FIN3403 Exam 1 Study Guide This study guide covers chapters 1 2 3 1 5 and 6 This is a compilation of the main concepts covered in class and in the book Firm a business or company In accounting it is considered a collection of assets used to produce a product or service There are three types of business operations Sole proprietorship one owner operating the entire business All of the assets are really owned by the individual and not considered assets of the company Legally everything is mixed together including the cash and assets o Example local plumber o Advantages easy to form start and run Everything is taxed as personal income o Disadvantages seizes to exist when you stop working or die It s difficult to transfer ownership A lot of time the business reputation is based off of the person and their relations with customers Also any liability of the company is the liability of that person so all of the individual s assets could be taken legally It s also harder to access capital It s harder to get loans or investors because the individual and the business are mixed together making it difficult to be sure that the money will be used for company purposes and not personal Partnership similar to a sole proprietorship but with multiple owners The partners have proportional ownership The organization is a bit more complicated because it has to be legally documented about the ownership liability and how everything is shared Usually includes a plan for what would happen if the partnership dissolves o Example practices such as law or medical o Advantages all income is taxed as personal income o Disadvantages unlimited liability hard to borrow money or obtain more capital as it s not a separate entity difficult to dissolve or transfer ownership Corporation most organized form of a business It is considered a separate legal entity that can be sued sign contracts etc Legally it is pretty much a person making it separate from the owners and limiting their liability o Example Pepsi o Advantages easy to transfer ownership by selling shares limited liability it s easier to raise both debt and equity capital as the bank knows this will be used to invest into the company and for no other purpose o Disadvantages corporations experience double taxation on income This is because the company itself must pay income tax for itself After that when an owner receives a dividend from his earnings he will be taxed on that money Another problem is because ownership and management are separated owners don t have as much say in what s going on Capital money that is invested in the business This can be divided into ownership capital equity and debt capital Equity is called stock on the corporate level It s ownership of the business A share of stock is proportional ownership and a shareholder is a person who owns those shares Debt includes loans A debt holder is someone who loaned you money also called a creditor or lender They invested money but do not own part of it They expect to get their money back with some interest Agents someone that is hired to advise or make decisions on their behalf They have the legal right to enter into contracts for who they are representing The owners pick the board of directors who choose the managers The directors are agents of the owners and they act on the owners behalves This makes the owner unable to change day to day operations and to make changes they must vote in or out different board members The problem of owners and managers not being on the same page is called an agency problem because you have opted into someone else act on your behalf Agency problems and costs Direct costs Overconsumption of perquisites people taking advantage of their job and perks people in the company taking office supplies home with them the corporate plane being used for personal reasons and being charged to the company Taking a too long lunch or abusing a perk Indirect costs paying people to create and enforce policies to prevent direct costs These come from any prevention over a direct cost Another one is a manager choosing a less risky path for the company that he knows will work out but maybe not as great This one is hard to quantify and are usually more fuzzy Sometimes it s hard to even tell from the outside if it truly is happening pay the top executives in cash and stock shares This way they directly benefit from the share price increasing aligning their interests with the owners Sometimes they also offer them stock at a frozen price so they can help the company grow but still be able to buy the stock at a low price Controls Fraud management doing something illegal or unethical Usually happens in accounting where they misrepresent the numbers so managers look like they are doing a better job than they are This will usually be caught eventually just because the difference between the numbers and the actual performance will be increasingly obvious Sarbanes Oxley Act Enron WorldCon Tyko They inflated the numbers of company results to increase the stock prices in the short term Then everything fell apart and the government tried to hold them accountable but the top executives didn t seem aware that this was going on It was difficult to identify with evidence who was at fault so the Sarbanes Oxley Act was formed This was intended to create the chain of evidence to ensure that the top executives did know what was going on in the company and can see who is in charge of decisions With this every time someone makes a decision to change something the supervisor has to sign it Every quarter everyone who enters anything in the company s ledger has to sign agreeing that they did everything right and am not aware of any fraud If they are aware they have to list it so the top executives can never claim they are unaware of anything Corporate finance addresses three main important questions 1 How will the everyday financial activities of the firm be managed Working capital management a Working capital is the capital for day to day operations This capital deals with all of the short term concerns so it can be determined if the firm can cover their upcoming expenses It s important also not to have too much of this capital either as the firm would be better off if it was in use b Liquidity this is used to talk about if you can sell an item quickly and get a fair price for it Liquidity is how things can be traded and turned into cash Things that can be turned into cash quickly and easily are considered
View Full Document
Unlocking...