4 Major Ways People Make Money

4 Major Ways People Make Money
Copyright © 2011 Pearson Prentice Hall. All rights reserved.

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To start moving from the rat race to the fast

track, one needs to raise enough capital to
acquire assets
The primary way to raise capital is by saving

the right way
Most Filipinos don’t know or are not saving

the right way

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Wrong way of saving:
Income – Expenses = Savings
Right way of saving:
Income – Savings = Expenses

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Income – Savings = Expenses
It’s battle between WANTS & NEEDS

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People should at least save 20% of their

Income
Have at least 6 months worth of living

expenses before acquiring assets

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Assets put money in your pocket whether

you work or not
ie. Stocks/bonds
businesses
real estates
Liabilities take money from your pocket

ie. one’s personal residence
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Once you’re on the fast track
Once you raised enough capital to start

moving to the fast track
You need to know how to successfully run

your business and/or invest successfully
This is where Corporate Finance comes in
Even if you’re only investing you still need to

know Corporate Finance
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What is Finance?
Corporate Finance is the study of the

following:
1.Capital Budgeting
2.Capital Structure
3.Working Capital Management

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Three Questions Addressed by the
Study of Finance:
1. What long-term (long-lived) assets should

the firm undertake? (capital budgeting)
2. How should the firm fund these assets?
(capital structure)
3. How can the firm best manage its cash
flows as they arise in its day-to-day
operations? (working capital
management)

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Finance, Accounting & Economics
Finance
(Prescription)
Economics Accounting
(Description) (Presentation)

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What is Finance
Finance used to be a branch of Economics
but somewhere along their history they split
Finance is much concerned about a particular firm

ie. cash flows

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What is Finance
Economics is much more concerned about
a particular industry and the general economy ie.
market structure and GDP

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Business Organizational Forms
Business
Forms
Sole Partnerships
Corporations Hybrids
Proprietorships
FINC-301, Chapter 1, Russel

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Sole/Single Proprietorship
• It is a business owned by a single individual
that is entitled to all the firm’s profits and is
responsible for all the firm’s debt.
• There is no separation between the business

and the owner when it comes to debts or
being sued.
• Sole proprietorships are generally financed by

personal loans from family and friends and
business loans from banks.

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• Advantages:
– Easy to start
– No need to consult others while making decisions
– Income included & taxed on proprietor’s personal
tax return
• Disadvantages:
– Personally liable for the business debts
– Ceases on the death of the proprietor

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In the Philippines:
All business entities in the country are

registered with the Department of Trade &
Industry (DTI)

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Partnership
• A general partnership is an association

of two or more persons who come together
as co-owners for the purpose of operating
a business for profit.
• There is no separation between the

partnership and the owners with respect to
debts or being sued.

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Partnership
• Advantages:
– Relatively easy to start
– Income included & taxed on partner’s personal tax
return
– Access to funds from multiple sources or partners
• Disadvantages:
– Partners jointly share unlimited liability

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Partnership
• In limited partnerships, there are two
classes of partners: general and limited.
• The general partners run the business
and face unlimited liability for the firm’s
debts, while the limited partners are
only liable on the amount invested.
• One of the drawbacks of this form is
that it is difficult to transfer the
ownership of the general partner.

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Partnership
• In the Philippines:
Partnership is a contract whereby two

or more persons bind themselves to
contribute money, property, or industry
to a common fund, with the intention of
dividing the profits among themselves
-Article 1767: Civil Code of the
Philippines-

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Corporation
• Corporation is “an artificial being, invisible,

intangible, and existing only in the
contemplation of the law.”
• The focus of this course.

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Corporation
• Corporation can individually sue and be

sued, purchase, sell or own property, and
its personnel are subject to criminal
punishment for crimes committed in the
name of the corporation.

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Corporation
• Corporation is legally owned by its current

stockholders.
• The Board of directors are elected by the

firm’s shareholders. One responsibility of
the board of directors is to appoint the
senior management of the firm.

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Corporation
• Advantages
– Liability of owners limited to invested funds
– Life of corporation is not tied to the owner
– Easier to transfer ownership
– Has better access to financing
• Disadvantages
– Greater regulation
– Double taxation (Corporate income is taxed &
dividends paid to owners are also taxed.It’s
instructive to think of yourself as part-owner of
the business)
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Corporation
5 or more persons, not exceeding 15 a

majority of whom are resident of the
Philippines, may form a private corporation
for any lawful purpose/s.
--Corporation Code--

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Corporation
Corporations have a life of 50 years but is

renewable to any number of times
provided that the renewal shall not exceed
50 years in any one instance.

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Corporation
Corporations & partnerships are regulated

by the Philippine Securities & Exchange
Commission (SEC)

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Corporation
One of the powers & functions of the SEC

is Jurisdiction and supervision over all
corporations, partnerships or associations
who are the grantees of primary franchises
and/or a license or permit issued by the
Government

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Hybrid Organizations
• These organizational forms provide a cross

between a partnership and a corporation.

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• Limited Liability Company (LLC) combines

the tax benefits of a partnership (no
double taxation of earnings) and limited
liability benefit of corporation (the owner’s
liability is limited to what they invest).
• No LLC’s in the Philippines
• Prevalent in the US

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• Concept originated in the 1892 German

company law known as Gesellschaft mit
beschrnkter Haftung (GmbH)
• A relatively new concept in the States
• The state of Wyoming enacted a company

law modeled after the German concept in
1977

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• All fifty states and the District of Columbia

now have statutes that legally recognize
and govern LLCs.

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Approximate International Equivalents:
Japan: Godo-kaisha (合同会社)

-modeled after the US version
Korea: Yuhan Hoesa
China: 有限責任公司

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• Limited Liability Partnership (LLP) is similar

to an LLC but are used for professional firms
in the fields of accounting, law, and
architecture while LLC’s are used by other
businesses
• No LLP’s in the Philippines

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Equity holders vs Shareholders
Both mean an ownership interest in a

business
Arises because some businesses do not issue

shares
Equity holder is a broader term while

shareholder is a more specific term

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A shareholder is a person who owns shares of

stock in a company—public or private.
Represents a fractional ownership interest
May be sold to the public through an offering,

or privately placed

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A sole proprietorship, for instance, has just

one owner, who owns a 100% equity stake
(but no shares).
A partnership is an arrangement under which

two or more investors each own an equity
stake in the business, but there is no stock
and therefore no shareholders.

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All shareholders are equity holders, but not all

equity holders are shareholders.
It is possible to have an ownership interest in

a business that does not issue shares of stock.

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How Does Finance Fit into the Firm’s
Organizational Structure?
• In a corporation, the Vice President of

Finance or the Chief Financial Officer
(CFO) is responsible for managing the
firm’s financial affairs.
• Figure 1-2 shows how the finance function

fits into a firm’s organizational chart.

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Treasurer/Chief Financial Manager

• External-focused
• Cash flow-oriented
• Use of financial data to make business
decisions
Financial planning & fund raising

Cash Management
Making Capital Expenditure (CAPEX)
decisions 1-45
Controller/Chief Accountant
• Internal-focused
• Accounting-oriented
• Collection & presentation of financial data
Corporate accounting
Tax Management

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What’s the primary goal of these 2 firms?

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Corporate Mission (for-profit
business)
To increase market share?
All we have to do is lower our prices or relax

our credit terms. Similarly, we can always
cut costs simply by doing away with things
such as research and development.

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business)
To avoid financial distress & bankruptcy?
We can avoid bankruptcy by never

borrowing any money or never taking any
risks, and so on.

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business)
But seriously will you be happy if
you’re the business owner?

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business)
To maximize profit?
A flawed goal because the ff are ignored
1. The timing of returns

2. The cash flows available to stockholders
3. Risk

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business)
Corporations commonly measure profits in

terms of Earnings Per Share (EPS),
formula of which is as follows:
EPS = Net income÷ Number of shares

outstanding

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business)

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Timing of Returns
• Profit maximization: Choose B
However, it is much better to receive the

funds sooner rather than later
Because the firm can reinvest that fund to

provide greater future earnings

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Cash flow to Shareholders
However, profit is not the same as cash

Profit is an accounting measure, while cash
is cash

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Risk
The higher the risk, the higher the

expected return. Ergo, to maximize profit
is to take higher risks. However,
stockholders are generally risk-averse.

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business)
To maximize the value of the existing owners’
equity.
The total value of the stock in a corporation is

simply equal to the value of the owners’
equity.
For publicly traded companies:

To maximize the current value per share of
the existing stock.
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business)
• Although Buffett’s firm, Berkshire Hathaway, is

a publicly traded company, his favorite
yardstick of growth is shareholders’ equity
• Because over long periods, there's a strong

correlation between book value growth & share
price growth

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These 2 firms have the same primary goal

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What happens if stock price goes to
zero
• Usually, a stock will only reach zero due to the

bankruptcy or other dissolution of the parent
company.
• Even when a company declares bankruptcy, the

stock will not immediately fall to zero. Usually,
speculators keep trading the stock in the hope
that somehow the company may survive.
However, stock in bankrupt companies is
almost always ultimately rendered worthless.
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The case of negative equity
• Arises when the liabilities on the balance sheet

exceed the assets
• Shareholders' equity consists of two elements:

contributed capital and retained earnings.
• Contributed capital is the money the company

received from selling stock to shareholders.

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• Realistically, this amount won't be negative,
so if the company is showing a shareholder
deficit, it will be because retained earnings
show a deficit -- one that exceeds the amount
of contributed capital.
• Retained earnings is the sum total of all the

profits and losses the company has
experienced in its history, minus any dividends
paid to shareholders.

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• If retained earnings are negative, it generally

means the company has been losing money --
which is how a company winds up with
liabilities in excess of assets.
• In the case of a business organized as a

corporation, the owners are shareholders, so
such situation is referred to as a "shareholder
deficit.”

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• A shareholder deficit can be, and often is, a
bad sign. It means the company not only has
been losing money, but has lost more money
than its owners put into the company in the
first place
• A shareholder deficit is not always an indicator

of impending doom. It can also mean that a
business is in the ramp-up stage, and has
used a large amount of funds to create
products and infrastructure that will later yield
profits. 1-64
• Start-ups commonly lose money for a while as

they lay the groundwork for success. Once a
company breaks into the black, it can begin to
erase the deficit

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Enter the stakeholders
Groups such as employees, customers,

suppliers, creditors, and others who have a
direct economic link to the firm.
Firms should maximize shareholder wealth

while at the same time making their
stakeholders happy.

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Agency Considerations in Corporate
Finance
• Agency relationship exists when one or

more persons (known as the principal)
contracts with one or more persons (the
agent) to make decisions on their behalf.
• In a corporation, the managers are the

agents and the stockholders are the
principal.

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Agency Considerations in Corporate
Finance (cont.)
• Agency problems arise when there is conflict of
interest between the stockholders and the
managers. Such problems are likely to arise more
when the managers have little or no ownership in
the firm.
• Examples:
– Stealing, expensive perks.
• All else equal, agency problems will reduce the firm

value.

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How to Reduce Agency Problems?
1. Monitoring
(Examples: Reports, Meetings, Auditors, board of
directors, financial markets, bankers, credit agencies)
2. Compensation plans
(Examples: Performance based bonus, salary, stock
options, benefits)
3. Others
(Examples: Threat of being fired, Threat of takeovers,
Stock market, regulations such as Sarbanes Oxley)
The above will help to reduce agency

problems/costs.

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More on Sarbanes-Oxley Act
(SOX/Sarbox)
• Passed in 2002 that aims to safeguard

the interests of shareholders by providing
greater protection against accounting
fraud & financial misconduct
• Section 302: requires the senior officers

of a public company to certify that they
have established, maintained and
designed internal controls to ensure the
accuracy of company information found
in their periodic reports.
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More on Sarbanes-Oxley Act
(SOX/Sarbox)
• Section 404:requires management and

external auditors to report on the
adequacy of the internal control over
financial reporting.

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4 Major Ways People Make Money

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

To start moving from the rat race to the fast

The primary way to raise capital is by saving

Most Filipinos don’t know or are not saving

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Wrong way of saving:

Income – Expenses = Savings

Right way of saving:

Income – Savings = Expenses

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Income – Savings = Expenses

It’s battle between WANTS & NEEDS

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

People should at least save 20% of their

Have at least 6 months worth of living

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Assets put money in your pocket whether

Liabilities take money from your pocket

Once you raised enough capital to start

You need to know how to successfully run

This is where Corporate Finance comes in

Even if you’re only investing you still need to

Corporate Finance is the study of the

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

1. What long-term (long-lived) assets should

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Finance is much concerned about a particular firm

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

market structure and GDP

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

FINC-301, Chapter 1, Russel

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

• There is no separation between the business

• Sole proprietorships are generally financed by

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

All business entities in the country are

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

• A general partnership is an association

• There is no separation between the

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Partnership is a contract whereby two

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

• Corporation is “an artificial being, invisible,

• The focus of this course.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

• Corporation can individually sue and be

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

• Corporation is legally owned by its current

• The Board of directors are elected by the

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

5 or more persons, not exceeding 15 a

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Corporations have a life of 50 years but is

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Corporations & partnerships are regulated