Corporate Finance For Dummies

Author: Michael Taillard

• corporate finance is the study of the relationships between groups of people, I’m referring to measuring how groups of people are allocating resources among themselves, putting value on goods and services, and interacting with each other in the exchange of these goods and services.

• Finance is the study of relationships between people: how they distribute themselves and their resources, place value on things, and exchange that value among each other.

• Because that’s the case, finance (all finance) is really the science of decision-making.

• Corporate finance, as a result, studies decision-making in terms of what is done by groups of people working together in a professional manner.

• An investment is anything that you buy for the purpose of deriving greater value than you spent to acquire it.

• it can be measured in terms of money, decisions will be made in terms of money. If you’re not the one making those decisions, you should probably be asking yourself who is.

• Anytime you give your money to someone with the expectation that the person will hold it for you and give it back when you request it, you’re either dealing with a depository institution or acting very foolishly.

• Originally, this setup allowed corporations and individuals to share the risk of loss; each person paid just a little bit so no person had to face the full cost of a serious disaster. Unfortunately, this is decreasingly the case, as insurance companies grow in profitability and incur unnecessary overhead costs. That’s precisely why many nations require their insurance companies to operate as nonprofit organizations.

• GMAC, the financing arm of General Motors, which changed its name to Ally Bank, is the captive credit financing company for the corporation General Motors.

• Another form of high-interest loan is called the payday loan. The payday loan basically makes loan sharks legal (organizations that offer loans at rates above the legal level and who often have heavy-handed tactics).

• A special type of auditing, wherein auditors do their calculations for the purpose of presenting them in court, is called forensic accounting.

• Really, any schmuck can try to be a trader; some will succeed and others will fail.

• There are really only two primary ways that corporations can raise capital: By incurring debt or by selling equity.

• The combination of these two funding sources brings me to the explanation of the most fundamental equation in corporate finance: Assets = Liabilities + Equity The total value of assets held by a company is equal to the total liabilities and total equity held by the company.

• In these cases, the receivable remains receivable until either the money is paid or the period in which the money is due passes. After the period passes, the company subtracts the value of the account owed from accounts receivable and transfers it to a subaccount called allowances. Allowances include the value of the money that’s still owed and past due but has yet to be written off as uncollectible (which is considered an expense).

• When a company pays for some expense in advance, the value of that prepayment becomes an asset (called a prepaid account) for which the company will receive services in the future.

• The property, plant, and equipment (PPE) category includes nearly every major physical asset a company has that it will use for more than one year.

• The easiest type of depreciation to use is called straight-line depreciation. Straight-line depreciation is cumulative, meaning that if you report a value in depreciation for a piece of equipment one year, that same amount gets added to the next year’s depreciation, and so on until you get rid of the equipment or its value drops to 0.

• A similar type of depreciation, called unit-of-production depreciation, replaces years of usage with an estimated total number of units that the equipment can produce over its lifetime.

• To calculate the depreciation each year by using the sum of years method, you divide the remaining number of years of life the equipment has left, n, by the sum of the integers 1 through n, and then multiply the answer by the cost of the equipment minus salvage cost.

• Intangible assets are things that add value to a company but that don’t actually exist in physical form.

• When a company receives payment for a product or service but has yet to provide the goods or services it was paid for, the value of what the company owes the customer contributes to its unearned income.

• When a company owes money that it expects to pay in a time period that’s longer than one year, the value of that money

• When a company leases a piece of capital, the total amount owed on that lease adds to the value of the capital lease obligations category of liabilities.

• As you may have already guessed, financial statements are designed to be easily understood, not creatively labeled.

• The investment bankers determine the value of the company, which is used to establish the amount to be raised, and then divide that amount by the total number of shares to get the par value.

• Any amount that the company raises over par value contributes to the additional paid-in capital and shows up on the balance sheet as such.

• For corporations, any money that doesn’t go to the stockholders in the form of dividends (which are reported on the income statement; see Chapter 5) is reinvested in the value of the company as retained earnings.

• The income statement is a report that explains all about the revenues that a company makes and the costs it incurs so that it can evaluate its profitability.

• Simply put, the income statement is a financial report that describes whether a company is thriving in its pursuit of income or flushing money down the proverbial toilet.

• Income statements come in two types: single step and multiple step. They’re essentially the same thing except that a multiple-step income statement provides more detail,

• The big difference between the multiple-step income statement and the single-step income statement is that the single-step statement doesn’t separate costs and revenues by their source operations.

• Instead, it lists all income, breaking it down into net sales and other, and then lists all costs, with a total of the costs. Finally, it lists earnings before interest and taxes (EBIT), taxes, net income, and earnings per share (EPS).

• The first portion of the income statement, called gross profit, seeks to calculate the profitability of a company’s operations after direct costs.

• Net sales is all the money that a company makes from its primary operations.

• Some companies refer to net sales as gross income, income from sales, or some other similar term. Just remember that net sales is always the very first item on the income statement, regardless of what a company calls it.

• No matter what its primary operation is, every company adds up all the direct costs it incurs as a result of actually making its product or service, not including indirect costs (sales costs, administrative costs, research costs, and so on), and includes them under cost of goods sold (COGS) on the income statement.

• So when the things a company purchase changes, it must choose how it will measure the cost of goods sold.

• Because the value of inventory minus costs influences all other financial statements, a company must choose to use either FIFO accounting or LIFO accounting and stick with it for everything.

• The last part of the gross profit portion of the income statement is the gross margin, which you get by subtracting the cost of goods sold from the net sales.

• The gross margin is all the money a company has left over from its primary operations to pay for overhead and indirect costs, like the sales staff, building rent, janitorial services, and everything else that’s not directly related to the production or purchase of inventory.

• When you divide gross margin by net sales, you get the percentage of net sales that isn’t spent on producing the inventory.

• The next portion of the income statement takes into account the rest of a company’s costs of doing business (other than the costs of goods sold) and is called operating income.

• Selling expense includes everything a company spent on selling the products it bought or made, such as advertising, sales wages or commissions, shipping, and the cost of retail outlets.

• General and administrative costs, also called G&A costs, cover all the expenses of running a company. The salaries of the finance, marketing, human resources, and management staff fall into this category, as do the salaries of everyone who isn’t directly associated with making or selling the inventory.

• Any time a company decides to stop pursuing one or more of its operations, the amount of profit or loss experienced from stopping, as well as the amount generated from running those operations up until that point, goes here.

• Profit/loss for discontinued operations: Any time a company decides to stop pursuing one or more of its operations, the amount of profit or loss experienced from stopping, as well as the amount generated from running those operations up until that point, goes here.

• You calculate EBIT by taking gross margin and then subtracting or adding the different sources of costs and revenues associated with nonprimary business operations.

• The amount of income taxes a company pays is based on their EBT (earnings before tax, but not interest).

• Simply put, the net income is the final amount that a company walks away with after it has considered all costs.

• Companies calculate the basic earnings per share by dividing net earnings by the total number of common shares outstanding.

• Diluted earnings per share: A company can issue a number of options that can eventually turn into common stock. For example, company employees may be given stock options, or preferred shares and convertible bonds may be converted into common stock.

• So a company that made $1,000andhas1,000sharesofstockhasanearningspershareof$1. But if that company also has 1,000 shares of convertible preferred stock, its diluted earnings per share is $0.50.

• While other financial reports provide important information, the income statement is the final test of whether a company is succeeding or failing in the pursuit of success — that is, making money.

• cash and cash equivalents refers to any money that’s either currently in the possession of the company or can almost instantly be put in the company’s possession by way of withdrawals on bank accounts.

• This category doesn’t include interest generated from investments because investing isn’t part of the company’s primary operations (unless the company is a bank or some other financial type of company). Holding cash in an account, on the other hand, is a primary necessity of business operations, so the interest generated in that regard counts as an operational cash flow.

• Together, the total of the values from the income statement and the balance sheet should total the net cash provided by operating activities

• The statement of cash flows is a big deal for lenders who are considering whether or not to give loans to a company. Even if a company is making money, lenders want to make sure the company will have the cash available to make payments on their loans.

• When comparing data from the statement of cash flows for the same company over a period of years, you can evaluate effective cash management and track the sources of cash flows for the use of financial efficiency and asset utilization optimization.

• Unless you know what to look for, you could stare at a financial statement for hours and accomplish little more than high levels of boredom.

• Just as a person who writes a bad check to pay his water bill shouldn’t expect to use the toilet for much longer, a company that can’t pay its bills will have to stop output in the near future.