Finance and Investment: Key Concepts, Valuation, and Career Paths

Finance

Making decisions that add value

Timing

One of the 3 important cash flow elements

Risk

One of the 3 important cash flow elements

Magnitude

One of the 3 important cash flow elements

Accounting

Tends to look back at transactions from the past

Finance

Focuses on cash flows for the future

Time Value of Money

Used to value estimated future cash flows

Value

What something is truly worth today

Fundamental Value

Another term for value or intrinsic value

Intrinsic Value

The discounted value of the cash that can be taken out of a business during its remaining life

Financial Asset Valuation Variables

There are only 2 variables needed to value any financial asset

Corporate Finance, Investments, and Personal Finance

3 Broad Finance Career Paths

Financial Planning

Involves working with families and requires relationship building

Wealth Managers

Work with people who have more money

Finance Career Skills

Decision making, evaluating risk and return tradeoffs, quantitative methods, detail orientation, analytical and logical skills, and interpersonal skills

Corporate Finance

Finance career involving decisions such as expanding operations into new markets or moving production

Corporate Finance Credentials

MBA, MSF

Investments

Performing detailed analysis on companies to make recommendations about investment securities

Investment Credentials

CFA

Financial Planning Typical Day

Understanding a client's needs, goals, and risk tolerance to help them make sound financial decisions

Financial Planning Credentials

CFP

Compensation in Finance

Finance career paths tend to be relatively lucrative

Equity Securities

Stocks that represent ownership claims on the firm

Shareholders

Also known as stockholders and equity-holders; they have voting rights, limited liability, and a residual claim on the firm's assets

Debt Securities

Borrowing instruments such as bonds

Fixed-Income Securities

Another name for debt securities

Debt Securities Promise

A promise to repay a liability through interest payments or coupons along with repayment of principal

Derivative Securities

Securities whose payoff is derived from the performance of another underlying asset

Call Option

Gives the owner the right, but not the obligation, to purchase the underlying stock at a prespecified price on or before a prespecified date

Put Option

Gives the owner the right, but not the obligation, to sell the underlying stock at a prespecified price on or before a prespecified date

Other Derivatives

Forward contracts, futures contracts, and swaps

Composite Assets

Assets such as mutual funds and exchange-traded funds (ETFs)

Financial Intermediaries

Pool funds from investors and buy assets that make up mutual funds or ETFs

Benefits of Composite Assets

Diversification, low management fees, and professional management

Index Funds

Composite assets designed to track the performance of a certain index such as the S&P 500

Asset-Backed Securities (ABS)

Securities backed by specific assets such as mortgages, credit cards, or student loans

Mortgage-Backed Securities (MBS)

Asset-backed securities backed by mortgages

Capital Budgeting

Decision-making process for accepting or rejecting long-term projects

Capital

Think long-term assets

Capital Structure

The mix of the various debt and equity capital maintained by the firm

Net Working Capital

Current assets minus current liabilities

Balance Sheet Model of the Firm

Assets = Liabilities + Owner's Equity

Current Assets

Cash, accounts receivable, and inventory

Fixed Assets

Long-term assets such as equipment, patents, and trademarks

Total Value of Firm to Investors

Current liabilities, long-term debt, and shareholders' equity

Financial Manager's Primary Goal

Increase the value of the firm

Value-Creating Projects

Projects with positive net present value (NPV)

Capital Budgeting Decision

Selecting value-creating projects

Financing Decision

Making smart decisions about the firm's capital structure

Corporate Form of Business

Standard method for solving problems involved in raising large amounts of cash

Sole Proprietorship

Business owned by a single individual

Partnership

Business formed by 2 or more co-owners

Corporation

Business created as a legal person composed of one or more actual individuals or legal entities

Shareholders

Owners of the corporation

Directors

Individuals responsible for overseeing the corporation

Corporate Officers

Top management of a corporation

Corporation Benefits

Ease of ownership transfer, perpetual succession, and limited liability for shareholders

Corporation Disadvantage

Double taxation

Limited Liability Company (LLC)

Hybrid form of organization that falls between partnerships and corporations

Shares of Stock

Represent ownership in a company

Stockholders

Another name for shareholders and equity-holders

Equity-Holders

Another name for shareholders and stockholders

Corporation Liquidity and Marketability

Shares can be easily exchanged

Partnership Liquidity and Marketability

Subject to substantial restrictions

Corporation Voting Rights

Usually each share gets one vote

Partnership Voting Rights

General partner is in charge; limited partners may have some voting rights

Corporation Taxation

Double taxation

Partnership Taxation

Partners pay personal taxes on partnership profits

Corporation Reinvestment and Dividend Payout

Broad latitude

Partnership Reinvestment and Dividend Payout

All net cash flow is distributed to partners

Corporation Liability

Limited liability

Partnership Liability

General partners may have unlimited liability; limited partners have limited liability

Corporation Continuity

Perpetual life

Partnership Continuity

Limited life

Benefit Corporation

A for-profit company with additional legal attributes of accountability, transparency, and purpose

Benefit Corporation Accountability

Must consider how an action will affect stakeholders

Benefit Corporation Transparency

Must provide an annual report detailing how the company pursued a public benefit or what inhibited this goal

Benefit Corporation Purpose

Must provide a public benefit to society or the environment

Financial Manager's Most Important Role

Create value through capital budgeting, financing, and net working capital decisions

Value-Creating Asset Purchase

Buying assets that generate more cash than they cost

Financial Instrument Sale

Selling bonds, stock, and other financial instruments that raise more cash than they cost

Balance Sheet

Assets = Liabilities + Owner's Equity

Income Statement

Also known as the P&L; reports sales, COGS, SG&A expenses, depreciation, interest, tax, and net income

Sales

Revenue reported on the income statement

COGS

Cost of goods sold

Selling, General, and Administrative Expenses

Operating expenses reported on the income statement

Depreciation

Expense related to the reduction in value of long-term assets

Interest

Financing expense reported on the income statement

Tax

Tax expense reported on the income statement

Net Income

Final income amount after expenses and taxes

Goal of Financial Management

Maximize value to the shareholder

Financial Management Is Not Necessarily About

Surviving, avoiding financial distress or bankruptcy, beating competition, maximizing sales or market share, minimizing costs, maximizing profits, or maintaining steady earnings growth

Agency Relationship

Relationship between the principal (stockholders) and the agent (management of a firm)

Agency Problem

Conflict of interest between stockholders and management

Agency Costs

Costs resulting from the conflict of interest between stockholders and management

Management Goals

May differ from shareholder goals

Management Perquisites

Expensive benefits or privileges management may want

Management Survival

Management may prioritize keeping their positions

Management Independence

Management may want independence from outside control

Empire Building

Seeking larger company size to increase management's power, prestige, and compensation