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Scope of Corporate Finance Cheat Sheet by

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What Should a Financial Manager Try to Maximize?

Maximize Profit?
Many believe managers job
Take only actions to increase revenues
Maximise amount earned on each share
Earnings per share (EPS) = earnings of common stockh­olders divided by number of shares of common stock outsta­nding
Flaws in approach:
- Figures for earnings histor­ical, reflect past perfor­mance
- Do not focus on what is happening now / in future
- Timing may be ignored. Large profits that pay off many years in future may be less valuable than smaller profits received next year
Maximize Shareh­older Wealth?
Current theory
Measured by market price of firm's stock.
Stock price reflects timing, magnitude, and risk of cash flows that investors expect a firm to generate over time.
Take only actions that increase value of firms future cash flows.
Shareh­olders are residual claimants. Can claim only on cash flows that remain after employees, suppliers, creditors, govern­ments, and other stakeh­olders are paid in full
There is a risk shareh­olders receive nothing
Shareh­olders bear most of risk of running firm
This is why firms operate to maximize shareh­older wealth. The benefit to all is that it gives investors incentive to accept the risks necessary to buy stock and provide funds necessary for a business to thrive.
-
Focus on other Stakeh­old­ers?
Many firms also focus on employees, customers, tax author­ities, and commun­ities
These firms consci­ously avoid actions that harm stakeh­olders by transf­erring their wealth to shareh­olders.
Not to maximize others interests but to preserve those interests.
Benefits
-
Keeping stakeh­olders happy has long-term benefit to share-­holders
-
Helps minimise employee turnover, conflicts, and litiga­tion.
-
Usually actually leads to maximizing shareh­older wealth
Conflicts
-
Between these two objectives inevitably arises.
-
Firms is ultimately run to benefit stockh­olders.
-
Corpor­ations are generally expected to be socially respon­sible
-
But rarely required by law to be in US and AUS

Finance skills

All finance jobs require:
Good written and verbal commun­ication skills
Ability to work in teams
Profic­iency with computers and the Internet
Many finance jobs require:
In-depth knowledge of intern­ational business
Finance career opport­uni­ties:
Corporate finance
Commercial banking
Investment banking
Money management
Consulting

Consulting

Analyse firms business processes and strategies
Recommend how practices should change to make firms more compet­itive
Implement recomm­end­ations
Spend up to 200+ days yearly on the road

Money Management

Indu­stry
Investment advisory firms
Mutual fund companies
Pension fund managers
Trust depart­ments of commercial banks
Investment arms of insurance companies
Any person or instit­ution that acts as a fiduci­ary­—so­meone who invests and manages money on someone else's behalf
Trends
Baby Boomers investing large sums in prepar­ation for retirement - demand for pofess­ional money managers surged
Australian supera­nuation legisl­ation passed in 1992 requring all employees to be members of a superfund - that industry grew massively
Instit­uti­ona­lis­ation of invest­ment, means today instit­utional investors dominate the markets

Corporate Finance

The duties of the financial manager in a business / Not for profit / Corpor­ation
Tasks include:
Budgeting
Financial foreca­sting
Cash management
Credit admini­str­ation
Investment analysis
Funds procur­ement
Modern business changes:
Increases in regulatory enviro­nments have increased the importance and complexity of the financial manager's duties
Global­isation has increased need to assess and manage the risks associated with volatile exchange rates and rapidly changing political enviro­nments.

Finance Function: Financial Management

Managing firms operating cash flows as effici­ently and profitably as possible.
Capital structure decision finding right mix of debt and equity securities to maximise firms overall market value.
Managing working capital
Ensure enough working capital on hand for day-to-day operations
Obtaining seasonal financing
Building up enough invent­ories to meet customer needs
Paying suppliers
Collecting from customers
Investing surplus cash
Mainta­ining adequate cash balances
Skil­ls:
Technical and analytical skills
People skills - relati­onships with customers, suppliers, lenders, and others

Finance function: Risk Management

Identi­fies, measures, and manages many types of risk exposures including:
-
Predic­table business risks-­losses such as adverse interest rate movement commodity price changes, and currency value fluctu­ations.
-
Unpred­ictable 'acts of nature'
Risk management techni­ques
Insurance products (fire, flood, theft, injury)
Self-i­nsu­rance to manage exposures
Quantify the sources and magnitudes of risk exposure and decide whether to accept them or to manage them.
Divers­ifi­cation (contract with several suppliers, even if it means purchasing the input at slightly more than the lowest possible price)
Modern risk manage­ment
Market­-driven risks interest rates, commodity prices, and currency values.
Financial instru­ments called deriva­tives (derive their value from other, underlying assets) have been developed for use in hedging (offse­tting) for more threat­ening market risks.

Australian legal forms of business

Sole propri­eto­rships
General Partne­rships
Limited Partne­rships
Proprietry Limited Company
Company

General Partne­rsh­ips

Propri­eto­rship between 2+ owners
No distin­ction between owners and business
Joint and several liability
Unless specified all debts and equity, profits, are split evenly
Decision making ability is split evenly
Income taxed at personal level
Limited life - cease when one owner dies or retires
Limited access to capital - Reinve­sting profits, personal loans
Unlimited personal liability - Personally liable owner for all debts, including lawsuits

Prop­rietry Limited Company

Business seperate entity to owner
Creates roles of employee, director, shareh­older
Regulated under the corpor­ations act 2001
Establ­ishment and ongoing costs to manage can be high
Suited to Medium and Large businesses
 

Role of finance manager

constantly apply financial tools to solve real business problems
Ensure business managers take only actions where benefits exceed costs
Interact with experts in a wide range of discip­lines
Study economics of a market
Develop pricing strategy
Negotiate licensing agreements
Work with author­ities to ensure compliance
Advise business managers and profes­sionals
Work with accounting and systems staff to develop systems
Managing cash flows
Assessment and funding of research
Aid business in accumu­lating the capital needed to fund projects
The skills and knowledge needed to achieve corporate business objectives are the same as those needed to be a successful entrep­reneur, to manage family busine­sses, or to run a nonprofit organi­zation. Successful financial managers must be able to creatively manage both people and money.

Financial interm­ediary

Companies can obtain debt capital by selling securities either directly to investors or through financial interm­edi­aries.
Fina­ncial interm­edi­ary
Instit­ution that raises capital by issuing liabil­ities against itself
Uses the capital raised to make loans to corpor­ations and indivi­duals
Borrowers have no direct contact with those who funded the loan
Financial interm­edi­aries include:
-
Insurance companies
-
Savings and loan instit­utions
-
Credit unions
-
Commercial banks
Modern financial interm­ediary services
Loans to corpor­ations and indivi­duals
Allow companies and indivi­duals to place their money in demand deposits
Backbone of the payments system:
-
Collect payment on transfers sent to corporate customers
-
Make payment on the transfers by their customers to other parties
-
Provide inform­ati­on-­pro­cessing services to SME businesses
-
Handle large-­volume transa­ctions such as payroll
These organi­sations issue liabil­ities such as demand deposits (checking accounts) to companies and indivi­duals and then loan these assets to corpor­ations, govern­ments, and households

Investment Banking

Intere­sting nature of work
Three main types of activi­ties:
Helping corporate customers obtain funding by selling securities such as stocks and bonds to investors
Providing advice to corporate clients on strategic transa­ctions such as mergers and acquis­itions
Trading debt and equity securities for customers or for the firm's own account
Prof­ita­bil­ity
High income potential
Extrao­rdi­narily high since the early 1990s
Highly volatile industry
Entry-­level salary range $50,000 to more than $80,000, plus bonuses
Incomes often rise rapidly
Indu­stry
Dominant AU firms: Macquarie Group, and CommSec
Dominant foreign firms: BNP, Deutsche Bank, Credit Suisse, HSBC, J. P. Morgan Chase, Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup
Extremely compet­itive
Long working hours
Lucrative rewards for those who master the game
Key skills
Good analytical and commun­ication skills
Social and networking skills also pay handsome dividends.
Growth expect­ati­ons
Ongoing develo­pment of new financial products and services
Continued intern­ati­ona­liz­ation of corporate finance

Finance Function: Capital Budgeting

Financial managers single most important activity
Managers evaluate very large invest­ments in the capital budgeting process
Companies prosper in a compet­itive economy only by seeking out the most promising new products, processes, and services to deliver to customers.
Big companies make huge capital outlays
ROI drive the value of their firms and wealth of shareh­olders.
Conseq­uences of flawed capital budgeting processes are serious
The capital budgeting process:
1. Identi­fying potential invest­ments
2. Analysing the set of investment opport­unities and identi­fying those that create shareh­older value
3. Implem­enting and monitoring the invest­ments selected in Step 2
Managers have the greatest opport­unity to create value for shareh­olders by acquiring assets that yield benefits greater than their costs

Finance function: Corporate Governance

Important to avoid scandal and damage to reputation
Systems of incentive / structures that influence good ethical behaviours and decision making
Inte­nti­ons
Determine who benefits most from company activities
Develop procedures to maximise firm value and to ensure that employees act ethically and respon­sibly
Encourage the hiring and promotion of qualified and honest people
Motivate employees to achieve company goals through salary and other incentives
Chal­lenges in practice
Conflicts inevitably arise among stockh­olders, managers, and other stakeh­olders.
Stockh­olders want managers to work hard and to protect shareh­olders interests.
It costs time and money to ensure that managers act approp­ria­tely.
Though managers may wish to maximize shareh­older wealth, they do not want to work harder than necessary, especially if others are going to reap most of the benefits.
Managers and shareh­olders may decide together to run a company to benefit themselves at the expense of creditors or other stakeh­olders
Creditors and other stakeh­olders generally don't have a voice in corporate govern­ance.
Strong boards of directors play a vital role in any well-f­unc­tioning governance system, because boards must hire, fire, pay, and promote senior managers.
Boards must also develop fixed and contingent compen­sation packages that align managers incentives with those of shareh­olders.
In Austra­lia
ASIC - Australian Securities and Invest­ments Commission oversees corporate activities
Est in 1998
Corporate, markets and financial services regulator
ASIC enforce and regulate company and financial services laws to protect Australian consumers investors and creditors
ASIC oversees the Australian Securities Exchange (ASX) (2006 merger of Aus stock exchange and Sydney Futures Exchange)
Most work done under the Corpor­ations Act 2001
Gove­rnments govern­ance
Countries also struggle
Govern­ments establish legal frameworks for corporate finance that encourage compet­itive businesses to develop and efficient financial markets to run properly
Commercial laws should
-
Provide protection for creditors and minority shareh­olders
-
Limit opport­unities for managers or majority shareh­olders to transfer corporate wealth from investors to themse­lves.

Sole propri­eto­rsh­ips

One legal owner
No distin­ction between owner and business
Owners personal property
Limited life - cease when owner dies or retires
Limited access to capital - Reinve­sting profits, personal loans
Unlimited personal liability - Personally liable owner for all debts, including lawsuits
High risk, often not insurable
Income taxed at personal level

Limited Partne­rsh­ips

Sprung from legisl­ation in 2000
Unlimited personal liability
Ideal for start ups with losses in early years - limited partners can use to offset other income tax
1+ partners with unlimited personal liability who receives a greater share of income
Other partners
- Limited liability partners
- Must be completely passive
- Name cannot be associated with business
- Can not take a role in the business
- Can not be employed by the business
- No personal liability for debts
- Can not be sued
- Income taxed as personal income
 

Modern businesses

Face a modern, knowledge based economy
Finance role is vital in creating wealth
Involve people with many different skills and backgr­ounds working together toward common goals.

Debt and Equity: The Two Flavors of Capital

Two broad types of capital exist: debt and equity
Debt capital
Long term borrowing from creditors
Borrower pays interest, at a specified annual rate, on the loans principle (full amount borrowed)
Borrower repays the principal amount at the debts maturity
Payments made on a fixed schedule
Creditors have a legally enforc­eable claim against the firm.
Defaults on debt payments mean creditors can take legal action to force repayment.
Creditors can sometimes force the borrowing firm into bankru­ptcy, out of business and selling (liqui­dating) assets to repay creditor claims.
Equity capital
Business owners contri­bution
Expected to remain perman­ently invested in the company
Sources of equity capital
Common stock
-
Bear most of the firms business and financial risk
-
Receive returns on their invest­ments only after creditors and preferred stockh­olders are paid in full
Preferred stock
-
Similar to creditors
 
"­Pre­ferred Stockh­old­ers­"
 
Promised a fixed annual payment on their invested capital
 
Claims are not legally enforc­eable
 
Cannot force a company into bankruptcy if a preferred stock dividend is missed
 
Upon liquid­ation, preferred stockh­olders claims are paid before any money is paid to common stockh­olders.

Commercial Banking

In Australia is dominated by the 'big four' (75% market share):
ANZ
Common­wealth Bank
NAB
Westpac
Hiring
Banks continue to hire large numbers of new business and finance graduates each year
Banks train many managers who later migrate to other fields
Key skills
Cash flow valuation
Financial and credit analysis
Consumer banking vs Commercial banking
Excellent finance skills
Intimate knowledge of teleco­mmu­nic­ations and computer technology

Investment Banking

Intere­sting nature of work
Three main types of activi­ties:
Helping corporate customers obtain funding by selling securities such as stocks and bonds to investors
Providing advice to corporate clients on strategic transa­ctions such as mergers and acquis­itions
Trading debt and equity securities for customers or for the firm's own account
Prof­ita­bil­ity
High income potential
Extrao­rdi­narily high since the early 1990s
Highly volatile industry
Entry-­level salary range $50,000 to more than $80,000, plus bonuses
Incomes often rise rapidly
Indu­stry
Dominant AU firms: Macquarie Group, and CommSec
Dominant foreign firms: BNP, Deutsche Bank, Credit Suisse, HSBC, J. P. Morgan Chase, Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup
Extremely compet­itive
Long working hours
Lucrative rewards for those who master the game
Key skills
Good analytical and commun­ication skills
Social and networking skills also pay handsome dividends.
Growth expect­ati­ons
Ongoing develo­pment of new financial products and services
Continued intern­ati­ona­liz­ation of corporate finance

Five Basic Corporate Finance Functions

Generally = managing cash flows
Five basic functi­ons
Raising capital via external financing
Capital budgeting function - choosing the best projects in which to invest resources
Financial management (cash flows)
Corporate governance
Risk management

Finance function: Financing

Raise money to support investment and other activities
Via
Internally by retaining and reinve­sting operating profits
Externally from shareh­olders or creditors
Inte­rna­lly
Companies raise about two-thirds of their required funding internally each year
Exte­rna­lly
Sole propri­eto­rships and partne­rships have limited external funding opport­unities
Corpor­ations have varied opport­unities
-
selling equity (common or preferred stock)
-
borrowing money from creditors
-
Young and small corps usually raise equity capital privately, from friends and family, or from profes­sional investors such as venture capita­lists.
-
Venture capita­lists make high-r­isk­/hi­gh-­return invest­ments in rapidly growing entrep­ren­eurial businesses
-
Larger corps can go public by conducting an initial public offering (IPO) of stock—­selling shares to outside investors and listing the shares for trade on a stock exchange.
-
After IPO, selling additional stock in the future

Growing Importance of Financial Markets

Tradit­ional interm­edi­aries (banks) useage as providers of debt capital to corpor­ations has declined
Nonfin­ancial corpor­ations often go to capital markets for external financing
New types of interm­edi­aries: pension funds and mutual funds
Beca­use
-
Modern inform­ation processing enables investors to evaluate thousands of potential corporate borrowers and issuers of common and preferred stock equity
-
These interm­edi­aries are major purchasers of the securities non-fi­nancial corpor­ations issue
Primary market transa­cti­ons
Corpor­ations sell securities to investors in exchange for cash
Raise capital
Firm actually receives the proceeds from issuing securities
Large fraction of all bond market transa­ctions
True capita­l-r­aising events
Seco­nda­ry-­market transa­cti­ons
After firms initial offering (IPO) investors can sell securities to other investors
Trades between investors
Generate no new cash flow for the firm
Most stock market transa­ctions
Not true capita­l-r­aising events

Comp­any

An entity created by charter, prescr­iption or legisl­ation
A 'person' seperate from shareh­olders
Many same economic rights / respon­sib­ilities as indivi­duals
Owned by shareh­old­ers
- Shares of stock carry voting rights
- Shareh­olders vote at annual meetings to elect boards of directors (BOD)
- BOD hire / fire managers, and set corporate policys
Cons­tit­ution
- Legal document
- Created at company's inception
- Parameters of corporate governance
- Can only be changed by vote of shareh­olders
Can sue and be sued
Can own property and execute contracts in their own names
Can be tried and convicted for crimes committed by their employees
Unlimited life - Perpetual life until explicitly terminated
Limited liability - Shareh­olders cannot be held personally liable
CEOs and chief financial officers (CFOs) can be held personally liable under the Sarban­es-­Oxley Act if the debts result from improper accounting practices or fraudulent acts.
Sepa­rable contra­cti­ng. Can contract indivi­dually with managers, suppliers, customers, and ordinary employees, and each contract can be renego­tiated, modified, or terminated without affecting other stakeh­olders.
Improved access to capital
- Can borrow money from creditors
- Can issue preferred and common stock to equity investors
- Ownership stock claims can be freely traded among investors without obtaining permission from other investors
- A public company can list shares on a public security market

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