Navigating the World of Corporate Finance (1/2)
In this lesson, you’re expected to learn about:
– incorporated entities and companies
– depository institutions
– insurance companies
In this lesson, we’ll see some of the different organizations and jobs involved in finance.
There are a number of organizations, each one specializing in a different area of financial goods and services and many of them are interconnected, with each one playing a vital role in the wider economy.
Let’s now look at some of the most common financial institutions and related organizations.
An incorporated entity refers to limited liability companies (those with ‘Ltd.’ after their name) or public limited companies (those with ‘PLC’ after their name).
In this course, when we say company or firm, assume that we are referring to this type of organization.
What is a Company?
Companies are a special type of organization whereby the people who have ownership (shareholders) can transfer their shares of ownership to other individuals without having to reorganize the company legally.
This transferring of shares is possible because the company is considered a separate legal entity from its owners, which isn’t the case for other forms of entities.
Features of a Company
This characteristic has a few significant implications that influence the financial operations and status of company compared to other organizations.
· Professional managers typically run companies rather than the owners.
· The company is taxed on its profits separately from the owners.
· Companies have limited liability, meaning that the owners can’t be sued for the actions of the company.
· Companies are registered to disclose all their financial information in a regulated, systematic and standardized manner.
Goal of a Company
The primary goal of companies is to provide goods or services in exchange for money and their underlying objective is to generate a profit.
The management of a company is required to act in the best interest of shareholders by increasing shareholder wealth as much as possible and also to act in the interest of third parties such as creditors and banks.
These institutions come in several different types but they all function in the same manner.
– While holding your money, they lend it out to other people or organizations in the form of mortgages or other loans and generate more interest than they pay you.
– When you want your money back, they have to return it. This is possible as they usually hold enough money deposits so that they can give you back what you want.
The three main types of depository institutions are:
– Commercial Banks
– Savings Institutions
– Credit Unions
Commercial banks are by far the largest type of depository institution. They’re for-profit organizations that are usually owned by private investors. Often the size of the bank determines the scope of the services it offers.
For example, regional banks typically limit their service to consumer banking and small-business lending/loans and other services with a limited range of markets. Larger national banks often also perform services for large companies and even other banks. These large commercial banks have the most diverse set of services of all the depository institutions.
Savings institutions are financial institutions that have a primary focus on consumer mortgage lending. Sometimes savings institutions are designed as companies; other times they’re set up as mutual co-operatives, whereby paying cash into an account buys you a share of ownership in the institution.
The profits of that credit union are distributed to everyone who has an account in the form of dividends. Since credit unions are highly focused on consumer services, we won’t discuss them extensively.
A company periodically gives them money and, in return, they promise to pay for the losses the company incurs if some unfortunate event occurs, causing damage to the well being of the organization.
· Benefits: the money the insured receives from the insurance company when something goes wrong.
· Claim: the act of reporting an insurable incident to request that the insurer pay for coverage.
· Co-payment: an expense that the insured pays when sharing the cost with the insurer.
· Indemnify: a promise to compensate the insured for losses experienced.
· Premium: the periodic payments the insured makes to ensure that insurance cover is maintained.
Insurance companies can calculate the probability of something happening and then charge you a price based on the estimated cost of insuring you. They generate profits by charging more than your statistical cost of making claims.
Originally, this set-up allowed companies and individuals to share the risk of loss; each person paid a little so that no person had to face the full cost of a serious disaster. Unfortunately, this situation is becoming less common as insurance companies grow in profitability and incur unnecessary overhead costs.
You can insure just about anything you want. We’ll now see three of the most common and relevant types of insurance companies as far as firms are concerned.
– the probability of large groups of people being rewarded more than they pay in premiums is lower then that of individuals.
– group insurance is frequently the only option that allows for coverage on pre-existing conditions.
Many companies also offer group life insurance, which, like health insurance, is cheaper than individual insurance. Life insurance comes in two forms: whole and term. Each one has a wealth of variations and additional options.
Term life insurance is paid for a set period and is only valid as long as it’s being paid, whereas whole life insurance is considered permanent and builds value over time.