilities-of-financial-managers.html, accessed 24 February 2020.

The agency issue: https://www.investopedia.com/ask/answers/041015/how-do-modern- corporations-deal-agency-problems.asp, accessed 24 February 2020.

SELF-ASSESSMENT EXERCISES

After each section in this chapter of the textbook, there are review questions. You should test your knowledge and understanding of the different sections by answering these questions and then checking your answers by finding the correct answers in the relevant sections.

At the end of this chapter in the textbook, there is a series of different self-test problems, warm-up exercises and problems. You should attempt to answer these questions, perform the calculations and use them to practise and re-enforce your learning and understanding. You may submit any of your answers to the lecturer for assessment and feedback.

SBS also shares copies of previous exam papers with you during the semester. The questions in these exam papers are very good examples of what you are expected to know and be able to do having studied and mastered the content of chapter 1 of the prescribed textbook and having followed the guidance provided in this topic.