FIN 402 Midterm 1 Flashcards
3 Aspects of Role of Financial Manager (and their questions)
- Working Capital Management (how much money does a firm need)
- Capital Structure (how does the firm acquire money?)
- Capital Budgeting (what should the firm do with its money)
3 questions on Working Capital Mgmt
How much cash/inventory should we MAINTAIN (inv/cash)
Should we sell on credit (AR) goal of credit manager is to optimize mix of sales and bad debt
How should we obtain ST financing (AP)
Capital Structure (how does the firm acquire money?)
3 Concerns:
(1) How
(2) Who
(3) When
- Optimal Mix of debt and equity
- What are the least expensive sources of funds (creditors or shareholders)
- What is the time horizon for the funds needed (ST or LT)
Use FRICTO analysis to see impacts of capital structure decisions:
- Flexibility - growth opportunities / debt covenants
- Risks - sales stability / operating leverage
- Income - impact on value and/org EPS
- Control - ownership / dilution
- Timing - market conditions / econ cycles / politics
- Other - speed, etc.
Role of Financial Manager is also who else?
CFO is usually the top financial manager within the firm
However, treasurer oversees capital structure as well
Business Process for Public Companies
- Elect BOD
- Hire Mgmt Team
- Responsible for Running Company
- Shareholders
Principal-Agent Problem; direct and indirect costs
- Indirect Costs: Management may desire job security over taking on the big risk projects that shareholders would want to maximize potential returns.
- Direct Costs: luxury jets, premium office space, expense accounts, etc. (ex. G. Sheppard)
Principal Agent Problem - 4 major requirements by SOX (SALF)
- 1)Signature Clause: CEOs of publicly traded companies must vouch for the veracity of published financial statements.
- 2)Independent Audit: Corporate boards must have audit committees drawn from independent [outside] directors.
- 3)Prohibits Loans: Companies can no longer make loans to corporate directors.
- 4)Fraud Prevention Policies: Companies must test their internal financial controls against fraud.
Primary, Secondary, Dealer, Auction markets
- Primary: Public Offering vs. Private Placement
- Secondary: Involves one owner creditor selling to another
- Dealer market
- 1) Dealer buy and sell for themselves at own risk
2) Over-the-Counter [now electronically connected]
Example: NASDAQ
- Auction market:
- 1) Primary purpose to match buyers and sellers
2) Exchange has a physical location [Wall Street]
Example: NYSE, LSE, TSE, etc.
Sole Proprietorship (definition & advantages/disadvantages)
- Most common form of business organization; owned by ONE person. You may be able to establish sole proprietorship simply by getting a business license.
Advantages
–Easiest and most inexpensive to start
–Least regulated
–Single owner keeps all the profits
–Taxed once as personal income
Disadvantages
–Limited to life of owner
–Equity capital limited to owner’s personal wealth
–Unlimited liability
–Difficult to sell ownership interest
Partnership:
Similar to a proprietorship except a partnership has two or more owners [partners]. May be a general partnership or a limited partnership. Partnership agreement important.
Advantages
–Two or more owners share responsibility
–Specialization and potential for synergy
–More capital available
–Relatively easy to start
–Income taxed once as personal income
Disadvantages
–Unlimited liability [General vs. limited partnership]
–Negotiate everything
–Partnership dissolves when one partner dies or wishes to sell
–Difficult to transfer ownership [succession]
- Note that unlimited liability applies to all partners in a general partnership but only to the general partners in a limited partnership.
- Partnerships present the involved parties with special challenges that must be navigated unto agreement. Overarching goals, levels of give-and-take, areas of responsibility, lines of authority and succession, how success is evaluated and distributed, and often a variety of other factors must all be negotiated. Once agreement is reached, the partnership is typically enforceable by civil law, especially if well documented. Partners who wish to make their agreement affirmatively explicit and enforceable typically draw up Articles of Partnership. It is common for information about formally partnered entities to be made public, such as through a press release, a newspaper ad, or public records laws.
While partnerships stand to amplify mutual interests and success, some are considered ethically problematic. When a politician, for example, partners with a corporation to advance the latter’s interest in exchange for some benefit, a conflict of interest results; consequentially, the public good may suffer. While technically legal in some jurisdictions, such practice is broadly viewed negatively or as corruption.
Written agreements are essential due to the unlimited liability.
Limited partners cannot be involved in the business or else they may be deemed as general partners
Corporations:
A legal “person” separate and distinct from its owners. It has many rights, duties, and privileges of an actual person (i.e. borrow $, own property, sue/be sued, enter into contracts, etc.). Articles of Incorporation and Bylaws.
Advantages
–Limited liability
–Unlimited life
–Separate ownership and management [most lose = $ invest]
–Transfer of ownership [i.e. shares] is easy
–Easier to raise capital
Disadvantages
–Separate ownership and management
–Double taxation [income taxed at corporate rate and then dividends taxed at personal rate]
–Initial and ongoing fees
–Formal documentation
Documentation: Corporations need to maintain more records than other business entities. Corporations must file annual reports and tax returns and maintain business bank accounts and records that are separate from personal accounts. Shareholder meeting records, board of director meeting records, licenses and other corporate records also are necessary.
Separation of ownership and management can be both an advantage and a disadvantage:
- Advantages
- You can benefit from ownership in several different businesses (diversification)
- You can take advantage of the expertise of others (comparative advantage)
- Easier to transfer ownership
- Disadvantage
- Agency problems if management goals and owner goals are not aligned
Costs
One of the primary disadvantages of a corporation is the costs for running a corporate form of business. It costs money to incorporate with the state where the business operates. You can choose to hire an attorney or accountant to help you complete the incorporation paperwork, but it is not a requirement. If you incorporate directly with the Secretary of State, as of 2010, the fee ranges from $99 to $150. Beyond the initial incorporation fees, the corporate form of business also has ongoing fees associated with it. An annual report fee can range up to $150 a year for each year the corporation exists after the initial incorporation filing.
A pertinent discussion is the implementation of Sarbanes-Oxley and the effect it has had. Although increased information flow is good for shareholders, it has come at a cost. In fact, some firms have chosen to “go dark,” while others have avoided going public altogether.
Fixed assets are spontaneous when…
–Key Analysis Involves Capacity. Excess?
What are special-case accounts when it comes to forecasting?
How to calculate RE & Payout Ratio
- Interest expense
- Retained Earnings (must be independently forecasted)
RE = old RE + (forecasted sales * net margin * (1-payout)
Payout = div / NI
When the balance sheet no longer balances, what two scenarios will it probably be?
- Shortfall = have opportunities and need EFN
- Surplus = dividends paid
