Chapter 1: Introduction to Financial Management Flashcards
what four main areas are financial topic gourd into?
corporate finance (business finance)
investments
financial institutions
international finance
investments
broadly speaking, investments deal with the purchase and sale of financial assets, like stocks and bonds
value of financial assets, risk vs return, and asset allocation
what job opportunities are open to students who specialize in investments and finance?
portfolio managers, stockbrokers, security analysis
financial institutions
banks and insurance companies are probably the most popular
banks, credit unions, savings and loans, commercial and investment
a commercial loan officer at a ban would evaluate whether a particular business has a strong enough financial position to warrant extending a loan. at an insurance company, an analyst would decide whether a particular risk was suitable for insuring and what the premium should be
international finance
people might specialize in non-US companies analysis. similarly, many US businesses have extensive overseas operations and need employees familiar with such international topics as exchange rates and political risk
may allow you to travel regularly and work in other countries
need to understand politics in other countries and potentially speak different languages
marketing and finance
marketers constantly work with budgets, and they need to understand how to get the greatest payoff from marketing expenditures and programs
financial analysts rely heavily on marketing analysts, and the two frequently work together to evaluate the profitability of proposed projects and products
accounting and finance
in smaller business especially, accountants have to make financial decisions as well as perform traditional accounting tasks
financial analysis takes extensive use of accounting information; they are some of the most important end users
management and finance
in broader terms, management employees of all types are expected to have a strong understanding of how their jobs affect profitability, and they are expected to be able to improve p[profitability of their departments
you and finance
you will have to make major financial decisions for the rest of your life
what three main questions do you have to answer in business finance?
1) what long term investments should you take on?
2) where will you get the long-term financing to pay for your investments
3) how will you manage your everyday financial activities, such as collecting from customers and paying suppliers?
financial manager
usually the CFO or vice president of finance (generally controls the controller and treasurer)
the controller
handles financial and cost accounting, tax payments, and management information systems
treasurer’s office
managing the firm’s cash and credit, its financial planning, and its capital expenditures. these treasury activities are all related to the three general questions raised above
capital budgeting
the process of planning and managing a firm’s long-term investments
in capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire (value of the cash flow generated by an asset exceeds the cost to acquire that asset)
what is the essence of capital budgeting?
the size, timing, and risk of the asset
capital structure
refers to the specific mixture of long-term debt and equity the firm uses to finance its operations
working capital
a firm’s short-term asset, such as inventory, and its short-term liabilities, such as money owed to suppliers. managing the firm’s working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and void costly interruptions
what are the three areas of business finance management?
working capital management, capital structure, and capital budgeting
sole proprietorship
a business owned by a single individual. this is the simplest type of business to start and is the least regulated form of organization
the owner of the SP keeps all the profits
the owner has unlimited liability, which means hat creditors can look to the proprietor’s personal assets for payment
there is no distinction between personal and business income, so all income is taxed as personal income
partnership
similar to a SP, but there is unlimited liability spread between all the partners. gains and losses are defined in the partnership agreement
limited partnership
there are one or more general partners that run the business and have unlimited liability, but there will be one or more limited partners who do not actively participate in the business (common in real estate)
the limited partner’s liability is limited to the amount of the original contribution that partner made to the venture
advantages and disadvantages of partnerships
similar to SP’s
easy to form and not heavily regulated
all income is taxed as personal income the partners, and the amount of equity that can be raised is limited to the partners’ combined wealth
having a written agreement is extremely important cause a partner in a general partnership can be help responsible for all partnership debts
corporation
the most important form of business organization in the US.
a business created as a separate, distinct legal entity owned by one or more individuals or entities
corporations can own property and borrow money, can sue and be sued, and can enter into contracts. it can even be a general or legal partner in a partnership, and a corporation can own stop in another corporation
what does it take to start a corporation?
involves preparing articles of incorporation (a charter) and a set of bylaws. the articles of incorporation must contain a byre of things, including a contraptions name, intended life, its business purpose, and the number of shares the can be issued
bylaws
rules describing how the corporation regulates its own existence (describes how directors are elected)
does a corporation have to pay taxes?
yes. money paid out to stockholders in the form of dividends is taxed again as income to those stockholders. this is double taxation, meaning that corporate profits are taxed twice: at the corporate level and when they are earned and again at the personal level when they are paid out
profit maximization
the most commonly cited business goal
what is the goal of financial management?
to maximize the value per share of existing stock
that is a more concrete goal than profit maximization
what is a good business goal for a company that doesn’t issue stock?
to maximize the market value of the existing owner’s equity
sarbanes oxley act
in response to corporate scandals involving companies such as enron, world com, tyco, and adelphi’s, congress enacted the sarbanes oxley act in 2002, which is intended to strengthen protection against corporate accounting fraud and financial malpractice
officers at a company must review and sign the financial reports (makes management personally responsible for the accuracy of the financial statements)
the agency problem
when stockholders elect board members to represent their interests, there can be conflicts of interest when management is trying to maximize the value per share of exiting stock in the long term when investors may desire short-term payouts
agency relationship
relationship between management and stockholders
such a relationship exists when someone (a principal) hires another (the agent) to sell a car that you own while you are away at school
agency problem
a conflict of interest between a principal and an agent; or between management and the owners of a firm
not unique to corporations - they happen anywhere there is split ownership in things
management goals
sometimes they overemphasize organizational survival to protect job security. they may have a somewhat risky venture that their stakeholders want them to invest in, but when equity in the company is diluted enough and management essentially run the business, they will choose not to engage in risky behavior sometimes for fear of it not working out
managerial compensation
management will frequently have a significant economic inventive to increase share value for two reasons 1) managerial compensation, particularly at the top, is tied to financial performance 2) better performers tend to get promoted, so managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries
control of the firm
proxy fights occur when people vote other shareholders stock to vote out the board of directors so they can fire management
takeover also incentivizes management to act in the shareholders’ best interest because poorly run firms are more attractive for acquisitions because there is greater potential for profit
conclusion on management goals
stockholders control the firm and that stockholder wealth maximization is the relevant goal of the corporation. even so, there will undoubtedly be times when management goals are pushed at the expense of the shareholders
stakeholder
someone, other than the stockholder or creditor who potentially has a claim on the cash flows of the firm
what is the primary advantage of a corporation?
ownership can be transferred very easily from one person or entity to the next and that money can be raised more readily
primary markets
refers to the original sale of securities by governments and corporations
in a primary market transaction, the corporation is the seller and the transaction raises money for the corporation. there are two types of primary market transactions: public offerings and private placements
secondary markets
those in which these securities are bought and sold after the original sale
there are two kinds: dealer and auction markets
public offering
involves selling securities to the general public, whereas a private placement is a negotiated sale involving a specific buyer
public offerings of debt and equity must be registered with the securities and exchange commission, which requires the firm to disclose a great deal of information before selling any securities
private placements
partly to avoid various regulatory requirements and the expense of public offerings, debt and equity are often sold privately to large financial institutions such as life insurance companies or mutual funds. such private placements do not have to be registered with the SEC and do not require the involvement of underwriters (investment banks that specialize in selling securities to the pubic)
dealer markets
dealers buy and sell for themselves, at their own risk. a car dealer, for example, buys and sells automobiles. in contrasts, brokers and agents match buyers and sellers, but they do not actually own the commodity that is bought or sold
dealer markets in stocks and long-term debt are called over-the-counter (OTC) markets. most trading in debt securities takes place over the counter
auction markets
have a physical location (Wall Street) unlike dealer markets, and in a dealer market, most of the buying and selling is done by the dealer. the primary purpose of an auction market, on the other hand, is to match those who wish to sell with those who wish to buy
trading in corporate securities
the equity shares of most of the large firms int he United States trade in organized auction markets like the NYSE
NASDAQ
national association of securities dealers automated questions system, is a large OTC market for stocks
what large and important financial markets outside the US are there?
the Tokyo stock exchange and the London stock exchange
