Corporate Finance A1
Vysoká škola finanční a správní
Summer Semester 2012
Jaromír R. Stemberg
jaromir@mail.vsfs.cz
Course Layout
• Twelve two-hour lessons
• The course is to introduce general financial
management problems, realtions, terminology, and
solutions
• Ends with Credit (zápočet)
Literature
• Block, Stanley: Foundations of Financial
Management
McGraw-Hill, 2009
ISBN 978-0-07-128525-4
Grading
• Pass / Fail
• 50%: Five mathematical group excercises
• 50%: Written test
• Minimum to pass:
70%
Contents
•
Introduction
- history of finance
- goals of financial management
- financial markets
•
Review of Accounting
- the nature and role of the balance sheet
- theories of balance and their development
- creation of the second balance
- third and fourth balance, their formation and construction
Contents
•
Concept of capital
- preservation of the capital substance of a company
- ways of addressing it
•
Accounting systems in the world
- characteristics of accounting systems
- process of accounting harmonization
- US GAAP
- IAS/IFRS, link to the directives of the European Union
History of Money and Accounting
Barter Trade
• Exchange of personal possessions of value for other
goods
• From 9,000-6,000 B.C., livestock was often used as a
unit of exchange; as agriculture developed, people
used crops for barter
• This kind of exchange started at the beginning of
humankind and is still used today
Barter Trade Problems
• Finding the other party:
- interest
- time
• Establishing equal value of exchanged goods
• Durability of the exchanged goods, potentiality to
store it
• Need for a common, durable, storable, non-decaying,
generally accepted unit of exchange
Cowry Shells
• The first money (or medium of exchange)
• Began to be used at about 1200 B.C. in China
• Accepted in some African regions till 1950s
Metal Coins
• China, 1000 BC:
Bronze and copper cowry imitations were considered the
earliest forms of metal coins. They contained holes so they
could be put together like a chain.
• Lydia (Turkey), 500 BC:
The first coins developed out of lumps of silver and were
stamped with emperors to mark their authenticity. The
techniques were quickly copied by the Greeks, Persians, and
the Roman Empire. Unlike Chinese coins, these were made
from precious metals such as silver and gold, which had more
inherent value.
Banknotes
• China, 100 BC:
Leather money – pieces of painted white deerskin.
• China, 800 AD:
The first paper banknotes appeared.
• China, 1450 AD:
Printing money led to a soaring inflation so the use
of paper money in China disappeared (this was still
years to come before paper currency would be used
in Europe).
Development of Accounting
• Babylon, 18th century B.C.
- first organized records kept to account for assets and loans
- other ancient civilizations (Roman Empire, Greek Cities,
Egypt) followed
• Europe, 1st millennium A.D.
fall of the Roman Empire caused serious setback in education
• Italy, 13th century A.D.
- growing trade in the Mediterranean and accumulation of
wealth in Italy gave grounds to the development of banking
- double-entry bookkeeping was invented by Luca Pacioli
Modern Times Accounting
• 17th century
France:
- obligation to present bi-yearly balances of financial situation
Italy:
- complete theory of accounting
Holland:
- first corporation established, need for equity accounting
• 19th century
- massive increase of accounting operations
- perfection of accounting principles
- rules for asset evaluation
History of Accounting Standards
• 1938: American Institute of Certified Public Accountants
began to develop accounting standards (request of the
Securities and Exchange Commission)
• 1959: Accounting Principles Board established, introduction
of GAAP
• 1973: the International Accounting Standards Board (IASB)
formed to develop International Accounting Standards (IAS)
• 2001: end of IAS (41 issued so far, still valid); new standards
are from now on called International Financial Reporting
Standards (IFRS) that quickly became accepted world wide
Principles of Accounting
Record Keeping
• Information – a basic management tool needed for
- past references and reporting
- present registration and evidence
- future planning and management decision making
• Registered entries keep track of:
- amount how much
- count how many
- time when
- place where
- person who
Double-Entry Accounting
• Accounts
- recognition of individual transactions
- debit and credit to be recorded at the same time
• General Ledger (hlavní kniha)
- transactions recorded in accounts, total of both sides must
be equal
- can be extended by subsidiary ledgers
• Journal (účetní deník)
- transactions recorded in order as they occurred
- both sides of the record must be equal
Purpose of Record Keeping
• Financial accounting
- provides information for owners, investors and other stake
holders
- serves as a base for income tax due calculation
- subject to regulations by accounting standards
- must be true and honest
• Managerial accounting
- serves the managers as base for strategy planning and
decision making
- provides specified pieces of information
- outcomes don’t have to be understood by the general public
Financial Reports Analysis
Balance Sheet
Assets
Liabilities
Current Assets
Cash and Equivalents
Short-Term Receivables
Inventory
Accruals and Other S/T Assets
Current Liabilities
Short-Term Accounts Payable
Current Tax Payable
Short-Term Loans and Borrowings
Accruals and Other S/T Liabilities
Long-Term Assets
Intangible Fixed Assets
Tangible Fixed Assets
Long-Term Receivables
Long-Term Liabilities
Long-Term Payables
Provisions
Owners’ Equity
Share Capital
Share Premium and Capital Funds
Retained Earnings
Y-T-D Profit (Loss)
Revenue
Material
Production Exp.
Commission
Other Selling Exp.
Cost of Goods Sold
Gross Profit
Marketing
Administration
Office Exp.
Consultants
Depreciation
Other Exp.
Total G&A Expenses
Profit from Operations
Financial Income
Financial Exp.
Net Financial Result
Profit before Tax
Corporate Income Tax
Net Profit
Cash Flow Statement
Statement of Changes in Equity
Share
Capital
Balance
at 31 Dec. X-1
Distribution of
profit or loss
Change in share
capital
20 000
Capital
Funds
Statutory
Funds
374
4 304
26
5 024
Current
Total Equity
Period
Profit
9 050
33 728
-9 050
-4 000
0
Dividends paid
Payments from
capital funds
Profit or loss
current period
Balance
at 31 Dec. X
Retained
Earnings
4 000
4 000
0
20 000
400
13 328
9 954
9 954
9 954
43 682
Profitability Ratios
• Profit margin
• Return on assets (investments)
• Return on equity
Profit Margin
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Net income / Sales = 200 / 4 000 = 5%
1 600
Return on Assets
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Net income / Total assets = 200 / 1 600 = 12,5%
1 600
Return on Equity
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Net income / Stockholders‘ equity = 200 / 1 000 = 20%
1 600
Asset Utilization Ratios
•
•
•
•
•
Receivable turnover
Average collection period
Inventory turnover
Fixed asset turnover
Total asset turnover
Receivable Turnover
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Sales / Accounts receivable = 4 000 / 350 = 11,4 times
1 600
Average Collection Period
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Accounts receivable / (Sales / 365) = 350 / 11 = 32 days
1 600
Fixed Assets Turnover
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Sales / Fixed Assets = 4 000 / 800 = 5 times
1 600
Total Assets Turnover
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Sales / Total assets = 4 000 / 1 600 = 2,5 times
1 600
Inventury Turnover
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Sales / Fixed Assets = 4 000 / 800 = 5 times
1 600
Liquidity Ratios
• Current ratio
• Quick ratio
Current Ratio
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Current assets / Current liabilities = 800 / 300 = 2,67
1 600
Quick Ratio
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
1 600
(Current assets - Inventory) / Current liabilities = 430 / 300 = 1,43
Debt utilization Ratios
• Debt to total assets
• Times interest earned
Debt to Total Assets
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
Total debt / Total assets = 600 / 1 600 = 37,5%
1 600
Times Interest Earned
Sales
Cost of goods sold
Gross profit
Selling & admin exp.
Operating profit
Interest expense
Extraordinary loss
Net income before tax
Income tax
Net income
4 000
3 000
1 000
450
550
50
200
300
100
200
Cash
30
S/T securities
50
A/R
350
Inventory
370
Total S/T assets
800
Plant & equip.
1 000
Accum depreciation -200
Tot. L/T assets
800
A/P
50
N/P
250
Total S/T liab
300
L/T liabilities
300
Total liabilities
600
Common Stock
400
Retained earnings 600
Total equity
1 000
Total assets
Total liab+equity
1 600
EBIT / Interest = 550 / 50 = 11 times
1 600
Du Pont Analysis
Trend Analysis
Forecast and Budget
Budgetting
• Systematic setting of future goals
• Bottom-up or top-down
• Identification of external influence and risks (such as
customers, competition, macroeconomics)
• Identification of external influence and risks (such as
capacity of production and resources, human factor)
• Setting of expected growth (reduction), pipeline,
percent-of-sales, investment planning
Financial Forecasting
• Pro forma income statement
• Revenue (pipeline, funnel, percentage)
• Expenses (variable, fixed)
• Pro forma balance sheet
• A/R, A/P, inventory
• Fixed assets, liabilities, equity
• Pro forma cash flow statement
Operational and Financial Leverage
Fixed and variable expenses
total expenses
$
fixned expenses
0
No. of units produced
Fixed and variable expenses
total expenses
$
fixned expenses
No. of units produced
Break-Even Point
revenue
$
total expenses
fixed expenses
No. of units produced
Break-Even Point
revenue
$
profit
total expenses
fixed expenses
No. of units produced
Break-Even Point
revenue
$
total expenses
fixed expenses
No. of units produced
Operational leverage
• Uses fixed/variable cost
• Can increase profits but increases risk
_
Fixed costs
_
Price – Variable cost per unit
Operational leverage
_
Fixed costs
_
Price – Variable cost per unit
Fixed cost 60.000
Variable cost 0,80 / unit
Unit price 2,00
Fixed cost 12.000
Variable cost 1,60 / unit
Unit price 2,00
60.000/(2,00-0,80) = 50.000
break-even point is
50.000 units
12.000/(2,00-1,60)= 30.000
break-even point is
30.000 units
Financial Leverage
2 firms: exactly the same
• Same sector
• Same opportunities
• Same Management…
The only difference: the debt
• L (leveraged firm) has 50% of debt
• U (unleveraged firm) has no debt
Financial Leverage
Firm U
Firm L
100 000
0
100 000
50 000
50 000
100 000
Number of shares
(Price of a share 100)
1 000
500
EBIT
Financial interests
(interest rate 5%)
Net income before tax
EPS before tax
10 000
0
10 000
2 500
Shares (Capital)
Financial debt
Total
Net income after tax
(Tax rate 33%)
EPS after tax
10 000
10 (10 000/1 000)
6 700
6,70
7 500
15 (7 500/500)
5 000
10,00
Financial Leverage
The shareholder of L has a return of 15 (before tax)
The shareholder of U has a return of 10 (before tax)
What do you prefer?
Financial Leverage
Firm U
Firm L
100 000
0
100 000
50 000
50 000
100 000
Number of shares
(Price of a share 100)
1 000
500
EBIT
Financial interests
(interest rate 5%)
Net income before tax
EPS before tax
0
0
0
2 500
0
0
-2 500
-5
Net income after tax
EPS after tax
0
0
-2 500
-5
Shares
Financial debt
Total
Financial Leverage
The shareholder of L has a return of -5 (before tax)
The shareholder of U has a return of 0 (before tax)
What do you prefer?
Financial Leverage
For leverage to be profitable,
the rate of return on the investment
must be higher than the cost of the borrowed money
Conclusion
Leverage can create value or destroy it
To create value, the IRR must be higher than the cost of
loan; if not, leverage destroys value.