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Corporate Finance
University of North Carolina School of Law
Omarova, Saule T.

Corporate Finance Outline
Prof. Omarova Spring 2011
I.            ACCOUNTING
                 A.            FS of Company are the start of a business valuation. Role of accounting is recording of money denominated assets. System that creates records for receipt & disbursement of assets.
1.      PURPOSE OF FS: Internal Reasons for keeping Accounting Records
a.      Need records to ensure responsibility of those records.
b.      Prevent theft & misuse
c.       Help management in running the Co & assessing how well or how poor the business is doing & adjust it.
d.      Purpose of paying taxes & dealing with regulators.
2.      LENDERS: Reason for keeping Accounting Records
a.      Provide basis for valuing that Co's business on an ongoing basis.
b.      They want to know who has a claim on the Co's assets. Do they have to share this asset with someone else.
                  B.            RULE MAKING BODIES IN ACCOUNTING
                                          1.            AICPA  – American Institute of Certified Public Accountants. Not a gov't entity. Founded in 1939.
                                          2.            FASB – Financial Accounting Standards Board -> primary professional organization that produces standards for accounting. It produces substantive standards that all accountants should use when they prepare financial statements. These are standards and not rules!!  They provide guidance in how to go about providing accounting & leave discretion/judgment to accountant b/c different business differ from on another in what happens to them.
                                          3.            GAAP –  Generally Accepted Accounting Principles
                                          4.            SEC – Gov't agency that administers securities law under 33 & 34 Act. Has statutory power for Corps whose securities are traded in public markets.  The SEC relies on the AICPA & FASB to come up with substantive principles for accounting.
                                          5.            IASB – International Accounting Board – IFRS which is similar to GAAP.
                                          6.            PCAOB – created by Sarbanes Oxley Act. This board does not issue standards for accounting, but instead requires registration of auditing companies & monitors the conduct of business of those companies b/c of fraud.
                  C.            BASIC ACCOUNTING PRINCIPLES
                                          1.            Historical Cost  – what you paid when you got the asset.
                                          2.            Reliability Principle – reports/FS should be verifiable from the records. Sarbanes Oxley made this principle impt –> Must certify the accuracy of FS & that Co has sufficient internal mechanisms to deal with this.
                                          3.            Economic Entity Principle –  says that the reports must cover the entire economic entity.
a.      Consolidation required if Corp owns 50% or more of voting stock…not debt security or preferred stock.
b.      If Corp owns less than 50% but more than 20% than they list the Sub as an “Investment” b/c they are considered not to control.
c.       Less than 20% is listed as trading securities or securities for sale.
                                          4.            Matching Income & Expenses in Accounting Period (Accrual) – Look at the period (i.e. Yearly) & say that all income during this period must be recorded.  All expenses occurred must also be reported & matched against this income in the same period.
a.      Basic rule is that income is earned when the business has a legal right to that stream of revenue/asset regardless of when the business gets paid.
b.      Expenses are incurred when obligation is regardless of when it's paid.
c.       Good sold on credit –> What happens? Right to payment has risen today when you sold the goods but  not get payment until later. To record this transaction by recording the sale & recognizing that income, but the asset is account receivable. When you get the cash you record the same amount in cash which will extinguish the account receivable.
                                          5.            Transparency of Methods – information that you include in your FS must be understandable. (Questions to ask is how the Corp came up with that number…what did they include?)  Footnotes to FS disclose the method that the Corp used to arrive at the particular number & the kinds of judgments the Corps accounts made in how to account for certain transactions.
                                          6.            Consistency of Methods – reports should be prepared on a comparable basis from period to period. Can't use 1 method 1yr & then change it the next yr. Can't Willy Nilly pick & choose of what would make their FS look better b/c you wouldn't be able to tell how/project how the business is doing. You should use the same methods that are typically used by Companies in that industry. Not required to do so, but should. If they choose another method they should disclose it & tell why they are choosing to use another method.
                                          7.            Going Concern Assumption – this principle holds that reports that the Company will con't in business.
                                          8.            Conservatism Principle –  it's better to understate than overstate potential losses/profits. With respect to assets held for sale, those assets must be valued at the lower of their historical cost or FMV.
                 D.            Quick Check Question 2.1 (p.9)
                                          1.            Two principles at play.
a.      Historical Cost –> He didn't pay cash but he gave away an asset..the dog. The historical cost for the cats would be how much he paid for them.
                                                                                                        i.            We assume that the current market value of the dog is 100k.
b.      Conservatism Principle –> so depending on what he thinks the cats are valued & what he paid..he pay list them at a lower price.
                     A.         BALANCE SHEET (p. 10)
1.      Def.) Is a snapshot of a companies assets & liabilities for a particular period.
2.      Sets forth the fundamental accounting equation:       ASSETS     =      Liabilities + Equity (By creditors & shareholders) – means that all assets are claimed either by creditors or the shareholders.
3.      Format of Balance Sheet: See pg. 11–> Assets on left side are typically listed in order of liquidity & Liabilities & Owners Equity on right side.
4.      Assets – Def.) Are what that companies owns. Potential benefits that are coming that companies way
a.      Typically recorded at cost of that asset. (Historical Cost Principle)
                                                                                                  i.      2 EXCEPTIONS:
1.      Inventory recorded at the lower cost or market.
2.      Good-will – intangible asset.
b.      Assets Classified in 2 ways:
                                                                                                  i.      Current – Assets that can be converted into cash in 1yr
                                                                                                ii.      Non-Current/ Long-Term/Capital Assets – Those assets which can't be converted into cash within 1 yr.  All assets that are not qualified as current assets. You don't except them to turn into cash within next 12mths.
c.       Depreciation – what becomes relevant is the fact that the asset is carried at historical cost/book value which could fluxuate. This creates a certain issue & creates a fundamental tension. This is an assumption that every asset has a useful life & it has to be judged.  Accountant use it to disburse the cost over the useful life of that asset that used/consumed during that accounting period.
d.      Int

r to profit margin…measure of how much each sale dollar becomes income.  This can be impt measure of efficiency
5.      Return on Assets (ROA) (EBIT/avg total assets) – How profitable the use of your assets is. How much benefit does your assets generate.
6.      Sales to Assets (Asset Turnover) Ration (Sales/avg total assets) – This talks about how well you are using your assets. How much sales you are generating with the use of these assets.
7.       Return on Equity (ROE) (net income/avg shareholders' equity)
1.      Debt/Assets Ratios – the higher the ratio the greater burden & debt is on the company. This ration uses book value which should be a concern. This doesn't necessarily correspond with the FMV of those assets.
2.      Debt/Equity Ratio –  measures total debt to total equity. Used to describe the leverage of a company
3.      Fixed Assets/Tangible Net Worth Ratio (the owners' investment in plant & equipment) – measures the extent of owners capital has been invested in PPE. Fixed assets are illiquid so the more capital that is tied up in these assets, the less the liquidity is.
1.      Current Ratio – Current Assets / Current Liabilities (Difference is Working Capital) If working capital that is not a good sign. The company will have to raise more debt to satisfy their current liabilities.
2.      Quick (“Acid-Test”) Ratio – shows the quick liquidity for the next 12 months.  Cash + short Term securities + Receivables/ Current Liabilities) This is a more conservative measure of liquidity than the current ratio
3.      Cash Ratio – assumes some of the receivables will never be collected.  (Cash + Short Term Securities/ Current Liabilities) This is even more conservative than quick.
4.      Times-Interest Earned (Interest Cover) Ratio – EBIT/Interest. If EBIT is not enough to cover your interest payments then you are in trouble.
1.      Asset Turnover Ratio – Net Sales/Avg Total Assets; indicates how many $ of revenue the Company generates. Higher the ratio the better it is and the more efficient you are in using your assets. The lower interest is red flag for mismanagement.
2.      Receivables Turnover Ratio – Sales/Avg Receivables
3.      Inventory Turnover Ratio – Cost of Goods Sold/Avg Inventory;  Cost of goods sold comes from inventory statement. This shows how well the company is doing in terms of selling what they are producing. Are they accumulating too much..things they cannot sell.
1.      Price-Earnings Ratio (PE) – Market price per share. Whatever the price is today of that stock is divided by earnings per share which is reported. This ratio is a good way to show if the stock is over priced.
2.      Dividend Yield – Dividend Per Share/Market Price
3.      Dividend Payout Ratio – Dividend Per Share/Earnings Per Share
4.      Market to Book Ratio – Stock Price/Book Value Per Share
5.      Tobin's q – Market Value of Assets/Estimates Replacement Cost
I.        TAKE AWAY: Ratio's are important b/c they give you basis for comparison. These ratio's show why its impt to look at financial statements b/c to arrive at these numbers you need to look at these