1 FINC3131 Business Finance Chapter 1: Introduction & overview

2 Learning Objectives 1.Identify 3 main subject areas in finance 2.Why sound financial management is vital to survival in business 3.Difference between Finance (corporate financial management) and Accounting 4.Relationship between cash and value, Importance of cash 5.Goal of financial management 6.Describe different forms of business organization

3 Areas in Finance 1.Corporate finance (financial management) 2.Investments 3.Financial markets & institutions

Why I need to learn Finance? Suppose I want to be a money manager. Q1: shall I buy stocks or bonds? Q2: Which stocks shall I buy? Q3: How to form an investment portfolio? Q4: How to use derivatives to hedge the risk? ….. 4

Why I need to learn Finance? Suppose I want to buy a house with a mortgage loan. Q1: Shall I borrow fix-rate or flexible-rate loan? Q2: Shall I borrow for 15 years or 30 years? Q3: How much shall I repay the bank every month? Q4: How much can I save from paying the interest? 5

Why I need to learn Finance? Suppose I am a marketing manager sitting with finance guys and we are evaluating a potential project, producing i- Pad 7. Finance guys are talking about NPV, the cost of capital, operating cash flows, sunk cost, etc. And then they reject the project based on their reasoning that the NPV of the project is negative. Q1: What is NPV, operating cash flows, etc? Q2: How can I defend the project if I do not understand those finance terms? 6

7 Poor financial management can cause a firm to fail, EVEN IF it efficiently produces, markets and delivers a product that is in great demand. Financial Management

8 Corporate Finance vs. Accounting Accounting historically based/ backward looking Corporate finance forward looking Corporate Finance (financial management) involves analysis of income statement and balance sheet, as financial statements provide information useful for estimating future cash flows and firm value.

9 Cash and Value 1.Relationship between cash (cash flows) and value: The value of an investment is determined by the future cash flows that the investment generates for the investor 2.Why focus on cash? Simple, the only thing that investors eventually want is CASH.

Finance Within the Organization Board of Directors Chief Executive Officer (CEO) Chief Operating Officer (COO) Marketing, Production, Human Resources, and Other Operating Departments Chief Financial Officer (CFO) Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations 1-10

11 Primary Goal of Financial Management Maximize the wealth of stockholders/owners Why? Stockholders invest in the firm because they want to make money. maximizing shareholders’ wealth is equivalent to maximizing stock price or market value of the firm

Why the following answers are wrong? 1.To maximize the current dividends per share paid out to shareholders. 2.To maximize the current net income. 3.To maximize the operating profit of the current year. 4.To maximize the asset. 12

Main forms of Business Organization 1.Sole proprietorship 2.Partnerships 3.Corporations 4.Limited liability companies (LLCs) and Limited liability partnerships (LLPs) 13

Sole proprietorship 1.Easily and inexpensively formed 2.100% owned and managed by one person 3.Few government regulations 4.Personal income taxes, no corporate income taxes 5.Unlimited personal liability 6.Difficult to obtain large sums of capital 14

Partnerships 1.Easily and inexpensively formed 2.Owned and managed by two or more persons 3.Few government regulations 4.Personal income taxes, no corporate income taxes 5.Unlimited personal liability 6.Difficult to raise large amounts of capital 15

Corporations (C corporations) 1.Separation of ownership and management. 2.Easier to transfer the ownership 3.Easier to raise the capital 4.Double taxation. 5.Limited liability * S corporations are exempt from corporate income tax. (no more than 100 stockholders) 16

LLC and LLP 1.Limited liability 2.Personal income taxes, no corporate income taxes 3.LLPs are used for professional firms in accounting, law and architecture 4.LLCs are used by other businesses. 17

Firms and Organizations related to Finance 1.All industrial firms 2.Banks, investment company, insurance companies, mutual funds, hedge funds, other financial institutions 3.Federal Reserve Banks, SEC, IMF, World Bank, etc. 4. non-profit organizations. 18