Principles of Finance Chapter #1

Key Determinants of Share Price

- Return - Risk

Sole Proprietorship

- a business owner by one person who operates it for his or her own profit - unlimited liability - 61% of all businesses

Limited Partnership (LP)

- a partnership in which one or more partners have limited liability as long as at least one partner (the general partner) has unlimited liability - the limited partners are passive investors that cannot take an active role in the firm's management

S Corporation

- a tax-reporting entity that allows certain corporations with 100 or fewer stockholders to choose to be taxed as partnerships - its stockholders receive the organizational benefits of a corporation and the tax advantages of a partnership

Corporations

- an entity created by law - has the legal powers of an individual in that it can sue and be sued, make and be party to contracts, and acquire property in its own businesses - 80% of total business revenues - Owners of a corporation are its stockholders, whose ownership takes the form of common stock - stockholders have limited liability - their losses are limited to the amount they invested

Partnerships

- consists of two or more owners doing business together for profit - 8% of all businesses - established by a written contract known as Articles of Partnership - all partners have unlimited liability - each partner is legally liable for all of the debt of the partnership

Board of Directors

- group elected by the firm's stockholders and typically responsible for approving strategic goals and plans, setting general policy, guiding corporate affairs, and approving major expenditures

Cash Flows

- profits do not necessarily result in cash flows available to the stockholders - higher earnings do not necessarily translate into a higher stock price.

Residual Claimants

- stockholders are paid last, after employees, suppliers, tax authorities, and lenders receive what they are owed - if the firm does not generate enough cash to pay everyone else, there is nothing available for stockholders

Earnings Per Share (EPS)

- the amount earned during the period on behalf of each outstanding share of common stock calculated by dividing the period's total earnings available for the firm's common stockholders by the number of shares of common stock outstanding. - corporations commonly measure profits in terms of earnings per share

Risk

- the chance that actual outcomes may differ from those expected - trade-off exists between return (cash flow) and risk

Two Essentials Parts of Profit

1. Time 2. Cash Flow

President or Chief Executive Officer (CEO)

Corporate official responsible for managing the firm's day-to-day operations and carrying out the policies established by the board of directors

Marginal Cost - Benefit Analysis

Economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs

Balance Sheet

Investment decisions: - Current Assets - Fixed Assets Finance Decisions: - Current Liabilities - Long-term Liabilities

Limited Liability Partnership (LLP)

Permitted in most states, LLP partners are liable for their own acts of malpractice, but not for those of other partners. The LLP is taxed as a partnership and is frequently used by legal and accounting professionals

Limited Liability Company (LLC)

Permitted in most states, the LLC gives it owners limited liability and taxation as a partnership. But unlike an S Corp, the LLC can own more than 80% of another corporation, and corporations, partnerships, or non-U.S. Residents can own LLC shares

Financial Analyst

Prepares the firm's financial plans and budgets. Other duties include financial forecasting, performing financial comparisions, and working closely with accounting

3 Legal Forms of Business

Sole Proprietorship Partnership Corporation

Financial Manager

actively manages the financial affairs of all types of businesses, whether private or public, large or small, profit-seeking or not for profit - places primary emphasis on cash flows, the intake and outgo of cash

Credit Analyst/Manager

administers the firm's credit policy by evaluating credit applications, extending credit, and monitoring and collecting accounts receivable

Sarbanes-Oxley Act of 2002

an act aimed at eliminating corporate disclosure and conflict of interest problems

Project Finance Manager

arranges financing for approved long-term investments. Coordinates consultants, investment bankers, and legal counsel.

Time

because the firm can earn a return on funds it receives, the receipt of funds sooner rather than later is preferred

How do stockholders expect a return?

by receiving dividends

Managerial Finance

concerns the duties of the financial manager in a business

What is an Accountants Primary Function

develop and report data for measuring the performance of the firm, assess its financial position, comply with and file reports required by securities regulators, and file and pay taxes

"Creative Accounting"

earnings management, misleading financial forecasts, insider trading, fraud, excessive executive compensation, options backdating, bribery, and kickbacks

Capital Expenditures Manager

evaluates and recommends proposed long-term investments. May be involved in the financial aspects of implementing approved investments

Stakeholders

groups such as employees, customers, suppliers, creditors, owners, and others who have a direct economic link to the firm

Accrual Basis

in preparation of financial statements, recognizes revenue at the time of sale and recognizes expenses when they are incurred

institutional investors

investment professionals such as banks, insurance companies, mutual funds and pension funds.

individual investors

investors who own relatively small quantities of shares so as to meet personal investment goals

Common Stock

is the purest and most basic form of corporate ownership

Cash Manager

maintains and controls the firm's daily cash balances. Frequently manages the firm's cash collection and disbursement activities and short-term investments and coordinates short-term borrowing and banking relationships.

Foreign Exchange Manager

manages specific foreign operations and the firm's exposure to fluctuations in exchange rates

Goal of the Firm

maximize shareholder wealth

Pension fun manager

oversees or manages the assets and liabilities of the employees' pension fund

Dividends

periodic distributions of cash or by realizing gains through increases in share price

Business Ethics

standards of conduct or moral judgement that apply to persons engaged in commerce.

C - Corporation

taxed at the local level, separate from its owners

Financial Services

the area of finance concerned with the design and delivery of advice and financial products to individuals, businesses, and governments

Foreign Exchange Manager

the manager responsible for managing and monitoring the firm's exposure to loss from currency fluctuations

corporate goverance

the rules, processes, and laws by which companies are operated, controlled and regulated.

Finance

the science and art of managing money

The Firm's Share Price

the simplest and best measure of stockholder wealth