CORPORATE FINANCE

CORPORATE FINANCE

The term Corporate or Corporation gives glimpse of Associates, Conglomerates, Business Empires, Multinationals etc. These corporates are generated by share or stake holders with business, acquisition, contracts, profits as prime motives.

There are also Not-for-profit entities operate under the category of charitable organizations, which are dedicated to a particular social cause such as educational, religious, scientific, or research purposes.

The Corporation commence their operations with their active Board of Directors elected by shareholders. The business requires Capital, planning & strategy, team, finance etc.

The BOD is decision making authority and sense to define corporate strategy. Corporate strategy takes a portfolio approach to strategic decision making by looking across all of a firm’s businesses to determine how to create the most value. In order to develop a corporate strategy, firms must look at how the various business they own fit together, how they impact each other, and how the parent company is structured, in order to optimize human capital, processes, and governance. Corporate strategy builds on top of business strategy, which is concerned with the strategic decision making for an Individual business.

The key components of Corporate Strategies are,

• Allocation of resources

• Organizational design

• Portfolio management

• Strategic tradeoffs

 

Here skilled manpower is our asset distributed throughout the firm. The Leader at the right place at right time to create the most business value. Allocation of capitol across all businesses to earn highest risk-adjusted return. Also, looking for external opportunities i.e., contracts and Acquisition for internal projects.

We have to ensure necessary corporate structure the Head office and reporting system of individual business unit to generate maximum number of values.

Portfolio management looks at the way business units complement each other, their correlations, and decides where the firm will “play” (i.e., what businesses it will or won’t enter). The companies are categorized by their Market capitalization. We have Apple, Microsoft, IBM & Facebook large cap (MC>$10BN) companies. Others are Mid cap, small cap and Micro cap.

One of the most challenging aspects of corporate strategy is balancing the tradeoffs between risk and return across the firm. It’s important to have a holistic view of all the businesses combined and ensure that the desired levels of risk management and return generation are being pursued.

We have analyst and associates spends lots of time in Excel spread sheet to forecast a business’ financial performance into the future.  The forecast is typically based on the company’s historical performance, assumptions about the future, and requires preparing an income statement, balance sheet, cash flow statement, and supporting schedules (known as a 3-statement model). From there, more advanced types of models can be built such as discounted cash flow analysis (DCF model), leveraged buyout (LBO), mergers and acquisitions (M&A), and sensitivity analysis. The output of a financial model is used for decision making and performing financial analysis, whether inside or outside of the company. It helps executives to make decisions about Raising capital (debt and/or equity), Making acquisitions (businesses and/or assets), Growing the business organically (e.g., opening new stores, entering new markets, etc.), Selling or divesting assets and business units Budgeting and forecasting (planning for the years ahead), Capital allocation (priority of which projects to invest in), Valuing a business & Financial statement analysis/ratio analysis Management accounting.

The bank shows the valuation methods it used to reach certain conclusions. For example, the bank may use comparable analysis to benchmark the client’s business against other similar firms in its market. It obtains the figures using sales, revenues, and valuation multiples like PE and trading multiples. Other valuation methods that can be used include financial modeling and DCF analysis.

Private Equity (PE) is an asset class and investing style that consists of buying an ownership interest in operating companies that are private – not publicly-traded.  Common strategies within P.E. include leveraged buyouts (LBO), venture capital, growth capital, distressed investments, and mezzanine capital.  Typically, a PE firm looks for firms that are undervalued, so that acquiring the company will create value for the PE firm. Top PE firms are,

·         The Carlyle Group – Washington D.C.

·         Kohlberg Kravis Roberts (KKR) – New York City

·         The Blackstone Group – New York City

·         Apollo Global Management – New York City

·         TPG – Fort Worth

·         CVC Capital Partners – Luxembourg

·         General Atlantic – New York City

·         Ares Management – Los Angeles

·         Clayton Dubilier & Rice – New York City

·         Advent International – Boston

 

Financial summary:

Sales and Revenue figures with number of % growth/down fall compared to past records. Here sales are generated from sold goods for particular period of time.

While Revenue generated, comes with number of sales-component including good sales. Also, Net income and Basic earnings at Is Net Income (NI)?

Net income (NI):

Also called net earnings, is a useful number for investors to assess how much revenue exceeds the expenses of an organization.

The formula to determine net income is sales minus cost of goods sold, selling- general and administrative expenses, operating expenses, depreciation, interest, taxes,

and other expenses.

Net income =Sales - (Gen Sales + COG sold + Expense (admin + Operating) + Depreciation + Interest)

Income statement:

Gross margin:

Gross margin is the percentage of a company's revenue that's retained after direct expenses such as labor and materials have been subtracted. It's an important profitability measure that looks at a company's gross profit as compared to its revenue. Gross profit is determined by subtracting the cost of goods sold from revenue.

Gross Profit = Revenue - COG

The gross margin and net margin are frequently used together to provide a comprehensive overview of a company's financial health. Where the gross margin only accounts for the COGS, net margin accounts for all indirect, interest, and tax expenses. The gross margin is an important and widely used financial analysis ratio.

Operating Margin or Return on Sales:

Operating margin, also known as return on sales, is an important profitability ratio measuring revenue after the deduction of operating expenses. It is calculated by dividing operating income by revenue. The operating margin indicates how much of the generated sales is left when all operating expenses are paid off.

It is a measurement of how many dollars of profit a company earns per dollar of sales after paying operating expenses. It considers cost such as wages, overhead and materials, but does not include non-operating expenses like taxes or interest.

Net profit margin:

Net profit margin, or simply net margin, measures how much net income or profit a company generates as a percentage of its revenue. It is the ratio of net profits to revenues for a company or business segment. Net profit margin is typically expressed as a percentage but can also be represented in decimal form.

Return on investment:

Return on investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost. Key factors influencing ROI include the initial investment amount, ongoing maintenance costs, and the cash flow generated by the investment.

To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio.

Key Features:

·         Return on Investment (ROI) is a popular profitability metric used to evaluate how well an investment has performed.

·         ROI is expressed as a percentage and is calculated by dividing an investment's net profit (or loss) by its initial cost or outlay.

·         ROI can be used to make apples-to-apples comparisons and rank investments in different projects or assets.

·         ROI does not take into account the holding period or passage of time, and so it can miss opportunity costs of investing elsewhere.

·         Whether or not something delivers a good ROI should be compared relative to other available opportunities.

Balance sheet:

The Quick ratio:

is an indicator of a company’s short-term liquidity position and measures a company’s ability to meet its short-term obligations with its most liquid assets.

Current Ratio:

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.

Current ratio is computed by dividing total current assets by total current liabilities of the business.

Current ratio = Total current assets / Total current liabilities

 

LT Debt to Equity:

It is leveraging ratio that compares the total amount of long-term debt against the share-holder’s equity of company. It helps determine how much leverage the company is taking. With higher ratio indicating more debt and greater financial risk. It can be an indicator bankruptcy risk.

Debt to Equity Ratio:

The debt-to-equity (D/E) ratio is used to evaluate a company’s financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity. Total Liabilities / Shareholders Equity

The D/E ratio is an important metric in corporate finance. It is a measure of the degree to which a company is financing its operations with debt rather than its own resources. The debt-to-equity ratio is a particular type of gearing ratio.

 

Key Features

·         The debt-to-equity (D/E) ratio compares a company’s total liabilities with its shareholder equity and can be used to assess the extent of its reliance on debt.

·         D/E ratios vary by industry and are best used to compare direct competitors or to measure change in the company’s reliance on debt over time.

·         Among similar companies, a higher D/E ratio suggests more risk, while a particularly low one may indicate that a business is not taking advantage of debt financing to expand.

·         Investors will often modify the D/E ratio to consider only long-term debt because it carries more risk than short-term obligations.

 

Total Assets:

Total assets refer to the sum of all assets owned by a person, company or organization, these assets include, 1. Cash 2. Accounts receivable 3. Inventory 4. Equipment 5. Tools   

Total assets = Liabilities + Owner’s equity

 

Total Liabilities:

Total liabilities are the combined debts and obligations that an individual or company owes to outside parties. Everything the company owns is classified as an asset and all amounts the company owes for future obligations are recorded as liabilities. On the balance sheet, total assets minus total liabilities equals equity.

They are generally broken down into three categories: short-term, long-term, and other liabilities.

 

Total Equity:

Equity, referred to as shareholder’s equity (or owners' equity for privately held companies), represents the amount of money that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debt was paid off in the case of liquidation. In the case of acquisition, it is the value of company sales minus any liabilities owed by the company not transferred with the sale.

In addition, shareholder equity can represent the book value of a company. Equity can sometimes be offered as payment-in-kind. It also represents the pro-rata ownership of a company's shares. Equity can be found on a company's balance sheet and is one of the most common pieces of data employed by analysts to assess a company's financial health.

 

Key Features:

·         Equity represents the value that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company's debts were paid off.

·         We can also think of equity as a degree of residual ownership in a firm or asset after subtracting all debts associated with that asset.

·         Equity represents the shareholders’ stake in the company, identified on a company's balance sheet.

·         The calculation of equity is a company's total assets minus its total liabilities, and it's used in several key financial ratios such as ROE.

·         Home equity is the value of a homeowner's property (net of debt) and is another way the term equity is used.

 

Cash flow statement:

Cash flow/Share

Free cash flow (FCF) is similar to cash flow per share in that it expands on the attempt to avoid artificial deflation of a company’s cash flow. The free cash flow calculation includes the costs associated with one-time capital expenditures, dividend payments, and other non-reoccurring or irregular activities. The company accounts for these costs at the time they occur as opposed to spreading them out over time.

Free cash flow provides information about the amount of cash that a company actually generates during the time period being examined. Because they view free cash flow as providing a more accurate snapshot of a company's finances and profitability, some investors prefer to evaluate a stock on its free cash flow per share instead of its earnings per share.

Cash flow per share is calculated as a ratio, indicating the amount of cash a business generates based on a company’s net income with the costs of depreciation and amortization added back. Since the expenses related to depreciation and amortization are not actually cash expenses, adding them back keeps the company’s cash flow numbers from being artificially deflated.

The calculation to determine cash flow per share is:

Cash Flow Per Share = (Operating Cash Flow – Preferred Dividends) / Common Shares Outstanding

Earnings Per Share vs. Cash Flow Per Share

A company's earnings per share is the portion of its profit that is allocated to each outstanding share of common stock. Like cash flow per share, earnings per share serves as an indicator of a company's profitability. Earnings per share is calculated by dividing a company’s profit, or net income, by the number of outstanding shares.

Since depreciation, amortization, one-time expenses, and other irregular expenses are generally subtracted from a company’s net income, the outcome of an earnings per share calculation could be artificially deflated. Additionally, earnings per share may be artificially inflated with income from sources other than cash.

Non-cash earnings and income can include sales in which the purchaser acquired the goods or services on credit issued through the selling company, and it may also include the appreciation of any investments or selling of equipment.

Since the cash flow per share takes into consideration a company's ability to generate cash, it is regarded by some as a more accurate measure of a company's financial situation than earnings per share. Cash flow per share represents the net cash a firm produces on a per-share basis.

Revenue/Share

Revenue is the money generated from normal business operations, calculated as the average sales price times the number of units sold. It is the top line (or gross income) figure from which costs are subtracted to determine net income. Revenue is also known as sales on the income statement.

EPS is calculated by taking the net income a company produces—which is the money that is left over in the company once all of the appropriate expenses and taxes have been subtracted from the company’s revenue—and dividing it by the total number of outstanding shares of stock in the company.

 

Key Features:

·         Revenue, often referred to as sales or the top line, is the money received from normal business operations.

·         Operating income is revenue (from the sale of goods or services) fewer operating expenses.

·         Non-operating income is infrequent or nonrecurring income derived from secondary sources (e.g., lawsuit proceeds).

·         Non-business entities such as governments, nonprofits, or individuals also report revenue, though calculations and sources for each differ.

·         Revenue is only sale proceeds, while income or profit incorporate the expenses to generate revenue and report the net (not gross) earnings.

 

Operating Cash flow:

Operating Cash Flow (OCF) is the amount of cash generated by the regular operating activities of a business within a specific time period.

The formula for each company will be a little different, but the basic structure always consists of the three same elements:

1) OCF begins with net income.

2) adds back any non-cash items.

3) and adjusts for changes in net working capital.

Summing these three elements together arrives at the total cash generated or consumed by operations in the period.

When performing financial analysis, operating cash flow should be used in conjunction with net income, free cash flow (FCF), and other metrics to properly assess a company’s performance and financial health.

OCF = Net Income + Non-cash Expenses + Increase in Working Capital

Cah from Operating activities:

 

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement.

Cash flow from operating activities does not include long-term capital expenditures or investment revenue and expense. CFO focuses only on the core business and is also known as operating cash flow (OCF) or net cash from operating activities.

Cash flow from investing activities (CFI) is one of the sections of a company's cash flow statement. It reports how much cash has been generated or spent from various investment-related activities in a specific period.

Investing activities include purchases of physical assets, investments in securities, or the sale of securities or assets. Investments can be made to generate income on their own, or they may be long-term investments in the health or performance of the company.

Key Features:

Cash flow from investing activities is a section of a business's cash flow statement that shows the cash generated by or spent on investment activities.

Investing activities include the purchase of physical assets, investments in securities, or the sale of securities or assets.

Negative cash flow from investing activities is not a bad sign if it indicates that management is investing in the long-term health of the company.

The total cash flow from investing in an accounting period is found by adding together both positive and negative investing activities listed on the cash flow statement.

Cash from Financing Activities:

Cash flow from financing activities (CFF) is a section of a company’s cash flow statement that shows the net flows of cash that are used to fund the company.

Financing activities include transactions involving debt, equity, and dividends.

Cash flow from financing activities provides investors with insight into a company’s financial strength and how well a company’s capital structure is managed.

 

Key Features:

·         Cash flow from financing activities is a section of a company’s cash flow statement that shows the net flows of cash that are used to fund the company.

·         Financing activities include transactions involving debt, equity, and dividends.

·         Debt and equity financing are reflected in the cash flow from financing section, which varies with the different capital structures, dividend policies, or debt terms that companies may have.

Net change in cash:

Net change in cash in the Cash Flow Statement is the increase or decrease in cash and cash equivalents from the beginning to the end of a year. It is equal to the net change in cash and cash equivalents as a result of the company’s operating, investing and financing activities. It is also equal to net income plus depreciation and other non-cash items.

The net change shows the difference in a company's cash balance over a given period, typically a full year or part of a year.

we can calculate,

·         Starting cash balance.

·         Net cash provided by operating activities.

·         Net cash used in investing activities.

·         Net cash used in financing activities.

Financial ratios:

Financial matrices and Ratios are useful to prepare Company's Balance sheet, Profit & Loss statements, Accounts, Annual Reports etc. These reports give company's overall performance. And based upon this performance reports, An Analyst plans the future strategy for investing portfolios and predicts the individual company’s growth prospects.

To finance the Corporate, market overview and the related strategy formulation should be well understood. For that We can utilize the credible data sources from resources like, World-bank, Gartner, IDC, Forrester, Bloomberg, Reuters etc.

Financial Modelling and Valuation analysis plays key role in Corporate Finance.