Corporate Finance: Inflation and Deflation

Corporate Finance

• Individuals prefer present consumption over future consumption
• Monetary inflation is a risk factor in cash flow
• Present Value (PV) - Barwert
• Future Value – zukünftiger Wert
• EU inflation rate = 2.4% (October 3, 2024)
• High inflation countries (Summer 2024, July-August): Turkey, Venezuela, Argentina, Syria, South Sudan, Zimbabwe, etc.
• Inflation can be beneficial for companies
• Inflation is a general price increase in goods and services over time
• Deflation (negative inflation) countries (Summer 2024): Sri Lanka, Senegal, Afghanistan, etc.
• Deflation: decrease in the general price level of goods and services
• Disinflation: a slowdown in the inflation rate
• Deflation is detrimental to the economy, as it indicates slower production by companies and usually leads to falling wages.
• Customers view deflation as it providing lower costs for goods or services, however, it takes a longer time to acquire the goods/service due to lower production.
• First test date: November 7th

Financial Statements

• Balance sheet: a snapshot of a company's financial position at a specific time.

• Assets: what the company owns (short-term and long-term)

• Liabilities: what the company owes

• Stockholders' Equity: the difference between a company's assets and liabilities

• Current assets: cash or assets that can be easily turned into cash within a year

• Current liabilities: obligations that must be paid within a year

• Long-term liabilities: obligations that must be paid over a period of more than one year.

• Current assets examples: cash, marketable securities, accounts receivable, and inventories.

• Current liabilities examples: Accounts payables, Short-term debt, Current maturities of long-term debt, wages payable.

• Long-term liabilities examples: Long-term debt, Capital leases, Deferred taxes

• Stockholders' equity is the book value of assets less the book value of liabilities.

Retained Earnings

• Net income (net profit) - no dividends
• Current assets:
  • Cash
  • Raw material
  • Accounts receivable
  • Marketable securities
  • Inventories

Statement of Cash Flows

• Summarizes cash flow entering and leaving a company
• Operating activities
• Investing activities
• Financing activities
• Direct method - every spending is noted
• Indirect method - balance sheet detail is used instead of the transaction details

Income Statement

• Revenues = total revenues
• Cost of sales = cost of revenues
• EBITDA = EBITDA - gross profit = other operating expenses
• EBIT = EBIT - EBITDA = depreciation
• EBT = EBIT - interest expense
• Tax expenses = difference between Net income and EBT

Financial Analysis

• Comparing a company's performance over time or against other similar companies
• Evaluating stability, liquidity, solvency, and profitability.
• Internal users: management.
• External users: investors, creditors, regulators, stock market analysts, and auditors

Short Term Asset Management

• Short-term assets or securities in investments refer to assets that are held for less than one year.
• Examples: Cash, marketable securities, accounts receivable, inventories, and other current assets

Net Working Capital

• Net Working Capital = Current Assets - Current Liabilities
• A measure of a company's liquidity, operational efficiency, and short-term financial health

Cash Management

• Operating cycle: time it takes to buy goods, sell them, and receive cash.
• Cash conversion cycle (CCC): time it takes to convert cash spent on inventory into cash from sales.
• Inventory turnover: ratio of inventory to total sales, multiplied by 360.
• Accounts receivable turnover: ratio of accounts receivable to total sales, multiplied by 360
• Accounts payable turnover: ratio of accounts payable to total sales, multiplied by 360.
• Cash cycle = inventory turnover + accounts receivable turnover - accounts payable turnover

Inventory Management

• Ordering, storing, using, and selling a company's inventory (raw materials, components, finished goods)
• Capital tied up
• Costs of holding stock

Economic Order Quantity (EOQ)

• The ideal quantity of units a company should purchase to meet demand while minimizing inventory costs(holding costs, shortage costs and order costs)
• EOQ = √(2*(O)*(S))/C O = Cost of placing an order S = Annual demand C = Holding cost of one unit

Just-in-Time (JIT) Inventory Control

• Inventory is received as close as possible to when it's needed.

Account Receivables Management

• Monitoring and controlling customers' credit.
• Establishing credit standards and terms.
• Establishing a collection policy.
• Accounts Receivable Days: average number of days to collect on sales.

Short-Term Financing

• Financing of business for a short period (less than one year).
• Trade credit (accounts payable): floating time to pay for goods/services.
• Bank finance (unsecured and secured): a way of borrowing from the bank, such as working capital loan, bill discounting, overdraft, letter of credit, and cash credit.
• Accrued expenses: expenses already acknowledged, but not yet paid.
• Commercial papers: short-term notes to provide financing for trade receivables.

Deferred Revenues

• A part of the firm's income that has not been acquired, but pre-payment has received from the customers

Long-Term Financing

• Financing for capital assets
• Equity financing: sale of company shares
• Debt financing: loans or bond issues
• Angel investors: wealthy individuals who invest in businesses
• Venture capital firms: groups of investors who invest in growing businesses
• Initial public offerings (IPOs): companies selling shares to the public.

Investment Decision-Making

• Putting investment into something to generate profit.
• Investment analysis: return greater than the minimum acceptable hurdle rate, the mix of debt or equity financing.
• Investment decision-making ('Capital Budgeting'): dealing with physical and intangible assets.

Capital Expenditures (CAPEX)

• Costs incurred on the acquisition of a fixed asset or any subsequent expenditure that increases the earning capacity

Cash Flow from Investments

• aggregate change in a company's cash position resulting from investments in financial markets and operating subsidiaries
• Examples of cash flows from investment activities: payments for long-term assets, cash receipts from the sale of assets.
• Evaluations of investment projects effectiveness
• Methods:
  • Accounting Rate of Return
  • Payback Period
  • Net Present Value
  • Internal Rate of Return

Cost of Capital

• The return a company needs to justify capital project cost.
• Weighted average cost of capital (WACC)
  • Average cost of all types of financing; weighted by their proportion in the capital structure.
• Cost of Debt
  • Effective interest rate for loans/bonds.
• Cost of Equity
  • Return that the market demands for ownership risk.
  • Dividend capitalization model
  • Capital asset pricing model (CAPM).

Optimal Capital Structure

• Best mix of debt and equity for maximizing market value and minimizing cost of capital.
• Finding the optimal point when the marginal benefit of debt equals marginal cost

Company's Profit and Dividend Policy

• Revenue: average sales price multiplied by the number of units sold

• Costs / Expenses:

  • Operating expenses: costs directly related to business operations
  • Non-operating expenses: costs not directly related to business operations
  • Costing methods
    • Activity-Based Costing (ABC)
    • Activity-Based Management (ABM).

• Break-even point: the production level where total revenues equal total expenses

Company Valuation

• Determining the economic value of a company or business unit.
• Tools used: management analysis, capital structure, future earnings.
• Methods
  • Market Approach:
    • Market capitalization
    • Times revenue method
    • Earnings multiplier
  • Yield Method
    • Discounted Cash Flow (DCF)
    • Economic Value Added (EVA)
  • Book Value