2. Introduction to Financial Management –
Marko Korkeakoski 2006
Introduction
• Imagine yourself starting your own business. No matter
what type you started, you would have to answer
following questions:
– What long-term investments should you take on? What kind
of machinery, buildings, equipments etc. you need?
– Where will you get the long-term financing to pay for your
investments? Own money, borrowing…?
– How will you manage your everyday financial activities such
as collecting from customers and paying suppliers?
– How will you keep your company profitable and competitive?
3. Introduction to Financial Management –
Marko Korkeakoski 2006
What is a firm
• A firm is an institution that hires factors of
production and organises them to produce and
sell goods and services
• Firms:
– Combine resources to produce different types of
outputs
– Costs of output is determined by nature of production
process
– Main goal is to maximize profits?
– Profits = revenue – costs. Compare revenue and
costs
– Necessary to choose the correct combination of
price + output
4. Introduction to Financial Management –
Marko Korkeakoski 2006
Characteristics of the Firm
The Firm makes decisions about what is to be
produced and how it is to be produced
• Entrepreneur has to choose those inputs of
production which minimise production costs.
Examples?
• More efficient at coordinating production than
individuals.
• Employs specialists who can take advantage of
skills, knowledge, expertise and experience.
Examples?
• Costs to consumers can be minimised.
Examples?
5. Introduction to Financial Management –
Marko Korkeakoski 2006
Role of Firms
The firm plays an important role in the economic
system.
• Firms employ the resources provided by the
consumer or household sector.
– The firm is the basic production unit in the economy
– Provides us with the capacity of participating in the
market
• Firms are also the producer of the economies
out put (goods and services)
– Provides the basis of satisfying most of our wants.
6. Introduction to Financial Management –
Marko Korkeakoski 2006
Firms goals
• What is the ultimate goal for a Firm?
• Most of us would probably say ”profit maximisation” -
but there are few problems arising if only thinking about
profits. Can you come up with some reasons?
• Or could it be shareholder wealth maximisation? Milton
Friedman (Nobel prize winner) stated that organisational
goal is to serve the interests of the firm's owners, the
shareholders.
• However, there might be problems in this thinking, too
7. Introduction to Financial Management –
Marko Korkeakoski 2006
Goals of Firms
• Obviously it might be difficult to set goals for financial
management if the organisational goals are not known
• Possible goals could be:
– Surviving
– Avoiding financial distress and bankruptcy
– Beating the competition
– Maximising sales or market share
– Minimising costs
– Maximising profits
– Maintaining steady earnings growth
– Maximising the current value of the shares
8. Introduction to Financial Management –
Marko Korkeakoski 2006
Types of Firms
• Each type of business organisation can be distinguished
from other types by considering:
– Who owns it
– Whether owners will have to repay any business debts
– Who controls the organisation from day to day
– How the business is financed
– Who gets the profits
– How big are the risks (for individuals)
– etc.
9. Introduction to Financial Management –
Marko Korkeakoski 2006
Types of Firms
• Firms vary according to
– Size
– Type of product produced or sold
– Service provided
– Legal structure
• There are several different types of
organisations:
– Sole proprietor (sole trader)
– Partnership
– Public/Private Limited Company (PLC)
10. Introduction to Financial Management –
Marko Korkeakoski 2006
Sole Trader
• This type of ownership is suitable when there’s only one
owner who has control over everything that happens in
the company
• Most common type in terms of the number of firms
(usually offering small-scale services)
• Very easy to establish in terms of formalities, law and
finances
• Initial investment is made by entrepreneur him/herself –
often they have to borrow money from bank as well
11. Introduction to Financial Management –
Marko Korkeakoski 2006
Sole Trader
• Advantages
– Personal business – all decisions can be controlled easily –
being his/her own boss
– All the profit come to entrepreneur
– Easy to set up and run
• Disadvantages
– Unlimited liability they are liable for all debts of the firm
(possibility to lose own personal property if assets of the
business are not enough to offset debts).
– Full responsibility of all decisions
– More difficult to raise capital for expansion– investments
can be difficult to make
12. Introduction to Financial Management –
Marko Korkeakoski 2006
Partnership
• Similar to sole proprietor but ownership is hands of more
than one person (usually something between two to
twenty)
• All partners have equal share of ”power” over the
company – they also have unlimited liability
• More owners, more funding
• Easy to set up too – no minimum investments required
• Traditionally associated with professions like lawyers,
doctors etc.
13. Introduction to Financial Management –
Marko Korkeakoski 2006
Partnership
• Advantages
– More people, more money and ideas
– Setting up a partnership is easy
– Partners can help in decision making – responsiblities can
be divided
• Disadvantages
– Partners have unlimited liability –they can lose their
personal property if things go wrong
– Lack of capital
– Possible disagreements between partners
14. Introduction to Financial Management –
Marko Korkeakoski 2006
Public/Private Limited Company
• shareholders elect a board of directors who run the firm
• board of directors usually hire managers
• These companies sell shares to investors in order to raise capital
• Both need to go through certain legal and business procedures
before they can be established –
• Governments are monitoring and controlling limited companies –
Governed by Corporations Act (2001)
• Requires more detailed information. Example publishing financial
details to public etc.
• Company lasts in perpetuity
15. Introduction to Financial Management –
Marko Korkeakoski 2006
Public/Private Limited Company
• Shareholders liability is limited to the amount of money
they have invested to shares – more shares they own,
more power they have over the decision-making
• PLC has its own independent legal identity
• Private Limited Company is only selling shares to special
group (family, friends) – it’s not for general public
• Public Limited Companies are quoted on a stock
exchange so basically anyone can buy their shares
16. Introduction to Financial Management –
Marko Korkeakoski 2006
Private Limited Company
• Advantages
– Shareholders have limited liability – safe way to invest
money without losing the control on decision making
– Shareholders do not take care of the day-to-day
operations of the company
– The company is a separate legal entity
• Disadvantages
– Possibilities to raise capital are limited since shares are
sold only to specific group
– Formalities, annual general meetings etc.
– Company information has to be given to public
17. Introduction to Financial Management –
Marko Korkeakoski 2006
Public Limited Company
• Advantages
– Can sell shares on Stock Exchange – unlimited possiblities
to get capital
– Shareholders have limited liability
– Biggest and most profitable companies have to go public
• Disadvantages
– Forming and launching is expensive
– The orginal owners of the company may lose control (e.g.
hostile takeover)
– Bigger PLC’s are so huge that they might lose some power
– management problems are more difficult to solve
18. Introduction to Financial Management –
Marko Korkeakoski 2006
Business Sales Number of Firms
Sole proprietorships 6% 75%
Partnerships 5% 7%
Corporations 90% <20%
19. Introduction to Financial Management –
Marko Korkeakoski 2006
• conflicting objectives between owners,
managers, and other employees
• employees want to maximize their earnings or
utility
• owners want to maximize profit:
• = R - C
– R = revenue = pq = price x quantity
– C = cost
Objectives
20. Introduction to Financial Management –
Marko Korkeakoski 2006
Managers vs. owners
• The 2000 stock market crash followed by
revelations that managers had perpetrated
outrageous frauds (Enron, WorldCom in USA &
HFC in Australia)
– managers engaged in actions that directly benefited
themselves at expense of unsuspecting
shareholders
– often frauds involved misreporting of earnings to
mislead investors and raise the price of the stock
temporarily
– Substantial loans given to managing directors and
others high up in management without due
financial security given
– Insider trading was also evident
21. Introduction to Financial Management –
Marko Korkeakoski 2006
Production
• production process: transform inputs or factors
of production into outputs
• common types of inputs:
– capital: buildings and equipment
– Labor: part-time, casual, full time to suit
purpose of firm.
– materials: raw goods and processed
products
– Land: Agricultural products
– Enterprise: entrepreneurial skills such
organization and ideas for improving
production processes.
