FIN 320F: UNIT 1

What are the 3 key roles of the government?

1. Enhance the welfare of its citizens 2. Limit opportunistic behavior 3. Modify or replace markets (take on economic activity)

What are the three sources of return to those involved in a company?

1. Labor (compensation is due) 2. Capital (risk of stocks and bonds gets compensated accordingly) 3. Economic rents

3 decision that managers in corporations make to determine the level of efficiency and thus the wealth-increasing potential of the corporation, which are...

1. capital budgeting decision (what productive assets should the firm obtain? this is guided by the customers) 2. capital structure decision (must raise capital from investors by issuing financial securities to finance its operations) 3. net working capital decision (corporation must be able to manage its short-term expenses)

Efficiency comes from 2 sources, which are...

1. efficient production of goods and services via specialization 2. raising sufficient investment capital to obtain the company's productive assets

What 2 objectives occur when a business if efficient?

1. organizing productive effort 2. raising capital

What is Laissez Faire?

A hands off approach to an economy that has little to no government interference

What is a capital lease?

A lease considered to have the economic characteristics of asset ownership.

What is the agent?

A person that acts for or in place of another by authority of that person.

What is the principal?

A person who employs another to act on the principal's behalf and controls that person's actions.

What is a corporation?

A business that is chartered by government to conduct business. It is a legal entity separate from its owners, and can enter into contracts separate from its owners.

What is a proprietorship?

A business where a person combines the functions of owner, manager and worker. Proprietorships are efficient in small-scale operations.

What is a general partnership?

A business where several people share ownership and management.

What are amortization/impairments charges?

A charge that captures the change in value of acquired assets. Like depreciation, amortization is not an actual cash expense.

What is corporate social responsibility?

A corporation's responsibility for its effects on environmental and social well being, often involving efforts that go beyond what may be required by regulation.

What is a fiduciary?

A fiduciary is responsible for making decisions that benefit another, not the person making the decisions. (i.e. guardian of a minor)

What are liabilities?

A firm's obligations to its creditors.

What is inventories?

A firm's raw materials as well as its work-in-progress and finished goods

What is book value?

Acquisition cost of an asset less its accumulated depreciation

What is Depreciation expense?

Amount deducted, for accounting purposes, from an asset's value to reflect wear and tear over a given period

What is accounts receivable?

Amounts owed to a firm by customers who have purchased goods or services on credit

What is long-term debt?

Any loan or debt obligation with a maturity of more than a year.

What is a stakeholder?

Anyone other than shareholders or bondholders who have a stake, or interest in the firm.

What is a shareholder?

Have control of the company and rights to all residual profit. Also called equity holders and stockholders.

Cash management/Working capital management decision

How does the corporation ensure that it has enough cash to operate on a daily basis?

What are deferred taxes?

Balance sheet: Any asset or liability that results from the difference between a firm's tax expenses as reported for accounting purposes, and the actual amount paid to the taxing authority. Income statement: The difference between accounting income and taxable income.

Capital Structure/Financing decision

How should the company raise capital to finance its activities?

What is performance?

How well have the managers used assets and claims to produce a profit, or Income over a given period of time.

What is the financing decision/capital structure decision?

How will the company obtain investment capital to obtain its productive assets?

What are agency costs?

Reduction in a corporation's cash flows created by the existence of the agency conflict.

What are current assets?

Cash or assets that could be converted into cash within one year, liquid assets. Includes: marketable securities, accounts receivables, inventories, and pre-paid expenses such as rent and insurance

What is agency relationship?

The corporate organizational form legally separates ownership and management. The shareholders of the company are principals and hire managers as their agents to run the corporation.

What are external control devices?

Controls on managers that exist outside of the corporation. i.e. government regulation, external audits, hostile takeover, institutional investors, corporate social responsibility (CSR)

What are internal control devices?

Controls on managers that exist within the corporation. i.e. compensation contracts, board of directors, governing documents, managers

What is short-term debt?

Debt with a maturity of less than one year.

What are the GAAP?

Generally Accepted Accounting Principles A comment set of rules and standard format for public companies to use when they prepare financial reports

What is the Cost Principle?

Generally recording an item at cost, and does not adjust its value in the accounting statements

What is a mixed economy?

Governments and markets interact (private property rights are respected and businesses have substantial economic freedom to operate, but where governments do intervene in economic activity in order to achieve social goals)

What is change in net working capital?

Investing or disinvesting in current (short-term) assets.

What are long-term liabilities?

Liabilities that extend beyond one year.

What are current liabilities?

Liabilities that will be satisfied within one year. They include accounts payable, notes payable, short-term debt, current maturities of long-term debt, salary or taxes owed, and deferred or unearned revenue.

In a corporation, what is management?

Managers are employees hired by the corporation to run it for the benefit of its owners, the shareholders.

What is an agency problem?

Managers might use their position to make themselves better off at the expense of the shareholders. This agency conflict potentially reduces the profitability of the firm for its shareholders.

What are long-term assets/Capital assets?

Net property, plant, and equipment, as well as property used in business operations, start-up costs with a new business, investments, in long-term securities, and property held for sale.

What are intangible assets?

Non-physical assets, such as intellectual property, brand names, trademarks, and goodwill. Intangible assets appear on the balance sheet as the difference between the price paid for an acquisition and the book value assigned to its tangible assets.

In a corporation, what is ownership?

Owners, called shareholders, provide investment equity capital to the company and in return are given control of the company and the rights to all profits earned by the company. They hire managers to run the company for their benefit.

What is the pass through provision?

Profits of the company are not taxed at the corporate level but passed through to the owners and taxed as personal income.

What is cash?

Purchasing power accepted by market participants in the form of money or its equivalents

What is the Realization Principle?

Recognizing revenues when a contractual obligation occurs, such as a formal sales contract where a customer purchases a product from the company, or debt is incurred

What is preferred stock?

Represents a claim that is senior to common stock but subordinate to liability claims. Preferred stock holders general get a set payment, a dividend, and do not have voting rights except under certain conditions where there promised payments are in jeopardy.

What is common stock?

Represents equity, or ownership of shares in the company. Common shareholders have the right to all profits after the other claimants of the firm are satisfied. They also control the corporation via their votes at the shareholders' annual meeting. Shareholders bear the residual risk of the company, in that they are not promised any set rate of return, but get only the residual based on the company's performance.

What is the Accrual Method/Matching Principle?

Revenues should be matched with the expenses used to produce them

What is a Marketable Security?

Short-term, low-risk investments that can be easily sold and converted to cash (such as money market investments, like government debt, that mature within a year; Treasury bills)

What is the Balance Sheet?

Statement of Financial Position It reflects the accounting value of the firm's productive assets and the claims against those assets

What is value?

The ability to value a company.

What are accounts payable?

The amounts owed to creditors for products or services purchased with credit.

What is unlimited life?

The business is a separate legal entity that does not end with the life of an owner.

What is limited life?

The business is owned by a natural person/persons and ends when the owner/s die.

What is accumulated depreciation?

The cumulative depreciation of an asset up to a given point in its life equal to last period's accumulated depreciation plus the current period's depreciation expense

What is Net Working Capital?

The difference between a firm's current assets and current liabilities that represents the capital available in the short-term to run the business. It is a measure of a firm's liquidity: its ability to pay its short-term liabilities. Net working capital = Current assets - Current liabilities

What is the book value of equity/shareholder equity?

The difference between the book value of a firm's assets and its liabilities, also called stockholders' equity, it represents the net worth of a firm from an accounting perspective.

What is goodwill?

The difference between the price paid for a company and the book value assigned to its assets

What is accounting liquidity?

The ease and quickness with which assets can be converted to cash

What is transferability?

The ease with which ownership interests can be transferred from one owner to another

What is dismal science?

The natural constraint of resources (all resources, such as water, electricity, roads, food) makes economics

What is limited liability?

The owner/s liability in the business is limited to the amount that they have invested in the business.

What is unlimited liability?

The owner/s of the business are personally liable for the obligations of the business.

What is corporate governance?

The structure and procedures that allow the shareholders to control the corporation.

What is the balance sheet/accounting identity formula?

Total assets = total liabilities + stockholders' equity

What is the product decision?

What product should the company produce?

What is the production decision/capital budgeting decision?

What productive assets will the company obtain?

Capital Budgeting/Investment decision

What productive projects should the firm undertake?

What is socialism?

a command economy, uses collective or governmental control of property rights (meaning that the government directs the economy to provide a fair distribution of society's output) Governmental control of property rights reduces economic inequality, leading to grater social cohesion and protection of people's dignity

What is capitalism?

a market economy, uses individual control of property rights (participants act on incentives to maximize welfare) This maximizes the standard of living for society as a whole

What is an NGO?

a more general term; private sector, voluntary (and usually non-profit and non-sectarian) organization that contributes to, or participates in, cooperation projects, education, training or other humanitarian, progressive, or watchdog activities. Some of them are accredited by the UN, and some collect donations for distribution among disadvantaged or distressed people. Major worldwide NGOs include International Air Transport Association (IATA), International Chamber Of Commerce (ICC), International Committee Of The Red Cross, International Organization For Standardization (ISO), Transparency International, World Wide Web (W3) Consortium, and World Wildlife Fund (WWF)

What is fairness?

all humans have access to a decent standard of living

What are assets?

cash, inventory, property, plant and equipment, and other investments that a company has made

What is fiscal policy?

collective term for the taxing and spending actions of governments (In the US, the national fiscal policy is determined by the Executive and Legislative branches) (one way the government manages the economy)

What is an economic asset?

entities functioning as stores of value and over which ownership rights are enforced by institutional units, individually or collectively, and from which economic benefits may be derived by their owners by holding them, or using them, over a period if time

What is economic efficiency?

getting the most output from scarce productive resources

What is a nonprofit organization?

groups that are tax-exempt under Internal Revenue Code Section 501(c)(3) as "public charities" because they are formed to provide "public benefit." Community foundations are also part of this group (and so are private foundations, although tax rules treat them a bit differently than public charities

Human beings can be characterized by 3 elements, which are...

incentives (evaluative), maximization (imperfectly), resourcefulness

What are the corrective mechanisms that a market has in place in regards to ethics?

information, competition,

What is economic activity?

involves the production, distribution, and consumption of economic assets

What is Smith's definition of self-interest?

market participants pursue their own interests, but do respect the rights of other market participants; seeking a fair deal

What is Smith's definition of opportunism?

market participants seek to benefit themselves by unethical behavior (theft, deception, etc.), which reduces both the efficiency and fairness of economic activity

What is often the most important incentive for people?

money

What is creative destruction?

new technologies replacing old

What are ethics?

norms of how people treat other people

What is a business?

organization that produces goods or services for sale to a customer base; aka firms or enterprises. *IMPORTANT* It is an organization that... 1. raises capital from investors 2. uses this capital to obtain productive assets 3. uses these productive assets to produce economic assets, aka goods and services, for customers

What is economic rent?

payments that are not required to bring forth a good or service; they are an exploitation of some advantage that restricts competition, such as control of a market or political favoritism that allows the producer to receive a profit larger than what would be expected in a competitive market and above the proper compensation to labor and capital

What is monetary policy?

primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks such as the Federal Reserve (one way the government manages the economy)

What are agency control devices?

procedures, contracts and organizations that corporations can use to guide managers to focus on their fiduciary duties and limit opportunistic behavior.

What is profit?

revenues from selling economic assets - costs of producing economic assets

What is confirmation bias?

seeing out information that confirms existing opinions and overlook or ignore the information that goes against it

How do humans act in a competitive environment (2 choices)?

self-interest, opportunism

What is efficiency in economic activity?

squeezing the maximum output from limited resources

What is market value?

the price at which buyers and sellers would trade the assets

What are property rights?

the right to control an asset (includes how the property should be used, how the benefits from this use are distributes, and the ability to dispose of the asset)

What is the invisible hand?

the unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically; allocative force, incentive to produce, incentives + ethics

What is the goal of a corporation?

to maximize the wealth of its owners, the shareholders, by maximizing the price of the corporation's stock