ENTREPRENEURIAL FINANCE Fifth Edition Chapter 1 Financial and Economic Concepts

Buffett and Gates Buffett and Gates Section 5 http://www.youtube.com/watch?feature=player_detailpage&v=_4_jj843x2Q Buffett and Gates Section 6 Buffett and Gates Section 7 http://www.youtube.com/watch?feature=player_detailpage&v=g3e3RFx0D_c Buffett and Gates Section 8 http://www.youtube.com/watch?feature=player_detailpage&v=Ez_pjiIy0sY

What is it? Finance is essentially any transaction in which money or a money- like instrument is exchanged for other money or another money- like instrument. Tasks Cash management Investing Financing Implementation of strategic plans

Cash Management Critical task for managers Obviously need cash to operate Cannot exist very long with poor cash management What do we manage Inflow of cash From customers From investors Outflow of cash To suppliers To creditors To owners

Investing Managers invest in two basic asset types Invest in the securities of other companies Strategies followed are identical to the strategies of individual investors Invest in plant and equipment Processes are very similar to individuals Ultimate goal is to maximize the value of the firm

Financing Where do managers get funds to enable the firm to grow and operate. Sources of funds Their own assets Friends, family, other people Banks and insurance companies Bonds Stocks Profits of the firm The size and type of the firm will determine which of these can be used.

Source: www.bizstats.com

Implementation of the strategic plan The overall outcome of financial management is to provide the mechanism and tools to implement the plans of the company. A secondary activity is providing data for understanding how the plan is functioning. Also, data for the creation of the plan is provided through the tools available from financial management.

Economic concepts In the US, basic principle is that individuals can achieve their own objectives within a free enterprise system. Market economy – individuals and institutions exchange goods and services freely Real estate Retail Commodities Financial instruments Who gains when we perform transactions? Both sides (buyers and sellers) believe they gain from a transaction.

Economic Concepts Scarce resources – scarce because people want more than they have. Types Natural resources Human resources Capital resources Economic Financial Entrepreneurial resources http://www.youtube.com/watch?feature=player_detailpage&v=VttAbSYYIsw

Expected Annual Return (%) Economic Concepts Opportunity costs The highest value that is surrendered when a decision to invest funds is made. http://www.youtube.com/watch?feature=player_detailpage&v=pWE7WDZC-lQ Table 1-1 Expected Financial Returns of Investment Opportunity Investment Opportunity Expected Annual Return (%) Purchase stock 11 Purchase home 9 Purchase bonds 6 Place money in bank savings account 2 Purchase new car -15  

Income, Expenditures, and Taxes Gross income is all of the money received from all sources during the year. Wages Tips Interest earned on savings and bonds Income from rental property Profits to entrepreneurs

Taxes Progressive taxes: larger percentage of tax paid as income increases. Regressive taxes: larger percentage of tax paid as income decreases. Proportional taxes: percentage of tax paid remains the same at all levels of income.

Example of Progressive Tax Formula for tax percentage paid: Income tax is progressive:

Example of Regressive Tax Sales tax is regressive: Income = $20,000; savings = 0; sales tax = 5% Sales tax paid = $20,000 x 0.05 = 1,000 Income = $60,000; savings = $10,000; sales tax = 5% Sales tax paid = $20,000 x 0.05 = $1,000

Example of Proportional Tax Formula for tax percentage paid: Medicare tax is 1.45% Annual income $30,000 Medicare tax = $30,000 x 0.0145 = $435 Annual income $500,000 Medicare tax=$500,000 x 0.0145 = $7,250

Basic Income Calculations Gross income - taxes = Disposable income For most of us, disposable income is take-home pay. Disposable income - Fixed expenses = Discretionary income Fixed expenses are contractual obligations like rent, utilities, insurance, and car payments. Discretionary income is that we can spend or save. Does this include debt?? NO Would the government want to find a way to increase disposable income? Why?? Would the government rather you spend or save your disposable income??

What do we learn? We have a progressive tax system. Fixed expenses decrease as a percentage of income, as income increases. Discretionary income increases as wealth increases.

Economic Concepts Factors Affecting Interest Rates The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds. law of supply relates to the price paid and the quantity of a resource that is provided at that price. The demand for borrowed funds is all of the money that is demanded in our economy at a given price. The law of demand states that as the price of an item de-creases, people will demand a larger quantity of that item,

As interest rates increase, all people would desire to save more money, but at a decreasing rate.

Economic Concepts Factors Affecting Interest Rates The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds. law of supply relates to the price paid and the quantity of a resource that is provided at that price. The demand for borrowed funds is all of the money that is demanded in our economy at a given price. The law of demand states that as the price of an item de-creases, people will demand a larger quantity of that item,

Factors Affecting Interest Rates (continued) In a totally free market supply and demand will determine interest rates. We do not have a totally free market. Federal Reserve Policy The Federal Reserve is the central bank of the United States. Monetary policy is the government’s action to alter the supply of money. Goals of monetary policy Economic growth Price stability Full employment

Factors Affecting Interest Rates (continued) Inflation is a primary concern for the FED. A primary goal is to assure that inflation remains in check to create stability in prices. How do they attempt to control inflation? Open market operations Discount rate Reserve requirements

Factors Affecting Interest Rates (continued) Risk Systematic Risk: Risk associated with economic, political, and sociological changes that affect all participants on an equal basis. Frequently referred to as market risk This risk is not diversifiable Unsystematic Risk: Risk unique to an individual, firm, or industry. Frequently referred to as company specific risk This risk is diversifiable