Corporate Finance Lecture 1 PDF

SKEMA BUSINESS SCHOOL LECTURE 1 FINANCIAL MANAGEMENT AND THE BUSINESS ENVIRONMENT  READING REQUIREMENTS Chapter 1 Introduction to corporate finance, Chapter 2 Corporate governance...

SKEMA BUSINESS SCHOOL LECTURE 1 FINANCIAL MANAGEMENT AND THE BUSINESS ENVIRONMENT  READING REQUIREMENTS Chapter 1 Introduction to corporate finance, Chapter 2 Corporate governance Chapter 3 Financial statement analysis Corporate Finance, European edition, by Hillier, Ross, Westerfield, Jaffe and Jordan, McGraw-Hill ed., 4th. Get access to the book @ https://k2.skema.edu in the course Corporate Finance Lecture 1: Financial Management and the Business Environment PLAN Financial management and control of a firm The role of the financial manager What is a firm from a financial perspective? An overview of financial statements Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Different forms of business organisation SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Sole Proprietorship Business owned by one person Taxed as personal income No distinction between business income and personal income Advantage easy to start Disavdavantage Unlimited liability Creditors can look beyond business assets to personal asset Limited transferability Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Corporation Corporation = legal ‘person’ Separate and distinct from owners Can borrow money Enter into contracts Own property Sue and be sued Can own stock in another corporation Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Corporation Stockholders elect Board of Directors Only Board of Directors has legal power To declare a dividend To issue securities To commit large investment outlays Directors elect senior management (CEO, President) To run the corporation in interest of stockholders Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Since the 1980s, the mainstream view is that the purpose of corporations is only about generating profits and maximizing value for its shareholders However this is a narrow financial perspective that does not maximize societal welfare Pollution, unhealthy products, monopolies, labor exploitation This view has started to be questionned after the financial crisis and the growing environmental awareness Lecture 1: Financial Management and the Business Environment  FINANCIAL MANAGEMENT AND CONTROL OF A FIRM … which translates into greater concerns for stakeholders, leads to redefining the purpose of corporations … Statement on the Purpose of a Corporation Delivering value to our customers. Investing in our employees. Dealing fairly and ethically with our suppliers. Supporting the communities in which we work. Generating long-term value for shareholders Published on Aug 19, 2019 by Business Roundtable https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM … and give rise to the emergence of new corporate forms “Benefit corporation” in the U.S.A., “entreprise à mission” in France Aims to challenge the “shareholder primacy” rule and include social and/or environmental issues in addition to the seek of profit, in their legal provisions But so far, in most cases the view of shareholders still prevails, for good or bad … Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM Are capitalism and market economy able to address the growing social and environmental pressures faced by our societies? Lecture 1: Financial Management and the Business Environment FINANCIAL MANAGEMENT AND CONTROL OF A FIRM In the rest of this course, we will adopt the shareholder’s perspective But do not forget that there are many other stakeholders with different and very legitimate objectives Lecture 1: Financial Management and the Business Environment  WHAT IS A FIRM FROM A FINANCIAL PERSPECTIVE? WHAT is a firm from a financial perspective? A pool of resources In order to finance and run Assets and investment projects Lecture 1: Financial Management and the Business Environment  THE ROLE OF THE FINANCIAL MANAGER The CFO (Chief Financial Officer) stands between Cash flows invested in the real assets of the firm Cash flows generated by the real assets of the firm Cash flows invested in the firm by the investors Cash flows generated by the firm and returned to the investors or retained into the firm Lecture 1: Financial Management and the Business Environment  THE ROLE OF THE FINANCIAL MANAGER The Chief Financial Officer (CFO) is in charge of Treasurer Controller Capital budgeting Accounting Financing Preparation of financial Cash management statements Recommending Preparing budgets dividend policy Internal auditing Insurance Pension plans Lecture 1: Financial Management and the Business Environment  THE ROLE OF THE FINANCIAL MANAGER The CFO tries to maximize the value of the firm through Investment decision Financing decision Dividend decision Lecture 1: Financial Management and the Business Environment WHAT IS A FIRM FROM A FINANCIAL PERSPECTIVE? A VERY CONCRETE EXAMPLE What about starting a new business and selling croissants in the lounge for Skema students? Mysmallbusiness corp. Lecture 1: Financial Management and the Business Environment WHAT IS A FIRM FROM A FINANCIAL PERSPECTIVE? A VERY CONCRETE EXAMPLE: MYSMALLBUSINESS CORP. What about selling croissants in the lounge ? What do you need to run this business? Fixed assets 1 table $50 1 cash register $100 1 freezer $150 1 microwave oven $150 Current assets A stock of 200 frozen croissants $50 $50 in cash (coins&banknotes) $50 Total Assets = $550 Lecture 1: Financial Management and the Business Environment  WHAT IS A FIRM FROM A FINANCIAL PERSPECTIVE? A VERY CONCRETE EXAMPLE: MYSMALLBUSINESS CORP. You need $550 to start this business How to finance it? For instance let’s assume You put $300 from your own savings into this business. You are the only owner (shareholder) of Mysmallbusiness corp. The company Mysmallbusiness corp. borrows from your parents $250 for five years Lecture 1: Financial Management and the Business Environment  WHAT IS A FIRM FROM A FINANCIAL PERSPECTIVE? A VERY CONCRETE EXAMPLE: MYSMALLBUSINESS CORP. Balance sheet Mysmallbusiness corp. ASSETS (investments) LIABILITIES (resources) Current Assets Equity (stockholders) Common stock $300 Cash $50 Long-Term Debt (debtholders) Inventories (croissants) $50 Long-term notes $250 Fixed Assets $450 TOTAL ASSETS $550 TOTAL LIABILITIES $550 Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS THE BALANCE SHEET The balance sheet gives a picture of the firm What are the assets available to run the business? How were these assets financed? Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS THE BALANCE SHEET Balance sheet ASSETS (investments) LIABILITIES (resources) Equity (shareholders) Current Assets – Preferred and Common stock Cash – Retained earnings Accounts receivable Debt Inventories Fixed Assets – Long-Term Debt Machinery Long-term notes Land, etc, etc Mortgages Other Assets – Current Debt Patents Accounts payable Goodwill Accrued expenses Short-term notes TOTAL ASSETS = TOTAL LIABILITIES Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS TESLA’S BALANCE SHEET TESLA Balance sheet 2019 In Millions of USD Assets Liabilities & Shareholders' Equity + Cash, Cash Equivalents & STI 6268 + Payables & Accruals 6448 + Accounts & Notes Receiv 1324 + ST Debt 2013 + Inventories 3552 + Other ST Liabilities 2206 + Other ST Assets 959 Total Current Liabilities 10667 Total Current Assets 12103 + LT Debt 12590 + Property, Plant & Equip, Net 14061 + Other LT Liabilities 2942 + LT Investments & Receivables 393 Total Noncurrent Liabilities 15532 + Other LT Assets 7752 Total Liabilities 26199 Total Noncurrent Assets 22206 Total Equity 8110 Total Assets 34309 Total Liabilities & Equity 34309 A balance sheet must be BALANCED, Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS THE INCOME STATEMENT Now that we are given the assets, we can run the business and start to record our activity It’s going to be recorded in the Income statement Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS THE INCOME STATEMENT What do we record in the income statement? Revenues Expenses necessary to earn the revenues. When do we record in the income statement? Revenues are recorded when earned, not when they are paid Expenses are recorded when incurred to produce the revenues, not when they are paid Periodicity Quarterly, semi-annual, annual Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS THE INCOME STATEMENT Operating Activities Income Statement + Sales - Cost of producing or acquiring product/services = Gross Profit - Operating Expenses marketing and selling expenses general and administrative expenses depreciation expenses = Operating Income - Interest expense Financing +/- Exceptional revenues/costs Activities = Earnings before taxes - Corporate taxes = Net Income Lecture 1: Financial Management and the Business Environment AN OVERVIEW OF FINANCIAL Revenue + Sales & Services Revenue 24 578 23 047 STATEMENTS + Other Revenue 1 531 - Cost of Goods and Services 20 509 TESLA’S INCOME STATEMENT Gross Profit 4 069 - Operating Expenses 3 843 + Selling, General & Admin 2 646 + Research & Development 1 343 + Other Operating Expense (146) Operating Income (Loss) 226 - Non-Operating (Income) Loss 596 + Interest Expense, Net 641 + Foreign Exch (Gain) Loss (48) + Other Non-Op (Income) Loss 3 Pretax Income (Loss), Adjusted (370) - Abnormal Losses (Gains) 295 + Disposal of Assets 146 + Other Abnormal Items 149 Pretax Income (Loss), GAAP (665) - Income Tax Expense (Benefit), GAAP 110 Income (Loss) from Cont Ops, GAAP (775) Income (Loss) Incl. MI, GAAP (775) - Minority Interest, GAAP 87 Net Income, GAAP (862) Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS Depreciation Depreciation is the process by which a company gradually records the loss in value of a fixed asset. Depreciation is a cost (recorded in the income statement) and impact the net value of the assets (recorded in the balanced sheet) Depreciation is a non-cash expense Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS Let’s recap The balance sheet records the assets available in the firm and how are they financed at a particular time The income statement reports the earnings of a company by recording all income and expenses of the company over a certain period Balance sheet and income statement do not reflect the actual disbursements (cash outflows) made by the firm nor the actual payments (cash inflows) received by the firm. It is done with a third financial statement called the cash flow statement Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS CASH FLOWS STATEMENT What are the different kinds of cash flows circulating in or around a firm? 2°)Cash invested 1°)Cash raised in projects from investors reinvested 4°a)Cash Firm's Financial Financial operations manager resources 3°)Cash generated 4°b)Cash returned by operations to investors Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS CASH FLOW STATEMENT Three sections in the cash flow statement Cash flow from the operations Cash flow from investing Cash flow from financing Two ways to prepare a cash flow statement Direct method: Reports all cash receipts and cash disbursements from operating activities. Lengthy and tedious. Indirect method The indirect method adjusts net income for items that affected reported net income but didn't affect cash. Easier and faster. Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS CASH FLOW STATEMENT (INDIRECT METHOD) Cash flow from the operations Cash flow from operations Net income Additions to cash + Depreciation + Decrease in accounts receivable + Increase in accounts payable + Increase in taxes payable + Decrease in inventory Subtractions from cash - Increase in accounts receivable - Decrease in accounts payable - Decrease in taxes payable - Increase in inventory = Net cash from operations Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS CASH FLOW STATEMENT (INDIRECT METHOD) Cash flow from investing Cash flow from investing - In Fixed assets Net cash from investing Cash flow from financing Cash flow from financing - Dividends paid - Payment of loans + Proceeds from loans Net cash from financing Net cash position at the end of the period Initial cash position + increase/decrease in cash Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS TESLA’S CASH FLOW STATEMENT TESLA Cash flow statement 2019 Cash from Investing Activities Cash from Financing Activities Cash from Operating Activities + Change in Fixed & Intang (1 377) + Dividends Paid - + Net Income (862) + Other Investing Activities (59) + Cash From (Repayment) Debt 585 + Depreciation & Amortization 2 154 Cash from Investing Activities (1 436) + Cash (Repurchase) of Equity 1 022 + Non-Cash Items 772 + Other Financing Activities (78) + Chg in Working Capital 341 Cash from Financing Activities 1 529 + (Inc) Dec in Accts Receiv (367) + (Inc) Dec in Inventories (429) Effect of Foreign Exchange Rates 8 + Inc (Dec) in Other 1 137 Cash from Operating Activities 2 405 Net Changes in Cash 2 506 Cash from operating activities + 2 405 Cash from investing activities (1 436) Cash from financing activities + 1 529 Effect of FX rates + 8 Net change in cash in 2019 + 2 506 Lecture 1: Financial Management and the Business Environment  AN OVERVIEW OF FINANCIAL STATEMENTS FINANCIAL STATEMENTS WRAP-UP Balance sheet Income statement Cash flow statement Lecture 1: Financial Management and the Business Environment