The Balance Sheet

• An accountant’s snapshot of the firm’s accounting value as of a particular date. • The Balance Sheet Identity is:
Assets ≡ Liabilities + Stockholder’s Equity
• When analyzing a balance sheet, the financial manager should be aware of three concerns:accounting liquidity, debt versus equity, and value versus cost.

The Balance-Sheet Model of the Firm16

Net Working Capital
Net Working Capital ≡ Current Assets – Current Liabilities
– NWC > 0 when Current Assets > Current Liabilities
– NWC < nwc =" 0" assets =" Current" style="font-weight: bold;">The Balance-Sheet Model of the Firm

The Net Working Capital Investment Decision

The Firm and the Financial Markets

Financial Markets

• Primary Market
– When a corporation issues securities, cash flows from investors to the firm.
– Usually an underwriter is involved
• Secondary Markets
– Involve the sale of “used” securities from one investor to another.
– Securities may be exchange traded or trade over-the-counter in a dealer market.

Financial Markets

Dealer Vs. Auction Markets

• Auction markets are different from dealer markets in two ways:
– Trading in a given auction exchange takes place at a single site on the floor of the
exchange.
– Transaction prices of shares are communicated almost immediately to the public.
– Listing

Topics under Discussion

• Firm and the Financial Markets
• Financial Statements
– Balance Sheet
• Assets
• Liabilities and Owners’ Equity
• Working Capital
• Liquidity
• Market Value vs. Book Value
– Income Statement
• GAAP
• Non-cash Items
• Time and Costs

Review of the Previous Lecture

• Forms of Business Organization
– Proprietorship
– Partnership
– Corporation
• Goals of the Corporate Firm
• Agency Problem

The Agency Problem

The Agency Problem

• Agency relationship
– Principal hires an agent to represent their interest
– Stockholders (principals) hire managers (agents) to run the company
• Agency problem
– Conflict of interest between principal and agent
• Management goals and agency costs

Managerial Goals

• Managerial goals may be different from shareholder goals
– Expensive perquisites
– Survival
– Independence
• Increased growth and size are not necessarily the same thing as increased shareholder wealth.

Do Shareholders Control Managerial Behavior?

• Shareholders vote for the board of directors, who in turn hire the management team.
• Contracts can be carefully constructed to be incentive compatible.
• There is a market for managerial talent—this may provide market discipline to the managers—
they can be replaced.
• If the managers fail to maximize share price, they may be replaced in a hostile takeover.

Managing Managers

• Managerial compensation
– Incentives can be used to align management and stockholder interests
– The incentives need to be structured carefully to make sure that they achieve their goal
• Corporate control
– The threat of a takeover may result in better management
• Other stakeholders

Summary

• Forms of Business Organization
– Proprietorship
– Partnership
– Corporation
• Goals of the Corporate Firm
• Agency Problem

Upcoming Topics

• Firm and the Financial Markets
• Financial Statements
– Balance Sheet
• Assets
• Liabilities and Owners Equity
• Working Capital
• Liquidity
• Market Value vs Book Value
– Income Statement
• GAAP
• Non-cash Items
• Time and Costs

Goal of the Corporate Firm

• The traditional answer is that the managers of the corporation are obliged to make efforts to
maximize shareholder wealth.
• Alternatively, the goal of the financial manager is to maximize the current value per share of
the existing stock

The Set-of-Contracts Perspective

• The firm can be viewed as a set of contracts.
• One of these contracts is between shareholders and managers.
• The managers will usually act in the shareholders’ interests.
– The shareholders can devise contracts that align the incentives of the managers with the
goals of the shareholders.
– The shareholders can monitor the managers behavior.
• This contracting and monitoring is costly.

Forms of Business Organization

Forms of Business Organization

• Three major forms
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• Limited liability company

Sole Proprietorship

• Advantages
– Easiest to start
– Least regulated
– Single owner keeps all the profits
– Taxed once as personal income
• Disadvantages
– Limited to life of owner
– Equity capital limited to owner’s personal wealth
– Unlimited liability
– Difficult to sell ownership interest

Partnership

• Two or more owners (partners)
– General partnership: all partners share in gains and losses and all have unlimited liability
for all partnership debts
– 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 do not actively participate in
the business and their liability is limited to their contribution.

• Advantages
– Two or more owners
– More capital available
– Relatively easy to start
– Income taxed once as personal income
• Disadvantages
– Unlimited liability
• General partnership
• Limited partnership
– Partnership dissolves when one partner dies or wishes to sell
– Difficult to transfer ownership
• Two or more owners (partners)
– General partnership: all partners share in gains and losses and all have unlimited liability
for all partnership debts
– 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 do not actively participate in
the business and their liability is limited to their contribution.
• Advantages
– Two or more owners
– More capital available
– Relatively easy to start
– Income taxed once as personal income
• Disadvantages
– Unlimited liability
• General partnership
• Limited partnership
– Partnership dissolves when one partner dies or wishes to sell
– Difficult to transfer ownership

Corporation

• A business created as a distinct legal entity owned by one or more individuals or entities.
• Forming of corporation involves preparing
– Charter including corporation’s name, intended life, business purpose and number of
shares
– Set of bylaws which describes the regulations for the business

Separation of Ownership and Control
Corporation

• Advantages
– Limited liability
– Unlimited life
– Separation of ownership and management
– Transfer of ownership is easy
– Easier to raise capital
• Disadvantages
– Separation of ownership and management
– Double taxation (income taxed at the corporate rate and then dividends taxed at personal
rate)

Review of the Previous Lecture

• Finance
– Components
– Significance
• Financial Management Decisions
– Capital Budgeting
– Capital Structure
– Working Capital Investment
• Role of Financial Manager

Topics under Discussion

• Forms of Business Organization
– Proprietorship
– Partnership
– Corporation
• Goals of the Corporate Firm
• Agency Problem
• Firm and the Financial Markets

The Corporate Firm

• The corporate form of business is the standard method for solving the problems encountered inraising large amounts of cash.
• However, businesses can take other forms.

Business Finance and Financial Manager

Financial Management Decisions– Capital Budgeting
– Capital Structure
– Working Capital Management
Financial Management Decisions

• Capital Budgeting

– The process of planning and managing a firm’s long-term investments

• Financial managers concern with how much, when and how likely is cash expected to receive

• Evaluating the size, timing and risk of future cash flows is the essence of capital budgeting

The Capital Structure Decision

Capital Structure

• The value of the firm can be thought of as a pie.
• The goal of the manager is to increase the size of the pie.
• The Capital Structure decision can be viewed as how best to slice up the pie.
• If how you slice the pie affects the size of the pie, then the capital structure decision matters.

The Net Working Capital Investment Decision

The Corporate Firm

• The corporate form of business is the standard method for solving the problems encountered in raising large amounts of cash.
• However, businesses can take other forms.

Forms of Business Organization

• Three major forms

– Sole proprietorship
– Partnership

• General
• Limited

– Corporation

• Limited liability company

Sole Proprietorship

• Advantages

– Easiest to start
– Least regulated
– Single owner keeps all the profits
– Taxed once as personal income

• Disadvantages

– Limited to life of owner
– Equity capital limited to owner’s personal wealth
– Unlimited liability
– Difficult to sell ownership interest

Partnership

• Two or more owners (partners)

– General partnership: all partners share in gains and losses and all have unlimited liability
for all partnership debts
– 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 do not actively participate in
the business and their liability is limited to their contribution

• Advantages

– Two or more owners
– More capital available
– Relatively easy to start
– Income taxed once as personal income

• Disadvantages

– Unlimited liability

• General partnership
• Limited partnership

– Partnership dissolves when one partner dies or wishes to sell
– Difficult to transfer ownership

Summary

• Why Study Finance
• The Role of the Financial Manager
• Financial Management Decisions

– Capital Budgeting
– Capital Structure
– Working Capital Investment

• Forms of Business Organization

Upcoming Topics

• Forms of Business Organizations (Cont.)
• Goals of the Corporate Firm
• Agency Problem
• Firm and the Financial Markets

The Financial Manager
To create value, the financial manager should:

• Try to make smart investment decisions.
• Try to make smart financing decisions.

Hypothetical Organization Chart

What is Business Finance?

What is Business Finance?
• In order to start any new business, the following issues become vital
– What long-term investment should be taken on?
– From where to get the long-term financing to pay for investment? Bring in other owners
or borrow the money?
– How to manage everyday financial activities?

Why Study Finance?

• Marketing and Finance
– Marketers have to work with budgets
– Need to get greatest payoffs from marketing expenditures and programs
– Cost and Benefit analysis of projects
– So finance is vital for
• Marketing research
• Design of marketing and distributions channels
• Product pricing
• Accounting and Finance
– Accountants are required to make financial decisions as well as understand the
implications of new financial contracts
– Financial analysts make extensive use of accounting information
• Management and Finance
– Business Strategy is always disastrous if financial planning is not adhered to .

Business Finance

Business Finance

The Primary textbook for the course is
• Essentials of Corporate Finance, by Ross, Westerfield and Jordan, fourth edition, McGraw
Hill Publishers, ISBN 0-07-121057-7
Reference books will be
• Introduction to Finance by Lawrence J. Gitman and Jeff Madura, Addison-Wesley
Publishers
• Foundations of Financial Management by Stanley B. Block and Geoffrey A. Hirt, McGraw
Hill Publishers

UBS fined £8m by the UK regulator

The Financial Services Authority FSA has fined Swiss banking giant UBS £8m for failing to stop its employees making unauthorised transactions.

The FSA said four UBS employees had carried out the transactions (the action of conducting business) using customer money on at least 39 accounts.

The unauthorized (not having official permission or approval) activities took place between January 2006 and December 2007. The FSA also said the trade involved foreign exchange and precious metal.

Earlier this week, UBS reported a loss for the July to September quarter.

'Steep penalties'

According to the FSA, an internal UBS investigation found that as many as 50 unauthorized transactions a day were taking place at the operation's peak.

It criticized (disapprovingly indicate the faults of) the bank not only for system failure that led to the trade, but also for not responding to "several warning signs" that the systems were not working.

"These employees were able to take advantage of UBS' inadequate system and control, giving them free rein to make unauthorized trades with customer money that they were then able to conceal," said the FSA's director of enforcement and financial crime, Margaret Cole.

"The penalty, one of the largest fine we have levied, reflect our tougher enforcement (cause to happen by necessity or force) stance and our policy of imposing steep penalties to achieve credible deterrence."

The £8m fine is the third largest imposed by the FSA.

The regulator said that UBS agreed to settle at an early stage of its investigation, allowing the bank to qualify for a 20% discount.

Without the discount, the fine would have been £10m.

Last month, Switzerland's stock exchange said it was investigating UBS for possible breaches of public disclosure rules during the financial crisis.

Earlier this year, UBS was accused of helping Americans evade US taxes by opening accounts in Switzerland