FIF Summary
Chapter 1
What is Finance?
Finance can be defined as the science and art of managing money.
- Personal level: individual decisions about how much of their earnings
they spend, save or invest.
- Business context: involves decisions about how firms invest money in an
attempt to earn a profit, and how they decide whether to reinvest profits
in the business or distribute them back to investors.
Financial Services is the area of finance concerned with the design and delivery
of advice and financial products to individuals, businesses, and governments.
Managerial finance is concerned with the duties of the financial manager
working in a business.
- Factors of global financial crises, subsequent responses by regulators,
increased competition and technological change increase demand for
financial experts who can manage cash flows in different currencies and
protect against the risks that arises from international transactions.
- Both areas rely on a common analytical tool kit.
- Financial managers actively develop and implement corporate strategies
aimed at helping the firm grow and improve its competitive position.
Financial managers administer the financial affairs of all types of businesses—
private and public, large and small, profit seeking and not-for-profit.
Legal forms of business organizations:
- How business is organized legally influences the risk that the firm’s
owners must bear, how the firm can raise money and how the firm’s
sole proprietorship: a business owned by one person and operated for his or
her own profit.
- Most common type in general.
- Wholesale, retail and construction industries.
- Proprietor rises capital from personal resources
- Drawback: unlimited reliability.
A partnership is a business owned by two or more people and operated for
profit.
- Common in finance and real estate industries.
- Established by articles of partnership: written contracts
A corporation is an entity created by law. Corporations have the legal powers of
an individual in that it can sue and be sued, make and be party to contracts, and
acquire property in its own name.
- Most common type for large companies, especially manufacturing firms.
,Table 1.1 for strengths and weaknesses
Stockholders/residual claimants: owners of a corporation whose ownership,
or equity, takes the form of common stock or preferred stock.
- Owners of the corporation
- Expect to earn a return by receiving dividends – periodic distributions of
cash to the stockholders of a firm.
Limited liability: legal provision that limits stockholder’s liability for a
corporation’s debt to the amount they initially invested in the firm by purchasing
stock.
- Losses are limited to the amount of money invested in the firm.
Common stock: purest and most basic form of corporate ownership.
Board of directors: group elected by the firm’s stockholders and typically
responsible for approving strategic goals and plans, setting general policy,
guiding corporate affairs, and approving major expenditures.
President/chief executive officer (CEO): Corporate official responsible for
managing the firm’s day-to-day operations and carrying out the policies
established by the board of directors.
- Reports periodically
Limited partnership (LP): partnership in which one or more partners have
limited liability as long as at least one partner has unlimited liability.
- Limited partners are passive investors that cannot take an active role in
the firm’s management.
Other limited liability organization:
- Owners enjoy limited liability, and they typically have fewer than 100
owners.
S corporation: tax reporting entity that allows certain corporation with 100 or
fewer stockholders to choose to be taxed as partnership.
- Stockholders receive the organizational benefits of a corporation and the
tax advantages of a partnership.
Limited liability company: gives its owners limited liability and taxation as a
partnership. Can own more than 80% of another corporation.
Limited liability partnership: are liable of their own acts of malpractice, but not
for those of other partners.
- Taxed as a partnership.
- Frequently used by legal and accounting professionals.
Goals of firm/management:
- Maximize stock prices
- Take actions that increase stockholders’ wealth
, - Key variables to consider are return and risk
Earnings per share (EPS): amount earned during the period on behalf of each
outstanding share of common stock.
- Calculated by: period total earnings available for common stock
holders/shares of common stock outstanding.
Profit maximization does not lead to the highest possible share price because of:
- Timing
- Profits and cash flows are not identical
- Risk (Risk averse: requiring compensation to bear risk)
Stakeholders are groups such as employees, customers, suppliers, creditors,
owners, and others who have a direct economic link to the firm.
- A firm with a stakeholder focus consciously avoids actions that would
prove detrimental to stakeholders. The goal is not to maximize
stakeholder well-being but to preserve it.
- Long-run benefit for shareholders when maintaining good relationships
with stakeholders
Business ethics: standards of conduct or moral judgement that apply to persons
engaged in commerce.
- Goal is to motivate business and market participants to adhere to both the
letter and the spirit of laws and regulations concerned with business and
professional practice.
- Use of corporate ethics policies.
Considering ethics:
- Is the action arbitrary or capricious?
- Does the action violate the moral or legal rights of any individual or
group?
- Does the action conform to accepted moral standards?
- Are there alternative courses of action that are less likely to cause harm?
Organization of finance function:
- Small firms: finance function performed by the accounting department.
- Bigger firms: separate accounting departments
Treasurer: firm’s chief financial manager, who manages the firm’s cash, oversees
its pension plans, and manages key risks.
Controller: firm’s chief accountant, who is responsible for the firm’s accounting
activities, such as corporate accounting, tax management, financial accounting
and cost accounting.
Foreign exchange manager: manager responsible for managing and monitoring
the firm’s exposure to loss from currency fluctuations.
, Marginal cost–benefit analysis is the economic principle that states that
financial decisions should be made and actions taken only when the added
benefits exceed the added costs
Accrual basis: in preparation of financial statements, recognizes revenue at the
time of sale and recognizes expenses when they are incurred.
- Collection and presentation of financial data.
Cash basis: Recognizes revenues and expenses only with respect to actual
inflows and outflows of cash.
- Primarily making investments and financing decisions.
Corporate governance refers to the rules, processes, and laws by which
companies are operated, controlled, and regulated.
• It defines the rights and responsibilities of the corporate participants such as the
shareholders, board of directors, officers and managers, and other stakeholders,
as well as the rules and procedures for making corporate decisions.
- Can be strengthened by ensuring that managers’ interests are aligned
with those of shareholders.
- Threat of takeover (rival managers will try to gain control over the firm)
Individual investors are investors who own relatively small quantities of shares
so as to meet personal investment goals.
- Act as a group in order to influence the firm
Institutional investors are investment professionals, such as banks, insurance
companies, mutual funds, and pension funds, which are paid to manage and hold
large quantities of securities on behalf of others.
- Banks, insurance companies, mutual funds, and pension funds.
- Can directly pressure the management board.
Unlike individual investors, institutional investors often monitor and directly
influence a firm’s corporate governance by exerting pressure on management to
perform or communicating their concerns to the firm’s board.
Sarbanses Oxley Act of 2002 (SOX): Act aimed at eliminating corporate disclosure
and conflict of interest problems. Contains provisions about corporate financial
disclosures and the relationship among corporations, analysts, auditors,
attorneys, directors, officer’s and shareholders.
A principal-agent relationship is an arrangement in which an agent acts on the
behalf of a principal. For example, shareholders of a company (principals) elect
management (agents) to act on their behalf.
- Own goals more important than shareholder’s wealth
Agency problems arise when managers place personal goals ahead of the goals
of shareholders.
Chapter 1
What is Finance?
Finance can be defined as the science and art of managing money.
- Personal level: individual decisions about how much of their earnings
they spend, save or invest.
- Business context: involves decisions about how firms invest money in an
attempt to earn a profit, and how they decide whether to reinvest profits
in the business or distribute them back to investors.
Financial Services is the area of finance concerned with the design and delivery
of advice and financial products to individuals, businesses, and governments.
Managerial finance is concerned with the duties of the financial manager
working in a business.
- Factors of global financial crises, subsequent responses by regulators,
increased competition and technological change increase demand for
financial experts who can manage cash flows in different currencies and
protect against the risks that arises from international transactions.
- Both areas rely on a common analytical tool kit.
- Financial managers actively develop and implement corporate strategies
aimed at helping the firm grow and improve its competitive position.
Financial managers administer the financial affairs of all types of businesses—
private and public, large and small, profit seeking and not-for-profit.
Legal forms of business organizations:
- How business is organized legally influences the risk that the firm’s
owners must bear, how the firm can raise money and how the firm’s
sole proprietorship: a business owned by one person and operated for his or
her own profit.
- Most common type in general.
- Wholesale, retail and construction industries.
- Proprietor rises capital from personal resources
- Drawback: unlimited reliability.
A partnership is a business owned by two or more people and operated for
profit.
- Common in finance and real estate industries.
- Established by articles of partnership: written contracts
A corporation is an entity created by law. Corporations have the legal powers of
an individual in that it can sue and be sued, make and be party to contracts, and
acquire property in its own name.
- Most common type for large companies, especially manufacturing firms.
,Table 1.1 for strengths and weaknesses
Stockholders/residual claimants: owners of a corporation whose ownership,
or equity, takes the form of common stock or preferred stock.
- Owners of the corporation
- Expect to earn a return by receiving dividends – periodic distributions of
cash to the stockholders of a firm.
Limited liability: legal provision that limits stockholder’s liability for a
corporation’s debt to the amount they initially invested in the firm by purchasing
stock.
- Losses are limited to the amount of money invested in the firm.
Common stock: purest and most basic form of corporate ownership.
Board of directors: group elected by the firm’s stockholders and typically
responsible for approving strategic goals and plans, setting general policy,
guiding corporate affairs, and approving major expenditures.
President/chief executive officer (CEO): Corporate official responsible for
managing the firm’s day-to-day operations and carrying out the policies
established by the board of directors.
- Reports periodically
Limited partnership (LP): partnership in which one or more partners have
limited liability as long as at least one partner has unlimited liability.
- Limited partners are passive investors that cannot take an active role in
the firm’s management.
Other limited liability organization:
- Owners enjoy limited liability, and they typically have fewer than 100
owners.
S corporation: tax reporting entity that allows certain corporation with 100 or
fewer stockholders to choose to be taxed as partnership.
- Stockholders receive the organizational benefits of a corporation and the
tax advantages of a partnership.
Limited liability company: gives its owners limited liability and taxation as a
partnership. Can own more than 80% of another corporation.
Limited liability partnership: are liable of their own acts of malpractice, but not
for those of other partners.
- Taxed as a partnership.
- Frequently used by legal and accounting professionals.
Goals of firm/management:
- Maximize stock prices
- Take actions that increase stockholders’ wealth
, - Key variables to consider are return and risk
Earnings per share (EPS): amount earned during the period on behalf of each
outstanding share of common stock.
- Calculated by: period total earnings available for common stock
holders/shares of common stock outstanding.
Profit maximization does not lead to the highest possible share price because of:
- Timing
- Profits and cash flows are not identical
- Risk (Risk averse: requiring compensation to bear risk)
Stakeholders are groups such as employees, customers, suppliers, creditors,
owners, and others who have a direct economic link to the firm.
- A firm with a stakeholder focus consciously avoids actions that would
prove detrimental to stakeholders. The goal is not to maximize
stakeholder well-being but to preserve it.
- Long-run benefit for shareholders when maintaining good relationships
with stakeholders
Business ethics: standards of conduct or moral judgement that apply to persons
engaged in commerce.
- Goal is to motivate business and market participants to adhere to both the
letter and the spirit of laws and regulations concerned with business and
professional practice.
- Use of corporate ethics policies.
Considering ethics:
- Is the action arbitrary or capricious?
- Does the action violate the moral or legal rights of any individual or
group?
- Does the action conform to accepted moral standards?
- Are there alternative courses of action that are less likely to cause harm?
Organization of finance function:
- Small firms: finance function performed by the accounting department.
- Bigger firms: separate accounting departments
Treasurer: firm’s chief financial manager, who manages the firm’s cash, oversees
its pension plans, and manages key risks.
Controller: firm’s chief accountant, who is responsible for the firm’s accounting
activities, such as corporate accounting, tax management, financial accounting
and cost accounting.
Foreign exchange manager: manager responsible for managing and monitoring
the firm’s exposure to loss from currency fluctuations.
, Marginal cost–benefit analysis is the economic principle that states that
financial decisions should be made and actions taken only when the added
benefits exceed the added costs
Accrual basis: in preparation of financial statements, recognizes revenue at the
time of sale and recognizes expenses when they are incurred.
- Collection and presentation of financial data.
Cash basis: Recognizes revenues and expenses only with respect to actual
inflows and outflows of cash.
- Primarily making investments and financing decisions.
Corporate governance refers to the rules, processes, and laws by which
companies are operated, controlled, and regulated.
• It defines the rights and responsibilities of the corporate participants such as the
shareholders, board of directors, officers and managers, and other stakeholders,
as well as the rules and procedures for making corporate decisions.
- Can be strengthened by ensuring that managers’ interests are aligned
with those of shareholders.
- Threat of takeover (rival managers will try to gain control over the firm)
Individual investors are investors who own relatively small quantities of shares
so as to meet personal investment goals.
- Act as a group in order to influence the firm
Institutional investors are investment professionals, such as banks, insurance
companies, mutual funds, and pension funds, which are paid to manage and hold
large quantities of securities on behalf of others.
- Banks, insurance companies, mutual funds, and pension funds.
- Can directly pressure the management board.
Unlike individual investors, institutional investors often monitor and directly
influence a firm’s corporate governance by exerting pressure on management to
perform or communicating their concerns to the firm’s board.
Sarbanses Oxley Act of 2002 (SOX): Act aimed at eliminating corporate disclosure
and conflict of interest problems. Contains provisions about corporate financial
disclosures and the relationship among corporations, analysts, auditors,
attorneys, directors, officer’s and shareholders.
A principal-agent relationship is an arrangement in which an agent acts on the
behalf of a principal. For example, shareholders of a company (principals) elect
management (agents) to act on their behalf.
- Own goals more important than shareholder’s wealth
Agency problems arise when managers place personal goals ahead of the goals
of shareholders.
