Chapter 1 PPT


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Chapter 1 PPT

  1. 1. Chapter 1 Foundations
  2. 2. An Overview of Finance <ul><li>Investments and financial markets </li></ul><ul><li>Financial management of corporations </li></ul><ul><ul><li>Fields are separate but related </li></ul></ul>
  3. 3. Financial Assets <ul><li>Real asset—an object that provides a service, such as a house, car, art, coin… </li></ul><ul><li>Financial asset—a document representing a claim to future income </li></ul><ul><ul><li>Stock represents ownership interest </li></ul></ul><ul><ul><li>Bond represents a debt relationship </li></ul></ul><ul><li>Investing involves buying financial assets in the hope of earning more money (a return) </li></ul><ul><ul><li>Investments can be made directly or indirectly through a mutual fund </li></ul></ul><ul><li>A Security is a financial asset that can be traded among investors </li></ul>
  4. 4. Raising Money <ul><li>The most common use of the word finance involves raising money to acquire assets </li></ul><ul><li>Forms of Financing </li></ul><ul><ul><li>Issuing stock - equity financing </li></ul></ul><ul><ul><li>Borrowing money - debt financing </li></ul></ul><ul><ul><ul><li>Bank </li></ul></ul></ul><ul><ul><ul><li>Issuing bonds </li></ul></ul></ul><ul><ul><ul><li>Leasing is like borrowing </li></ul></ul></ul><ul><ul><li>Internal financing - retaining earnings </li></ul></ul>
  5. 5. Raising Money <ul><li>The field of finance deals with both raising and investing money, but: </li></ul><ul><li>Changing Focus of Finance </li></ul><ul><ul><li>Past - finance was limited to financial market activity </li></ul></ul><ul><ul><li>Now - it includes: </li></ul></ul><ul><ul><ul><li>Goals and activities of investors: Portfolios </li></ul></ul></ul><ul><ul><ul><li>The financial management of organizations </li></ul></ul></ul>
  6. 6. Financial Management <ul><li>Functions of the finance department: </li></ul><ul><ul><li>Keeping records </li></ul></ul><ul><ul><li>Receiving payments from customers </li></ul></ul><ul><ul><li>Making payments to suppliers </li></ul></ul><ul><ul><li>Borrowing funds </li></ul></ul><ul><ul><li>Purchasing assets </li></ul></ul><ul><ul><li>Selling stock </li></ul></ul><ul><ul><li>Paying dividends </li></ul></ul><ul><ul><li>Analysis of business decisions </li></ul></ul><ul><ul><li>Oversight of other departments </li></ul></ul>
  7. 7. Business Decisions <ul><li>Finance department provides analyses to : </li></ul><ul><ul><li>Determine which assets are purchased </li></ul></ul><ul><ul><ul><li>Acquiring another firm </li></ul></ul></ul><ul><ul><ul><li>Expanding operations </li></ul></ul></ul><ul><ul><li>Decide how those assets are financed </li></ul></ul><ul><ul><ul><li>Equity </li></ul></ul></ul><ul><ul><ul><li>Debt </li></ul></ul></ul><ul><li>Oversight </li></ul><ul><ul><li>Finance department oversees how other departments spend money </li></ul></ul>
  8. 8. The Price of Securities—A Link Between the Firm and the Market <ul><li>Two sides of finance – investments and financial management – connected since firms sell securities to investors in financial markets </li></ul><ul><li>Investors buy securities for the future cash flows expected from them </li></ul><ul><li>Link between company management and investors comes from this relationship between price and expected financial results </li></ul>
  9. 9. Finance and Accounting <ul><li>Accounting </li></ul><ul><ul><li>System of record-keeping designed to portray a firm’s operations in a fair/unbiased manner </li></ul></ul><ul><ul><li>Generate financial statements which are provided to the marketplace </li></ul></ul><ul><li>Finance </li></ul><ul><ul><li>Process of decision-making related to raising money, analyzing results </li></ul></ul><ul><ul><li>Use the output generated by accountants as inputs in finance </li></ul></ul>
  10. 10. Finance Department Organization Figure 1.2
  11. 11. The Importance of Cash Flow <ul><li>Accounting creates statements that are designed to portray what is physically occurring in numbers </li></ul><ul><li>Finance is concerned with current and future cash flow </li></ul><ul><li>In finance: Cash is King </li></ul>
  12. 12. 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. Example
  13. 13. The Language of Finance <ul><li>Accounting is the language of finance </li></ul><ul><ul><li>Finance professionals need some accounting knowledge </li></ul></ul><ul><ul><ul><li>Level of accounting knowledge depends on job </li></ul></ul></ul><ul><ul><ul><ul><li>Financial analyst needs to know LOTS of accounting </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Stockbrokers do not need as much </li></ul></ul></ul></ul>
  14. 14. The Truth About Limited Liability <ul><li>Limited liability states that a stockholder is not liable for a corporation’s debts </li></ul><ul><ul><li>Implies that the most a stockholder can lose is 100% of his investment in the stock </li></ul></ul><ul><ul><li>True for owners not involved in the business </li></ul></ul><ul><li>However, for owner operated small businesses </li></ul><ul><ul><li>Personal guarantees make entrepreneurs liable for loans made to their business </li></ul></ul><ul><ul><li>Legal system holds individuals liable for negligence </li></ul></ul><ul><ul><li>These destroy the value of limited liability </li></ul></ul>
  15. 15. S-Type Corporations and LLCs <ul><li>Major advantage: Treated as a partnership with respect to federal income taxes </li></ul><ul><ul><li>LLC is replacing S-type </li></ul></ul><ul><li>Government encourages formation of small businesses because they create jobs </li></ul><ul><ul><li>S-type corporations and LLCs </li></ul></ul><ul><ul><ul><li>Let small businesses avoid double taxation </li></ul></ul></ul><ul><ul><ul><li>Offer limited liability </li></ul></ul></ul><ul><ul><ul><li>Offer the ability to sell stock to raise money </li></ul></ul></ul>
  16. 16. Goals of Management <ul><li>Economics —goal is to maximize profit </li></ul><ul><ul><li>Runs into short/long run problems </li></ul></ul><ul><ul><li>What about R&D? </li></ul></ul><ul><li>Finance —goal is to maximize stockholders’ wealth by maximizing stock price </li></ul><ul><ul><li>Bypasses the concern of whether the short-term or long-term is more important, because stock price set in the financial market incorporates both ! </li></ul></ul>
  17. 17. Stakeholders and Conflicts of Interest <ul><li>Stakeholders that have an interest in the way the firm is operated include: </li></ul><ul><ul><li>Stockholders </li></ul></ul><ul><ul><li>Employees </li></ul></ul><ul><ul><li>Customers </li></ul></ul><ul><ul><li>Community </li></ul></ul><ul><ul><li>Management </li></ul></ul><ul><ul><li>Creditors </li></ul></ul><ul><ul><li>Suppliers </li></ul></ul>
  18. 18. Conflicts of Interest An Illustration <ul><li>Example: Employees want management to build an athletic facility on corporate grounds </li></ul><ul><ul><li>Benefit—more effective employees (feel better, happier, therefore more productive) </li></ul></ul><ul><ul><li>Cost—will come from profits that belong to stockholders </li></ul></ul><ul><ul><li>Represents a conflict of interest between stockholders and employees </li></ul></ul><ul><ul><li>What if the request was for healthier working conditions? </li></ul></ul>
  19. 19. Creditors Versus Stockholders—A Financially Important Conflict of Interest <ul><li>Creditor - anyone owed money by a business including lenders, vendors, employees, or the government </li></ul><ul><li>If actions of the borrowing firm become </li></ul><ul><li>riskier than before loan, creditors/lenders </li></ul><ul><li>are subject to more risk </li></ul><ul><ul><li>But risk taking rewards all go to stockholders </li></ul></ul><ul><li>Lenders put clauses in loan agreements to prevent this </li></ul>