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Finance Chapter 01

Principle of finance ,Accounting department

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23 views8 pages

Finance Chapter 01

Principle of finance ,Accounting department

Uploaded by

abdullahtashin90
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Fundamentals of Finance

Lecture: 01
Overview of the finance
1. What is Finance?
2. Three Types of Business Organizations
3. Hierarchy
4. The Goal of the Financial Manager
5. The Four Basic Principles of Finance
6. Agency Relationship

What is Finance?
Finance means the collection of funds and allocation of that collected funds.

Three questions addressed by the study of finance:


1. What long-term investments should the firm undertake?

(capital budgeting decisions - how to spend the money?)
2. How should the firm fund these investments?

(capital structure decisions – How to get the money?)
3. How can the firm best manage its cash flows as they arise in its day-to-
day operations?
(working capital management decisions – how to manage cash money?)

There are three types of business:


 Sole proprietorships
 Partnerships
 Corporations
Sole Proprietorship
 It is a business owned by a single individual that is entitled to all the
firm’s profits and is responsible for all the firm’s debt.
 There is no separation between the business and the owner when it comes
to debts or being sued.
 Sole proprietorships are generally financed by personal loans from family
and friends and business loans from banks.

Advantages Disadvantages
• Easiest to start. • Limited to life of owner.
• Least regulated. • Equity capital limited toowner’s
• Single owner keeps all of personal wealth.
theprofits. • Unlimited liability.
• Taxed once as personal income. • Difficult to sell ownership interest.

Partnership
 A general partnership is an association of two or more persons who come
together as co-owners for the purpose of operating a business for profit.
 There is no separation between the partnership and the owners with respect
to debts or being sued.

Advantages Disadvantages
• Relatively easy to start, Two or more • Partnership dissolves when one
owners. partner dies or wishes to sell.
• More capital available. • Difficult to transfer ownership.
• Relatively easy to start.
• Income taxed once as personal income.
Limited Partnership:
 In partnerships, there are two classes of partners: general and limited.
 The general partners runs the business and face unlimited liability for the
firm’s debts, while the limited partners are only liable on the amount
invested.
 One of the drawback of this form is that it is difficult to transfer the
ownership of the general partner.

Corporation
 Corporation is “an artificial being, invisible, intangible, and existing only
in the contemplation of the law.”
 Corporation can individually sue and be sued, purchase, sell or own
property, and its personnel are subject to criminal punishment for crimes
committed in the name of the corporation.
 Corporation is legally owned by its current stockholders.
 The Board of directors are elected by the firm’s shareholders.

Advantages Disadvantages
 Limited liability.  Separation of ownership and
 Unlimited life. management (agency problem)
 Separation of ownership and  Double taxation (income taxed at
management. the corporate rate and then
 Transfer of ownership is easy dividends taxed at personal rate,
 Easier to raise capital. while dividends paid are not tax
deductible)
Hierarchy
How the finance area fits into a corporation firm's vice president of finance is
many times called its chief financial officer, or cceo. This
his person oversees all
the firm's financial activities through the offices of the firm's treasurer and
controller

Board of
Directors
The Goal of the Financial Manager
• The goal of the financial manager must be consistent with the mission of
the corporation.
• To maximize firm value shareholder’s wealth (as measured by share
prices).
• While managers have to cater to all the stakeholders (such as consumers,
employees, suppliers etc.), they need to pay particular attention to the
owners of the corporation, i.e. shareholders.
• If managers fail to pursue shareholder wealth maximization, they will lose
the support of investors and lenders. The business may cease to exist and
ultimately, the managers will lose their jobs!

Financial managers try to answer some, or all, of these questions:


1. What long-term investments should the firm take on?
2. Where will we get the long-term financing to pay for the
investments?
3. How will we manage the everyday financial activities of the firm?

Financial Management Decisions


Capital budgeting: What long-term investments or projects should the
business take on?
Capital structure: (1) How should we pay for our assets? (2) Should we use
debt or equity?
Working capital management: How do we manage the day-to-day finances
of the firm?
Dividend Policy Decision: How much current earns will be paid out as
dividend to stockholders?
The Agency Problem & Managing Managers
Agency relationship
• Principal hires an agent to represent its interests.
• Stockholders (principals) hire managers (agents) to run the company.
Agency problem: Conflict of interest between principal and agents.

Managing Managers
Managerial compensation
Incentives can be used to align management and stockholder interests
The incentives need to be structured carefully to make sure that they
achieve their goal
Corporate control: The threat of a takeover may result in better
management

The Four Basic Principles of Finance


1. Money has a time value: A dollar received today is more valuable than a
dollar received in the future (due to interests, investment returns,…)
2. There is a risk-return trade-off: One shall take extra risk only if one
expects to be compensated for extra return.
3. Cash flows are the source of value: Profit is an accounting concept
designed to measure a business’s performance over an interval of time.
Cash flow is the amount of cash that can actually be taken out of the
business over this same interval.
4. Market prices reflect information: Investors respond to new information
by buying and selling their investments.
Quick Quiz
• What is finance?
• What are the financial management decisions, and what questions are
they designed to answer?
• What are the three major forms of business organization?
• What is the goal of financial management?
• What are agency problems, and why do they exist within a corporation?
• What are the four basic areas of finance?

Money is the best dream to be slave.

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