Introduction Lecture

Page 1

Introduction to Finance (FIN 300)

Definition of Finance

Two common pronunciations: Fi-nance and Fin-ance (both correct).

Defined as the science of managing money matters, meaning it is a trainable skill.

Three Main Areas of Finance

Managerial Finance

Focuses on financial management within a company.

Decisions include asset buying/selling, financing choices, and cost control.

Example: Choosing to buy, lease, or finance a car applies similar decision-making to businesses.

Investments

Includes buying, holding, and selling financial assets (stocks, bonds).

Companies manage securities for surplus cash.

Financial planners help individuals decide on investments based on risk tolerance and goals.

Financial Markets

Money Market: Trades short-term securities like Treasury bills.

Capital Market: Trades long-term assets like stocks and bonds.

Financial Intermediation: Banks and credit unions facilitate money flow between savers and borrowers.

Major Principles of Finance

Risk-Return Tradeoff

Higher risk should lead to higher expected returns.

Example: Stocks have higher risk than savings accounts but offer potential for greater returns.

Time Value of Money (TVM)

Money today is worth more than the same amount in the future due to potential earnings.

Present Value (PV) vs. Future Value (FV) used in capital budgeting decisions.

Cash is King

A company can be profitable but still fail due to lack of cash flow.

Example: Accounts receivable (sales made but cash not received) can lead to liquidity issues.

Incremental Cash Flows

Only consider the additional cash flow generated by a decision.

Example: Savings from replacing an old machine with a new one.

Competitive Markets

Competition leads to efficiency in pricing and operations.

Efficient Capital Markets

Information spreads quickly, making it difficult to profit from insider knowledge.

Agency Issue

Employees and managers work for stockholders, not themselves.

Potential conflict when managers prioritize personal job security over shareholders’ interests.

Tax Impact

Financial decisions should be analyzed after considering tax consequences.

Diversification

Spreading investments reduces risk.

Example: Not investing all money in one stock.

Ethics in Finance

Business decisions should be made with integrity.

Many financial scandals result from unethical behavior.

Types of Business Organizations

Sole Proprietorship

Single owner, full control, personal liability, profits taxed once.

General Partnership

Two or more owners, shared decision-making, personal liability for all partners.

Limited Partnership (LP)

Includes general partners (unlimited liability) and limited partners (liable only for investment).

Limited Liability Partnership (LLP)

Hybrid structure, partners are not personally liable for business debts.

Corporation

Separate legal entity, owners (shareholders) not personally liable, subject to double taxation (corporate tax + dividend tax).

S-Corporation

Hybrid structure, limited liability, taxed like a partnership.

Key Financial Concepts

Raising Capital: Sole proprietorships struggle more than corporations to raise funds.

Selling Ownership: Easier for corporations (stock market) than for partnerships.

Business Continuity: Corporations can exist indefinitely, whereas sole proprietorships and partnerships may dissolve upon owner’s death.