Corporate Finance and the Financial Manager

Why Study Finance?

You may not realize it but finance is all around us. Some of the financial decisions we must make include: how much can I afford to pay for a new car or home, what is my monthly budget, and how much should I be saving each year to name just a few.
This is why studying and becoming familiar with the fin​ancial process is very important because finance surrounds us almost everyday of our lives.

Four Types of Firms

Before jumping into the financial aspects that a business encounters, it is important to understand the different types of business structures that can be formed. There are Four general types of businesses:

  • Sole Proprietorships : This is a business owned and run by only one person. They are the most common type of firm in the world but generate a very small portion of total business revenue. An advantage of this form of business is that it is very easy to set up. Disadvantages would be that the owner has unlimited personal liability which means that creditors can come after the owner's personal assets if the business defaults on debt repayment. Another disadvantage is that the firm's life is limited to the life of the owner. It is not easy to transfer ownership of a sole proprietorship.
  • Partnerships : This is a business owned and run by more than one owner. In a partnership, all partners are liable for the firm's debt.Like a sole proprietorship, a partnership also ends upon the death or withdrawal of a partner.
    • Limited Partnership : A type of partnership with two kinds of owners: general and limited partners. General partners have the same rights and privileges as in a normal partnership. However, limited partners have limited liability, that is their liability is limited to the amount they invest in the company. The death of a limited partner does not dissolve the partnership because they have no management authority.
  • Limited Liability Companies (LLC) : This is like a limited partnership but all partners are limited partners. Here, limited partners are able to manage the business while only being liable for the amount of their investment. LLCs are relatively new in the United States.
  • Corporations : A legal entity separate from its owners. The owners of a corporation are not personally liable for the corporation's obligations nor is the corporation liable for any personal obligations of the owners
    • Corporations are time consuming to form because they must be legally created. A corporation must be legally charted in the state in which it headquarters.
    • Ownership of a corporation is broken in shares of stock. The corporation's equity is the collection of all the outstanding shares of the corporation. A stock owner of a corporation is often referred to as a shareholder, stockholder, or equity holder. This provides corporations a tremendous advantage: they are able to easily raise capital by issuing shares of stock to interested investors.
    • Shareholders receive periodic payments from the corporation called dividend payments.
      • C Corportation : A disadvantage of the corporate structure is that corporations are subject to double taxation. The corporation itself pays taxes on earnings. Remaining earnings are then distributed to the owners who pay personal taxes on this share of income.
      • S Corporation : Corporations that are exempt from double taxation. The firms profits and losses are not subject to taxation. Instead, earnings are distributed to the owners and they in turn report the income on their personal tax statements. To qualify, shareholders must be US citizens or residents, and there can't be more than 100 owners.

To find out more about the different business structures and the difficult process of choosing one, please click below.
Choosing Your Business Structure

The Financial Manager

The financial manager's job is to make the important financial decisions of the business. Their ultimate goal is to maximize the wealth of the owners. Financial managers have 3 overriding tasks in an organization: make investment decisions, make financing decisions, and manage the cash flow from operations.

The Financial Manager's Place in the Corporation

The board of directors are a group of people in an a corporation who have the ultimate decision making authority. It is through this group that shareholders exercise their control. The board makes rules about how the company will be run, sets policies, and monitors performance. The chief executive officer (CEO) is responsible for managing the corporation by enforcing the rules and policies the board of directors created.

Because the owners of a corporation do not manage it, they put their trust in the board of directors and the CEO to look after their interests. Sometimes, however, these groups put their own interests ahead of the shareholders and problems arise. This phenomenon is referred to as the agency problem, when managers put their own interests ahead of the interests of the shareholders even though they were hired as agents of the shareholders.

So how can managers tell if shareholders think they are doing a good job at managing the corporation? One way to tell is by looking at the price of the corporation's stock. A high price can indicate they are doing a good job. A well managed corporation will entice investors to purchase stock which drives the price up. However, if shareholders aren't satisfied, they will only be willing to buy stock at a low price. These low stock prices can create an opportunity for profit. An individual or corporation can purchase a large portion of the company's outstanding stock. This is known as a hostile takeover.

The Stock Market

Shareholders of a corporation trade their shares on an organized market often referred to as a stock market, stock exchange, or bourse. These markets are where the share price is determined and they also provide liquidity for the company's shares. A liquid investment is one which can be easily converted into cash by selling it immediately at a price at which could contemporaneously buy it.

There are two types of stock markets. The primary market refers to a corporation issuing new shares of stock and selling them to investors. Selling shares in the primary market is the only time corporations will make a profit. The secondary market is where outstanding shares continue to trade between investors without any involvement from the corporation.

The New York Stock Exchange (NYSE) is the largest and best known stock market in world. On the floor, there are market makers (specialists) that match buyers and sellers. These specialists post two different prices for every stock: the bid price is the price they are willing to buy the stock at and the ask price is the price they are willing to sell the stock at. Investors buy stock at the ask price and sell at the bid price. Because asking prices are higher than bid prices, there is a bid-ask spread. The bid-ask spread is a transaction cost that investors have to pay in order to trade their shares.

The NASDAQ is another well known stock market. Unlike the NYSE, NASDAQ is not a physical location. On the NASDAQ, each stock has multiple market makers whereas the NYSE only has one market maker per stock. As a result, market makers compete with each other on the NASDAQ for the best prices.

If you click on the following link, you will be directed to the NASDAQ website where you can explore and get more familiar with different stocks and their pricing NASDAQ