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Jamil Ahmed

Assistant Professor

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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 in both the Local and global

economies.

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

Working

Capital

InvestmentDecisions

Financing

Decisions

Macro Finance

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$1,068,232,095

$479,673,700

$149,121,474

$2,808,013,079

Size of Payroll (000s)

1,292,081

2,584,427

622,908

1,011,973

Number of Firms in the U.S.

Corporation

S-Corporation

Partnership

Sole

Proprietorship

Goals and Governance of the

CorporationThis Lecture introduces the corporation, its goals, and the roles

of financial managers.

Source: U.S. Census 2008SUSB Annual Data

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FinancialS

ervices Industry inUK

In UK industry accounts for about a

proportion of National Output as the whole of

Manufacturing Industry (2008).

The growth is still amazing. It contributed

$200 billions, accounting for10% of totaleconomic output.

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Areas ofSpecialization in Finance

Financial Markets

Markets of users and savers of funds.

FinancialServices

Design and delivery of financial advice and

products to individuals, businesses, government.

Managerial Finance

Financial management of business firms.

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Basic Forms ofBusiness

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 ProprietorshipSTRENGTHS:

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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PartnershipsSTRENGTHS: Improved funding

sources

Increased managerialtalent

Income split bypartnership contract,

taxed as personalincome

WEAKNESSES:

Unlimited liability to

all partners

Partnership dissolvedupon death of partner

Difficult to liquidate or

transfer ownership

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CorporationsSTRENGTHS:

Owners liability limited

Large capitalization

possible, greater funding

Ownership readily

transferable Indefinite life

Professional management

WEAKNESSES:

Higher tax rates/Double

Taxation Expensive organization

Greater governmentregulation

When publicly traded,lacks secrecy

Improper corporatestructures may lead toAgency Problems

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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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What is a Corporation?

Corporation-A business organized as a

separate legal entity owned by stockholders.

Types ofCorporations:

Public Corporations

Private Corporations

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Goals of The Corporation

Managers/Investors forced to make decisions and choices in

the harsh environment.

All must therefore be very clear about the purpose of the

organization and its imperative for the management teams to be

aware of, respect and contribute to the objectives. Achieving Target Market Share.

Keeping Employees at peace.

Survival.

Creating an Industrial Empire.

Maximization of profit.

Maximization ofShareholders Wealth.

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Goals of The Corporation

Wealth maximization vs. profit maximization:

Prospects: Identical profits by two firms but one is valued

more and otherless by shareholders. As profits fails to

reflect the relative potential of two firms.

Risk: Same profits and same future prospectus. But the

returns of one firms have a greater variability.

Accounting Problems

Communications

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The Ethics of Maximizing ValueDoes value maximization justify unethical behavior?

Recent examples: Enron

WorldCom

Bernard Madoff

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Agency Problem

Do managers really maximize value?

Agency Problems

Managers are agents for stockholders, but the

managers may act in their own interests rather than

maximizing value

Shareholders vs. Stakeholders

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Agency Problem

Different Information

Stock prices vs. returns

Dividend Policy

Financing Decisions

Different Objectives

Managers vs.shareholders

Top managers vs. lower

managers

Stockholders vs. banksand lenders

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Agency Problem Solutions

Compensation plans

Board of Directors

Blockholders

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Agency Problem Solutions

Takeovers

Specialist Monitoring

Legal and Regulatory Requirements

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4A. Cash reinvested in the firm

4B. Cash returned to investors

Role of the Financial Manager

Financial

Manager

(1)(2)

(3)

(4a)

(4b)Real assets

Investors

Financial

Assets

Firms

Operations

1. Cash raised from investors (how?)2. Cash invested in firm

3. Cash generated by operations

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The Flow of Capital:Closely Held Corporations

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The Flow of Capital:

Public Corporations

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Financial Markets

Financing Decision

Source of Funds (Capital)

CapitalStructure

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The Flow of Capital:Public Corporations

Financial Market:Market where securities are issued and traded.

Primary Market:

Market for the sale of new securities by corporations.

Secondary Market:Market in which previously issued securities are traded among

investors.

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Financial Markets

Initial Public Offering (

IPO):First offering of stock to the general public.

Fixed-Income Market:Market for debt securities

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Financial Markets:Markets for Debt

Capital Markets are used forlong-term financing

Example oflong-term debt: Bonds

Money Markets are used for short-term financing.

Example of short-term debt: Commercial Paper

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Information Provided byFinancial Markets:

Commodity Prices

Interest Rates

Company Value

Cost ofCapital

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Financial Intermediaries

Mutual FundAn investment company that pools the savings of many

investors and invests in a portfolio of securities

Hedge FundA private investment pool, open to wealthy or institutional

investors, that is only lightly regulated and therefore can pursue

more speculative policies than mutual funds

Pension FundFund set up by an employer to provide for employees

retirement

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Flow of Cash Example:Mutual Fund

$ $

Sells

shares

Issues

shares

Bank ofAmerica

InvestorsExplorerFund

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A Closer Look:

Financial Institutions

CommercialBank

Investment Bank

Insurance Company

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Company

Intermediaries

Banks

Insurance Companies

Brokerage Firms

Obligations Funds

Companies and Intermediaries

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Intermediaries and Investors

Intermediaries

Investors

Depositors

Policyholders

Investors

Obligations Funds

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Cash Flow Example:

Banks

Banks

Depositors

$2.5 mil

Cash

Loan

Deposits

Company

Intermediary

Investor

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Cash Flow Example:

Insurance Company

Insurance

Company

Policyholders

$2.5 mil

Cash

Issue Debt

Sell Policies

Company

Intermediary

Investor

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Function of Financial Markets

Transport cash across time

Risk transfer and diversification

Liquidity

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Function of Financial Markets

Payment mechanism

Provide information