Corporate Finance & Business Organizations

Corporate Finance & Financial Manager

• Corporate finance involves making financial decisions for a company, such as determining investments, financing, and managing day-to-day financial activities.
• Financial managers act as representatives of the owners, focusing on three key areas: capital budgeting, capital structure, and working capital management.
• Capital budgeting: involves planning and managing long-term investments, considering the value, timing, and risk of cash flow.
• Capital structure: involves determining the mix of debt and equity used to finance operations, impacting the firm's risk and value.
• Working capital management: focuses on managing short-term assets and liabilities, ensuring sufficient resources for smooth operations and mitigating costly disruptions.

Forms of Business Organization

• Sole Proprietorship: a single-owner business, simplest to establish with unlimited liability for debts, profits taxed as personal income.
• Partnership: two or more individuals or entities forming a business, with general partners bearing unlimited liability and limited partners having limited liability based on their contribution.
• Corporation: a separate legal entity with unlimited life, limited liability, and easier access to funding, subject to double taxation on profits.

Goal of Financial Management

• The primary goal of financial management is to maximize the current value per share of existing stock, which translates to maximizing the market value of the owners' equity.
• This emphasizes the focus on aligning business decisions with stock value for optimal shareholder benefit.

Agency Problem and Control of the Corporation

• Agency problem arises due to the separation of ownership and management, potentially creating conflict of interest between owners and managers.
• Agency cost is incurred to mitigate this conflict, including direct costs like management benefits and monitoring expenses, and indirect costs like lost opportunities.
• The effectiveness of aligning managers' interests with stockholders' goals depends on managerial compensation, job prospects, and control mechanisms like proxy fights and takeovers.

Financial Markets and the Corporation

• Financial markets facilitate the transfer of corporation ownership and raise necessary funds for growth.
• Primary markets involve initial public offerings (IPO) or private placements, while secondary markets involve trading of existing shares.
• Dealer markets (OTC) involve dealers buying and selling for themselves, while auction markets (like Wall Street) match buyers and sellers.
• NYSE and NASDAQ are prominent examples of auction markets supporting corporate financial activities.

The Balance Sheet

• A snapshot of a firm's financial position at a specific point in time.
• Assets: What a firm owns (e.g., tangible assets like trucks, intangible assets like patents).
• Liabilities: What a firm owes (e.g., short-term debt like accounts payable, long-term debt like bonds).
• Equity: The difference between assets and liabilities, representing the owners' stake in the firm.
• Balance Sheet Identity: Assets = Liabilities + Stockholders' Equity.

Assets: The Left Side

• Fixed Assets: Have a relatively long lifespan (e.g., buildings, machinery).
• Current Assets: Have a life of less than a year (e.g., cash, inventory).

Liabilities: The First thing On The Right Side

• Current Liabilities: Due within a year (e.g., accounts payable).
• Long-Term Liabilities: Not due in the coming year (e.g., long-term debt, bonds).

Owners’ Equity: The Right Side

• Shareholders' Equity: Represents the residual value of the firm after all liabilities are paid.
• The balance sheet always balances because the value of assets equals the value of liabilities and equity.

Net Working Capital

• Net Working Capital (NWC): Current assets minus current liabilities.
• Positive net working capital typically indicates a healthy firm.

Liquidity

• Liquidity: The ease and speed with which an asset can be converted to cash.
• Highly Liquid Asset: Converted quickly with minimal loss of value.
• Illiquid Asset: Difficult to convert quickly without substantial price reduction.
• Assets are listed on the balance sheet in order of decreasing liquidity (cash, receivables, inventory, fixed assets).
• Liquidity is valuable, but liquid assets are often less profitable.

Debt vs. Equity

• Debt: Creditors receive first claim to the firm's cash flow.
• Equity: Shareholders receive the remaining cash flow after creditors are paid.
• Financial Leverage: Using debt in a firm's capital structure, which can magnify both gains and losses.

Market Value vs. Book Value

• Book Value: Assets are recorded on the balance sheet at historical cost (based generally accepted accounting principles or GAAP).
• Market Value: The actual worth of an asset in the market.
• Market values are typically more relevant to managers and investors than book values.

The Income Statement

• Measures a firm's performance over a specific period (usually a quarter or year).
• Income Statement Equation: Revenues - Expenses = Income.

The Income Statement (Continued)

• Earnings Per Share (EPS): Net Income ÷ Number of Shares Outstanding.
• Retained Earnings: Profits not distributed to shareholders, added to the cumulative retained earnings account on the balance sheet.
• GAAP Matching Principle: Recognizes revenue when earned and matches the expenses associated with generating that revenue.
• Noncash Items: Accounting entries that do not involve actual cash flows (e.g., depreciation).

Taxes

• Corporate Tax Rate: In 2018, the corporate tax rate in the U.S. was simplified to 21% regardless of taxable income.

Marginal vs. Average Tax Rates

• Marginal Tax Rate: The percentage paid on the next dollar earned.
• Average Tax Rate: Total taxes paid divided by taxable income.
• In a flat tax system, the marginal rate equals the average rate.

Cash Flow

• Cash Flow: The difference between cash inflows and cash outflows.
• Statement of Cash Flows: Provides a detailed breakdown of cash flows.
• Cash Flow Identity: Cash Flow From Assets (CFFA) = Cash Flow To Creditors + Cash Flow To Stockholders.

Cash Flow From Assets (CFFA)

• Operating Cash Flow (OCF): Cash generated from a firm's daily operations.
• Net Capital Spending (NCS): Net investment in fixed assets.
• Changes in Net Working Capital (NWC): The change in current assets minus the change in current liabilities.
• CFFA = OCF - NCS - Changes in NWC.

This quiz covers essential concepts of corporate finance, including capital budgeting, capital structure, and working capital management. Additionally, it explores various forms of business organization such as sole proprietorships and partnerships. Test your knowledge on how financial managers make strategic decisions for companies.