CP-E1

FIN 6301, Corporate Finance 1

Course Learning Outcomes for Unit I Upon completion of this unit, students should be able to:

1. Formulate financial decisions based on financial statement analysis. 1.1 Identify different types of financial markets and financial institutions.

2. Assess a company’s performance based on financial ratio analysis.

2.1 Analyze financial ratios. 2.2 Interpret different kinds of financial statements.

Course/Unit Learning Outcomes

Learning Activity

1.1

Unit Lesson Chapter 1, pp. 3–16 Chapter 2, pp. 56-82 Chapter 3, pp. 101–127 Unit I Essay

2.1

Unit Lesson Chapter 1, pp. 3–16 Chapter 2, pp. 56-82 Chapter 3, pp. 101–127 Video Segment: “Corporate Business Structures” Unit I Essay

2.2

Unit Lesson Chapter 1, pp. 3–16 Chapter 2, pp. 56-82 Chapter 3, pp. 101–127 Unit I Essay

Required Unit Resources Chapter 1: An Overview of Financial Management and the Financial Environment, pp. 3–16 Chapter 2: Financial Statements, Cash Flow, and Taxes, pp. 56–82 Chapter 3: Analysis of Financial Statements, pp. 101–127 In order to access the following resource, click the link below. Films for the Humanities & Sciences. (Producer). (2011). Corporate business structures (Segment 6 of 9)

[Video segment]. In Planning your business: Research, goals, and business plans. https://libraryresources.columbiasouthern.edu/login?auth=CAS&url=http://fod.infobase.com/PortalPla ylists.aspx?wID=273866&xtid=42248&loid=116024

The transcript for this video can be found by clicking the “Transcript” tab to the right of the video in the Films on Demand database.

UNIT I STUDY GUIDE

The Corporation and Introduction to Financial Statement Analysis

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Unit Lesson

Recognized Forms of Business In the United States, there are four recognized types of businesses. Probably the most familiar forms of business to you are the sole proprietorship and the corporation. The other forms of businesses are partnerships and limited liability companies (LLCs). Each type of business has distinguishing characteristics primarily pertaining to the ownership of the business—who is legally responsible for the business and who is responsible for paying income taxes. Businesses are also defined by Internal Revenue Service (IRS) tax regulations within these four types, resulting in business forms that have characteristics of more than one type. You will focus on the corporation form of business in this class. Corporations are considered legal entities, distinct and separate from their owners. This means a corporation can enter into contracts, acquire property, and incur debt—it has its own identity and can conduct business on its own behalf. The corporation is not liable for any personal obligations of its owners, and, in turn, the owners are not liable for any obligations incurred by the corporation. A corporation must be legally formed to be recognized as a separate, legal entity. Each state has distinct regulations for corporations; many corporations consider the differences in regulations before choosing where to incorporate. A corporate charter, which includes the articles of incorporation and the corporate bylaws, must be created and submitted to the chosen state government for consideration. Once the state recognizes the corporate charter and bylaws, the corporation is subject to the chosen state’s regulations. The owners of a corporation are shareholders. The number of shares to be issued for a corporation are stated in the articles of incorporation. Commonly called stock, the shares may be sold to the public on the stock market (publicly traded) or held privately. Shareholders have equity in the corporation, and they are entitled to dividend payments. The amount of equity held by an individual shareholder is dependent upon the percentage of the shares issued by the corporation he or she owns. A much-discussed disadvantage of the corporation form of business is the so-called double taxation of the profits. The corporation pays taxes on its net income. The IRS Form 1120 is completed and filed on behalf of the corporation each tax year. If the corporation pays out dividends to the shareholders, distributing part or all of the profits, the individual shareholders must declare the income when they file their IRS Form 1040. In effect, the net income of the corporation is taxed twice. An S Corporation, a form of corporation defined in the IRS tax code, favors the legal entity distinction and avoids the double taxation issue by treating net income or net loss like a partnership; the business is not taxed before distributing the income to the shareholders. Unlike sole proprietorships, partnerships, and LLCs, the control of a corporation is not in the hands of the shareholders. This is based on the fact that shareholders are free to sell or buy stock at any time, especially for publicly traded corporations. A board of directors, elected by the shareholders, appoints a chief executive officer (CEO) who manages the operations. In this way, changes in ownership do not have a direct impact on the operations of the company. The objective of the executives and board of directors is to increase the wealth of the shareholders.

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Financial Reporting

Accounting is often called the language of business. Organizations communicate the details and results of their activities in various accounting reports or financial statements. Financial statements are used by internal management to effectively operate the business. Financial managers, investors, shareholders, financial analysts, and creditors rely on the financial statements to formulate investment strategies and obtain credible business information. You need to understand the purpose of each financial statement and its uses in financial analyses. The income statement reports the business’s operating revenues, expenses, and any income taxes paid for a specific period of operation. If extraordinary events

occur, the financial information will be reported separately from the routine operating expenses. The information from this financial statement can be analyzed in several ways. Return on investment (ROI), return on equity, earnings per share, and DuPont identity are all commonly used ratios based on the income statement information to evaluate a company’s financial status. The balance sheet reports the business’s assets, liabilities, and stockholders’ equity balances as of a specific date. Several financial ratios use the information from this financial statement including the current ratio, inventory turnover ratio, and working capital. The sources and uses of cash are reported in the statement of cash flows. The amount of cash a business has will never be equal to the net income because of non-cash expenditures and proceeds as well as disbursements related to financing, investments, and shareholder activities. This report details these activities, reconciling the cash balance to the net income. Interested parties use this report to analyze working capital management and investment activities. The income statement, balance sheet reports, and statement of cash flow provide a complete picture of the financial status of a company. Understanding the information reported in these financial statements is fundamental for the effective analysis of a business. Once you know where to locate needed information, you can perform the necessary analysis and be assured of accurate findings.

Financial Decision-Making As a financial manager, you must be able to perform various analyses to provide sufficient information for effective business decisions. One of the most common analyses is cost-benefit analysis. This analysis can take many different forms. Consider the following situation. You might be asked to evaluate the opportunity to purchase or lease a piece of property. You would need to perform a number of tasks to properly evaluate this opportunity, including researching the factual details of the piece of property, the cost of leasing versus purchasing, and the opportunity cost. One of the first steps you take is to identify the costs and benefits of a financial decision. You need to quantify the costs in a manner so that the options are comparable. It is difficult to fairly and accurately compare a bicycle with a car. This is done much like in math class where you find a common denominator. One method for quantifying values of business opportunities is to use the market prices for the options being considered. This method termed as the valuation principle is defined as the value of an asset and is determined by its competitive market price. When the value of the benefits exceed the value of the costs, the

(Meepian, n.d.)

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value of the firm will increase. This method is considered a cash value method, assuming the benefits and costs both occur in the same financial period. Most financial decisions must be made regarding an opportunity that has costs and benefits occurring at different times. In order to properly analyze these opportunities, you must measure the costs and benefits in a manner that provides current and future value information. The value of a dollar today will be different than the value of a dollar in the future. The time value of money (TVM) is defined as the difference in value between money today and money in the future. The net present value (NPV) of a project is the difference between the present value of its benefits and the present value of its costs. If the NPV for a project is positive, the project will increase the value of the company, which makes it a good decision for the company. If you are considering more than one project, the project with the highest NPV would be the best choice. Projects with negative NPVs will reduce the wealth of the investors and, therefore, should be avoided.

Arbitrage and the Law of One Price Arbitrage occurs when a corporation buys and sells equivalent goods in different markets to take advantage of a price difference. Arbitrage opportunities always have positive NPVs; therefore, financial managers actively seek these opportunities on behalf of their investors. The law of one price states that equivalent goods or securities will trade for the same price in each market if they trade simultaneously in different competitive markets. Financial managers can save time by using any competitive price, rather than pricing all possible markets, when evaluating costs and benefits.

Conclusion This unit introduced you to the recognized forms of business in the United States. The basics of financial statements and the TVM will serve as springboards for further exploration of corporate financial management concepts. The effectiveness of corporations as a means of creating wealth was examined, keeping in mind that the long-term viability of any business depends on how well managers understand the limits and opportunities that external forces exert on their organization.

Reference Meepian, N. (n.d.). Accountants work analyzing financial reports on a laptop at his (ID 101094966)

[Photograph]. Dreamstime. https://www.dreamstime.com/accountants-work-analyzing-financial- reports-laptop-his-office-business-fintech-concept-accountants-work-analyzing-image101094966