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Introduction

Introduction. Organizing a Business The Role of The Financial Manager Financial Markets Corporate Goals & Incentives. Organizing a Business. Types of Business Organizations Sole Proprietorships Partnerships Corporations Hybrids Limited Partnerships LLP LLC PC. Organizing a Business.

mechelle-emerson
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Introduction

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  1. Introduction • Organizing a Business • The Role of The Financial Manager • Financial Markets • Corporate Goals & Incentives

  2. Organizing a Business • Types of Business Organizations • Sole Proprietorships • Partnerships • Corporations • Hybrids • Limited Partnerships • LLP • LLC • PC

  3. Organizing a Business

  4. The Role of The Financial Manager (2) (1) (4a) (4b) (3) (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors Financial Firm's Financial managers operations markets

  5. Obligations Funds Banks Insurance Cos. Brokerage Firms Obligations Funds Depositors Policyholders Investors Financial Markets Company Intermediary Investor

  6. The Role of The Financial Manager • Investment Decisions • “Capital Budgeting” • Buy real assets that are worth more than they cost • Financing Decisions • Source of Funds “Capital Markets” • Capital Structure

  7. Advantages of Intermediation • 1 – Transaction costs/Payments mechanisms. • 2 – Matching borrowers and lenders • Borrower may want to borrow for 2 years • May have many lenders that want to lend for a year each. • 3 – Pooling of Risk

  8. Goals of The Corporation • Shareholders desire wealth maximization • Do managers maximize shareholder wealth? • Managers have many constituencies “stakeholders” • “Agency Problems” represent the conflict of interest between management and owners

  9. Goals of The Corporation Agency Problem “Solutions” 1 - Compensation plans 2 - Board of Directors 3 - Takeovers 4 - Specialist Monitoring 5 – Auditors Remark: Problems can still occur because of differences of information.

  10. Financial Accounting • The Balance Sheet • The Income Statement • The Statement of Cash Flows • Accounting for Differences • Taxes

  11. The Balance Sheet Definition Financial statements that show the value of the firm’s assets and liabilities at a particular point in time (from an accounting perspective).

  12. The Balance Sheet The Main Balance Sheet Items Current Assets Cash & Securities Receivables Inventories + Fixed Assets Tangible Assets Intangible Assets

  13. The Balance Sheet The Main Balance Sheet Items Current Liabilities Payables Short-term Debt + Long-term Liabilities + Shareholders’ Equity Current Assets Cash & Securities Receivables Inventories + Fixed Assets Tangible Assets Intangible Assets =

  14. Market Value vs. Book Value Book Values are determined by GAAP Market Values are determined by current values Equity and Asset “Market Values” are usually higher than their “Book Values”

  15. Market Value vs. Book Value Example According to GAAP, your firm has equity worth $6 billion, debt worth $4 billion, assets worth $10 billion. The market values your firm’s 100 million shares at $75 per share and the debt at $4 billion. Q: What is the market value of your assets?

  16. Market Value vs. Book Value Example According to GAAP, your firm has equity worth $6 billion, debt worth $4 billion, assets worth $10 billion. The market values your firm’s 100 million shares at $75 per share and the debt at $4 billion. Q: What is the market value of your assets? A: Since (Assets=Liabilities + Equity), your assets must have a market value of $11.5 billion.

  17. Market Value vs. Book Value Example (continued) Book Value Balance Sheet Assets = $10 bil Debt = $4 bil Equity = $6 bil

  18. Market Value vs. Book Value Example (continued) Book Value Balance Sheet Assets = $10 bil Debt = $4 bil Equity = $6 bil Market Value Balance Sheet Assets = $11.5 bil Debt = $4 bil Equity = $7.5 bil

  19. The Income Statement Definition Financial statement that shows the revenues, expenses, and net income of a firm over a period of time (from an accounting perspective).

  20. The Income Statement Earnings Before Interest & Taxes (EBIT) EBIT = total revenues minus costs minus depreciation

  21. The Income Statement Pepsico Income Statement (year end 1998) Net Sales 22,348 COGS 9,330 Other Expenses 291 Selling, G&A expenses 8,912 Depreciation expense 1,234 EBIT 2,581 Net interest expense 321 Taxable Income 2,260 Income Taxes 270 Net Income 1,990

  22. Profits vs. Cash Flows • Differences • “Profits” subtract depreciation (a non-cash expense) • “Profits” ignore cash expenditures on new capital (the expense is capitalized) • “Profits” record income and expenses at the time of sales, not when the cash exchanges actually occur • “Profits” do not consider changes in working capital

  23. The Statement of Cash Flows Pepsico Statement of Cash Flows (excerpt - year end 1998) Net Income 1,990

  24. The Statement of Cash Flows Pepsico Statement of Cash Flows (excerpt - year end 1998) Net Income 1,990 Non-cash expenses Depreciation 1,234 Other 382 Changes in working capital A/R=(303) A/P=253 Inv=(284) other=(47)(381) Cash Flow from Operations 3,212

  25. The Statement of Cash Flows Pepsico Statement of Cash Flows (excerpt - year end 1998) Net Income 1,990 Non-cash expenses Depreciation 1,234 Other 382 Changes in working capital A/R=(303) A/P=253 Inv=(284) other=(47)(381) Cash Flow from Operations 3,212 Cash Flow for New Investments (5,019) Cash Raised by New Financing 190 Net Change in Cash Position (1,617)

  26. Taxes • Taxes have a major impact on financial decisions • Marginal Tax Rate is the tax that the individual pays on each extra dollar of income. • Average Tax Rate is the total tax bill divided by total income.

  27. Taxes Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not.

  28. Taxes Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not. Firm A EBIT 100 Interest 40 Pretax Income 60 Taxes (35%) 21 Net Income 39

  29. Taxes Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not. Firm A Firm B EBIT 100 100 Interest 40 0 Pretax Income 60 100 Taxes (35%) 21 35 Net Income 39 65

  30. Taxes FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow) Firm A Firm B Net Income 39 65 + Interest 40 0 Net Cash Flow 79 65

  31. Why the difference? Firm A Firm B Net Income 39 65 + Interest 40 0 Net Cash Flow 79 65 • Interest is not taxed! • 40*0.35=14 (which is the difference)

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