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Advanced Corporate Finance all lecture notes (2021)
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All notes made during the course Advanced Corporate Finance.
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Week 1: The balance sheet and financing of companiesThe higher the debt, the higher the financial risk
Liquidity risk is short term and solvency risk is long term risk
Debt risk is about PD (probability of default)
Equity risk is about sigma (Assets, stock price)
Working capital funding need = Cash conversion cycle/365 X average of COGS and Sales
Telecommunications for example very low ccc due to prepaid
Your ccc as company is determined by your place in the supply chain
Aggressive short-term finance is called aggressive because you also finance long term with
short term debt.
Aggressive → Lower capital costs but higher financial risk
Conservative → Higher costs but lower financing risk
Supply chain finance fundamentals:
Reverse factoring (or supply chain finance) → a set of solutions that optimizes cash flow by
allowing buyers to extend supplier payment terms.
Because there is no lending on either side of the buyer/supplier-equation, it doesn’t impact
the balance sheets.
Factoring → supplier sells invoices to factoring agent (most cases financial institutions) in
return for earlier but partial payment.
Short-term finance and the management of working capital:
Main objective of working capital management → increase profitability and ensure that a
company has sufficient liquidity to meet short-term obligations.
Levels of working capital:
Aggressive policy: Company chooses to operate with lower levels of inventory, trade
receivables and cash for a given level of activity or sales → Increase profitability but also risk
Conservative policy: Larger cash balance, investing in short-term securities, offering more
generous credit terms and holding higher levels of inventory → Lowers risk but at expense
of reducing profitability.
Moderate policy: Middle path between previous two.
(See figure below)
,Short term sources of finance are riskier than long-term sources from the borrower’s
perspective in that they may not be renewed or be renewed on less favorable terms.
We can divide the company’s assets into three different types:
Non-current assets: long term assets.
Permanent current assets: Represents the core level of investment needed to sustain normal
levels of business or trading activity.
Fluctuating current assets: variations in the level of current assets arising from business
activity.
A matching funding policy is one that finances fluctuating current assets with short-term
funds and permanent assets and non-current assets with long-term funds.
A conservative funding policy uses long-term funds to finance not only non-current assets
and permanent current assets, but some fluctuating current assets as well.
An aggressive funding policy uses short-term funds to finance not only fluctuating current
assets, but some permanent current assets as well. → This policy carries the greatest risk to
solvency, but also offers the highest profitability and increases shareholder value.
Working capital can be seen dynamically as an equilibrium between the income-generating
and resource-purchasing activities of a company.
The Cash conversion cycle tells you the period of time between the outlay of cash on raw
materials and the inflow of cash from sales.
The greater CCC, the greater the amount of investment needed in working capital.
CCC = Inventory days + trade receivables days – trade payables days
The amount of inventory period can be reduced by using Just-in-time.
,Trade receivables period can be shortened by offering incentives for early payment, by
reducing the period of credit offered to customers, by chasing slow or late payers, and by
assessment of the creditworthiness of clients.
The trade payables period is less flexible as it is determined mostly by suppliers.
Overtrading → trying to support too large volume of trade from too small a working capital
base. This can be causes by a rapid increase in turnover or if a company starts off with
insufficient capital.
The classical inventory management model calculates an optimum order size by balancing
the costs of holding inventory against the costs of ordering fresh supplies.
Putting holding costs equal to ordering costs and rearranging gives:
Lead time → delay between ordering and delivery.
The float → the period of time between initiating payment and receiving cash in a
company’s bank account. It can be several days and consists of:
- Transmission delay: the time taken for a payment to pass from payer to receiver
, - Lodgment delay: the delay in banking any payments received
- Clearance delay: the time taken by a bank to clear a presented instruction to pay.
the float can be reduced by minimizing lodgment delay (for example by using electronic
payment methods) and by speeding up cash handlings.
Effective management of receivables can be assisted by factoring and invoice discounting
Working capital ratios and Turnover ratios
Days ratios and CCC
Inventory days → Inventory/COGS * 365
Receivable days → acc. Receivable/Sales * 365
Payable days → Acc. Payables/Sales * 365
CCC (Cash Conversion Cycle) is the sum of these days.
Turnover ratios
Inventory turnover → COGS/inventory
Receivables Turnover → total revenue/receivables
Payables turnover → total revenue/payables
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