Fundamentals of corporate finance
Chapter 1 – Introduction to corporate finance
Accounting Finance
• Records the past • Discounting the future cash flows
• Works with real amounts • Works with forecasts
1.1 Corporate finance and the financial manager
Three important questions:
1. What long-term investments should you make?
2. Where will you get the long-term financing to pay for your investment?
3. How will you manage your everyday financial activities?
Three important points for financial management:
Capital budgeting: the process of planning and managing a firm’s long-term investments. The
financial manager tries to identify investment opportunities that are worth more to the firm than
they cost to acquire.
Capital structure: the mixture of long-term debt and equity maintained by a firm. What mixture of
debt and equity is best and what are the least expensive sources of funds for the firm?
Working capital: a firm’s short-term assets and liabilities.
Financial goals
• Profitability
• Liquidity
• Security
• Independence
1.2 The goal of financial management
Possible goals for for-profit businesses:
• Survive
• Avoid financial distress and bankruptcy
• Beat the competition
, • Maximize sales or market share
• Minimize costs
• Maximize profits
• Maintain steady earnings growth
These goals are easy to achieve, but most of these actions are not in the shareholders’ best interests.
Like lowering prices or never borrow any money.
These goals all fall into two classes. The first of these relates to profitability, the goals involving sales,
market share and cost control. The second group containing bankruptcy avoidance, stability and
safety, relate in some way to controlling risk.
The goal of financial management is to maximize the current value per share of the existing equity.
The total value of the equity in a corporation is simply equal to the value of the owners’ equity.
1.3 Financial markets and the corporation
Cash flows to and from the firm:
Cash flows to the firm from financial markets. The firm invests the cash in assets. These can be short-
term (current) or long-term (non-current), and they generate cash, some of which goes to pay
corporate taxes. After taxes are paid, some of this cash flow is reinvested in the firm. The rest goes
back to the financial markets as cash paid to creditors and shareholders. The financial markets are
not funded just by corporations paying cash to creditors or shareholders. The savings of households
also find their way into the financial markets. For example, whenever your salary goes into your
bank account or whenever you pay insurance, this money will end up in financial markets. This
happens because the financial institutions you pay your money to use it to invest in the financial
markets.
Primary markets: the original sale of securities by governments and corporations. Money that is
raised goes to issuing the firm. Corporations engage two types of primary market transaction, public
offerings, and private placements. A public offering involves selling securities to the general public,
whereas a private placement is a negotiated sale involving a specific buyer.
First share issue is called an Initial Public Offering and a second share issue is called a Seasoned
Offering.
Secondary markets: where these securities are bought and sold after the original sale. They provide
the means for transferring ownership of corporate securities. Investors are much more willing to
purchase securities in a primary market transaction when they know that those can be resold if
desired. Money that is raised goes to seller of securities.
Two kinds of secondary markets:
, Dealer market: /over the counter (OTC) markets, most of the selling and buying is done by a dealer
Auction market: Has a physical location, matches those who wish to sell and who wish to buy
Trading in corporate securities: The equity shares of most large firms trade in organized auction
markets.
Listing: Securities that trade on an organized exchange are said to be listed on that exchange. To be
listed, firms must meet certain minimum criteria concerning, for example, asset size and number of
shareholders.
Chapter 3 – Financial statement analysis
NWC: Net working capital
P/E ratio: Price-earnings ratio
PPE: Property, plant and equipment
ROA: Return on assets
ROE: Return on equity
3.1 The annual report
The annual report presents three financial statements:
1. The statement of financial position, or balance sheet
2. The income statement
3. The statement of cash flows
The statement of financial position (Balance sheet): Financial statement showing a firm’s
accounting value on a particular date. It is a convenient means of organizing and summarizing a
firm’s assets, liabilities and the difference between the two, equity, at a given point in time.
The balance sheet equation: Assets = liabilities + equity
Asset, the left side: Classified as current, life of less than 1 year, or non-current, life greater than 12
months and can be tangible or intangible.
Liabilities and owners’ equity, the right side: The firm’s liabilities are the first thing listed on the right
side of the statement of financial position, classified as current or non-current. The difference
between the total value of the assets and the total value of the liabilities is the shareholders equity,
also called ordinary equity or owners’ equity. If the firm were to sell all its assets and use the money
to pay of its debs, than whatever residual value remained would belong to the shareholders.
