Introduction Flashcards
How does money flow?
Money flows from individuals who want to improve their
financial future to businesses that want to expand the
scale or scope of their operations
These financial exchanges lead to
– A more productive economy
– The growth of individuals’ wealth
Money Flow
People invest money into companies to help them grow, and in return, companies use this capital to increase productivity and create wealth.
what are the economic participants
Money: People and organizations with funds to invest.
Business Ideas: Companies and entrepreneurs with profitable business opportunities.
There are different types of businesses depending on whether they have extra money or economically viable business ideas.
where does cash go?
investors > companies > projects > sources of friction eg retained earnings > back to investors (in the form of dividends etc)
what are the key areas of finance
investment
financial management
financial institutions and markets
international finance
investment
Involve methods and techniques for making decisions
about the following:
– What kinds of securities to own (e.g., bonds or
stocks)
– Which firms’ securities to buy
– How to pay the investor back in the form that the
investor wishes (e.g., the timing and certainty of the
promised cash flows)
Financial Management
How businesses manage their money, including decisions on raising capital (funds), investing in projects, and paying back investors.
Example: If you’re the CFO of a company, do you choose to invest in new products, improve technology, or focus on environmental responsibility?
Financial Institutions & Markets
These entities help move money from investors to businesses (e.g., banks, stock markets).
International Finance
Deals with managing financial issues globally, such as dealing with foreign exchange rates, political risks, and cross-border laws.
Types of Business Forms (US)
Sole Proprietorships
General Partnerships
Corporations
Hybrids
Sole Proprietorships
Owned by one person, easiest to start, but the owner has unlimited liability.
Most common in the US
Advantages
– Easy to start
– Light regulatory and paperwork burden
– Owner receives all the firm’s profits and is solely responsible for
all losses
Disadvantages
– Unlimited liability
– Limited access to capital
UK similar organisations: Sole trader, self-employment
General Partnerships
Partners own the business together
* Advantages
– Relatively easy to start
– Profits are added to each partner’s personal income and taxed
at personal income tax rates
* Disadvantages
– Partners jointly share unlimited liability
– Personally liable for legal actions and debts of firm
– Partners may need to give up some ownership and control in
the firm to raise more equity capital
Public Corporations
Legally independent entity entirely separate from its owners
(separation of ownership and control)
* Advantages
– Limited liability for owners
– Can raise large amounts of capital
– Easy to transfer ownership
* Disadvantages
– Double taxation (corporate level and personal level)
* UK similar organisations: Public limited company (PLC) and
private limited liability company (Ltd).
Hybrid Organizations
Combine attributes of several forms
* Advantages
– Offer single taxation and limited liability to all owners
* Limited Liability Partnerships (LLPs)
* Limited Liability Companies (LLCs)
* UK similar organisation: Limited Liability Partnership
(LLP).
Firm goals
Maximise profits
Survive
maximise sales
earnings growth
avoid distress
Elkingtons triple bottom line
People: How a company treats its employees and the well-being of its workforce
Planet: How a company impacts the environment
Profit: A company’s financial performance
It encourages companies to consider the full costs of their activities, not just their financial bottom line
Who are stakeholders?
Shareholders
Creditors
Suppliers
Community
Employees
Customers
Stakeholder perspective of firm goals
From a stakeholder perspective, which emphasise social
responsibility over profitability, managers should:
Maximise the satisfaction of all stakeholders in a
business.
Finance practitioners on firm goals
Finance practioners and academics tend to
support the owner perspective, that is the only
appropriate goal for managers is to
Maximise shareholder wealth (firm value)
Shareholder Primacy vs. Stakeholder Orientation
Shareholder primacy
– Corporate management should focus on shareholder
value maximization only
Stakeholder orientation
– Corporate management should also consider long-term
stakeholder interests
Adam Smith (The Wealth of Nations, 1776)
He was one of the first to argue that in capitalism, an
individual pursuing his own interests tends to
promote the good of the community.
He argued that through competition and free pricing, only
the most efficient and beneficial activities will survive in
the long run.
These are the same which also profit the individual the
most.
What is Agency Theory?
Agency Theory explains the conflict of interest between business managers (agents) and shareholders (owners). Managers might act in their own interest, not in the best interest of the company.
What are Agency Costs?
Direct Costs: Managers benefiting personally at shareholders’ expense (e.g., company spending on luxury items).
Indirect Costs: Lost opportunities due to misaligned interests between managers and shareholders.
What is Corporate Governance?
Corporate governance ensures that managers act in the best interests of the shareholders. It includes monitoring by both internal and external parties.
Who are the “inside” and “outside” monitors in corporate governance?
Inside Monitors: Board of Directors, Internal Auditors.
Outside Monitors: Auditors, analysts, investment banks, credit rating agencies, government agencies.
What is the role of the Board of Directors?
The Board hires the CEO, evaluates management, and designs compensation packages that tie managers’ pay to firm performance.
What are some ways to ensure managers act in shareholders’ best interests?
Use accountants to monitor financials.
Provide equity stakes or stock options to align managers’ interests with those of shareholders.
Why is maximising shareholder wealth a key goal?
It provides a clear, measurable way to assess a company’s success, typically through the stock price.
