You work as a financial analyst at a large automobile corporation that occasionally makes acquisitions of smaller companies that specialize in the production and assembly of small component parts. In

Business Organization and Financial Data

LEARNING OBJECTIVES

After studying this chapter, you should be able to do the following:

LO 13.1 Explain the role of mission statements with regard to business planning.

LO 13.2 Describe the three major forms of business organization.

LO 13.3 Distinguish between accounting and financial perspectives and the role of accounting principles in communicating information.

LO 13.4 Describe and summarize the information in the income statement.

LO 13.5 Describe and summarize the information in the balance sheet.

LO 13.6 Describe and summarize the information in the statement of cash flows.

LO 13.7 Describe applications of financial statement analysis to different situations.

LO 13.8 Identify the goal and functions of financial management.

LO 13.9 Describe the agency relationships in a business organization and their implications for financial management.

LO 13.10 Explain the role of finance in the firm’s organizational chart.

Where we have been…

We have seen how the financial system supports the flow of funds from saving units to those who need to borrow funds or raise equity by selling shares. Financial markets, interest rates, securities prices, risk, and return concerns help direct funds efficiently to their best purpose, to help the global economy run as smoothly as possible. One of the biggest users of capital in the financial markets are businesses, from the entrepreneur seeking start-up financing, to the firm issuing shares for the first time in an initial public offering (IPO), to an exporter arranging overseas financing for a purchase. No discussion of finance is complete without a look at financial management; meaning, how business uses the financial system and markets to raise funds and direct capital to keep their firms running and to meet customers’ needs.

Where we are going…

How a business is organized has implications on a manager’s incentives. Financial statement information is valuable to investors and managers to help them make appropriate decisions. We’ll see applications of these concepts in the next few chapters, including financial analysis (Chapter 14), managing working capital (Chapter 15), and capital budgeting analysis (Chapter 17).

How this chapter applies to me…

Rather than accept the first job offered to you, try to work for a company with a mission and vision that relates to your personal values. Statistics show that, on average, people have five to seven different “careers” during their working lives as their employers and career paths change. You will probably not stay with the firm that hires you after graduation, but you want that first job and all successive positions to be a “fit” for your values and lifestyle. Annual reports are important sources of information about the firm to you as an investor and employee.

Successful businesses prepare financial plans. To make this point more clearly, we provide the following quotation from an unknown author:

Failure to plan is planning to fail.

An important part of planning is to do financial planning for a firm. All businesses require financing. Money is needed to finance plant and equipment and to support current operations. Some firms require little capital, and the industries in which these firms operate have a vast number of competitors. Any field of activity that requires little financial capital is open to a host of people who want to establish their own business, such as website designers or financial counselors. At the other extreme are businesses that require huge amounts of financial capital to operate even on a minimum scale. In the cement and steel industries, for example, because of capital requirements, only a few large firms dominate in national or regional markets.

We begin this chapter with a brief preview of some of the factors to consider when deciding to start a business. One of the decisions to be made is how the business will be organized. We discuss issues relating to a firm’s goals, and problems that can arise if a firm’s owners are not the same people as the firm’s managers.

The remainder of the chapter focuses on the financial data provided by business firms. Those firms organized as corporations must provide a summary of their financial performance in an annual report to their shareholders. Included in annual reports are three basic financial statements that businesses need to prepare: the income statement, the balance sheet, and the statement of cash flows. Even individually owned, or closely held firms, need to prepare financial statements for tax purposes. Just as important, these financial statements contain much of the language of business, such as revenues, expenses, assets, liabilities, and equity. The financial statements are analyzed by the firm’s managers, the firm’s competitors, banks, and other financial market participants who are considering buying or selling the firm’s securities. In this chapter’s Learning Extension, we discuss taxation and depreciation concepts that business managers must understand if they are to be successful in managing their businesses.

13.1 STARTING A BUSINESS

In our market economy, individuals have the freedom to establish any legal business they choose. However, they must have adequate financial capital of their own or be able to arrange the necessary financing. The success of a business in raising funds for operations depends on its profit potential.

13.1.1 STRATEGIC PLAN WITH A VISION OR MISSION

A business should begin with a vision or mission statement that is consistent with the planned overall strategy. The vision or mission should indicate what the firm wants to produce, distribute, and sell or indicate what services it wants to provide. The statement helps declare what is the company’s main reason for being; in times when new opportunities look attractive, the firm’s managers should go back and read the mission statement to ensure their actions are consistent with it. Comments on quality objectives and customer and owner focus are, typically, found in vision and mission statements. Some statements are idealistic in their views.

mission statement statement of a firm’s main reason for being; sometimes called a vision statement

Both small and large companies formulate strategic plans with visions and missions. Let’s take a look at some of these statements.1

Wells Fargo, a nationwide diversified financial services company providing banking, insurance, investments, and other financial services, has the following vision:

We want to satisfy our customers’ financial needs and help them succeed financially.

Merck & Company, Inc., one of the world’s largest pharmaceutical companies, states its mission is the following:

To discover, develop and provide innovative products and services that save and improve lives around the world.

SMALL BUSINESS PRACTICE

HABITS OF SUCCESSFUL SMALL COMPANIES

As we know, hundreds of thousands of firms start up each year. Many will fail or go out of business for various reasons. Some will struggle while a few will thrive. You probably are ready to ask, what are some of the characteristics or “habits” of firms that become successful? An article by Leslie Brokaw entitled “The Truth about Start-Ups” in Small Business Success, a supplement to Inc. magazine, has identified some of these habits. Each year Inc. identifies the 50 fastest-growing companies in the United States. These firms often are examined in an effort to identify common characteristics or habits. Following are some findings.

Successful small rapidly growing firms “often rely on team efforts.” We often credit the success of a start-up to a single founder or chief executive officer (CEO). Rather, many successful firms are started by team efforts in the form of founding partners. Successful firms generally are “headed by people who know their line of work.” Past professional experience in their fields is a common characteristic of successful entrepreneurs. Brokaw also suggests that successful companies are founded and built by “people who have started other businesses.” For example, many of the Inc. 500 CEOs had started at least one other business prior to their current business.

Brokaw also suggests that highly successful, rapidly growing firms are “disproportionately manufacturers and they’re high tech.” For example, nearly one-half of the Inc. 500 companies view themselves as being high-tech ventures. These rapidly growing firms also “are not owned by the founders alone.” Many of the CEOs of Inc. 500 companies own less than 50% of the equity in their businesses.

Google, a division of Alphabet Inc., has a mission statement that is mainly focused on its search engine product:

Organize the world’s information and make it universally accessible and useful.

Chick-fil-A, a fast-food restaurant best known for its chicken sandwiches and for being closed on Sundays, has a mission:

To glorify God by being a faithful steward of all that is entrusted to us and to have a positive influence on all who come into contact with Chick-fil-A.

13.1.2 BUSINESS AND FINANCIAL GOALS

A guiding force behind top management’s decisions should be the mission statement. At the same time, the mission statement should not be carved in stone; it should be periodically reviewed to ensure it is current and reflects market needs in a dynamic, global economy. On the other hand, a business cannot chase every idea developed by its managers. Businesses need to stick to what they do best, or in the parlance of management, strategic goals should be related to the firm’s core competencies.2 Businesses must support their visions and missions with business and financial goals or plans, sometimes referred to as operating plans. Such plans may include specific numeric goals for customer satisfaction ratings, market share, and return to shareholders. Such plans allow managers to track their progress toward achieving the plan and mission of the firm.

Attracting and acquiring financing is necessary to obtain the factors of production necessary to conduct business operations. Allocation of these factors is largely automatic under the market system. Resources flow smoothly to those businesses that, through their past operations and the promise of profitable future operations, are able to pay for them. Investors, as providers of debt and equity capital, expect a return on their investment. As we saw in Chapter 12, actual returns usually differ from expected returns. This is the risk faced by investors, but the investor or the financial intermediary who assumes an unusually large risk does so with the full expectation that if things go well with the firm, the rewards for the investment will be great. Where the possible risk is small, the potential reward is small. As explained in Chapter 12, there is a trade-off between expected return and risk. Investment funds flow to risky firms and to safe firms, invested according to the intermediary’s or the investors’ risk preferences.

LEARNING ACTIVITY

Most corporation’s websites will have links to their mission or vision statements. Visit the home pages of firms you are familiar with and find their missions. The websites of the firms mentioned in this section are https://www.wellsfargo.com, https://www.merck.com, https://www.google.com, and https://www.chick-fil-a.com.

Concept Check: Learning Objective 13.1

13.2 FORMS OF BUSINESS ORGANIZATION IN THE UNITED STATES