Basic Areas Of Finance
Finance examines how the firm can best manage its scarce resources and assets. It is usual to divide finance into four basic areas: |
Corporate finance |
deals with how the firm raises funds and utilises them. |
Investments |
Work with financial assets such as stocks and bonds |
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Value of financial assets, risk versus return, and asset allocation |
Financial institutions |
bring together people, companies or the government who need funds with people, firms or the government that have excess funds to invest. Companies that specialize in financial matters |
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- Banks: commercial and investment, credit unions, savings and loans |
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- Insurance companies |
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- Brokerage firms |
International finance |
An area of specialisation within each of the areas discussed so far |
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May allow you to work in other countries or at least travel on a regular basis |
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Need to be familiar with exchange rates and political risk |
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Need to understand the customs of other countries; speaking a foreign language fluently is also helpful |
Business Finance
Some important questions that are answered using finance
- What long-term investments should the firm take on?
- Where will we get the long-term financing to pay for the
investments?
- How will we manage the everyday financial activities of the firm? |
Why Study Finance?
Marketing |
Budgets, marketing research, marketing financial products |
Accounting |
Dual accounting and finance function, preparation of financial statements |
Management |
Strategic thinking, job performance, profitability |
Personal finance |
Budgeting, retirement planning, college planning, day- to-day cash flow issues |
Financial Manager
Financial managers try to answer some, or all, of these questions |
The top financial manager within a firm is usually the Chief Financial Officer (CFO) |
* Treasurer – oversees cash management, credit management, capital expenditures, and financial planning |
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* Controller – oversees taxes, cost accounting, financial accounting, and data processing |
Financial Management Decisions
Capital budgeting |
What long-term investments or projects should the business take on? |
Capital structure |
How should we pay for our assets? |
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Should we use debt or equity? |
Working capital management |
How do we manage the day-to-day finances of the firm? |
Forms of Business Organization
Sole proprietorship |
Business owned by one person |
Partnership |
General |
Business owned by two or more persons |
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Limited |
consists of general partner(s) and limited partner(s). There is no limit on the number of the partner |
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Limited Liability |
LLPs give owners the flexibility of operating as a partnership whilst giving them limited liability |
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- Private Limited Company (Pte. Ltd.) |
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- Public Limited Company |
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- Public Company Limited by Guarantee |
Companies |
Privately held companies that can be used for a variety of purposes. These companies have fewer than fifty shareholders. |
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Sole Proprietorship
Advantages |
Disadvantages |
Easiest to start |
Limited to life of owner |
Least regulated |
Equity capital limited to owner’s personal wealth |
Single owner keeps all of the profits |
Unlimited liability |
Taxed once as personal income |
Difficult to sell ownership interest |
Partnership
Advantages |
Disadvantages |
Two or more owners |
Unlimited liability: |
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- General partnership |
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- Limited partnership |
More capital available |
Partnership dissolves when one partner dies or wishes to sell |
Relatively easy to start |
Difficult to transfer ownership |
Income taxed once as personal income |
Corporation
Advantages |
Disadvantages |
Limited liability |
Separation of ownership and management (agency problem) |
Limited liability |
Separation of ownership and management (agency problem) |
Unlimited life |
Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible) |
Separation of ownership and management |
Transfer of ownership is easy |
Easier to raise capital |
Goal Of Financial Management
What should be the goal of a corporation? |
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- Maximize profit? |
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- Minimize costs? |
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- Maximize market share? |
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- Maximize the current value per share of the company’s existing stock |
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- Maximize the market value of the existing owners’ equity |
Does this mean we should do anything and everything to maximize owner wealth? |
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- Outsourcing? |
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- Off-shoring? |
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- Enron? |
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- Corporate support of charities? |
The Agency Problem
Agency relationship |
Principal hires an agent to represent its interests |
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Stockholders (principals) hire managers (agents) to run the company |
Agency problem |
Conflict of interest between principal and agent |
Management goals and agency costs |
Do Managers Act in the Shareholders’ Interests?
Managerial compensation |
Incentives can be used to align management and stockholder interests |
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Incentivesneedtobecarefullystructured toinsurethat they achieve their goal |
Corporate control |
Threat of a takeover may result in better management |
Other stakeholders |
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