Finance
ADMS 3530 - Winter 2012 – Professor Lois King
Lecture 1 – The Firm and the Financial Manager – Jan 03
1.1
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Introduction to Finance
Definition of finance.
Financial markets & participants.
Categories of finance.
Finance versus accounting.
Definition of Finance
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Finance studies and addresses the ways in which individuals, businesses and
organizations raise, allocate and use monetary resources over time, taking into
account the risks entailed in their projects.
The term finance may incorporate any of the following:
o The management of money and other assets;
o Profiling and managing project risk;
o As a verb, ‘to finance’ is to provide funds for a business.
Financial Markets
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The term ‘financial market’ usually means is a mechanism that allows people to
easily buy and sell financial securities (such as stocks and bonds) at low transaction
costs and at fair prices.
Traditional Financial Participants
Lenders
Individuals
Businesses
Governments
Financial
Intermediaries
Banks
Insurance Firms
Brokerage Firms
Pension Funds
Mutual Funds
New Financial Participants
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Hedge funds
Private equity funds
Venture capital firms
Financial Markets
Stock Exchange
Bond Market
Money Market
Foreign Exchange
Commodities
Borrowers
Individuals
Businesses
Governments
Categories of Finance
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Corporate finance
Public (government) finance
Personal finance
Corporate Finance
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Corporate finance – an area of finance dealing with the financial decisions that
corporations make, and the tools and analysis used to make these decisions.
Primary goal: to enhance corporate value while reducing the firm’s financial risks.
Public Finance
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Public finance – the field of economics that deals with budgeting the revenues and
expenditures of a public sector entity, usually government.
Personal Finance
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Personal finance involves the monetary decisions of an individual or family unit.
How individuals or families obtain, budget, save and spend monetary resources over
time.
Finance versus Accounting
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1.2
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1.3
Difference:
o Finance: current and future planning (more forward looking).
o Accounting: recording of past transactions.
Similarity:
o Both analyzing assets and liabilities.
Why Study Finance?
Finance affects our everyday decisions.
o Using credit cards
o Buying versus leasing a car.
o Mortgage decisions.
o Retirement planning.
Many of the most interesting and best-paying jobs in business are in the finance
field.
Types of Business Organizations
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Sole proprietorship
Partnership
Corporation
Hybrid organizations
Major Differences
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The ease of setting up and maintaining the business.
The potential exposure of personal assets to obligations of the business (degree of
liability).
Taxation issues.
Requirements for outside financing.
Succession issues.
Sole Proprietorship
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A business owned and operated by one person.
The owner (proprietor) is personally liable for all the firm’s obligations.
Owner and business are taxed as one entity.
The firm has limited life.
Partnership
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A business owned and operated by two or more people.
Each partner is jointly and separately responsible for all the liabilities of the
partnership.
Each partner’s share of partnership income is included on his personal tax return.
Limited life.
Corporation
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A business organized and taxed as a separate legal entity.
Shareholders have limited liability.
Corporations have perpetual lives.
May have access to capital from outside markets.
Managers may not necessarily be the owners.
Have greater organizational and legal costs.
Hybrid Organizations
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Owners/partners want the tax advantages or flexibility of a partnership but with
limited liability.
Examples include:
o Limited liability partnership (LLP).
o Limited liability corporations (LLC).
o Professional corporations (PC).
1.3 Types of Business Organizations
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1.4
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A great Canadian example of how an organization’s changing needs and growth
resulted in a change in its organizational type is McCain Foods Inc.
o The firm started as a sole proprietorship then became a partnership as it
grew and needed new talent. As it grew to a $4 billion company which
employed 20,000 people, a corporate structure was required to deal with its
changing tax needs, liability issues and succession planning decisions.
Role of the Financial Manager
A financial manager refers to anyone who is responsible for a significant corporate
investment or financing decision.
Financial Managers
o Financial Firms (TD Bank)
 Senior loans officer
 Portfolio manager
 VP risk manager
o Non-financial firms (McCain Foods)
 CFO
 Controller
 Treasurer
Two major business decisions:
o Capital budgeting decision.
 What assets or projects to invest in?
o Financing decision
 How to pay for those new assets or projects?
Real World Example: Talisman Energy Inc.
o Talisman Energy Inc., one of Canada’s largest oil and gas exploration
companies, is trying to decide between two projects:
 Whether to invest $6 billion into the Alberta oil sand project, or
 Whether to increase its current investment in the Hebron Oil Project,
off the coast of Newfoundland, by $6 billion.
The actual analysis and choice between the two projects is called a ‘capital
budgeting’ or ‘investment’ decision.
How the $6 billion will be financed, either through a bond offering, internally
generated funds, or a combination of sources is called the ‘financing’ decision.
1.5
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Goals of the Corporation
Since shareholders are the owners:
o Primary goal = to maximize value of their investment.
 Maximize current share price.
Small or medium size companies.
o Shareholders (owners) may also be the managers.
Large public corporations
o Shareholders.
o Directions.
 Manager (finance).
 Manager (marketing).
Agency relationship:
o Explains the concept that the managers (the agents) work on behalf of the
owners (shareholders) of the firm.
Agency problems:
o Problems that arise due to the potential divergence of interest between
managers, shareholders and creditors.
Ways to mitigate agency problems:
o Compensation plans that tie the fortune of the manager to the fortunes of the
firm.
o If the corporation is publicly-listed, there will be constant monitoring by
security analysts, creditors and investors.
o If the share price performance is poor, managers will be removed by the
board of directors.
Ethics and management.
o Shareholders and the public are concerned that mangers:
 Operate within the law and
 Maintain the reputation and ethical good standing of the corporation.
Resolving ethical problems:
o Often firms realize that reputational risk is at stake and hence share price, if
ethical behaviour is ignored.
o Most firms realize that fair and ethical relationships build and maintain longrun value.