Finance Chapter 1 Why study finance- marketing, accounting, management, personal finance. The functions of corporate finance include external financing, capital budgeting, financial management, corporate governance, risk management 4 Basic areas of finance: corporate finance, investments, financial institutions, international finance External financing- raising capital to support companies’ operations and investment programs externally from: shareholders equity or creditors (debt). By doing IPOs financial management- managing firms internal cash flow, a mix of debt and equity financing, maximize the value of debt and equity. Ensures a company can pay off their obligations when they are due. Capital budgeting- selecting the best projects in which to invest the resources of the firm, based on each project’s perceived risk and expected return. Selecting which investments to go in on to maximize profits. Risk management- managing firms’ exposure to all types of risk. To maintain optimum risk-return trade-offs and thereby maximize shareholder value. Modern risk management focuses on adverse interest rate movements, commodity price changes, and currency value fluctuations. Corporate governance- Developing ownership and corporate governance structures for companies that ensure that managers behave ethically and make decisions that benefit shareholders. Includes the Sarbanes-Oxley Act of 2002. Make sure firms don’t govern themselves The main goal of financial management is to maximize the value of the company. Make sure the company is run profitably, strong balance sheet, look out for shareholders, maximize value of the stock. 3 Financial management decisions- capital budgeting, capital structure, working capital management 1. Capital Budgeting- planning and managing a firm’s long-term investments. This includes being concerned with how much cash you expect to receive (size), when you expect to receive it (timing) and how likely you are to receive it (risk) 2. Capital structure- how the firm obtains financing it needs to support its long-term investments. Capital structure refers to the specific mixture of long-term debt and equity the firm uses to finance its operations. Two questions: How should the firm borrow? And What are the least expensive sources of funds for the firm? Also choose among lenders and among loan types as well as how and where to raise the money 3. Working capital management- short term assets and short-term liability. How much cash and inventory should we have on hand? Should we sell on credit to our customers? How will we obtain any needed short-term financing? If we borrow in the short term, how and where should we do it? Agency problem: Conflict of interest between principal and agent. Stockholders (principals) hire managers (agents) to run the company. Balance sheet: assets=Total liabilities + equity. Capital structure is made up of two percentages. The first one is total liabilities/total assets. The other one is Total shareholder equity or equity/assets. Both numbers add up to 100%. Capital structure tells you how to use your money. Working capital: current assets (cash/inventory/cash receivable) compared to current liabilities. Current assets- current liabilities. If it is positive its good and it means, it’s managing its cash and can meet short term expenses. Three major forms of business organizations in the US: Sole proprietorship Partnership (general or limited) Corporation (C-Corp, S-Corp or LLC). LLC is not a corporation. Corporations get double taxed for the owner and for the business Sole proprietorship- No liability protection. It is on your tax return. Taxed once. Need own liability insurance for it. Taxes on your own tax return. Limited life, difficult to transfer. Equity capital limited to owner’s own wealth Partnership (general)- No liability protection. Two or more partners. Taxes on your own tax return. Only taxed once. Difficult to transder ownership Partnership (limited)- limited liability (some protection). The general partner has unlimited liability, but the limited partner has limited liability depending on how much they invested into the business. Taxes on your own tax return C-Corporation- unlimited shareholders. Complete liability protection for the shareholders. Only risk is what you invested and nothing else. Pay income taxes to the IRS. Based on state law. Unlimited business life. Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible). S-Corporation- limited number of shareholders. Good for small businesses. Complete liability protection. Unlimited business life LLC- liability protection. The owner is called a member. The taxes are on your own tax returns. Chief financial officer- monitor and interpret business’s financial information. Deeply involved in financial policy making and corporate planning. General managerial responsibilities and member of board of directors. Maintaining corporation financial strength and maximizing shareholder value. Communicate financial information to others • Treasurer—oversees cash management, credit management, capital expenditures, and financial planning. • Controller—oversees taxes, cost accounting, financial accounting, and data processing. Debt and equity Debt capital: borrowed money. The borrower is obliged to pay interest, at a specified annual rate, on the full amount borrowed, as well as to repay the principal amount at the debt’s maturity. Equity Capital: An ownership interest usually in the form of common or preferred stock. Common stockholders receive returns on their investments only after creditors and preferred stockholders are paid in full. Financial Intermediary- An institution that raises capital by issuing liabilities against itself, and then lends that capital to corporate and individual borrowers. Working capital management- are decisions related to company current assets and liabilities Capital structure- the mixture of debt and equity in a firm General partnership- IS when they both have full personal liability for the firm’s debt, they share the profits and losses and decision making. - Any one of the partners can be held solely liable for all the partnership's debt. Corporation- a separate legal entity with no personal liability for the firm’s debt Sole proprietorship has its profits taxed as personal income - It doesn’t provide limited financial liability for its owner It doesn’t involve significant legal costs during the formation process It CAN Obtain additional equity is dependent on the owner's personal finances. Limited partnership- offers liability protection to some of its owners but not all of its owners. Losses limited to capital invested. Provides limited liability while avoiding double taxation.
