Finance & risk management - IB
Lecture 1: Introduction to Corporate Finance
What is Finance about?
Art & Science of Managing Wealth ➔ Wealth reflects market value, not historical, of assets.
What is Corporate Finance ?
Financial decisions: capital investment, operation, financing, budgeting.
The role of the management is to make sure that the firm can operate and has sufficient
cash flow to pay ST/LT expenses.
Making decisions regarding WHAT assets to buy / sell and WHEN to buy / sell those
assets.
TIME: Timing of cash inflows & outflows are different.
UNCERTAINTY: Expectation, but NOT guarantee that inflows will be received.
Investment:
• What long-term investments will you make?
• Timing: Cash outflow today to generate future cash inflows.
Financing:
• Where will you get long-term financing for your long-term projects?
• Timing: Cash inflows today and cash outflows in the future in order to meet obligations.
Liquidity (daily basis activities):
• How will you manage your everyday activities?
• Timing: Balance of cash inflows and outflows in the short-term.
Corporate finance takes into account: debt financing, equity financing (money from
shareholders), bankruptcy risk, make decision btw short and LT investments.
The Goal of Financial Management
Manage Risk + Maximize share price + Avoid Financial distress = Maximize Value of Owner’s
Equity (Market value of shareholdings).
Value maximization as the goal of the firm implies enhancing the wealth of shareholders
1
,Financial Statements
Financial Management → Keep track of the cash that comes in & goes out of the business.
▪ Balance Sheet→ Snapshot of the company at a single point in time.
▪ Income Statement (Profit and Loss account) → Profitability of the company for a
specific period.
Financial Analysis → Cash flow is the main valuation input of the stock of the company
Financial Management Decisions
Capital Budgeting Decision:
The process of planning and managing a firm’s long-term investments
>>> Look at the LT assets in the Balance Sheet
Capital Structure Decision:
How to raise the Capital needed to buy assets? Raise found from investors/ borrow money
from the bank
>>> Look at the LT liabilities / Stockholders equity in the Balance Sheet ( =Capital Mix)
Working Capital Management:
How to operate the firm; How much short-term cash flow does a company need to pay its
bills? Daily operations of the company: Short-term
>>> Look at the current assets and current liabilities in the Balance Sheet
Net Working Capital (NWC) = Current Assets – Current Liabilities
Forms of Business Organization
Sole Proprietorship: The business is owned by only one person. Unlimited liabilities. No
difference made btw personal and business assets. The owner is fully responsible of
the company’s obligations.
Partnership: Two or more individuals can decide together to form partnership. At some point
they will be a corporation since it’s difficult to raise funds.
Corporation: Completely separate from the owners.
➢ Unlimited life
➢ Easy transfer of ownership (sell and buy shares very easily on the stock market)
➢ Limited liability: as an owner you have restricted responsibility
➢ Increased access to funding: capital market
2
,Managerial vs Shareholder Goals
▪ Corporation is a set of contracts
▪ Agency Relationship: contract between shareholders & managers. Separation of control
and management
Financial Goal: Maximize shareholder’s wealth
Managerial Goal: Can be different from shareholder’s wealth maximization.
Conflicts of Interest may arise : agency problems.
Corporate Governance
Set of rules, practices, and processes by which a company is directed and controlled.
Main goal is to protect shareholders’ interests and reduce agency problems.
Devise contracts that align the incentives of managers to those of shareholders.
• Managerial compensation plans: give him some shares.
• Threats of termination of employment: if the goals are not reach, he can lose his job.
• Threats of takeover: if the company is performing badly, all managers can lose their job.
Cash Flows
The most important item to take from financial statements
Cash Flow is NOT the same as Net Working Capital
Cash Flows from Assets = Cash Flows to Creditors and Equity Investors
Total Cash Flow comes from operating activities, investing activities, & financing activities
Calculation of Cash Flows from Operating Activities
Operating Cash Flow = Net Income + Depreciation + Interest Expense - Change in
Net Working Capital
= EBIT + Depreciation - Taxes - Change in Net Working Capital
Start with the Net Income:
We add back depreciation to Net Income
because depreciation is a NON-CASH EXPENSE.
We also don’t want to include interest
expenses because it is a financing expense.
We calculate the Change in Net
Working Capital (Delta NWC) =
Payment for short-term assets
3
, Note: If it was negative, then raising more short-term debt than investing in short-term
assets
Dividend, shareholders’ claim is paid from net income. The rest of net income goes to
Retained Earnings.
∆ = (55 – 32.7) – (47 – 27.7)
= 22.3 – 19.3
∆=
= Net Income + Depreciation + Interest Expense - ∆
= 2 + 1.2 + 7.7 − 3 = 7.9
= EBIT + Depreciation - Taxes - ∆
= 10.4 + 1.2 – 0.7 − 3 = 7.9
Financial Markets
Companies raise cash they need for their operations from investors by utilizing financial
markets.
Classification of markets by the maturity of assets:
• Money Market: Assets will mature within 1 year.
• Capital Market: Assets will mature in over 1 year.
Classification of markets by owners of assets:
• Primary Market: “First sale” market.
• Secondary Market: “After sale” market.
Primary Market
Corporations raise external funds through financial assets, such as stocks & bonds
Secondary Market
The sale of securities from one investor to another
4
Lecture 1: Introduction to Corporate Finance
What is Finance about?
Art & Science of Managing Wealth ➔ Wealth reflects market value, not historical, of assets.
What is Corporate Finance ?
Financial decisions: capital investment, operation, financing, budgeting.
The role of the management is to make sure that the firm can operate and has sufficient
cash flow to pay ST/LT expenses.
Making decisions regarding WHAT assets to buy / sell and WHEN to buy / sell those
assets.
TIME: Timing of cash inflows & outflows are different.
UNCERTAINTY: Expectation, but NOT guarantee that inflows will be received.
Investment:
• What long-term investments will you make?
• Timing: Cash outflow today to generate future cash inflows.
Financing:
• Where will you get long-term financing for your long-term projects?
• Timing: Cash inflows today and cash outflows in the future in order to meet obligations.
Liquidity (daily basis activities):
• How will you manage your everyday activities?
• Timing: Balance of cash inflows and outflows in the short-term.
Corporate finance takes into account: debt financing, equity financing (money from
shareholders), bankruptcy risk, make decision btw short and LT investments.
The Goal of Financial Management
Manage Risk + Maximize share price + Avoid Financial distress = Maximize Value of Owner’s
Equity (Market value of shareholdings).
Value maximization as the goal of the firm implies enhancing the wealth of shareholders
1
,Financial Statements
Financial Management → Keep track of the cash that comes in & goes out of the business.
▪ Balance Sheet→ Snapshot of the company at a single point in time.
▪ Income Statement (Profit and Loss account) → Profitability of the company for a
specific period.
Financial Analysis → Cash flow is the main valuation input of the stock of the company
Financial Management Decisions
Capital Budgeting Decision:
The process of planning and managing a firm’s long-term investments
>>> Look at the LT assets in the Balance Sheet
Capital Structure Decision:
How to raise the Capital needed to buy assets? Raise found from investors/ borrow money
from the bank
>>> Look at the LT liabilities / Stockholders equity in the Balance Sheet ( =Capital Mix)
Working Capital Management:
How to operate the firm; How much short-term cash flow does a company need to pay its
bills? Daily operations of the company: Short-term
>>> Look at the current assets and current liabilities in the Balance Sheet
Net Working Capital (NWC) = Current Assets – Current Liabilities
Forms of Business Organization
Sole Proprietorship: The business is owned by only one person. Unlimited liabilities. No
difference made btw personal and business assets. The owner is fully responsible of
the company’s obligations.
Partnership: Two or more individuals can decide together to form partnership. At some point
they will be a corporation since it’s difficult to raise funds.
Corporation: Completely separate from the owners.
➢ Unlimited life
➢ Easy transfer of ownership (sell and buy shares very easily on the stock market)
➢ Limited liability: as an owner you have restricted responsibility
➢ Increased access to funding: capital market
2
,Managerial vs Shareholder Goals
▪ Corporation is a set of contracts
▪ Agency Relationship: contract between shareholders & managers. Separation of control
and management
Financial Goal: Maximize shareholder’s wealth
Managerial Goal: Can be different from shareholder’s wealth maximization.
Conflicts of Interest may arise : agency problems.
Corporate Governance
Set of rules, practices, and processes by which a company is directed and controlled.
Main goal is to protect shareholders’ interests and reduce agency problems.
Devise contracts that align the incentives of managers to those of shareholders.
• Managerial compensation plans: give him some shares.
• Threats of termination of employment: if the goals are not reach, he can lose his job.
• Threats of takeover: if the company is performing badly, all managers can lose their job.
Cash Flows
The most important item to take from financial statements
Cash Flow is NOT the same as Net Working Capital
Cash Flows from Assets = Cash Flows to Creditors and Equity Investors
Total Cash Flow comes from operating activities, investing activities, & financing activities
Calculation of Cash Flows from Operating Activities
Operating Cash Flow = Net Income + Depreciation + Interest Expense - Change in
Net Working Capital
= EBIT + Depreciation - Taxes - Change in Net Working Capital
Start with the Net Income:
We add back depreciation to Net Income
because depreciation is a NON-CASH EXPENSE.
We also don’t want to include interest
expenses because it is a financing expense.
We calculate the Change in Net
Working Capital (Delta NWC) =
Payment for short-term assets
3
, Note: If it was negative, then raising more short-term debt than investing in short-term
assets
Dividend, shareholders’ claim is paid from net income. The rest of net income goes to
Retained Earnings.
∆ = (55 – 32.7) – (47 – 27.7)
= 22.3 – 19.3
∆=
= Net Income + Depreciation + Interest Expense - ∆
= 2 + 1.2 + 7.7 − 3 = 7.9
= EBIT + Depreciation - Taxes - ∆
= 10.4 + 1.2 – 0.7 − 3 = 7.9
Financial Markets
Companies raise cash they need for their operations from investors by utilizing financial
markets.
Classification of markets by the maturity of assets:
• Money Market: Assets will mature within 1 year.
• Capital Market: Assets will mature in over 1 year.
Classification of markets by owners of assets:
• Primary Market: “First sale” market.
• Secondary Market: “After sale” market.
Primary Market
Corporations raise external funds through financial assets, such as stocks & bonds
Secondary Market
The sale of securities from one investor to another
4
