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МІНІСТЕРСТВО ОСВІТИ І НАУКИ УКРАЇНИ ДЕРЖАВНИЙ ЕКОНОМІКО-ТЕХНОЛОГІЧНИЙ УНІВЕРСИТЕТ ТРАНСПОРТУ Кафедра «Іноземні мови» Л. В. КУШМАР FINANCE Навчальний посібник у ІІ частинах. Частина 1. Для студентів освітнього рівня «Бакалавр» напряму підготовки 6.030508 «Фінанси і кредит» усіх форм навчання. Київ 2016 УДК 811.111 Кушмар Л. В. FINANCE : Навчальний посібнику ІІ частинах. Частина 1. Для студентів освітнього рівня «Бакалавр» напряму підготовки 6.030508 «Фінанси і кредит» усіх форм навчання / Л. В. Кушмар. – Київ : Державний економіко-технологічний університет транспорту, 2016. – 181 с. Навчальний посібник рекомендовано для вивчення навчальної дисципліни «Англійська мова за професійним спрямуванням» для студентів І та ІІ курсів економічного факультету денної та заочної форм навчання освітнього рівня «Бакалавр» та розроблено відповідно до Робочої навчальної програми «Англійська мова (за професійним спрямуванням)» напряму підготовки 6.030508 «Фінанси і кредит» усіх форм навчання. Навчальні матеріали посібника спрямовані на розвиток навичок розуміння й аналізу оригінальних текстів з основних проблем економіки, нагромадження словникового запасу із фінансової тематики, удосконалення навичок розмовної мови, уміння вести бесіду, брати участь у дискусіях англійською мовою, формування соціально-комунікативної позиції фахівця у галузі фінансів. Методичні рекомендації розглянуто та рекомендовано до друку рішенням кафедри «Іноземні мови» Державного економіко-технологічного університету транспорту (протокол № 3 від 9 листопада 2015 р.), методичної комісії факультету Управління залізничним транспортомДержавного економіко-технологічного університету транспорту (протокол № 5 від 25 січня 2016 р.). Укладач: Л. В. Кушмар, кандидат філологічних наук, доцент кафедри «Іноземні мови» Державного економіко-технологічного університету транспорту Рецензенти: Т. Є. Недашківська, кандидат філологічних наук, доцент кафедри слов’янських і германських мов Житомирського державного університету імені Івана Франка С. А. Ісаєнко, кандидат педагогічних наук, доцент кафедри «Іноземні мови» Державного економіко-технологічного університету транспорту © Кушмар Л. В. © ДЕТУТ, 2016 FINANCE Навчальний посібнику ІІ частинах Частина 1 3 CONTENTS I. PREFACE______________________________________________________7 II. BLOCKS 1. WHAT IS ECONOMICS?_____________________________________11-18 Part 1_______________________________________________________13 Part 2_______________________________________________________15 Part 3_______________________________________________________17 2. ECONOMIC SYSTEMS______________________________________19-27 Part 1_______________________________________________________22 Part 2_______________________________________________________24 Part 3_______________________________________________________26 3. BUSINESS ORGANIZATIONS________________________________28-35 Part 1_______________________________________________________30 Part 2_______________________________________________________32 Part 3_______________________________________________________34 4. MONEY AND INCOME______________________________________36-45 Part 1_______________________________________________________38 Part 2_______________________________________________________40 Part 3_______________________________________________________42 Part 4_______________________________________________________44 5. FINANCE___________________________________________________46-53 Part 1_______________________________________________________48 Part 2_______________________________________________________50 Part 3_______________________________________________________52 4 6. FINANCIAL STATEMENTS__________________________________54-63 Part 1_______________________________________________________56 Part 2_______________________________________________________58 Part 3_______________________________________________________60 Part 4_______________________________________________________62 7. FINANCIAL MANAGER_____________________________________64-71 Part 1_______________________________________________________66 Part 2_______________________________________________________68 Part 3_______________________________________________________70 8. FINANCIAL PLANNING_____________________________________72-77 Part 1_______________________________________________________74 Part 2_______________________________________________________76 9. FINANCIAL RATIOS________________________________________78-85 Part 1_______________________________________________________80 Part 2_______________________________________________________82 Part 3_______________________________________________________84 10. CORPORATE FINANCE: STOCS and SHARES________________86-91 Part 1_______________________________________________________88 Part 2_______________________________________________________90 11. ACCOUNTING and BOOKKEEPING_______________________92-99 Part 1_______________________________________________________94 Part 2_______________________________________________________96 Part 3_______________________________________________________98 5 12.BANKING________________________________________________100-107 Part 1______________________________________________________102 Part 2______________________________________________________104 Part 3______________________________________________________106 13. PRICING________________________________________________108-115 Part 1______________________________________________________110 Part 2______________________________________________________112 Part 3______________________________________________________114 14. INFLATION _____________________________________________116-123 Part 1______________________________________________________118 Part 2______________________________________________________120 Part 3______________________________________________________122 III. TEXTS FOR ADDITIONAL READING_________________________124 IV. GLOSSARY_________________________________________________137 V. ACCOMPANYING LITERATURE______________________________176 VI. LIST OF REFERENCES______________________________________177 6 PREFACE The claim to create the European Higher Education Area setschallenging tasks for Ukraine that in 2005 joined the Bologna process withthe ambition to enhance its educational potential in terms of greater mobilityfor students, more effective international communication and better accessto information. It has particular implications with respect to languageteaching and learning. One of the emphases in this field is being made todeveloping communicative skills which are required within the frameworkof academic mobility of students in the multilingual and multicultural contextof the European continent. Within this context, it is critical for each student to understandwhat (s)he personally wants from a job if (s)he plans to find thejob and the employer that matches his/her needs. Successful candidates require having the following core skills: – ability to communicate effectively at all levels; – ability to apply technical or academic knowledge to practical situations; – awareness of the commercial implications of their actions; – self-motivation and self-management; – team-work and team leadership. «FINANCE» – is a range of economic materials that includes components specifically designed to meet the needs of the students specializing in finance and needing to learn economic phenomenathrough English or do business tasks in English and whose future workbrings them into the contact with international finance. Thesematerials can be used individually or, as they share a core language andskills syllabus, can be used in a variety of combinations. «FINANCE» is a practical and accessiblecourse aimed at developing students’ ability to communicate effectivelyin most economic settings and situations. It is intended for the students who study English of finance for their professional needs. It is aimed for students of the first and second-year of studying majoring in Finance. 7 The first part of the book contains six chapters: I. PREFACE II. BLOCKS III. TEXTS FOR ADDITIONAL READING IV. GLOSSARY V. ACCOMPANYING LITERATURE VI. LIST OF REFERENCES. The second chapter consists of 14 blocks which are important for future financiers: 1. WHAT ISECONOMICS? 2. ECONOMIC SYSTEMS 3. BUSINESSORGANIZATIONS 4. MONEY AND INCOME 5. FINANCE 6. FINANCIAL STATEMENTS 7. FINANCIAL MANAGER 8. FINANCIAL PLANNING 9. FINANCIAL RATIOS 10. CORPORATE FINANCE: STOCS and SHARES 11. ACCOUNTING and BOOKKEEPING 12. BANKING 13. PRICING 14. INFLATION Each block consists of some parts and includes: - key terms – a list of words andoften phrases, usually arranged alphabetically and defined; a lexicon or glossary of the topic; - texts dealing with the impact of economy and finance on the economic interaction: these texts are intended as a basis for discussion and economic awareness. Reading means: 1. to activate and reinforce other skills (grammar, vocabulary, pronunciation, and writing). In the same way that oral dialogues, short 8 compositions, and listening activities do, reading can put into practice grammatical structures, new lexical items, and elements of pronunciation; 2. to become a better reader. Reading is a skill in itself, and the advantage of working with adult language learners is that they are usually literate in their native language. This means that they are able to transfer advanced reading skills to the second language. Reading in English can activate and develop these skills, making the students better readers in both languages. Reading skills include: skimming, scanning, predicting, and reading for detailed comprehension; 3. to develop critical thinking skills. This is important to address because when teaching English for general purposes, it can be easy to dismiss reading as an activity more suited for an academic environment;4. to read for enjoyment. Students ideally discover not only the usefulness but also the pleasure of being able to read in a second language; - practice which contains a variety of lexical exercises such as matching, filling in, finding the similar / the opposite word, questions on the texts and may include different topics related to the subject of the block or to make presentations on the topic; problem-solving activities to review functional language developed within the economic topic. All tasks focus on the four basic skills of reading, writing, speaking, and listening in addition to providing instruction in grammar and vocabulary. The book presents general economic and specialized finance terms. Readers are encouraged to practice the lexicon presented in the texts in a range of vocabulary, writing and speaking exercises, such as summaries of the texts presentations on the topics etc. Readers gradually accumulate special vocabulary; learn to read thoroughly and to scan the text to pick out necessary data and information, to organize ideas logically. All blocks develop students’ key skills of communicating positively and appropriately in different economic situations. They focus on the factors that make a good communicator: – using appropriate functional expressions in common economic situations; 9 –having effective conversations which build rapport and mutual understanding; – considering social etiquette and being sensitive when communicating with different cultures. The course is designed to build competence in a variety of economic contexts such as financial planning, accounting and bookkeeping, corporative financing, banking, pricing and others. It seeks to build students’ confidence to communicate appropriately in these situations, to understand economic phenomena and use knowledge in making decisions. The language development work focuses on the functions and communicative strategies required to perform these skills effectively. Target language is represented mostly through dialogues. All parts of the blocks develop key communicative skills to help students feel confident with in any organizational environment. It raises students’ awareness of how cultural differences in economic and financial spheres can affect communication between people of different nationalities. «FINANCE»helps the students to perfect their abilities to read, to analyze, to compare, to make conclusions and to present their ideas in a systematic manner. The book is complied in compliance with the requirements of curriculum of the course of «English for Special Purposes» for the students of Finance. 10 WHAT IS ECONOMICS ? 11 WHAT IS ECONOMICS ? KEY TERMS Economics is the study of how people choose to use resources.Resources include the time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services. In short, economics includes the study of labor, land, and investments, of money, income, and production, and of taxes and government expenditures. The most famous book in economics is the Inquiry into the Nature and Causes of The Wealth of Nations written by Adam Smith, and published in 1776 in Scotland. Economics, Relationship to Finance – the field of economics provides the basic frameworkwithin which managers make firm-leveldecision, since microeconomic decisions are implementedin the context of a dynamic, global macroeconomy. Like economics, finance employs the theory of rational decision making; like quantitativemanagement science, finance does use somehighly structured models and methods. Economies of Scale and Economies of Scope – economies of scale and high capital requirementstypically go together. Scale economies occur asaverage production cost declines with rising outputper period. Any new entrant must (1) have availablefinancing to construct a large-scale factoryand (2) be able to sell in sufficient quantity to becost-competitive. Entry may be especially unattractivewhen the entrant considers the impactof added volume on market price; the increase insupply caused by a new entry may lower productprices, making it more difficult for the new entrantto compete in the market. Scale requirements candeter entry and promote positive net present valueprojects among existing firms. Economies of scope,in particular, refer to financial institution’s abilitiesto generate synergistic cost savings throughjoint use of inputs in producing multiple products. 12 WHAT IS ECONOMICS ?________________________________________ PART 1 It is necessary to know what economics is all about. Unfortunately, it is not possible to define the subject by a single word. Economics was defined as the study ofmankind in the everyday business life. This means that economics deals with production, distribution, exchange and consumption. It answers such questions as: How do we produce all the things we need? How are prices determined? Economics is also concerned with unemployment, inflation, international trade, the interaction of business and labour, and the effects of government spending and taxes. Economics is a social science like history, geography, politics, psychology and sociology. It is the study of human efforts to satisfy what seems like unlimited and competing wants through the careful use of relatively scarce resources. Economists study what is or tends to be and how it came to be. They oughtto be. People must make up their own minds about that. Economics is therefore concerned with activities relating to wealth, i.e. production, consumption, exchange and distribution. For our own purpose, we shall define economics as the study of man in his attempts to gain a living by utilizing his limited resources. Economics like any other social science has its own vocabulary. To understand economics, a review of some key terms is necessary: needs, wants, and demands [24]. 13 PRACTICE I. Match each term in Column A with its definition in Column B: Column A Column B 1. economics a. Something in short supply; not enough to meet demand. 2. production 3. distribution 4. exchange 5. consumption 6. business 7. trade 8. scarce b. Activity of buying and using goods. c. The creation of services or the changing of material into products. d. The activity of selling goods and services in order to make a profit. e. The production, distribution and sale of goods and services for a profit. f. The movement of finished products fromthe manufacturing location to the marketplace. g. The social science that describes and analyzes how society chooses from among scarce resources to satisfy its wants. h. The process of trading or bartering one unit or set of goods or services for another unit or set. II. Fill in the blanks with prepositions or adverbs if necessary: 1. Unfortunately, it is not possible to define the subject ______ a single word. 2. Economics deals ______ production, distribution, exchange and consumption. 3. Economics is also concerned ______ unemployment, inflation, international trade, the interaction ______ business and labour, and the effects ______government spending and taxes. 4. Economics does not stop ______ the description ______ economic activity ______ description alone leaves unanswered many important why and how questions. 5. It is the study ______ human efforts to satisfy what seems like unlimited and competing wants ______ the careful use ______ relatively scarce resources. III. Give the corresponding nouns to the following verbs: to require, to know, to accept, to survive, to achieve, to satisfy, to differ, to communicate, to develop, to fulfill, to employ, to relate, to express, accomplish. IV. Define which of the following items best completes the statement: 1. Economics is a social science likea. history; b. politics; c. mathematics; d. sociology. 2. Economics deals with a. production; b. distribution; c. exchange; d. consumption. 14 WHAT IS ECONOMICS ?________________________________________ PART 2 A need is a basic requirement for survival. People have basic needs such as food, clothing and shelter. People also have higher level needs, such as communication, love, acceptance, knowledge, hope and accomplishment. A want is a means of expressing a need. Food, for example, is a basic need related to survival. To satisfy this need, a person may want a pizza, hamburger or other favorite food. That is there are any numbers of foods that will satisfy the basic need for food. The point is that the range of things represented by the term «want» is much broader than those represented by the term «need». Sometimes the difference between a want and a need is clear, at other times, it is not. A basic need is reflected in a want for a particular product. A want cannot be counted in the marketplace until it becomes a demand – the willingness and ability to purchase a desired object. Since an individual has limited resources, only some wants will end up as measurable demands. The terms goods and services are used to describe many things people desire. Consumer goods are intended for final use by individuals to satisfy their wants and needs. Manufactured goods used to produce other goods and services are called capital goods. An example of capital goods would be a computer. The other type of economic product is a work that is performed for someone. Services can include haircuts, repairs to home appliances and forms of entertainment like rock performances. They also include the work performed by doctors, lawyers and teachers. The difference between goods and services is that the services are something that cannot be touched or felt like goods [24]. 15 P R A C T IC E I. Match each term in Column A with its definition in Column B: Column A Column B 1. goods a. Something in short supply; not enough to meet demand. 2. services b. Something intended for final use by individuals to satisfy their wants and needs. 3. price c. The goods or services one receives in an exchange. 4. capital goods d. Tangible commodities or merchandise. 5. product e. Work performed for someone. Intangible commodity. 6. free products f. The money value of goods or services. 7. consumer goods g. Something created to produce other goods or services. 8. scarce h. Products existing in such large quantities that they need not be rationed out among those wishing to use. II. Fill in the blanks below with the most appropriate termsfrom the list: capital goods; manufactured goods; free products; consumer goods; service; goods 1. The terms ______ and services are used to describe many things people desire. 2. _____ are intended to satisfy individuals’ wants and needs. 3. _____are used to produce other goods and services. 4. A haircut is an example of _____. 5. Sunshine, rainfall, fresh air are _____. 6. _____ include plant and machinery, industrial buildings, and raw materials. III. Define which of the following items best completes the statement: 1. The study of economics is concerned with economic products that are a. useful; b. free; c. scarce; d. transferable. 2. Goods in the economic sense may be a. a haircut; b. a washing machine; c. a visit to a doctor; d. advice from a lawyer. 3. Scarcity exists because of a. unlimited wants; b. governmental regulation; c. limited land, labour and capital resources; d.unlimited wants and limited land, labour and capital resources. IV. Which explanation of an economic term (or collocation) iscorrect: 1. a) We are all part of the world economy. b) Only educated people can be part of world economy. c) Only the developed countries can be part of world economy. 2. a) Per capita means for one individual. b) Per capita means for one company. 16 c) Per capita means for one country. WHAT IS ECONOMICS ?________________________________________ PART 3 Many other things – sunshine, rainfall, fresh air – are known as free productsbecause they are so plentiful. No one could possibly own them, nor would most people be willing to pay anything for them. In fact, some are so important, that life would be impossible without them. Even so, free products are not scarce enough to be major concern in the study of economics. In economics the term value means something having a worth that can be expressed in dollars and cents. Someone may say that he or she has a valuable coin; the value is determined by the price someone would pay for the collection. But what makes some things worth more than others? The diamond-water paradox, also known as the paradox of value, helps answer this question. Early economists observed that some things like water were essential to life, yet had little monetary value. Later economists decided that part of the reason was due to scarcity. F. e., water is so plentiful in many areas that it has little or no value. On the other hand, diamonds are so scarce that they have great value. In order to have value, it has to be somewhat scarce. Scarcity, however, is not enough. If something is to have value, it must also have utility, or the capacity to be useful to someone. Utility is not something that is fixed and can be measured like weight or height. Instead, the utility of goods or services may vary. F. e., one person may, for example, get a great deal of enjoyment from a home computer, another may get very little. In the end, for something to have value, it must be scarce and have utility. Another economic concept is wealth – the sum of those economic products that are tangible, scarce, useful and transferable from one person to another. Most economic goods are counted as wealth, but services are not. The reason is that it is difficult to measure the value of services accurately. F. e., it is difficult to measure the contribution made by people’s abilities and talents to a nation’s wealth. 17 A country’s total worth then is the stockpile of useful scarce, tangible things in existence at a given time [24]. PRACTICE I. Match each term in Column A with its definition in Column B: Column A Column B 1. coin a. The stockpile of useful, scarce, tangible thingsin existence at a given time. 2. wealth b. Goods that are scarce relative to the total amount of those that are desired. 3. scarcity c. The paradox that many necessities of the life havea low market price, while many luxuries with little use have a high market price. 4. economic goods d. The total satisfaction derived from the consumption of goods or services. 5. paradox of value e. The total value of one’s tangible assets. 6. utility f. The worth of smth in terms of money or other goods for which it can be exchanged. 7. country’s total worth g. A limit to the supply of productive resourcesor consumer goods in relation to the producers or consumers demand for them. 8. value h. Metallic forms of money. II. Complete the following sentences: 1. Economics the term value means ______ . 2. Someone may say that ______. 3. Early economists observed that ______ . 4. Later economists decided that ______ . 5. If something is to have value ______ . 6. Utility is not something that ______ . 7. Someone may, for example, get ______ . 8. Wealth is the sum of those economic products that are ______ . 9. National wealth includes all such items as ______ . 10. A country’s total worth, then is______ . COMMUNICATIVE SITUATIONS 1. Although economists know a great deal about how to stabilize the economy, our system still goes through periods of expansion and contraction. Describe some of the problems facing decision makers who are trying to use fiscal and monetary policies to keep the economy growing steadily. 2. As the economy moves from «recession» to «expansion», what is likely to happen to wages, investment, employment, profits? 18 3. During which phase of the cycle («recession» or «expansion») is production increasing? Why? 19 ECONOMIC SYSTEMS 20 ECONOMIC SYSTEMS KEY TERMS Economic system – is a system of production, resource allocation,exchange, and distribution of goods and services in a societyor a given geographic area. It includes the combination of the various institutions, agencies, entities, decision-making processes, and patterns of consumption that comprise the economic structure of a given community. As such, an economic system is a type of social system. The study of economic systems includes how these various agencies and institutions are linked to one another, how information flows between them, and the social relations within the system (including property rights and the structure of management). The analysis of economic systems traditionally focused on the dichotomies and comparisons between market economies andplanned economies, and on the distinctions between capitalism and socialism. Subsequently the categorization of economic systems expanded to include other topics and models that do not conform to the traditional dichotomy. Today the dominant form of economic organization at the world level is based on market-oriented mixed economies. Subcategories of different systems there include: planning, coordination, and refor productive enterprises; factor and product markets; prices; population public economics; financial economics national income, product, and expenditure; money; inflation international trade, finance, investment, and aid consumer economics; welfare and poverty performance and prospects natural resources; energy; environment; regional studies political economy; legal institutions; property rights. 21 ECONOMIC SYSTEMS____________________________________________ PART 1 The survival of any society depends on its ability to provide food, clothing and shelter for its people. Since these societies are also faced with scarcity decisions concerning What, How and for Whom to produce must be made. All societies have something else in common. They have an economic system or an organized way of providing for the wants and needs of their people. The way in which these decisions are made will determine the type of economic system they have. There are three major kinds of economic systems: traditional, command and market. In a society with a traditional economy nearly all economic activity is the result of ritual and custom. Habit and custom also prescribe most social behavior. Individuals are not free to make decisions based on what they want or would like to have. Instead, their roles are defined. They know what goods and services will be produced, how to produce them, and how such goods and services will be distributed. An example of traditional economy is the society of polar Eskimo of the last century. For generations, parents taught their children how to survive in a harsh climate, make tools, fish and hunt. Their children, in turn, taught these skills to the next generation. The main advantage of the traditional economy is that everyone has a role in it. This helps keep economic life stable and community life continuous. The main disadvantage of the traditional economy is that it tends to discourage new ideas and even punishes people for breaking rules or doing things differently. So it tends to be stagnant or fails to grow over time[24]. 22 PRACTICE I. Give the corresponding nouns to the following verbs: to survive to generate to depend on to behave to provide to define to prescribe to know to decide to punish to distribute to tend to determine to grow to organize to direct II. Define the parts of speech of the following words: economy, economic, authority, leader, production, large, responsibility, drastically, decide, decision, to stress, military, equipment, advantage, incentive, relatively, different, tendency, to increase. III. Find the synonyms: decision approximately produce, shelter to make type habitation as the community major concerning to produce the society main nearly about kind since product solution IV. Completethefollowingsentences: 1. In a command economy decisions are made ______ . 2. It means that ______ . 3. Government decides ______ . 4. If the planning body wants to strengthen national defense, it can ______ . 5. The major advantage of a command system is ______ . 6. The major disadvantage of a command system is ______ . 7. The second disadvantage of the command economy is ______ . 8. The command economy requires ______ .9. The survival of any society depends on ______ . 10. Since these societies are also faced with scarcity ______ . 11. All societies have an organized way of providing for ______ . 12. The way in which these decisions are made ______. 13. There are three major kinds of economic systems: ______ . 14. In a society with traditional economy nearly all economic activity is ______ . 15. Individuals are not free to make decisions based on ______ . 18. The main advantage of the traditional economy is ______ . 23 ECONOMIC SYSTEMS____________________________________________ PART2 Other societies have a command economy – one where a central authority makes most of the What, How and for Whom decisions. Economic decisions are made at the top and people are expected to go along with choices made by their leaders. It means that major economic choices are made by the government. It decides goals for the economy and determines needs and production quotas for major industries. If the planning body wants to stress growth of heavy manufacturing, it can shift resources from consumer goods to that sector. Or, if it wants to strengthen national defense, it can direct resources from consumer goods or heavy manufacturing to the production of military equipment and supplies. The major advantage of a command system is that it can change direction drastically in a relatively short time. The major disadvantage of the command system is that it does not always meet the wants and needs of individuals. The second disadvantage of the command economy is the lack of incentives that encourage people to work hard. In most command economies today workers with different degrees of responsibility receive similar wages. In addition, people seldom lose their jobs regardless of the quality of their work. As a result, there is a tendency for some to work just hard enough to fill production quotas set by planners. The command economy requires a large decision-making bureaucracy. Many clerks, planners, and others are needed to operate the system. As a result, most decisions cannot be made until a number of people are consulted, or a large amount of paperwork is processed. This causes production costs to increase and decision-making to slowdown. Thus, a command system does not have the flexibility to deal with day-to-day problems [24]. 24 PRACTICE I. Match each term in Column A with its definition in Column B: Column A Column B 1. economicsystem a. An economic system that allocates scarce resources according to custom. 2. traditionaleconomy b. An economic system in which major decisions concerning the allocation of resources are made by agencies of the government. 3. commandeconomy c. The approach a country uses to deal withscarcity and achieve its economic goals. 4. business d. The production, distribution, and sale of goods and services for a profit. 5. consumer e. The rivalry among buyers and sellers in the purchase and sale of resources and products. 6. competition f. A person who buys and uses goods or services. 7. market g. The difference between revenues andoperation costs incurred by a business. 8. profit h. Place where buyers and sellers come together to conduct transactions. II. Fill in the blanks with prepositions or adverbs if necessary: 1. In a market economy, the questions ______What, How and ______ Whom to produce are made ______individuals and firms acting ______ their own best interests. 2. A market economy is flexible and can adjust to change ______ time. 3. Since consumers like products ______ low prices and high quality, producers ______ a market economy will try to supply such products. 4. Those who make the best products ______ the lowest prices will stay ______ business. 5. The second major advantage ______ the market economy is the freedom that exists ______ everyone involved. 6. The final advantage ______ the market economy is the incredible variety ______ goods and services available ______ consumers. III. Answer the following questions: 1. What is the major advantage of a command system? 2. What disadvantages does the command economy have? 3. What does the command economy require? 4. The command system doesn’t have the flexibility to deal with day-to-day problems, does it? 5. What is the main advantage/disadvantage of the traditional economy? 25 ECONOMIC SYSTEMS____________________________________________ PART3 In a market economy, the questions of What, How and for Whom to produce are made by individuals and firms acting in their own best interests. In economic term a market is an arrangement that allows buyers and sellers to come together to conduct transactions. Since consumers like products with low prices and high quality, producers in a market economy will try to supply such products. Those who make the best products for the lowest prices will make profits and stay inbusiness. Other producers will either go out of business or switch to different products consumer can buy. A market economy has several major advantages that traditional and command economies do not have. First, a market economy is flexible and can adjust to change over time. When gas prices in the United States began to level off in 1985 and then decline in 1986, the trend slowly began to reverse. The second major advantage of the market economy is the freedom that exists for everyone involved. Producers are free to make whatever they think will sell. They are also free to produce their products in the most efficient manner. Consumers on the other hand are free to spend their money or buy whatever goods and services they wish to have. The third advantage of the market economy is the lack of significant government intervention. Except for national defense, the government tries to stay out of the way. As long as there is competition among producers, the market economy generally takes care of itself. The final advantage of the market economy is the incredible variety of goods and services available to consumers. In fact, almost any product can and will be produced so long as there is a buyer for it [24]. 26 PRACTICE I. Define which of the following items best completesthe statement: 1. A market exists a. where consumers express their needs and wantsb. b. when are advertised; c. where merchants build shops; d. where buyers and sellers exchange goods and services. 2. Individuals and businesses have the greatest say about what is produced in a. market economies; b. traditional economies; c. command economies; d. all economic systems. 3. The special role of the profit motive in a market economy is that, it a. drives sellers to produce what buyers want; b. results in high prices; c. discourages people from taking risks; d. keeps people from going into business. 4. In another country, privately owned business firms can produce goods or services in any lawful manner that they choose. This country has a. a market economy; b. a traditional economy; c. a command economy; d. a mixed economy. II. Answer the following questions: 1. Who asks the questions of What, How and for Whomto produce in a market economy? 2. What is a market in economic term? 3. What prescribes most social behavior? 4. What is the role of individuals in a traditional economy? 5. Who will stay in business in a market economy? 6. What advantages does market economy have? Explain it in details. 7. What does the final advantage of the market economy consist in? COMMUNICATIVE SITUATIONS All countries have developed economic systems (ways of producing and distributing goods and services). How are different economic systems used to answer the three basic economic questions: What goods and services are to be produced? How are goods and services to be produced? For whom are goods and services to be produced? 27 BUSINESS ORGANIZATIONS 28 BUSINESS ORGANIZATIONS KEY TERMS Corporation– 1.Firm that meets certain legal requirements to be recognized as having a legal existence, as an entity separate and distinct from its owners. Corporations are owned by their stockholders (shareholders) who share in profits and losses generated through the firm's operations. Limited liability – a firm and its owners are limited in their liability to the creditors and other obligors only up to the resources of the firm, unless the owners give personal-guaranties. Partnership –a type of business organization in moreindividualspool money, skills, which and two or other resources, and share profit and loss in accordance with terms of the partnership agreement. In absence of such agreement, the participants in a partnership is an enterprise agree assumed to exit where to share the associated risks and rewards proportionately . Sole proprietorship – simplest, oldest, and most common form of business ownership in which only one individual acquires all the benefits and risks of running an enterprise. In a sole-proprietorship there is no legal distinction between the assets and liabilities of a business and those of its owner. Unlimited liability – A type of business where owners share joint and several responsibility for the entire amount of debt and other liabilities amassed by the business. Unlimited liability is not capped at a maximum amount and exists regardless of the amount of investment each owner has personally made. If the business is unable to meet any financial obligations or settle any outstanding liabilities, the owner's personal assets can be seized to satisfy the debts. This is in contrast to a limited liability structure where owners' losses cannot exceed the total amount invested in the business. Unlimited liability is found in general partnerships and sole proprietorships. 29 BUSINESS ORGANIZATIONS______________________________________ PART 1 One of the major economic institutions is the business organization, a profitseeking enterprise that serves as the main link between scarce resources and consumer satisfaction. These businesses compete with one another for the chance to satisfy people’s wants. There are three major kinds of business organizations: the sole proprietorship, the partnership and the corporation. The most common form of business organization is the sole proprietorship – a business owned and run by one person. The main advantage of a sole proprietorship is that it is the easiest form of business to start and run. There is almost no red tape involved. Most proprietorships are able to open for business as soon as they set up operations. In the event that the owner wants to dissolve the business, a sole proprietorship is as easily dissolved as it is formed. Sole proprietors own all the profits of their enterprises and are free to make whatever changes they please. They have minimal legal restrictions and do not have to pay the special taxes placed on corporations. They also have the opportunity to achieve success and recognition through their individual efforts. Sole proprietorships are generally found in small-scale retail and service businesses such as beauty salons, repair shops, or service stations. The major disadvantage of a sole proprietorship is the unlimited liabilitythat each proprietor faces. Since the business and the owner are legally the same, the sole proprietor is liable for all financial losses or debts that the business may incur. If a business fails, the owner must personally assume the debts. This could mean the loss of personal property such as automobiles, homes and savings. A second disadvantage of the sole proprietorship is that it has limited financial resources. The money that a proprietor can raise is limited by the amount of savings and ability to borrow. Another serious problem faced by the sole proprietorship is the lack of continuity of the business. When the owner dies, the business also legally terminates[24]. 30 PRACTICE I. Substitute the words in bold type by their synonyms: 1. Business organization is a profitable enterprisethat serves as themain link between scarce resources and consumer satisfaction. 2. The firms compete with one another for the chance to meet people’s requirements. 3. The simplest form of business undertaking is that managedby one person. 4. There is almost nobureaucracy involved. 5. In the event the owner wants to go out of business, a sole proprietorship is as easily dissolved as it is formed. 6. Sole proprietors have the chance to succeed in business through their individual efforts. 7. Theyare responsible for the firm’s operation and take all risks of loss. 8. Many small businesses have gone bankrupt recently. II. Fill in the blanks with prepositions or adverbs if necessary: 1. A business organization is a profit-seeking enterprise that serves ______the main link ______ scarce resources and consumer satisfaction. 2. These businesses compete ______ one another ______ the chance to satisfy people’s wants. 3. The most ______ common form ______ business organization is the sole proprietorship – a business owned and run ______ one person. 4. Most ______ proprietorships are able to open ______ business ______ they set ______ operations. 5. Sole proprietors have the opportunity to achieve success and recognition ______ their individual efforts. III. Find the antonyms: profitable separately advantage producer to give permission limited unprofitable jointly disadvantage to prohibit illegal unlimited legal to succeed in business to be out of business consumer IV. Answer the following questions: 1. What is a business organization? 2. What are the major kinds of business organizations? 3. What is the most common form of business organization? 4. The sole proprietorship is a business owned and run by one person isn’t it? 5. What is the main advantage of a sole proprietorship? 31 BUSINESS ORGANIZATIONS______________________________________ PART 2 A partnership is a business that is jointly owned by two or more people who have combined their talents and resources for the purpose of earning a profit. Partnerships are most common in such professional fields as medicine, law, accounting, stock brokerage, but they are also found in manufacturing, wholesaling and retailing The most common form of partnership is a general partnership. General partners own the business, work in it and share the profits and losses. They are responsible for the management of the business and usually agree with each other before making any major decisions. There may be a special type of partnership, called limited partnership. Limited partners are only liable for the amount they have invested in the business. They are usually not involved in the management of the firm. Partnerships have more advantages than sole proprietorships. Like sole proprietorship they are easy to form and often get tax benefits from the government. Partnerships have certain disadvantages too. The major disadvantage is unlimited financial liability. It means that each partner is responsible for all debts and is legally responsible for the whole business. But one of the greatest problems in partnerships is that partners may disagree with each other causing management conflicts [24]. 32 PRACTICE I. Match each term in Column A with its definition in Column B: Column A Column B 1. organization a. A business that is owned by two or more people. 2. sole proprietorship b. People or groups working for a common purpose and whose tasks are often divided into specializations. 3. partnership c. Payments made from the earnings of a corporation to its stockholders. 4. corporation d. Owner of stock in a corporation. 5. charter e. A business organization created under a government charter. 6. stockholder f. A document issued by a state government granting a corporation permission to operate. 7. dividends g. Owners of the partnership have unlimited liability. 8. general partnership h. A business that is owned by one person. II. Fill in the blanks below with the most appropriate termsfrom the list: the profits; losses; tax benefits; the management; general partners; sole proprietorships; wholesaling; unlimited financial liability; limited partners 1. Partnerships are also found in manufacturing, ______ and retailing. 2. ______ are the partners with unlimited liability. 3. General partners own the business, work in it and share ______ and ______ .4. General partners are responsible for ______ of the business. 5. Partnerships have more advantages than ______ . 6. The major disadvantage of a partnership is ______ . 7. ______ are usually not involved in the management of the firm. 8. Partnerships very often receive ______ from the government. III. Memorize the following proverbs «business».Translate them into Ukrainian: 1. Everybody’s business is nobody’s business. 2. Every man to his business. 3. Business before pleasure. 33 with the word BUSINESS ORGANIZATIONS______________________________________ PART 3 Nearly 90 per cent of all business is done by corporations. A business corporation is an institution established for the purpose of making profit. It is operated by individuals. People, who would like to form a corporation, must file for permission in the state where the business will have its headquarters. If approved, a charter, government document that gives permission to create a corporation, is granted. The charter states the name of the company, address, purpose of business etc. The charter specifies the number of shares of stock, or ownership parts of the firm. These shares are certificates of ownershipand are sold to investors called shareholders or stockholders. The money is then used to set up corporation. If the corporation is profitable it will eventually issue dividend or a check, representing a portion of the corporate profits to shareholders. There are several advantages of the corporate form of ownership. The major advantage is the ability to acquire greater financial resources than other forms of ownership. The next advantage is that the corporation attracts a large amount of capital and can invest it in plants, equipment and research. It can offer higher salaries and thus attract talented managers and specialists. Corporations have great capacity for growth and expansion. Corporations face some major disadvantages. It is difficult and expensive to organize a corporation. The process of obtaining a charter usually requires the services of a lawyer. Most small firms prefer to avoid these expenses by forming proprietorships and partnerships. There is also an extra tax on corporate profits. The government taxes corporate income in addition to the taxes paid by shareholders on their dividends [24]. 34 PRACTICE I. Which of two parallel sentences are true: 1. The heart of capitalism is private a. The heart of capitalism is public ownership. ownership. 2. The owners of a company never b. Sometimes, the owners of a company have to pay more than they have have to pay more than they have invested in it. invested in it. 3. Companies are able to raise a c. Companies prefer to raise a large large amount of funds through sale amount of funds through borrowing of shares. money at high interest rates. 4. The creditors of a bankrupt d. The creditors of a bankrupt company company have right to pursue for the have no right to pursue share holders company’s unpaid debts. shareholders for the companies unpaid debts. COMMUNICATIVE SITUATIONS 1. Make a report in your class: «Sole proprietorship is the most common form of business ownership». 2. You would like to open your own business. What type of business organizations would you prefer? Explain your choice. 3. You want to go into business with a partner. Consult a lawyer how to form a partnership. 4. You are at the conference. The theme of your report is: «Advantages and disadvantages of the corporate form of ownership». 5. Discuss the following problems: a) Is the job of a businessperson popular in your country? Why? b) Could you describe a typical entrepreneur working in the sphere of business using the following tips: - Age; -Sex; -Background; -Marital status (married, single, divorced). c) Why do you think people are interested in doing business? Look at the following factors and choose among them. Can you add any more reasons? - communicating with people - traveling abroad - participating in different exhibitions - meeting new interesting people - making money - enjoying the job itself d) What companies or people do you know that succeed in business? 35 ___________________________________________MONEY AND INCOME 36 ___________________________________________MONEY AND INCOME KEY TERMS Bills –requests for the payment of money owed for services such as electricity, gas and telephone connections. Bonus – extra money given for meeting a target or for good financial results. Commission –money paid to salespeople and agents – a certain percentage of the income the employee generates. Fees –money paid to professional people such as lawyers and architects. Health insurance –financial protection against medical expenses for sickness or accidental injuries. Living expenses –money spent on everyday needs such as food, clothes and public transport. Money – any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts in a particular country or socio-economic context, or is easily converted to such a form. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, sometimes, a standard of deferred payment.Any item or verifiable record that fulfills these functions can be considered money. Mortgage –repayments of money borrowed to buy a house or flat. Overtime –money received for working extra hours. Pension – money paid by a company or the government to a retired person. Rent –the money paid for the use of a house or flat. Salary –money paid monthly by an employer, or wages: money paid by the day or the hour, usually received weekly. Social security –money paid by the government to unemployed and sick people. Tax – money paid to finance government spending. 37 MONEY AND INCOME___________________________________________ PART1 The main feature of money is its acceptance as the means of payment or medium of exchange. Nevertheless, money has other functions. It is a standard of value, a unit of account, a store of value and a standard of deferred payment. Money is a medium of exchange in economy. It is a means of payment for goods and services and in settlement of debts. Money is also a standard of value for measuring the relative economic worth of different goods and services. The price of the commodity is the number of units of money required to buy this commodity. The main functions of money are a medium of exchange and the measure of value. Without the use of money, trade would be reduced to barter, that is to direct exchange of one commodity for another. Barter trade was the means used by primitive peoples, and it is still practiced in some parts of the world. In a barter economy, a person having something to trade must find another who wants it and has something acceptable to offer in exchange. In a money economy, the owner of a commodity may sell it for money and buy anything he wants for money. Money can also serve as a standard of value. Society considers it convenient to use a monetary unit to determine relative costs of different goods and services. In this function money appears as the unit of account, is the unit in which prices are quoted and accounts are kept. To be accepted in exchange, money has to be a store of value. Money is a store of value because it can be used to make purchases in the future. Houses, stamp collections, and interest-bearing bank accounts all serve as stores of value. Since money pays no interest and its real purchasing power is eroded by inflation, there are almost certainly better ways to store value. Finally, money serves as a standard of deferred payment or a unit of account over time. When you borrow, the amount to be repaid next year is measured in money value [27]. 38 PRACTICE 1. 2. 3. 4. 5. I. Match the following definitions: Money a) are the examples of commodity money. Barter b) is paper money the value of which is fixed by government. Fiat money c) is any generally acceptable medium of exchange. Golden coins d) is accepted by the laws as a means of payment. Token money e) is trade without using money. II. Define which of the following items best completes the statement: 1. Most of the money in circulation consists of a. paper money; b. coins; c. checking accounts; d. savings accounts. 2. In a money economy, money serves as a a. medium of exchange; b. measure of value; c. store of value; d. all of the above. 3. The value of money a. can increase or decrease; b. remains the same at all times; c. increases with the passage of time; d. rises when prices rise. 4. The purchasing power of money a. increases during periods of inflation; b. decreases during an inflation; c. decreases during a deflation; d. is unaffected by inflation or deflation. III. Say whether these statements are true or false and if they are false, say why: 1. Money is a medium of exchange. 2. The main function of money is to pay for goods. 3. In barter economy goods are traded directly for other goods. 4. A monetary unit is used to determine relative costs of goods and services. 5. Money is not a store of value. IV. Answer these questions: 1. Is the currency in America called the dollar? 2. Is a five-pound note worth less than a fifty-pence piece? 3. If you lend something to someone, do they borrow it? 4. If you waste money, do you use it well? 5. Is ‘sterling’ a currency? 6. If you ‘can’t afford’ something, do you have enough money for it? 7. Does ‘cost of living’ mean the same as ‘standard of living’? 8. If someone tells you a hotel is reasonable, is it very expensive? 39 MONEY AND INCOME___________________________________________ PART2 The most important types of money are commodity money, credit money, and fiat money. The value of commodity money is about equal to the value of the material contained in it. The principal materials used for this type of money have been gold, silver, and copper. Credit money are documents with promises by the issuer to pay an equivalent value in the standard monetary metal. Fiat money is paper money the value of which is fixed by government. Most minor coins in circulation are also a form of fiat money, because the value of the material of which they are made is usually less than their value as money. Golden coins are the examples of commodity money, because their gold content is a commodity. A token money is a means of payment whose value or purchasing power as money greatly exceeds its cost of production or value in uses other than as money. By collectively agreeing to use token money, society economizes on the scarce resources required to produce money as a medium of exchange. Society enforces the use of token money by making it legal tender. The law says it must be accepted as a means of payment. In modern economies, token money is supplemented by IOU money. An IOU money is a medium of exchange based on the debt of a private firm or individual. A bank deposit is IOU money because it is a debt of the bank. When you have a bank deposit the bank owes you money. You can write a cheque to yourself or a third party and the bank is obliged to pay whenever the cheque is presented. Bank deposits are a medium of exchange because they are generally accepted as payment[27]. 40 PRACTICE 1. 2. 3. 4. 5. 6. 7. 8. 9. I. Match each term in Column A with its definition in Column B: Column A Column B money a. The exchange of one good or service for another. currency b. Anything generally accepted as payment for goods and services. barter c. A book of forms for writing cheques. inflation d. The total amount of money that exists in the economy of a country at a particular time. check e. Period of rising prices during which the purchasing power of the dollar is falling. money supply f. An institution, such as a bank, that deals in short-term loans, foreign exchange, etc. money market g. Paper money and coins issued by the federal government. checkbook h. Metallic forms of money. coin i. A special printed form on which one writes an order to a bank to pay a sum of money from one’s account. II. Complete the sentences with the words: overtime, commission, bonus, pension, currency, rent, earn, salary, mortgage, social security, tax 1. After I lost my job, I was living on ______ for three months. This was difficult, ______ because the amount was much lower than the ______ I had before. 2. I used to work as a salesperson, but I wasn’t very successful, so I didn’t ______ much ______ . 3. If the company makes 10% more than last year, we’ll all get a ______ at the end of the year. 4. It’ll take me at least 25 years to repay the ______ on my house. 5. Many European countries now have the same ______, the euro. 6. My wages aren’t very good, so I do a lot of ______ . 7. Nearly 40% of everything I earn goes to the government as ______ . 8. The owner has just increased the ______ on our flat by 15%. 9. When I retire, my ______ will be 60% of my final salary. III. Are the following statements true or false: 1. Bank deposits are not classified as money. 2. People earning wages get paid more often than people earning a salary. 3. People working on commission always get paid the same amount. 4. When you stop working at the end of your career, you receive a pension. 5. Most people pay a rent and a mortgage. 41 MONEY AND INCOME___________________________________________ PART3 The second of the three economic issues is the question of income that is, income distribution, the way in which income – that’s what people earn – is distributed or shared around. You, and you family, have an income. You have an annual income that is what you earn in a year. This income allows you to enjoy various goods and services. It means you have a certain standard of living. Your standard of living, of course, includes what you think of as necessary to your life, things like food, water, somewhere to live, health and education. But your income doesn’t just cover the necessities of life. It also includes recreation, whether that’s sport or TV or a holiday. Your income will be less than some of your neighbors’, but it will be morethan some of your neighbors’. Your neighbors’ means not just people living in yourown country, but also people living in other countries. Just as you and your family have an income, so nations, different countries, also have an income – the national income, it’s often called. A national income is not the money the government gets. The national income is the sum total of the incomes of all the people living in that country, in other words, everyone’s incomeadded together. In the same way one can think of world income as the total of all the incomes earned by all the people in the world. Concerning the distribution of national and world income, some questions are to be asked: who, in the world, gets what share of these incomes? The distribution of income, either in the world or in a country, tells us how income is divided between different groups or individuals[27]. 42 PRACTICE I. Suggest the Ukrainian equivalents for the following phrases: 1. income is shared around; 2. income doesn’t just cover the necessities of life; 3. to suggest an answer to the question; 4. to direct the production towards the goods and services; 5. individual governments. II. Answer the questions: 1. What are the most important types of money? 2. What is commodity money? 3. What is the difference between credit money and fiat money? 4. What does IOU mean? 5. Why bank deposits are a medium of exchange? 6. Why do people accept money? 7. What are the functions of money? 8. What would trade be reduced to without using of money? 9. What does barter economy mean? 10. Is money a store of value? Why? 11. What countries are called poor? 12. For whom and what does economy produce? 13. What is the role of governments in distributing incomes? III. Read these sayings about money and discuss them giving your point of view whether you agree or disagree with them: 1. After good health, money is the most important thing in life. 2. Money can’t buy happiness. 3. Money is the roof of evil. 4. Look after the pennies and the pounds will look after themselves. 5. Some people seem to get the idea they are worth a lot of money just because they have it. IV. Discuss the types of money and give examples of each type: commodity money (gold, silver) representative money (old U.S. Notes) fiat money (U.S. currency and coin) checkbook money. 43 MONEY AND INCOME___________________________________________ PART4 In poor countries, like India, China and the Sudan, the income per head is only one hundred and fifty-five pounds per year. But at the same time, they have fifty point seven per cent of the world’s population. These poor countries only have five per cent of the world’s income. In middle-income countries the income per head is eight hundred and forty pounds, that’s in countries like Thailand and Brazil. In the major oil countries, like Kuwait and Saudi Arabia, it’s seven thousand, six hundred and seventy. In industrial countries it’s six thousand, two hundred and seventy. Turning to middle-income countries again, they have twenty-five point one per cent of world population, with fourteen point two per cent of world income. The major oil countries have point four per cent of population, the industrial countries fifteen point six. The oil countries have one point five per cent of world income, the industrial countries sixty-four point eight. The first economic question is for whom does the world economy produce? As the table shows, it produces essentially for the people living in the rich industrial countries. They get sixty per cent of the world’s income, although they only have sixteen per cent of its population. This suggests an answer to the second question that is of what is produced. The answer is that most of world production will be directed towards the goods and services that these same rich industrialized countries want. The third question is how goods are produced. In poor countries, with little machinery, not very much technical training and so on, workers produce much less than workers in rich countries. And poverty is very difficult to escape. It continues on and on. And this goes some way towards accounting for the differences in national incomes. It accounts for an unequal distribution of income, not just between countries but also between members of the same country, although there individual governments can help through taxation. In other words, governments can act to help distribute income throughout their population [27]. 44 PRACTICE I. Give the definition of: -«income distribution» -«national income». II. Fill in the gaps with the words and expressions: 1. You have ______ that is what you earn in a year. 2. Your income doesn’t just ______ the necessities of life. 3. It includes ______, whether that’s sport or TV or a holiday. 4. ______ is the sum total of the incomes of all the people living in that country. 5.______ is the total of all the incomes earned by all the people in the world.6. In poor countries ______ is only one hundred and fifty-five pounds per year. 7. In ______ countries the income per head is eight hundred and forty pounds. 8. Most of world production ______ towards the goods and services that these same rich industrialized countries want. 9. In poor countries, with ______, not very much technical training workers produce much less than workers in rich countries. 10.This goes some way towards ______ the differences in national incomes. COMMUNICATIVE SITUATIONS 1. Speak on: «Money in our society». 2. Discuss the functions of money: Medium of Exchange (money is accepted by people when they buy or sell goods and services or productive resources). Standard of Value (money is used like a ruler to compare the value of things people buy and sell). Store of Value (Money is a way to store value from the time people receive it until another time when they spend it). 3. Discuss the characteristics of money that help make it effective in accomplishing these functions: portability, uniformity, acceptability, durability, divisibility, stability in value. 4. Express your attitude to the following expressions: Money spent on the brain is never spent in vain. Time is money. Money is the root of all evil. Money is the guarantee of security. Money has no smell. No bees, no honey; no work, no money. 45 _________________________________________________________FINANCE 46 _________________________________________________________FINANCE KEY TERMS Finance – is the study of how to manage assets andobtain funds in order to maximize the wealth of theowner. Thus, the broad field of finance deals withsuch varied topics as designing a personal retirementplan, managing inventory, investing excess cash, borrowing money, or attracting bank depositors.Business operations generate profits when thefirm can raise funds at a lower cost than the returngenerated by the investment of the funds. Finance Company – a firm that borrows from the money and capitalmarkets to make loans to individuals and commercialenterprises. The services provided by financecompanies include consumer lending, businesslending and mortgage lending. Finance companiesdo not accept deposits but instead rely on shortand long term debt as a source of funds. Additionally,finance companies often lend money to customerswho commercial banks find too risky. Financial Assets – financial assets such as stocks and bonds areclaims to the income generated by real assets orclaims on income from the government. Financial Statements – the primary means of communicating important accounting information to users. They include the income statement, statement of owner’s equity, balance sheet, and statement of cash flows. Expenses – decreases in owner’s equity that result from operating a business. Calculation – resultofcalculating. Total Costs – the sum of fixed and variable costs for any given level of production. Variable – variable thing or quantity. Variable Costs – costs, that vary directly with the level of production. Volume – large amount or quantity. 47 FINANCE_________________________________________________________ PART 1 Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term finance may thus incorporate any of the following: - the study of money and other assets; - the management and control of those assets; - profiling and managing project risks; - as a verb to finance is to provide funds for business. The activity of finance is the application of a set of techniques that individuals andorganizations (entities) use to manage their financial affairs, particularly the differences between income and expenditure and the risks of their investments. An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary, such as a bank or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and thefinancial intermediary pockets the difference. A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space. Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization[27]. 48 PRACTICE I. Match the synonyms: 1. income a) share 2. losses b) entity 3. organization c) profit 4. intermediary d) expenditure 5. to borrow e) to incorporate 6. to lend f) to ask for money 7. stock g) middleman 8. to own h) to obtain 9. to include i) to provide money 10. to raise j) to have II. Say whether these statements are true or false and if they are false, say why: 1. Finance studies the ways in which organizations; individuals use their monetaryresources without taking into account the risks. 2. To finance means to provide funds for business. 3. An entity whose income is less than its expenditure can raise capital by increasing its expenses. 4. The intermediary pays a higher interest than the lender receives. 5. A bank accepts deposits from lenders and then lends them to borrowers. III. Make up sentences with the following synonyms: increase – growth to take into account – to takeinto consideration country – state – nation to grow – to increase products – goods – articles IV. Fill in the gaps with the words and expressions: Finance studies and addresses the ways in which ______ raise, allocate, and use monetary resources over time, ______. The term finance may thus incorporate any of the following ______.The activity of finance is the application of ______ that individuals andorganizations (entities) use to manage ______, particularly the differences between income and ______ and the risks of their investments.An entity whose income exceeds its expenditure can ______. On the other hand, an entity whose income is less than its expenditure can ______. 49 FINANCE_________________________________________________________ PART 2 Finance is the function in a business, in both the private and public sectors that is responsible for obtaining funds for the firm and managing funds within it, that is preparing budgets, doing cash flow analyses, and planning for the expenditure of funds on such assets as plant, equipment, on promotion of a new product, and remuneration of staff. In every business, the careful consideration of the way which funds are raised, and the monitoring of the way they are used is a vital aspect of the firm's operation. Most organizations have finance departments, or a manager in charge of financial operations. The fundamental charge is to obtain money and then plan, use and control money effectively. You must be sure, that without a carefully calculated financial plan, the firm has little chance for survival. Financial planning involves an analysis of the shortand long-term money flows to and from the firm. The objective of financial planning is to optimize profits and make the best use of money. Financial planning involves three steps: 1) forecasting financial needs (financing dаі1y operations, managing accounts receivable, the purchase of inventory and the purchase of major assets); 2) developing budgets to meet those needs; 3) establishing financial control to sec how well the company is following the financial plans. By forecasting financial needs we ask questions such as: What business are we in and should we be in 5 years from now? How much money should we invest in automation and new equipment over the next decade? A budget is a financial plan that allocates resources based on projected revenues. There are usually several budgets established in a firm: an operating budget, a capital budget, a cash budget and a master budget[20,21]. 50 PRACTICE I. Make sure that you understand the following: financial plan to lose money to prepare budget small and medium-size businesses to do cash flow analyses tax laws marketing effectiveness to minimize the taxes financial operations finance department to control money tax computation II. Fill in the blanks with appropriate words and word-combinations: 1. Investing means committing capital with the expectation of making ______ . a) business; b) profit; c) accounts; d) stocks. 2. The financial manager traces _____ from investors to the firm and back to investors again ________ . a) real estate; b) shares; c) the flow of cash; d) bonds. 3. Financial manager must know how _______ investments in countries with different currencies, interest rates, inflation rates and tax systems. a) to sell; b) to borrow; c) to purchase; d) to evaluate. 4. _______, who prepares the financial statements, manages the firm’s internal accounting and looks after its tax obligations. a) a treasure; b) a controller; c) a stockholder; d) a manager. 5. _______ is one that cannot be shifted from the person upon whom it is levied to somebody else, for example the property tax. a) a direct tax; b) an indirect tax; c) the sale tax; d) benefit. 6. In commercial practice _______ is restricted to the amount of money payable for goods, services and securities. a) price; b) value; c) decrease; d) increase. III. Say whether these statements are true or false and if they are false, say why: 1. Finance is not the function in a business, in both the private and public sectors. 2. Finance is responsible for obtaining funds for the firm and managing funds within it, 3. Most organizations don’t have finance departments, or a manager in charge of financial operations. 4. The fundamental charge is to obtain money and then plan, use and control money effectively. 51 FINANCE_________________________________________________________ PART 3 Obtaining funds –is a very important finance function, because the amount of money needed for various tune periods and it's sources are fundamental questions in sound financial management. Financial control means that the actual revenues, costs, and expenses are periodically reviewed and compared with projection. In our day-to-day life we are familiar with such finance functions as buying merchandise on credit and collecting payments from buyers. The major problem that arises with credit purchasing is that as much as 25 per cent of the firm's assets could be tied up in accounts receivable (to refresh your accounting memory, accounts receivable is money, owed to a business from customers who bought goods or services on credit). This outflow of funds causes financial managers to focus their attention on efficient collection overdue payments. Both credit and collection are important responsibilities of financial managers. They must be sure that the firm does not lose too much money to bad debt losses. Managing taxes means analyzing of tax implications of various managerial decisions, and designing strategies to minimize the taxes paid by the business. The importance of tax responsibility of the management is constantly being increased because tax laws and tax liabilities have been changed and tax computation is under strict scrutiny of tax authorities. Then auditingcomes. Auditors (internal or independent) check on the journals. ledgers, and financial statements prepared by the accounting department to be sure that all transactions have been treated in accordance with established .accounting rules and procedures, and to measure a company's health. And finally, financial people provide information and analyses to top management to assist them in decision making –advising top management on financial matters[20,21]. 52 PRACTICE І. Answer the questions: 1. What does finance study? 2. What techniques does the activity of finance include? 3. When can an entity lend the excess income? 4. What does the lender receive by selling the notes or bonds? 5. Who pockets the difference of interests? 6. What activities does a bank aggregate? 7. Why is finance so important? 8. What are the most common ways firms fail financially? 9. What are responsibilities of financial managers? 10. What are the main financial functions? II. Fill in the blanks with appropriate words and word-combinations: 1. Total ______ is the increase in value of an investment over time, usually a year. a) decrease; b) return; c) yield; d) liquidity. 2. If the firm does well, the real assets generate cash inflows which more than repay the initial ______ . a) investment; b) financial assets; c) bonds; d) share. 3. The fundamental financial objective of the firm is ______ the value of the cash invested by the stockholders. a) to give; b) to reduce; c) to maximize; d) to obtain. 4. The ______ is responsible for looking after the firm’s cash, raising new capital and maintaining relationships with banks, stockholders, etc. a) controller; b) investor; c) director; d) treasurer. 5. ______ is levied not on the individual, but on goods which the individual purchases. a) a direct tax; b) an indirect tax; c) the income tax; d) a compulsory charge. 6. ______ is the price for temporary use of somebody else’s money. a) value; b) increase; c) interest rate; d) output. 1. 2. - COMMUNICATIVE SITUATIONS Make a report in your class: «Areas of financial need». You are at the conference. Discuss the following problems: Sources of short-term financing. Functions of finance. 53 ________________________________________FINANCIAL STATEMENTS 54 ________________________________________FINANCIAL STATEMENTS KEY TERMS Annual report – the medium in which the general – purpose external financial statements of a business are communicated once a year to stockholders and other interested parties. Balance– the difference in national currency between the total debit footing and the total credit footing of an account. Balance sheet – the financial statement that shows the assets, liabilities and owner’s equity of a business at a point in time. Cost of goods sold – the amount a merchant paid for the merchandise sold during an accounting period. Also called cost sales. Current assets – cash or other assets that are reasonably expected to be realized in cash, sold, or consumed within one year or within the normal operating cycle, whichever is longer. Income statement – the financial statement that summarizes the revenues earned and expenses incurred by a business over a period of time. Net income – the difference between revenues and expenses when revenues exceed expenses. Net loss – the difference between expenses and revenues when expenses exceed revenues. Retained earnings – the account that reflects the stockholders’ claim to the assets earned from operations and reinvested in corporate operations. Also called earned capital. Statement of cash flows – The financial statement that shows theinflows and outflows of cash from operating activities, investing activities over a period of time Statement of stockholders’ equity – a financial statement that shows thesame basic information as the statementof retained earnings, but also shows the changes in all owners’ equity accounts. 55 FINANCIAL STATEMENTS_______________________________________ PART 1 When people want to set up or start a company, they need money, called capital. Companies can borrow this money, called a loan, from banks. The loan must be paid back with interest: the amount paid to borrow the money. Capital can also come from issuing shares or equities – certificates representing units of ownership of a company. The people who invest money in shares are called shareholders and they own part of the company. The money they provide is known as share capital. Individuals and financial institutions, called investors, can also lend money to companies by buying bonds – loans that pay interest and are repaid at a fixed future date. Money that is owed – that will have to be paid – to other people or businesses is a debt. In accounting, companies’ debts are usually called liabilities. Long-term liabilities include bonds; short-term liabilities include debts to suppliers who provide goods or services on credit – that will be paid for later. The money that a business uses for everyday expenses or has available for spending is called working capital or funds. All the money coming into a company during a given period is revenue. Revenue minus the cost of sales and operating expenses, such as rent and salaries, is known as profit, earnings or net income. The part of its profit that a company pays to its shareholders is a dividend. Companies pay a proportion of their profits to the government as tax, to finance government spending. They also retain, or keep, some of their earnings for future use. Companies give information about their financial situation in financial statements. The balance sheet shows the company’s assets – the things it owns; its liabilities – the money it owes; and its capital. The profit and loss account shows the company’s revenues and expenses during a particular period, such as three months or a year [6]. Professional English in Use 56 PRACTICE І. Match the words/expressions on the left with the best synonym on the right: 1. to be compatible with a. to balance 2. to summarize b. to total/to add 3. stable c. to be in line with/budgeted 4. to be as expected d. to expand 5. grow e. static 6. to allocate f. to fit in with 7. to equal g. to give to 8. to contribute to h. to assign 9. to consist of i. to picture/to illustrate 10. to show j. to be composed of/to include II. Complete the text with words. You will need to use each word more than once: financing investing operations 1. ______ means making money by selling goods and services. 2. ______ is spending cash, for the business’s future growth, including cash acquired by selling assets. 3. ______ involves raising money by issuing stocks and bonds (and also paying dividends and interest and repaying bonds). 4. It is better for the company if it can pay for future growth out of money from ______ without having to use ______. 5. So a ‘healthy’ cash flow means that the amount of cash provided by ______. 6. ______ is greater than the cash used for ______. III. It is interesting to know that: Adam Smith wrote in his book “The Wealth of Nations” that government must interfere into business as little as possible. It was written in 1776. SBA (Small Business Administration) in the USA gives advice to small business for free. In the most developed countries about 80 per cent of businesses are sole proprietorships. The term big business took origin in 1901 in the USA.Sole proprietorships, however, account only for 17 per cent of all business receipts. 57 FINANCIAL STATEMENTS_______________________________________ PART2 Companies’ annual reports contain a profit and loss account. This is a financial statement which shows the difference between the revenues and expenses of a period. Nonprofit (or not-for-profit) organizations such as charities, public universities and museums generally produce an income and expenditure account. If they have more income than expenditure this is called a surplus rather than a profit. At the top of these statements is total sales revenue or turnover: the total amount of money received during a specific period. Next is the cost of sales, also known as cost of goods sold (COGS): the costs associated with making the products that have been sold, such as raw materials, labour, and factory expenses. The difference between the sales revenue and the cost of sales is gross profit. There are many other costs or expenses that have to be deducted from gross profit, such as rent, electricity and office salaries. These are often grouped together as selling, general and administrative expenses (SG&A). The statement also usually shows EBITDA (earnings before interest, tax, depreciation and amortization) and EBIT (earnings before interest and tax). The first figure is more objective because depreciation and amortization expenses can vary depending on which system a company uses. After all the expenses and deductions is the net profit, often called the bottom line. This profit can be distributed as dividends (unless the company has to cover past losses), or transferred to reserves. British and American companies also produce a cash flow statement. This gives details of cash flows – money coming into and leaving the business, relating to: operations – day-to-day activities; investing – buying or selling property, plant and equipment; financing – issuing or repaying debt, or issuing shares. The cash flow statement shows how effectively a company generates and manages cash. Other names are sometimes used for it, including funds flow statement and source and application of funds statement [6]. 58 PRACTICE I. Which figure in each of the following pairs is higher for a profitable company: cost of sales / sales revenue net profit / pre-tax income gross profit / net profit income tax / net profit EBIT / EBITDA II. Complete the sentences: 1. ________ are companies that provide other companies with materials, components, etc. 2. ________ are profits that the company has not distributed to shareholders. 3. ________ are things a company owns and uses in its business. 4. ________ consist of everything a company owes. 5. ________ consists of money belonging to a company’s owners. III. Fill in the blanks with noun, verb or adjective forms. Use your dictionary if necessary: Noun Verb Adjective 1) production produce productive 2) – satisfy – 3) – – valuable 4) success – – 5) – – applicable 6) – define – IV. Match up the halves of the sentences: 1. An opportunity cost is the cost of a) (both positive and negative) minus doing a particular activity the amount of the original investment. 2. A discounted cash flow is b) a series of future earnings. 3. The discount rate selected depends c) present value. on 4. NPV is the sum of the present d) instead of doing something. values series of cash flows e) different rate of return). 5. A break-even point is the sales at f) that would give a project a of zero. which 6. The internal rate of return is the g) the cost of capital, the level or risk, discount (interest) rate etc. total revenues equal total costs or expenses. 59 FINANCIAL STATEMENTS_______________________________________ PART3 The balance sheet is a document which has two halves. The totals of both halves are always the same, so they balance. One half shows a business’s assets, which are things owned by the company, such as factories and machines that will bring future economic benefits. The other half shows the company’s liabilities, and its capital or shareholders’ equity. Liabilities are obligations to pay other organizations or people: money that the company owes, or will owe at a future date. These often include loans, taxes that will soon have to be paid, future pension payments to employees, and bills from suppliers: companies which provide raw materials or parts. If the suppliers have given the buyer a period of time before they have to pay for the goods, this is known as granting credit. Since assets are shown as debits (as the cash or capital account was debited to purchase them), and the total must correspond with the total sum of the credits – that is the liabilities and capital – assets equal liabilities plus capital (or A = L + C). American and continental European companies usually put assets on the left and capital and liabilities on the right. In Britain, this was traditionally the other way round, but now most British companies use a vertical format, with assets at the top, and liabilities and capital below. Shareholders’ equity consists of all the money belonging to shareholders. Part of this is share capital – the money the company raised by selling its shares. But shareholders’ equity also includes retained earnings: profits from previous years that have not been distributed – paid out to shareholders – as dividends. Shareholders’ equity is the same as the company’s net assets, or assets minus liabilities. A balance sheet does not show how much money a company has spent or received during a year. This information is given in other financial statements: the profit and loss account and the cash flow statement [6]. 60 PRACTICE I. Make word combinations using a word from each box. Then use the word combinations to complete the sentences below: distribute earnings grant credit owe profits pay money retain liabilities 1 We ______ a lot of our ______ because we don’t ______ any of our to the shareholders. 2 Most businesses have customers who ______ , because they ______ them 30 or 60 days’______. 3 We have a lot of ______ that we’ll have to ______ later this year. 1. 2. 3. 4. 5. 6. II. Match the two parts of the sentences: A company’s value on the stock a) are current assets. exchange is nearly always Brand names, trade marks, b) are examples of intangible patents, customers, and qualified assets. staff Cash, money owed by customers, c) are examples of tangible, and inventory fixed assets. Companies record inventory at d) by deducting the amount the cost of buying or making the from profits. items, Companies write off bad debts, e) higher than the value of its and make provisions net assets. Land, buildings, factories and f) or the current market price, equipment whichever is lower. III. Give the right answer: 1. What happens to shareholders when the liabilities of the company exceed the level of its assets? a) They become happy.b) They become rich.c) They become nervous. 2. Do shareholders support the company if it declares bankruptcy? a) Yes, they do.b) No, they don’t want to be around on this day. c) They are waiting when the company starts a new business. 3. How often is the company’s accounting published? a) Twice a week.b) Monthly.c) Once a year. 61 FINANCIAL STATEMENTS_______________________________________ PART4 In accounting, assets are generally divided into fixed and current assets. Fixed assets (or non-current assets) and investments, such as buildings and equipment, will continue to be used by the business for a long time. Current assets are things that will probably be used by the business in the near future. They include cash – money available to spend immediately, debtors – companies or people who owe money they will have to pay in the near future, and stock. If a company thinks a debt will not be paid, it has to anticipate the loss – take action in preparation for the loss happening, according to the conservatism principle. It will write off, or abandon, the sum as a bad debt, and make provisions by charging a corresponding amount against profits: that is, deducting the amount of the debt from the year’s profits. Assets can also be classified as tangible and intangible. Tangible assets are assets with a physical existence – things you can touch – such as property, plant and equipment.Tangible assets are generally recorded at their historical cost less accumulated depreciation charges – the amount of their cost that has already been deducted from profits. This gives their net book value. Intangible assets include brand names – legally protected names for a company’s products, patents – exclusive rights to produce a particular new product for a fixed period, and trade marks – names or symbols that are put on products and cannot be used by other companies. Networks of contacts, loyal customers, reputation, trained staff or ‘human capital’, and skilled management can also be considered as intangible assets. Because it is difficult to give an accurate value for any of these things, companies normally only record tangible assets. For this reason, a going concern should be worth more on the stock exchange than simply its net worth or net assets: assets minus liabilities. If a company buys another one at above its net worth – because of its intangible assets – the difference in price is recorded under assets in the balance sheet as goodwill [6]. 62 PRACTICE I. Find words and expressions from the texts with the following meanings: 1. an amount of money that is owed but probably won’t be paid; 2. the accounting value of a company (assets minus liabilities); 3. a legal right to produce and sell a newly invented product for a certainperiod of time; 4. the historical cost of an asset minus depreciation charges; 5. the amount a company pays for another one, in excess of the net value of its assets; 6. a legally protected word, phrase, symbol or design used to identify a product; 7. to accept that a debt will not be paid; 8. to deduct money from profits because of debts that will not be paid; 9. products that are not complete or ready for sale; 10. the amount of money owed by customers who have bought goods but not yet paid for them. II. Sort the following into current, fixed and intangible assets:buildings, cash in the bank, goodwill, stock, land, debtors, reputation, investments, human capital Current assets Fixed assets Intangible assets III. Finish the sentences referring to the information: 1. A balance sheet is 2. A balance sheet is made up 3. The list of labeled assets includes 4. The company lists its liabilities 5. A book value shows COMMUNICATIVE SITUATIONS 1. Prove the importance of Financial Statements in decision making for any business organization. 2. From the business section of your local paper or a daily newspaper, clip an article about a company. List all the financial and accounting terms used in the article. 63 __________________________________________ FINANCIAL MANAGER 64 __________________________________________ FINANCIAL MANAGER KEY TERMS Chief Financial Officer (CFO) – is a person who oversee both thetreasurer’s and the controller’s work. Controller – is a person who prepares the financial statements, manages the firm’s internal accounting, and looks after its tax obligations. Financial Management Analysis – financial management analysis is a field in financethat studies how an organization should manage its assets, liabilities, and equity to produce a goodor service. Financial Risk – is determined by how the firmdecides to finance its assets. Financial risk occurs as a result of fixed costs in a firm’s financial structure.A firm’s financial structure is the combination of debt and equity that it uses to finance assets. Equity dividends, including preferred stock dividends, are considered to be a variable financing cost, as the firm can reduce the dollar amount of dividends or eliminate them entirely if its cash flow is poor. Shareholders may be unhappy, but even preferred shareholders can do little to force the firm to pay dividends. In sum, financial risk refers to potential variation in income before interest and taxes associated with fixed interest payments ondebt and lease payments. Financial Services Holding Company – a parent company that owns a bank holding company plus other subsidiaries, such as a thrift holdingcompany and insurance subsidiary. Treasurer– is responsible for looking after the firm’s cash, raising new capital, and maintaining relationships with banks, stockholders, and other investors who hold the firm’s securities. 65 FINANCIALMANAGER __________________________________________ PART 1 The term financial manager refers to anyone responsible for a significant investment or financing decision. But only in the smallest firms is a single person responsible for all financialdecisions. In most cases, responsibility is dispersed. Top management is of course continuously involved in financial decisions. The marketing manager who commits to a major advertising campaign is also making an important investment decision. Nevertheless there are some managers who specialize in finance. Their roles aresummarized in Figure 2. The treasurer is responsible for looking after the firm’s cash, raising new capital, and maintaining relationships with banks, stockholders, and other investors who hold the firm’s securities. Fig.2 For small firms, the treasurer is likely to be the only financial executive. Larger corporations also have a controller, who prepares the financial statements, manages the firm’s internal accounting, and looks after its tax obligations. The treasurer and controller have different functions: The treasurer’s main responsibility is to obtain and manage the firm’s capital, whereas the controller ensures that the money is used efficiently.Still larger firms usually appoint a chief financial officer (CFO) to oversee both thetreasurer’s and the controller’s work. The CFO is deeply involved in financial policy and corporate planning. Often he or she will have general managerial responsibilities beyond strictly financial issues and may also be a member of the board of directors [27]. 66 PRACTICE I. Say whether these statements are true or false and if they are false, say why: 1. Top management is sometimes involved in financial. 2. The treasurer is the only financial executive in small firms. 3. The controller's main responsibility is to obtain and manage the firm's capital. 4. CFO may be a member of the board of directors. 5. Staff members specializing in corporate planning are too drawn into capital budgeting. II. Match the synonyms: 1. to involve a) to raise money 2. to executive b) plan 3. responsibility c) to draw into 4. to obtain capital d) to look after 5. to commit e) share 6. to supervise f) manager 7. projectg) duty 8. earnings h) return 9. stock i) to manage 10. to oversee j) to invest III. Read the words and expressions. Put into the gaps in the properform: a customer an entrepreneur to be in great demand profitable to expand 1. A company has decided to open a new consulting center to give advice to their ______ about new services.2. If a small company wants to earn more money and attract more customers, it must ______ its business. 3. The new technologies are developed very fast and we can see that different mobile phones, notebooks and computers ______ nowadays. 4. If you want your company to be ______ you must take care of your employees. 5. We call ______ a person who starts and manages a business and has all the responsibility for its development, growth and survival. 67 FINANCIALMANAGER __________________________________________ PART 2 The controller or CFO is responsible for organizing and supervising the capital budgeting process. However, major capital investment projects are so closely tied to plans for product development, production, and marketing that managers from these areas are inevitably drawn into planning and analyzing the projects. If the firm has staff members specializing in corporate planning, they too are naturally involved in capital budgeting. Because of the importance of many financial issues, ultimate decisions often rest by law or by custom with the board of directors. The financial manager stands between the firm’s operations and the financial (or capital) markets, where investors hold the financial assets issued by the firm. The financial manager’s role is illustrated in Figure 1, which traces the flow of cash from investors to the firm and back to investors again. The flow starts when the firm sells securities to raise cash (arrow 1 in the figure). The cash is used to purchase real assets used in the firm’s operations (arrow 2). Later, if the firm does well, the real assets generate cash inflows which more than repay the initialinvestment (arrow 3). Finally, the cash is either reinvested (arrow 4a) or returned to theinvestors who purchased the original security issue (arrow 4b). Of course, the choice between arrows 4a and 4b is not completely free. For ex., if a bank lends money at stage 1, the bank has to be repaid the money plus interest at stage 4b. Fig.1 Flow of cash between financial markets and the firm’s operations. 68 Key:(1) Cash raised by selling financial assets to investors; (2) cash invested in the firm’s operations and used to purchase real assets; (3) cash generated by the firm’s operations; (4a) cash reinvested; (4b) cash returned to investors [27]. PRACTICE I. Match the correct function to each statement below: 1. Planning a) Finance manager decided to include money for a new personal computer in the operating budget. 2. Budgeting b) A company has a lot of bad debts, so finance manager developed a more effective system to collect accounts receivable. 3. Obtaining funds c) Ann’s duty is to be sure that no mistakes were made in posting journal entries into the general ledger. d) Finance manager designed a very good 4. Controlling funds strategy to minimize the tax paid by his company. e) To increase its output the plant borrowed a 5. Collecting funds short-term loan and bought the inventory needed for production. f) Then this plant developed a long-term 6. Auditing strategy of automating its production facilities, which would cost millions of hryvnias. g) In his report to top management the finance 7. Managing taxes manager outlined the effect of the new accounting system in recording and posting financial entries. II. Say whether these statements are true or false and if they are false, say why: 1. When analyzing capital projects the financial manager can forget about financialmarkets. 2. Financial managers must decide not only which assets their firm should invest in but also where those assets should be located. 3. Financial markets to refer to all sources of financing. 4. Short-term financing means more than one year. 5. To raise cash a corporation can borrow from its hometown bank. 6. Financial manager has to know how to evaluate investments in countries with different currencies, interest rates, inflation rates, and tax systems. 7. Major capital investment projects are so closely tied to plans for production. 69 FINANCIAL MANAGER __________________________________________ PART 3 Financial managers of large corporations also need to be men and women of the world. They must decide not only which assets their firm should invest in but also where those assets should be located. Take Nestle, for example. It is a Swiss company, but only a small proportion of its production takes place in Switzerland. Its 520 or so factories are located in 82 countries. Nestle’s managers must therefore know how to evaluate investments in countries with different currencies, interest rates, inflation rates and tax systems. Financial managers use the terms financial markets and capital markets almost synonymously. But capital markets are, strictly speaking, the source of long-term financing only. Short-term financing comes from the money market. “Short-term” means less than one year. We use the term financial markets to refer to all sources of financing. The financial markets in which the firm raises money are likewise international. The stockholders of large corporations are scattered around the globe. Shares are traded around the clock in New York, London, Tokyo, and other financial centers. Bonds and bank loans move easily across national borders. A corporation that needs to raise cash doesn’t have to borrow from its hometown bank. Day-to-day cash management also becomes a complex task for firmsthat produce or sell in different countries [27]. \ 70 PRACTICE I. Answer the questions: 1. What is financial manager responsible for? 2. Is the marketing manager involved in financial decision? 3. What is the role of the treasurer? 4. Does the controller prepare the financial statements? 5. What is the difference between the controller's and treasurer's duties? 6. What does the CFO do? 7. What the place of the financial manager in a firm? 8. What does the firm's flow of cash consist of? 9. What are two basic questions which the financial manager deals with? II. Complete the passage which describes the functions of the finance department: former, latter, subdivided, broken into, latter, former, is divided, is responsible, split into, control, provides, finally, looks, financing, planning The financial department _______ into three sections: ______ , ______ , ______ . Financing is further ______ into short-term and long-term financing. The ______ deals with the management of cash and working capital; the ______ with long-term loans and repayments (collecting). The control function is also ______ two sections: accounts and credit. The accounts section ______ bookkeeping and production of financial statements. The credit function ______ after credit terms and creditworthiness of supplies. ______ , the planning department is _______ two sections: budgets and investment. The ______ is ______ for making annual budgets and updating and revising them on a monthly basis while the ______ assesses the return and profitability of new investment projects. COMMUNICATIVE SITUATIONS Imagine you are a successful business person. You are going to write your own career profile. Before doing this think, what steps you should take to start your own business. Answer the following questions: 1. Where did you take money for your business? 2. When did you start your business? 3. What product or service do you produce? 4. Why is your product or service successful? 5. Who are your competitors? 6. What do you do to succeed in business? 71 ___________________________________________FINANCIAL PLANNING 72 ___________________________________________FINANCIAL PLANNING KEY TERMS Financial planning – is the process of analyzing alternativeinvestment, financing, and dividend strategiesin the context of various potential economicenvironments. In developing a long-term financial plan, thesethree decisions (policies) can be described moreexplicitly as follows: 1. The firm’s investment decision. This refers tothe amount of cash needed for the firm’s investmentin a new asset (it is also called thecapital budgeting decision). In addition, it alsorefers to the amount of working capital neededon an ongoing basis (also referred to as theworking capital decision). 2. The firm’s financing decision. This refers to newborrowing or new equity issued for financingthe firm’s investment in new assets. This decisionis influenced by the degree of financialleverage the firm chooses to employ and howit plans to raise the necessary new funds. 3. The firm’s dividend decision. This refers to theamount of cash the firm thinks is necessaryand appropriate to pay equity holders as cashdividends. Financial Requirements – in the financial plan, financing arrangements thatare necessary to meet the overall corporate objective.The plan will include a section on financingarrangements. This part of the plan should discussdividend policy and debt policy. Sometimes firmswill expect to raise equity by selling new shares ofstock. In this case the plan must consider whatkinds of securities must be sold and what methodsof issuance are most appropriate. 73 FINANCIALPLANNING___________________________________________ PART 1 Financial planning (like all planning) begins with: 1. Establishing Organizational Goals and Objectives. Establishing goals and objectives is an important management task. A goal is an end state that the organization wants to achieve. Objectives are specific statements detailing what the organization intends to accomplish within a certain period of time. If goals and objectives are not specific and measurable, they cannot be translated into costs, and financial planning cannot proceed. They must also be realistic. Otherwise, it may be impossible to finance or achieve them. 2. Budgeting for Financial Needs. A budget is a financial statement that projects income and/or expenditures over a specified future period of time. Once planners know what the firm's goals and objectives are for a specific period of time – say, the next calendar year – they can estimate the various costs the firm will incur and the revenues it will receive. By combining these items into a companywide budget, financial planners can determine whether they must seek additional funding from sources outside the firm. Usually the budgeting process begins with the construction of individual budgets for sales and for each of the various types of expenses: production, human resources, promotion, administration, and so on. Budgeting accuracy is improved when budgets are first constructed for individual departments and for shorter periods of time. These budgets can easily be combined into a companywide cash budget. In addition, departmental budgets can help managers monitor and evaluate financial performance throughout the period covered by the overall cash budget [37]. 74 PRACTICE I. Match the words in the box with the definitions below: a. a series of future earnings converted 1. discount rate to their value today 2. purchasing power b. the annual percentage amount of income received from an investment 3. discounted cash flow c. the interest rate an investment earns when the present value of all costs equals the present value of all returns 4. rate of return d. the difference between the value of money held now, and its value if it is received in the future, because it could be invested during that period 5. internal rate of return e. the value of money, measured by the quantity (and quality) of products and services it can buy 6. time value of money f. the interest rate used to calculate the present value of future cash flows II. Are the following statements true or false? Find reasons for your answers: 1 If a company uses its own money for a new project, there is no opportunity cost of capital. 2 A project financed by borrowed money requires a rate of return higher than the cost of capital. 3 Because of inflation, money will usually be worth more in the future than at the present. 4 The longer you have to wait for investment returns, the less their present value is. III. Complete the sentences: 1. Every successful business plan should include ... 2. The executive summary briefly sets ... 3. Section «Market Description and Analysis» profiles three key areas: ... 4. Section «Marketing Strategy» should clearly specify ... 5. The object of the section Research and Development is to explain ... 6. The quality of the management team determines ... 75 FINANCIALPLANNING___________________________________________ PART 2 Most firms today use one of two approaches to budgeting. In the traditional approach, each new budget is based on the dollar amounts contained in the budget for the preceding year. These amounts are modified to reflect any revised goals, and managers must justify only new expenditures. The problem with this approach is that it leaves room for the manipulation of budget items to protect the (sometimes selfish) interests of the budgeter or his or her department. This problem is essentially eliminated through zero-base budgeting. Zero-base budgeting is a budgeting approach in which every expense must be justified in every budget. It can dramatically reduce unnecessary spending. However, some managers feel that zero-base budgeting requires too much timeconsuming paperwork. 3. Identifying Sources of Funds. The four primary sources of funds are sales revenue, equity capital, debt capital, and the sale of assets. Future sales generally provide the greatest part of a firm's financing. Sales revenue is the first type of funding. The second type of funding is equity capital, which is money received from the sale of shares of ownership in the business. Equity capital is used almost exclusively for long-term financing. Thus it might be used to start a business and to fund expansions or mergers. It would not be considered for short-term financing needs. The third type of funding is debt capital, which is money obtained through loans. Debt capital may be borrowed for either short- or long-term use. The fourth type of funding is the sale of assets. A firm generally acquires assets because it needs them for its business operations. Therefore, selling assets is a drastic step. However, it may be a reasonable last resort when neither equity capital nor debt capital can be found. Assets may also be sold when they are no longer needed[37]. 76 PRACTICE I. Match the two parts of the sentences: 1. Future cash flows are a. businesses look for the usually discounted one with the highest internal rate of return 2. If a project seems to be b. by the cost of the capital particularly risky or uncertain involved in the investment 3. Money you possess now c. discounted to their is worth more than money received in current value the future, because 4. The net present value of d. it can earn interest in that a project is the sum of all the returns time, and there might be inflation it is expected to provide 5. When choosing among e. you can increase the potential investments discount rate you use in your calculations II. Match the words in column one with their antonyms in column two: 1) relevant a) non-perspective 2) to involve b) to be useless 3) short-tern c) irrelevant 4) perspective d) to finish 5) to be useful e) to extract from, to derive 6) to start f) long-term from III. Fill in the blanks with noun, verb or adjective forms. Use your dictionary if necessary: Noun Verb Adjective 1. writing to write written 2. – – involved 3. – to make – 4. satisfying – satisfied 5. – to require – 6. valuation – – IV. Discuss the following questions. Prove your opinion with arguments. 1. Do you agree that a goal setting is an important part of business planning? 2. What are the primary barriers for planning and how can they beovercome? 77 ______________________________________________FINANCIAL RATIOS 78 ______________________________________________FINANCIAL RATIOS KEY TERMS Ratio Analysis – is another means by which to gain insight regarding a firm’s strengths and weaknesses. Ratios are constructed by dividing various financial statement numbers into one another. The ratios then can be examined to determine trends and reasons for changes in the financial statement quantities. Ratios are valuable tools, as they standardize balance sheet and income statement numbers; thus, differences in firm size will not affect the analysis. There are also many categories of financial ratios. The following list represents the most basic categories: Liquidity Ratios – measure the ability of a firm to meet its maturing financial obligations and recurring operating expenses. In general, these are shortterm obligations, normally due within one year. Several ratios provide evidence of liquidity. Current Ratio – is defined as current assets (cash, marketable securities, accounts receivable, inventories, and prepaid expenses) divided by current liabilities (typically, accounts payable and short-term bank loans). Asset Management Ratios – asset management ratios (also called activity or asset utilization ratios) attempt to measure the efficiency with which a firm uses its assets. Capital Structure Ratios – (sometimes called debt utilization or leverage ratios) compare the funds supplied by the owners (equity) with the funds provided by creditors (debt). The debt-to-assets ratio is calculated as total debt (i.e., the sum of current and long term liabilities) divided by total assets; it measures the proportion of assets financed by borrowers. The debt-to-equity ratio is computed as total debt divided by stockholders’ equity. Profitability Ratios – show the ability of a firm to use its sales, assets, and equity to generate returns. The profit margin, or return on sales, represents the proportion of each sales dollar that becomes profit or net income to the firm. 79 FINANCIAL RATIOS______________________________________________ PART 1 Financial ratios express the relationships between two or more items on financial statements. They allow investors and creditors to compare a company’s present situation and performance with its past performance, and with other companies. Ratios measure: - liquidity: how easily a company can turn some of its assets into cash; - solvency: whether a company has enough cash to pay short-term debts, or whether it could go bankrupt – have its assets sold to repay creditors; - efficiency: how well a company uses its resources. - current assets current liabilities This is the current ratio, which is a calculation of current assets divided by current liabilities. It measures liquidity and shows how much of a company’s assets will have to be converted into cash in the next year to pay debts. The higher the ratio, the more chance creditors have of being paid. For example, if MacKenzie Inc has current assets of $23,244,000 and current liabilities of $15,197,000, its current ratio is 1.53, which is acceptable. It is often argued that the current ratio of a healthy company should be closer to 2.0 than 1.0, meaning that it has nearly twice as many assets as liabilities. Suppliers granting short-term credit to a company prefer the current ratio to be high because this reduces their risk. Yet shareholders usually prefer it to be low, because this means that the company has invested its assets for the future. liquid assets current liabilities This is the quick ratio or acid test, which is a calculation of liquid assets divided by current liabilities. It measures short-term solvency. Liquid assets are current assets minus stocks or inventory, as these might be difficult to sell [6]. 80 PRACTICE I. Match the two parts of the sentences: 1. Financial ratios express a) a calculation of current assets divided by current liabilities. 2. They allow investors and b) have to be converted into cash in the creditors to compare a company’s next year to pay debts. present situation and 3. This is the current ratio, which c) as these might be difficult to sell. is 4. It measures liquidity and shows d) performance with its past how much of a company’s assets performance, and with other will companies. 5. Liquid assets are current assets e) the relationships between two or minus stocks or inventory, more items on financial statements. II. Fill in the blanks below with the most appropriate terms: 1. Financial ratios express ______ between two or more items on______. 2. They allow investors and creditors to compare ______ with its past performance, and with other companies. 3. Ratios measure ______. 4. The current ratio – is a calculation of current assets divided by______. 5. Suppliers granting short-term credit to a company prefer ______ to be high because this reduces their risk. 6. This is ______ which is a calculation of liquid assets divided by current liabilities. It measures short-term solvency. IIІ. Answer the questions: 1. What expresses the relationships between two or more items on financial statements? 2. What do ratios measure? 3. What is the current ratio? 4. Suppliers granting short-term credit to a company prefer the current ratio to be high because this reduces their risk, don’t they? 5. Shareholders usually prefer the current ratio to be low, because this means that the company has invested its assets for the future, don’t they? 6. What is the quick ratio or acid test? 7. What are liquid assets? 8. Which formula is for the liquid assets calculation? 81 FINANCIAL RATIOS______________________________________________ PART 2 Shareholders are interested in ratios relating to a company’s share price, earnings, and dividend payments total earnings for the year the number of ordinary shares This is earnings per share (EPS). It tells investors how much of the company’s profit belongs to each share. If a company makes a post-tax profit of €1.5 million, and it has issued 2 million shares, EPS = €0.75. the market price of an ordinary share the past year’s EPS This is the price/earnings ratio or P/E ratio. It shows how expensive the share is. If a company has EPS of €0.75 and the share is selling for €9.00, the P/E ratio is 12 (€9 per share divided by €0.75 earnings per share = 12 P/E.) A high P/E ratio shows that investors are prepared to pay a high multiple of the earnings for a share, because they expect it to do well in the future. ordinary share dividend net profit This is dividend cover or times dividend covered, which shows how many times the company’s total annual dividends could have been paid out of its available annual earnings. If a company has EPS of 75 cents and it pays out a dividend of 30 cents, the dividend cover is 75 / 30 = 2.5. A high dividend cover shows that the company has a lot of money, but that it is not being very generous to its shareholders. A ratio of 2.0 or higher is generally considered safe (it means that the company can easily afford the dividend), but anything below 1.5 is risky. A low dividend cover – below 1.0 – means the company is paying out retained surpluses from previous years [6]. ) 82 PRACTICE 1 2 3 4 I. Find words with the following meanings: the ability to sell an asset for cash; how well a business uses its assets; the relationship between two figures; how easily a business can pay bills or debts when they are due. II. Match the two parts of the sentences: a. it does not measure how 1. If a company pays out efficiently the company is utilizing its retained surpluses from past years resources. b its dividend cover will fall 2. Some investors are below 1.0. worried that the new stock issue c makes the market very 3. A high current ratio expensive, as the long-term average is indicates short-term financial 14.45. strength but d will dilute the company’s 4. Wall Street is on a earnings per share. historic price-earnings ratio of around 35, which III. Think of word combinations with these words: assets shares capital cost to manage return cash liabilities value ratio earnings IV. Answer the questions: 1. Shareholders are interested in ratios relating to a company’s share price, earnings, and dividend payments, don’t they? 2. What information does earnings per share (EPS)tell investors? 3. What is the price/earnings ratio or P/E ratio? 4. What information the price/earnings ratio show? 5. A high P/E ratio shows that investors are prepared to pay a high multiple of the earnings for a share, because they expect it to do well in the future, doesn’t it? 6. Does a high dividend cover show that the company has a lot of money, but that it is not being very generous to its shareholders? 7. What does a low dividend cover mean? 83 FINANCIAL RATIOS______________________________________________ PART 3 There are various profitability ratios that allow investors to compare a company’s profit with its sales, its assets or its capital. Financial analysts usually include them in their reports on companies. gross profit (sales – cost of goods sold) sales This is the gross profit margin. It is the money a company has left after it pays for the cost of the goods or services it has sold. A company with a higher gross profit margin than competitors in its industry is more efficient, and should be able to make a profit in the future. net profit total assets This is return on assets. It measures how efficiently the firm’s assets are being used to generate profits. Net profit shareholders’ equity This is return on equity (ROE). It shows how big a company’s profit is (after interest and tax) compared with the shareholders’ equity or funds. debt shareholders’ equity This is gearing or leverage, often expressed as a percentage. It shows how far a company is funded by loans rather than its own capital. A highly geared or highly leveraged company is one that has a lot of debt compared to equity. EBIT interest charges This is interest cover or times interest earned. It compares a business’s annual interest payments with its earnings before interest and tax, and shows how easily the company can pay long-term debt costs. A low interest cover (e.g. below 1.0) shows that a business is having difficulties generating the cash necessary for its interest payments [6]. 84 PRACTICE I. Match the two parts of the sentences: 1. After borrowing millions a. gross profit margin rose 9% to finance the takeover of a rival from a year ago, so senior firm, the company’s management isn’t worried, 2. Although sales fell 5%, b. how good a company is at the company’s making money, 3. Like profit growth, c. interest cover is the lowest it has return on equity is a measure of ever been. 4. With just 24% gearing, d. to acquire its rival, which would the company can afford help to increase its steady growth. II. Think of the verbs that are commonly used with: funds, financing, assets, inventory, cash, merger, dividends, assets, business, solvency, profitability, risk, return III. Think of the nouns that are most often used with: to acquire to distribute to finance to hold to borrow to manage 1. 2. 3. 4. 5. 6. 7. 8. 9. IV. Finish the sentences: Financial ratios express… Ratios measure… The current ratio is a calculation of … The quick ratio or acid test is … There are various profitability ratios that allow investors to … The gross profit margin is the money … This is return on assets. It measures … The return on equity (ROE) shows … The gearing or leverage, often expressed as a percentage shows … COMMUNICATIVE SITUATIONS Study the following case and complete the tasks. You need to present your firm. Form a team, share the tasks and make a short presentation. You should include the following points into your presentation: History of a Firm; Product or Service; Market Description and Analysis; Management; Risks and Problems; Finances; Financial Ratios. 85 ____________________CORPORATE FINANCE: 86 STOCS and SHARES ____________________CORPORATE FINANCE: STOCS and SHARES KEY TERMS Blue chips– stocks in large companies with a reputation for quality, reliability and profitability. More than two-thirds of all blue chips in industrialized countries are owned by institutional investors such as insurance companies and pension funds. Growth stocks –stocks that are expected to regularly rise in value. Most technology companies are growth stocks, and don’t pay dividends, so the shareholders’ equity or owners’ equity increases. This causes the stock price to rise. Income stocks – stocks that have a history of paying consistently high dividends. Defensive stocks – stocks that provide a regular dividend and stable earnings, but whose value is not expected to rise or fall very much. Value stocks – stocks that investors believe are currently trading for less than they are worth – when compared with the companies’ assets. Prospectus – a document inviting the public to buy shares, stating the terms of sale and giving information about the company. Flotation – an offer of a company’s shares to investors. Go public –change from a private company to a public limited company (PLC) by selling shares to outside investors for the first time (with a flotation). Due diligence – a detailed examination of a company and its financial situation. Financial results – details about sales, costs, debts, profits, losses, etc. Underwrites– a stock issue: guarantees to buy the shares if there are not enough other buyers. 87 CORPORATE FINANCE: STOCS and SHARES_____________________ PART 1 Stocks and shares are certificates representing part ownership of a company. The people who own them are called stockholders and shareholders. In Britain, stock is also used to refer to all kinds of securities, including government bonds. The word equity or equities is also used to describe stocks and shares. The places where the stocks and shares of listed or quoted companies are bought and sold are called stock markets or stock exchanges. A successful existing company wants to expand, and decides to go public.The company gets independent accountants to produce a due diligence report.The company produces a prospectus which explains its financial position, and gives details about the senior managers and the financial results from previous years.The company makes a flotation or IPO (initial public offering). An investment bank underwrites the stock issue. If a company has only one type of share these are ordinary shares. Some companies also have preference shares whose holders receive a fixed dividend (e.g. 5% of the shares’ nominal value) that must be paid before holders of ordinary shares receive a dividend. Holders of preference shares have more chance of getting some of their capital back if a company goes bankrupt – stops trading because it is unable to pay its debts. If the company goes into liquidation – has to sell all its assets to repay part of its debts – holders of preference shares are repaid before other shareholders, but after owners of bonds and other debts. If shareholders expect a company to grow, however, they generally prefer ordinary shares to preference shares, because the dividend is likely to increase over time[6]. 88 PRACTICE I. Match each term with its definition: 1. bankrupt a. a document describing a company and offering stocks for sale 2. going public b. a market on which companies’ stocks are traded 3. flotation c. buyers of stocks 4. investors d. changing from a private company to a public one, quoted on a stock exchange 5. liquidation e. the first sale of a company’s stocks to the public 6. prospectus f. to guarantee to buy newly issued shares if no one else does 7. ordinary shares g. shares that pay a guaranteed dividend 8. preference share h. the most common form of shares 9. stock exchange i. insolvent, unable to pay debts 10. to underwrite the sale of the assets of a failed company II. Are the following statements true or false: 1 New companies can apply to join a stock exchange. 2 Investment banks sometimes have to buy some of the stocks in an IPO. 3 The due diligence report is produced by the company’s own accountants. 4 The dividend paid on preference shares is variable. 5 If a company goes bankrupt, the first investors to get any money back are the holders of preference shares. III. Make up questions to have the following answers: 1. Stocks and shares are certificates representing part ownership of a company. 2. The people who own them are called stockholders and shareholders. 3. In Britain, stock is also used to refer to all kinds of securities, including government bonds. 4. The word equity or equities is also used to describe stocks and shares. 5. The places where the stocks and shares of listed or quoted companies are bought and sold are called stock markets or stock exchanges. 6. A successful existing company wants to expand, and decides to go public. 7.The company gets independent accountants to produce a due diligence report. 8. The company makes a flotation or IPO (initial public offering). 9. An investment bank underwrites the stock issue. 89 CORPORATE FINANCE: STOCS and SHARES_____________________ PART 2 After newly issued shares have been sold (usually by investment banks) for the first time – this is called the primary market – they can be repeatedly traded at the stock exchange on which the company is listed, on what is called the secondary market.Major stock exchanges, such as New York and London, have a lot of requirements about publishing financial information for shareholders. Most companies use over-the-counter (OTC) markets, such as NASDAQ in New York and the Alternative Investment Market (AIM) in London, which have fewer regulations. The nominal value of a share – the price written on it – is rarely the same as its market price – the price it is currently being traded at on the stock exchange. This can change every minute during trading hours, because it depends on supply and demand – how many sellers and buyers there are. Some stock exchanges have computerized automatic trading systems that match up buyers and sellers. Other markets have market makers: traders in stocks who quote bid (buying) and offer (selling) prices. The spread or difference between these prices is their profit or mark-up. Most customers place their buying and selling orders with a stockbroker: someone who trades with the market makers. Companies that require further capital can issue new shares. If these are offered to existing shareholders first this is known as a rights issue – because the current shareholders have the first right to buy them. Companies can also choose to capitalize part of their profit or retained earnings. This means turning their profits into capital by issuing new shares to existing shareholders instead of paying them a dividend. There are various names for this process, including scrip issue, capitalization issue and bonus issue. Companies with surplus cash can also choose to buy back some of their shares on the secondary market. These are then called own shares.Investors tend to classify the stocks and shares available in the equity markets in different categories[6]. 90 PRACTICE 1. 2. 3. 4. 5. 6. 7. I. Match the words with the definitions: to capitalize a. new shares offered to existing shareholders market price b. the price written on a share, which never changes primary market c. to turn profits into stocks or shares rights issue d. the market on which shares can be re-sold secondary market e. the price at which a share is currently being traded nominal value f. shares that companies have bought back from their owners own shares g. the market on which new shares are sold II. Are the following statements true or false: 1 Stocks that have already been bought at least once are traded on the primary market. 2 NASDAQ and the AIM have more regulations than the New York Stock Exchange and the London Stock Exchange. 3 The market price of stocks depends on how many buyers and sellers there are. 4 Automatic trading systems do not require market makers. 5 Market makers make a profit from the difference between their bid and offer prices. III. Answer the following questions: 1. What are stocks and shares? 2. The people who own them are called stockholders and shareholders, aren’t they? 3. Is the word equity or equities also used to describe stocks and shares? 4. The places where the stocks and shares of listed or quoted companies are bought and sold are called stock markets or stock exchanges, aren’t they? 5. What is the nominal value of a share? 6.What is themarket price? COMMUNICATIVE SITUATIONS You are at the conference. The themes of your report are: - Stocks and shares are certificates representing part ownership of a company. - Investors tend to classify the stocks and shares available in the equity markets in different categories. 91 _______________________________ACCOUNTING and BOOKKEEPING 92 _______________________________ACCOUNTING and BOOKKEEPING KEY TERMS Account Activity – transactions associated with a deposit account,including home debits, transit checks, deposits,and account maintenance. Accounting Earnings – earnings of a firm as reported in its income statement. Accounting Insolvency – total book liabilities exceed total book value ofassets. A firm with negative net worth is insolventon the books. Accounting Liquidity – the ease and quickness with which assets can beconverted to cash. Current assets are the mostliquid and include cash and those assets that willbe turned into cash within a year from the date ofthe balance sheet. Fixed assets are the least liquidtype of assets. Accounting, Relationship to Finance – the accounting function, quantifies, to a certainextent, the economic relationships within the firmand provides data on which management bases itsplanning, controlling, and operating decisions. Likeaccounting, finance deals with value and the monetary resources of the organization. Accounts Receivable – money owed to the firm by customers; theamounts not yet collected from customers forgoods or services sold to them (after adjustmentfor potential bad debts). Accounts Receivable Financing – a secured short-term loan that involves either theassigning of receivables or the factoring of receivables. Accounts Receivable Turnover – credit sales divided by average accounts receivable.In general, a higher accounts receivable turnoverratio suggests more frequent payment ofreceivables by customers. 93 ACCOUNTING and BOOKKEEPING_______________________________ PART1 If you were a bookkeeper, the first task you would perform would be to divide allof the firm’s paperwork into meaningful categories. Those categories would probably include the following: - various expense documents - sales documents (sales slips, cash register receipts, invoices) - purchasing documents - shipping documents - bank documents (checks, deposit slips) - payroll records If you collected all this information, you would have several piles of papers, muchlike the piles that are generated in the preparation of income tax forms. If this information is not compressed somehow, it will become too unmanageable. Therefore, the bookkeeper much begins to record the data from the original transaction documents into record books called journals. Journals are the books where accounting data are first entered. The term journal comes from the Frenchword jour, which means day. There are eight steps to the bookkeeping cycle. A bookkeeper is a person that performs one or more of these steps or sometimes called AAT (accounting technicians). In large companies, for instance, the bookkeeping cycle might be divided into departments such as Accounts Receivable, Accounts Payable, or Payroll. While most often these people are referred to as clerks, they might also be considered bookkeepers as they are keeping the books for a company. In smallcompanies, the bookkeeper may perform the entire bookkeeping process, or mightjust enter data to give to the accountant [22]. 94 PRACTICE I. Match the words in the box with the definition below: 1. credit a. suppliers who are owed money for purchases not yet paid for 2. ledger b. goods stored ready for sale 3. stock c. an amount entered on the right-hand side of an account, recording a payment received 4.debtors d. customers who owe money for goods or services not yet paid for 5.creditors e. a book of accounts 6.debit f. an amount entered on the left-hand side of an account, recording money paid out II. Are the following statements true or false: 1. A ledger is a book of original entry. 2. A chart of accounts is a list of all the accounts in a company's general ledger. 3. The total amount of credit balances should be higher than the total amount ofdebit balances. 4. Balance sheet accounts are closed at the end of the accounting year. 5. Revenue and expense accounts begin the financial year with a zero balance. III. Answer the following questions: 1. What qualities does a good bookkeeper need? 2. Would you like to work as a bookkeeper? 3. If not, which type of accounting do you think is the most interesting and why? 4. Who did recommend you to be a bookkeeper? 5. Could you define accounting to your group mate so that he or she would clearly understand what is involved? IV. Make up questions to have the following answers: 1.If you were a bookkeeper, the first task you would perform is to divide all of the firm’s paperwork into meaningful categories: sales documents, purchasing, shipping and bank documents, payroll records, travel and entertainment records. 2. After recording the original transaction documents in a journal, the accountant or bookkeeper transfers the data to certain accounts. 3. Accountants use five major accounts to prepare financial statements: assets, liabilities, owners, equity, revenues and cost of goods sold. 4. Accounts payable – money owed to others for merchandise and services purchased on credit but not paid for yet. 95 ACCOUNTING and BOOKKEEPING_______________________________ PART 2 All bookkeeping steps are mechanical in nature. Bookkeeping is a regimentedprocess usually occurring in monthly cycles consisting of entering transactions intothe journals, making adjustments, and preparing reports. The accounts Receivable Clerk may be assigned to enter all sales on account and all payments from thecustomers. The Accounts Payable Clerk’s responsibility would to be enter purchaseorders and checks. Again, in a small company, both duties may be performed by thesame person. The full-charge bookkeeper is someone who can do it all – includingcompiling the data into the General Ledger and preparing financial statements. Bookkeeping is an essential accounting tool. A small business or company mayemploy only one bookkeeper, who records all of the financial data by hand; largeorganizations may employ many bookkeepers, who use electronic and mechanicalequipment for a large part of their work. Someone has to set up the bookkeeping system, monitor it, and interpret the results. These processes are called Accounting. Accounting is the recording, classifying, summarizing and interpreting of financial events and transactions to provide management and other interested parties the information they need to make better decisions. The accounting process is much less mechanical and more subjective. It begins with designing a system that will benefit the business, by capturing the financial information in a useful manner without being overly burdensome to the bookkeeper. Once set up, the accountant monitors the systems to ensure it’s doing what it’s supposed to do. And finally, on a monthly basis usually, the accountant presents the financial statements to the business management in such a way that decisions can be made [22]. 96 PRACTICE I. Match the words in the box with the definition below: 1.account 2.accounting period 3.credit 4.debit 5.ledgers 6.revenue 7.suppliers 8.transactions a. a length of time for which financial statements are made, usually a year b. a statement of transactions (money paid, received or owed) c. an amount of money paid out, entered on the left side of an account d. an amount of money received, entered on the right side of an account e. books of accounts f. business deals (sale or purchases) g. businesses that sell materials or goods to other companies h. money received by a business for goods sold and services provided II. Complete sentences with words control, monitor, check: 1. The chief accountant _______ all the documents to make sure that everything was in order. 2. There is still inflation in this country but it is under _______. 3. Accounting information is necessary for the management to exercise operational _______. 4. Our accountant _______ situation carefully and if anything goes wrong he takes actions immediately. 5. The monthly balance sheet has not been drawn up today because of reasons beyond our _______. 6. Despite inflation the government of this country _______ the growth of consumer goods prices. 7. Production _______ shows that there is a growth trend in some businesses. III. Answer the following questions: 1. What is the difference between accounting and bookkeeping? 2. What is accounting journal? 3. What does the idiom jack of all trades mean for you? 4. Why is accounting considered an information system? 5. What is the role of accounting in the decision-making process, and what broad business goals and activities does it help management to achieve and manage? 6. What is the difference between accounting and bookkeeping? 7. Use the terms business transaction, money measure and separate entity» in a single sentence that demonstrates their relevance to financial accounting. 8. Can you define assets, liabilities, and owners’ equity? 97 ACCOUNTING and BOOKKEEPING_______________________________ PART 3 Since accounting requires an understanding of the bookkeeping process, accountants typically supervise the bookkeepers. In a large corporation there may be several, possibly even thousands of accountants. One will be designated as the Controller who oversees the entire accounting and bookkeeping system. In a small business, one person, often a freelancer (a contract accountant or full charge bookkeeper) will perform all the phases of accounting and bookkeeping for a company. Since Accountant is the more prestigious title, most small business jackof-all trades call themselves an Accountant. It merits some note that a few states actually regulate the use of the title Accountant. In these states, the Accountant»title is reserved for CPA’s only. This does not necessarily coincide with the definition of an accountant since most CPA’s don’t perform the role of an Accountant as described above and many people that perform the accountant’s roles are not CPA’s. Nevertheless the laws define it as such [22]. 98 PRACTICE I. Match up these six accounting principles with their definitions: 1. The separate a. Accounts record the initial price paid for entity or accounting assets,and these amounts are not changed when entity or assumption. the assets'economic entity market values change. 2. The continuity or a. All transactions are accounted for in a concern assumption single monetary unit. 3. The unit-ofb. An enterprise is an accounting unit measure assumption separatesits owners, and their personal transactions. 4. Periodicity or the c. An ongoing business reports financial data time period assumption forparticular periods (years, quarters, months). 5. The historical d. Revenue is realized at the moment when cost principle goodssold or when services are provided, not whenpayment is received. 6. The revenue or e. The business will continue indefinitely realization principle into thefuture. II. Which principles do these sentences refer to: 1. This is in accordance with a company's legal status as an artificial person. 2. The company's fixed assets are not for sale, so their value (the company's forced sale or break-up value) is not relevant. 3. This makes it unnecessary to estimate current market values of assets every year. 4. This means that each company has its own financial year (BrE) or fiscal year (AmE). 5. This requires multinational companies to convert their consolidated statements into a single currency. 6. This is why balance sheets often contain an entry for accounts receivable or debtors: goods that have been sold, but not paid for yet. COMMUNICATIVE SITUATIONS 1. Describe each of the following: account, journal, ledger. 2. Distinguish between auditing, income taxation, and non-business organizations. 3. Prove the statement: Accounting is the language of business Debits are bad; credits are good 99 _________________________________________________________BANKING 100 _________________________________________________________BANKING KEY TERMS Commercial bank – a bank which accepts deposits, grantscredits, collects cheques drawn on other banks, bills of exchange and other items and effects transfers on the basis of standing orders, through bank giro and the direct debiting service. Merchant bank – a bank which has developed from the activities of immigrants to Britain in the 18th century. Nowadays they deal in acceptance, deposit banking, management of clients’ funds, management of mergers and takeover bids, transactions in foreign exchange, the issue and placing of shares and debentures, marine and insurance business, etc. Clearing bank – a bank which clears customers’ cheques drawn on other banks through a central clearing house, a bank which is a member of a central clearing organization. Investment bank – a bank which provides long-term fixed capital for industry, in return taking over shares in the borrowing companies, so that some measure of influence or control can be exercised. Credit card – a piece of plastic about 85mm by 54mm, bearing the name and computer number of the holder and the period of availability. The holder must sign it. The best known cards are: the VISA card, the ACCESS card, the MASTER card, etc. Payroll transfer operations – operations with money, paid by a company in salaries (by means of bank transfer). Allocation of credit – dividing a sum of money in various ways; giving money to people who have applied for it. Investment activity – placing of money so that it’ll increase in value and produce an income. Factoring operations – business of buying debts at a discount. Deposit operations –operations with money placed in a bank. 101 BANKING_________________________________________________________ PART1 The key to the distinction between banking and the banking system is that the latter is the principle mechanism through which the money supply of the country is created and controlled. The banking system is still normally understood to include the commercial banks (joint-stock banks), the secondary banks, the central bank, the merchant banks, or accepting houses and the discount houses (which are not banks as such), but to exclude investment banks and other intermediaries (e.g. building societies, finance houses, the savings banks, the National Giro). All commercial banks have a similar structure and mode of working. The owners are the shareholders.At the outset they provide the necessary capital. They are all organized on the joint stock principle and are registered public companies. The Chairman and Board of Directorsare elected by the ordinary shareholders at the Annual General Meeting and are responsible for the efficient management of the bank. The Board is concerned with the over-all policy of the bank and the major decisions, which put that policy into effect. The Board will appoint a Managing Director who is directly responsible to them and a member of the Board. They will also appoint the most senior executives who in turn appoint the rest of the clerical staffwho will be responsible in different capacities for the day to day running of the bank. The essence of a bank’s activities is the collection of deposits through current accountsand deposits accountsand the use of these funds to provide loans or funds for investment. The current account is the one commonly held and is drawn by cheques and standing orders. The deposit account is more in the nature of a saving account. The pattern of investment, which a bank decides upon, is crucial because, on the one hand, the bank must use the funds wisely to make a profit and, on the other, funds must be available for depositors to withdraw when they wish to do so [18]. 102 PRACTICE 1. 2. 3. 4. I. Match each term in Column A with its definition in Column B: Column A Column B Commercial bank a) a bank which has developed from the activities of immigrants to Britain in the 18th century. Clearing bank b) a bank which provides long-term fixed capital for industry, in return taking over shares in the borrowing companies, so that some measure of influence or control can be exercised. Investment bank c) a bank which accepts deposits, grantscredits, collects cheques drawn on other banks, bills of exchange and other items and effects transfers on the basis of standing orders, through bank giro and the direct debiting service. Merchant bank d) A bank which clears customers’ cheques drawn on other banks through a central clearing house, a bank which is a member of a central clearing organization. II. Make sure that you understand what it means: dividend the efficient management to invest activity reserve collection similar structure funds capital in the nature director to recommend III. Answer the following questions: 1. Who owns the commercial banks? 2. How does a bank start? 3. Who chooses the Board? 4. What is the Board’s task? 5. Who hires the employees? 6. What are the bank’s main activities? IV. Finish the sentence: 1. The key to the distinction between banking and the banking system is … 2. The banking system is still normally understood to include … 3. All commercial banks have … 103 BANKING_________________________________________________________ PART2 At the end of each business year the Directors recommend and the Annual General Meeting decides how much of the profit should be distributed to the shareholders as dividend,and how much should be retained in the business. In preparation to the Annual General Meeting, a bank publishes its Report and Account. These must be sent to every shareholder and are also available for anyone with an interestin the affair of the bank. From the published accounts shareholders can easily determine the total profits the bank has earned and how much is avail About banking in Ukraine.It dates to March 1991 the Ukrainian Parliament passed the law On Bank and Banking Activities, determining this system as twolevel, composed of the National Bank and commercial banks. Starting when even Ukraine’s Central Bank was little more than a transit for funds coming from Moscow, a new Ukrainian banking system has managed to materialize in just a few short years. It has been steadily developing and growing since 1989, and by November 1994, 227 banks where registered in Ukraine. These Financial institutions range from credit unions to full-scale banks offering up to 30 different type services. The activity of these banks – most of them commercial – is overseen by the country’s central bank, the National Bank of Ukraine (NBU). Although the NB is under jurisdiction of the country’s legislatureable for the distribution. Ukroshchadbank holds most the saving accounts for Ukraine’s citizens in branches that stretch across the country. It has also opened privatization accounts for Ukrainians to take part in the privatization drive. Plans are already underway by the NB to turn Ukroshchadbank into a joint-stock company, which is expected to improve and widen its daily operations [18]. 104 PRACTICE I. Check the words in the left-hand column which mean the same or nearly the same as the words and phrases in the right-hand column written opposite them: A B 1. create, run, deal, mange a. shape, form, invent, make out of smth. 2. loan, credit, debt b. obligation, liability 3. coin, coupon, money c. medium, of exchange, currency, funds 4. write, paint, draw on d. make use of, exploit (a source, fund), withdraw (money) 5. deposit, account, holding(s) e. property, possessions II. Explain the following: to raise capital to become a public company to put money into business 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. profits not paid out as dividends to run a bank to make a loan III. Answer the following questions: What is Ukraine transferring to? What does July 16,1990 mark? What are the basic goals of the new state? What is meant by the phrase «the two-tier banking system»? What banks were the first to appear? What has given the impetus to the formation of cooperative banks? What did these banks demonstrate? What services do commercial banks offer to their customers? Explain the reason for which the banks have to compete for clients? What in necessary for the implementation of commercial banks’ activity? What makes the state-owned banks revise relationship with their customers? How was a new Ukrainian banking system developing? How many banks were registered in Ukraine? IV. Say whether these statements are true or false and if they are false, say why: 1. In 1991 the Ukrainian Parliament passed the law On Bank and Banking Activities. 2. Banking Activityhas not been steadily developing and growing since 1989. 3. The National Bank of Ukraine is not under jurisdiction of the country. 105 BANKING_________________________________________________________ PART3 Although these former state banks hold 88% of the country’s financial market a new wave of young commercial banks is quickly edging its way into their territory. Most of these are banks formed by small state enterprises with the help of private capital. These banks are serving the new and growing private sector, particularly trade and export-import companies. Even state businesses are slowly starting to turn to these enterprising young banks to take advantage of their competitive services. There are yet other banks in Ukraine that were established by ministries and large state enterprises. These banks serve specific sectors of the economy. Ukraine also boasts 2 banks with foreign investments: Credid Lyonnais Ukraine and First Ukrainian International Bank. Regardless of the NB’s tight fiscal policy – aimed to combat inflation – Ukrainian banks are still working at increasing their resources and capital shares, and technically improving their banking operations. In so doing they hope to promote Ukraine’s economic development, bring its banks to world standards, and enter the world banking system. More than 10 of the country’s largest banks are already connected to the SWIFT international settlement system. As well, a number of banks, in the effort to meet growing customers demands have established correspondence accounts with foreign banks, and started working with credit card and traveller’s cheques. The Interbank electronic payment system was launched. These new commercial banks have already gained experience from working in the Ukrainian and foreign financial markets. The Ukrainian Association of Banks – the largest banking association in the country – views banks, both small and large, as paying a vital supporting role in the country’s transitions to a market economy[18]. 106 PRACTICE I. Express it in other way: to offer services to give guarantees goal, creation state-owned bank get under way feasibility II. Fill in the gaps: data, the transactions, to record, enters, loans, indicates 1. Banks use sophisticated accounting systems ______ as clearly as possible the financial situation of the bank. 2. If we deposit some sum money with a bank, for example, the bank ______ a debit for the receiver and the credit for the giver. 3. The largest asset of a bank is usually its total portfolio of ______ . 4. Profitability ______ how well the bank has managed the recourses under its control. 5. A bank's accounting systems are designed to record and present ______ that take place every day. 6. Published figures provide some important ______ on the liquidity, safety and income of a bank. 1. 2. 3. 4. 5. 6. 7. III. Answer the following questions: How was a new Ukrainian banking system developing? How many banks were registered in Ukraine? Who oversees the activity of these banks? What banks are state-owned? How were most commercial banks formed? Are there banks with foreign investments in Ukraine? What are Ukrainian banks working at? COMMUNICATIVE SITUATIONS 1. What do you understand by the terms: cooperative bank, state-owned bank; feasibility, crediting, business organization, to go through, a training course, limited company, small business, medium-sized business. 2. Speak with your group friends about different problems which the banks face. 3. Give your viewpoint on the role which banks play in increasing the total money supply of the country and the necessity to control the creation of credit by the banking system. 107 __________________________________________________________PRICING 108 __________________________________________________________PRICING KEY TERMS Bargaining – discussion of prices, terms of trade. Bribe – thing given, offered or promised to sb. to influence or persuade him to do sth. Charge – is the amount of money asked, usually for a service. Commission – payment to sb. for selling goods which increases with the quantity of goods sold. Cost – price (to be) paid for a thing. Cost usually relates to services or processes. Dues – charges or fees. Fare – money charged for a journey by bus, ship, taxi, etc. Fee – amount paid for professional advice or service. Fixed – already arranged and decided not changing. Fixed costs – costs that do not vary with production or sales level. Floor –minimum level for wages or prices. Honorarium (pl. honoraria) – voluntary payment made for professional services for which a fee is not normally paid or required by law. Income taxes –tax payable according to the level of one’s income. Market segment – A group of consumers who respond in a similar way to a given set of marketing stimuli. Premium – additional payment. Rent – regular payment made for the use of land, premises, a telephone, machinery, etc.; sum paid in this way. Salary – Payment to employees doing other than manual or mechanical work. To bribe – Give a bribe (of sth) to sb.; try to persuade sb. to sth. Toll – Money paid for the use of a road, bridge, harbor. Wage –payment made or received for work or services. 109 PRICING__________________________________________________________ PART 1 Price is the amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service. Price is all around us. You pay rent for your apartment, tuition for your education, and a fee to your physician or dentist. The airline, railway, taxi, and bus companies charge you a fare; the local utilities call their price a rate; and the local bank charges you interest for the money you borrow. The price for driving your car on Florida’s Sunshine Parkway is a toll, and the company that insures your car charges you a premium. The guest lecturer charges an honorarium to tell you about a government official who took a bribe to help a shady character steal dues collected by a trade association. Clubs or societies to which you belong may make a special assessment to pay unusual expenses. Your regular lawyer may ask for a retainer to cover her services. The price of an executive is a salary, the price of a salesperson may be a commission, and the price of a worker is a wage. Finally, although economists would disagree, many of us feel that income taxes are the price we pay for the privilege of making money. How are prices set? Historically, prices usually were set by buyers and sellers bargaining with each other. Sellers would ask for a higher price than they expected to get, and buyers would offer less than they expected to pay. Through bargaining, they would arrive at an acceptable price. Individual buyers paid different prices for the same products, depending on their needs and bargaining skills. Historically, price has been the major factor affecting buyer choice. This is still true in poorer nations, among poorer groups, and with commodity products. However, nonprice factors have become more important in buyer-choice behavior in recent decades [35]. 110 PRACTICE I. Match each term in Column A with its definition in Column B: Column A Column B 1. Honorarium a) discussion of prices, terms of trade. 2. Rent b) thing given, offered or promised to sb. to influence or persuade him to do sth. 3. Commission c) is the amount of money asked, usually for a service. 4. Salary d) payment to sb. for selling goods which increases with the quantity of goods sold. 5. Wage e) price (to be) paid for a thing. Cost usually relates to services or processes. 6. Bargaining f) amount paid for professional advice or service. 7. Cost g) voluntary payment made for professional services for which a fee is not normally paid or required by law. 8. Fee h) regular payment made for the use of land, premises, a telephone, machinery, etc.; sum paid in this way. 9. Bribe i) payment to employees doing other than manual or mechanical work. 10.Charge j) payment made or received for work or services. II. Answer the following questions: 1. What is price? 2. What does «price is all around us» mean? 3. How is price set? 4. How would a seller and a buyer arrive at an acceptable price? 5. What is the only element in the marketing mix that produces revenue? 6. Why is price one of the most flexible elements of marketing mix? 7. Why can price be changed quickly? 8. What are the most common mistakes that are not revised often enough for different products, market segments and purchase occasions? III. Say whether these statements are true or false and if they are false, say why: 1. Price is not the amount of money charged for a product or service. 2. Price isn’t all around us. 3. Prices usually were set by buyers and sellers bargaining with each other. 4. Historically, price has been the major factor affecting buyer choice. 5.Non-price factors haven’t become more important in buyer-choice behavior in recent decades. 111 PRICING__________________________________________________________ PART 2 Price is the only element in the marketing mix that produces revenue; all other elements represent costs. Price is also one of the most flexible elements of the marketing mix. Unlike product features and channel commitments, price can be changed quickly. At the same time, pricing and price competition is the numberone problem facing many marketing executives. Yet, many companies do not handle pricing well. The most common mistakes are: pricing that is too cost oriented; prices that are not revised often enough to reflect market changes; pricing that does not take the rest of the marketing mix into account; and prices that are not varied enough for different products, market segments, and purchase occasions. Costs set the floor for the price that the company can charge for its product. The company wants to charge a price that both covers all its costs for producing, distributing, and selling the product and delivers a fair rate of return for its effort and risk. A company’s costs may be an important element in its pricing strategy. Many companies work to become the low-cost producers in their industries. Companies with lower costs can set lower prices that result in greater sales and profits. A company’s costs take two forms, fixed and variable. Fixed costs (also known as overhead) are costs that do not vary with production or sales level. For example, a company must pay each month’s bills for rent, heat, interest, and executive salaries, whatever the company’s output.Variable costs vary directly with the level of production. Each personal computer produced by Compaq involves a cost of computer chips, wires, plastic, packaging, and other inputs. These costs tend to be the same for each unit produced. They are called variable because their total varies with the number of units produced.Total costs are the sum of the fixed and variable costs for any given level of production. Management wants to charge a price that will at least cover the total production costs at a given level of production. The company must watch its costs carefully [35]. 112 PRACTICE I. Find in the text the following words and word combinations and translate the sentences in which they are used: Costs; the floor; to charge for; to charge a price; distributing; selling; a fair rate; risk; overhead; pay each month’s bills for rent; heat; interest; executive salaries; whatever; company’s output; computer chips; management; to cover the total production costs; hand-held calculator; per day; to move up; average costs; inefficient; to break down; work arrangements; paperwork; a cheap image. II. Answer the following questions: 1. What sets the floor for the price that the company can charge for its product? 2. What does the company want to charge a price? 3. What may be an important element in a company’s pricing strategy? 4. What two forms do a company’s costs take? 5. What are fixed costs? 6. What are variable costs? 7. What are total costs? 8. Why is it difficult to determine the right price? 9. Why is the seller interested in the price that produces the highest volume of sales at the lowest unit cost? III. Match the price term with the person or organization that charges it: Price term 1) salary 2) rate 3) premium 4) fare 5) commission 6) fee 7) rent 8) dues 9) retainer 10) tuition 11) wage 12) toll 13) honorarium 14) interest Person/organization charging a) visiting lecturer b) insurance company c) white-collar worker d) local council e) social club f) blue-collar worker g) taxi driver h) sales agent i) private school j) lawyer k) bridge owner l) bank m) architect n) property owner 113 PRICING__________________________________________________________ PART 3 To price wisely, management needs to know how its costs vary with different levels of production. For example, suppose Texas Instruments (TI) has built a plant to produce 1,000 hand-held calculators per day. The cost per calculator is high if TI’s factory produces only a few per day. But as production moves up to 1,000 calculators per day, average cost falls. This is because fixed costs are spread over more units, with each one bearing a smaller fixed cost. TI can try to produce more than 1,000 calculators per day, but average costs will increase because the plant becomes inefficient. Workers have to wait for machines, the machines break down more often, and workers get in each other’s way. Costs as a function of production experience. Suppose TI runs a plant that produces 3,000 calculators per day. As TI gains experience in producing handheld calculators, it learns how to do it better. Workers learn shortcuts and become more familiar with their equipment. With practice, the work becomes better organized, and TI finds better equipment and production processes. With higher volume, TI becomes more efficient and gains economies of scale. As a result, average cost tends to fall with accumulated production experience. Not only will the company’s unit production cost fall, but it will fall faster if the company makes and sells more during a given time period. But the market has to stand ready to buy the higher output. And to take advantage of the experience curve, TI must get a large market share early in the product’s life cycle. This suggests the following pricing strategy. TI should price its calculators low; its sales will then increase, and its costs will decrease through gaining more experience, and then it can lower its prices further[35]. 114 PRACTICE I. Answer the following questions: 1. Why do many business follow unsound pricing policies? 2. In what way are agricultural prices decided? 3. How are industrial products usually priced? 4. Why does the government usually set the prices for public utility services? 5. Why is it so important to know the levels of supply and demand when dealing with the pricing? 6. Why is everything related by price? II. Translate into your native language: 1. Inflation affects the cost of everything you buy. 2. The government has got to do something about the high cost of living. 3. Equipment is sometimes available at a low cost for elderly people. 4. We will deliver and install the equipment at no extra cost. 5. This is a good product at a reasonable price. 6. You can get cars in Europe at very low prices. 7. They charge the same prices for a takeaway as they do for eating in the restaurant. 8. There is a set charge of 15 % for service. 9. Before buying, always check that there are no additional charges. 10. Although it costs considerably more to do it this way, it does work out cheaper in the long run. COMMUNICATIVE SITUATIONS 1. What do you understand by the following: Розрахунок цін – справа нелегка, оскільки різні товари залежать одне від одного за попитом і витратами. 2. Speak with your group friends about What is price? 3. Give your viewpoint on the following: - Price is the only element in the marketing mix that produces revenue; all other elements represent costs. - Price is also one of the most flexible elements of the marketing mix. - Each needs the other: capital cannot do without labor, not labor withoutcapital. (Pope Leo XIII) - The wealth of nations is men, not silk ad cotton and gold. (Richard Hovey) - The instinct of ownership is fundamental in man's nature. (William James) 115 _______________________________________________________INFLATION 116 _______________________________________________________INFLATION KEY TERMS Inflation– when the economy begins to expand too quickly, demand from consumer and business spending may outstrip supply, driving prices upward; this is inflation. Inflation Differential Risk– is the second added dimension of international diversification. Suppose an investor in the US has a security in England whose return is fixed in terms of the pound. Assuming that there is no inflation in the US but that the inflation rate in England is uncertain. Inflation-Escalator Clause– a clause in a contract providing for increases or decreases in inflation based on fluctuations in the cost of living, production costs, and so forth. Default– the failure to make obligated interest and principal payments on a loan. Default Correlation – is a measurement of the degree to which default of one asset makes more or less likely the default of another asset. One can think of default correlation as being jointly due to (1) a macroeconomic effect which tends to tie all industries into the common economic cycle, (2) a sector-specific effect, and (3) a company-specific effect. Default Premium – a differential in promised yield that compensates the investor for the risk inherent in purchasing a corporate bond that entails some risk of default. Default Probability (DP) – the likelihood that an obligor or counterparty will encounter credit distress within a given time period. Credit distress usually leads to either an omitted delayed payment or distressed exchange which would impair the value to senior unsecured debt holders. Default Risk – the chance that interest or principal will not be paid on the due date and in the promised amount under the loan contract. 117 INFLATION_______________________________________________________ PART 1 Most people associate inflation with price increases on specific goods and services. The economy is not necessarily experiencing an inflation, however, every time the price of a cup of coffee goes up. We must be careful to distinguish the phenomenon of inflation from price increases for specific goods. Inflation is an increase in the average level of prices, not a change in any specific price. We first determine the average price of all output – the average price level – then look for changes in that average. A rise in the average price is referred to as inflation.The average price level may fall as well as rise. A decline in average prices – a deflation – occurs when price decreases on some goods and services outweigh price increases on all others. Relative price is the price of one good in comparison with the price of other goods. Because inflation and deflation are measured in terms of average price levels, it is possible for individual prices to rise or fall continuously without changing the average price level. Nominal income is the amount of money you receive in a particular time period; it is measured in current dollars. Real income, by contrast, is the purchasing power of that money, as measured by the quantity of goods and services your dollars will buy. If the number of dollars you receive every year is always the same, your nominal income doesn’t change – but your real income will rise or fall with price changes. There are two basic lessons about inflation to be learned: - Not all prices rise at the same rate during an inflation. Typically, someprices rise very rapidly, others only modestly, and still others not at all. - Not everyone suffers equally from inflation. Those people who consume the goods and services that are rising faster in price bear a greater burden of inflation; their real income fall more. Other consumers bear a lesser burden or even none at all, depending on how fast the prices rise for the goods they enjoy [16]. 118 PRACTICE I. Match the words from B column with their definitions from A column: A B 1. inflation a. the amount of money that you must pay for sth 2. deflation b. the quality or state of being steady and not changing in any way 3. price c. used to describe a rate or other figure that refers to current prices or numbers, but has not been changed to consider the effects of inflation 4. income d. a rise in the general prices of goods and services in a particular country over a period of time, resulting in a fall in the value of money; the rate at which this happens 5. nominal e. a person who buys goods or services for their own use 6. increase f. a reduction in the amount of money in a country’s economy so that prices fall or remain the same 7. relatively g. a rise in the amount, number or value of sth 8. consumer h. a system that shows the level of prices, wages, etc. so that they can be compared with those of a previous day or time 9. index i. the money that a person, a region, a country, etc. earns from work, from investing money, from business, etc 10. stability j. to a fairly large degree, especially in comparison to sth else II. Answer the following questions: 1. What is inflation? 2. What is deflation? 3. What is the difference between inflation and deflation? 4. What do we call the price of one good in comparison with the price of othergoods? 5. What are the two basic lessons about inflation? 6. What phenomenon do economists call money inflation? 7. How do people respond to inflation? 8. What is inflation rate in Ukraine now? 119 INFLATION_______________________________________________________ PART 2 Money illusion is the use of nominal dollars rather than real dollars to gauge changes in one’s income or wealth. The most common measure of inflation is the Consumer Price Index. As its name suggests, the CPI is a mechanism for measuring changes in the average price of consumer goods and services. Inflation Rate is the annual rate of increase in the average price level. Price stability is the absence of significant changes in the average price level; officially defined a s a rate of inflation of less than 3 percent. Our goal of “full” employment is defined as the lowest rate of unemployment consistent with stable prices. CAUSES OF INFLATION: • Demand pull influences. These are factors which cause an increase in aggregate demand to levels beyond the ability of the economy to deliver the appropriate level of output. Such factors include increases in public spending, or sudden increases in credit creation and money supply by the banking system. In such conditions buyers want to buy more goods and services than are available at the time. The demand for goods and services is related to the amount of money in the economy. If the supply of money increases faster than production increases, theresult is inflation. • Cost push influences. These are factors on the supply side of the economy which lead to increases in the costs of production which are then passed on in higher prices. Such pressure may be caused by the strong bargaining power of large labour unions (especially at times of full employment) or by increases in the cost of basic raw materials which force up industrial costs of production. Businesspeople raise prices when the costs of various factors of production go up [16]. 120 PRACTICE I. Match the words with the definitions: 1. output a) A continuing increase in prices, or the rate at which prices increase 2. inflation b) The amount that a unit of money can buy c) To large or difficult to deal with 3. insurmountable d) A very fast rise in prices that seriously 4. hyperinflation damages a country’s economy e) The difference between the cost of 5. purchasing power producing something and the price at which you sell it f) The amount of goods or work produced by a 6. profit margin person, machine, factory etc II. Make the following sentences negative: 1. In the early 1970s the price of oil increased fourfold. 2. Inflation may have alarming political consequences. 3. Some consumer goods are likely to experience sharp falls in demand. 4. Hyperinflation leads to the collapse of normal trading. 5. Interest rates usually rise during periods of inflation. 6. The firm will need to raise prices to maintain its profit margins. 7. Lower government spending would reduce aggregate demand. III. Answer the following questions: 1. What is the most common measure of inflation? 2. How can we calculate the inflation rate? 3. What is demand-pull inflation? 4. What is cost-push inflation? 5. What are the major causes of inflation? 6. Why is inflation damaging for the economy? 7. Who suffers most in case of inflation? 8. How does government respond to inflation? 9. Are there doubts about the firm’s financial stability? 10. Were low interest rates responsible for the consumer boom? 11. Are shoppers unwilling to pay full price for electrical goods? 12. Why are companies still laying off employees as deflation continues to reduce their revenue? 121 INFLATION_______________________________________________________ PART 3 Many economists see inflation as being the most damaging economic phenomenon which can affect an advanced nation. It may also have alarming political consequences. Some economists however take the view that some inflation is an acceptable price for economic growth. There is no clear agreement as to when inflation becomes unacceptable, but rates in excess of perhaps 5% are generally thought to be threatening, whilst rates in excess of perhaps 15% (hyperinflation)may cause social and political breakdown. There are a number of reasons for arguing that inflation is damaging: • When price raises surge ahead of rates of increase of money income, the real income of consumers will decrease. Consumers will then have to adjust their purchases and the demand for some products may decrease. High price consumer durables, for example cars, are likely to experience sharp falls in demand. • Hyperinflation may destroy confidence in money, leading to a return to barter and the collapse of normal trading. • People who rely on incomes derived from past savings or who are in occupations where pay rates are slow to respond to changes in inflation, will be severely hit by inflation. In extreme cases the value of savings may be destroyed. • Businesses are also affected adversely. The costs of inputs will rise, and the firm will need to raise prices if possible to maintain its profit margins. If it cannot do so, it may find itself in financial difficulties. • Interest rates usually rise during periods of inflation. For instance the government may raise interest rates to discourage borrowing and spending, and thereby curb demand pull inflation. • The attempts by workers and their unions to force up wages in response to inflation may cause widespread lay-offs where these cost increases cannot be passed on to consumers in higher prices. • Firms which rely on export markets will find that their relative prices may rise, causing them to be priced out of world markets [30]. 122 PRACTICE I. Fill in the blanks below with the most appropriate terms: 1. ______ is the use of nominal dollars rather than real dollars to gauge changes in one’s income or wealth. 2.The most common measure of inflation is ______ . 3. Many economists see inflation as ______ which can affect an advanced nation. 4. Some economists however take the view that some inflation is ______ for economic growth. 5. There is no clear agreement as to when inflation becomes ______, but rates in excess of perhaps 5% are generally thought to be threatening, whilst rates in excess of perhaps 15% (hyperinflation) may cause social and political ______. II. Have a discussion on the topic Inflation. Use the following questions as a plan: 1. How is the Retail Price Index (RPI) calculated? 2. What are causes of inflation? 3. How can inflation damage the economy? 4. May inflation have alarming political consequence? 5. What is an extreme form of inflation? 6. Who is severely hit by inflation? 7. Why do interest rates usually rise during periods of inflation? 8. What may happen if workers and their unions try to force up wages in response to inflation? 9. What are government responses to inflation? 10. What response to inflation is more effective? III. Fill in the table Ukrainian steps according to Inflation: Period Level of Inflation COMMUNICATIVE SITUATIONS 1. Can inflation be beneficial? Give your reasons. 2. Can you identify any groups of who are particularly helped or hurt by inflation? Explain. 3. Does an increase in the price level automatically lower society’s real income? Explain. 4. Would it be advantageous to borrow money if you expected prices to rise? Why, or why not? Provide a numerical example. 123 TEXTS FOR ADDITIONAL READING The Federal Reserve: Central Bank of the United States The Federal Reserve System is the nation’s central bank. It providesessential services to the banking community, and it functions as a bank for thefederal government. The Federal Reserve also makes and implementsmonetary policy for the United States and is an important supervisor andregulator of banking organizations. The structure of the Federal Reserve System can be compared to apyramid. At the pyramid’s base are the nation’s depository institutions.Federal law requires these institutions to report certain deposits to the FederalReserve and to maintain reserves on some of these deposits. Reserve accountsare noninterest-bearing deposits and are maintained either directly orindirectly with the Federal Reserve System. At one time, the reserverequirement applied only to deposits at certain commercial banks, but theMonetary Control Act of 1980 extended the requirement to deposit at allbanks and thrift institutions. In the middle of the pyramid are the 12 Federal Reserve Banks. EachReserve Bank serves one of the nation’s Federal Reserve Districts.At the top of the pyramid is the Board of Governors of the FederalReserve System, commonly referred to as the Federal Reserve Board. TheBoard consists of seven persons, appointed by the President of the UnitedStates and confirmed by the Senate for fourteen-year terms. The terms arestaggered, so that one term expires every two years. The long terms andstaggered appointments are designed to contribute to the independence andstability of the Board. Questions to the text: 1. How is the structure of the Federal Reserve System organized? 2. Who appoints and confirms the Board of Governors? 3. It the structure of the US Federal Reserve System similar to the structureof the National Bank of Ukraine? 124 Bank Loans Recently banks have started to offer many new facilities to theircustomers. There are new types of accounts, cheque cards, cash cards, creditcards, insurance cover, and investment services. However, one of the most important services banks offer is that they lendmoney to their customers. The methods available for a customer to borrowfrom his bank and the rate of interest he is charged vary from country tocountry and bank to bank. One way of borrowing is to overdraw on your account. This is useful ifyou only wish to borrow a small amount for a short time. The interest rate onoverdrafts depends upon the bank rate. In the U. K. at the moment it is 12 %over base rate i. e. 23 %. Of course you can only have an overdraft with yourmanager’s permission. Another way is to arrange a personal loan. A personal loan is for a fixedperiod of time usually 3–5 years. Many people take out a personal loan, forexample, to buy a car. Each month the customer makes a payment on the loanto the bank. The main advantage of a personal loan is that the interest rate isfixed. In the U. K. at the moment it is 19 %. Of course, for both a personal loan and a long term loan the bank requiressome kind of security e. g., shares. Questions to the text: 1. What facilities have banks started to offer their customers? 2. When is it useful to overdraw on your account? 3. Is it possible to get a personal loan in Ukraine? Yes/No? Why? Selecting a Bank The most important thing in the choice of a bank is its integrity. The size and the type of the bank must be taken into consideration too. 125 If you are going into business, there is an advantage for a small business to place an account in a small bank. The staff of such a bank know each customer and can estimate your business better. However, there are the advantages of a larger bank. It is true, that dealings with a large bank are more impersonal. But, it is also true, that a large bank can offer more facilities. Large banks can make a loan at more favorable interest rate. They also can make as large a loan as it is desired. In any case, selecting a bank people learn, as much information about the reputation of a bank as possible. As a summary, therefore, the following six guides are suggested. 1. Choose a bank whose officers possess character, leadership, and the willingness to assume a risk provided, there is a reasonable chance of repayment. 2. Choose a progressive bank – one whose officers are alert to current industrial trends and are willing to make loans for new products and more efficient processes. 3. Choose a bank that stresses an attitude of friendliness to a small business. 4. Choose a bank that has confidence in the future of your community and thus is willing to invest in it. 5. Choose a bank that quotes reasonable interest rates. 6. Choose a bank that gives good service. Requirements for Obtaining a Loan When making a loan for some business most banks want additional information. The complete list of such information is given below. It includes the business ability of a borrower, his past experience, his chances of success in the future, the need and purpose of the loan, etc.There are 10 items: Proper identification. Nature of business. How the business is organized, its ownership, and any special agreements. 126 Personal data on all principal owners as to age, connection with the business, connection with other businesses, life insurance, banking connections, and civic activities. Other financial relations of the business, such as other bank connections and indebtedness. The amount, the purpose, the need, and the plan for repaying the loan that is requested. A detailed balance sheet showing the assets, liabilities, and ownership of the business. A detailed income and expense statement showing the income and expenditures of the business. Detailed information in regard to liabilities and claims, such as unpaid taxes and other business debts that are due or will become due. Proof as to the future prospects and business plans. Questions to the text: 1. What is the most important thing in the choice of a bank? 2. What bank would one prefer doing small business? 3. Are there any advantages of a large bank? 4. How can one know the reputation of a bank? 5. What are the six' main guides in choosing a proper bank? 6. What guide do you think is the most important? Give your reasons. 7. Why do most banks want additional information from a borrower who obtains a loan for the first time? 8. What do these requirements include? Сentral Bank Most countries have a central bank: for example the Bank of England in the United Kingdom; the Federal Reserve System in the United States of America; the Deutsche Bundesbank in Germany; the Banque de France; the Bank of Japan; the National Bank of Ukraine, etc. Each differs a little from the others in the range of 127 its activities, in the power and techniques it can use, and in the nature of its relationship with government; but they all serve as bank both of their country’s government and to its banking system. It is through the interactions of these two roles that central banks come to play their key part in carrying out monetary policy in their respective countries – that is policies affecting the cost and availability of money and credit. This makes central banks individually important in their domestic economies, and collectively extremely influential in world financial markets, In addition, many central banks are involved in supervising financial markets, banks and other institutions. Let us consider the activities of the Bank of England as an illustration of the above. Founded in 1694, the Bank of England is one of the oldest central banks. However, its original purposes and functions were very different from its present ones. There are several of them now but all are related to the pursuit of three main objectives. These are: first, maintain the value of the nation’s money, mainly through policies and market operations agreed with the government; second, ensuring the stability of the financial system, through direct supervision of banks and participants in some City financial markets and by promoting sound and efficient payment and settlement arrangements; the third, promoting the efficiency and competitiveness of the financial system, so that the City of London can serve industry and commerce at home and maintain its place as the world’s leading international financial centre. Like any bank, the Bank of England offers a range of services to its customers. Those customers are, however, rather different from those of other banks. Most of its 10,000 private account-holders are staff and pensioners of the Bank itself. There are three other important groups of customers. The commercial banks. All the commercial (clearing) banks keep accounts at the Bank of England. When the banks settle daily differences between themselves in the clearing – that is, in the exchange of cheques written by each others’ customers or of credits moving from one bank to another – they do it using their accounts at the Bank of England. 128 Other central banks keep accounts and gold at the Bank of England and may conduct foreign exchange and bullion business in London through the Bank. The government keeps its main banking accounts at the Bank of England, so that payments of taxes to the government and payments by die government for social security, defense and so on are ultimately made to and from accounts at the Bank. The government accounts are managed in such a way that day surplus funds are invested in the money markets or used to reduce the government’s short-term debts. As banker to the government, the Bank also manages the UK’s reserves of gold and foreign exchange, arranges government borrowing andassists in managing the national debt. Questions to the text: 1. What are the names of central banks in different countries of the world? 2. Is the range of activities of these banks absolutely similar? 3. What do all the central banks in different countries have in common? 4. What role do central banks play in carrying out monetary policy in their respective countries? 5. Why are central banks collectively extremely influential in world financial markets? 6. When was the Bank of England founded? 7. What are the Bank’s main objectives? 8. What are the Bank’s customers? Assets and Liabilities The term «asset» means anything of value that is owned by a company and can be expressed in terms of money. Economic resources that provide a potential future service to the organization are called assets in accounting. A company’s total assets include such items as cash, buildings, equipment, any other property and accounts receivable, that is, money owned by its customers. Assets are usually classified as current and long-term, both types consisting of tangible as well as of intangible items. Current tangible assets including cash, 129 accounts receivable, stock-in-trade are usually converted into cash within one year and sometimes can be used as a means of payment. On the other hand, current intangible assets consist of short-term investments in stocks and bonds. Long-term intangible assets are not really visible and include such items as goodwill, patents, trademarks, copyrights, these assets often being the most important factor for obtaining future incomes. For example, goodwill means an intangible asset which takes into account the value added to a business as a result of its reputation which cannot be really calculated. In contrast, the real estate (such as farm land, machinery, buildings and other physical objects) belongs to longterm tangible assets. Liabilities are obligations that a company owes to another organization, to an individual (such as creditors and employees) or to the government. Like assets, liabilities are divided into current and long-term ones. Current liabilities are usually amounts that are paid within one year, including accounts payable, taxes on income and property, short-term loans, salaries and wages, and amounts of money owed to suppliers of goods and services. Noncurrent liabilities often called long-term are usually debts, such as bonds and long-term loans. The amount by which the total assets exceed total liabilities is known as the net worth which is usually called the equity for companies. When the company is a corporation, the equity means the investment interest of the owners (that is, the stockholders) in the organization’s assets. The owners’ equity can be increased either by investing more money in the company or by earning a profit and can be decreased because of the company’s losses. All companies keep proper accounting system in order to know whether or not they are operating profitably, each of the assets and the liabilities and the equity being shown in a company’s accounts separately. The balance sheet prepared by the company’s accountant is one of the important financial reports showing the value of the total assets, total liabilities and equity on a given date. The relationship of these main categories is represented by 130 the fundamental accounting equation: assets (everything that is owned) are equal to liabilities (wed) plus equity (clear of debt). ASSETS = LIABILITIES + EQUITY As all three factors are expressed in terms of money, they are limited to items that can be given a monetary value. The accounting equation should always be in balance, so that one side must equal the other. Questions to the text: 1. What does the term «asset» mean? 2. How can the company’s assets be classified? 3. How can «goodwill» increase the company’s profits? 4. What liabilities does the company usually have? How are they classified? 5. How is the net worth calculated? 6. What accounts should be kept by the company? 7. What is the main accounting equation? 8. Why is it important to keep the proper accounting system? The Development of Money Systems Until about 10.000 years ago, all human beings were huntergatherers,providing for their wants and needs with foods that were freely provided in nature. The Neolithic agricultural revolution changed all that. People gradually abandonedtheir nomadic life of hunting and food gathering and settled down to tend crops anddomesticated animals. Along with permanent settlement the agricultural revolutionbrought surplus production.Farmers could produce substantially more than they needed for survival. Theagricultural surplus allowed the creation of new occupations. Freed from having togrow their own food, people formed new classes-artisans, soldiers, priests,government officials – as they turned their talents to performing specializedservices and producing goods other than food. They also produced more than theythemselves needed and traded the excess to obtain other goods and services.The exchange of goods and services in early societies commonly took place bysimple mutual agreement among neighbors. In 131 the course of time, however, tradingbecame centered in particular gathering places called markets. The earliest market economies depend to some considerable extent on barter,the trading of goods directly for other goods.Barter was common in the earliest societies that flourished before the inventionof money and in medieval villages and survived in isolated cases into more recenttimes. However, barter can be costly process in terms of the time spent searchingout satisfactory exchanges. Barter, was a very unsatisfactory system becausepeople’s precise needs seldom coincided. People needed a more practical system ofexchange, and various money systems developed based on goods which themembers of a society recognized as having value. Cattle, grain, teeth, shells,feathers, skulls, salt, elephant tusks, and tobacco have all been used.Precious metals gradually took over because, when made into coins, they wereportable, durable, recognizable, and divisible into larger and smaller units of value.The evolution of money has made trading easier. Money eliminates theinconvenience of barter by allowing the two sides of the barter transaction to beseparated.Farmers who have wheat and want hammers do not have to search forindividuals who have hammers and want wheat. They take money in exchange,then find people who wish to trade hammers, and offer money for the hammers. Questions to the text: 1. What changes occurred in the lives of human beings as a result of the Neolithicagricultural revolution? 2. What were the preconditions for creation of new occupation? 3. What forced people to start trading? 4. How did the process of trading change in the course of time? 5. What new systems of exchange were developed? 6. Is it possible to say that evolution of money made people’s life easier and forcedeconomy to function? Different Kinds of Money What makes money valuable? Why is a piece paper marked $10 worthmore that one marked $1? You could say there is no reason. It’s true that aspecial kind of 132 paper is used to make dollar bills, and they are pretty, butthat’s not what makes them valuable. The real reason money is valuable isthat everyone believes it is. Ancient economies had no paper money or coins. Some used barter – trading one thing for another. Others used all kinds of objects as money. Anyobject would do, as long as there was not an unlimited amount of it. Animalsor metals were popular, and so were manufactured products like jewellery orweapons. Wealth in ancient Greece was measured in tools or cattle. This kindof money had two purposes. First, it was useful in itself. Tools and cattle canbe used for farming. And second, it was a way to symbolize and measurevalue. A house, for example, would be valued at a certain number of tools orcattle. This greatly simplified trade. Other societies used money that wastotally symbolic. For instance, American Indians used wampum, which ismade from seashells. And until recently on the Pacific island of Yap, peopleused large stone discs as money. In most places these types of money died out because more practicalforms of money were invented. People started using precious metals, such asgold and silver that were easier to carry around than tools or stones. And inthe eighteenth century, paper money was introduced. At first people weresuspicious of the new currency, but they came to accept it because thegovernment or bank issuing it would exchange an equal amount of gold forthe paper. A $10 bill really was worth $10 of gold. But now, people are usedto the idea that the government doesn’t have to back its money with gold.Everyone believes that a $10 bill is worth $10 and that is good enough. But if,for some reason, people ever lost faith in paper money, ten dollars wouldn’tbe worth the paper it’s printed on. Questions to the text: 1. What were the first kinds of money? 2. Why are gold and silver useful as a kind of money? 3. Why were people suspicious of paper money? Direct Contact Public Relations Modern organizations are also concerned about the effects of their actionson people outside their target markets. These people may have little contactwith the organization but feel it affects their welfare in some way. Unless theorganization 133 understands their concerns and communicates its goals andinterests, they may misinterpret, distort, or be openly hostile to theorganization’s actions. Communication to correct erroneous impressions,maintain the goodwill of the organization’s many publics, and explain theorganization’s goals and purposes is called public relations (PR).Unlike the other promotion mix elements, a public relation is concernedprimarily with people outside the target market, although it may include them.Government agencies, communities in which plants are located, consumerists,environmentalists, stockholders, and college professors are some of thegroups reached by an organization’s public relations efforts.The discussion that follows focuses on one of the approaches toconducting PR: Direct Contact Public Relations Direct Contact with a public includes letters, plant tours, visits by publicrelations personnel, and company-sponsored events. Employers who recruiton college campuses may write personal letters to professors explaining theirmanagement philosophy and required qualifications for student interviewees.Plant tours often are scheduled by breweries and soft drink bottlers. Visits byPR personnel include speakers at civic and service club meetings to explaintheir firms’ goals and policies that may be of interest to the local community.Company-sponsored events include craft fairs, youth athletic programs, andevents such as Manufacturers Hanover Corporation’s corporate challengerunning races. Hospitals often sponsor blood pressure screening clinics atshopping malls as part of their PR effort. Questions to the text: 1. Why do companies use public relations? 2. What kinds of activity does direct contact with a public include? 3. What types of direct contact PR are likely to lead to publicity? Why? What Is Business Business is a word that is commonly used in many different languages.But exactly what does it mean? The concepts activities of business haveincreased in modem times. Traditionally, business simply meant exchangeor trade for things people wanted or needed. Today it has a more technicaldefinition. One definition 134 of business is the production, distribution, andsale of goods and services for a profit. To examine this definition, we will look at its various parts. First, production is the creation of services or the changing of materialsinto products. One example is the conversion of iron ore into metal carparts. Next, these products need to be moved from the factory to themarketplace. This is known as distribution. A car might be moved from afactory in Detroit to a car dealership in Miami. Third is the sale of goods and services. Sale is the exchange of aproduct or service for money. A car is sold to someone in exchange formoney. Goods are products that people either need or want; for example,cars can be classified as goods. Services, on the other hand, are activitiesthat a person or group performs for another person or organization. Forinstance, an auto mechanic performs a service when he repairs a car. Adoctor also performs a service by taking care of people when they are sick. Business; then, is a combination of all these activities: production,distribution, and sale. However, there is one other important factor. Thisfactor is the creation of profit or economic surplus. A major goal in thefunctioning of an American business company is making a profit. Profit isthe money that remains after all the expenses are paid. Creating aneconomic surplus or profit is, therefore, a primary goal of business activity. Questions to the text: 1. What is one modern definition of business? 2. What does production involve? How do goods differ from services? 3. In addition to production and sale, what other factor is important in defining business? Company Structure Most companies are made up of people: the shareholders (who provide thecapital), the management and the workforce. At the top of the companyhierarchy is the Board of Directors, headed by the Chairperson orPresident. The Board is responsible for policy decisions and strategy. Itusually appoints a Managing Director or Chief Executive Officer, who has overall 135 responsibility for the running of the business. Senior managers orcompany managers head the various departments of functions within thecompany, which may include the following. Marketing department decides where it will be most successful to sell theproducts and what type of consumers they want to reach.Public Relations department answers enquiries made by customers; informsthe press of new products and changes within the company. Information Technology department ensures that all systems workproperly; designs and develops new applications to make it easier foremployees to exchange the information. Personnel department reviews salaries; hires and reduces employees. Finance department produces reports; works with acoounts. Production department discusses the quality of products, the ways ofimproving manufacturing techniques. Research and Development designers new products, looks for new ideas,experiments new products. Questions to the text: 1. What are the three groups of people a typical company consists for? 2. What are the responsibilities of a CEO? 3. Who provides the capital? 4. What is IT department responsible for? 5. What do people in finance department do? 136 GLOSSARY accounts payable See payables. accounts receivable See receivables. accredited investor A person or legal entity, such as a company or trust fund,that meets certain net worth and income qualifications and is considered tobe sufficiently sophisticated to make investment decisions in complex situations.Regulation D of the Securities Act of 1933 exempts accredited investorsfrom protection under the Securities Act. Typical qualifications for a person are$1 million net worth and the two most recent years of annual income equal toor exceeding $200,000 individually or $300,000 with a spouse, and the expectationof the same level of income for the current year; $5 million in assets foran entity. alternative asset class A class of investments that includes private equity, real estate,and oil and gas, but excludes publicly traded securities. Pension plans, collegeendowments, and other relatively large institutional investors typically allocate acertain percentage of their investments to alternative assets with an objective todiversify their portfolios. antidilution A contract clause that protects an investor from issuances of securitie at a price below that paid by the investor; upon a sale at a lower price, the clauseapplies a formula to the investor’s investment that increases the number of sharesissuable to the investor. There are two basic antidilution provisions – weightedaverage and ratchet. arbitrage An investment opportunity that requires zero investment, has no risk,and still yields a positive return is called an arbitrage opportunity.This can beaccomplished by taking advantage of a price imbalance of two or more markets. asset-based lending (ABL) The traditional definition of asset-based financing refersto a loan extended to a borrower in the form of a revolving credit facility or termloan. An asset-based loan in the form of a revolving credit facility focuses onthe level of current assets of a company. A loan amount is negotiated up front,and the amount of the loan that a lender funds will be a 137 function of the levelsof assets generated or held by the borrower. Typical revolving credit facilitiesapply a negotiated percentage to the level of accounts receivable and the levelof inventory in order to determine the variable levels of borrowing capacityavailable to a borrower during the life of a loan. bankruptcy Bankruptcy law provides for the development of a plan that allows adebtor who is unable to pay his or her creditors to resolve the debts through thedivision of his or her assets among creditors. This supervised division also allowsthe interests of all creditors to be treated with some measure of equality. Certainbankruptcy proceedings allow a debtor to stay in business and use revenuegenerated to resolve his or her debts. An additional purpose of bankruptcylaw is to allow certain debtors to free themselves (to be discharged) of thefinancial obligations they have accumulated, after their assets are distributed,even if their debts have not been paid in full. barter To trade goods or services without the exchange of money. best efforts offering A commitment by a syndicate of investment banks to use bestefforts to ensure the sale to investors of a company’s offering of securities. Ina best efforts offering, the syndicate avoids any firm commitment for a specificnumber of shares or bonds. blue-sky law State regulations governing the sale of securities. These regulationsprovide investors with full and complete disclosures regarding contemplatedinvestment opportunities. blue-sky stock Stocks that have values based on promises of performance in thefuture with little or no real prospect of success. blowout round A financing event in which new investors with substantial capitalare able to demand and receive contractual terms that effectively cause theissuance of sufficient new shares by the start-up company to significantly reduce(dilute) the ownership percentage of previous investors. board of advisers A group of individuals, typically composed of technical and industryexperts, who provide guidance and feedback to the company’s managersand board of directors. The board of advisers does not have a 138 fiduciary responsibilityand is usually established by the senior management and the board ofdirectors. board of directors A group of individuals, typically composed of managers, investors,and experts, which has a fiduciary responsibility for the well-being andproper guidance of a corporation. The board is elected by the shareholders. boat anchor In business, a person, project, or activity that hinders the growth of acompany. bond covenants Covenants are restrictions built into contractual agreements.Covenants may be affirmative or negative in nature, reflecting actions requiredof or restrictions placed on a company. book-to-market ratio The ratio of the book value of equity to the market value ofequity. bootstrapping The actions of a start-up to minimize expenses and build cash flow,thereby reducing or eliminating the need for outside investors. breakeven The level of revenue in a business in which sales minus variable costsminus fixed costs equals zero. breakup fee Amount paid by a selling company to a potential buyer when the sellerterminates an agreement in favor of a higher bid for the selling company. bridge financing Temporary funding that will eventually be replaced by permanentcapital from equity investors or debt lenders. In venture capital, a bridge isusually a short-term note (6 to 12 months) that converts to preferred stock;in addition to receiving interest, a bridge lender receives warrant coverage tocompensate the investor for taking an early risk in the company. broad-based weighted-average ratchet A type of antidilution mechanism. Aweighted-average ratchet adjusts downward the price per share of the preferredstock of investor A due to the issuance of options, warrants, convertible securities,or shares to new investor B at a price lower than the price investor Aoriginally paid. Investor A’s preferred stock is reprised to a weighted averageof investor A’s price and investor B’s price. A broad-based 139 weighted-averageantidilution formula uses all common stock outstanding on a fully diluted basis(including all convertible securities, warrants, and options) in the denominatorof the formula for determining the new weighted average price. burn rate The rate at which a company with little or no revenue uses cash savingsto cover expenses, usually expressed on a monthly or weekly basis. The term istypically used in reference to start-ups. business plan A document that describes the concept for a business opportunity.A business plan summary,market typically need, includes solution, the following sections: technology, competition, executive marketing, management, operations,and financials. business structures Legal alternatives of business ownership. _corporation An ownership structure that allows a number of individuals orcompanies to own shares of the capital investment in a business. A corporationis a stand-alone legal entity, so it offers risk protection to its owners, managers,and investors from liability resulting from its actions, including bankruptcy. Theinvested moneys are at risk. _partnership Relationship between two or more persons who join to carry ona trade or business, with each person contributing money, property, labor, orskill and each expecting to share in the profits and losses of the business asreported in Form K-1 for each partnership fiscal year. Earnings are taxed onlyonce. _general partner (GP) A class of partner in a partnership. Each general partnerretains liability for the actions of the partnership and is personally liable forpartnership debts. In the private equity world, the GP is the fund managerwhile the limited partners (LPs) are the institutional and high net worthinvestors in the partnership. The GP earns a management fee and, after limitedpartners receive a return of their capital, a percentage of profits (see carriedinterest), typically based on an 80/20 split, where 80 percent is distributed tothe limited partners. 140 _ limited partner (LP) An investor in a limited partnership. The general partneris liable for the actions of the partnership while the limited partners aregenerally protected from legal actions and any losses beyond their originalinvestment. _ limited partnership A legal entity formed under a state limited partnershiplaw and composed of at least one general partner and one or more limitedpartners. The general partner manages the business or trade and is liablefor the actions of the partnership while the limited partners are generallyprotected from legal actions and any losses beyond their investment. Thegeneral partner receives a management fee and a percentage of profits, while the limited partners receive income, capital gains, andtax benefits. _ limited liability partnership (LLP) A legal entity formed under a state limitedpartnership law for professionals. Generally, a partner in an LLP is responsiblefor the partner’s own actions, but not personally liable for the debts of theLLP or any other partner, nor is a partner liable for the acts or omissions ofany other partner, solely by reason of being a partner. _ limited liability company (LLC) An ownership entity formed under state lawand designed to limit the founders’ and investors’ losses to the amount of theirinvestment. An LLC does not pay taxes; rather, its owners pay taxes on theirproportion of the LLC profits at their individual tax rates. An LLC may beclassified for federal income tax purposes as either a partnership or an entitydisregarded as an entity separate from its owner by applying the IRS regulations,and as determined on IRS Form 8832, Entity Classification Election. LLCs mayelect to be taxed as corporations. _ sole proprietor (SP) Unincorporated business owned and controlled by oneperson under his or her name, or doing business as (DBA) a name other than theowner’s. Many successful SPs start as garage operations and are subsequentlyconverted into entities such as corporations or LLCs. buyout firm An entity in the private equity industry that purchases a controllinginterest in a company (as in a leveraged buyout), in many cases accompanied bya management team (as in a management buyout). 141 buy-sell agreement A contract that sets forth the conditions under which a shareholdermust first offer his or her shares for sale to the other shareholders beforebeing allowed to sell to entities outside the company. capital asset pricing model (CAPM) Used to determine the required rate of returnfor stocks. capital call A request from a general partner that an investor in a partnership orLLC provide additional capital. Usually an investor will agree to a maximuminvestment amount and the general partner will make a series of capital calls overtime to the investor as opportunities arise to finance the capital requirements oftargeted companies. capital charge The product of the cost of capital times the amount of capital usedby a particular company or business unit. Typically referred to in the calculationof economic profits versus operating profits. capital efficiency (leverage alliances) Refers to the concept of efficient deploymentof capital by venture capitalists. Best practices include offshore development andunderstanding the sales and distribution model for a start-up business beforeramping operations; hire two to four people to experiment and test the market,then ramp. capital expenditure Also referred to as capex; this is the investment of funds in fixedor capital assets of a company. Among other things, this can include software,office equipment, buildings, land, factory, and equipment. capital gains (losses) A tax classification of investment earnings (losses) resultingfrom the purchase and sale of assets. Typically, an investor prefers that investmentearnings be classified as long-term capital gains (held for a year or longer),which are taxed at a lower rate than ordinary income. capital stock Stock authorized by a company’s charter and having par value, statedvalue, or no par value. Capital stock includes common stock and preferredstock. capped participating preferred Preferred stock whose participating feature is limitedso that an investor cannot receive more than a specified amount withoutconverting to common stock. 142 cash flow The amount of cash generated from operations. This amount may benegative. Generally considered the amount of cash available to stockholders andlong-term lenders of the corporation. There are several calculations that serveas a proxy for cash flow: net operating profit less adjusted taxes (NOPLAT),earnings before interest and taxes (EBIT), or earnings before interest, taxes,depreciation, and amortization (EBITDA). catch-up A clause in the agreement between the general partner and the limitedpartners of a private equity fund. Once the limited partners have received acertain portion of their expected return, the general partner can then receive amajority of profits until the previously agreed-upon profit split is reached. change of control bonus A bonus of cash or stock given to members of a managementgroup upon successful completion of the sale of a company. clawback A clause in the agreement between the general partner and the limitedpartners of a private equity fund. The claw back gives limited partners the rightto reclaim a portion of disbursements to a general partner early in the life of alimited partnership for profitable investments when there are significant lossesfrom later investments in a portfolio. commercial bank Widely known as a source of debt financing for businesses, commercialbanks generally provide lines of credit, term loans, and revolving loans.Traditionally, commercial banks are cash flow lenders and view collateral asa secondary source of repayment; from experience, bankers’ actions do not alwaysevidence this thinking. Focus is placed on lending to borrowers that havedurability and predictability of cash flows. To assure liquidity and stability forthe public, banks are highly regulated by states, the Federal Deposit InsuranceCorporation (FDIC), and by the operating cash cycle (OCC). commercial paper An unsecured, short-term loan issued by a corporation, typicallyfor financing accounts receivable and inventories. It is usually issued at adiscount reflecting prevailing market interest rates. Maturities on commercialpaper rarely are any longer than 270 days. 143 commitment An obligation, typically the maximum amount that an investor orlender agrees to invest in a fund or to loan to a company. common stock A type of security representing ownership rights in a company.Usually, company founders, management, and employees own common stockwhile investors own preferred stock. In the event of a liquidation of the company,the claims of secured and unsecured creditors, bondholders, and preferredstockholders take precedence over common stockholders. comparable A publicly traded company with similar characteristics to a privatecompany that is being valued. For example, a telecommunications equipmentmanufacturer whose market value is two times revenues can be used to estimatethe value of a similar and relatively new company with a new product in thesame industry. contingent value rights (CVR) Provides the holder with the right to sell a share ofstock in the underlying company at a fixed price during the life of the right. contribution margin Selling price minus variable cost. For a business operatingabove breakeven, the contribution margin from incremental sales becomesoperating profit. control The authority of an individual or entity that owns more than 50 percentof equity in a company or owns the largest block of shares compared to othershareholders. convergence The Financial Accounting Standards Board (FASB) is working withthe International Accounting Standards Board (IASB) to converge their respectiveaccounting standards into a set of rules that will meet the needs of preparersand users of financial statements and other accounting information in all globalconstituencies. conversion The right of an investor or lender to force a company to replace theinvestor’s preferred shares or the lender’s debt with common shares at a presetconversion ratio. A conversion feature was first used in railroad bonds in the1800s. 144 convertible debt A loan that allows the lender to exchange the debt for commonshares in a company at a preset conversion ratio. convertible preferred stock A type of stock that gives an owner the right to convertto common shares of stock. Preferred stock is granted certain rights not normallygranted to the holders of common stock, such as decision-making managementcontrol, a guaranteed return on investment, or senior priority in receiving proceedsfrom a sale or liquidation of the company. Convertible preferred is themost common tool for private equity funds to invest in companies. convertible security A security that gives its owner the right to exchange the securityfor common shares in a company at a preset conversion ratio. The security is typically preferred stock or debt. corporate charter The document prepared when a corporation is formed. Thecharter sets forth the objectives and goals of the corporation, as well as ageneral statement of what the corporation can and cannot do while pursuingthese goals. corporate venturing Venture capital provided by in-house investment funds of largecorporations to further their own strategic interests. cost of capital Actual or implied interest rate for the use of money or assets of acompany. cost of goods sold (COGS) Same as cost of sales. cost of revenue Same as cost of goods sold, though the term usually refers to costsincurred to generate service revenues versus those of product revenues. Costof revenue and cost of goods sold are usually comprised of direct and indirectcosts. Direct costs are those that are attributed directly and proportionally tocreating the product or service (i.e., materials and labor). Indirect costs are thoseexpenses that are attributed to creating the product or service but are generalin nature and not easily allocated on a per unit basis (i.e., engineering supportcosts and facilities costs related to producing the product or service). 145 cost of sales (COS) The burdened expenses incurred to generate the revenue of acompany; includes direct and indirect costs. covenant A legal promise to do or not do a certain thing. For example, in a financingarrangement, company management may agree to a negative covenant wherebyit promises not to incur additional debt. The penalties for violation of a covenantmay vary from repairing the mistake to losing control of the company. cumulative dividends The owner of preferred stock with cumulative dividends hasthe right to receive accrued (previously unpaid) dividends in full before dividendsare paid to any other classes of stock. current ratio The ratio of current assets to current liabilities. Less than 1 indicatesnegative working capital. The current ratio is used to measure liquidity. data room Central location for due diligence materials provided by a companyto all potential purchasers or investors in connection with an acquisition orinvestment. days sales outstanding (DSO) The average period in days in which a company’saccounts receivable remain due from the customer. deal flow A measure of the number of potential investments that a fund reviews inany given period. debt-for-equity swaps A voluntary exchange of outstanding debt for equity ofequal market value. debt service The ratio of a loan payment amount to available cash flow earnedduring a specific period. Typically lenders insist that a company maintain acertain debt service ratio or else risk penalties such as having to pay off the loanimmediately. debt-to-equity (D/E) ratio Total liabilities divided by total equity of the entity asshown in its balance sheet. The D/E measures the entity’s leverage level. A debt-to-equity ratio of 1 indicates that the entity’s total liabilities equal the equitydollar amount. 146 default A company’s failure to comply with the terms and conditions of a financingarrangement. deficiency guaranty A guarantee limited in amount to the deficiency suffered bythe creditor in event of default on a loan or debt; usually covering the first lossby the lender. A limited deficiency guaranty will contain a maximum or limit ofexposure for the guarantor. definitive agreement The final, fully negotiated agreement between parties, containingall material terms, conditions, and agreements relating to the subjectmatter of the transaction in question. demand right A type of registration right. Demand rights give an investor the rightto force a company to register its shares with the SEC. direct costs See cost of revenue. disbursement An investment by a fund in a company. discount rate The interest rate used to determine the present value of a series offuture cash flows. discounted cash flow (DCF) Calculation of the present value of a stream of forecastedcash flow discounted using an interest rate appropriate to the risk of theventure creating the cash flow. discounted free cash flow (DFCF) Equity valuation method in which a discountpercentage is applied to a stream of forecasted free cash flows, where free cashflow is defined as net operating cash flow increased by net debt issuances anddecreased by net investment. distribution The transfer of cash or securities to a limited partner resulting fromthe sale, liquidation, or IPO of one or more portfolio companies in which ageneral partner chose to invest. dividend Payment made by a company to the owners of its securities out of earningsof the company based solely on the amount of securities owned. dividend yield The dollar dividend per share divided by the current price pershare. domain expertise Intelligence of an investor, partner, or potential employee in thespecific business or industry occupied by a company. 147 double taxation Refers to the same income being taxed twice, once at the entitylevel and once at the individual level. Thus, dividends, which are paid out ofafter-tax corporate profits, are double taxed when individuals have to pay taxeson them as well. down round A round of financing whereby the valuation of the company is lowerthan the value determined by investors in an earlier round. drag-along rights The contractual right of an investor in a company to force allother investors to agree to a specific action, such as the sale of the company. due diligence The investigatory process performed by individuals or entities consideringtransactions with a third party to evaluate the business and finances ofa company. earnings before interest and taxes (EBIT) A measurement of the operating profitof a company. One possible valuation methodology is based on a comparisonof private and public companies’ value as a multiple of EBIT. earnings before interest, taxes, depreciation, and amortization (EBITDA) A measurementof the cash flow of a company. One possible valuation methodologyis based on a comparison of private and public companies’ value as a multipleof EBITDA less funded debt. economic profit The difference between the amount received in connection withthe sale of a good or service and the cost of goods or services sold analyzed onthe basis of their opportunity cost. Also defined as EBIT minus a charge for thecost of capital deployed to generate the EBIT. employee stock ownership program (ESOP) An equity plan established by a companythat permits the grant of options on stock of the company for longtermincentive compensation for employees. equity The ownership structure of a company represented by common shares,preferred shares, or unit interests. Equity = Assets – Liabilities. escrow Documents, real estate, money, or securities deposited with a neutral thirdparty (the escrow agent) to be delivered upon fulfillment of certain conditions,as established in a written agreement. 148 evergreen fund A fund that reinvests its profits in order to ensure the availabilityof capital for future investments. exit strategy The plan for generating profits for owners and investors of a company.Typically, exit strategies include mergers and acquisitions, recapitalizations, andinitial public offerings (IPOs). expansion stage The stage of a company characterized by a complete managementteam and a substantial increase in revenues. factor analysis A statistical technique where past data is analyzed with the intentof extracting common factors that might have affected the data.19 factoring The selling of a company’s accounts receivable, at a discount, to athird party who either then assumes the credit risk of the account debtors,known as nonrecourse factoring, or assumes no credit risk, known as recoursefactoring, and receives cash as the company’s customers pay theiraccounts. fairness hearing The hearing conducted by a state agency in connection with aproposed business combination, merger, or acquisition that results in the issuerof securities receiving a transactional exemption from registration of the securities,and the target shareholders, other than affiliates of the resulting company,receiving freely tradable shares. fairness opinion A letter issued by an investment bank to assess the fairness of atransaction such as the negotiated price for a merger or an acquisition. Financial Accounting Standards Board (FASB) The private-sector organizationempowered to establish financial accounting and reporting standards. Althoughthis function legally resides with the Securities and Exchange Commission forpublic companies, the SEC has traditionally provided the private sector withthe opportunity for self-regulation. Since 1973, the SEC has relied on theFASB for standard setting. The FASB operates under the oversight of the FinancialAccounting Foundation, which is responsible for funding the activitiesof both the FASB and its counterpart for state and local government,the Governmental Accounting Standards Board. The Financial AccountingFoundation also is responsible for selecting the members of both accountingstandards boards and their respective advisory 149 councils. Eleven members of theboard of trustees of the Financial Accounting Foundation are nominated byeight organizations and approved by the trustees. financial intermediaries Institutions that provide the market function of matchingborrowers and lenders or traders. financial investor An investor interested solely in achieving a financial return froman investment, rather than a return coupled with a strategic benefit associatedwith the investment. financing slack The difference between the debt that a firm chooses to carryand the optimal debt that it could carry, when the former is less than thelatter. financing statement Document filed with a lender detailing personal property takenas collateral from a borrower. The financing statement, a standard documentunder the Uniform Commercial Code, is filed with the secretary of state orother designated public official. The document is time-stamped, the filing dateis noted, and a file number is assigned, placing the public on notice regardingthe lender’s claim to the specified collateral. fire sale A sale of merchandise and other assets after a fire at very low prices. It isalso used figuratively when merchandise and other assets of companies are soldat very low prices to ensure a fast disposal of surplus items. firm commitment A commitment by a syndicate of investment banks to purchaseall the shares available for sale in a public offering of a company. The shareswill then be resold to investors by the syndicate. flipping The act of selling shares immediately after an initial public offering.Investment banks that underwrite new stock issues attempt to allocateshares to new investors who indicate they will retain the shares for severalmonths. fixed charge coverage ratio This ratio is used by lenders to compare committedfixed payments to available cash flow. Following are two actual formulas usedby asset-based lenders to illustrate the concept: 1. The ratio calculated on a rolling four-quarter basis of EBITDA to the sum of (1)cash interest expense, plus (2) cash tax expense, plus (3) current maturities oflong-term debt, subordinated debt, and capital leases of the borrower, plus 150 (4)the sum of dividends or distributions paid by the borrower during this period,plus (5) nonfinanced capital expenditures. 2. The ratio of (1) EBITDA plus cash equity, minus unfinanced capitalized expendituresmade during such period, minus cash taxes, dividends, and distributions,if any, made during such period, to (2) all senior debt payments plus, withoutduplication, all subordinated debt payments during such period. In this case,senior debt payments include all cash actually expended by borrower to make(1) interest payments on any advances hereunder, plus (2) payments for all fees,commissions, and charges set forth herein and with respect to any advances,plus (3) capitalized lease payments, plus (4) payments with respect to any otherindebtedness for borrowed money. forward contract An agreement to buy or sell the underlying asset at a fixed priceat a future point in time. founder A person who participates in the creation of a company. Typically,founders manage the company until it has enough capital to hire professionalmanagers. free cash flow The amount of cash a company has after expenses, debt service, capitalexpenditures, and dividends. Free cash flow measures the financial comfortlevel of the company as a going concern. friends and family financing Capital provided by the friends and family of foundersof an early stage company. Founders should be careful not to create an ownershipstructure that may hinder the participation of professional investors oncethe company begins to achieve success. full ratchet An antidilution protection mechanism whereby the price per shareof the preferred stock of investor A is adjusted downward due to the issuanceof options, warrants, or securities to new investor B at a price lowerthan the price investor A originally received. Investor A’s preferred stock isreprised to match the price of investor B’s option, warrant, or securities. fully diluted basis A methodology for calculating any per share ratios wherebythe denominator is the total number of shares issued by the company on 151 theassumption that all warrants and options are exercised and that all convertiblesecurities have been converted. fund of funds A fund created to invest in private equity funds to minimize portfoliomanagement efforts. GAAP See generally accepted accounting principles. garage operation Figurative denomination applied to a start-up business venturewith very little resources; a reference to businesses that actually started froman individual’s garage at home where the individual or small group sets up anoffice, a lab, or a light manufacturing operation. generally accepted accounting principles (GAAP) A voluminous set of standards,interpretations, opinions, and bulletins developed by the Financial AccountingStandards Board. going-concern value The value of a company to another company or individualin terms of an operating business. The difference between a company’s goingconcernvalue and its asset or liquidation value is deemed goodwill and plays amajor role in mergers and acquisitions.25 golden parachute A contractual clause in a management contract that allows themanager to be paid a specified sum of money in the event the control of the firmchanges. graduated payment Repayment terms calling for gradual increases in the paymentson a closed-end obligation. A graduated payment loan usually involves negativeamortization. greenmail The purchase of a potential hostile acquirer’s stake in a business at apremium over the current fair market value of the stock. gross margin Revenue associated with the sale of a product or service less the directcosts of providing the product or service. grossing up An adjustment of an option pool for management and employees of acompany that increases the number of shares available over time. This usuallyoccurs after a financing round whereby one or more investors receive a relativelylarge percentage of the company. 152 growth stage The stage of a company when it has received one or more rounds offinancing and is generating revenue from its product or service. Same as middlestage. haircut Reduction in value taken by one party in order to compensate anotherparty or facilitate a transaction. Hamburger Helper bridge A colorful label for a traditional bridge loan that includesthe right of the bridge lender to convert the note to preferred stock at aprice that is a 20 percent discount from the price of the preferred stock in thenext financing round. harvest To generate cash or stock from the sale or IPO of companies in a privateequity portfolio of investments. hedge A transaction that reduces the risk of an investment.29 hockey stick The general shape and form of a chart showing revenue, customers,cash, or some other financial or operational measure that increases dramaticallyat some point in the future. Entrepreneurs often develop business plans withhockey stick charts to impress potential investors. holding period Length of time an asset (property) is held by its owner. The holdingperiod for short-term capital gains and losses is one year or less. The holdingperiod for long-term capital gains and losses is more than one year. To figurethe holding period, begin counting on the day after you receive the property andinclude the day you disposed of it. hot issue Stock in an initial public offering that is in high demand. hurdle rate A minimum rate of return required before an investor will make aninvestment. incubator A company or facility designed to host start-up companies. Incubatorshelp start-ups grow while controlling costs by offering networks of contacts andshared back-office resources. indicative offer Short form term sheet in which a potential investor, partner, oracquirer provides a target with an informal description of the material termsand conditions of an offer. 153 information asymmetry Imbalance that arises anytime one party to a transactionor agreement has more or better information than others. initial public offering (IPO) The first offering of stock by a company to the public.New public offerings must be registered with the Securities and ExchangeCommission. inside round A round of financing in which the investors are the same investors asin the previous round. insider information Material information about a company that has not yet beenmade public. It is illegal for holders of this information to make trades basedon it, however received. insiders Directors and senior officers of a corporation – in effect, those who haveaccess to inside information about a company. An insider also is someone whoowns more than 10 percent of the voting shares of a company. insolvency risk The risk that a firm will be unable to satisfy its debts. Also knownas bankruptcy risk. insolvent Unable to pay debts (e.g., a firm’s liabilities exceed its assets). institutional investors Organizations that invest, including insurance companies,depository institutions, pension funds, investment companies, mutual funds,and endowment funds. interest The price paid for borrowing money. It is expressed as a percentage rateover a period of time and reflects the rate of exchange of present consumptionfor future consumption. Also, a share or title in property. interest coverage ratio Earnings before interest and taxes divided by the interestexpense. The interest coverage ratio is a measure of the firm’s capacityto service its interest payments, with higher coverage ratios representing moresafety. interest coverage test A debt limitation that prohibits the issuance of additionallong-term debt if the issuer’s interest coverage would, as a result of the issue,fall below some specified minimum. interest deduction An interest expense, such as interest on a margin account, thatis allowed as a deduction for tax purposes. 154 interest expense The money the corporation or individual pays out in interest onloans. interest in arrears Interest that is due only at the maturity date rather than periodicallyover the life of the loan. interest-only loan A loan in which payment of principal is deferred and interestpayments are the only current obligation. interest tax shield The reduction in income taxes that results from the tax deductibilityof interest payments. interim statement A financial statement that reflects only a limited period of acompany’s financial statement, not the entire fiscal year. internal finance Finance generated within a firm by retained earnings anddepreciation. internal growth rate Maximum rate a firm can expand without outside sources offunding. Growth generated by cash flows retained by the company. internal rate of return (IRR) Interest rate that is applied to a stream of cash outflowsand inflows that causes the sum of the outflows and inflows to equal zero. International Accounting Standards Board (IASB) In March 2001, the InternationalAccounting Standards Committee (IASC) Foundation was formed as anot-for-profit corporation incorporated in the State of Delaware, U.S. The IASCFoundation is the parent entity of the International Accounting Standards Board(IASB), an independent accounting standard-setter based in London, UK. OnApril 1, 2001, the IASB assumed accounting standard-setting responsibilitiesfrom its predecessor body, the IASC. International Financial Reporting Standards (IFRS) A set of accounting standards,developed by the International Accounting Standards Board (IASB), that is becomingthe global standard for the preparation of public company financialstatements. intrinsic value of a firm The present value of a firm’s expected future net cash flowsdiscounted by the required rate of return. 155 inventory turnover A measure of how often the company sells and replaces itsinventory. It is the ratio of annual cost of sales to the latest inventory. Onecan also interpret the ratio as the time for which inventory is held. For example,a ratio of 26 implies that inventory is held, on average, for two weeks.It is best to use this ratio to compare companies within an industry (highturnover is a good sign) because there are huge differences in this ratio across industries. invested capital Total assets minus non-interest-bearing liabilities. This term is usedin the calculation of return on invested capital (ROIC). investment banking Financial intermediaries who perform a variety of services,including aiding in the sale of securities, facilitating mergers and other corporatereorganizations, acting as brokers to both individual and institutional clients,and trading for their own accounts. investment grade bond A bond with a rating better than BBB. Some institutionalinvestors, such as pension funds, are constrained from holding bonds with lower ratings. investment tax credit Tax credit provided by some states for investments madeinto qualified investments. investment thesis/investment philosophy The fundamental ideas that determine thetypes of investments that an investment fund will choose in order to achieve itsfinancial goals. IPO See initial public offering. IRR See internal rate of return. issuer A company that sells its debt or equity securities. junior debt A loan that has a lower priority than a senior loan in case of a liquidationof the assets of the borrowing company. Also referred to as second lien,last-out participation, or tranche B debt.While subordinated debt is technicallyjunior to the senior debt in a company, it typically sits below junior debt and isunsecured. junk bond A bond with a speculative credit rating of BB (S&P) or BA (Moody’s)or lower. Junk or high-yield bonds offer investors higher yields 156 than bonds offinancially sound companies. Two agencies, Standard & Poor’s and Moody’sInvestors Service, provide the rating systems for companies’ credit. kicker An additional feature of a debt obligation that increases its marketabilityand attractiveness to investors. last-out participation See junior debt. later stage The stage of a company that has proven its concept, achieved significantrevenues compared to its competition, and is approaching cash flow breakevenor positive net income. The rate of return for venture capitalists that invest inlater stage, less risky ventures is lower than in earlier stage ventures. LBO See leveraged buyout. lead investor The venture capital investor that makes the largest investment in afinancing round and manages the documentation and closing of that round. Thelead investor sets the price per share of the financing round, thereby determiningthe valuation of the company. letter of intent A document confirming the intent of an investor to participatein a round of financing for a company. By signing this document, the subjectcompany agrees to begin the legal and due diligence process prior to the closingof the transaction. leverage The use of debt to acquire assets, build operations, and increase revenues.By using debt, a company is attempting to achieve results faster than if it usedonly its cash available from preleverage operations. leveraged buyout (LBO) The purchase of a company or a business unit of a companyby an outside investor using mostly borrowed capital. leveraged recapitalization Transaction in which a firm borrows money and eitherbuys back stock or pays a dividend, thus increasing its debt ratio substantially. LIBOR See London Interbank Offered Rate. limited deficiency guaranty See deficiency guarantee. line of credit An informal loan arrangement between a bank and a customer,allowing the customer to borrow up to a prespecified amount. 157 liquid yield option note (LYON) Notes whose holders have the right either to putthem back to the firm under specified circumstances or to convert them intoequity. liquidation The selling off of all assets of a company prior to the complete cessationof operations. Corporations electing formal insolvency proceedings to liquidatedeclare Chapter 7 bankruptcy. In a liquidation, the claims of secured and unsecuredcreditors, bondholders, and preferred stockholders take precedence overcommon stockholders. liquidation analysis Consideration of the market factors that influence the valuesof assets to be liquidated in connection with the cessation of a going concern’soperations. liquidation balance sheet A company’s balance sheet adjusted to reflect reductionsin the value of assets that are normally experienced when the assets of a goingconcern are sold off after the entity stops conducting business. liquidation preference The contractual right of an investor to priority in receivingthe proceeds from the liquidation of a company. liquidation value The estimated amount of money that an asset or company couldquickly be sold for, such as if it were to go out of business. liquidity discount A decrease in the value of a private company compared to thevalue of a similar but publicly traded company. Since an investor in a privatecompany cannot readily sell his investment, the shares in the private companyare normally valued less than a comparable public company. liquidity event A transaction whereby owners of a significant portion of the sharesof a private company sell their shares in exchange for cash or shares in another,usually larger company. For example, an IPO is a liquidity event. lockup agreement A specific time period after an IPO, usually 6 to 12 months,during which investors, management, and employees agree not to sell theirshares. London Interbank Offered Rate (LIBOR) A short-term interest rate often quotedas a one-, three-, or six-month rate for U.S. dollars. LYON See liquid yield option note. 158 management buyout (MBO) A leveraged buyout controlled by the members of themanagement team of a company or a division. management fee A fee charged to the limited partners in a fund by the generalpartner. Management fees in a private equity fund typically range from0.75 percent to 3 percent of capital under management, depending on the typeand size of fund. management presentation A program presented by the officers or directors of acompany in connection with a potential equity or debt transaction, or strategicor collaborative partnering agreement. management rights The rights often required by a venture capitalist as part of theagreement to invest in a company. The venture capitalist has the right to consultwith management on key operational issues, attend board meetings, and reviewinformation about the company’s financial situation. marginal cost An increase or a decrease in the total costs of a business firm asthe result of one more or one less unit of output. Also called incremental costor differential cost. A firm is operating at optimum output when marginalcost coincides with average total unit cost. Thus, at less than optimum output,an increase in the rate of production will result in a marginal unit cost lowerthan average total unit cost; production in excess of the optimum point willresult in marginal cost higher than average total unit cost. market capitalization The value of a publicly traded company as determined bymultiplying the number of shares outstanding by the current price per share. MBO See management buyout. merchant banking A merchant bank invests its own capital in leveraged buyouts,corporate acquisitions, and other structured finance transactions. Merchantbanking is a fee-based business, where the bank assumes market risk but nolong-term credit risk. The Gramm-Leach-Bliley Act allows financial holdingcompanies, a type of bank holding company created by the Act, to engage in merchant banking activities. mezzanine A layer of financing that has intermediate priority (seniority) in thecapital structure of a company. For example, mezzanine debt has lower 159 prioritythan senior debt but higher priority than equity. Mezzanine debt usually hasa higher interest rate than senior debt and often includes warrants. In venturecapital, a mezzanine round is generally the round of financing that is designedto fund the operations of a company to a liquidity event such as an IPO. middle-market Companies with revenues up to $500 million. middle stage The stage of a company when it has received one or more rounds offinancing and is generating revenue from its product or service. monetary assets and liabilities Assets and liabilities in which the amounts are fixedin currency units. If the value of the currency unit changes, it is still settled with the same number of units. multiple A valuation methodology that compares public and private companies interms of a ratio of value to an operations figure such as revenue or net income.For example, if several publicly traded computer hardware companies are valuedat approximately two times revenues, then it is reasonable to assume that a startupcomputer hardware company that is growing fast has the potential to achievea valuation of two times its revenues. Before the start-up issues its IPO, it willlikely be valued at less than two times revenue because of the lack of liquidityof its shares. narrow-based weighted-average antidilution A type of antidilution mechanism thatadjusts downward the price per share of the preferred stock of investor A dueto the issuance of options, warrants, or securities to new investor B at a pricelower than the price that investor A originally paid. Investor A’s preferred stockis repriced to a weighted average of investor A’s price and investor B’s price. Anarrow-based weighted-average antidilution formula uses only common stockoutstanding in the denominator for determining the new weighted average price. NASDAQ Formerly an acronym for the National Association of Securities DealersAutomated Quotation system. An electronic quotation system that providesprice quotations to market participants about the more actively traded 160 commonstock issues in the over-the-counter market. About 4,000 common stock issuesare included in the NASDAQ system. NDA See nondisclosure agreement. net capital expenditure The difference between capital expenditures and depreciation.It is a measure of the financing needed, from internal or external sources,to meet investment needs. net operating income (or loss) See operating profit (or loss). net operating profit less adjusted taxes (NOPLAT) Represents the after-tax operatingprofits of a company after adjusting the taxes to a cash basis. net present value (NPV) The sum of the discounted present values of the expectedcash flows of the investment. net present value (NPV) profile This measures the sensitivity of the net presentvalue to changes in the discount rate. New York Stock Exchange (NYSE) The oldest and largest stock exchange in theUnited States. Also known as the Big Board or the Exchange. noncompete An agreement often signed by employees and management wherebythey agree not to work for competitor companies or form a new competitorcompany for a certain time period after termination of employment. noncumulative dividends Dividends that are payable to owners of preferred stockat a specific point in time only if there is sufficient cash flow available after allcompany expenses have been paid. nondisclosure agreement (NDA) An agreement issued by entrepreneurs to protectthe privacy of their ideas when disclosing those ideas to third parties. noninterference An agreement often signed by employees and managementwhereby they agree not to interfere with the company’s relationships withemployees, clients, suppliers, and subcontractors for a certain time period aftertermination of employment. nonrecourse Term referring to the absence of any legal claim against a seller or priorendorser. The seller (or the endorser of a check or other negotiable document)is not liable or otherwise responsible for payment to the holder.66 161 nonsolicitation An agreement often signed by employees and managementwhereby they agree not to solicit other employees of the company regarding jobopportunities. NOPLAT See net operating profit less adjusted taxes. NYSE See New York Stock Exchange. offering memorandum A legal document that provides details of an investment topotential investors. See private placement memorandum. OID See original issue discount. operating profit (or loss) Earnings before interest and taxes or operating income. opportunity cost The cost assigned to a project resource that is already owned bythe firm. It is based on the next best alternative use.67 optics The way a concept is presented. Sometimes entrepreneurs’ presentations arestrong on optics but weak in content. option See stock option. option pool A group of options set aside for long-term, phased compensation tomanagement and employees. original issue discount (OID) A discount from par value of a bond or debtlikeinstrument. In structuring a private equity transaction, the use of a preferredstock with liquidation preference or other clauses that guarantee a fixed paymentin the future can potentially create adverse tax consequences. The IRS views thiscash flow stream as, in essence, a zero coupon bond upon which tax paymentsare due yearly based on so-called phantom income imputed from the differencebetween the original investment and guaranteed eventual payout. origination fee A fee charged by a lender or investor to formally process a loan orconduct due diligence. Generally expressed as a percentage of the amount to belent or invested. orphan A start-up company that does not have a venture capitalist as aninvestor. outstanding shares The total amount of common shares of a company, not includingTreasury stock, convertible preferred stock, warrants, and options. 162 oversubscription When demand exceeds supply for shares of an IPO or a privateplacement. over-the-counter (OTC) A decentralized market (as opposed to an exchange market)where geographically dispersed dealers are linked by telephones and computerscreens. The market is for securities not listed on a stock or bond exchange. par Equal to the nominal or face value of a security. pari passu A legal term referring to the equal treatment of two or more parties inan agreement. For example, an investor may agree to have registration rightsthat are pari passu with the other investors in a financing round. participating dividends The right of holders of certain preferred stock to receivedividends and participate in additional distributions of cash, stock, or otherassets. participating preferred stock A unit of ownership that repays an investor the faceamount of the original investment, plus an amount equal to the investor’s prorata ownership of a company. partnership See business structures. pay to play A clause in a financing agreement whereby any investor that does notparticipate in a future round agrees to suffer significant dilution compared toother investors. The most onerous version of pay to play is automatic conversionto common shares, which in essence ends any preferential rights of an investor,such as the right to influence key management decisions. payables Accounts payable resulting from purchases of materials and services fromvendors and other creditors on credit terms. payback The length of time it will take for nominal cash flows from a project to cover the initial investment. P/E ratio See price-earnings (P/E) ratio. PEG Abbreviation for private equity group. PIK Payment in kind. 163 pink sheets Refers to over-the-counter trading. Daily publication of the NationalQuotation Bureau that reports the bid and ask prices of thousands of OTCstocks, as well as the market makers who trade each stock. PIPE See private investment in public equities. placement agent A company that specializes in finding institutional investors thatare willing and able to invest in a transaction. Management typically hires aplacement agent so the managers can focus on operating their company ratherthan on raising capital. poison pill A security or a provision that is triggered by the hostile acquisition ofa company, resulting in a large cost to the acquirer. portfolio company A company that has received an investment from an investmentfund. post-money valuation The valuation of a company including the capital providedby the current round of financing. For example, a venture capitalist may invest$5 million in a company valued at $2 million premoney (before the investmentwas made). As a result, the start-up will have a post-money valuation of$7 million. preference Seniority, usually with respect to dividends and proceeds from a sale ordissolution of a company. preferred stock A type of stock that has certain rights that common stock doesnot have. These special rights may include dividends, participation, liquiditypreference, antidilution protection, and veto provisions, among others. Privateequity investors usually purchase preferred stock when they make investmentsin companies. pre-money valuation The valuation of a company prior to the current round offinancing. For example, a venture capitalist may invest $5 million in a companyvalued at $2 million pre-money. As a result, the start-up will have a post-moneyvaluation of $7 million. price–earnings (P/E) ratio The ratio of a public company’s price per share and itsnet income after taxes on a per share basis. private equity Equity investments in nonpublic companies. 164 private investment in public equities (PIPE) A PIPE is a transaction in which accreditedinvestors are allowed to purchase stock in a public company, usuallybelow the listed market price. The stock is registered with the SEC so that itmay later be resold to the public. private placement The sale of a security directly to a limited number of institutionaland qualified individual investors. If structured correctly, a private placementavoids registration with the Securities and Exchange Commission. private placement memorandum (PPM) A document explaining the details of aninvestment to potential investors. For example, a private equity fund will issue aPPM when it is raising capital from institutional investors. Also, a start-up mayissue a PPM when it needs growth capital. private securities Securities that are not registered with the Securities and ExchangeCommission and do not trade on any exchanges. The price per share is negotiatedbetween the buyer and the seller (the issuer). promote See carried interest. pro rata Shared or divided according to a ratio or in proportion to participation. prospectus Formal written document to sell securities that describes the plan fora proposed business enterprise, or the facts concerning an existing one, that aninvestor needs to know in order to make an informed decision. Prospectusesare used by mutual funds to describe fund objectives, risks, and other essentialinformation. protective put (in a bond) A protective put in a bond allows a bondholder to returnthe bonds to the issuer before maturity and receive the face value, under a seriesof conditions that are enumerated in the bond covenants. For instance, the putmay be triggered by an increase in the leverage. public and private information Public information refers to any information thatis available to the investing public, whereas private information is informationthat is restricted to only insiders or a few investors in the firm. purchase order (PO) financing Credit obtained from a third party based on advancinga portion of the proceeds of a company’s potential sale in 165 connectionwith the promise by a customer that products or services will be purchased inspecific quantities. put The right to sell an underlying asset at a price that is fixed at the time the rightis issued and during a specified time period. qualified business venture (QBV) In the State of North Carolina, this is a businessorganized to engage primarily in manufacturing, processing, warehousing,wholesaling, research and development, or a service-related industry. To be eligiblefor registration as a QBV, the business must have been organized in thesame year as the year in which it applies for registration, or it must not havegenerated more than $5 million in gross revenues as of its last fiscal year. Furthermore,it cannot engage to any substantial degree in the following: providingprofessional services, contracting or construction, selling or leasing at retail,investing, entertainment or recreation, or managing or operating real estate. qualified IPO A public offering of securities valued at or above a total amount specifiedin a financing agreement. This amount is usually specified to be sufficientlylarge to force a conversion of preferred stock to common stock in connectionwith an IPO. qualified opinion An auditor’s opinion expressing certain limitations of an audit. Opposite of unqualified opinion. quartile One-fourth of the data points in a data set. Often, private equity investorsare measured by the results of their investments during a particular period oftime. Institutional investors often prefer to invest in private equity funds thatdemonstrate consistent results over time, placing in the upper quartile of theinvestment results for all funds. quiet period Refers to the period of time during which a company makes no publiccomments, and approximates the period of time during which a company has aregistration statement filed with the SEC. raider Individual or corporate investor who intends to take control of a company(often ostensibly for greenmail) by buying a controlling interest in its stock andinstalling new management. Raiders who accumulate 5 percent or 166 more of theoutstanding shares in the target company must report their purchases to theSEC, the exchange of listing, and the target itself. ratchet Amechanism to prevent dilution. An antidilution clause is a contract clausethat protects an investor from a reduction in percentage ownership in a companydue to the future issuance by the company of additional shares to other entities.A ratchet protects an investor by reducing the effective purchase price paidby the investor to the lowest price paid by a subsequent investor for options,warrants, or securities. real estate investment trust (REIT) An entity that owns real estate and is allowedto pass through its earnings to its investors without being taxed. In return, itis restricted to just real estate investments, and it has to pay 95 percent of itsearnings as dividends. realization ratio The ratio of cumulative distributions to paid-in capital. The realizationratio is used as a measure of the distributions from investment results ofa private equity partnership compared to the capital under management. recapitalization The reorganization of a company’s capital structure. receivables Accounts receivable resulting from sales of products or services to customerson credit terms. recourse Term describing a type of loan. If a loan is with recourse, the lender hasthe ability to fall back to the guarantor of the loan if the borrower fails to pay.For example, Bank A has a loan with Company X. Bank A sells the loan to BankB with recourse. If Company X defaults, Bank B can demand Bank A fulfill theloan obligation. redeemable preferred Preferred stock that can be purchased by a company inexchange for a specific sum of money, or preferred stock than an investor canforce a company to repurchase. redemption or call Right of the issuer to force holders on a certain date to redeemtheir convertibles for cash. The objective usually is to force holders to convertinto common prior to the redemption deadline. Typically, an issue is not calledaway unless the conversion price is 15 to 25 percent below the 167 current level ofthe common. An exception might occur when an issuer’s tax rate is high, andthe issuer could replace it with debt securities at a lower aftertax cost. redemption rights The right of an investor to force a company to buy back theshares issued as a result of the investment. In effect, the investor has the right totake back his investment. red herring A preliminary prospectus filed with the Securities and Exchange Commissionand containing the details of an IPO offering. The name refers to thedisclosure warning printed in red on the cover of each preliminary prospectus. registration rights The rights of investors to have their shares included in a registration.Demand rights are granted to investors to permit the investors to forcemanagement to register the investors’ shares for a public offering. Piggybackrights are granted to investors to permit the investors to add their shares to aregistration statement filed by the company on behalf of the company or onbehalf of other investors. REIT See real estate investment trust. reserve (1) In asset-based lending, the difference between the value of the collateraland the amount lent. From the point of view of financial statements, reservesare provided as an estimate of liabilities that have a good probability of arising;for example, a bad debt reserve is an attempt to estimate what percentage of thefirm’s debtors will not pay (based on previous records and practical experience).Reserves are always a subjective estimate (since they reflect contingent liabilities).(2) An accounting entry that properly reflects contingent liabilities. restricted stock Shares that cannot be traded in the public markets. In some instancesthese shares are subject to transfer restrictions in the private market. restructure A transaction or series of transactions associated with rearranging thedebt or equity structure of a company, and typically associated with poor financialperformance of the company. 168 return on assets (ROA) Indicator of profitability. Determined by dividing net incomefor the past 12 months by total average assets. Result is shown as apercentage. ROA can be decomposed into return on sales (net income/sales)multiplied by asset utilization (sales/assets). return on equity (ROE) Indicator of profitability. Determined by dividing net incomefor the past 12 months by common stockholder equity (adjusted for stocksplits). Result is shown as a percentage. Investors use ROE as a measure of howa company is using its money. ROE may be decomposed into return on assets(ROA) multiplied by financial leverage (total assets/total equity). return on invested capital (ROIC) NOPLAT divided by invested capital. Investedcapital is calculated by subtracting non-interest-bearing liabilities from totalassets. return on investment (ROI) The proceeds from an investment, during a specifictime period, calculated as a percentage of the original investment. return on sales (ROS) A measurement of operational efficiency equaling net pretaxprofits divided by net sales, expressed as a percentage.88 reverse split A proportionate decrease in the number of shares, but not the totalvalue of shares of stock held by shareholders. Shareholders maintain the samepercentage of equity as before the split. For example, a 1-for-3 split would resultin stockholders owning one share for every three shares owned before the split.After the reverse split, the firm’s stock price is, in this example, three timesthe prereverse split price. A firm generally institutes a reverse split to boost itsstock’s market price. Some think this supposedly attracts investors. revolving loan Loan with a stated maximum loan amount but variable amountsthat can actually be drawn down by a borrower, which are determined periodicallyby reference to certain levels of borrower assets. Assets used to determinea borrower’s available loan amount normally include accounts receivable andinventory. Also called revolver or revolving credit facility. 169 right of co-sale with founders A clause in venture capital investment agreementsthat allows the VC fund to sell shares at the same time that the founders of astart-up choose to sell. right of first refusal A contractual right to participate in a transaction. For example,a venture capitalist may participate in a first round of investment in a start-upand request a right of first refusal in any following rounds of investment. rights offering An offering of stock to current shareholders that entitles them topurchase the new issue. ROI See return on investment. roll-up The purchase of relatively smaller companies in a sector by a rapidly growingcompany in the same sector. The strategy is to create economies of scale. round A financing event usually involving several private equity investors. salvage value The estimated liquidation value of the assets invested in a project atthe end of the project’s life.90 scalability A characteristic of a new business concept that entails the growth ofsales and revenues with a much slower growth of organizational complexityand expenses. Venture capitalists look for scalability in the startups they selectto finance. scale-up The process of a company growing quickly while maintaining operationaland financial controls in place. SEC See Securities and Exchange Commission. second lien debt See junior debt. secondary market A market for the sale of partnership interests in private equityfunds. Sometimes limited partners choose to sell their interest in a partnership,typically to raise cash or because they cannot meet their obligation to investmore capital according to the takedown schedule. Certain investment companiesspecialize in buying these partnership interests at a discount. 170 Securities and Exchange Commission (SEC) The regulatory body that enforcesfederal securities laws such as the Securities Act of 1933 and the SecuritiesExchange Act of 1934, as amended over the years. security A document that represents an interest in a company. Shares of stock,notes, and bonds are examples of securities. seed capital Investment provided by angels, friends, and family to the founders ofa start-up in its seed stage. seed stage The stage of a company when it has just been incorporated and itsfounders are developing their product or service. senior debt A loan that has a higher priority in case of liquidation of the assets ofa company. seniority Higher priority. series A preferred stock Preferred stock issued by a company in exchange for capitalfrom investors in the A round of financing. The preferred stock has priority overcommon stock for dividends and the proceeds of any liquidation or sale of acompany. shell Usually refers to a company with little or no assets and with more than 300shareholders that is formed for the purpose of becoming a de facto public entity.This shell company is used to acquire or merge with a privately held companyas a vehicle for the private company to become public without an initial publicoffering. SME A small to medium size enterprise. spin-off A company can create an independent company from an existing part ofthe company by selling or distributing new shares in the so-called spin-off. spin-out A division of an established company that becomes an independent entity. stalking horse Third-party bidder in the investment or acquisition process that isused by the target company to obtain a higher share or acquisition price. sticky dividends Term refers to the reluctance on the part of firms to change dividendsfrom period to period. stock A share of ownership in a corporation. 171 stock grant Determination by the board of directors of a company to issue stockto an employee or third party in connection with the provision of services to acompany or the extension of debt or equity to a company. stock option A right to purchase or sell a share of stock at a specified price withina specified period of time. Stock purchase options are commonly used as longtermincentive compensation for employees and management of fastgrowthcompanies. strategic investor A third party that agrees to invest in a company in order to haveaccess to a proprietary technology, product, or service. By having this access,the third party can potentially achieve its strategic goals. structured overadvance A loan in excess of the agreed-upon borrowing base. Repaymentis typically scheduled within 12 to 24 months. subordinated debt A loan that has a lower priority than a senior loan in case of aliquidation of the asset or company. sweat equity Ownership of shares in a company resulting from work rather thaninvestment of capital. sweetener A feature of a security that makes it more attractive to potentialpurchasers. An example is a warrant. syndicate A group of investors who agree to participate in a round of funding fora company. Alternatively, a syndicate can refer to a group of investment banksthat agree to participate in the sale of stock to the public as part of an IPO. syndication The process of arranging a syndicate. synergy The additional value created by bringing together two entities and poolingtheir strengths. In the context of a merger, synergy is the difference betweenthe values of the merged firm and the sum of the values of the firms operatingindependently. tag-along rights The right of an investor to receive the same rights as owners ofa majority of the shares of a company. For example, if a majority shareholderwants to sell his or her interest in a company, an investor with 172 minority ownershipand tag-along rights would be able to sell his or her interest as well. takedown A schedule of the transfer of capital in phases in order to complete acommitment of funds. Typically, a takedown is used by a general partner tosecure capital from an entity’s limited partners to fund the entity’s investments. takeover The transfer of control of a company. ten bagger An investment that returns 10 times the initial capital. term loan A fixed amount of money advanced by a lender to a borrower where theborrower is expected to repay the loan amount plus interest over a specified periodof time. The repayment terms are negotiated based on the anticipated abilityof the borrower to repay the loan, based on financial projections provided bythe borrower and agreed to by the lender. A term loan may be repaid in a lumpsum at the end of a fixed period or amortized and paid in specified periodicpayments during the term of the loan. term sheet A document confirming the intent of an investor to participate in a roundof financing for a company. By signing this document, the subject companyagrees to begin the legal and due diligence process prior to the closing of thetransaction. Same as letter of intent. tranche The piece, portion, or slice of a deal or structured financing. The socalledA to Z securities of a collateralized mortgage obligation (CMO) offeringof a partitioned mortgage-backed securities (MBS) portfolio. It can also referto segments that are offered domestically and internationally. Tranches havedistinctive features that for economic or legal purposes must be financiallyengineered or structured in order to conform to prevailing requirements. tranche B See junior debt. treasury stock Common stock that has been repurchased by the company and heldin the company’s treasury. turnaround A process resulting in a substantial increase in a company’s revenues,profits, and reputation. 173 underwriter An investment bank that chooses to be responsible for the process ofselling new securities to the public. An underwriter usually chooses to workwith a syndicate of investment banks in order to maximize the distribution ofthe securities. unitranche financing A hybrid senior loan product that blends first and second liendebt, and in some instances mezzanine, into a single tranche. unrestricted stock Freely tradable shares. value of equity The value of the equity stake in a business; in the context of apublicly traded firm, it is the value of the common stock in the firm. value of firm The value of all investors who have claims on the firm; thus, itincludes lenders and debt holders (who have fixed claims) and equity investors(who have residual claims). variance in returns A measure of the squared difference between the actual returnsand the expected returns of an investment. venture capital A segment of the private equity industry that focuses on investingin companies with high growth rates. venture capital method A valuation method whereby an estimate of the future valueof a company is discounted by a certain interest rate and adjusted for futureanticipated dilution in order to determine the current value. Usually, discountrates for the venture capital method are considerably higher than public stockreturn rates, representing the fact that venture capitalists must achieve significantreturns on investment in order to compensate for the risks they take in fundingunproven companies. vintage The year that a private equity fund stops accepting new investors andbegins to make investments on behalf of those investors. voting rights The rights of holders of preferred and common stock in a company tovote on certain acts affecting the company. These matters may include paymentof dividends, issuance of a new class of stock, merger, or liquidation. waiting period See quiet period. walk-away point A predetermined amount at which either the buyer will not paya higher price or the seller will not accept a lower price. 174 warrant A security that gives the holder the right to purchase shares in a companyat a predetermined price. A warrant is a long-term option, usually valid forseveral years. Typically, warrants are issued concurrently with debt instrumentsin order to increase the appeal of the debt instrument to potential investors. washout round A financing round whereby previous investors, the founders, andmanagement suffer significant dilution. Usually as a result of a washout round,the new investor gains majority ownership and control of the company. weighted average antidilution An antidilution protection mechanism whereby theconversion rate of preferred stock is adjusted in order to reflect the issuance ofoptions, warrants, or securities at a price less than the conversion rate of theexisting preferred stock. weighted average cost of capital (WACC) A calculation of the cost of capital byadding the products of relative amounts of equity (E), debt (D), and preferredstock investments (P) multiplied by their respective rates of return (r):rWACC = rE [E/(E + D+ P)] + rD [D/(E + D+ P)] + rP [P/(E + D+ P)] wipeout bridge A short-term financing that has onerous features whereby if thecompany does not secure additional long-term financing within a certain timeframe, the bridge investor gains ownership control of the company. write-down A decrease in the reported value of an asset or a company. write-off A decrease in the reported value of an asset or a company to zero. write-up An increase in the reported value of an asset or a company. yield The percentage return paid on a stock in the form of dividends, or the effectiverate of interest paid on a bond or note. zero coupon bond A bond that pays no interest during the life of the bond and paysthe face value of the bond at maturity. It has a duration equal to its maturity. zombie A company that has received capital from investors but has only generatedsufficient revenues and cash flow to maintain its operations without significantgrowth. Typically, a venture capitalist has to make a difficult decision as towhether to kill off a zombie or continue to invest funds in the hopes that thezombie will become a winner. 175 ACCOMPANYING LITERATURE 1. Cotton D. Market Leader : Practice File / D. Cotton, D. Falvey,S. Kent. – Madrid : Longman, 2000. – 125 p. 2. Doodale M. The Language of Meetings / M. Doodale. – Brighton : Commercial Colour Press Ltd, 1997. – 128 p. 3. Hindle T. Making Presentations / T. Hindle. – Dorling Kindersley, London, 2002. – 72 p. 4. Mackenzie I. English for Business Studies : A Course of Business Studies and Economics Students / I. Mackenzie. – Cambridge University Press, 1998. – 176 p. 5. Nick Brieger. Test Your Professional English : Accounting / N. Brieger. – Penguin English, 2002. – 104 p. 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