Finance Chp 1 Terms

Sarbanes-Oxley Act of 2002

*"Sarbox" is intended to protect investors from corporate abuses.* - ex: one part of the act prohibits personal loans from a company to its officers. section 404 requires, among other things, that each company's annual report must have been an assessment of the company's internal control structure and financial reporting. An independent auditor must then evaluate and attest to management's assessment of these issues. the officers of the corporation must review and sign the annual reports. They must explicitly declare that the annual report does not contain any false statements or material omissions. that the financial statements fairly represent the financial results; and that they are responsible for all internal controls. Finally, the annual report must list any deficiencies in internal controls. *In essence, Sarbox makes company management responsible for the accuracy of the company's financial statements.* Because of its extensive reporting requirements, compliance with Sarbox can be very costly, which has led to some unintended results. Since its implementation, hundreds of public firms have chosen to "go dark," meaning that their shares are no longer traded on the major stock exchanges, in which case Sarbox does not apply. Most of these companies stated that their reason was to avoid the cost of compliance.

Capital Budgeting

*The process of planning and managing a firm's long-term investments.* - in capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire it. - in other words, this mean that the value of cash flow generated by an asset exceeds the cost of that asset. Ex: Walmart deciding to open another store would be an important capital budgeting decision Ex: a software company, such as Oracle or Microsoft, the decision to develop and market a new spreadsheet program would be a major budgeting decision. financial managers must be concerned with not only HOW MUCH cash they expect to receive, but also with WHEN they expect to receive it and HOW LIKEY they are to receive it. Evaluating the *size, timing, and risk of future cash flows* is the essence of capital budgeting.

Working Capital

*a firm's short-term assets and short-term liabilities* managing the firm's working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. - this includes a number of activities related to the firm's receipts and discernment of cash. *Some* questions that must be answered about working capital: 1. how much cash and inventory should we keep on hand? 2. should we sell on credit? if so, what terms will we offer, and to whom will we extend them? 3. how will we obtain any needed short-term financing? will we purchase them on credit? or will we borrow in the short term and pay cash? if we borrow in the short term, how and where should we do it?

General partnership

*all* the partners *share in gains or losses*, and *all* have *unlimited liability* for *all partnerships debts*, not just some particular share. - the way partnerships gains (and losses) are divided is described in the partnership agreement, which can be an informal oral agreement or a lengthy formal written agreement. - GP have unlimited liability for all partnerships debts; GP can be held responsible for all partnership debts (therefore, having a written agreement is very important) - the partnership terminates when a GP wishes to sell out or dies. - all income is taxed as personal income to the partners. - the amount of equity that can be raised is limited to the partners' combined wealth. - ownership of a GP is not easily transferred b/c a transfer requires that a new partnership be formed.

Sole Proprietorship

*is a business owned by one person.* - this is the simplest type of business to start and is the least regulated form of organization. - the owner keeps *all the profits*. - the owner has *unlimited liability* for the business debts. this means the creditors can look beyond the business assets to the proprietor's personal assets for payment. - all *business* income is taxed as *personal* income. - the *life* of a sole proprietor is *limited to the owner's life span.* - the amount of equity that can be raised is limited to the amount of the proprietor's personal wealth. which often means that the business is unable to make full use of and derive the benefit from new opportunities b/c of insufficient capital. - ownership may be *difficult to transfer* b/c this transfer requires the *sale of the entire business to a new owner.* - up to 20% of the partner's income may be exempt depending on various rules spelled out in the Tax Cuts and Jobs Acts of 2017.

Capital structure (financial structure)

*is the specific mixture of long-term debt and equity the firm uses to finance its operations.* - the financial manager has two concerns in this area: 1. how much should the firm borrow (the mixture chosen will affect both the risk and the value of the firm) 2. what are the least expensive sources of the funds for the firm? - what percentage of the firm's cash flow will go to creditors and what percentage will go to shareholders? *The question of whether one structure is better than any other for a particular firm is the heart of the capital structuring issue.* - in addition to deciding on the financing mix, the financial manager as to decide exactly how and where to raise the money. - choosing among lenders and among loan types if another job handled by the financial manager.

Limited Partnership

*one or more general* partners *will run* the business and have *unlimited liability*. but there will be *one or more limited* partners who *will not actively participate* in the business. - a limited partner's liability for business debts is limited to the amount that partner contributes to the partnership. - for example, this form of organization is common in real estate ventures. - a LP's interest can be sold w/o dissolving the partnership, but finding a buyer may be difficult.

primary disadvantages of sole proprietorships and partnerships:

1) unlimited liability for business debts on the part of the owners 2) limited life of the business 3) difficulty transferring ownership. These three disadvantages add up to a single, central problem: The ability of such businesses to grow can be seriously limited by an inability to raise cash for investment.

double taxation

C profits are taxed twice; first at the C level when they are earned and again at the personal level when they are paid out.

Corporation

a business created as a distinct legal entity composed of one or more individuals or entities. it is a legal "person," separate and distinct from its owners, and it has many of the rights, duties, and privileges of an actual person. - corporations can borrow money, own property, sue and be sued, and enter into contracts. - a C can even be a GP or a LP in a partnership, and a C can own stock in another C. - Forming a C involves preparing *articles of incorporation* and a set of *bylaws*. - in a C, the stockholders and the managers are usually separate groups. - the stockholders elect a board of directors, who then select the managers. - managers are charged with running the C's affairs in the stockholders' interest. - the stockholders control the C b/c they elect the board of directors. - ownership can be readily transferred - the life of the C is therefore not limited - the C borrows the money in its own name. - as a result, the stockholders in a C have limited liability for corporate debts. the most they can lose is what they have invested. *The relative ease of transferring ownership, the limited liability and unlimited life are reasons why the C form is superior for raising cash.* C form has a significant disadvantage. - b/c a C is a legal person, it must pay taxes. - moreover, the money paid out to stockholders in the form of dividends is taxed again as income to those stockholders. (double taxation)

Stakeholder

a person, organization, or group that may be affected by the organization's actions, objectives and policies. Ex: creditors, directors, employees, government (and its agencies), owners (shareholders), suppliers, unions, and the community from which the business draws its resources.

Partnership

is similar to a proprietorship except that there are two or more owners (partners). - partnerships based on a relatively informal agreement are easy and inexpensive to form.

Goal for financial management:

is to make money or add value for the owners. The goal of financial management is to maximize the current value per share of the existing stock. - this statement avoids the problem of different goals, which encompasses both factors of trying to maximize profits and safety.

The financial manager must be concerned with three basic types of questions:

the *first* question concerns the firm's long-term investments. (Capital budgeting) the *second* question concerns ways in which the firm obtains and manages the long-term financing it needs to support its long-term investments. (Capital structure) the *third* question concerns (Working capital) management.