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MBA ASAP Corporate Finance Fundamentals

The Concepts and Tools of Financial Analysis and Decision Making
Instructor:
John Cousins
5,379 students enrolled
English [Auto]
Corporate Finance is the tools and techniques of how companies make decisions about what projects to pursue, and how to value those projects. This course provides a framework for how financial professionals make decisions about how, when, and where to invest money.
You will be able to use these tools and calculations to value assets and make financial decisions relative to investing and allocating money and resources to the best projects.
Hone new skills online with expert faculty.
What Will I Learn Analyze and understand an income statement (even if you have no experience with income statements). Analyze and understand a balance sheet (even if you have no experience with balance sheets). Analyze and understand a cash flow statement (even if you have no experience with cash flow statements). Understand the Financial Concepts of: Time Value of Money Interest Rates and Discount Rates Financial Risk Present Value Future Value Discounting Cash Flows (DCF) Valuation Understand the gold standard financial decision-making tools: Net Present Value (NPV) Internal Rate of Return (IRR)

Don’t let lack of financial intelligence stop you from getting ahead.

“It is a 5-star course by any means. Contents, way of communication and pace is so much easy that even Non Finance guys can understand easily.”   Asad

Learn how to raise money and invest it wisely. Learn how to analyze and value companies and income producing assets. Make better business decisions and support them with financial analysis and rationale.    

This course includes the eBook version of MBA ASAP Corporate Finance, voted best Corporate Finance book of all time by BookAuthority.

Corporate Finance is the Tools and Techniques of how Companies Make Decisions about what Projects to Pursue, and how to Value those Projects.

   

  • Time Value of Money

     

  • Present Value and Future Value

     

  • Net Present Value

     

  • Internal Rate of Return   

     

Ever wonder how the top executives at your company got there and what they think about?

This course provides a framework for how financial professionals make decisions about how, when, and where to invest money. Corporate Finance comprises a set of skills that interact with all the aspects of running a business. It is also extremely helpful in our personal lives when making decisions about buying or leasing, borrowing money, and making big purchases. It provides analytic tools to think about getting, spending, and saving.

     

Content and Overview       

We will explore the time value of money and develop a set of tools for making good financial decisions, tools like Net Present Value and Internal Rate of Return.  We will explore the trade off between risk and return, and how to value income producing assets.       

Valuation of companies and assets can seem mysterious. Where do you even begin? How can you value a startup that doesn’t even have any revenues yet? You will gain confidence in your knowledge and understanding of these concepts.   

The tools of corporate finance will help you as a manager or business owner to evaluate performance and make smart decisions about the value of opportunities and which to pursue.  An understanding of Corporate Finance is essential for the professional manager in order to meaningfully discuss issues with colleagues and upper management. You need to be versed in this subject in order to climb any corporate ladder. Get started understanding corporate finance today.        

This course is based on my best selling book MBA ASAP Understanding Corporate Finance. Here are some reviews:   

I am a big fan of your books, which make all these difficult topics really easy to understand. This is excellent work.   Adnan   

After reading John Cousins’ book I was finally able to understand a subject that has been, for me, very foreign and intimidating. He makes the topic of corporate finance accessible to people like me who need the knowledge but easily get lost “in the weeds”. Clear and very easy to digest and apply!  Lizabeth   

   

Having read the ’10 minutes to understanding Corporate Finance’ I can honestly say that it comprises a well-structured and straightforward presentation of the core elements of corporate finance. Nikolaos

 

 

Introduction to Corporate Finance

1
Introduction

Welcome to this course on Corporate Finance!  The video lectures are the main part of the course and the book supports the lectures.  Download the book provided here and give it a quick peruse.  You can follow along in the book with each video segment and the two will reinforce each other and the concepts presented.


Some of the material may seem repetitive.  I repeat the fundamental concepts from several different angles so that they have a chance to sink in.  If you find any of the videos or material repetitive, consider it a good sign.  That means you understand that concept.  The course isn't too long so have patience with the process.  Once you are comfortable with these concepts like Ratio Analysis, Time Value of Money, Discounted Cash Flows, and Present Value, you will be unstoppable!

   

This course is part of the MBA ASAP series.  I hope you find it valuable, instructive, and enjoyable.  

If you have any questions or suggestions email me at jjcousins@gmail.com   

 

Follow me on twitter @jjcousins   

 

Sign up for my email list at MBA-ASAP.com  

Thanks!  

John  

2
Overview of Course
3
Introduction to Corporate Finance

Financial Statements

1
Intro to Financial Statements Lecture

The Most Important Finance Job

The most important set of tasks that a CFO (Chief Financial Officer) has is the oversight, management, and preparation of financial statements.  Financial reporting with financial statements happens regularly, at least every quarter and once a year for audited financials.  Once you complete a set of financial statements, you are working on the preparation of the next set. 

Becoming intimately familiar with financial statements and how they are interconnected and flow is the critical skill set for corporate finance.   

Financial statements also underlay Discounted Cash Flow analysis, NPV, IRR, and all the valuation techniques of finance.  We will now spend some time thoroughly understanding financial statements.


Intro to Financial Statements

  • What are financial statements?

  • The 3 Financial Statements:

  • Income Statement

  • Balance Sheet

  • Cash Flow


Understanding Financial Statements   

When you have completed this section of MBA ASAP, you will have a solid understanding of Financial Statements and you will be able to draw meaningful conclusions from their contents.  This knowledge can be highly impactful for the quality of your career, job prospects, and life.   

Financial Statements are the basic language of money and business. Everyone should have a basic understanding of Financial Statements: what they are and what information they provide.  It’s a competency that can open up opportunities and vistas that are closed off otherwise.        

Executives like the CEO, COO, and CFO routinely share and discuss financial data with marketing, operations, and other direct reports and personnel within an organization.  They also compile and share financial information with stakeholders outside the firm such as bankers, investors and the media.    

But how much do you really understand about finance and the numbers? A recent investigation into this question concluded even most managers and employees don’t understand enough to be useful. Check out the quiz in this section to see how you stack up.  I will offer the quiz again at the end of the course so you will be able to gauge how your level of financial competency has improved.    

 

Three Main Financial Statements   

There are three main financial statements and they are linked together to provide a picture of the financial position and health of an enterprise. They represent the end product of accounting, meaning they are the reports generated by accounting covering all of the transactions of a company.   

The three basic financial statements are the   

  • Balance Sheet: which shows firm's assets, liabilities, and net worth on a stated date   

  • Income Statement: also called profit & loss statement or simply the P&L: which shows how the net income of the firm is arrived at over a stated period, and    

  • Cash Flow Statement: which shows the inflows and outflows of cash due to the firm's activities during a stated period.    

Knowing how to read and understand financial statements is a business skill you can’t ignore. It can help working your way up the corporate ladder by communicating with others in your company and understanding the big picture.  It is also a useful skill in order to understand where your efforts and work can make the most impact.    

When you are thinking about possibly changing jobs and working for a company you can check their financials and make sure they are a healthy organization.  If you are considering starting your own company you will need to have financials prepared by your accountant in order to talk to investors, bankers and vendors.    

If you want to invest wisely in the stock market, analyze the competition or benchmark your performance, you can look up the financials of any publicly traded company at the Securities and Exchange Commission website’s’ EDGAR filings and get an idea of how they are doing.  Check out any public company’s most recent 10K filing there.  A 10K is the Annual Report of the company and its most important business and financial disclosure document.          

Next we will go over each of the financial statements individually and how they are interrelated.  You will find lots more information in the books and other downloadable documents that accompany this course.

2
The Importance of Accounting Lecture

In this video I discuss that Financial Statements are what accounting produces.  Double entry bookkeeping and accounting helped usher in the modern world. History of Accounting and Commerce


The Fundamental Importance of Understanding Financial Statements

Being able to read and understand financial statements is a fundamental skill to understanding how businesses function. Since financial statements are the end product of accounting, understanding them provides the context for understanding accounting. Mastering this skill will help you become a better manager.    

Being able to read financial statements will also help you make better investment decisions in the stock market because you will be able to get meaningful information out of an Annual Report or a 10K.    

If you are an entrepreneur planning a start up then understanding financial statements is critical for your credibility as you meet with angel investors, bankers, and VCs.    

Financial Statements   

Accounting information is prepared, organized, and conveyed is in Financial Statements. Financial statements are reports in which accounting information is organized so users of financial information have a consistent, quick, and thorough means of reading and understanding what is going on in the business.     

There are two basic financial statements: the Balance Sheet and the Income Statement.     

Interested parties need to understand the financial and accounting activities of a business.  The Balance Sheet and Income Statement are a formal record of the financial activities of a business. They are presented in a structured manner and in a form that is consistent and easy to understand once you understand the format.   

Financial Statements provide a high level view of accounting and a summary of how a business is performing. They provide a quick picture that can be easily compared across businesses and industries. Understanding how to read and analyze a Balance Sheet and Income Statement is a great place to start understanding accounting and finance.     

Financial statements are the end product of bookkeeping.  Think of financial statements as the destination or goal of bookkeeping and accounting. When you know where you are going and who the audience is, it is easier to make good bookkeeping decisions.  When you understand the liquidity, solvency and capital structure of a company you can make good financing and investment decisions.    

Financial Statements contain information required to quickly analyze and assess the relative health of a business.  A basic understanding of financial statements also provides the high level perspective on the goals of the bookkeeping work and accounting entries.  The daily operations of a business are measured in the money that comes in as revenues, the money that goes out as expenses, the money that is retained as profit, the money that is invested in operational assets, and the money that is owed.  It’s all about the money. Financial statements let you follow the money.

3
The downloadable eBooks on Reading and Understanding Financial Statements

Finally understand the numbers side of Business.  Financial Literacy matters to your career and success   Senior executives routinely share and discuss financial data with marketing directors, operations chiefs, and other direct reports. But how much do those managers really understand about finance and the numbers? A recent investigation into this question concluded most managers understand not enough to be useful.  Asked to take a basic financial-literacy exam—a test that any CEO or junior finance person should easily ace—a representative sample of U.S. managers from C-level executives to supervisors scored an average of only 38%.   Lack of financial literacy matters and impacts an organizations ability to optimally perform. Those who can’t speak the language of business can’t contribute much to a discussion of performance and are unlikely to advance in the hierarchy or reach their full potential.   Does a lack of financial literacy matter? From a managers’ point of view, it surely does. Those who can’t speak the language of business can’t contribute much to a discussion of performance and are unlikely to advance in the hierarchy. They may get caught off guard by financial shenanigans, as many employees at Enron were.    

They also are unable to gauge the health of a prospective or current employer.  The CFO of a small manufacturing company often asks candidates for engineering positions whether they would like to review the past two years of the company’s financials. None yet have taken him up on the offer—knowing, perhaps, that they could make neither head nor tail of the statements.  People don’t tell their bosses that they don’t speak finance. It’s the usual human reluctance to admit ignorance. In a survey managers were asked what happens in meetings when people don’t understand financial data. The majority chose answers reflecting that reluctance, such as “Most people don’t ask because they don’t want to appear uninformed in front of their boss or peers.”  Don’t let this be you. Take this course and understand Financial Statements.

Download the two attached eBooks for a thorough understanding of financial statements and the terms associated with them.

4
The Income Statement Lecture

The Income Statement

The basic structure and components of the Income Statement are reviewed in this lecture.  The Income Statement is sometimes called the Profit and Loss Statement or P&L for short. 

The components of the Income Statement are:

  • Revenue

  • Expenses

  • Net Income

  • Profit

  • Earnings


The Income Statement    

The daily operations of a business are measured in the money that comes in as revenues, the money that goes out as expenses, the money that is retained as profit, the money that is invested in operational assets, and the money that is owed.  It’s all about the money. Financial statements follow the money.    

The report that measures these daily operations, of money in and money out over a period of time, is the Income Statement.    

Revenues minus Expenses equals Net Income   

The Income Statement can be summarized as: Revenues less Expenses equals Net Income.  The term Net Income simply means Income (Revenues) net (less) of Expenses.  Net Income is also called Profit or Earnings.  The terms "profits," "earnings" and "net income" all mean the same thing and are used interchangeably. They are synonyms for the bottom line number on the Income Statement. Revenues are often called Sales and are represented on the top line.    

You understand the dynamics of this concept intuitively.  We always strive to sell things for more than they cost us to make or buy. When you buy a house you hope that it will appreciate in value so you can sell it in the future for more than you paid for it. It’s also the rule for stocks: buy low, sell high. In order to have a sustainable business model in the long run, the same logic applies.  You can’t sell things for less than they cost to make and stay in business for long. If you own run a sandwich shop you had better make sure that you are selling the sandwiches for more than they cost you to make.    

Think of the Income Statement in relation to your monthly personal finances.  You have your monthly revenues: in most cases the salary from your job.  You apply that monthly income to your monthly expenses: rent or mortgage, car loan, food, gas, utilities, clothes, phone, entertainment, etc.    Our goal is to have our expenses be less than our income.     

There is an old adage: “If you outflow is more than your income, your upkeep is your downfall.”   

Over time, and with experience, we become better managers of our personal finances and begin to realize that we shouldn’t spend more that we make.  We strive to have some money left over at the end of the month that we can set aside and save.  In business, what is set aside and saved is called Retained Earnings.      

Some of what we set aside we may invest with an eye toward future benefits.  We may invest in stocks and bonds or mutual funds, or we may invest in education to expand our future earning and career prospects.  This is the same type of money management discipline that is applied in business.  It’s just a matter of scale. In business we buy assets that help the enterprise expand or perform more efficiently. There are a few additional zeros after the numbers on a large company’s Income Statement but the idea is the same.    

This concept applies to all businesses.   Revenues are usually from Sales of products or services.  Expenses are what you spend to support those sales in terms of the operations: Salaries, raw materials, manufacturing processes and equipment, offices and factories, consultants, lawyers, advertising, shipping, utilities etc.   What is left over is the Net Income or Profit.   Again: Revenues – Expenses = Net Income.    

Net income is either saved in order to smooth out future operations and deal with unforeseen events (save for a rainy day); or invested in new facilities, equipment, and technology. Or part of the profits can be paid out to the company owners, called shareholders or stockholders, as a dividend.     

The Income Statement is also known as the "profit and loss statement". Business people sometimes use the shorthand term "P&L," which stands for profit and loss statement.  A manager is said to have “P&L responsibilities” if they run an autonomous division where they make the decisions about marketing, sales, staffing, products, expenses, and strategy. P & L responsibility is one of the most important responsibilities of any executive position and involves monitoring the net income after expenses for a department or entire organization, with direct influence on how company resources are allocated and responsibility for performance.     

Google the term “income statement” and you will see lots of examples of formats and presentations. You will see there is variety depending on the industry and nature of the business but they all follow these basic principles.    

Remember:  Income (revenue or sales) – Expenses = Net Income or profit   

5
Price, Sales and Revenue

This lecture analyzes the top line of the Income Statement: Revenue.  Revenue is calculated as Price X Quantity Sold.  I go into detail as to how prices are determined through supply and demand. 

6
The Income Statement and Taxes
7
The Balance Sheet Explained

Balance Sheet Basics 

  The Balance Sheet is a condensed statement that shows the financial position of an entity on a specified date, usually the last day of an accounting period.         

Among other items of information, a balance sheet states

  • What Assets the entity owns,    

  • How it paid for them,   

  • What it owes (its Liabilities), and    

  • What is the amount left after satisfying the liabilities (its Equity)   

Balance sheet data is based on what is known as the 

Accounting Equation: Assets = Liabilities + Owners' Equity.   

Think of a Balance Sheet in terms related to everyday life.  Home ownership, when you have a mortgage, is represented as a Balance sheet. Your home ownership basically has the three components of Asset, Liability and Equity. The Asset is the value of the house. This is determined by an appraisal. An appraisal takes into account recent sales of homes in the area and compensates for differences like the number of bath or bedrooms, the size of the lot, etc.    

The Liability is the mortgage. This is how much you owe against the house. The Equity is the difference between the value of the Asset and the amount of the Liability. If your home is worth $200,000 and you have a remaining mortgage balance of $150,000, then you have $50,000 in Equity. We sometimes call this homeowner’s equity.    

If your mortgage balance is more than the value of the home, then you are considered “upside down” or “under water”. The same principle applies to a business: if the value of its Liabilities is more than the value of the Assets then the enterprise is insolvent and probably headed for bankruptcy.     

    A Balance Sheet is organized under subheadings such as current assets, fixed assets, current liabilities, Long-term Liabilities, and Equity With income statement and cash flow statement, it comprises the financial statements; a set of documents indispensable in running a business.     

What does the Balance Sheet balance?   

The balance sheet is structured to show the amount and type of assets an enterprise owns and how those assets are funded.  One side of the balance sheet shows what you have (assets) and the other side shows how you paid for it (debt and equity).    

Assets can be purchased and paid for in two ways: with debt or with equity (or a combination of the two).  What a company owes, the debts or loans, are called Liabilities; what a company owns is the Equity or Stock.    

The Liabilities and Equity are equal to the Assets.  They are two sides of the same coin and they must balance; hence the term Balance Sheet. This is a fundamental principal of Accounting called the Accounting Equation.  Assets = Liabilities + Equity.     

Balance Sheet Format   

A Balance Sheet is typically organized in two columns with the Assets on the left and the Liabilities and Equity on the right. It is divided into subcategories with the most current types on top and the more long-term varieties towards the bottom.     

Current Assets are ones like cash that can be used on short notice and Long term Assets are things like factories that would take longer to convert to cash.  Current means short term; stuff that needs to be addressed within one year. Long-term means stuff longer than the next year.    

Bills that need to be paid within the month are considered Current Liabilities and loans that are paid back over years are considered Long term Liabilities.    

Equity is what the owners actually own.  Equity is basically Assets less the Liabilities and is shown as accounts below the Liabilities on the left hand side.  Equity is shown below the Liabilities because debt has senior claims on the assets. In the event of liquidation like a bankruptcy, the debt holders get paid from the sale of assets first and then anything left over goes to the equity holders.    

Here is an example Balance Sheet to get and idea of the format; notice that the Total Assets equals the Total Liabilities plus Equity.

8
The Balance Sheet

The Balance Sheet


Assets = Liabilities + Equity

9
The Interconnection of Financial Statements
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Accrual Accounting and the Cash Flow Statement
11
Income Statement and Balance Sheet Interconnection Recap

In this lecture I review the Balance Sheet and Income Statement and how they are connected and the flow of money through them.  This is a summary and preparation for discussing the Cash Flow Statement. 

12
The Matching Principle and Liquidity Ratios

In this lecture I talk about Accrual Accounting and the Matching Principle and why they are so important.  Then I discuss the impact of these concepts on the Balance Sheet and Income Statement.  Then I talk about Liquidity Ratios and the Current Ratio and the Quick Ratio. 

So this lecture starts to tie together Accounting, Financial Statements, Corporate Finance, and Financial Analysis.

13
Depreciation and Financial Performance

Depreciation is the last concept I present in preparation of discussing the Cash Flow Statement.  Depreciation is an accrual concept that creates an asset on the Balance Sheet and a non-cash expense during the asset's useful life.  Depreciation then gets reconciled with cash in the Cash Flow Statement.  You are really starting to become a savvy business person!

14
The Cash Flow Statement
15
Cash Flow, Reconciliation, and Summary

In this lecture I tie together the financial statement interconnection and flow and then review the Balance Sheet and Income Statement.

16
Use and Users of Financial Statements
17
The Use of Financial Statements for Raising Capital
18
Financial Statements and Entrepreneurship
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Budget Construction and the Income Statement
20
Budgets and Management Practice
21
Financial Statements, Finance, and Managerial Decision Making
22
Financial Statement Ratio Analysis

Financial Statement Interconnection and Flow

1
Financial Statement Interconnection
2
Financial Statement Review
3
Financial Statement Interconnection and Flow

The Big Picture of Financial Statements

The three Financial Statements: Balance Sheet, Income Statement, and Cash Flow Statement, are interconnected and the accounting numbers flow through them.   They are the measure of a company’s performance and health.

The basic interconnection starts with a Balance Sheet showing the financial position at the beginning of the period (usually a year); next you have the Income Statement that shows the operations during the year period, and then a balance Sheet at the end of the year. 

The Cash Flow is necessary to reconcile the cash position starting from the Net Income number at the bottom of the Income Statement. The cash number calculated from the Cash Flow Statement is added to the cash reported on the beginning Balance Sheet. This number needs to match the actual cash in the bank at the end of the period and is used as the Cash account balance at the top right (Asset column) of the end of year (EOY) Balance Sheet. 

The Net Income number from the Income Statement is then added to the Retained Earnings number in the Equity section (lower left hand side) of the end of year (EOY) Balance Sheet.

Changes in non-cash accounts like Accounts Receivable and Accounts Payable and Depreciation and Amortization will make up the difference between the Cash Flow number added on the right side of the Balance Sheet and the Net Income number added on the left hand side.

When this is done correctly, all the numbers should reconcile and the Assets will be equal to the Liabilities and Equity (remember the Accounting Equation A = L + E) of the EOY Balance Sheet.

Financial Statement Interconnections and Flow

Think of it as a system of two Balance Sheets acting as bookends for the Income Statement.  And the Cash Flow Statement used to reconcile the Net Income (or Loss) at the bottom of the Income Statement with the amount of cash actually in the bank.  This process accounts for every penny that has come in, gone through, and gone out of a company during the period.

Understanding these three financial statements and how they knit together will allow you to assess the financial health, viability and prospects of any company, and help you make rational fact-based investment decisions. This is how Warren Buffett does it.

This post ties together the functionality of the financial statements. I hope this might be an “aha” moment for you. It was for me when I finally realized how this all fit and worked together. This is the basis of Financial Literacy and Capitalism. Understanding this conceptual big picture of accounting will provide a context to keep you from ever getting lost in the details.

4
Worksheet and Quiz

Now its time to test your new knowledge.

Here is a quiz to test your new knowledge of financial statements and how they interconnect and flow together. Download the spreadsheet and fill in the yellow squares numbered 1-22. The only number you need to know is at the top where it says that Accounts Receivable AR increased by $75.

The following video will go over the quiz and the answers. Don't peak! : )

5
Financial Statement Quiz Answers and Review

Download the PDF with the answers to the quiz and follow along with the video lecture.

Financial Statement Analysis

1
Intro to Financial Statement Analysis Lecture

Intro to Financial Ratios and Analysis

  • Financial performance metrics

2
Intro to Financial Statement Analysis

There are essentially two basic techniques that are used in Corporate Finance. One is the ratio analysis of financial statements and the other is calculating the present value of future cash flows.  Bankers, investors, financiers, CFOs and entrepreneurs use these tools and techniques to value assets and make decisions.

In these next three lectures we will look at using financial ratios as a capital budgeting tool. There are lots of different accounting ratios that get used inside of a firm. 

By ratio analysis I mean taking two numbers from financial statements and dividing one by the other. What we are doing is taking two pieces of accounting data, put one over the other, and this forms a ratio. We are taking two pieces of data and forming a performance metric. Ratios are usually presented as a percentage or a number depending on whether the usual case is bigger or less than one.

Besides being a capital budgeting tool, ratios allow us to compare different companies or a company over time. Ratios are great tools to do this comparison because they allow us to “normalize” the numbers. A ratio eliminates any size differences and allows for pure comparison so you can compare apples to apples.

Financial ratios are derived from accounting information and rely on an understanding of financial statements. The eBook attached to this section provide a primer on the subject. Download and check out MBA ASAP Understanding Financial Statements before you go through this section of lectures.  It will get you up to speed on this critical business skill quickly. Also download and review the attached Financial Statement Glossary of Terms.

You also may want to go through the video lectures on Ratios, then read the book, and then go back through the videos.  That way you will know where we are headed with this information. 

3
Financial Ratio Analysis

Financial Statement Analysis and Ratios


Accounting and Finance overlap in this area.  The launching place for Corporate Finance is the ability to read and understand Financial Statements. The analysis of financial statements and subsequent assumptions and projections based on that analysis is the next step.  Financial Statement Analysis is the process of analyzing a company's financial statements and comparing the analysis across companies and industries in order to make better operating and investing decisions. This analysis method involves specific techniques for evaluating and quantifying risk, performance, financial health, and the future prospects of an enterprise.  We can look at the performance of a particular company over time such as year to year results.  This is called Horizontal Analysis.  And we can look at various performance characteristics within a single time period. This is called Vertical Analysis.  We can create metrics across an industry segment as an average value to compare our company against.  This is called Benchmarking.  We can also aggregate up different industry groups and see how they perform relative to each other.  This type of analysis can be helpful in gauging where to allocate investment dollars in a portfolio.  It can also be used to see how a management team is performing relative to its competition. 

4
Financial Ratios: Calculation of Liquidity and Solvency Ratios

In this lecture I show you a spreadsheet with Financial Statements and we calculate and discuss financial ratios.   Download the spreadsheet in order to get better insight into the calculations and how financial statements interconnect and flow.


Horizontal and Vertical Analysis

 

Horizontal analysis compares financial information over time, typically from past financial statements such as the income statement. When comparing this past information we look for variations of particular line items such as higher or lower earnings, sales revenues, or particular expenses. Horizontal analysis is used to look for trends that can be extrapolated in order to predict future performance.

Vertical analysis is a proportional analysis performed on financial statements. It is ratio analysis. Line items of interest on the financial statement are listed as a percentage of another line item. For example, on an income statement each line item will be listed as a percentage of Sales.  

 

Financial Ratios

 

Financial ratios are powerful tools used to assess company upside, downside, and risk. There are four main categories of ratios: liquidity ratios, profitability ratios, activity ratios and leverage ratios. These are typically analyzed over time and across competitors in an industry. Using ratios “normalizes” the numbers so you can compare companies in apples-to-apples terms.

 

Liquidity and Solvency

 

Solvency and liquidity are both refer to a company’s financial health and viability. Solvency refers to an enterprise's capacity to meet its long-term financial commitments. Liquidity refers to an enterprise’s ability to pay short-term obligations. Liquidity is also a measure of how quickly assets can be sold to raise cash.

A solvent company is one that owns more than it owes. It has a positive net worth and is carrying a manageable debt load. A company with adequate liquidity may have enough cash available to pay its bills, but may still be heading for financial disaster down the road. In this case a company meets liquidity standards but is not solvent. Healthy companies are both solvent and possess adequate liquidity.

Liquidity ratios are used to determine whether a company has enough current asset capacity to pay its bills and meet its obligations in the foreseeable future (current liabilities).  Solvency ratios are a measure of how quickly a company can turn its assets into cash if it experiences financial difficulties or is threatened with bankruptcy. Both measure different aspects of if, and how long, a company can pay its bills and remain in business.

The current ratio and the quick ratio are two common liquidity ratios. The current ratio is current assets/current liabilities and measures how much liquidity (cash) is available to address current liabilities (bills and other obligations).  The quick ratio is (current assets – inventories) / current liabilities.  The quick ratio measures a company’s ability to meet its short-term obligations based on its most liquid assets, and therefore excludes inventories from its current assets. It is also known as the “acid-test ratio.”

The solvency ratio is used to examine the ability of a business to meet its long-term obligations. Lenders and bankers most commonly use the solvency ratio because they are most concerned about their ability to get paid back any money they lend. The ratio compares cash flows to liabilities. The solvency ratio calculation involves the following steps:

All non-cash expenses are added back to after-tax net income. This approximates the amount of cash flow generated by the business. You can find the numbers to add back in the Operations section of the Cash Flow Statement.

Add together all short-term and long-term obligations.  This is the Total Liabilities number on the Balance Sheet. Then divide the estimated cash flow figure by the liabilities total.

The formula for the ratio is:

(Net after-tax income + Non-cash expenses)/(Short-term liabilities + Long-term liabilities)

A higher percentage indicates an increased ability to support the liabilities of a business over the long-term. Acceptable solvency ratios vary from industry to industry, but as a general rule of thumb, a solvency ratio of greater than 20% is considered financially healthy. 

Remember that estimations made over a long term are inherently inaccurate. There are many variables that can impact the ability to pay over the long term. Using any ratio to estimate solvency needs to be taken with a grain of salt.

5
Ratio Analysis: Summary, Conclusion and Where We are Headed

The Time Value of Money

1
The Time Value of Money Introduction

There are two sets of data that we use in corporate finance: retrospective and prospective. Retrospective data is compiled in financial statements. These represent the historical performance of an enterprise and can be analyzed, compared, and extrapolated. Ratios are the tools of financial statement analysis and we just discussed them

Prospective data is compiled in financial projections. These represent management’s forecast of how the enterprise will perform in the future. These projections can be analyzed, risk adjusted, and a present value of those future cash flows can be calculated. We will now get into the forward-looking aspects of finance with the concept of the Time Value of Money (TVM).

Time is money, literally. If there is a prospect of receiving a certain sum, then the sooner you receive it, the more it is worth. Interest rates describe this relationship between present value and future value. This is the fundamental concept of finance. We will explore this relationship between present and future value from different angles and I will phrase it in different ways in order to let it sink in.

TVM represents the conceptual basis of finance. This is the underlying principle of how banks function, how stocks and bonds are priced, how assets and companies are valued, how projects are analyzed, and how you should think about the nature and function of money.

Lets look at the video lectures and explore this concept in more depth. 

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The Time Value of Money TVM
3
History Lesson: Time Value of Money

History Lesson

The concept of the time value of money dates back to the 1500s. Martín de Azpilcueta of the School of Salamanca (December 13, 1491 – June 1, 1586), also known as Doctor Navarrus, was an important Basque theologian, and an early economist and the first person to develop monetarist theory. He invented the mathematical concept of the time value of money. It’s an idea that’s about 500 years old.

4
Discounting Cash Flows DCF: Present Value and Future Value

The core of corporate finance is calculating the present value of future cash flows.  This concept is based on the time value of money. A company is essentially an entity that generates cash flows each year into the future.  The trick is estimating those future cash flows and how much they might grow or shrink and what the risks are to realizing (i.e. receiving) them. 

It’s difficult to peer into the fog of the future. This is where you have to polish your crystal ball and do some deep analysis of the business, its markets and competitors. All this information is compiled in a spreadsheet of financial projections and the bottom line represents the future cash flows in each year. These are discounted back to the present value at a discount rate that takes into account what similar investments, which are just streams of expected cash flows, are priced at in the market and any and all risks specific to the particular enterprise or asset we are contemplating buying or selling.

This is the basic concept of Valuation. Valuation is an estimate of something’s worth.  Something’s worth can be set at auction where people bid and the highest bidder wins. But how do bidders know how much to bid and how much is too much? For income producing assets, like stocks, it’s the present value of the future cash flows.

5
Financial Statements, Finance, and Decision Making Lecture

Financial Statements, Finance, and Decision Making

  • Time value of money

  • Discounting cash flows

Net Present Value

1
Intro to NPV

So far we have analyzed and calculated the value of future cash flows and brought them back to present value. Net Present Value (NPV) takes this idea a step further and accounts for the transactional aspect. We must “purchase” the future cash flows either by:

  • Buying a bond or stock, or
  • Acquiring a company, or
  • Purchasing an income-producing asset, or
  • Undertaking a project and incurring the costs of developing or building the income-producing asset.

Net present value “nets out” the cost of acquiring the future cash flows.  NPV compares the cost in today’s dollars to the present value of projected income or benefits also in today’s dollars. Its only worth doing if the price is less than our assessment of the future benefits.

2
NPV Analysis

The NPV is equal to the initial cost, which has a minus sign in front of it, plus the present value of what's coming in off the project as cash flows. Cash flow in period 1, discounted one period back, plus the cash flow in period two, discounted two periods back, the cash flow in period 3, discounted back three periods, you get the idea, plus all the other cash flows coming in discounted by their period. 

What we do is take that initial cost and weigh that against the present value of all the cash coming in. We're going to “net” the two. There's a minus sign on the costs, and plus signs on all of the present value cash flows. 

We ask how all the money going out weighs against all the money coming in. Think of it like a balance. If we know the initial investment and the stream of money coming in from the project in the future, we can measure the NPV as the difference between the two; the net between those two streams. 

3
NPV Calculation

Internal Rate of Return

1
IRR Analysis and Calculations

Next we are going to explore using the Internal Rate of Return (IRR) as a capital budgeting tool for deciding how to best to invest and allocate money. Internal rate of return is the discount rate used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. The higher the internal rate of return of a proposed project, the more desirable it is to undertake the project. 

The internal rate of return is derivative of NPV. NPV basically tells us whether or not the present value of the cash coming in exceeds the cash going out. NPV calculates the net of the present value of the cash flows. With IRR we come at the issue from a different angle.

2
IRR Shortfalls and Caveats

Finance Q&A

1
Frequently Asked Questions Answered about Finance and Accounting

The attached book is a collection of questions and answers from my Quora and responses to students' questions.  It addresses a broad range of issues that come up about the nature of financial statements, how to value a company or startup, how to analyze financials, and how to create personal wealth. 

The Q&A format gives you a different angle on many of these concepts and principles.  Check it out as another learning tool to help you cement these ideas.

Financial Projections

1
Financial Projections

Financial Projections Lecture

How to construct Pro Forma Financial Projections


In this lecture I go over:


· Income Statement format of pro formas

· Cost Structure

· Fixed and Variable Costs

· Risk Management and Fixed Costs

· Revenues

· Price and Quantity

· Cost of Goods Sold COGS

· Cost Accounting

· Contribution Margin

· Breakeven Analysis

· Profit


To get a valuation for your project or enterprise: take the stream of profits from your projections and pull them back to Present Value using Discounted Cash Flow technique. That present value calculation is your best estimate of the value of your venture!

See the attached slide deck and Excel workbook template that accompany this video lecture to get a better understanding of how to structure financial projections and calculate a valuation using DCF and NPV.

2
Real Option Pricing:Projects that expand the set of opportunities have positive

Real Option Pricing

Projects that expand the set of opportunities have positive option values.


Taking on new projects opens doors to new opportunities. Those opportunities have a value that can be analyzed using option-pricing models. When we are valuing new enterprises, startups, or projects, we may not be adequately capturing this in our valuations.


Projects that expand the set of opportunities have positive option values. And conversely shutting down a project limits the set of opportunities going forward and has a negative option value.


A project’s impact on the firm’s opportunities, or its option value, may not be captured by conventional NPV analysis.


The Black-Scholes Option Pricing Model is the most famous formula and a straightforward way to price options.


The oil company Anadarko famously employed this new analytical method in 1994 to value oil field prospects and made winning bids in Gulf leases.


The new economy is filled with rapid change and uncertainty and real option valuation helps more accurately price those risks and opportunities.


Breakeven Analysis

1
How to analyze costs and calculate Breakeven and CVP

Budgets

1
Budgets
2
Budgets and Financial Management

Budgets and Managerial Practice

  • What gets measured gets managed

  • Measure what matters

  • Quality Decision Making

Technology Trends in Accounting and Corporate Finance

1
Technology Trends in Accounting and Corporate Finance

How to Create a Diversified Stock Portfolio

1
Use and Users of Financial Statements

Use and Users of Financial Statements

  • Investors

  • Value Investing

  • Intelligent Investor

  • Bankers and lending criteria

  • Fraud detection

2
Public Company Financial Reporting and the SEC

Public Company Financial Reporting and the SEC

  • Why financial statements and their reporting are important.

3
Financial Statements and Accounting Standards
4
Audited Financial Statements

Audited Financial Statements

  • Transparency

  • Interpretation

  • Conflict of Interest

  • Accounting Firms and Consulting business

  • SOX Sarbannes Oxley

  • Regulation, how much is just enough

  • Materiality

5
Beta and the Capital Asset Pricing Model CAPM
6
Stock Price and Valuation

This is a lecture about how stock price is determined in publicly traded companies.  The stock price is the aggregate average estimation of all the investor's bid and ask prices.  These estimations are guesses about the present value of the future cash flows of the company.

7
Valuation: Present Value of Future Cash Flows

Startup Finance

1
Introduction to Startup Finance
2
Startup Funding Rounds

Download the Cap Table Template and Exit Scenario Spreadsheet to get an idea of how a Cap Table is structured and how the ownership and investment interests are calculated and distributed as part of a successful Exit. 

3
Raising Capital Lecture

Raising Capital

  • Equity and Debt

  • Financial Statements

  • Operating History

  • Debt Service Coverage Ratio

  • Credit Analysis and credit risk

4
Entrepreneurship and Financial Statements

Entrepreneurs need to be literate in financial statements.  Startups need to produce financial statements to measure progress and performance internally and to show to key stakeholders like investors, bankers, and vendors externally.

Corporate Finance and Business Ethics

1
Corporate Finance and Business Ethics Lecture

Business schools teach ethics and companies have developed and instituted policies aimed at fostering an ethical workplace. If these efforts are more than lip service, why is unethical behavior and corporate corruption so prevalent?

Corporate corruption is widespread. Unethical behavior permeates organizations. It rarely is organized from the top however.

Granted, some leaders are crooks and some managers become involved in institutionalized breaking of rules and ethical standards in order to meet targets and goals. KPIs are gamed because that is what is incentivized.

But the intention of the majority of managers and leaders is to run ethical organizations.

Usually employees end up bending or breaking ethics rules for personal gain and because those in charge unknowingly encourage it.

These behaviors are the unintended consequences of setting aggressive targets and goals without addressing and implementing guardrails and rules of the game. You need to frame the market.

In many cases ethics is not taken into consideration in business situations. Companies are in business to maximize profits and create shareholder value. It is the sole focus of the corporate charter. Collateral impact and implications are not addressed in articles of incorporation or corporate bylaws.

Correcting mistakes takes time and resources and that translates into costs, lost market share and dings to the brand. That cascades into lost revenues and reduced profits.

Admitting problems and attempting to remedy them can damage a brand’s reputation and decrease market share and competitive position. These are all business issues that incentivize not dealing with, delaying dealing with, or covering up problems. This behavior is unacceptable from an ethical standpoint but is baked into the corporate mandate.

We can examine a long list of case studies: Ford and the infamous Pinto, Enron, Volkswagen and emissions cheating, and on and on.

What would make CBS CEO Leslie Moonves say of our United States poisonous political environment, “It may not be good for America, but it’s damn good for CBS.” He was certainly not thinking of patriotism, high ideals or coming from a principled position.

Bottom line:

Greed and vanity are the twin engines of capitalism.

They are powerful motive forces and drive much productivity and innovation. But the side effects are debilitating. Nassir Ghaemi in his book A First Rate Madness makes the interesting claim that there is a sweet spot of madness that allows people to function and perform at a high level. Less madness and a person is unmotivated, too much and they are psychopaths. But the goldilocks principle applies to just the right amount to succeed in society; to rise to the top.

This phenomena speaks to the the dysfunction of unregulated capitalism and its pernicious social effects. Proper regulation can frame markets and nudge good behavior and curb bad behavior.

We can apply this thinking to corporations and find the sweet spot of regulation that allows profit maximization to spur creativity and innovation but not to spill over into anti social behavior.

Reigning and Framing

With all this said about reigning in and framing corporate behavior, the overwhelming benefits of the invention of the corporation are sometimes obscured and overlooked.

The corporate structure of organizing activity is one of the greatest beneficial inventions of modernity. The concepts of limited liability, governance by plurality, and separating ownership from management, were massively innovative and have spurred economic growth for 150 years.

Corporation form and stock markets were the perfect combination and were the dual engines of growth during the twentieth century. Stock markets have become less central to sourcing capital as we have private companies with great than one billion valuations called unicorns. But even as capital markets evolve and private equity becomes a big player, the corporate form of organization is still the standard.

Innovation in organization

We usually think of innovation as coming from science and technology. Corporate form is an innovative way of organizing people to get things done. One form that seems to be challenging corporate supremacy is wiki and open source forms.

Linux and Wikipedia are two examples of people self-organizing and working on massive projects without being managed or paid.

Ethical Leadership

Ethical leaders have external reference points and guiding principles. They have a pole star that they navigate by and criteria against which they measure each and every decision and action.

These external reference points come from study and observation. They come from philosophy, religion, psychology, biography, and history. They come from non-fiction and fiction. They come from doing the hard work of thinking, drawing conclusions, and taking stands.

These are deep resources to draw on when making difficult decisions. These are how values are created that can be lived by.

Persistence

1
Persist in Your Efforts

Conclusion

1
Conclusion

Corporations and investors invest in real assets that are intended to be productive in generating income. Some of these assets such as apartment buildings, factories, offices, machinery and computers are tangible. Others such as brand names and patents are intangible.

The decision-making tools of corporate finance assess the value of proposed projects and income producing assets based on the time value of money and its relation to risk. We rank projects based on the present value of their future cash flows. How we do that is called discounted cash flow (DCF) valuation.

Lets take stock of the capital budgeting tools that we've talked about:

  • Net present value
  • IRR
  • Accounting ratios

CFOs rely on multiple metrics when making capital budgeting decisions. There are pros and cons to IRR, net present value and accounting ratios. What is important to understand is that each one of those data points represents an interesting and informative perspective. 

Using a portfolio of different capital budgeting tools helps make for better financial decisions. NPV is the gold standard.

2
Final Quiz

Here are some questions to help you assess your knowledge and understanding of the material covered in this course on Corporate Finance. 

You can view and review the lecture materials indefinitely, like an on-demand channel.
Definitely! If you have an internet connection, courses on Udemy are available on any device at any time. If you don't have an internet connection, some instructors also let their students download course lectures. That's up to the instructor though, so make sure you get on their good side!
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