Chapter 2 (Financial Environment)

22
Financial Environment
Learning Outcomes
At the end of this chapter, you should be able to:

 Identify the basic forms of business in Malaysia and
explain the respective strengths and weaknesses
 Identify, describe and explain the various financial
statements that businesses produce
 Prepare simple financial statements of a firm
 Show an appreciation of the make-up of financial
markets in Malaysia
 Distinguish between primary and secondary markets
Financial Management Third Edition All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T), 2017 2– 3
Forms of Business
 Sole Proprietorship
 Partnership
 Company (Firm)

Sole Proprietorship
 Owned by a single person

 Owner has title to the business’ assets, and all of
the business’ liabilities as well.
 No limitation as to the amount of gains and losses
that the owner shall be entitled or be liable for.
 Owner is entitled to all of the business’ profits, and
yet must absorb any and all losses that may arise.

Sole Proprietorship (cont.)
Advantages:
 No legal requirements other than the need to register
the business with the Registrar of Business
 Cheapest form of business
 Business incurs no corporation or income tax – tax
liability borne by the individual owner
 Life of business depends on the life of the owner
(ceases upon death of the owner) or at the choice of the
owner
Sole Proprietorship (cont.)
Disadvantages:
 Funds in business limited to amount that the sole
proprietor has personally
 Sole proprietor has unlimited liability for business debts
and liabilities.
 No distinction and separation is made between business
and personal assets
 Creditors may claim the sole proprietor’s personal assets
when the business’ assets cannot pay the creditors.

Partnership
 Coming together (association) of two or more

individuals for a common purpose to operate a
business together for profit.
 Two subcategories of partnership:
i. General partnerships
ii. Limited liability partnerships
https://www.ssm.com.my/Pages/Register_Business_Company_LLP/LLP/Starting-a-
Limited-Liability-Partnership-(LLP).aspx

General Partnerships
 All partners agree to provide an agreed portion

of funding and work contribution into the joint
business.
 To share in the resulting profits and losses, on a
pre-agreed profit sharing ratio
 Each partner shall be liable, jointly and
severally, for the losses incurred by the
business.

Limited Liability Partnership
 Liability of certain partners shall be limited (restricted)

to the amount of capital put in by the said partner into
the partnership.
 However, there must exist at least one partner who is
not a limited liability partner.
 Losses (and liabilities) incurred by the business that
cannot be met by the capital contributed by the
partners shall be borne by this non-limited liability
partner(s).
 Limited liability partners may not be allowed to
participate in the management and daily running of the
business.
Advantages of Partnerships
 Inexpensive and easy to form.

 Management control resides with the
general partners.

Disadvantages of Partnerships
 General partners have unlimited liability on all

debts incurred by the partnership (but contrast
with limited liability partnerships).
 Partnership is terminated when one partner dies
or withdraws from the partnership arrangement.
 It may be difficult to raise additional funding.
Equity contribution is limited to the partner’s
ability and desire to contribute funds to the
partnership.
 Income from a partnership is taxed as personal
income of the partners.
Company (Firm)
 Given its legal status by the Companies Act,

2016
 Subject to the laws as set out in the Act, for
which a company must be incorporated with the
Registrar of Companies, under Companies
Commission of Malaysia
 Must have a Memorandum and Articles of
Association (M&A)
 Separation of ownership and control

Advantages of Having a
Company (Firm)
 Ownership can be transferred by way of transfer

of shares from one shareholder to another.
 Companies can have unlimited life.
 Shareholders’ liability limited to the amount
invested in the company.
 Easier for a company to raise additional funding
from external providers of finance (e.g. bank)

Disadvantages of Having a
Company (Firm)
 Annual accounts would have to be prepared—
responsibility of the directors of the company
 Accounts of the company would have to be audited by
external auditors.
 Filing of financial statements and annual returns must be
made with the Registrar of Companies every year.
 Annual and extraordinary general meetings must be
conducted.
 At least two directors must be appointed
 Is subject to corporation tax
Note: AGM and two directors are no longer required under
new Companies Act unless is a public company.
Financial Statements of a
Company
 Income Statement—presents the revenues and

expenses, and resulting net income or loss of a firm
for a specified financial period
 Statement of Financial Position—reports the assets,
liabilities and shareholders’ equity of a firm as at a
specific date
 Statement of Cash Flows—summarizes the
information concerning the cash inflows (receipts) and
outflows (payments) for a specified financial period

Income Statement

Income Statement (cont.)

Statement of Financial Position

(cont.)

(cont.)

Statement of Cash Flows

Financial Markets
 Perform the important economic function of

channelling funds from the providers (households,
other firms and government) that have surplus
funds to those who have a shortage of funds (and
hence, require funds).
 Financial markets bring these two groups together:
(a) Providers of funds
(b) Users of funds

Financial Markets (cont.)
The roles of financial markets include:

 Facilitation of savings by individuals by allowing
them to consume less today (savings) to be able to
consume more in the future
 Platform to raise financing by the users (firms) of
finance
 Channel whereby demand for and supply of funds
can interact and arrive at a suitable market price for
funds
 Provision of financial services that allow
participants to work out and balance their risk
tolerance and expected returns

Debt vs. Equity Securities
 Debt securities—contractual obligations by the

firm to repay borrowings, in the form of interest
and principal
 Equity securities—comprise of ordinary and
preferred shares; represents claims by the
holders of this type of security on the firm’s
residual cash flows after having settled with the
debt holders

Primary vs. Secondary Markets
 Primary markets—funds are raised from

providers of finance by firms that require such
funds
 Firms issue shares and debt instruments (bonds
or loan stock) to providers of finance.
 Secondary markets—investors (providers of
finance) buy and sell shares, bonds, loan stocks
and so on

Money Markets
 Markets for debt securities that will be repaid in the

short term (< one year)
 Relates to a group of loosely connected markets,
e.g. dealer markets
 Main player in the role as dealer is the banks;
particularly active in this market, both as lenders
and borrowers
 Large firms lend when they have surplus cash
(invest in Certificate of Deposits, Commercial
Paper, Treasury Securities, Bankers’ Acceptances,
etc.) and borrow when they are short of money
Capital Markets
 Markets for long-term debt (i.e. debt securities

that will be repaid after more than one year) and
equity

Capital Markets (cont.)
Long-term debt
 Bonds, debentures or loan stocks
 Term loan
 Leasing
 Industrial hire purchase
Features:
 Contractual (legal) obligation to repay borrowings
 Interests and principal

Equity
 Shares are equity in a firm

 Represents ownership
 Residual interest in a firm—shareholders can
only claim on their share of earnings and assets
of a firm after the distribution of earnings or
assets has been made to other claimants (debt
holders)
 Shareholders have dividend rights, voting
rights, liquidation and pre-emptive rights.
Primary Market
 Used when firms (and government) first issue

securities for funds
 Firms engage into two types of primary market
activities—public offerings and private placements
 Public offerings—issue of debt/equity securities to
the public at large
 Publish prospectuses and advertise in national
newspapers, calling for subscriptions for the
securities by the public

Primary Market (cont.)
 Issues underwritten by merchant banks,

stockbroking companies or investment banks
 Firms concerned would have to be listed with
Bursa Malaysia
 Private placements—firms may issue debt or
equity to certain parties (and not to the public at
large) after having undertaken private
discussions and negotiations
 Providers of finance under this category include
pension funds, insurance firms, banks and
selected individual investors.
Secondary Markets
 Holder of a security sells the security concerned to

another investor
 Provide the means for transferring ownership of a
security (debt/equity)
 ASEAN Exchanges - collaboration of 7
exchanges from Indonesia, Malaysia, Philippines,
Singapore, Thailand and Vietnam (6 countries) -
promote the growth of the ASEAN capital market
by bringing more ASEAN investment opportunities
to more people
Derivative Markets
 Financial instrument that is derived from

other financial securities or some other
underlying asset
 Examples of derivatives are forwards,
futures, options and swaps.

Derivative Markets (cont.)
 Forward contract—agreement to buy or sell an

underlying asset at some time in the future, at a price
agreed upon today
 Tailor-made to suit the participant’s or investor’s
requirement
 Futures—agreement by the investors or participants to
deliver or take delivery (buy or sell) an underlying asset
some time in the future at a price agreed upon today
 Futures are standardized contracts and are typically
traded through an exchange.

 Option gives the holder the right but not the

obligation, to buy or sell a fixed quantity of
asset, at a pre-specified price, on or before a
fixed future expiry date.
 A call option gives the holder the right to buy
an asset whereas a put option gives the
holder the right to sell an asset.

 Swap—agreement to exchange a series of

payments sometime in the future
 Fixed-for-floating interest rate swap—one party
pays fixed interest and receive floating interest,
whereas the other party would be the one to pay
floating interest and receive fixed interest
 Currency swapInvolves two different currencies
whereby one party pays in one currency and
receives in the other currency, and vice versa.

Tutorial 2
1. Define:
(a) Sole proprietorship
(b) Partnership
(c) Company (firm)
2. Identify the primary characteristics of each form of
business stated above.
3. What is meant by limited liability? How does it differ in

the case of sole proprietorship, partnership and a firm?


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22

At the end of this chapter, you should be able to:

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Owned by a single person

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Coming together (association) of two or more

Financial Management Third Edition All Rights Reserved

 All partners agree to provide an agreed portion

Financial Management Third Edition All Rights Reserved

 Liability of certain partners shall be limited (restricted)

 Inexpensive and easy to form.

Financial Management Third Edition All Rights Reserved

 General partners have unlimited liability on all

 Given its legal status by the Companies Act,

Financial Management Third Edition All Rights Reserved

 Ownership can be transferred by way of transfer

Financial Management Third Edition All Rights Reserved

 Income Statement—presents the revenues and

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Perform the important economic function of

Financial Management Third Edition All Rights Reserved

The roles of financial markets include:

Financial Management Third Edition All Rights Reserved

 Debt securities—contractual obligations by the

Financial Management Third Edition All Rights Reserved

 Primary markets—funds are raised from

Financial Management Third Edition All Rights Reserved

 Markets for debt securities that will be repaid in the

 Markets for long-term debt (i.e. debt securities

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Shares are equity in a firm

 Used when firms (and government) first issue

Financial Management Third Edition All Rights Reserved

 Issues underwritten by merchant banks,

 Holder of a security sells the security concerned to

 Financial instrument that is derived from

Financial Management Third Edition All Rights Reserved

 Forward contract—agreement to buy or sell an

Financial Management Third Edition All Rights Reserved

 Option gives the holder the right but not the

Financial Management Third Edition All Rights Reserved

 Swap—agreement to exchange a series of

Financial Management Third Edition All Rights Reserved

3. What is meant by limited liability? How does it differ in

Financial Management Third Edition All Rights Reserved

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