A business exists to produce goods and or services and sell them to those who demand such goods and services. If a business reads the lay of the land well, understands what the market will buy, understands the nature of current demand, what people are willing to pay for, and produces them, it sells them.

A business that sells its goods and services probably will make profits. Profits meaning that the income coming to the business exceeds its expenditure. A business spends money to produce goods and services and markets them. If the money it receives from its business activities (sales) exceeds the money it expended in producing and marketing its goods and services it makes profit.

With profit (bottom line) the business plans for its future business activities. In poorly run businesses profits may be squandered (by management giving itself raises and in the context of Nigeria having parties). In properly managed businesses profits could be used for business expansion.

The subject of corporate finance asks this question: where will the business obtain money with which to run its business activities?

New businesses often obtain their seed money from the owners of the businesses past savings. If you want to start a business you probably have some pot of money that is already available to you and with which you invest in your new business venture. Lenders seldom lend money for business start ups; it is too risky to lend to new businesses for only about five percent of new businesses survive for two years.

Already existing businesses obtain money for expanded business activities from their past profits.

Let us say that a textile manufacturing business would like to increase its capacity and build more factories and or expand already existing ones. Its engineers (productions management) and accountants provide the management (president, chief executive officer) with cost information. How much is the proposed factory going to cost? Once cost is established, the next question is where would the money come from? (In the lecture on marketing we shall see whether there is a market for the proposed product, otherwise why bother producing it?)

SAVINGS

Generally, the first source of finance is savings from past profits. A business that expects to expand in the future begins to save for it today. If it is going to cost five million dollars to fund a new factory, perhaps, the business can save that amount of money in three years and begin doing so now and when it has the money in hand undertakes construction of the factory?

COMMERCIAL BANKS

A business may opt to borrow money from financial institutions like banks. Generally, banks hesitate lending to new business money for business start ups. If a business has a good track record it may be able to obtain money from banks for business expansion.

We shall not dwell on the various types of lending that commercial banks extend to businesses, suffice it to say that there are many of them, some short term and others long term. For our present purposes, it is possible for commercial banks to lend money to an on-going business for its business activities.

VENTURE CAPITALISTS

The other source of business finance is from venture capitalists. There folks out there with large sums of money who would like to invest their monies in business ventures that they believe could yield them good profit. Thus, both new and on-going businesses write Business Plans regarding proposed new line of business activities that they would like to engage in and approach venture capitalists for funding.

Venture capitalists evaluate such business plans and make decisions whether there are markets for their products and how much profit is likely to be made. If they think that there is money to be made in the business they may agree to provide money to the business proposing to engage in the said line of activity.

A venture capitalist that thinks that textiles (clothing materials) are in demand in Nigeria and that the demand is strong enough for him to make a killing, profits from selling them could probably agree to go into business with the business and build a factory to produce the proposed textiles.

Nigerians love lace but import them from India and other countries. Perhaps, if they are produced in Nigeria the producers would sell them and make a handsome profit? But then again given the programmed self hatred Africans seem to have may be they would prefer textiles made in Manchester, England than ones made at Owerri? Perhaps, they attach prestige to imported goods and not to locally manufactured ones?

There are all sorts of variables that affect selling but for our present purposes the question is whether a product would sell? And if it would sell, would profit be made? And if profit is to be made by how much? Is the anticipated profit enough to cover the investment in the proposed new factory? The venture capitalist makes decisions and if he expects making a killing, he may provide the business with the money with which to build the proposed factory.

(Whoever pays the piper calls the tune; the person who lends you money to do something must be interested in how you do it; thus, venture capitalists often take over running the businesses they financed. Therefore, if management wants to retain its independence, it might not seek money from venture capitalists, at least, not from those who would write agreements with it that essentially entails its relinquishment of its independent decision making. It is not unusual for those who funded a business to kick out the already existing management and replace it with its own management team, if they think that in doing so that they would make better yields on their investment)

STOCKS AND BONDS

Whereas businesses obtain funds for business activities from several sources, the source of real money for business expansion is often in offering stocks (Securities). Banks hesitate lending big money for speculative business ventures. Venture capitalists seldom take risks in businesses that they do not believe that they are going to make immediate profits from. Business owners seldom have enough savings from past profits to embark on large scale business ventures. One way to obtain big money to embark on large scale business projects is to sale stocks and bonds.

Stocks and bonds are means of borrowing money from those who have them and using the money to engage in business activities. Let us return to our textile factory and see what it could do to obtain the proposed five million dollars it needs to build a new factory at Owerri. It could sell stocks for the amount it needs to finance the new factory. I am assuming that the original business is a corporation and that it has gone public and is authorized by appropriate state authorities to sell stocks and bonds.

The process of obtaining governmental authorization to sell stocks is a technical matter and is beyond the scope of this basic lecture.

The chief executive officer (CEO) of the company, working with his chief financial officer (CFO), prepares certain documents and submits them to appropriate state authorities; they are authorized to go to the public and sell stocks for five million dollars. Arrangements are made with stock companies and other financial institutions to prepare and sell the stocks.

Let us assume that each stock is sold at a $1. (Initial Product Offering, IPO) The financial institution that undertakes to sell the stocks for the business advertises the business stocks availability. Folks with money to buy stocks obtain information on the business and decide whether the company is sound enough for them to invest their monies in. If they believe that the business is sound and is likely to make profits and pay them dividends on their money (stocks) they buy its stocks and if not they do not buy its stocks.

A man with one million dollars available to him may decide to spend it buying the business’ stocks. If a stock sells at $1, it follows that the man spending one million dollars would have bought a million stocks in the business.

Several people buy stocks in a company, some more, others less. You give the business one dollar and you have one of its stocks.

The business obtains the five million dollars it requires to build its factory. It builds its factory and starts manufacturing. It produces a product, in this case textiles, and sells it. At the end of the day, it subtracts its costs from its revenue and knows whether it made profit or loss.

If it made profit, it may decide to share it with those who bought stocks in it. If it made, say, one million dollars in profits, it may decide to reinvest half of that money in its business or save it for future business expansions and share the balance with its stock holders. The five million stocks would share whatever pot of money is being disbursed and each stock would receive a certain amount. Those with many stocks, obviously, would receive the amount given to one stock times the quantity of stocks they hold.

The chances that businesses would give out dividends in the first few years of business operation are very slim. Companies may go for several years without giving out dividends. If at all they made profits, they simply reinvest them in their businesses. There is such a thing as operating costs (as well as capital expenditure, the money used in building the textile factory). Businesses have to pay the wages of their employees, maintain factories and so on. It generally takes several years before profits can be shared with stock holders in the business. Thus, if you are buying stocks in a business, do not expect to receive dividends during the first few years of the company’s operations.

There are many types of stocks and dividends. That subject is beyond the scope of our introductory lecture.

Whereas the stock owner may not receive dividends on his investments annually, he has other ways to make money on his investment. If the company that sold stocks is doing well and business looks like it is a winner, even though it is not paying out dividends yet there are some persons who would now like to own its stocks.

Whereas in the past cautious investors did not want to buy stocks in an unknown business, when that business begins to make profits and generally do well those persons may change their minds and want to buy its stocks.

Stocks are not offered everyday by businesses. Our textile factory has offered five million stocks to obtain five million dollars and may not sell future stocks in several years. In the meantime, it is making profits. Its already existing five million stocks are now appreciating in value for their holders. The stock that was bought for one dollar may now sale for five dollars. Indeed, it may sale for dollars.

This means that if the holder of that stock resells it in the stock market for twenty dollars he has made nineteen dollars profit on his original one dollar investment. The individual who bought a million shares (stocks) in the textile company at one dollar per share can now resale them for twenty million dollars, meaning that he has made nineteen million dollars gain in his original investment. (This is called capital gains.)

Each country, and segments of it, has a stock exchange, market for selling stocks, where publicly traded stocks are sold.

Stockbrokers help the public buy and sell their stocks. These days, with the advent of computers and the Internet, you can bypass stockbrokers and directly buy and sell stocks from stock exchanges.

For our present purposes, stock exchanges are, more or less, like gambling houses and study the performance of businesses and decide on how much their stocks are worth. Some stocks are overvalued and others are undervalued. There is complex mathematics available for valuing the worth of stocks. That subject is beyond the scope of this lecture.

For our present interest, all that we need to know is that the values of stocks are really speculative. A stock that is valued at $20 may, in fact, be worth nothing (as we found out in 1999 when the grossly over valued technology companies stocks crashed. Most of those companies were not even making profits yet but the market valued their stocks way too high. The market then corrected itself by essentially crashing and these companies went out of market.

What we need to know here is that companies sell stocks and that if the company does well in the market that its stocks would be valued highly and that those holding its stocks could resale them at the current high price and make profits. This is pretty much like gambling. But gambling or not, it is how the capitalist economy works.

What we need to know is that companies borrow money from those who have money in the form of stocks.

If you buy stocks in a company you become a stock holder in it. You are now technically part of the owners of the company. If the company makes profits you are entitled to receiving part of those profits (should it decide to share its profit as dividends)? If the company does not make profits, you do not receive any dividends, after all you are a part owner of the company and the company’s loss is your loss. Indeed, if the company goes broke you lose your investment in it, for, as part of its owner you risk loosing the amount of money you invested in it when it fails. You lose only your investment, not more (see lecture 19 on the nature of corporations and their limited liability).

As a part owner of the company, you obtain reports on how the company is doing. Generally, most companies have annual share holders meeting to which you are invited. The meeting elects the company’s Board of Directors (who may serve for three to five years) and the Board in turn hires the company’s president and chief executive officer. The CEO hires his management team (vice president finance, vice president operations, vice president marketing, vice president human resource etc and those in turn hire their own teams, managers and the managers of divisions hire their first line supervisors who hire line workers).

The company’s Board of Directors hires a president and CEO and delegates the responsibility of running the business, day to day, to him. If he does a good job, his contract is renewed, if not he is let go. The CEO’s job is a precarious one, for he may be unemployed at any time the Board decides to fire him, no questions asked. The board has the right to hire and fire him at will (as he, the CEO has the right to hire and fire his subordinates at will).

Generally, only those who own large shares in a company come to its annual share holders meetings. The man who bought a million dollars worth of shares in our imaginary textile firm is more likely to attend its share holders meeting than a man with only one hundred shares in it. The large share holders, in fact, are generally those who are elected to the company’s Board of Directors and, in turn, are those who hire and fire the company’s President and CEO. (Some times, for the sake of prestige and publicity, a company may invite a well known public official to join its Board of Directors. Thus, an ex-military governor could be invited to serve on the Board of Directors of our imaginary textile company at Owerri. He brings influence and connections to the rulers of the polity, intangible goods that the Board and company may benefit from.)

Whereas business firms generally obtain the money for their activities from selling stocks, these days some businesses also obtain money by selling bonds. It is generally those big corporations that have been around for so long that they might as well be governments that have access to the bond market. If you recall, in the previous lecture we talked about how governments obtain money through selling bonds. Generally, bonds are associated with governments, from city to municipalities, states and national governments. But these days’ big corporations are permitted to sell bonds.

Bonds are different from stocks. If you buy bonds from businesses you are not an owner of those businesses. You merely lent the business money to do something. If you own stocks in a company you are a part owner of that business and as noted is invited to its shareholders meeting where policy decisions are made. Bond holders merely lend their money to the company and the company agrees to repay them their money at specified dates and in the meantime pay them annual interests on their money. The interest rate vary, anywhere from 3-5%. Thus, annually the borrower (company) pays the lender (bond holder) interests on his money and at the end of the period specified for repaying the bond, the borrower pays the bond holder his money (principal) back.

As the business operates, the value of its bonds may go up or down. If the value of its bonds goes up, it means that the bond holders may resale them in the bond market, for a higher price than they had bought them. Let us say that an individual had bought a bond from a bond issuing company for the face value of $1000. The company agrees to repay him his money in ten years. In the meantime, the company agrees to pay him 3% annual interest on his $1000 investment. Each year, he receives 3% interests on his money and at the end of ten years he receives his original $1000 back. (In the 1980s we has Michael Millikan’s Junk Bonds scare.)

In the meantime, the company’s bonds are traded in the bond market. This is gambling. If the company is doing fabulously well and making lots of profits, the interests on the bond may go up to say 5%. This means that the person who originally bought it at 3% could resale the bond at a higher price and make profits. 5% of $1000 is higher than 3% of $1000 dollars. All these profit making is done at the stock/bond (securities) market level.

As noted, every country these days has its own securities exchange commission (SEC) governing the actives of the securities business. This business is like a gambling outfit and a lot of shenanigans take place in it. An in-dept look at the SEC is beyond the scope of this lecture.

For our present purposes, all we need to know is that business corporations do obtain money to run their businesses from selling stocks and bonds. The specifics of how this is done are for those interested in financial management.

Each corporation has a financial department. Here it has financial managers and accountants. Accountants, as we shall see in the next lecture, keep an eye on the company’s revenue and expenditure, and financial managers manage the company’s money.

The financial manager (Chief financial officer, CFO, comptroller etc) makes management decisions, with the CEO on where to obtain money for the business’ activities. The CFO helps the company decide whether to save money and use its savings to construct the proposed textile factory, to borrow that money from banks, from venture capitalists or to do so through stocks and or bonds.

In addition, the CFO invests the company’s profits. Companies, like individuals, do invest their money in other companies. Profits could be used to buy stocks and or bonds in other companies or even from safe government bonds. (I recommend buying government bonds, for you are not going to loose your money.) Big corporations have lots of money available to them to invest and often invest in other companies, to a point that they end up owning those companies. You have heard of hostile takeovers. A company may buy other companies stocks and literally buy a majority of them and end up dictating who serves on the companies board of directors hence hiring their CEOs and, in effect, taking them over. Again, we shall not get into such technical discussion here. It is enough for us to know how companies obtain their finances.

Corporate finance is filled with complex mathematics; I skip those for my goal is to provide basic information on the subject.

The individual ought to take a course on stocks and bonds and learn to know how the various companies stocks are doing. This information is generally printed in the business pages of most daily newspapers and, of course, in financial newspapers like the Wall Street Journal (a must read for any one who takes finance seriously). If you are going to invest your money in stocks and bonds, you ought to know how the companies you want to invest in are doing on a daily basis. You ought to study those companies, their management structure and general performance. You can learn a lot by reading the financial pages of newspapers.

I recommend that you take at least one course in corporate finance if you plan to be in leadership positions, either in government or the private sector.

Leaders deal with money and with managing the economy. Liberal arts education that purportedly train for leadership ignores the most crucial aspect of leadership training, training in managing money. Thus one can obtain a doctorate in political science and know nothing about how governments obtain and manage their monies and control the economy. This is very sad, sad indeed. Political science ought to be conjoined with business studies so that a graduate of political science is simultaneously a graduate of business administration. This is how it ought to be and the sooner the fools who run political science departments realize this fact and restructure their field and stop making it a useless scholastic field and rather transform it to a realistic field that deals with the economies of a polity the better it is for all concerned.

Some of us had PhDs in that field but had to go retrain ourselves in more realistic subjects. Young persons’ time and energy ought not to be wasted by idiotic professors who do not provide them with realistic education.

Obviously, we need to study political science but a political science that deals with the real world. The real world shows that politicians manage the country’s economy.

CONCLUSION

Those who manage the economy not only must understand basic economics but finance (applied economies) and other aspects of management. These lectures on managing the economy are designed to give us the awareness that political leaders manage the polity’s economy and ought to understand management. If politicians have not already learned about finance, public and corporate, they ought go back to night schools and study management.

If one is a legislator at Abuja, at state’s capitals and local government towns and does not have a background in business, one must register immediately at the local university and take business courses that give one the equivalent of a master’s in business administration. One must do this if one is to know what the hell is going on with managing the nation’s money.

These lectures are designed to give general information on management but are not meant to replace rigorous study of management, the type obtained at universities schools of management. Modern economies are big business and politicians as public managers must understand how to manage big businesses, they must understand public and business finance

Ozodi Thomas Osuji

Ozodi@africainstituteseattle.org

November 3, 2005