BUSINESS FINANCE

Introduction to Finance
• What is Finance?
• Cash flows between capital markets and firm’s operations.
• Finance is about the bottom line of business activities.
• Every business is a process of acquiring and disposing assets: – Real
assets (tangible and intangible). – Financial assets. Two objectives of
business: – Grow wealth. – Use wealth (assets) to best meet
economic needs.
• Financially, a business decision reduces to valuation of assets.
Valuation is the central issue of finance.
CASH FLOW OF A FIRM

(1) Cash raised from investors by selling financial assets.

(2) Cash invested in real assets (tangible and intangible).
(3) Cash generated by operations.
(4) Cash reinvested.
(5) Cash returned to investors. – mandatory (e.g. loan payments) – discretionary (e.g. dividends)
The role of a financial manager
• Forecasting and planning of firms’ financial needs
• Making financing and investment decisions
• Coordinating with other departments/divisions
• Dealing with financial markets
• Managing risks
Finance within an organization: importance of finance

Finance includes three areas

1. Financial management: corporate finance, which deals with
decisions related to how much and what types of assets a firm need to
acquire, how a firm should raise capital to purchase assets, and how a
firm should do to maximize its shareholders wealth - the focus of this
class
2. Capital markets: study of financial markets and institutions, which
deals with interest rates, stocks, bonds, government securities, and
other marketable securities. It also covers Federal Reserve System and
its policies.
3. Investments: study of security analysis, portfolio theory, market
analysis, and behavioral finance
The goal of a firm
•To maximize shareholder’s wealth (or
firm’s long-run value)
Forms of business organization

Sole Proprietorship
• Unincorporated business owned by one individual
• Advantages: Easy and inexpensive to form Subject to less
government regulations Lower income taxes
• Disadvantages: Unlimited personal liability Limited lifetime
of business Difficult to raise capital
Partnership
• Unincorporated business owned by two or more people Advantages
vs. disadvantages: similar to those of proprietorship
Corporation
• Legal entity created by a state Advantages: Limited liability Easy to
transfer the ownership Unlimited lifetime of business Easy to raise
capital Disadvantages: Double taxation (at both corporate and
individual levels) Cost of reporting S Corporation: allows small
business to be taxed as proprietorship or partnership Restrictions: no
more than 100 shareholders; for small and privately owned firms
Financial Management

11
Key Concepts and Skills

• Know the basic types of financial management

decisions and the role of the financial manager
• Know the financial implications of the different forms
of business organization
• Know the goal of financial management
• Understand the conflicts of interest that can arise
between owners and managers

12
Chapter Outline
• Finance: A Quick Look
• Business Finance and The Financial Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Problem and Control of the Corporation
• Financial Markets and the Corporation

13
Basic Areas Of Finance
• Corporate finance
• Investments
• Financial institutions
• International finance

14
Investments
• Work with financial assets such as stocks and bonds
• Value of financial assets, risk versus return, and asset
allocation
• Job opportunities
• Stockbroker or financial advisor
• Portfolio manager
• Security analyst

15
Financial Institutions
• Companies that specialize in financial matters
• Banks – commercial and investment, credit unions,
savings and loans
• Insurance companies
• Brokerage firms
• Job opportunities

16
International Finance
• This is an area of specialization within each of the
areas discussed so far
• It may allow you to work in other countries or at
least travel on a regular basis
• Need to be familiar with exchange rates and political
risk
• Need to understand the customs of other countries;
speaking a foreign language fluently is also helpful

17
Why Study Finance?
• Marketing
• Budgets, marketing research, marketing financial
products
• Accounting
• Dual accounting and finance function, preparation of
financial statements
• Management
• Strategic thinking, job performance, profitability
• Personal finance
• Budgeting, retirement planning, college planning, day-
to-day cash flow issues 18
Business Finance
• Some important questions that are answered using
finance
• What long-term investments should the firm take on?
• Where will we get the long-term financing to pay for the
investments?
• How will we manage the everyday financial activities of
the firm?

19
Financial Manager
• Financial managers try to answer some, or all, of
these questions
• The top financial manager within a firm is usually
the Chief Financial Officer (CFO)
• Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning
• Controller – oversees taxes, cost accounting, financial
accounting, and data processing

20
Financial Management Decisions
• Capital budgeting
• What long-term investments or projects should the
business take on?
• Capital structure
• How should we pay for our assets?
• Should we use debt or equity?
• Working capital management
• How do we manage the day-to-day finances of the firm?

21
Forms of Business Organization
• Three major forms in the United States
• Sole proprietorship
• Partnership
• General
• Limited
• Corporation
• S-Corp
• Limited liability company

22
Sole Proprietorship
• Advantages • Disadvantages
• Easiest to start • Limited to life of
• Least regulated owner
• Single owner keeps • Equity capital limited
all of the profits to owner’s personal
• Taxed once as wealth
personal income • Unlimited liability
• Difficult to sell
ownership interest

23
Partnership
• Advantages • Disadvantages
• Two or more owners • Unlimited liability
• More capital • General partnership
available • Limited partnership
• Relatively easy to • Partnership dissolves
start when one partner
• Income taxed once dies or wishes to sell
as personal income • Difficult to transfer
ownership

24
Corporation
• Advantages • Disadvantages
• Limited liability • Separation of ownership
• Unlimited life and management (agency
• Separation of problem)
ownership and • Double taxation (income
management taxed at the corporate rate
• Transfer of and then dividends taxed at
ownership is easy personal rate, while
dividends paid are not tax
• Easier to raise capital
deductible)

25
Goal Of Financial Management
• What should be the goal of a corporation?
• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the company’s stock?
• Does this mean we should do anything and
everything to maximize owner wealth?
• Sarbanes-Oxley Act

26
The Agency Problem
• Agency relationship
• Principal hires an agent to represent its interests
• Stockholders (principals) hire managers (agents) to run
the company
• Agency problem
• Conflict of interest between principal and agent
• Management goals and agency costs

27
Managing Managers
• Managerial compensation
• Incentives can be used to align management and
stockholder interests
• The incentives need to be structured carefully to make
sure that they achieve their goal
• Corporate control
• The threat of a takeover may result in better
management
• Other stakeholders

28
Example: Work the Web
• The Internet provides a wealth of information about
individual companies
• One excellent site is finance.yahoo.com
• Click on the Web surfer to go to the site, choose a
company and see what information you can find!

29
Figure 1.2

30
Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
• Dealer vs. auction markets
• Listed vs. over-the-counter securities
• NYSE
• NASDAQ

31
Quick Quiz
• What are the four basic areas of finance?
• What are the three types of financial
management decisions, and what questions are
they designed to answer?
• What are the three major forms of business
organization?
• What is the goal of financial management?
• What are agency problems, and why do they exist
within a corporation?

32
FINANCIAL INSTITUTION FROM
FINANCIAL INSTRUMENT AND
FINANCIAL MARKET
ROLE OF FINANCIAL MANAGER
FINANCIAL PLANNING
 FORMULA AND FORMAT FOR THE
PREPARATION OF BUDGETS AND PROJECTED
FINANCIAL STATEMENT
MANAGING CASH, RECEIVABLES,
AND INVENTORY