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Introduction to Accountancy Lecture Notes 21/22
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Introduction to Accountancy Lecture Notes 21/22
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Introduction to Accountancy1. Introduction
Key concepts and skills:
• Know the three main concerns of corporate financial management
• Grasp the goal of financial management
• Enumerate the financial benefits and drawbacks of differing forms of business organisation
• Understand the conflicts of interest that can arise between owners and managers
• Comprehend that corporate organisation are enhanced by financial markets
1.1 What is corporate finance? (Week 2)
Economic resources are required to establish and maintain a firm.
• Funds enable materials and processes for delivering sellable goods and services
• Funds are essential for assembling a workforce
• Funds are required to purchase long-lived assets such as equipment and buildings
The balance sheet offers insight into the array of decisions, activities and objectives of the financial
manager. On the left side of the balance sheet are assets (current and fixed). Fixed assets are assets
which will last a long time, for example, buildings, and can be tangible, such as machinery, or
intangible, such as patents. Current assets, on the other hand, will last a short time, such as
inventory; these assets will leave the firm soon, unless the firm has overproduced.
The forms of financing are represented on the right side of the balance sheet. A firm will issue pieces
of paper called debt (loan agreements) or equity shares (stock certificates). A short-term debt, which
is called a current liability, represents loans and other obligations that need to be repaid within a
year. Long-term debts are debts which do not have to be repaid within a year. Shareholders’ equity
represents the difference between the value of the assets and the debt of the firm; it is a residual
claim on the firm’s assets. The left and right hand side of the balance sheet must be equal.
Balance sheet model of the firm
The balance sheet reveals the top three concerns of corporate finance:
1. What long-term investments should the firm choose?
2. How should the firm raise funds for the selected investments?
3. How should current assets be managed and financed?
,The first question concerns the left side of the balance sheet. The types and proportions of assets
the firm needs tend to be set by the nature of the business. The term capital budgeting is used to
describe the process of making and managing expenditures on long-lived assets.
The second question concerns the right side of the balance sheet. The answer to this question
involves the firm’s capital structure, which represents the proportions of the firm’s financing from
current liabilities, long-term debt, and equity.
Finally, the third question concerns the upper portion of the balance sheet. There is often a
mismatch between the timing of cash inflows and cash outflows during operating activities.
Furthermore, the amount and timing of operation cash flows are not known with certainty; financial
managers must try to manage the gaps in cash flow.
Short-term management of cash flow, from a balance sheet perspective, is associated with a firm’s
net working capital, which is defined as current assets minus current liabilities. Firms want a good
amount of net working capital to feel comfortable that they can pay off their current liabilities, and
for any other expenses. There is a trade-off between net working capital for current liabilities and
being able to invest in fixed assets. From a financial perspective, short-term cash flow problems
come from the mismatching of cash inflows and outflows; this is the subject of short-term finance.
The order of the balance sheet matters. On the left side, current assets are at the top and fixed
assets at the bottom: assets that can be more quickly converted into cash are at the top, and assets
which cannot be quickly converted without a big loss in value are at the bottom.
On the right side, liabilities and equity are listed in the order that they are due. Current liabilities are
due within 12 months and so are at the top, and long-term debt isn’t due in less than 12 months so
is below current liabilities. Finally, shareholders aren’t paid until creditors are paid and so they
appear at the bottom. However, the shareholders have an advantage as they are entitled to any cash
not used to pay creditors.
Financial securities
A security is a fungible, negotiable instrument representing financial value. A share stock (equity
share) represents a share of ownership in a corporation (company). A bond is a formal contract to
repay borrowed money with interest at fixed intervals.
Bonds and stocks are both securities, but the major difference between the two is that stockholders
have an equity stake in the company (i.e. they are owners), whereas bonds holders have a creditor
stake in the company (i.e. they are lenders).
, The capital budgeting decision
The capital structure decision
Short-term asset management
Working Capital
All firms (including highly profitable ones) that don’t pay sufficient attention to working capital
management may be seriously damaged by the resulting loss of investor and creditor confidence
(delayed investment schedules, sub-optimal temporary finance, unscheduled sale of the firm assets).
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