An Introduction to Finance Economics allocation of scarce resources with alternative uses o Finance part of economics way individuals and businesses raise allocate and manage monetary resources Four areas Corporate Finance decisions the firm makes Investments Asset Pricing Financial Institutions International Finance Exclusively future oriented Risk and Return are positively related Who s who o Chief Financial Officer CFO top manager within firm o Treasurer oversees cash management credit management capital expenditures and financial planning o Controller oversees taxes cost accounting financial accounting and data processing normally a CPA Capital Structure o How to pay Capital management o Day to day responsibilities Forms of Business Organizations o Sole Proprietorship Single owner Single employee Ex Contractor Advantages Little regulations Easy to start Keep all profits Taxed once as personal income Disadvantages Limited to life of owner Equity capital limited to owner s personal wealth Unlimited liability legal issues Difficult to sell ownership interests o Partnership General and limited liabilities Examples Law Firms Accounting Firms Advantages Have more than one owner More capital available Easy to start partnership agreement Income taxed once as personal income o Based on personal income tax rates o Corporations Advantages Disadvantages partnership Unlimited liability general partnership and limited o General managing partner unlimited legal o Limited only lose what you have invested into liability company Partnerships dissolve when one partner dies or decides to sell harder to sell Difficult to transfer ownership Limited liability amount you invested in decreases risks Unlimited life own legal entity Separation of ownership and management Transfer of ownerships is easy high liquid Easier to raise capital o More stable Disadvantages Separation of ownership and management o Can t oversee day to day operations Double taxation income taxed at the corporate rate and then dividends taxed at the personal rate on corporate profits Goal of Financial Management o Maximize stock price Stock values reflect current and future long term interests of the firm o Agency relationships Principal hire an agent to represent his her interests Stockholders principal hire managers agents to run company and act on principal s behalf o Agency problems Conflict in interests between principal and agent Agent incentive although its not in the principal s best Managing managers interest o Managerial compensation manager pay o Incentives can be used to align management and stockholder interests stock for managers incentive o Incentives needs to be structured o Corporate control board of directors o Threat of takeover may result in better management o Other stakeholders Since goal is to grow stake wealth Financial Markers access of money o Cash flow to the firm o Primary market sell bonds and receive money Firms receive benefits ex IPO Sell company shares o Secondary all transactions that happen after initial transactions trade between individuals doesn t affect company Chapter 2 Financial Statements available o Balance Sheet Snapshot of firms assets and liabilities at a given point of time Assets are listed in order of decreasing liquidity o Liquidity ease of conversion to cash how easy to sell something without loss in value Formula Balance Sheet Identity Total Assets Total liabilities stockholder equity o Current assets highly liquid convert in less than o Fixed assets Tangible and Intangible convert in a year more than a year Tangible objects Intangible patent o Net Working Capital NWC Current Assets Current liabilities Positive when cash that will be received over the next 12 months exceed cash paid out indicate financially healthy firm o Liquidity Current vs Fixed Ability to convert to cash quickly ability to sell Low liquidity hard to sell take discount on price in order to sell faster Liquid firms are less likely to experience financial distress But liquid assets typically earn a lower return because it is easer to sell o Trade off to find balance between liquid and illiquid assets Illiquid assets produce higher return due to their risk Book value vs Market value o Book value on balance sheet value of assets liabilities and equity includes depreciation of value on books o Market value price at which assets liabilities or equity can actually be bought or sold Generally Market value is more important for firms Income Statement o Idea of cash coming into a firm Generally report revenues first and then deduct any expenses for period Matching principle GAAP says to show revenue when it accrues and match the expenses required to generate the revenue o Formula Net income Net sales Cost of Goods Sold Deprecation EBIT Earning before interest and taxes o EBIT Interest paid Taxable income o Taxable income taxes Net income Taxes o Marginal vs Average tax rates Marginal tax rates percentage paid on next dollar earned would the next dollar you make affect the tax bracket you are in Average tax rates tax bill taxable income o Other Taxes State Local city or town Corporate progressive taxes Increase tax rates when one makes more income 8 categories o Range from 15 to 39 for corporations o Average tax rates max out at 35 Government has incentives on corporate taxes may actually pay a different tax rate Smooth increase for average compared to marginal Marginal rate very important when making decision especially for new projects o Example Firm earns 4 million in taxable income What is the taxable liability Total paid in taxes use tax bracket sheet 50 000 34 25 000 25 25 000 34 235 000 39 3 665 000 34 1 360 000 What is the Marginal tax rate If the company got paid one extra dollar what would it affect the tax bracket 34 What is the Average Tax rate Taxable liability Total Income earned 1 360 000 4 000 000 34 Cash Flow o One of the most important pieces of information that financial managers can derive from financial statement o The statement of cash flows does not provide us with same information that we are looking for o We will look at how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assets o Formula CFFA Cash flow from assets cash flow available to creditor bondholders cash flow to stockholders owners OR CFFA Operating cash flow net capital spending change in network capital NWC WHERE Operating cash flow EBIT earning before interest and taxes
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