Zara Mahmood Roberts FE101 Corporate Finance and the Financial Manager WHY STUDY FINANCE Our career paths have become less predictable and more dynamic With each new opportunity we must weigh all the costs and benefits Valuation Principle shows how to make the costs and benefits of a decision comparable so that we can weigh them properly THE FOUR TYPES OF FIRMS There are four major types of firms sole proprietorships partnerships limited liability companies and corporations Sole Proprietorships Sole Proprietorship a business owned and run by one person Very small with few or no employees 71 of US business is sole proprietorships but only generates 5 of the revenue 1 Straightforward to set up 2 Only one owner in firm investors hold no ownership stake 3 Owner has unlimited personal liability for firm s debts 4 Life is limited to life of owner difficult to transfer ownership Disadvantages outweigh the advantages Many convert the business into another form after it grows Partnerships Partnerships A business owned and run by more than one owner 1 All partners are liable for firm s debt 2 Partnership ends in death or withdrawal of any single partner 3 Can avoid liquidation if partnership agreement provides alternatives like a buyout Some firms such as medical practices law firms run as partnerships Personal liability increases confidence of the firm s clients Limited Partnership A partnership with two kinds of owners general partners and limited partners Liability of a limited partner is limited to their investment Withdrawal of limited partner does not dissolve the partnership o Value of interest is transferable not interest itself Has no management authority and cannot be involved in managerial decision Limited Liability When an investor s liability is limited to her investment Limited Liability Companies Limited Liability Company LLC A limited partnership without a general partner All owners have limited liability o Can also run the business as managing members Zara Mahmood Roberts FE101 Corporations Corporation A legally defined artificial being separate from its owners Many of the legal power that people have o Enter into contracts acquire assets incur obligations protection against the seizure of its property Owners are not liable for any obligations the corporation enters into Formation of a Corporation Must be legally formed through consent by state by chartering it o More costly to set up Ownership of a Corporation No limit on number of owners o Each owner owns only a fraction of the corporation Stock The ownership or equity of a corporation divided into shares Equity The collection of all the outstanding shares of a corporation Shareholder An owner of a share of stock or equity in a corporation Dividend Payments Payments made at the discretion of the corporation to its equity holders Proportional to the amount of stock they own No limitation on who can own stock Allows free and anonymous trade in the shares of the corporation o Can raise substantial amounts of capital Tax Implications for Corporate Entities An important difference among the types of corporate organizational forms in the way they are taxed Corporation is separate legal entity profits are taxed separate from owners Double Taxation Corporation pays taxes on profits shareholders pay their personal income tax from divvied profits S Corporations Corporation structure organizations are the only ones double taxed S corporations are exempt from double taxation Subchapter S tax regulations firms profits and losses are not subject to corporate taxes but are allocated directly to shareholders based on their ownership share o Shareholders pay income tax on these profits C Corporations Government has strict limitations on S tax treatment Shareholders must be US citizens and residents Can be no more than 100 Zara Mahmood Roberts FE101 Many corporations are C corporations subject to corporate tax Only taxed when you receive income as a dividend THE FINANCIAL MANAGER Some companies have many owners so it does not make sense for them to have direct control of the firm Financial manager can make financial decisions for the business for the stockholders o Makes investment decisions o Makes financing decisions o Manages short term cash needs Making Investment Decisions Financial manager must weight costs and benefits of each investment Does it quality as good uses of the money stockholders have invested Shape what the firm does and whether it will add value for its owners Making Financing Decisions Once decision is made manager must decide how to pay for them Large investments may require corporation to raise additional money o Selling more shares of stock or taking bonds Managing Short Term Cash Needs Manger must ensure that the firm has enough cash on hand to meet its obligations everyday Managing working capital can mean the difference between success and A company burns through a lot of cash before the sales of the product o Financial manager makes sure that access to cash doesn t hinder failure generate income firm s success The Goal of the Financial Manager Decisions by financial manager are made to maximize the wealth of the owners stockholders Caretaker of stockholder money makes decisions in their interests When owners agree on corporation goals the goals are implemented THE FINANCIAL MANAGER S PLACE IN THE CORPORATION Board of directors and the management team headed by the CEO possess direct control of the corporation Zara Mahmood Roberts FE101 The Corporate Management Team Board of Directors A group of people elected by shareholders who have the ultimate decision making authority in the corporation Each share of stock gives a shareholder one vote in the election of the board of directors o Investors with more shares have more influence o Outstanding shareholders can be on the board or appoint board Chief Executive Officer Charged with running the corporation by instituting the rules and policies set by the BOD CEO can often be chairman of the board CFO reports directly to the CEO Ethics and Incentives in Corporations Agency Problems There is a separation of ownership and control in a corporation Managers have little incentive to work in the interest of shareholders o Working against their own self interest Agency Problem When managers despite being hired as the agents of shareholders put their own self interest ahead of the interests of those shareholders Try to minimize number of decisions managers make that