Unit 3: Structuring the Business Firm

1. What is a sole proprietorship? 2. Regulation? 3. Amount? 4. Profits? 5. Debts? 6. Income? 7. Proprietorship life? 8. Wealth?

1. A business owned by one person 2. Least regulated form of organization 3. More proprietorships than any other type of business 4. The owner of a sole proprietorship keeps all the profits 5. The owner has unlimited liability for business debts 6. No distinction between personal and business income, so all business income is taxed as personal income 7. Life is limited to the owner's life span 8. Wealth is limited to the owner's amount of wealth

What is working capital management?

1. A firms short term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers 2. A day to day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions

1. What is a corporation? 2. 3 things a corporation can do? 3. Partnership? 4. In a large corporation?

1. A legal "person" separate and distinct from its owners, and it has many of the rights, duties, and privileges of an actual person 2. Can borrow money and own property, can sue and be sued, and can enter into contracts 3. Can be a general partner or a limited partner in a partnership, and a corporation can own stock in another corporation 4. The stockholders and the managers are usually separate groups

1. What is a general partnership? 2. Gains and losses?

1. All the partners share in gains or losses, and all have unlimited liability for all partnership debts, not just some particular share 2. The way partnership gains and losses are divided is described in the partnership agreement. This agreement can be informal oral agreement or a lengthy formal written document

What are 2 disadvantages of corporations as forms of business organization?

1. Because a corporation is a legal person, it must pay taxes 2. Money paid out to stockholders in the form of dividends is taxed again as income to those stockholders, this is double taxation

CRITICAL THINKING: What are the three types of financial management decisions?

1. Capital budgeting: What productive assets should the business invest in? Managers must develop a product/service that is attractive to their potential customers. The product/service will exist only if the business invests in productive assets to produce the product/service. 2. Capital structure: How should a business raise the capital needed to invest in productive assets and finance its operations? Should managers issue financial securities—debt and equity—to raise capital? Is there an optimal mix of debt and equity? Instead of financial securities, should the business take out a bank loan? new equity and use the proceeds to retire outstanding debt 3. Working capital management: How can the company maintain its liquidity—its ability to ensure enough cash comes in on a daily basis to satisfy its short claims. Focuses instead on the ability to run the business on a daily basis. Examples would be how the business manages it trade credit policy, its short-terms lines of credit, inventory levels, etc.

CRITICAL THINKING: In a large corporation, what are the 2 distinct groups that report to the chief financial officer? Which group is the focus of corporate finance?

1. Controller's Office and the Controller's Office 2. The Controller's Office: -Handles the functions that help control the corporation's operations 3. The Treasurer's Office: -Focused on the corporation's outside activities, especially those involving raising and deploying capital, including cash and credit management, capital budgeting, and financial planning. 4. Our course focuses on the capital budgeting and capital structure decisions and will thus focus more on the functions of the treasurer's office.

1. What are external control devices? 2. Examples?

1. Controls placed on corporate managers by individuals and organizations outside of the corporation. 2. Lawsuits, large institutional investors, take over, government, and external audits

What are the 4 major areas of finance?

1. Corporate Finance 2. Investments 3. Financial Institutions 4. International Finance

1. What is the power of the stockholders in a corporation? 2. Management's job? 3. In principle?

1. Elect the board of directors, who then select the managers 2. Management is charged with running the corporation's affairs in the stockholders interests 3. Stockholders control the corporation because they elect the directors

Why do you need to understand finance?

1. For marketing, accounting, and management 2. You will have to make financial decisions personally

What are 2 factors that determine whether managers will act in the best interests of stockholders?

1. How closely are management goals aligned with stockholder goals 2. Can management be replaced if they do not pursue stockholder goals

What are 4 questions about working capital that must be answered?

1. How much cash and inventory should we keep on hand? 2. Should we sell on credit to our customers? 3. How will we obtain any needed short term financing? 4. If we borrow in the short term, how and where should we do it?

Sarbanes-Oxley Act (Sarbox): 1. Intended to? 2. Requirements are designed? 3. Sarbox makes? 4. Has caused? 5. Sarbox has affected?

1. Intended to strengthen protection against corporate accounting fraud and financial malpractice 2. Requirements are designed to ensure that companies tell the truth in their financial statements 3. Sarbox makes management personally responsible for the accuracy of a company's financial statements 4. Has caused many companies to "go dark" meaning that their shares are no longer traded in the major stock markets, in which case Sarbox does not apply 5. Sarbox has affected the number of companies going public in the United States

1. What are internal control devices? 2. Examples?

1. Internal to the firm in that they are created and run by the firm's managers and owners. These internal controls assure the stockholders that the managers will look after the stockholders' interests. 2. Compensation, the board of directors, charter, bylaws, managers

What are 3 other names for a corporation?

1. Joint Stock Companies 2. Public Limited Companies 3. Limited Liability Companies

What incentives do managers in large corporations have to maximize share value?

1. Managerial compensation is usually tied to financial performance in general and often times to share value in particular 2. Job prospects, better performers within the firm will tend to get promoted

What are the 3 hybrid organizations?

1. Master Limited Partnership (MLP) 2. Real Estate Investment Trusts (REIT) 3. Limited Liability Company (LLC)

What are 2 more general goals for financial management?

1. Maximize the market value of the existing owners equity 2. What this means is that the financial manager best serves the owners of the business by identifying goods and services that add value to the firm because they are desired and valued in the free marketplace

1. What must the articles of incorporation contain? 2. Information?

1. Must contain the corporation's name, its intended life (which can be forever), its business purpose, and the number of shares that can be issued 2. Information must normally be supplied to the state in which the firm will be incorporated; for legal purposes, the corporation is a "resident" of that state

What are 5 shortcomings of the goal of profit maximization?

1. Not a precise objective 2. Do we mean profits this year? 3. Do we mean something like accounting net income or earnings per share? 4. What do we mean by the long run? 5. This goal doesn't tell us the appropriate trade-off between current and future profits

What are the 3 rules a corporation should follow?

1. Offer customers a good value. 2. Use only the resources necessary. 3. Make the best use of investment capital.

1. What is a limited partnership? 2. Limited partner liability? 3. Limited partner interest?

1. One or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who do not actively participate in the business 2. A limited partners liability for business debts is limited to the amount that partner contributes to the partnership 3. A limited partners interest can be sold without dissolving the partnership

What are 2 advantages of corporations as forms of business organization?

1. Ownership can be readily transferred and the life of the corporation is therefore not limited 2. Corporation borrows money in its own name. As a result, the stockholders in a corporation have limited liability for corporate debts. The most they can lose is that they have invested

1. What are bylaws? 2. Example? 3. The bylaws may be?

1. Rules describing how the corporation regulates its own existence 2. The bylaws describe how directors are elected 3. May be amended or extended from time to time by the stockholders

What are the 3 forms of business organization?

1. Sole Proprietorship 2. Partnership 3. Corporations

1. Who are stakeholders? 2. Examples?

1. Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm 2. Employees, customers, suppliers, and the government

What are 2 ways to differentiate stakeholders from shareholders?

1. Stakeholder claims are generally specified as limited payments to factors of production that are obligations of the firm or fixed payments from customers. 2. Shareholders have only a residual claim on a company's cash flows. This residual claim means that the shareholders are paid only after all of the other stakeholders have been paid. No profit means that there is no payment to shareholders.

1. Who does control of the firm ultimately rest with? 2. Control of the firm can happen with? 3. Management can be replaced by?

1. The Stockholders 2. A proxy fight 3. Takeover

What are 3 reasons corporate form is superior when it comes to raising cash?

1. The ease of transferring ownership, the limited liability for business debts, and the unlimited life of the business are the reasons the corporate form is superior when it comes to raising cash 2. If a corporation needs new equity, it can sell new shares of stock and attract new investors 3. The number of owners can be huge; larger corporations have many thousands or even millions of stockholders

1. What is the goal of a limited liability company (LLC)? 2. Hybrid of? 3. The IRS?

1. The goal is to operate and be taxed like a partnership but retain limited liability for owners 2. Essentially an LLC is a hybrid of a partnership and a corporation 3. The IRS will consider an LLC a corporation, thereby subjecting it to double taxation, unless it meets certain specific criteria: cannot be too corporation like

1. What is a proxy fight? 2. What is a proxy? 3. How does a proxy fight develop?

1. The mechanism by which unhappy stockholders can act to replace existing management 2. A proxy is the authority to vote someone else's stock 3. A proxy fight develops when a group solicits proxies in order to replace the existing board and thereby replace existing management

1. What is capital budgeting? 2. What does the financial manager do? 3. What should you evaluate?

1. The process of planning and managing a firm's long-term investments 2. Tries to identify investment opportunities that are worth more to the firm than they cost to acquire 3. Evaluating the size, timing, and risk of future cash flows is the essence

1. What are agency relationships? 2. Exists when? 3. Possibility?

1. The relationship between stockholders and management 2. A relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interest. 3. There is a possibility of conflict of interest between the principal and the agent

1. What is capital structure? (Financial Structure) 2. What are the financial managers 2 concerns? 3. Must decide?

1. The specific mixture of long-term debt and equity the firm uses to finance its operations 2. 2 concerns: -How much should the firm borrow? -What are the least expensive sources of funds for the firm? 3. How and where to raise the money

1. What is a partnership? 2. What are the 2 types of partnerships?

1. Two or more owners (partners) of a business 2. General and Limited

What are 3 disadvantages of sole proprietorships and partnerships as forms of business organization?

1. Unlimited liability for business debts on the part of the owners 2. Limited life of the business 3. Difficulty of transferring ownership -These 3 disadvantages add up to a single central problem: the ability of such businesses to grow can be seriously limited by and inability to raise cash for investment

What is double taxation?

Corporate profits are taxed twice: at the corporate level when they are earned and again at the personal level when they are paid out

What is unlimited liability?

Creditors can look to the proprietor's personal assets for payment

What is agency cost?

If management does not take the investment because its risky, then the stockholders may lose a valuable opportunity

What are 2 things involved in forming a corporation?

Involves preparing articles of incorporation (or a charter) and a set of bylaws

What is the primary goal of financial management?

Make decisions that increase the value of the stock

The financial manager in a corporation?

Makes decisions for the stockholders of the firm

Fiduciary

One who has a legal obligation to act in the best interests of another.

The financial management function is usually associated with a top officer of the firm, often called?

The Chief Financial Officer (CFO)

What is agency problem?

The possibility of conflict of interest between the owners and management of a firm