Organizing a business

Module 1

Framework

Framework

Module 1: Organizing a Business

A. The Finance Function

Framework

Goals of the Firm

Other goals: To increase its value as a business entity

Growth Stability Owner’s Equity

To improve the quality of life in a community

Maximize shareholder valueMaximize shareholder value

What is Finance

Financial management is concerned with the maintenance and creation of economic value or wealth

Art and science of managing the financial resources of a business

The functions of business finance Allocation of financial resources Procurement of funds Efficient and effective utilization of

financial resources

Functions of business finance

•Is the project necessary? What are the alternatives?•What resources can be used?•How much is the estimated capital requirement?•Whati is the economic life?•What are the estimated cash returns?•How long will it take to recover investment?•What are the risks?

Financial Resource Allocation

Financial Resource Allocation

•Capital should be available at the least cost when needed•Cost of capital varies

•Borrowing•Contributed

•Repayment of capital and corresponding costs involved can be made from cash return from company projects•Repayment period should correspond with economic life

Fund procuremen

t

Fund procuremen

t •Efficient utilization – financial resources are used for what they have been intended•Effective utilization – use towards the attainment of pre-determined objectives (operational review vis-à-vis ST and LT goals)•Adoption of effective control measures•Working capital management, cash management

Financial Resource Utilization

Financial Resource Utilization

Module 1: Organizing a Business

B. Business Organizatio

n

Framework

Organizing a business

The decision to engage in business Social approval Profit Service to community and to employees Personal satisfaction Power Protection

Studies show that certain kinds of experiences and situational conditions, rather than personality or ego, are the major determinants of whether or not an individual becomes an entrepreneur.

Organizing a business

Entrepreneurship

Functions of an entrepreneur is different from a stockholder of a corporation

Functions To supply the capital of the firm Organize production by buying and

combining inputs Decide on the rate of output in light of his

expectations about demand Bear the risk involved in the activities

Prospecting The scan for business opportunities Business opportunities

Increasing demand for an increasing product Rising price (or cost) of an existing product Liberalization of government policies Development of a new service concept or

new product concept Rising requirements for specialized services Increasing requirements of an existing

industry

Promotion Promotion refers to the discover and

exploration of a business opportunity Steps in business promotion

1

2

3

Feasibility A feasibility study is a detailed

investigation and analysis of a proposed business venture to determine its viability Management, proponents, personnel and

organization Marketing Production facilities and product Taxation and legal implications Financing Financial statement estimates and analyses Social desirability

Assembling resources

Initial capital is required to take care of Cost of organizing Working capital Acquisition of fixed assets Reserves

Sources of initial capital Owners and creditors

Retention of control Leases Options and contracts Franchises and concessions Patents and copyright

Module 1: Organizing a Business

C. Forms of Business

Framework

Sole proprietorship There is only one owner

Partnership An association of two or more persons who bind

themselves to contribute money, property, or industry to a common fund, with the intention of dividing profits among themselves

Corporation Artificial being created by operation of law Has the right of succession and the powers,

attributed and properties expressly authorized by law or incident to its existence

Legal forms of a business

Sole Proprietorship: Advantages and Disadvantages

Easy to organize Decisions can be

easily made by the owner

Financial operations are not complicated

The owner is entitled to all profits his business realizes

Limited ability to raise capital

Unlimited liability Limited ability to

expand Business is entirely a

responsibility of the owner

Net income is subject to tax regardless of whether it is withdrawn or not

Advantages Disadvantages

Partnership: Advantages and Disadvantages

Easy to organize Flexibility of

operations Can operate more

efficiently due to the presence of more owners

Partners are expected to have great interest in the operations due to their unlimited liability in debts aside from profits

Unlimited liability for partnership debts

Limited life because it can easily be dissolved

Limited ability to raise capital

Net income is subject to tax whether distributed or not

Advantages Disadvantages

Corporation An artificial being with a personality

separate from its individual stockholders or members

Has a right to continuous existence irrespective of death, withdrawal, insolvency or incapacity of the individual members or stockholders and regardless of the transfer of their interest or shares of stock Limited to the term stated in the articles of

incorporation but it should not exceed 50 years Subject to extension for a period no longer

than 50 years in any one instance.

Corporation: Advantages and Disadvantages

Legal capacity to act as a legal unit

Continuity in existence Management is centralized

in the BOD Creation, organization,

management and dissolution processes are standardized

Shareholders have limited liability

Shareholders can transfer their shareholdings without consent of other shareholders

Ability to raise more capital Stockholders are taxed only

on their shares of distributed earnings

Subject to a greater degree of governmental control and supervision

Cost of formation and operation is relatively high

Formation and management is complicated

Subject to higher income tax rate

Limited powers - can only do what is expressly or impliedly allowed by law

Possible for BOD to abuse its powers

Advantages Disadvantages

Similarities between a corporation and a partnership

Has a juridical personality separate and distinct from those individuals composing it

Can be organized only where there is a law authorizing their organization

Composed of an aggregate of individuals

Distribute their profits to those who contribute capital

Subject to corporate income tax

Stocks and Stockholders

Pre-emptive right of stockholders Right to subscribe to all issues of shares of

any class in proportion to his shareholdings. Watered stock

Stocks issued less than par Voting Rights

Cumulative Voting E.g. Mr. Malakas owns 7,000 shares of the

25,000 outstanding shares of Company A’s capital stock. If there are 7 seats in the BOD, he can cast a total of 49,000 votes (7,000 * 7).

Let’s talk DIVIDENDS

Dividend: items of value received by stockholders from the corporation

All assets and earnings of a corporation are owned by the corporation and not by its stockholders. They may be transferred to stockholders upon declaration by the BOD

Types of dividends Cum-dividend Ex-dividend

Classification of Dividends

Cash dividends: paid in cash to stockholders Property Dividend: non-cash assets (e.g. stocks

of other companies) Stock dividend: stocks of the issuing corporation Scrip dividend: PN indicating the kind of benefits

the shareholder will receive in the future (e.g. cash, noncash assets, stocks)

Bond dividend: bonds of the company Liquidating Dividend: return of capital by a

corporation. It is a distribution of assets upon the company’s dissolution or cessation of operations

Effects of Dividends

Cash dividend Retained EarningsCash

Property dividend Retained EarningsAssets (investment)

Stock dividend Retained EarningsCapital stock

Scrip dividend Retained EarningsCurrent liabilities, long term liabilities or stock holder’s equity (depending on the nature of benefits)

Bond dividend Retained EarningsLiabilities

Liquidating dividend

Capital stock and premium on capital stockAssets

The Corporation And The Financial Markets

Corporations

Corporation invests in

return-generating

assets

Investors

Secondary Markets

Securities traded among investors

Government

Cash

Securities

Cash flow from cash distributed

Operations back to investors

Cash reinvested in the corporation

Taxes