Finance
• Finance is a broad term that is used regarding the management, creation, and study
of money and investment
◦ Public Finance – study of tax systems, government expenditures, budget procedures, and government debt
◦ Personal Finance – individual and household budgeting, mortgage planning,
savings, and retirement planning
◦ Corporate Finance – Managing assets, liabilities, revenues, and debt
• This course will focus mostly on topics in corporate finance, but will touch on some
extensions to personal finance
1.1 What is Finance?
• Economics tells us the goal of a firm is to maximize profits
◦ How do firms measure these profits?
– We will look at different metrics to evaluate profits
◦ How do firms account for risk?
– We will discuss how firms evaluate risk in decision making
◦ How do firms compare money they will receive today compared to money they
will get in the future?
• How do managers and investors evaluate the success of a company?
◦ This is not as simple as just looking at profit
Finance
• Finance uses the information accounting provides to determine the impact of managerial decisions on the market value of a company and the wealth of the owners
• Finance provides the skills managers need to:
◦ Identify and select the corporate strategies and individual projects that add value
to their firm
◦ Forecast the funding requirements of their company and devise strategies for acquiring those funds
• Finance evaluates a companies ability to generate cash
◦ Amount of expect cash flows (bigger is better)
◦ Timing of the cash flow stream (sooner is better)
◦ Risk of the cash flows (less risk is better)
Types of Businesses
Proprietorship
• This is an incorporated business owned by one person.
• Easy to start, must obtain a license form the city and/or state
• Advantages
◦ Easy and cheap to form
◦ Subject to few government regulations
◦ Taxed as personal income instead of corporate income
Disadvantages
◦ Hard to obtain capital to expand operations
◦ Owner has unlimited liability for business debts
– Can lose house, car, etc. in bankruptcy
◦ Limited to the lifespan of the owners
• 80% of all US companies are proprietorships
• They only make up 13% of total sales in the US
Partnership
• Some companies start with multiple owners
• Some proprietorships add more people over time
• Partnership agreements define the ways in which profits and losses are shared between
partners
• Partnerships can be very risky, so partners often try to limit the liability
• Limited Liability Partnership (LLP)
◦ At least one partner is the general partner that has operational and financial
control
– Maintains unlimited liability
◦ Limited partners typically only contribute capital and have limited liability
◦ Partners are responsible for their own actions, but are not responsible for actions
of other partners
◦ Often seen in firms that offer professional services (accounting and law firms)
• Limited Liability Company (LLC)
◦ A form of partnership where liability for general partners does not extend past
the assets of the business
– Partners may not have to lose personal assets due to cover business losses
Corporations
• Partnerships and proprietorships often have difficulty raising lots of capital
• This makes it difficult to raise money to take advantage of new opportunities
• A corporation is a legal entity that is created under state laws that is separate from
its owners and managers
Advantages
Unlimited lifespan
◦ Can easily transfer ownership
– Ownership interests are divided into shares of stock, which can be easily
transferred
◦ Liability is limited only to funds invested
• Disadvantages
◦ Complex and expensive to form
◦ Subject to corporate tax rates
◦ High level of regulatory oversight
– Must have charter, bylaws, and file many state and federal reports
- Teacher: Admin User