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COMM 200

Chapter 1- What is Business? The Big Picture - Business is a system of integrated actions designed to ensure that an organization develops and grows a market for its goods and/or services in a manner that creates organizational value (wealth) on behalf of its stakeholders. - Three fundamental characteristics: 1. Commercial endeavours= markets the organization serves, the products and services it offers, and the needs it professes to meet in the marketplace o Understanding supply and demand o System that creates profitable outcomes to the organization 2. Employee interaction= the value-creating skills an organization’s employees bring to the marketplace. The success of many businesses lies with the specialized skills of its workforce. o Leverage these skills in the production of goods in order to turn a profit 3. Organizational efficiency and structure= reflection of the complexities of the business activities that circulate within the organization; reflective of the development of the infrastructure and its related culture, which an organization creates, and the transaction processes it develops to service the marketplace it targets. ** An effective business system with possess all three fundamental characteristics. What is Business? - Business= mission-focused activities aimed at identifying the needs of a particular market or markets, and the development of a solution to such needs through the acquisition and transformation of resources into goods and services that can be delivered to the marketplace at a profit. - An organization builds itself around four fundamental resource areas: 1. Assets= infrastructure and resource base of the organization (e.g. land, buildings, equipment, technology, materials, brand power, etc.) 2. Labour= human resource requirements of the business. 3. Capital= money needed by an organization to support asset-based expenditures, meet operating cash requirements, and invest in the development of new products and/or services which the organization desires to introduce into the marketplace. 4. Managerial Acumen= foresight, drive, knowledge, ability, decision-making competency, and ingenuity of the organization’s key individuals- its owners or top-level managers. o Visionary leadership= ability of managers to establish a direction for the organization based on the needs identified in the marketplace and the mission of the organization; strategic plan is formed through this ** Together they make up a businesses operating platform or Business Model (System) - Role of management is to anticipate, recognize, or sense an opportunity to create a product, and to deliver a service that is meaningful to a targeted customer. o Conduct a ‘strategy’ (specific objectives during the planning cycle) and ‘3C Assessment’ (capabilities, capacity, and competencies) - Business Planning Cycle o Ideally it is built around competitive advantage= advantage an organization has over its competitors that enables it to generate more sales, achieve greater margins, achieve a lower cost base, or attract and retain more customers. o Businesses grow by executing a series of planning cycles over time o Businesses need to set specific, measurable, actionable, and controllable (SMAC) objectives in order to achieve a defined position in the marketplace o Failure to meet the objectives of a planning cycle can be the result of poor positioning, poor operational execution, or a combination and will result in the company not meeting its desired targets and the need to readjust its objectives. o Whether a plan is failing is indicated by the flattening, or declining, or revenue or a reduction in overall profitability - For-profit companies= organizations whose overarching objective is profitability and wealth creation on behalf of their shareholders and stakeholders - Not-for-profit organizations= organizations whose overarching objective is to deliver services to the people, groups, and communities that they serve via a model of collective interest and social goal achievement The Fundamental Objectives of Business 1. Short-term profit in order for the company to pay its bills and reinvest in the future; ensures immediate survival of the company 2. Long-term growth and profitability; keeping up with changes in the marketplace including new products and services 3. Social and environmental responsibility; consumers are encouraging that businesses operate in a way that demonstrates social responsibility in product development, resource consumption, and operating processes; green initiatives, sustainability, etc. o Managers are expected to make decisions that conform to the highest ethical standards and to place society, the organization, and the stakeholders ahead of personal gain. - Stakeholders= individuals, groups, or organizations that have a direct or indirect relationship with an organization, and that can be impacted by its policies, actions, and decisions. Stakeholders can include customers, suppliers, government, employees, etc. - NFPs have the same fundamental objectives and although they do not strive for profit they do need to create operational surpluses or secure external funding that ensure the company remains vibrant and responsive to the community’s needs. o Must do this in accordance with its charitable mission ** All three objectives must be considered equally; too much emphasis on short-term profitability may result in decisions that are detrimental to long-term market opportunities and fall short of social responsibility expectations. The Business Model and Profitability - A successful business model is one that enable a company to meet the needs of the marketplace in a manner which is superior to that of its competitors - Most common way of measuring a company’s performance is by measuring profitability over a period of time, and in direct comparison with its industry competitors The Difference between Profit and Profitability - Profit= the ‘bottom line’ result an organization has realized for an identified, immediate period of time. Total Revenue – Total Expenses = Profit - Profitability= measures how well a company is using its resources over a specific period of time to generate earnings relative to its competitors o Efficiency and effectiveness of an organization to use its assets and its capital to generate profits o Benefit of profitability analysis is that it levels the playing field between competitors, recognizing that some may be significantly larger than others; takes into consideration return on capital, return on equity, financial leverage, pre-tax income, etc. - Stockholders= any person, company, or organization that owns at least one share of stock in a specific company - To improve profitability companies develop new product opportunities, meet evolving needs in emerging markets, and streamline operations Creating a Value Proposition - Value proposition= statement that summarizes whom a product/service is geared toward and the benefits the purchaser will realize as a result of using the product Value proposition = Service Benefits + Product Benefits + Brand Benefits + Cost Benefits + Emotional Benefits - Companies develop value propositions for the purpose of communicating to customers how their products/services are different and the important benefits which they offer - Purchasers assess the price/quality relationship- relationship between what consumers are being asked to pay for a product and what they expect to receive (benefits can be both tangible and intangible) - In general, the more unique, important, and value-driven your product is, the greater the opportunity to communicate to the potential purchaser a value proposition which has a positive price/quality relationship, and which can be considered to be superior to those of your competitors - Not always about the lowest price; must meet needs of targeted consumer - In developing your value proposition five questions need to be assessed for how and where to compete in the marketplace: 1. What is my cost base for producing and/or delivering this product/service to the market place, and how does this compare to that of my main competitors? 2. Do I have a strong brand profile in the marketplace that I can leverage as part of the benefit to the customer when purchasing this product? 3. Are there emotional benefits that the customer will attach to this product/service offering? If so, how can I use this to assist me in strengthening my value proposition? 4. Are there unique service benefits I can incorporate into this value proposition that will assist me in supporting potential and existing customers? - In answering these questions can I create a strong value proposition to compete in the market segment? - Market segment= portion of the market that is deemed to possess unique characteristics businesses can target in order to generate a preference for their products and services Understanding your Cost Base - 2 types of expenses: o Asset-based expenditures= expenditures for the purchase of assets required by a firm in order to support the company’s business operations, and which contribute to the firm’s ability to earn a profit; commencing a business or expanding (i.e. buildings and equipment) o Operating expenditures= expenses incurred as a result of a company performing its normal business operations (i.e. salary and materials) The Business Decision-Making Landscape - Business Decision-Making Model - Strategy= development of plans and decisions that will guide the direction of the firm and determine its long-term performance - Tactics= immediate-term actions which a firm executes in order to meet the short-term objectives set forth in the current planning cycle ** Management teams must be successful in both planning strategy and executing tactics in order for company to grow and maintain profitability. ** Business is not only about producing and distributing goods and services; it is about delivering value to customers in a manner that meets their needs and desires. Chapter 5- Ethics and Corporate Responsibility - Ponzi Scheme= type of investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors What is Ethics? - Ethics and the Individual o Ethics= reflection of the moral principles or beliefs about what an individual views as being right or wrong; beliefs are built in part around the norms or standards of conduct society views as acceptable behavioural practices o Highly subjective and combines many different domains (I.e. culture, legality, etc.) o Interpretation of ethical vs. not ethical behaviour is influenced by many different things: - In making decisions, we need to think in terms not of what is in our personal best interests, but what is in the best interests of the stakeholder and the public at large - The “Triple-Yes Rule” 1. Does the decision that I am making fall within the accepted values of standards that typically apply to all organizational environments? 2. Would I be willing to have this decision communicated to all of my organization’s stakeholders, and have it reported on the front page of the newspaper? 3. Would the people in my life with whom I have a significant personal relationship (family, spouse, etc.), as well as managers of other organizations, approve of and support my decision? - This can be used in conjunction with the Ethical Decision-Making Process in order to determine whether a decision is ethical and maintains personal integrity - The most important skill you can bring to the workplace is integrity= honesty, reliability, ethics, moral judgement - Ethics and Culture o Critical component of an organization’s culture is the defining of the boundaries of acceptable behaviour for its management team and employees o Just as companies are vulnerable to shifts in market conditions, changes in the intensity of competitive rivalry, disruptive technologies, and changing customers, so, too, are they vulnerable to the serious consequences and brand equity erosion that accompanies unethical behaviour within their management and employee ranks. o Board of directors= governing body of a corporation, comprising individuals chosen or elected to oversee the management of the organization; responsible for developing policies related to ethics o The establishment of an accepted zone of behaviours keeps decision-making within the “green zone” of acceptable business principles. The green zone acts as a barrier to keep managers and individuals from straying into the zone of ethical and decision-making uncertainty (the grey zone), or the zone of clearly defined unethical behaviour (the red zone) - For boards to effectively create a culture of ethical behaviour they must: 1. Clearly define boundaries of ethical behaviour and financial integrity and create performance evaluations for these parameters 2. Boundaries must be clearly understood and communicated to all employees in the form of a policy or code of conduct 3. Appoint a representative, at the board level, whose responsibility is to audit managerial and employee performance in areas of this policy 4. Create and support a mechanism for the reporting of ethical concerns within the organization (called whistleblowing= process through which an individual informs an authority of a dishonest act/behaviour of another person) 5. Interact with senior management and external agencies monitoring the organization’s activities in order to discuss issues that could arise with respect to management or employees, and represent the best interests of the organization. ** To truly create a culture of ethical behaviour and financial decision integrity, the board of directors must be active in the ongoing monitoring of the organization and take a leadership role in the tightening of such processes when and where it is required. - Code of conduct= statement that describes the required responsibilities, actions, and rules of behaviour of an organization’s employees - The board of directors, as representatives of the stakeholders of an organization, must see itself as the creator and sentinel of the organization’s conscience Regulating Ethics - Government acts focus on protecting the interests of investors and all stakeholders by heightening the financial operational requirements of organizations around areas like auditor independence, audit committee responsibilities, CEO and CFO accountability for financial reporting and internal controls, faster public disclosure, and stiffer penalties for illegal activities; Sarbanes-Oxley Act of 2002 (SOX) and equivalents - G20 agreed to the development of global accounting standards; heightened reporting standardization and regulation - Forensic accounting= integration of accounting, auditing, and investigative skills; look beyond the numbers at what is actually transpiring within these companies What is CSR (Corporate Social Responsibility)? - Different meaning and interpretation for every person - CSR= understanding that the purpose of an organization is to create shared value (business and society) by strategically integrating into its actions a partnership mentality with society where the objectives of both parties are met; treating public interest as a key stakeholder in an organization’s operational success; actively participating in environmental, social, and public policy programs and initiatives that contribute to the long-term health of society - Why is CSR becoming so important? o Three trends are driving the CSR: 1. Despite the financial crisis of 2008, and the recession/recovery of 2009 and 2010, social responsibility has remained an important issue in the minds of more than 75% of the consumers surveyed 2. The ability to leverage CSR initiatives as a key differentiator between two businesses is an important part of an organization’s overall value proposition, especially when the organizations against which one is being compared are offering what are otherwise similar products/services 3. A growing percentage of consumers are willing to spend the same, or more, on products or services from organizations that demonstrate the effective execution of CSR initiatives o CSR is interpreted to mean that: 1. Companies should be giving back to local communities 2. Companies need to self-regulate their actions and be willing to be held accountable for their decisions - The result of the 2010 survey by Penn, Schoen, & Berland Associates and survey by Bonini, McKillop, and Mendonca, as well as others in this field, point toward the same conclusion: companies that do a better job of understanding consumer perceptions and expectations relating to CSR, and that utilize this knowledge in the delivery and support of their product/service value propositions, ultimately will be more successful in winning the public’s trust The Interdependency of CSR and Corporate Strategy - The CSR pyramid illustrates the four primary views associated with the integration of CSR into an organization. - Bottom of the pyramid strategies are the result of decisions that do not significantly influence forward-looking corporate strategy but rather seek to enhance or reinforce the company’s image or brand in the marketplace; focused on generic social issues o Philanthropy- Walmart donates money for Oprah to give away o Personal projects- M&M Meat Shops yearly BBQ for colitis - Operational initiatives integrates CSR initiatives into corporate strategy; transitions CSR into daily operations - In order to truly integrate social responsibility into the company, there needs to be a cultural shift in strategic partnering that includes two shifts: 1. The organization’s decision-making process evolves from one that responds to social issues identified as being pertinent to the organization, to a process that treats CSR as a core root of the organization’s strategic planning process. 2. The organization recognizes that certain social issues impact the key drivers of its competitiveness and, therefore, seeks to actively develop the necessary social partnerships in order to leverage such competitiveness in a way that positively impacts the people, communities, and environment around which it conducts its business. - Integration of CSR into Strategy - For managers, this means conducting a complete risk/reward audit of the full business system and strategic approach to the social partnership o Identify key social interactions that will occur on a day-to-day basis throughout the organization’s business system o Identify those social impacts that are critical to the organization’s success and then create definitive and sustainable solutions to such issues - Organizations that are able to climb to the top of the pyramid and develop the necessary social partnerships in a way that positively impacts the people, communities, and environment around which they conduct their business are those that are able to fuse and synthesize their organization’s values and financial aspirations into such a partnership; drive maximum benefit for society and, as a consequence, themselves as well. - Long-term health of society is fundamental to the long-term health of the organization; the two are interconnected versus being separate and distinct o End result being a strong society/business partnership The Challenge behind CSR Implementation - For many companies, transitioning to the top of the CSR pyramid would require a significant change not only in operating procedures and processes, but also in the entire culture of the organization - Such a change can require significant investment up front and potentially an additional cost layer to the operating budget - How much more will people pay for their products? How do you quantify the benefits of CSR initiatives? - Managers need to do the research to see how a conscious effort toward the “triple bottom line” of people, planet, and profits really does enhance the final P-profits - Equally challenging for management and the board of directors will be the task of communicating the societal partnership benefits to the external stakeholders and communities while communicating, internally, the win/win nature of the arrangement A Note Pertaining to Not-for-Profits - The goodwill associated with the work they do and the integrity with which they conduct themselves are fundamental to their existence - Heavily dependent upon monetary gifts from others - Challenge is how to communicate to potential donors the legitimacy of their work in a donation environment that is becoming increasingly concerned with fraud Chapter 13- Introduction to Capital and Financial Markets Business Ownership Options - Key initial decision associated with the formation of a business is the type of legal structure to be utilized in order to commence business operations - Five factors influence this decision: 1. Ease of business set-up and operation 2. The degree of control that an owner desires 3. The magnitude of risk that individuals are willing to take on 4. The capacity of individuals to provide the financial needs required 5. The anticipated skills required for success - Using these four factors individuals can decide to use one of three legal structures: sole proprietorship, a partnership, or a corporation - As the needs of the organization change, or the level of risk magnifies, the need to adjust the business organization’s legal structure may be in the best interests of all those involved Sole Proprietorships - Sole proprietorship= business that is owned by one person and that is initiated without a requirement to create a separate legal entity - The individual and the business are legally one in the same - Key advantages: simplicity of the commencement of the operation and the sole proprietor has 100 percent control of the business with regard to ownership and in making decisions relating to the business - Key risk issues: the sole proprietor is 100 percent personally exposed to the liabilities incurred by the business, the skill set of the business is limited to the skills of the proprietor, and proprietors are limited to their own personal capacity to invest and/or borrow money in support of the organization Partnerships - Partnership= business organization that is formed by two or more individuals - Partnership agreement= written agreement among the partners that outlines the expectations of each partner and details how the partnership is going to work o Don’t technically need one but recommended because it ensures that the expectations of each partner and how their partnership will work are understood by both partners - Joint and several liability= liability obligation of partners as the result of a legal contract. Partners can be held individually liable for their share of the obligation (several), or fully liable for the full obligation (joint) in the event that the other parties to the agreement are unable to pay their obligations - Increased financial capacity and skill set - Buy-sell agreement= written agreement among the partners that details the sale by one partner and the purchase by another of the business interest of the selling partner - Limited liability partnership (LLP)= partnership that is made up of both general partners (at least one) and limited (passive) partners o Limited partners are individuals who contribute equity capital (money in exchange for a percentage of ownership) to the organization, but are not actively involved in the management of the business operation and have minimal control over daily business decisions o General partners assume full liability o i.e. real estate sector Corporations - Corporation= business entity that, legally, is separate and distinct from its owners - Incorporation= legal process of setting up a corporation o Can be provincial OR federal; key advantage to incorporating federally is that you are able to use the same business name in all provinces but is more expensive and requires more paperwork - Board of directors= appointed or elected body of a for-profit or not-for-profit corporation that oversees and advises management on issues challenging the organization on behalf of its stakeholders and shareholders - Higher cost and longer time frame to set up - Advantages: o Protects the shareholders by limiting their liability o Ownership rights are clearly defined and as based on the percentage of stock owned by its owners o The ability to issue shares of stock as a means of raising additional cash o Eligible for federal government programs and tax incentives (corporate tax rate) - Incorporation does require filling a tax return for the corporation and the including income received from the corporation (dividends) on their personal tax returns - Two types: 1. Private corporations= corporations whose ownership is private. The shares of stock of the corporation are not publicly traded o The selling of the shares would be a private transaction between the current owner of the shares and a potential purchaser o Shares may be restricted on how they may be purchased and offered for sale; i.e. ‘first right of refusal’- obligation to offer existing shareholders the opportunity to refuse to sell the shares before a shareholder can seek an outside buyer o Greater difficulty in selling and establishing a price 2. Public corporations= corporations whose shares of stock are initially issued via an IPO, and whose shares are then traded on at least one stock exchange or are publicly available in the over-the-counter market (OTC) o Initial public offering (IPO)= the initial sale of stock, by a corporation, through a public exchange o Exchange= organization that facilitates the trading of securities, stocks, commodities, and other financial instruments. Exchanges provide a platform for selling these financial instruments to the public at large o Over-the-Counter (OTC)= stocks being publicly traded through a dealer network versus an exchange o Share value of publicly traded corporations is set as the result of daily trading activity on these shares by the marketplace (public) at large o More information filing requirements set out by the securities commission that oversees the exchange the company is trading its shares on; provincial level in Canada- Ontario Securities Commission (OSC) Business Evolution - Proprietorship is easiest and then as the business begins to grow, its cash requirements, as well as the potential liabilities, may necessitate revisiting of the initial legal formation - Business owners and managers need to continually be aware of the financial capacity of our business, the liability exposure, the risk incurred, and the skill sets necessary for success. Using these factors as a basis for a business review, we can then make forward-thinking adjustments as to how we operate our business in order to ensure ongoing success. The need to raise capital to fund future needs can, and often does, play a key role in this decision- making process. Funding the Organization - One of the core responsibilities of a manager is to assess the financial resource requirements of an organization and determine how those needs are going to be met - They need to review the corporate structure of their organization and make decisions as to how the organization is going to finance its operations and what will be the mixture of use of the different sources of funds it will have at its disposal o Corporate structure= organization’s mixture (use) of debt, internal cash reserves, and external equity- based investments in financial support of operational activities - Manage the debt/equity ratio which provides managers with an understanding as to how much debt the organization has incurred, or is willing to incur, in financing its operations, and whether this has added significant negative risk to the organization’s financial stability Sources of Finds 1. Funds derived from operations 2. Funds obtained via credit facilities (debt) 3. Funds obtained via equity financing Funds Derived from Operations - Two internal sources of funds: current-year operating profits and retained earnings - Operating profits= total revenue minus total operating expenses during current operating period o Shown on the organization’s income statement o This profit, unless paid out to investors/shareholders, becomes an immediate source of new capital for an organization, which it can then choose to reinvest in support of future growth opportunities, enhanced R&D exploration, or the acquisition and/or replacement of equipment in support of the organization - Retained earnings= dollar amount of net earnings accumulated over the history of an organization that is has chosen to hold within the organization o Owner’s equity section of the balance sheet o Source of funds for the organization to draw upon in the event of operating losses during a given period, or in the event that additional investment needs to be made into the organization (growth, R&D, equipment replacement, acquisitions, and so on) o Compensate for operating losses occurring in a given year ** Must consult the balance sheet to ensure that the dollar amount identified in retained earnings is still available to the organization in a liquid form (cash, near cash) Credit Facilities (Debt Financing) - Credit facilities= debt that an organization has taken on in support of its business activities - Organization borrowing money or receiving products or services on a credit basis from another organization - Type of debt financing. With debt financing comes a legal obligation to pay both the interest on the debt, if applicable, and the debt principle when due, regardless of the organization’s financial position Short-Term Credit Facilities - Short-term credit facilities= debt obligations that an organization takes on for a short period of time, generally less than one year - Trade credit (organization orders products or receives services from another organization but payment for these products or services is deferred until a later date, i.e. “30 days to pay”), borrowing against the organization’s future flow of accounts receivable, borrowing against a general line of credit, or borrowing on a short-term-note basis (i.e., borrowing a specific sum of money for a specified period of time- three months, six months, one year) - Accounts payable= money owed by an organization to its suppliers and other short-term service providers o Current liabilities section of the balance sheet - Accounts receivable= money owed by customers of the organization for products or services that the organization has delivered to such customers, but has not yet received payment for - Line of credit= arrangement with a lending institution that provides an organization with a pre-arranged borrowing ceiling (maximum) that the organization can draw on at any time, and in any amount, up to the agreed-upon time o Preapproved and allows the company to draw on this account to meet frequent, short-term capital needs - Borrowing against a future flow of accounts receivable works in a manner similar to a general line of credit. It is just that the accounts receivable of the organization are used as collateral against this loan or credit facility - Collateral= capital assets or monetary assets used to secure a credit facility. The collateral would be used to pay off the lender in the event that the organization cannot meet the credit facility repayment obligations - Credit facilities defined as short-term are expected to be repaid by the organization during the current operating year and are a key factor in assessing the liquidity of a company Long-Term Credit Facilities - Long-term credit facilities= debt that an organization obligates itself to repay over a time frame that exceeds one year - May or may not include an interest expense obligation - Cost of borrowing= total sum of money over and above the principle borrowed paid by an organization as a result of incurring and repaying a debt obligation. This would include interest paid as well as costs incurred in setting up the credit facility - Bonds, mortgages, long-term notes, and lease obligations - Bond= credit facility with which an organization borrows money for a stipulated period of time. In return for the use of these funds, the organization promises to pay the holder of the bond an agreed-upon amount of interest at regular intervals (generally, semi-annually) during the periods of time for which the funds are borrowed o At the end of the stipulated period of time the organization agrees to repay the full amount borrowed (bond principal or face value) o Purpose of a bond for many organizations is to raise capital for the firm to be used to build infrastructure, fund acquisitions, or provide new working capital to the organization for the purpose of developing and growing the business o Bonds represent a legal obligation to pay the face value of the bond on a given date in the future. This requires the organization to establish reserves for these bonds prior to this date so that when the maturity date is reached the bond repayment can be made. o Bonds may be resold; the initial investor transfers the rights to future interest paid on the bond by the bond issuer, as well as the receipt of the face value of the bond at its maturity date, to the new bondholder o When discussing bonds, potential buyers focus their attention toward three key areas: coupon rate (interest rate that the bond promises to pay on the face value of the bond), face value and maturity date o Two factors determine the coupon rate (interest rate) at which a bond is issued: 1. The risk-quality rating of the organization issuing the bond- probability that the organization issuing the bond will be able to repay to the bondholder the face value of the bond on its maturity date, as well as meet the required interest payments on the bond during the period when the bond is outstanding 2. The duration of the bond o Rating agencies= organizations that offer an objective and independent creditworthiness assessment of an organization’s solvency, liquidity, and overall long-term organizational health; assign a bond rating to organizations issuing bonds, or that currently have bonds outstanding  Ratings can range from a high of AAA (no chance of default) to BB (junk bond)  Junk bond= high probability of default; commonly referred to as speculative bonds due to their potential for default on either their interest rate or principal payment obligations  Lower the rating, the higher the interest rate o If bond repayment schedules are not met, bondholders have a legal right to take action against the organization issuing the bond. This could include requiring the organization to liquidate its assets in order to raise the required cash to meet its bond obligations. - Mortgage= credit facility that is backed by real estate collateral (generally, the real estate the mortgage underwrites), and that sets forth a defined schedule of period payments for the full repayment of the debt owed, plus interest, over a defined period of time o Four characteristics: 1. Mortgage value- amount of money that is being borrowed (the principal) o Principal= amount borrowed or the amount remaining on a loan separate from the cost of borrowing, as represented by the interest expense charges applicable to the credit facility (loan) o Based on an appraised value of the real estate, its actual purchase price, and any applicable down payment being made by the purchaser 2. Amortization period= length of time over which a credit facility (loan) will be paid off 3. Interest rate- cost of borrowing 4. Interest rate term- length of time on which the repayment schedule is based o Cost of borrowing is considered a business expense and will appear on the income statement - Long-term note= credit facility under which an organization borrows a stipulated amount of money for a defined period of time (which exceeds one year), and with a defined interest rate schedule (fixed or variable) o Defined repayment terms (similar to a mortgage) but over a shorter time duration o Can be written with or without collateral requirement o Can include customized features such as balloon payments (when a major portion of the principal owed on a loan is not included in the periodic payments made on the loan, but is deferred to a later date) or other ‘return of principal’ options o Interest rate can be variable; i.e. prime lending rate= the base lending rate used by banks. It is also often interpreted to be the rate of which banks lend money to their most preferred customers (e.g. prime + 1%) - Lease obligations= legal obligation to pay a service provider an agreed-upon amount of money, via a defined periodic payment schedule over an identified period, in return for use of property, equipment, etc. o Long-term is over one year o At the end of the period, provisions are sometimes in place that allow the organization to buy the asset o Lessor- who owns the land, etc. o Lessee- person who rents the land o The recognition of the legal obligation to pay, under the lease agreement, that results in the requirement to recognize it as a liability of the organization - Debt leverage= use of debt to finance an organization’s capital asset base - As managers, in making decisions to utilize debt financing (credit facilities) as a source of funds for our business we must ensure that the repayment obligations associated with the credit facilities undertaken do not jeopardize the liquidity and solvency of our organization Equity Options - Represent the acceptance of an ownership stake in the business in exchange for capital invested - Private equity= equity capital that is obtained by an organization from private sources (not through one of the public exchanges) o Family, friends, ‘backers’, venture capitalists o Available to proprietorships, partnerships, and corporations o Direct monetary investment into the company (proprietorships and partnerships) or monetary investments as a result of the issuance of stock (for corporations) o Stock= security that represents a percentage of ownership in a corporation’s assets, and entitlement to a pro-rata claim on earnings when released - Public equity= equity investments in an organization, by investors, as a result of the purchase of publicly traded shares (stock) due to an initial public offering (IPO) or an additional public offering (APO), also referred to as a second offering o Second offering= additional public offering of an organization’s stock for the purpose of raising new capital o Corporations only o The company receives the proceeds from the sale of stock only at the time of its initial issue and sale. After that, the trading (selling) of shares that occurs in the marketplace is between the owners of the stock (sellers) and the new purchasers o Managers must determine whether the conditions are right for the launch of an IPO or a secondary offering, and if the asking price will be received from public investors o Managers, in considering an APO or secondary share offering, must consider the impact on the current share value of the organization’s stock in the marketplace  Issuing additional shares of stock can result in price dilution  Price dilution= price of existing shares of stock will decline due to the fact that a larger number of shares (with represent ownership in the company) now exist o Market capitalization value= current market value of an organization. It is calculated by taking the number of shares outstanding multiplied by the current value of its shares o Additional money raised using secondary share offerings is typically applied to organization-based needs that are anticipated to improve the liquidity and/or performance of the company issuing these shares; upward influence on share value o As the organization only receives proceeds from the initial sale of its shares, the business organization’s managers, directors of its board, and the investment firm handling the issuance of the IPO or APO must all be confident that the timing and price point at which the shares are being introduced will result in the maximum benefit that the organization can expect to receive from the share issuance o Prospectus= legal document to be filed with the securities commission that has jurisdiction for the share issuance; it provides information relating to the current financial stability of the company and the intent of the share issuance, thereby enabling investors to make an informed decision on the risk associated with the purchase of the shares being offered Putting it All Together - Managers look first to internal options and only resort to external when they have to A Note Pertaining to Not-for-Profits - Can utilize cash available from internal operations, as well as debt financing via credit facility options; assumes that the NFP delivers its products and services for a fee and, therefore, has revenue-generation capabilities; also assumes that the NFP has established credit and has sufficient capital assets that can serve as collateral on a loan o Both of these situations may not exist; many rely on funding totally from outside sources, thus are expense-driven organizations, and some do not have the capital to serve as collateral - They are allowed to fundraise - Philanthropy and the ability to accept donations- and, if registered charities, issue donation tax receipts to their donors- represents a core fundamental source of capital for many NFPs - Philanthropy= receipt of funds from another person or organization for the purpose of using them to enhance the well-being of others - They have three sources of capital funding: operation, debt financing, and philanthropy (events, annual campaigns, and capital campaigns) - Prefer to take philanthropic initiatives over anything internal - Distribution of wealth and benefits through the NFPs activities, even in the absence of generating surplus, that must drive its management team’s decision-making focus Chapter 14- Understanding Financial Statements The Role of Financial Statements - Analysing and interpreting financial statements is what enables a management team to “keep its fingers of the pulse” of the organization - Financial statements keep managers up-to-date on the success of sales and marketing initiatives, and on the ability of the organization to control its costs and maintain its gross profit margin and overall profitability margin - Gross profit margin= portion of an organization’s revenue that is left over after the organization has paid the direct costs (wages, components, materials, etc.) associated with its products or services - Profitability margin= portion of an organization’s revenue that is left after all operating expenses associated with its products or services have been paid Two Fundamental Types of Business Transactions - Operational transactions= represent the flow of money within the organization that is directly related to day-to- day business dealings; i.e. revenue and recurring expenses - Capital asset transactions= the decisions managers make with respect to investment and divestment of capital assets (buildings, equipment, business subsidiaries) that may be needed, or are no longer needed, as part of the organization’s business system Liquidity, Solvency, Efficiency, and Financial Capacity - An important responsibility of managers, when conducting a financial analysis of their organization, is to draw conclusions about the current and future liquidity and solvency of the organization - Liquidity= ability of the company, on the basis of the cash it has on hand and the cash it is generating within its operations, to meet its ongoing financial obligations - Solvency= longer-term assessment of the financial stability of the organization. Focuses on the forward anticipated profitability of the firm, and whether the firm has or can acquire sufficient capital in order to remain in business - Efficiency= how effective the organization is in deploying its resources and managing its operational processes in the delivery of goods and/or services to the marketplace - Capacity= cash reserves and borrowing power; amount of financial resources company has to work with Three Primary Financial Statements 1. Income Statement - Summarizes the operational transactions of an organization - Is a good barometer of an organization’s efficiency and effectiveness - Shows the organization’s profit (over a defined period) after expenses and taxes - New Name: Statement of Comprehensive Income - Identifies the revenue we ha
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