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Lecture 1 & 2 Fundamentals of Finance for IB
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Summary + additional information of the first two lectures of fundamentals of finance for IB. Easy to understand, no unnecessary fancy words. Structured.
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Red = Important formulaOrange = Alternative formula
Purple = Self-made formula, just for guidance
Pink = Aiding formula, just for guidance but part of the course
Study red and pink first, orange and purple may help
Lecture 1
Finance = Art and science of wealth management
Three types of firms
1. Sole proprietorship (Eenmanszaak)
2. Partnership (Vof)
3. Corporation (BV/NV)
Corporation
- Unlimited life
- Easy transfer ownership
- Limited liability
- Easier to get funding (capital markets)
Financial markets
1. Money market (<1 year)
2. Capital market (>1 year)
1. Primary market (First sale)
2. Secondary market (after sale)
Manager vs shareholder
- Corporation = Set of contracts
- Agency relationship = Contract between shareholder and managers
- Goal: Maximize shareholder wealth
- But managers may have other goals too
- Results in agency problem
Corporate governance
- Solving the agency problem
- Monitoring manager behaviour is costly
- Incentives must be aligned, some ideas:
1. Managerial compensation plans
2. Threats of termination of employments
3. Threats of takeover
, Corporate finance
- It is deciding what to buy and sell en when to do so
- Time (of cash in and outflow) and uncertainty (of expectations) are crucial here
- It is investing (outflow now for future inflow), financing (inflow now for future outflow),
liquidity (balancing short-term in and outflows of cash
Financial management
- Goals: Manage risk, avoid financial distress, maximize shareprice
- Thus maximizing market value of the business
- Done by keeping track of cash coming in and flowing out
- Challenge, to do this while also doing CSR (corporate social responsibility),
nowadays ESG (environmental, social, governance)
Financial statements
- Balance sheet, the financial snapshot
- Income statement, the profitability over a period
- In financial analysis, cash flow is the main valuation input
Financial management decisions
1. Capital budgeting = Planning and managing a firm’s long-term investments
2. Capital structure = Mixture of debt and equity that the company should maintain
- How to raise capital for buying assets
- How much to borrow
- What the cheapest funding sources are
- Capital mix = Mix of equity and liabilities
3. Net working capital management = Management of short term assets and liab.
- How to operate the firm
- How much cashflow needed in the short term
- Net working capital (NWC) = Current assets - Current liabilities
Cash flows
- Not the same as NWC
- Most important of all statements
- Operating, investing, financing
- Cash flow from assets = The cash flow that goes to the debtors and the equity
investors. This is common sense, because they are the ones who the company pays.
You pay with money. Money comes from assets.
1 Cash flow from operating activities (CFO)
1. Take net income (NI) from income statement
2. Add depreciation
- It is a non-cash expense, thus should be added
- It does however decrease taxable income and thus taxes
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