CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES

Finance 110631-1165

CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES

Finance 110631-1165

Lecture outline

The notion and goal of corporate finance

Sources of financing companies

Sources of capital in companies

Finance 110631-1165

Corporate finance-definition

An area of finance focused on

monetary flows in enterprises, on the

ways of financing the companies’

activity and methods of financial

analysis

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Financial decisions

Short term eg. settling current liabilities

Long term egg. fundraising, investments

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The goal of corporate finance

The goal depends on the legal form and activity profile of the company

Maximizing the company’s profit Ensuring the company’s liquidity Maximizing the company’s value

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Liquidity vs. solvency

Liquidity- the ability to settle current

payments within the specified contract

deadlines (short term)

Solvency- the ability to meet long term

financial liabilities

The company’s value

Several ways of company valuation eg. asset based, income based, market based

The problem- which method reflects best the company’s value?

The most popular- discounted cash flow

Finance 110631-1165

Finance 110631-1165

Financing the company’s activity

The company’s activity requires several types of

resources

Monetary resources

Current assets

Fixed assets

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Financing the company’s activity

In the process of corporate financing there is

constant transformation of monetary resources

into assets and vice versa

E.g. the purchase of production infrastructure or

the sell of manufactured goods

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Sources of financing

Internal sources e.g. the company’s profits, sell of assets

External sources- fundraising e.g. issuing bonds, issuing equity securities, bank loans

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Sources of capital (1)

Sources of capital ≠ sources of financing

Not every source of financing is a source of

capital!

Monetary resources become capital only if they

are invested!

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Sources of capital (2)

Own capital also called equity- contributed by the owner

or entrepreneur

Borrowed capital- contributed by an external institution or

person

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Own capital (equity)

Own capital does not have to be returned in

contrast to borrowed capital

Therefore it is a safe source of financing

It constitutes a guarantee for the creditors

It enables the supervision of the

shareholders/owners over the management

Finance 110631-1165

Finance 110631-1165

Own capital-examples

Income derived from equity securities (shares)

issuance –this is an external source of own capital

Income derived from the companies profit

division –this is an internal source of own capital

Finance 110631-1165

Borrowed capital- examples

Short term and long term loans

Income derived from the issuance of long term and short term debt securities eg. bonds

Capital provision process

Investors provide capital to the company and receive a rate of return (interest payments)

The company invests the capital during its activity and receives a rate of profitability

Providing capital enables the company to invest and not to achieve a monetary surplus therefore this process is different from just providing finance!

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The financial decisions of the company

Decisions concerning the sources of

financing and the sources of capital

Decisions concerning investments

Decisions concerning revenue division

(payment of dividends)

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Finance 110631-1165

The financing strategy (1)

External or internal financing

The choice of capital sources

The choice of instruments to raise capital

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The financing strategy (2)

The financing strategy depends on the

specific financing need

E.g. Fixed assets should be financed by

long term capital

The choice of capital source

Own or borrowed

Long term or short term

Domestic or international sources

Provided by financial markets or financial

institutions

Balance sheet or off-balance sheet capital

Finance 110631-1165

Finance 110631-1165

Capital structure

The choice of capital sources influences

the capital structure vital importance

For some types of companies there are

regulatory requirements concerning capital

structure

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Own or borrowed capital?

The most important decision is whether the company requires own or borrowed capital

This choice influences the division of future profits

The profit can constitute a future internal source of own capital

If the company has to pay dividends- it will need external sources of capital

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Long term or short term capital?

The share of long and short term capital depends on the structure of the assets of the company

Current assetsFixed assets

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Assets Fixed assets Current assets

Liabilities Equity Borrowed capital

(interest payments) Other liabilities (no

interest payments)

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Long term or short term capital?

The capital requirement period should be synchronized with the period of the requirement of the assets which are financed by this capital

Fixed capital ≥ Fixed assetsShort term liabilities≤ current assetsThis should ensure liquidity

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Why do companies raise capital

abroad? More investors compared to the domestic

market

Higher market liquidity

Lower capital cost (lower interest payments,

favorable regulations)

Diversification of capital sources

Company’s image

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What risk do firms face when raising capital abroad?

Exchange rate risk the need of insurance

Currency mismatch- assets and liabilities held in

different currencies

High start up costs on foreign financial markets

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Is it profitable to raise capital on financial markets ?

Broader access to capital Higher liquidity of issued

securities Objective valuation of the

company Increasing credibility of

the company

High entry costs Disclosure

requirements Hostile takeover

possibility

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Balance-sheet or off balance sheet capital?

Off-balance sheet capital- a tool of risk management

Off-balance sheet capital is a reserve for unforeseen circumstances e.g. in the case of indemnity payments

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Off- balance sheet capital-examples

Conditional financing- funds are provided if specified conditions are met e.g. a natural disaster takes place

Contingent capitalCatastrophe bonds

The meaning of capital provision

Capital provision determines the scope of economic activity

Potential measure-domestic credit to private sector

Financial resources provided to the private sector: loans, purchases of nonequity securities, trade credits

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Source:World Bank

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Literature

R.W.Melicher, E.A.Norton, Introduction to Finance. Markets, Investments and Financial Management, John Wiley&Sons,2007