SK

CORPORATE FINANCE

LECTURER: DR. TRINH QUOC DAT

SKEMA BUSINESS SCHOOL
EMAIL: [email protected]

CORPORATE FINANCE
LECTURE 1: FINANCIAL MANAGEMENT
AND THE BUSINESS ENVIRONMENT
 READING REQUIREMENTS

Chapter 1 Introduction to corporate finance,

"Principles of corporate finance"
by Brealey, Myers and Allen, McGraw-Hill ed., 12th.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL MANAGEMENT
AND CONTROL OF A FIRM

• Different forms of business organisation

• SOLE PROPRIETORSHIP
• PARTNERSHIP
• CORPORATION

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• General partnership
• Similar to a sole proprietorship but with multiple
owners
• Disavdavantage
• Unlimited liability including for the business dealings of
other partners

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• Limited Liability partnership

• Similar to a general partnership but with a separate
classification of partners
• Advantage
• Liability can be limited for the "limited partners" as opposed to the
"general partners"
• Disadvantage
• More complex administrative requirements
• Limited partners are passive investors and have no control

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 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

CORPORATE FINANCE - 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 WHAT’S A FIRM FROM
A FINANCIAL PERSPECTIVE?

• What’s a firm from a financial perspective?

• A pool of resources

In order to finance and run

• Assets and investment projects

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 A VERY CONCRETE EXAMPLE

• What about starting a new business and

selling croissants in the lounge for Skema
students?
Mysmallbusiness corp.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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
CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business
Environment
 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL STATEMENTS

• The balance sheet gives a picture of the firm

• What are the assets available to run the business?

• How were these assets financed?

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL STATEMENTS
Balance sheet
ASSETS (investments) LIABILITIES (resources)
• Equity (shareholders)
• Current Assets • Preferred and Common stock
• Cash • Retained earnings
• Accounts receivable • Debt
• Inventories • Long-Term Debt
• Fixed Assets • Long-term notes
• Machinery • Mortgages
• Land, etc, etc • Current Debt
• Other Assets • Accounts payable
• Patents • Accrued expenses
• Goodwill • Short-term notes

TOTAL ASSETS
= TOTAL LIABILITIES

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 MCDONALD’S BALANCE SHEET

A balance sheet must be Total liabilities and equity 34,281,400

BALANCED…
CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business
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 FINANCIAL STATEMENTS

• 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL STATEMENTS
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
Financing - Interest expense
Activities +/- Exceptional revenues/costs
= Earnings before taxes
- Corporate taxes
= Net Income

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 MCDONALD’S INCOME STATEMENT

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL STATEMENTS

• Mysmallbusiness company was incorporated in August year n. Money was raised

at that time, equipments were purchased as well as frozen croissants.
• The company start its operations on Sept 1, year n and goes until Dec 31, year n.
Over this 4 months, it sells for $100 of croissants (warm not frozen…) destocking
for $20 of its frozen croissants.
• In order to inform Skema students about its new business, it makes and distributes
flyers for a cost of $8.
• On Dec 6, it decides to replenish its stock of frozen croissant and goes to Carrefour
(or Walmart). Bus ticket costs $2. It buys for $30 of frozen croissants.
• You pay a 10% interest rate to your parents for the money they lent to you. Tax
rate is 40%.
• All income and expenses are paid cash (no credit on sale)
• Show the income statement for the period Sep 1, year n up to Dec 31, year n.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 CASH FLOWS
• 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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.
(lenghty)
• Indirect method
• the Indirect method adjusts net income for items that affected reported net
income but didn't affected cash (easier)

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 MCDONALD’S CASH FLOW
STATEMENT

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 FINANCIAL STATEMENTS WRAP-UP

• Balance sheet

• Income statement

• Cash flow statement

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business
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 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

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 CFO is in charge of

• Treasurer
• Capital budgeting • Controller
• Financing • Accounting
• Cash management • Preparation of financial
• Recommending statements
dividend policy • Preparing budgets
• Insurance • Internal auditing
• Pension plans

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 The Role of the Financial Manager

• The CFO tries to maximize the value of the

firm through
• Investment decision
• Financing decision
• Dividend decision

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 Questions and Exercises

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 QUESTIONS

1. What is the main disadvantage of sole proprietorship compared to

corporation?
2. What does CEO mean?
3. With a financial perspective, one can say that a firm is a pool of
_____________ in order to ______________
4. What are the only two ways to finance a firm?
5. How do we call the money brought by shareholders?
6. What is the difference between a shareholder and a debtholder?
7. What are the three financial statements and what are they used for?
8. What is depreciation?

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

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 Questions - Solutions

• The main disadvantage of sole proprietorship

compared to corporation: unlimited liability

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 EXERCISE 1 MYSMALLBUSINESS CORP.
REMINDER (DATA ALREADY PRESENTED DURING THE
LECTURE)

• Mysmallbusiness company was incorporated in August year n. Money was raised

at that time, equipments were purchased as well as frozen croissants.
• The company start its operations on Sept 1, year n and goes until Dec 31, year n.
Over this 4 months, it sells for $100 of croissants (warm not frozen…) destocking
for $20 of its frozen croissants.
• In order to inform Skema students about its new business, it makes and distributes
flyers for a cost of $8.
• On Dec 6, it decides to replenish its stock of frozen croissant and goes to Carrefour
(or Walmart). Bus ticket costs $2. It buys for $30 of frozen croissants.
• You pay a 10% interest rate to your parents for the money they lent to you. Tax
rate is 40%.
• All income and expenses are paid cash (no credit on sale)
• Show the income statement for the period Sep 1, year n up to Dec 31, year n.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 EXERCISE 1
FINANCIAL STATEMENTS

• Question 1
• Following the Income Statement, give also the Cash
Flow statement as well as the Balance Sheet at the
end of the year (no depreciation, no dividend, all
earnings are reinvested).
• Question 2
• Give the new income statement assuming we record
$10 of depreciation on the equipments (fixed assets)

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 EXERCISE 1
FINANCIAL STATEMENTS

• Question 3
• Same exercise but now we are said that the company
sell $80 cash and $20 on credit
• It is offered a 4-month delay for paying the marketing
expenses and taxes will be paid next year (in year n+1).
• On Dec 31, you decide to buy a second microwave
oven financed with a $150 one-year loan
• Give IS, CF and BS statements from Sept 1 to Dec 31,
year n.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 EXERCISE 1
FINANCIAL STATEMENTS

• Question 3-1
• Same exercise but now we are said that the company sell
$40 cash and $60 on credit
• It is offered a 4-month delay for paying all the marketing
expenses and 50% of taxes will be paid next year (in year
n+1).
• On Dec 31, you decide to buy a second microwave oven
financed with a $150 5-year loan
• Give IS, CF and BS statements from Sept 1 to Dec 31, year n.

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment
 EXERCISE 2
FINANCIAL STATEMENTS

• If a company incurs $10 (pretax) of depreciation expense, how

does that affect the three financial statements?
• A company makes a $100 cash purchase of equipment on Dec.
31. How does this impact the three statements this year and
next year?
• Same question as the previous but the company finances the
purchase of equipment by issuing debt rather than paying cash.
• Continuing with the last question, on Jan. 1 of Year n+3 the
equipment breaks and is deemed worthless. The bank calls in
the loan. What happens in Year n+3?

CORPORATE FINANCE - LECTURE 1 : Financial Management and the Business

Environment