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© 2005 Pearson Education Canada Inc.
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Overview of Corporate Finance
Hashim Ali Shah
0333-4616495www.pakmanagement.com
© 2005 Pearson Education Canada Inc.
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Learning Goals
LG1 – Define finance and describe its three major areas and career opportunities.
LG2 – Review basic forms of business organization, their strengths and weaknesses.
LG3 – Describe managerial finance function and differentiate from economics and accounting.
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Learning Goals (continued)
LG4 – Identify key activities of financial manager within the firm.
LG5 – Explain why wealth maximization is firm’s goal.
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What is Finance?
• At the macro level, finance is the study of financial institutions and financial markets and how they operate within the financial system .
• At the micro level, finance is the study of financial planning, asset management, and fund raising for businesses and financial institutions.
• Financial management can be described in brief using the following balance sheet.
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What is Finance?
Assets: Liabilities & Equity:
Current Assets Current Liabilities
Cash & M.S. Accounts payable
Accounts receivable Notes Payable
Inventory Total Current Liabilities
Total Current Assets Long-Term Liabilities
Fixed Assets: Total Liabilities
Gross f ixed assets Equity:
Less: Accumulated dep. Common Stock
Goodw ill Paid-in-capital
Other long-term assets Retained Earnings
Total Fixed Assets Total Equity
Total Assets Total Liabilities & Equity
WorkingCapital
WorkingCapital
InvestmentDecisions
FinancingDecisions
Macro Finance
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Areas of Specialization in Finance
• Financial Markets– Markets of users and savers of funds.
• Financial Services– Design and delivery of financial advice and
products to individuals, businesses, government.
• Managerial Finance– Financial management of business firms.
Importantn Terms1. Financial Institutions
2. Financial Markets
3. Primary Market
4. Secondary Market
5. Money Market
6. Marketable Securities
7. Capital Market
8. Bonds
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Financial Institutions
An intermediary that channels the savings of individuals, busninesses, and governments into the loan or investment.
Financial Markets:
Forums inwhich suppliers of funds can transact business directly.
Primary Market:
Market in which securities are initially issued.
Secondary Market:
Market in which preowned securities are traded.
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Money Market:
A financial relationship created between suppliers and demanders of short term funds.
Marketable Securities:
Short term debts instruments, (such as bills, commercial papers and certificates)
Capital Market:
A market that enables suppliers and demanders of long term funds to make transactions.
Bonds:
Long term debt instrument used by business and government to raise large sums of money.
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© 2005 Pearson Education Canada Inc.
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Areas of Employment in Finance
• Financial Analyst
• Capital budgeting analyst/manager
• Project finance manager
• Cash manager
• Credit analyst/manager
• Pension fund manager
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Basic Forms of Business Organization
• Sole Proprietorship– Owned by one person, operated for personal profit.
• Partnerships– Owned by two or more people, operated for joint
profit.
• Corporations– “Legal entity”, owned by individuals, operated for
joint profit.
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Sole Proprietorship
STRENGTHS:• Low organizational cost• Income taxed once as
personal income• Independence• Secrecy• Ease of dissolution
WEAKNESSES:• Unlimited liability• Limited funding• Proprietor must be all• Difficult to develop staff
career opportunities• Lack of continuity on
death of proprietor
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Partnerships
STRENGTHS:• Improved funding
sources• Increased managerial
talent• Income split by
partnership contract, taxed as personal income
WEAKNESSES:• Unlimited liability to
all partners• Partnership dissolved
upon death of partner• Difficult to liquidate
or transfer ownership
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Corporations
STRENGTHS:• Owners’ liability limited• Large capitalization
possible, greater funding• Ownership readily
transferable• Indefinite life• Professional management
WEAKNESSES:• Higher tax rates• Expensive organization• Greater government
regulation• When publicly traded,
lacks secrecy
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Corporate Organization Chart
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Organization of Finance Functions
• CFO – Chief Financial Officer
• Treasurer responsibilities:– Financial planning, fund raising, capital
expenditure decisions, cash and credit management.
• Controller responsibilities:– Corporate accounting, cost accounting, and tax
management.
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Relationship to Economics
Fundamental Economic Principle:
• Marginal Analysis– Financial decisions should be made and actions
taken only when the added benefits exceed the added costs.
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Relationship to Accounting
• Cash Flows– Accrual Basis: recognizes sales revenue and
expenses incurred to make sale at time of sale.– Cash Basis: recognizes revenues and expenses
as they occur.
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Accounting vs. Financial ViewsAccounting View(Accrual Basis)
Income StatementPeakes Quay, Inc.
For year ended 12/31
Financial View(Cash Basis)
Cash Flow StatementPeakes Quay, Inc.
For year ended 12/31
Sales revenue $100,000Less: Costs 80,000Net Profit $ 20,000
Cash inflow $ 0Less: Cash outflow 80,000Net cash flow ($80,000)
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Financial Manager–Key Activities
Balance Sheet
CurrentAssets
_______________FixedAssets
CurrentLiabilities
_______________Long-Term Funds(Debt & Equity)
Financial Analysis & Planning
MakingInvestmentDecisions
MakingFinancingDecisions
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Should Firms Maximize Profit?
• Corporations commonly define profit as “Earnings per Share” (EPS).– A measure of total earnings divided by total
number of ownership shares.
• EPS ignores critical factors of– the timing of the returns.– cash flows available to common shareholders.– risk factors facing the firm.
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Or Should Firms Maximize Shareholder Wealth?
• Evaluating Shareholder Wealth addresses factors of timing, cash flows and risk ignored by the EPS.
• Therefore, Maximizing Shareholder Wealth is a more comprehensive goal for the firm, its managers and employees.
• This can be explored through “economic valued added” and a focus on stakeholders.
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What about Stakeholders?
• Stakeholders include groups that have direct economic links to the firm.
• Stakeholders include not only owners, but also employees, customers, suppliers, and creditors.
• Maintaining positive stakeholder relationships helps maximize long-term benefits to shareholders.
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Importance of EthicsThe standards of conduct or moral judgment:• Honesty, trustworthiness, fair dealing are
foundations of sustainable business relations:– With customers,– With suppliers,– With creditors,– With employees,– With owners.
• Ethical behaviour is necessary to achieve the goal of maximizing shareholder wealth.
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Financial Goals of a Company
• Maximize sales.• Maximize cash flow.• Maximize market
share.• Maximize profit.• Minimize costs.
• Maximize return on sales, investment, equity.
• Ensure earnings stability.
• Achieve target goals for sales, profits, market share or return.