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Practical financial managment 7e LASHER chapter 1

An Overview of Finance

Areas within Finance
Investments and financial markets
Financial management of corporations
Fields are separate but related


Financial Assets
Real asset—Objects that provide services: houses, cars, food, etc.

Financial asset—a document representing a claim to future income

Stock represents ownership interest
Bond represents a debt relationship

Investing involves buying financial assets in the hope of earning more money (a return)

Investments can be made directly or indirectly through a mutual fund

A Security is a financial asset that can be traded among investors


Financial Markets

Securities are issued by corporations to raise money, and purchased
by investors in financial markets

– A framework or organization in which people can buy/sell securities
Stock market
Stockbroker is licensed to trade



Simplified Financial System


Raising Money

The most common use of the word finance involves raising money
to acquire assets
Forms of Financing

– Issuing stock - equity financing
– Borrowing money - debt financing
– Internal financing - retaining earnings


Raising Money

The field of finance deals with both raising and investing money,
Changing Focus of Finance

– Past - finance was limited to financial market activity
– Now – Corporate finance includes the financial management of


Financial Management

The management and control of money and money-related operations
within a business

CFO – chief financial officer (VP of finance)

– Executive in charge of finance



Financial Management

Functions of the finance department:

– Keeping records
– Receiving payments from customers
– Making payments to suppliers
– Borrowing money
– Purchasing assets
– Selling stock
– Paying dividends


Business Decisions

Finance department provides:

– Analyses to determine which assets are purchased and how they are

– Oversight of how other departments spend money


The Price of Securities—A Link Between the Firm and the
Two sides of finance – investments and financial management
Investors buy securities for the cash income expected in the future
Link between company management and investors comes from this
relationship between price and expected financial results


Accounting and Finance
Broad Portrayal vs. Cash Flow

Accounting statements portray physical activity

The focus in Finance is on future cash

in numbers



In finance:

Cash is King


E.g. Depreciation


Finance and Accounting

Finance department generally consists of both the accounting and
treasury departments

– Controller is in charge of the
– Treasury department deals with

accounting department
other other financial activities


Figure 1-2 Finance Department Organization


Concept Connection Example 1-1
Accounting Records and Cash Flow
A $1,000 asset depreciated straight-line over five years:
Accounting perspective – Portrait Over Time
Initial $1,000 cost becomes an asset on books
$200 per year depreciation reduces profit
Book value shrinks as depreciation accumulates
Finance perspective – Focus On Cash Flow
Depreciation deduction saves cash by reducing tax
It took a $1,000 cash outflow to acquire the asset
Where did the money come from
Finance had to raise that money


The Language of Finance

Accounting is the language of finance

– All finance professionals need some knowledge of accounting
Level depends on job

Financial analyst needs to know LOTS of accounting
Stockbrokers not as much


Financial Theory—The Relationship with Economics

Modern financial theory began as a branch of economics in the

– Originally called “financial economics”
– Theoretical tools are very similar
Finance is a separate but still related field


Figure 1-3 The Influence of Accounting, Economics and Financial Theory on
Financial Management


Forms of Business Organization and Their Financial Impact

A businesses can be legally organized as a

sole proprietorship

Legal organization has an impact on

Raising money
Financial liability

For our purposes we’ll combine partner/proprietor


The Proprietorship Form

Easy to start

Profit is taxed as personal income
Taxed only once

Raising money – Investor’s perspective

A proprietorship can only borrow (no stock to sell)
But lending money to a new business is risky

Best outcome: repayment of principal and interest
Worst outcome: lose everything
Most new businesses fail

Result: Collateral required


The Corporate Form

Getting started

– Requires a legal incorporation process
Takes a little time, work and money


– Double taxation
Corporation pays corporate taxes on income
Dividends paid to owners are taxed as personal income


Concept Connection Example 1-2 Tax Consequences of Business
A business earns $100,000 before taxes.
Owner wants to take the earnings home.
Tax rates: Corporate - 34%
Personal - 30%
Compare total tax bills under corporate and proprietorship forms of organization


The Corporate Form

Raising Money


BUT owner can now offer stock (equity) to investors

Same issues faced by sole proprietorship

If sell less than 50% can maintain control

From the investor’s perspective

Stock is a risky investment but the reward may be worth it


Worst possible outcome: lose entire investment
Best possible outcome: get rich


The Truth About Limited Liability
Limited liability: stockholder not liable for a corporation’s debts

Implies that the most a stockholder can lose is 100% of his investment in the stock
True for owners not involved in the business

However, for owner operated small businesses

Personal guarantees make entrepreneurs liable for loans to their businesses
Legal system holds individuals liable for negligence
These destroy the value of limited liability


S-Type Corporations and LLCs

Major advantage: Treated as a partnership with respect to federal income taxes

LLC is replacing S-type

Government encourages small businesses because they create jobs

S-type corporations and LLCs
Avoid double taxation: profits “pass through” to owners as personal income
Offer limited liability
Offer the ability to sell stock to raise money


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