CORPORATE FINANCE
Polsky, Fall 2015
I. Introduction
Managerial accounting= internal use of accounting
Financial accounting= what we’re concerned with= produces reports that inform outsiders, such as investors and creditors, about the condition of the business
Event= transaction with a third party—when accounting entries are made à generally, assets and liabilities are recorded when there is an arm’s length, market transaction that is denominated in money terms—cash receipts and disbursements are the principal transactions
Cost Principal= assets are reported on a company’s books at their historical cost and not at higher market values
· i.e., parcel of land in the middle of Manhattan that was bought for $100,000 in 1920 will still be noted as that now on their books, even though that’s clearly
Accounting Reports Should Be:
1. Reliable= reasonably free from error, complete, and verifiable
2. Cost Effective= only report material information- of a magnitude that it might influence a decision
Economic entity= entire enterprise—reports must be made for both the corporation AND its subsidiaries
· Consolidated reporting= transactions between parent (>50% ownership interest) and subsidiary are eliminated for reporting purposes
· If parent owns 50%-20% of voting stock, then NO consolidated reporting à use equity method of accounting and enter the original investment in the subsidiary as an investment
· If parent owns LESS than 20% of voting stock à investment is carried on the balance sheet as either trading securities (if held with an intent to sell in the near term) or available-for-sale securities (if held for another other reason) = recorded on the balance sheet at their present fair market value
Accounting Period= accrual method= allocate income to the period WHEN IT IS EARNED, regardless of the time of receipt, and expenses WHEN INCURRED, regardless of time of payment
Monetary basis= in U.S. dollars (if a U.S. company does worldwide business, they must convert their foreign transactions into dollars on their statements)
Going concern= business will continue to operate for the infinite future
Transactions must be reported on a conservative basis= if there are 2 ways of doing something, then choose the most conservative one (understating profits does less harm than overstating them)
How to finance your business=
· Issue debt= get a loan/borrow money—claim on the business’s assets—less risk because they get paid first, but less gains because they only get their loan + interest
· Reinvest profits back into the business
· Sell equity
o Issue common stock: residual ownership of the company, they get paid last before creditors= most risk and most reward because they get whatever is left; AND/OR
o Issue preferred stock: entitled to a specified amount of dividends, they are paid before common stock, but they don’t participate in business growth—little more risk than debt, but they have a higher “coupon rate” than debtholders for taking on the additional risk
Senior Secured Debt à Unsecured Debt à Preferred Stock à Common Stock
(low interest rate) (higher coupon rate)
Low Risk High Risk
Low Reward High Reward
Waterfall Effect: if everything goes under, this is how everyone gets paid
3 Core Accounting Principles: They describe the business (what it owns, what it does):
Balance Sheet: snapshot of what the corporation owns and owes at the end of an accounting period (if calendar year, then on Dec. 31)
Income Statement: shows the earnings or income of a business over a period of time (ie Jan 1-Jan 31)
Statement of Cash Flows: looks at a period of time, and looks at the cash flows (increased or decreased cash) and where cash has been spent or generated
Profits and cash (=liquidity) are NOT synonymous: you generally need both to be successful—just because you have one doesn’t mean you have the other
· Must pay your debts in CASH
Who cares about these financial statements and why?
Common Shareholders: want to know what I’m getting when I take on all this risk to help me understand in what I’m investing
Creditors: give them a good idea of how much risk they’re taking
IRS: tax return is an income statement—tells the IRS what your income is for that years—but it’s different than the income statement because there are lots of othe
ion has only losses, the capital accounts will be diminished by the amount of the losses= negative entry in the surplus account (aka accumulated deficit)
Goodwill= arises only in the acquisition of another business à where the total purchase price for a business exceeds the fair market value of the tangible assets, the tangible assets will be assigned their fair market value on the buyer’s books, and the balance of the purchase price will be assigned an INTANGIBLE ASSET
· Intangible asset= trademarks, goodwill
Deferred Expenses= exists where tax accounting treatment differs from that of financial accounting—income for tax purposes may exceed income for financial reporting purposes (cash v. accrual method)
Albert D. Bolt v. Merrimack Pharmaceuticals, Inc.: issue= interpret a corporation’s articles of organization to decide whether it has an obligation to redeem shares of its stock à P owns 52,488 shares of Series A Redeemable Preferred Stock in D company—P wants to redeem his stock—redemption provision= if net worth of corporation equals or exceeds $5M, then he may redeem his stock at the redemption price of any and all of his shares—have to determine meaning of “net worth”= no definition in any of the documents, common meaning=the difference between a corporation’s total assets and total liabilities—issue of whether they should include Series B stock in net worth calculation
· = contingent redemption obligation—only have to redeem if x happens
· Court= net worth= $10M – you have to keep preferred and common stock separate on balance sheet, but they’re both still liabilities
2. The Income Statement
Income Statement= more like a historical novel—begins on first day of fiscal year and tells reader how the corporation’s balance sheet came to look the way it does at the end of the year à it’s the link between 2 balance sheets
Sales= total revenues for the period (vs. profit= net revenues)
