Introduction to Corporate Finance

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Corporate Finance is the division of finance that deals with financing, capital structuring, and investment decisions. Corporate Finance is primarily concerned with maximizing shareholder value through long and short-term financial planning and the implementation of various strategies. Corporate Finance activities range from capital investment decisions to investment banking.

Profit and Loss Statement & Priority of Claims

The profit and loss (P&L) statement is a financial statement that summarizes the revenues, costs and expenses incurred during a specified period, usually a fiscal quarter or year. The P&L statement is synonymous with the income statement. These records provide information about a company’s ability or inability to generate profit by increasing revenue, reducing costs or both. Some refer to the P&L statement as a statement of profit and loss, income statement, statement of operations, statement of financial results or income, earnings statement or expense statement.

Priority claims are nondischargeable unsecured debts that receive special treatment in bankruptcy. The most common types of priority claims include certain tax obligations, alimony, and child support.

Balance Sheet: Information, Incentives, and Opportunity Cost

A balance sheet is a financial statement that reports a company’s assets, liabilities and shareholders’ equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

It is used alongside other important financial statements such as the income statement and statement of cash flows in conducting fundamental analysis or calculating financial ratios.

The balance sheet is a snapshot representing the state of a company’s finances at a moment in time. By itself, it cannot give a sense of the trends that are playing out over a longer period. For this reason, the balance sheet should be compared with those of previous periods. It should also be compared with those of other businesses in the same industry since different industries have unique approaches to financing.

A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company’s finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet.

Connection between P&L and Balance Sheet

The balance sheet, and profit and loss statement are two of the three financial statements companies issue regularly. Financial statements provide an ongoing record of a company’s financial condition and are used by creditors, market analysts, and investors to evaluate a company’s financial soundness and growth potential. The third financial statement is called the cash-flow statement.

Although the balance sheet, and the profit and loss statement (P&L) contain some of the same financial information including revenues, expenses, and profits, there are important differences between the two of them. Here’s the main difference: The balance sheet reports the assets, liabilities, and shareholders’ equity during a specific period, while a company’s revenues, costs, and expenses during a quarter or fiscal year is summarized in a P&L statement.

One of the major differences between the balance sheet and the P&L statement involves their respective treatments of time. The balance sheet summarizes the financial position of a company for one specific point in time. The P&L statement shows revenues and expenses during a set period of time. The length of the period of time covered in the P&L statement may vary, but common intervals include quarterly and annual statements.

Leverage and Shareholder Risk

Leverage results from using borrowed capital as a funding source when investing to expand the firm’s asset base and generate returns on risk capital. Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment. Leverage can also refer to the amount of debt a firm uses to finance assets. When one refers to a company, property or investment as «highly leveraged,» it means that item has more debt than equity.

The shareholders and investors of the Company should be aware that the value of an investment in the Company is subject to normal market fluctuations and other risks inherent in investing in securities. There is no assurance that any appreciation in the value of the Shares will occur or that the investment objectives of the Company will be achieved. The value of investments and the income derived therefrom may fall as well as rise and investors may not recoup the original amount invested in the Company.

Broad Overview of Markets and Institutions

Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that facilitate the accumulation of capital and the production of goods and services. The combination of well-developed financial markets and institutions, as well as a diverse array of financial products and instruments, suits the needs of borrowers and lenders and therefore the overall economy.

In addition, efficient financial markets and institutions tend to lower search and transactions costs in the economy. By providing a large array of financial products, with varying risk and pricing structures as well as maturity, a well-developed financial system offers products to participants that provide borrowers and lenders with a close match for their needs. Individuals, businesses, and governments in need of funds can easily discover which financial institutions or which financial markets may provide funding and what the cost will be for the borrower. This allows investors to compare the cost of financing to their expected return on investment, thus making the investment choice that best suits their needs. In this way, financial markets direct the allocation of credit throughout the economy— and facilitate the production of goods and services.

Stock Markets: Introduction

The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place. Such financial activities are conducted through institutionalized formal exchanges or over-the-counter (OTC) marketplaces which operate under a defined set of regulations. There can be multiple stock trading venues in a country or a region which allow transactions in stocks and other forms of securities.

While both terms – stock market and stock exchange – are used interchangeably, the latter term is generally a subset of the former. If one says that she trades in the stock market, it means that she buys and sells shares/equities on one (or more) of the stock exchange(s) that are part of the overall stock market.

Bond Markets: Introduction

The bond market—often called the debt market or credit market—is a financial marketplace where investors can trade in government-issued and corporate-issued debt securities. Governments typically issue bonds in order to raise capital to pay down debts or fund infrastructural improvements. Publicly-traded companies issue bonds when they need to finance business expansion projects or maintain ongoing operations.

The bond market is broadly segmented into two different silos: the primary market and the secondary market. The primary market is frequently referred to as the «new issues» market in which transactions strictly occur directly between the bond issuers and the bond buyers. In essence, the primary market yields the creation of brand new debt securities that have not previously been offered to the public.

In the secondary market, securities that have already been sold in the primary market are then bought and sold at later dates. Investors can purchase these bonds from a broker, who acts as an intermediary between the buying and selling parties. These secondary market issues may be packaged in the form of pension funds, mutual funds, and life insurance polices among many other product structures.

References

  • Collings, S. and Taillard M. (2013). Corporate Finance FOR DUMMIES. John Wiley & Sons.
  • Collings, S. and Loughran, M. (2013). Financial Accounting FOR DUMMIES. John Wiley & Sons.
  • Berk, J. and DeMarzo, P. (2016). CORPORATE FINANCE. Pearson Education.
  • Harris, M. Stulz, R. M. and Constantinides, G. M. (2003). HANDBOOK OF THE ECONOMICS OF FINANCE. ELSEVIER.

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Galeazzi Giuliana. (2019, septiembre 24). Introduction to Corporate Finance. Recuperado de https://www.gestiopolis.com/introduction-to-corporate-finance/
Galeazzi, Giuliana. "Introduction to Corporate Finance". GestioPolis. 24 septiembre 2019. Web. <https://www.gestiopolis.com/introduction-to-corporate-finance/>.
Galeazzi, Giuliana. "Introduction to Corporate Finance". GestioPolis. septiembre 24, 2019. Consultado el 11 de Octubre de 2019. https://www.gestiopolis.com/introduction-to-corporate-finance/.
Galeazzi, Giuliana. Introduction to Corporate Finance [en línea]. <https://www.gestiopolis.com/introduction-to-corporate-finance/> [Citado el 11 de Octubre de 2019].
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