Practical Financial Management, 5e by William R. · PDF file4 Financial Assets Real...
-
Upload
truongtuyen -
Category
Documents
-
view
213 -
download
0
Transcript of Practical Financial Management, 5e by William R. · PDF file4 Financial Assets Real...
1© 2008 Thomson South-Western
Practical Financial Management,
5e
by William R. Lasher
Slides by
Bob Zaffram
Erie Community College
3
An Overview of Finance
Investments and financial markets
Financial management of corporations
○ Fields are separate but related
4
Financial Assets
Real asset—an object that provides a service, such as a house, car, art, coin…
Financial asset—a document representing a claim to future income
○ Stock represents ownership interest
○ Bond represents a debt relationship
Investing involves buying financial assets in the hope of earning more money (a return)
○ Investments can be made directly or indirectly through a mutual fund
A Security is a financial asset that can be traded among investors
5
Financial Markets
Financial assets, issued by corporations
to raise money, are bought by investors
in financial markets
○ A framework or organization in which
people can buy/sell securities• Best known financial market is
the stock market
– Stock exchange at center
• Stockbroker is licensed to trade
securities
7
Raising Money
The most common use of the word finance involves raising money to acquire assets
Forms of Financing
○ Issuing stock - equity financing
○ Borrowing money - debt financing• Bank
• Issuing bonds
• Leasing is like borrowing
○ Internal financing - retaining earnings
8
Raising Money
The field of finance deals with both
raising and investing money, but:
Changing Focus of Finance
○ Past - finance was limited to
financial market activity
○ Now - it includes:
• Goals and activities of investors: Portfolios
• The financial management of organizations
9
Financial Management
The management and control of money
and money-related operations within a
business
CFO – Chief Financial Officer
○ Executive in charge of finance
department
10
Financial Management
Functions of the finance department:
○ Keeping records
○ Receiving payments from customers
○ Making payments to suppliers
○ Borrowing funds
○ Purchasing assets
○ Selling stock
○ Paying dividends
○ Analysis of business decisions
○ Oversight of other departments
11
Business Decisions
Finance department provides analyses to:○ Determine which assets are purchased
• Acquiring another firm
• Expanding operations
○ Decide how those assets are financed• Equity
• Debt
Oversight○ Finance department oversees how
other departments spend money
12
The Price of Securities—A Link
Between the Firm and the Market
Two sides of finance – investments and financial management – connected since firms sell securities to investors in financial markets
Investors buy securities for the future cash flows expected from them
Link between company management and investors comes from this relationship between price and expected financial results
13
Finance and Accounting
Accounting○ System of record-
keeping designed to portray a firm‘s operations in a fair/unbiased manner
○ Generate financial statements which are provided to the marketplace
Finance○ Process of decision-
making related to raising money, analyzing results
○ Use the outputgenerated by accountants as inputs in finance
14
Finance and Accounting
Finance department generally consists
of both the accounting and treasury
departments
○ Controller is in charge of the
accounting department
○ Treasury department deals with
other financial activities
16
The Importance of Cash Flow
Accounting creates
statements that are
designed to portray
what is physically
occurring in
numbers
Finance is concerned
with current and
future cash flow
In finance:
Cash is King
17
The Importance of Cash Flow
Q: Example: In 1999 we purchased a $1,000 asset that will be depreciated over five years using straight-line depreciation. Explain how that asset will be viewed from both an accounting and finance viewpoint.
A: Accounting: The initial cost of the asset of $1,000 will be reflected on the books as will the $200 annual depreciation.
Finance: We are interested in the $1,000 cash outflow and the taxes saved from the depreciation deduction—not the depreciation itself.
Exam
ple
18
The Language of Finance
Accounting is the language of finance
○ Finance professionals need some accounting knowledge
• Level of accounting knowledge depends on job
– Financial analyst needs to know LOTS of accounting
– Stockbrokers do not need as much
19
Financial Theory—The Relationship
with Economics
Modern financial theory began as a
branch of economics in the 1950s
○ Originally called ―financial economics‖
Today finance is a separate field
21
Forms of Business Organization
and Their Financial Impact
Businesses can be legally or organized as○ A sole proprietorship
○ A partnership
○ A corporation
Legal organization has an impact on○ Raising money
○ Taxation
○ Financial liability
For financial purposes combine partner/proprietor
22
The Proprietorship Form
Easy to start
Taxes○ Profit is taxed as personal income
• Taxed only once
Raising money○ If going outside the firm, a proprietorship must
obtain a loan• Lending money to a new business is risky
– Best outcome: repayment of principal and interest
– Worst outcome: lose everything
– Most new businesses fail
• Result: Collateral required
23
The Corporate Form
Getting started
○ Requires a legal incorporation process
• Takes time, work and money
Taxes
○ Double taxation
• Corporation pays corporate taxes on income
• Dividends paid to owners are taxed as
personal income
24
The Corporate Form
Example 1.1
Q: Ruth Samson owns a business that earns $100,000 before taxes. She wants to take the earnings home and spend them on herself. Assume a simplified tax system in which the rates are 34% for corporations and 30% for individuals with tax on dividends capped at 15%. Compare the total tax bills under the sole proprietorship and corporate forms of organization.
A: Corporate Proprietor
Pretax earnings $100,000 $100,000
Corporate tax (34%) 34,000 -
Earnings/dividend $ 66,000 $100,000
Personal tax (15%, 30%) 9,900 30,000
Net $ 56,100 $ 70,000
Exam
ple
25
The Corporate Form
Raising Money
○ Borrowing– Same issues faced by sole proprietorship
○ BUT the entrepreneur can now offer
stock (equity) to investors– If sell less than 50% can maintain control
○ From the investor‘s perspective– Stock is a risky investment but the reward may be worth it
» Worst possible outcome: may lose the investment
» Best possible outcome: may get rich
26
The Truth About
Limited Liability
Limited liability states that a stockholder is not liable for a corporation‘s debts○ Implies that the most a stockholder can lose is 100%
of his investment in the stock
○ True for owners not involved in the business
However, for owner operated small businesses○ Personal guarantees make entrepreneurs liable for
loans made to their business
○ Legal system holds individuals liable for negligence
○ These destroy the value of limited liability
27
S-Type Corporations and LLCs
Major advantage: Treated as a partnership
with respect to federal income taxes
○ LLC is replacing S-type
Government encourages formation of small
businesses because they create jobs
○ S-type corporations and LLCs
• Let small businesses avoid double taxation
• Offer limited liability
• Offer the ability to sell stock to raise money
28
Goals of Management
Economics—goal is to maximize profit○ Runs into short/long run problems
○ What about R&D?
Finance—goal is to maximize stockholders‘ wealth by maximizing stock price○ Bypasses the concern of whether the short-term or
long-term is more important, because stock price set in the financial market incorporates both!
29
Stakeholders and
Conflicts of Interest
Stakeholders that have an interest in the way
the firm is operated include:
Stockholders
Employees
Customers
Community
Management
Creditors
Suppliers
30
Conflicts of Interest
An Illustration
Example: Employees want management to build an athletic facility on corporate grounds○ Benefit—more effective employees (feel better,
happier, therefore more productive)
○ Cost—will come from profits that belong to stockholders
○ Represents a conflict of interest between stockholders and employees
○ What if the request was for healthier working conditions?
31
Management—A Privileged
Stakeholder Group
Ownership of a widely held company is very dispersed so no one has enough control to influence/remove management
Allows top management to become entrenched in positions controlling large amounts of resources
Management can use resources for their own benefit
32
The Agency Problem
Conflict of interest between stockholders and management○ Agent is hired by a principal and given decision-making authority
The Abuse of Agency○ Privileges and luxuries provided to executives - ‗perks‘
Controlling the Agency Problem○ Manage the agency problem by:
• Monitoring management (audits)
• Tying executive compensation to stock performance
33
Creditors Versus Stockholders—A
Financially Important Conflict of Interest
Creditor - anyone owed money by a business
including lenders, vendors, employees, or the
government
If actions of the borrowing firm become
riskier than before loan, creditors/lenders
are subject to more risk
○ But risk taking rewards all go to stockholders
Lenders put clauses in loan agreements to
prevent this