Introduction to Corporate Finance

Financial Management Duties

• Capital Budgeting – The process of planning and managing a firm’s long-term investments.

• Capital Structure – The specific mixture of long-term debt and equity the firm uses to finance it operations.

• Working Capital Management – Managing the firm’s short-term assets and liabilities.

Financial Officers

• Chief Financial Officer – oversees the treasurer and controller and sets overall financial strategy.

• Treasurer – responsible for financing, cash management, and relationships with financial markets and institutions.

• Controller – responsible for budgeting, accounting, and auditing.

Forms of Business Ownership

• Proprietorship – An unincorporated business owned by a single individual.

Advantages

¤ Easily and inexpensively formed.

¤ Few government regulations.

¤ Avoids corporate income taxes.

Disadvantages

¤ Unlimited liability for the owner.

¤ Limited to the life of the owner.

¤ Illiquid.

¤ Difficult to obtain large amounts of capital.

• Partnership – Business owned by tow or more persons who are personally responsible for all its liabilities.

Advantages

¤ Easily and inexpensively formed.

¤ Few government regulations.

¤ Avoids corporate income taxes.

Disadvantages

¤ Unlimited liability for general partners.

¤ Limited life for the organization.

¤ Difficult to transfer ownership.

¤ Difficult to obtain large amounts of capital.

• Corporation – A business that is legally distinct from its owners.

Advantages

¤ Unlimited life.

¤ Easy to transfer ownership.

¤ Limited liability.

Disadvantages

¤ Double taxation.

¤ Complex legal requirements.

• Hybrid Forms of Organization

¤ Limited partnership – Certain partners are designated general partners, who have unlimited liability. Other owners are limited partners because their liability is limited.

¤ Professional Corporation – A type of corporation common among professionals. An S corporation has 75 or fewer shareholders.

The Goal of Financial Management

• Maximize Shareholder Wealth – Mangers work on behalf of shareholders and should pursue policies that enhance shareholder value.

• Social Responsibility – The concept that businesses should be actively concerned with the welfare of society at large.

Agency Problems and Control of the Corporation

• Agency Problem – The conflict of interest between the firm’s owners and managers.

• Management Goals – Managers have a tendency to increase their own perks or to increase the size of the organization in an attempt to increase their power.

• Methods to Entice Managers to Act in the Best Interests of Stockholders

¤ The threat of firing

¤ The threat of takeovers

¤ Managerial compensation

¤ Direct Intervention by Shareholders

• Ownership Structure outside the U.S. – in some countries, ownership is more concentrated, creating separate problems.

Lecture 2 – Financial Statements, Taxes, and Cash Flow

• Review the income statement, balance sheet, and cash flow statement.

• Emphasize cash flows and the difference between accounting accruals.

Income Statement

• Income Statement – Shows how profitable a firm has been over some period of time.

¤ GAAP – Revenues appear when they accrue, not when they are collected. Expenses are matched with the revenues that appear.

¤ Noncash items – Depreciation.

¤ Taxes – The marginal tax rate is the most relevant when evaluating projects.

Balance Sheet

• Balance Sheet – Presents a snapshot of the firm’s assets, liabilities, and owner’s equity.

¤ Assets – Listed in order of their liquidity on the left-hand side of the statement.

Current Assets – life of less than one year.

Fixed Assets – life longer than one year.

¤ Liabilities and Owners’ Equity – The claims against assets.

Current Liabilities – life of less than one year.

Long-term Liabilities – debt (financial leverage) that is not due in the next year.

Owners’ Equity – value of the capital supplied by common stockholders.

¤ Book Values vs. Market Values – assets must be shown on the balance sheet at their historical cost adjusted for depreciation. These are not market values.

Cash Flow Analysis

• Cash Flows Analysis – shows the firm’s cash receipts and cash payments over a period of time.

¤ Cash Flow from Operations – begins with net income and adjusts for non-cash items.

¤ Cash Used for Investments – money spent on fixed assets and received from sales of fixed assets.

¤ Cash Flow from Financing Activities

Cash flow to creditors – interest paid minus net new borrowing.

Cash flow to stockholders – dividends paid minus net new equity.

Anyone who has spent any time employed by a public company quickly learns the phrase “in the

best interests of the shareholders.” It is used to justify decisions on issues including (and

certainly not limited to) strategy, resource allocation, risk, personnel, marketing and reputation.

“In the best interests of the shareholders” – much like that booming voice in the “The Wizard of

Oz” – always bellows forth from the walled-off chambers of upper management, conveying an

unambiguous intention that it should (or must) reverberate from top to bottom, ultimately finding

its way into every corporate message and mission statement.

Stockholders have traditionally watched the results of the stock markets as a measure of their financial investment.  Stakeholders typically watch the behavior of those corporations they support as a measure of their interest and emotional support.  The level of support a business gets from people has a direct correlation to financial returns. Yet stockholders don’t typically see the things that influence the stakeholders support for a business.

A corporate stakeholder are those groups of people who can affect or be affected by the actions of the business as a whole.  Stakeholders are defined as “those groups without whose support the organization would cease to exist.  Stakeholders include stockholders but stockholders are influenced more by financial returns while the remaining stakeholders are influenced more by their experience with the organization.