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ABMF2103 Principles of Finance
ACADEMIC YEAR 2020/21

Chapter 1: Introduction to Financial Management
Learning outcomes
At the end of this chapter, you should be able to:
1
...
Explain financial management
3
...
Define cash, cash flow and funds
5
...
Types of Cash Transaction
7
...
Cash flow problem may arise due to the following circumstances
9
...
Cash Accounting and Accruals Accounting

1
...
The record can be used periodically to produce financial
statements such as Statement of Financial Position, Statement of Profit and Loss and
Cash Flow Statement
...

Finance consists of three key decisions/activities:
(i) Financing decision to decide the level of funds required, which types of funds to
raise and the raising of funds
...
from bank? or shareholders)
(ii) Investment decision is decide on the amount to be invested into which types of
assets
...


Financing

Investing

Dividend
Policy

Although account and finance do not involve the same aspects, they are closely related
...


1
...
It is concerned with the acquisition, financing and management of
assets with some overall goals in mind
...

The main objective of the Firm / Goal of the Corporation
The most important goal of most corporations is:

(Maximizing share price)

Maximising Shareholder wealth
maximisation"
Why don't we just maximize profit? It is the same with maximizing shareholders wealth?
The answer is both are not the same
...

 mostly concerned about short term benefits
...

Shareholder’s Wealth maximisation - maximising the value of the firm through
maximising the price of the firm’s common stock
...

 priority to value creation
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

1
...
g
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Factors affecting stock/share price of a company

Stock/Share price is always the best indicator of shareholders' wealth
...


Financial managers concentrate on increasing cash inflows and
decreasing cash outflows
...


(b)

Timing of cash flow

Refers to when the firms expect to receive cash and when they
expect to pay out cash
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(c)

Risk of expected cash flows
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
As risk increased, stock prices go down and vice versa
...


1
...
Forecasting and planning
...
(cash budget)
ii
...
A successful firm usually has rapid
growth in sales, which requires investments in plant, equipment and inventory
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(best way to find money)

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iii
...
The financial manager must interact with other executives
to ensure that the firm is operated as efficiently as possible
...

iv
...
The financial manager must deal with the money
and capital markets
...

In summary, financial managers make decisions regarding which assets their firms should
acquire, how those assets should be financed, and how the firm should manage its
existing resources
...

Non-Financial Responsibilities --- social responsibilities towards shareholders

1
...
A business that makes losses can last
for a few years but if a business is short of cash, it will collapse in a very short period of
time
...
It is the most liquid of
assets and represents the lifeblood for growth and investment
...
In other words, it represents the
cash movement for a particular organisation
...
e
...

Cash Outflows can occur for the following reasons:
i
...
Payments to government in term of taxes
iii
...
Payments to cover the purchase cost of non-current asset such as buildings and
equipment
...
They may be
irregular)
v
...
Purchase of foreign currency for trading oversea
Cash Inflows can come in from various sources such as below:
i
...
These are revenue receipts
ii
...

(Capital receipts as they are for long term investment in the business)
iii
...

 The liquidation of short term investments
...

Funds can be defined as any arrangement that enables goods or services to be bought ie
money or credit
...
A
company needs to purchase raw materials to be used in the production of goods and
services, to pay their labours, to rent factory and to acquire the necessary tools that are
required
...
Due to this time lag between paying for the factors of production
and receiving money from customers, the company must be able to balance the flow of
cash, how to negotiate funds to finance this operation and in managing the company’s
cash
...
6

1
...


The transactions motive (pay to suppliers, pay salary to employees)
A business holds cash in order to make the payments that are necessary to
keep the business going, such as wages, taxes and payments to suppliers
...
It is therefore the main motive for holding cash
...


The precautionary motive (emergency need) (payment for lawsuit)
The second motive in which business does not find itself in financial
difficulties should some unforeseen expenses arise
...
These do not cost businesses anything unless they are used
...


The speculative motive (payment for short-term investment)
A company might hold some cash that can be used if a business opportunity
arises
...
Holding cash might
therefore be a strategic measure taken by a company, to take opportunities for
developing the business whenever an attractive opportunity arises
...
Revenue Receipts and Revenue Payments
Cash receipts and payments arising from the normal course of business:Revenue receipts are cash receipts from: Cash sales
 Payments by trade debtors/receivables
Revenue payments are payments to: Trade creditors
 Employees for salaries and wages
 Business expenses such as office rental, utility bills and so on
...
Capital receipts and capital payments
Capital receipts are proceeds of long term funds from company’s owner or cash
from the sales of fixed assets or long term investments
...


Capital payments are cash payments for capital expenditure, such as the purchase of
new fixed asset (equipment, motor vehicles and so on)
...
A loan from a bank is a
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liability, but long term liabilities can be thought of as a capital receipt
...


iii
...

Businesses can pay dividends whenever they want to
...
One dividend payment is an interim
dividend, paid in the middle of the year when the profits for the first six months are
known
...

The term of disbursement simply means a payment for : Interest on loans and overdrafts, and on other debts for which interest is payable
...
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Other Categorisation of Cash Flows

Another method of categorisation that might be preferred gives four groupings:1
...
Priority cash flows are payments for non-trading cash payments that must be made
to keep the company functioning and have priority over other non-operational
payments
...
They include interest
payments and tax payments
...
Discretionary cash flows are cash payment or receipt that not necessary need to
incur
...
Discretionary inflows are sale of non-current
assets
...
Financial cash flows arise from variations in long term capital
...
Financial outflows include the
repayment of a long-term loan
When operational cash flows are insufficient, a top up of cash will be needed from
discretionary or financial sources
...


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Operational cash flow problems are much more likely to occur when the company is
making only small profit especially when the company is growing too fast and it’s
overtrading
...
9

Cash flow problem may arise due to the following circumstances

i
...

ii
...
The business can be making a profit in
historical cost accounting terms, but might still be not receiving enough cash to buy
replacement assets it needs
iii
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As its sales increases, the growing company may need additional
financing in order to employ more employees, buy additional equipments for
production, purchase additional materials and to extend customers payment period
...
Seasonal business
When a business has seasonal or cyclical sales, it may have cash flow difficulties at
certain times of the year
...
10

Negotiate for reduction in cash outflow

(get longer credit term from supplier)

Profit and Cash Flow

Trading profits and cash flows are different
...

Profit is not cash because:
i
...
Similarly
increase in bank overdraft provides a source of cash but it is not reported in the
statement of profit and loss
...
Cash may be paid for the purchase of fixed assets, but this transaction is not reflected
in statement of profit and loss
...
Profit is sales less the cost of sales
...
Cash received differs from sales because
of changes in the amount of receivables
...
Profit = sales - COS
Net cash flow = cash inflow - cash outflow

The difference between profit and cash flow has important implications:i
...
If a company needs to seek credit from a bank
to finance the growth in working capital, the management should consider
whether operational cash flows could be improved by squeezing working capital
and:
 Reducing receivables
 Reducing inventories
 Taking more credit from suppliers
Better control over working capital could remove the need to borrow
...
If a company is making losses, it could try to maintain a positive operation cash
flow by taking more trade credit (i
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1
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

Cash Accounting – It is a system of accounting for costs and income on the basis of
payments and cash receipts
...

Example:
Suppose that Midland Company is in the business of refining and trading gold
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The company had acquired the
gold for RM900,000 at the beginning of the year
...
Unfortunately, it has yet to collect from the customer to whom
the gold was sold
...

Midland seems to be profitable
...
It is interested in whether cash
flows are being created by the operation of
Midland
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Explain the Three (3) main activities/decisions in Finance
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Discuss the difference between profit maximisation and wealth maximisation
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Define Cash, cash flow and funds
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Explain Three (3) examples each for cash inflows and cash outflows
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What is generally understood by the following terms?
i) Revenue receipts
ii) Revenue payments
iii) Capital receipts
iv) Capital payments
6
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7
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8
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Explain how far you agree with the statement above
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What separates cash from profits? Explain why lots of sales might not mean lots
of cash

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