ECO CHAPTER 6
What are three ways small business owners typically raise money?
1. Retained earnings: profits reinvested in the firm, instead of paid to firm owners 2. recruit additional owners: such an arrangement would increase the firm's financial capital 3. Borrow: from financial institutions, or from friends and family
What are three types of firms?
1. Sole proprietorship 2. Partnership 3. Corporation
Sole Proprietorship and its advantages/ disadvantages
A firm owned by a single individual and not organized as a corporation A: control by owner, no layers of management D: unlimited personal liability, limited ability to raise funds
Partnership and its advantages/disadvantages
A firm owned jointly by 2 or more persons and not organized as a corporation A: ability to share work, ability to share risks. D: unlimited personal liability, limited ability to raise funds.
Corporation and its advantages/disadvantages
A legal form of business that provides owners with protection from losing more than their investment should the business fail. A: limited personal liability, greater ability to raise funds D: costly to organize, possible double taxation of income
What is separation of ownership from control? What is the key problem that arises from this?
A situation in a corporation in which top management, rather than the shareholders, controls day-to-day operations
Why might shareholders and managers in a corporation have different goals?
Corporate governance: the way in which a corporation is structured and the effect that structure has on the corporation's behavior Principle-agent problem: a problem caused by an agent pursuing the agent's own interest rather than the interests of the principle who hired the agent
What are the 2 avenues corporations use to get financing for growth?
Indirect finance: flow of funds form the savers and borrowers through financial intermediaries like banks Direct Finance: the flow of funds from savers to firms through financial markets, like the NY stock exchange
Why is the way we measure economic profit significant?
TO operate a business and make it a growing concern, you must include implicit and explicit costs
What is a key role for banks in the modern economy?
The economy's financial system facilitates the transfer of funds from savers to borrowers - firms can borrow money from banks -banks are acting as financial intermediaries, permitting indirect finance of the firm by their savers
Bonds
a financial security that is essentially a loan -a firm sells a bond for its face value, say $1000, promising to repay this principal at the end of some maturity, 30 years
income statement
a financial statement that shows a firm's revenues, cost and profit over a period of time -typically a 12 month fiscal year
balence sheet
a financial statement that sums up a firm's financial position on a particular day, usually the end of a quarter or year
implicit costs
a nonmonetary opportunity cost
accounting profit
accounting profit = revenue - explicit costs
explicit costs
actually involves money
Asset
anything of value owned by a person or firm -In sole proprietorship and partnerships, no legal distinction is made between the assets of the firm and the assets of its owner(s). -This is not the case for corporations. The owners of corporations have limited liability, a legal provision that shields owners of the corporation from losing more than they have invested in the firm.
How to explicit and implicit costs impact economic profit?
both are included when calculating economic profit
economic profit
economic profit = revenue -explicit costs-implicit costs or economic profit = (accounting profit) - implicit costs
stocks
financial security that represents partial ownership in a firm
how do you calculate a firm's net worth?
the amount of its assets minus the amount of its liabilities
intererst rate
the cost of borrowing funds, usually expressed as percentage of the amount borrowed
Securitization or Mortgage-backed securities (MBS)
when groups of mortgage loans are bundled together and sold as an investment
