Define the terms "finance" and "finance management."
Finance is the art and science of raising, planning and managing money or capital funds used in a business or organization. While financial management is the process of maintaining adequate amounts of funds for the smooth running of a business in order to improve its value and profitability.
Identify major sub-areas of finance.
There are two major sub-areas of finance, which are public finance and private finance. Private finance deals with the management of money or capital funds in individual businesses, firms or corporate institutions, while Public finance deals with disbursements of government revenue in the central government, state and semi- government institutions.
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Identify and define the three basic forms of business ownership. Describe the advantages and disadvantages of each.
The three basic forms of business ownerships are: sole proprietorship, General Partnerships and corporations. Although Sole proprietorship is the easiest to establish and manage, by family members or an individual, the business owner is always personally liable for all debts incurred by the business. General Partnerships on the other hand are run by two or more partners who are equally liable for debts of the partnership including profits and losses. But if one partner dies the partnership is automatically dissolved. Corporations are expensive and difficult to establish due to the legal government requirements, but it raises funds easily form the public by selling stock and shares. This feature makes it easy to transfer ownership even if the majority shareholder dies.
Define the term "agency relationship."
This is a contractual business relationship whereby a principle gives an agent legal authority to act on his behalf when dealing with third parties. For example, financial managers are often known as the agents and they have legal authority to manage the corporations’ finances on behalf of the shareholders (Shleifer & Vishny, 1989).
Define the term "agency problem.
is a conflict of interest between the needs of the principle and the agent. For example, financial analysts often take advantage of these agency types of relationships by investing against the best interest of their clients, like the case of Goldman Sachs real estate stock where brokers who made millions of dollars by shorting shareholders.
Explain three different approaches to minimizing the agency problem.
Minimizing agency costs by employing profit efficiency as a performance measure.
Leveraging debt instead of cash in company investments.
The use acquisitions as one way of diversifying company funds.
Evaluate the financial health of an organization.
The financial health of an organization comes from analyzing its financial statements. Indicators of strong financial performance include reliable revenue that is able to cover for operating expenses. Together with having enough working capital or debt equity to absorb cash flow problems and respond to new opportunities.
Explain the concept of shareholder wealth maximization. Is there a conflict between the goal of shareholder wealth maximization and the financial manager's need to act in an ethical manner? Why or why not?
The primary purpose of a firm is to make money for its shareholders, also known as shareholder wealth maximization, which is in the form of net payouts received by all shareholders at the end of a financial period. A critique of shareholder wealth maximization creates ethical conflicts between financial managers and shareholders. The controversy arises due to the passing of too much cash flow directly to shareholders through payouts such as bonuses and dividends. Financial managers believe such payouts reduce of the amount of resources under their control; thereby running the risk of being replaced by shareholders for bad investments ( Jensen, 1986).
Explain why ethical behavior is especially important in the field of finance.
All organizations that deal with finances, in the form of money or other liquid resources and they apply the same principles of financial management. Ethics is important within the financial industry to develop client relationships based on trust which protects the client, reputations and prevents wastage of company resources in unprofitable projects that can lead to business bankruptcy ( Benjamin,1976).
References:
Benjamin, S. (1976). Profit and other financial concepts in insurance. Journal of the Institute of Actuaries , 103 , 233-305.
Eisenhardt, K. M. (1989). Agency theory: An assessment and review. Academy of management review , 14 (1), 57-74
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American economic review , 76 (2), 323-329.
Shleifer, A., & Vishny, R. W. (1989). Management entrenchment: The case of manager-specific investments. Journal of financial economics , 25 (1), 123-139.
