Scope of Corporate Finance Cheat Sheet (2024)

Maximize Profit?

Many believe managers job

Take only actions to increase revenues

Maximise amount earned on each share

Earnings per share (EPS) = earnings of common stockh­olders divided by number of shares of common stock outsta­nding

Flaws in approach:

- Figures for earnings histor­ical, reflect past perfor­mance

- Do not focus on what is happening now / in future

- Timing may be ignored. Large profits that pay off many years in future may be less valuable than smaller profits received next year

Maximize Shareh­older Wealth?

Current theory

Measured by market price of firm's stock.

Stock price reflects timing, magnitude, and risk of cash flows that investors expect a firm to generate over time.

Take only actions that increase value of firms future cash flows.

Shareh­olders are residual claimants. Can claim only on cash flows that remain after employees, suppliers, creditors, govern­ments, and other stakeh­olders are paid in full

There is a risk shareh­olders receive nothing

Shareh­olders bear most of risk of running firm

This is why firms operate to maximize shareh­older wealth. The benefit to all is that it gives investors incentive to accept the risks necessary to buy stock and provide funds necessary for a business to thrive.

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Focus on other Stakeh­olders?

Many firms also focus on employees, customers, tax author­ities, and commun­ities

These firms consci­ously avoid actions that harm stakeh­olders by transf­erring their wealth to shareh­olders.

Not to maximize others interests but to preserve those interests.

Benefits

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Keeping stakeh­olders happy has long-term benefit to share-­holders

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Helps minimise employee turnover, conflicts, and litiga­tion.

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Usually actually leads to maximizing shareh­older wealth

Conflicts

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Between these two objectives inevitably arises.

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Firms is ultimately run to benefit stockh­olders.

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Corpor­ations are generally expected to be socially respon­sible

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But rarely required by law to be in US and AUS

All finance jobs require:

Good written and verbal commun­ication skills

Ability to work in teams

Profic­iency with computers and the Internet

Many finance jobs require:

In-depth knowledge of intern­ational business

Finance career opport­uni­ties:

Corporate finance

Commercial banking

Investment banking

Money management

Consulting

Analyse firms business processes and strategies

Recommend how practices should change to make firms more compet­itive

Implement recomm­end­ations

Spend up to 200+ days yearly on the road

Industry

Investment advisory firms

Mutual fund companies

Pension fund managers

Trust depart­ments of commercial banks

Investment arms of insurance companies

Any person or instit­ution that acts as a fiduci­ary­—so­meone who invests and manages money on someone else's behalf

Trends

Baby Boomers investing large sums in prepar­ation for retirement - demand for pofess­ional money managers surged

Australian supera­nuation legisl­ation passed in 1992 requring all employees to be members of a superfund - that industry grew massively

Instit­uti­ona­lis­ation of invest­ment, means today instit­utional investors dominate the markets

The duties of the financial manager in a business / Not for profit / Corpor­ation

Tasks include:

Budgeting

Financial foreca­sting

Cash management

Credit admini­str­ation

Investment analysis

Funds procur­ement

Modern business changes:

Increases in regulatory enviro­nments have increased the importance and complexity of the financial manager's duties

Global­isation has increased need to assess and manage the risks associated with volatile exchange rates and rapidly changing political enviro­nments.

Managing firms operating cash flows as effici­ently and profitably as possible.

Capital structure decision finding right mix of debt and equity securities to maximise firms overall market value.

Managing working capital

Ensure enough working capital on hand for day-to-day operations

Obtaining seasonal financing

Building up enough invent­ories to meet customer needs

Paying suppliers

Collecting from customers

Investing surplus cash

Mainta­ining adequate cash balances

Skills:

Technical and analytical skills

People skills - relati­onships with customers, suppliers, lenders, and others

Identi­fies, measures, and manages many types of risk exposures including:

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Predic­table business risks-­losses such as adverse interest rate movement commodity price changes, and currency value fluctu­ations.

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Unpred­ictable 'acts of nature'

Risk management techniques

Insurance products (fire, flood, theft, injury)

Self-i­nsu­rance to manage exposures

Quantify the sources and magnitudes of risk exposure and decide whether to accept them or to manage them.

Divers­ifi­cation (contract with several suppliers, even if it means purchasing the input at slightly more than the lowest possible price)

Modern risk management

Market­-driven risks interest rates, commodity prices, and currency values.

Financial instru­ments called deriva­tives (derive their value from other, underlying assets) have been developed for use in hedging (offse­tting) for more threat­ening market risks.

Sole propri­eto­rships

General Partne­rships

Limited Partne­rships

Proprietry Limited Company

Company

Propri­eto­rship between 2+ owners

No distin­ction between owners and business

Joint and several liability

Unless specified all debts and equity, profits, are split evenly

Decision making ability is split evenly

Income taxed at personal level

Limited life - cease when one owner dies or retires

Limited access to capital - Reinve­sting profits, personal loans

Unlimited personal liability - Personally liable owner for all debts, including lawsuits

Business seperate entity to owner

Creates roles of employee, director, shareh­older

Regulated under the corpor­ations act 2001

Establ­ishment and ongoing costs to manage can be high

Suited to Medium and Large businesses

constantly apply financial tools to solve real business problems

Ensure business managers take only actions where benefits exceed costs

Interact with experts in a wide range of discip­lines

Study economics of a market

Develop pricing strategy

Negotiate licensing agreements

Work with author­ities to ensure compliance

Advise business managers and profes­sionals

Work with accounting and systems staff to develop systems

Managing cash flows

Assessment and funding of research

Aid business in accumu­lating the capital needed to fund projects

Companies can obtain debt capital by selling securities either directly to investors or through financial interm­edi­aries.

Financial interm­ediary

Instit­ution that raises capital by issuing liabil­ities against itself

Uses the capital raised to make loans to corpor­ations and indivi­duals

Borrowers have no direct contact with those who funded the loan

Financial interm­edi­aries include:

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Insurance companies

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Savings and loan instit­utions

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Credit unions

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Commercial banks

Modern financial interm­ediary services

Loans to corpor­ations and indivi­duals

Allow companies and indivi­duals to place their money in demand deposits

Backbone of the payments system:

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Collect payment on transfers sent to corporate customers

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Make payment on the transfers by their customers to other parties

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Provide inform­ati­on-­pro­cessing services to SME businesses

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Handle large-­volume transa­ctions such as payroll

Intere­sting nature of work

Three main types of activi­ties:

Helping corporate customers obtain funding by selling securities such as stocks and bonds to investors

Providing advice to corporate clients on strategic transa­ctions such as mergers and acquis­itions

Trading debt and equity securities for customers or for the firm's own account

Profit­ability

High income potential

Extrao­rdi­narily high since the early 1990s

Highly volatile industry

Entry-­level salary range $50,000 to more than $80,000, plus bonuses

Incomes often rise rapidly

Industry

Dominant AU firms: Macquarie Group, and CommSec

Dominant foreign firms: BNP, Deutsche Bank, Credit Suisse, HSBC, J. P. Morgan Chase, Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup

Extremely compet­itive

Long working hours

Lucrative rewards for those who master the game

Key skills

Good analytical and commun­ication skills

Social and networking skills also pay handsome dividends.

Growth expect­ations

Ongoing develo­pment of new financial products and services

Continued intern­ati­ona­liz­ation of corporate finance

Financial managers single most important activity

Managers evaluate very large invest­ments in the capital budgeting process

Companies prosper in a compet­itive economy only by seeking out the most promising new products, processes, and services to deliver to customers.

Big companies make huge capital outlays

ROI drive the value of their firms and wealth of shareh­olders.

Conseq­uences of flawed capital budgeting processes are serious

The capital budgeting process:

1. Identi­fying potential invest­ments

2. Analysing the set of investment opport­unities and identi­fying those that create shareh­older value

3. Implem­enting and monitoring the invest­ments selected in Step 2

Important to avoid scandal and damage to reputation

Systems of incentive / structures that influence good ethical behaviours and decision making

Intentions

Determine who benefits most from company activities

Develop procedures to maximise firm value and to ensure that employees act ethically and respon­sibly

Encourage the hiring and promotion of qualified and honest people

Motivate employees to achieve company goals through salary and other incentives

Challenges in practice

Conflicts inevitably arise among stockh­olders, managers, and other stakeh­olders.

Stockh­olders want managers to work hard and to protect shareh­olders interests.

It costs time and money to ensure that managers act approp­ria­tely.

Though managers may wish to maximize shareh­older wealth, they do not want to work harder than necessary, especially if others are going to reap most of the benefits.

Managers and shareh­olders may decide together to run a company to benefit themselves at the expense of creditors or other stakeh­olders

Creditors and other stakeh­olders generally don't have a voice in corporate govern­ance.

Strong boards of directors play a vital role in any well-f­unc­tioning governance system, because boards must hire, fire, pay, and promote senior managers.

Boards must also develop fixed and contingent compen­sation packages that align managers incentives with those of shareh­olders.

In Australia

ASIC - Australian Securities and Invest­ments Commission oversees corporate activities

Est in 1998

Corporate, markets and financial services regulator

ASIC enforce and regulate company and financial services laws to protect Australian consumers investors and creditors

ASIC oversees the Australian Securities Exchange (ASX) (2006 merger of Aus stock exchange and Sydney Futures Exchange)

Most work done under the Corpor­ations Act 2001

Govern­ments governance

Countries also struggle

Govern­ments establish legal frameworks for corporate finance that encourage compet­itive businesses to develop and efficient financial markets to run properly

Commercial laws should

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Provide protection for creditors and minority shareh­olders

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Limit opport­unities for managers or majority shareh­olders to transfer corporate wealth from investors to themse­lves.

One legal owner

No distin­ction between owner and business

Owners personal property

Limited life - cease when owner dies or retires

Limited access to capital - Reinve­sting profits, personal loans

Unlimited personal liability - Personally liable owner for all debts, including lawsuits

High risk, often not insurable

Income taxed at personal level

Sprung from legisl­ation in 2000

Unlimited personal liability

Ideal for start ups with losses in early years - limited partners can use to offset other income tax

1+ partners with unlimited personal liability who receives a greater share of income

Other partners

- Limited liability partners

- Must be completely passive

- Name cannot be associated with business

- Can not take a role in the business

- Can not be employed by the business

- No personal liability for debts

- Can not be sued

- Income taxed as personal income

Face a modern, knowledge based economy

Finance role is vital in creating wealth

Involve people with many different skills and backgr­ounds working together toward common goals.

Two broad types of capital exist: debt and equity

Debt capital

Long term borrowing from creditors

Borrower pays interest, at a specified annual rate, on the loans principle (full amount borrowed)

Borrower repays the principal amount at the debts maturity

Payments made on a fixed schedule

Creditors have a legally enforc­eable claim against the firm.

Defaults on debt payments mean creditors can take legal action to force repayment.

Creditors can sometimes force the borrowing firm into bankru­ptcy, out of business and selling (liqui­dating) assets to repay creditor claims.

Equity capital

Business owners contri­bution

Expected to remain perman­ently invested in the company

Sources of equity capital

Common stock

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Bear most of the firms business and financial risk

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Receive returns on their invest­ments only after creditors and preferred stockh­olders are paid in full

Preferred stock

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Similar to creditors

"­Pre­ferred Stockh­old­ers­"

Promised a fixed annual payment on their invested capital

Claims are not legally enforc­eable

Cannot force a company into bankruptcy if a preferred stock dividend is missed

Upon liquid­ation, preferred stockh­olders claims are paid before any money is paid to common stockh­olders.

In Australia is dominated by the 'big four' (75% market share):

ANZ

Common­wealth Bank

NAB

Westpac

Hiring

Banks continue to hire large numbers of new business and finance graduates each year

Banks train many managers who later migrate to other fields

Key skills

Cash flow valuation

Financial and credit analysis

Consumer banking vs Commercial banking

Excellent finance skills

Intimate knowledge of teleco­mmu­nic­ations and computer technology

Intere­sting nature of work

Three main types of activi­ties:

Helping corporate customers obtain funding by selling securities such as stocks and bonds to investors

Providing advice to corporate clients on strategic transa­ctions such as mergers and acquis­itions

Trading debt and equity securities for customers or for the firm's own account

Profit­ability

High income potential

Extrao­rdi­narily high since the early 1990s

Highly volatile industry

Entry-­level salary range $50,000 to more than $80,000, plus bonuses

Incomes often rise rapidly

Industry

Dominant AU firms: Macquarie Group, and CommSec

Dominant foreign firms: BNP, Deutsche Bank, Credit Suisse, HSBC, J. P. Morgan Chase, Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup

Extremely compet­itive

Long working hours

Lucrative rewards for those who master the game

Key skills

Good analytical and commun­ication skills

Social and networking skills also pay handsome dividends.

Growth expect­ations

Ongoing develo­pment of new financial products and services

Continued intern­ati­ona­liz­ation of corporate finance

Generally = managing cash flows

Five basic functions

Raising capital via external financing

Capital budgeting function - choosing the best projects in which to invest resources

Financial management (cash flows)

Corporate governance

Risk management

Raise money to support investment and other activities

Via

Internally by retaining and reinve­sting operating profits

Externally from shareh­olders or creditors

Internally

Companies raise about two-thirds of their required funding internally each year

Externally

Sole propri­eto­rships and partne­rships have limited external funding opport­unities

Corpor­ations have varied opport­unities

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selling equity (common or preferred stock)

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borrowing money from creditors

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Young and small corps usually raise equity capital privately, from friends and family, or from profes­sional investors such as venture capita­lists.

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Venture capita­lists make high-r­isk­/hi­gh-­return invest­ments in rapidly growing entrep­ren­eurial businesses

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Larger corps can go public by conducting an initial public offering (IPO) of stock—­selling shares to outside investors and listing the shares for trade on a stock exchange.

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After IPO, selling additional stock in the future

Tradit­ional interm­edi­aries (banks) useage as providers of debt capital to corpor­ations has declined

Nonfin­ancial corpor­ations often go to capital markets for external financing

New types of interm­edi­aries: pension funds and mutual funds

Because

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Modern inform­ation processing enables investors to evaluate thousands of potential corporate borrowers and issuers of common and preferred stock equity

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These interm­edi­aries are major purchasers of the securities non-fi­nancial corpor­ations issue

Primary market transa­ctions

Corpor­ations sell securities to investors in exchange for cash

Raise capital

Firm actually receives the proceeds from issuing securities

Large fraction of all bond market transa­ctions

True capita­l-r­aising events

Second­ary­-market transa­ctions

After firms initial offering (IPO) investors can sell securities to other investors

Trades between investors

Generate no new cash flow for the firm

Most stock market transa­ctions

Not true capita­l-r­aising events

An entity created by charter, prescr­iption or legisl­ation

A 'person' seperate from shareh­olders

Many same economic rights / respon­sib­ilities as indivi­duals

Owned by shareh­olders

- Shares of stock carry voting rights

- Shareh­olders vote at annual meetings to elect boards of directors (BOD)

- BOD hire / fire managers, and set corporate policys

Consti­tution

- Legal document

- Created at company's inception

- Parameters of corporate governance

- Can only be changed by vote of shareh­olders

Can sue and be sued

Can own property and execute contracts in their own names

Can be tried and convicted for crimes committed by their employees

Unlimited life - Perpetual life until explicitly terminated

Limited liability - Shareh­olders cannot be held personally liable

CEOs and chief financial officers (CFOs) can be held personally liable under the Sarban­es-­Oxley Act if the debts result from improper accounting practices or fraudulent acts.

Separable contra­cting. Can contract indivi­dually with managers, suppliers, customers, and ordinary employees, and each contract can be renego­tiated, modified, or terminated without affecting other stakeh­olders.

Improved access to capital

- Can borrow money from creditors

- Can issue preferred and common stock to equity investors

- Ownership stock claims can be freely traded among investors without obtaining permission from other investors

- A public company can list shares on a public security market