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Content
I.

Introduction to corporate finance

II. Financial statements

CHAPTER 5

III. Financial analysis

CORPORATE FINANCE

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I. INTRODUCTION TO CORPORATE FINANCE

Finance is the study of how to allocate scarce


resources over time
(Bodie and Robert C. Merton, Finance)
Mobilizing
Acquiring

Using
monetary
funds

$$
Investing

Allocating
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I. INTRODUCTION TO CORPORATE FINANCE

3 key financial management decisions:


What long-term investment should the firm take on?
Capital budgeting
Where will the firm get long-term financing to pay
for the investments?
Capital structure
How will the firm manage its everyday financial
activities?
=> Working capital management
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Working capital management

I. INTRODUCTION TO CORPORATE FINANCE

3 types of activities

Managing the firms short-term assets and short-term


liabilities
Working capital = current assets current liabilities

Operating activities:
involve business activities
Investing activities:
involve financial investments
purchasing and selling fixed assets
Financing activities:
involve acquiring funds activities

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I. INTRODUCTION TO CORPORATE FINANCE


Firms operations

Financial
manager

Assets

Investors
Financial assets

Goal of financial management:


Maximize the wealth of current shareholders (maximize the
current value per share)

(1) Cash raised by selling financial assets to investors

Other goals:
Maximize profit
Minimize cost
Maintain steady growth
Avoid bankruptcy

(2) Cash invested in the firms operations


(3) Cash generated by the firms operations
(4a) Cash reinvested
(4b) Cash returned to investors

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II. FINANCIAL STATEMENTS

Functions of financial statements

1. Balance sheet assets and liabilities management

Provide information to stakeholders of the firm about


the companys current status and past financial
performance.

2. Income statement
3. Cash flows statement

Provide a convenient way for owners and creditors to


set performance targets and to impose restrictions on the
managers of the firm.

4. Notes to financial statements

Provide convenient templates for financial planning

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1. Balance sheet

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1. Balance sheet
ASSETS

Balance sheet is the financial statement that shows the


firms assets (the uses of the funds raise/ what it owns)
and liabilities (the sources of funds/ what it owes) at a
particular time (at a point of time).

LIABILITIES &
OWNERS EQUITY

CURRENT LIABILITIES
CURRENT ASSETS

The assets the liabilities = net worth/ owners equity


(for a corporation, - stockholders equity)

LONG-TERM
LIABILITIES
LONG-TERM ASSETS
(NON-CURRENT
ASSETS)

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OWNERS EQUITY
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Current

Liabilities

Long-term

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Market values and book values

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2. Income statement
Income statement is the financial statement that summarizes
the profitability of the firm over a period of time (it is usually
a year)
It shows the revenues, expenses and net income of a firm
during the past period.
Based on accrual accounting methods

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2. Income statement

Sales
Less deduction
Net sales
Costs of good sold
Gross profit
Operating expenses
Operating income (earnings before interest and taxes - EBIT)
Interest
Other income (- loss) net
Earnings before taxes (EBT)
Taxes
Net income

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3. Cash flows statement


Cash flows statement is a financial statement that shows
all the cash that flowed into and out of the firm during a
period of time.
Based on inflows and outflows
Cash flows from operations (CFO)
Cash flows from investments (CFI)
Cash flows from financing activities (CFF)
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4. Notes to financial statements

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III. FINANCIAL ANALYSIS


In analysing a firms performance using its financial

Providing:
An explanation of accounting methods used.
Greater detail regarding certain assets or liabilities.
Information regarding the equity structure of the firm.
Documentation of changes in operations.

statements, it is useful to apply some financial analysing


approaches:
Cross- sectional: Comparison against peers
Time- series: Comparison against self over time
Common- size (vertical) analysis
Trend (horizontal) analysis
Financial ratios: allow comparison between different size
firms on a common basis

Off-balance-sheet items.
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Financial ratios
To measure the outcome of these analyses, you need to
compare:
Against self (time- series, vertical, horizontal) and
Against peers/industry/market (cross- sectional, ratio)
For the best result, these approaches usually be applied
simultaneously.

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Profitability ratios
Debt (Financial leverage) ratios
Liquidity ratios
Asset turnover (Efficiency/Activity) ratios
Market value ratios

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Profitability ratios

Financial leverage

Return on sales (ROS): measures the return earned on the sales of the
firm.

Return on Assets (ROA): measures the overall effectiveness of


management in generating profits with its available assets.

Debt ratio: measures the proportion of total assets financed by the firms
creditors.

Time interest earned ratio: measures the firms ability to make


contractual interest payments.

Return on equity (ROE): measures the return earned on the ordinary


shareholders investment in the firm.

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Liquidity ratios

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Asset turnover ratios


Inventory turnover measures the activity (liquidity) of a firms inventory

The speed with which a company turns over its inventory is measured by
the number of days that it takes for the goods to be produced and sold.

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Asset turnover ratios


Receivables turnover

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Market value ratios

measures the ability to use credit sales in generating

PriceEarnings Ratio (price to earnings, P/E, ratio) measures the price


that investors are prepared to pay for each dollar of earnings.

revenue

The average collection period measures how quickly customers pay their
bills:

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Market-to-book Ratio (M/B)

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