Chapter 1:
Study of ways to answer questions about financial future of a company:
What long-term investments should be taken on?
What lines of business is the company in?
What kinds of buildings, machinery, equipment, etc. are needed
Where will long-term financing come from to pay for investments?
Will other investors be brought in, or will the money be borrowed?
How will everyday financial activities be managed, like collecting customers and
paying suppliers?
Capital Budgeting
Process of planning and managing a firm’s long-term investments
Find investment opportunities where:
Cash Flow of Asset > Cost of Asset
Evaluating size, timing, and risk of future cash flows
Capital Structure
How does a firm obtain and manage the long-term financing it needs to support its
long-term investments
Mixture of long-term debt and equity used for financing operations
Working Capital Management
Firm’s short-term assets, such as inventory and short-term liabilities
Forms of Business Organization
Sole Proprietorship
Owed by 1 person
Keep all profits, but unlimited
liability
Business income taxed as personal
income
Life of business = Owner’s life
Partnership
2 or more owners
Unlimited liabilities
Partnership
2 or more Owners
General
All share in gains and losses
Unlimited liability
Limited
“Nonactive” partners have limited
,liability
Unlimited liability
Life of business ends when partner
sells or die
Business income taxed as personal
income
Forms of Business Organization
Corporations
A legal “person,” separate and
distinct from its owners, and it has
many rights, duties, and privileges
of an actual person
Stockholders and managers tend to
be separate groups
Agency problem
Stockholders elect board of
directors, who select management
Managers run the corporations in
the stockholders’ interest
Advantages
Ownership easily transferred
Sell stock
Life is not limited
Limited liability
Disadvantage
Double Taxation
LLC – Limited Liability Company
Tax like partnership but keep
limited liability for owners
Goal of Financial Management
Maximize the Current Value per Share of the Existing Stock
Maximize profits
Minimize cost
2 overarching themes
Profitability
Control Risk
Corporate Finance – Study of the relationship between business decisions and
the value of the stock in the business
,Conflict of Interest
Agency Relationship
Relationship between stockholders and management
Occurs when someone (principal) hires another (agent) to represent the principal’s
interest
Agency Problem
The possibility of conflict of interest between the stockholders and management of
a firm
Agency Cost
Costs of the conflict
Indirect
Direct
Controls?
Managerial Compensation
Control of Firm
Chapter 2:
Balance Sheet
Financial Statement showing a firm’s accounting value on a particular date
Balance Sheet
Assets
Fixed Asset
Relatively long life
Tangible (Truck, computer)
Intangible (Trademark, patent)
Current Asset
Life of less than one year
Examples
Inventory
Cash
Accounts Receivable
Liabilities
Current Liabilities
Life less than 1 year
Accounts payable
Long-Term Liabilities
Debt lasting more than 1 year
Equity
Total Value of Assets – Total Value of Liabilities = Common Equity
, If the firm sells all its assets and pays of its debts, the rest will go to
shareholders
Assets = Liabilities + Shareholders’ Equity
Balance Sheet Identify
Net Working Capital
Current Asset – Current Liabilities = Net Working Capital
Positive: Cash brought in > Cash paid out
At least over next 12 months
Liquidity
Speed and Ease with which an Asset can be Converted to Cash
2 Dimensions
Ease of conversion
Loss of value
Debt vs Equity
Shareholders’ Equity = Assets – Liabilities
Financial leverage: use of debt in a firm’s capital structure
Market Value versus Book Value
Book Value: Value shown on balance sheet for assets
Generally Accepted Accounting Principles (GAAP): Uses historical cost
What the firm paid for the asset
Regardless of how long ago they were purchased or how much the asset is actually
worth
Income Statement
Measures performance over some period of time
Revenues – Expenses = Income
GAAP and the Income Statement
General Rule (recognition or realization principle): Recognize revenue when
the earnings process is virtually complete, and the value of an exchange of
goods or services is known or can be reliably determined.
Revenue is recognized at time of sale
Expenses are based on matching principle
Determine revenues then match with the cost associated with producing them
Noncash Items / Time & Costs
Short-Run
Some expenses are fixed
Long-Run
All business expenses are variable
Taxes
Average Tax Rate = Total Taxes / Total Taxable Income
Study of ways to answer questions about financial future of a company:
What long-term investments should be taken on?
What lines of business is the company in?
What kinds of buildings, machinery, equipment, etc. are needed
Where will long-term financing come from to pay for investments?
Will other investors be brought in, or will the money be borrowed?
How will everyday financial activities be managed, like collecting customers and
paying suppliers?
Capital Budgeting
Process of planning and managing a firm’s long-term investments
Find investment opportunities where:
Cash Flow of Asset > Cost of Asset
Evaluating size, timing, and risk of future cash flows
Capital Structure
How does a firm obtain and manage the long-term financing it needs to support its
long-term investments
Mixture of long-term debt and equity used for financing operations
Working Capital Management
Firm’s short-term assets, such as inventory and short-term liabilities
Forms of Business Organization
Sole Proprietorship
Owed by 1 person
Keep all profits, but unlimited
liability
Business income taxed as personal
income
Life of business = Owner’s life
Partnership
2 or more owners
Unlimited liabilities
Partnership
2 or more Owners
General
All share in gains and losses
Unlimited liability
Limited
“Nonactive” partners have limited
,liability
Unlimited liability
Life of business ends when partner
sells or die
Business income taxed as personal
income
Forms of Business Organization
Corporations
A legal “person,” separate and
distinct from its owners, and it has
many rights, duties, and privileges
of an actual person
Stockholders and managers tend to
be separate groups
Agency problem
Stockholders elect board of
directors, who select management
Managers run the corporations in
the stockholders’ interest
Advantages
Ownership easily transferred
Sell stock
Life is not limited
Limited liability
Disadvantage
Double Taxation
LLC – Limited Liability Company
Tax like partnership but keep
limited liability for owners
Goal of Financial Management
Maximize the Current Value per Share of the Existing Stock
Maximize profits
Minimize cost
2 overarching themes
Profitability
Control Risk
Corporate Finance – Study of the relationship between business decisions and
the value of the stock in the business
,Conflict of Interest
Agency Relationship
Relationship between stockholders and management
Occurs when someone (principal) hires another (agent) to represent the principal’s
interest
Agency Problem
The possibility of conflict of interest between the stockholders and management of
a firm
Agency Cost
Costs of the conflict
Indirect
Direct
Controls?
Managerial Compensation
Control of Firm
Chapter 2:
Balance Sheet
Financial Statement showing a firm’s accounting value on a particular date
Balance Sheet
Assets
Fixed Asset
Relatively long life
Tangible (Truck, computer)
Intangible (Trademark, patent)
Current Asset
Life of less than one year
Examples
Inventory
Cash
Accounts Receivable
Liabilities
Current Liabilities
Life less than 1 year
Accounts payable
Long-Term Liabilities
Debt lasting more than 1 year
Equity
Total Value of Assets – Total Value of Liabilities = Common Equity
, If the firm sells all its assets and pays of its debts, the rest will go to
shareholders
Assets = Liabilities + Shareholders’ Equity
Balance Sheet Identify
Net Working Capital
Current Asset – Current Liabilities = Net Working Capital
Positive: Cash brought in > Cash paid out
At least over next 12 months
Liquidity
Speed and Ease with which an Asset can be Converted to Cash
2 Dimensions
Ease of conversion
Loss of value
Debt vs Equity
Shareholders’ Equity = Assets – Liabilities
Financial leverage: use of debt in a firm’s capital structure
Market Value versus Book Value
Book Value: Value shown on balance sheet for assets
Generally Accepted Accounting Principles (GAAP): Uses historical cost
What the firm paid for the asset
Regardless of how long ago they were purchased or how much the asset is actually
worth
Income Statement
Measures performance over some period of time
Revenues – Expenses = Income
GAAP and the Income Statement
General Rule (recognition or realization principle): Recognize revenue when
the earnings process is virtually complete, and the value of an exchange of
goods or services is known or can be reliably determined.
Revenue is recognized at time of sale
Expenses are based on matching principle
Determine revenues then match with the cost associated with producing them
Noncash Items / Time & Costs
Short-Run
Some expenses are fixed
Long-Run
All business expenses are variable
Taxes
Average Tax Rate = Total Taxes / Total Taxable Income
