Its all about the money, ain’t a damn thing funny.
Money in business is what we count and keep track of first and foremost. its how we keep score. Money is what we measure and what gets measured gets managed.
If your output is more than your input, your upkeep is your downfall.
A successful business model is all about making more than you spend. Even if you are losing money with a strategy of gaining market share, the present value of that increased future market share needs to be more than the dollars you are spending today to capture it. That is the only rationale that makes economic sense.
Corporate Finance in its broadest sense encompasses everything that has to do with money in business. It includes accounting, funding, spending and investing in assets, and budgeting.
Accounting produces Financial Statements.
Funding has to do with the right hand side of the balance sheet: debt and equity. There is straight debt and equity and lots of hybrid finance instruments that blend attributes of the two. You can have senior and junior debt that prioritize the claims on the assets, you can have debt that is convertible into common stock, you can have common and preferred stock.
These are all negotiated with investors and bankers and the money they raise is used to acquire the assets listed on the left hand side of the balance sheet.
Discounting cash flows
Another part of Corporate Finance is calculating present value by discounting future cash flows. I’ll talk a bit more about this in the Future section below.
In business you need to know which income producing assets to purchase and which projects to pursue. Financial decision making tools like NPV and IRR are used to analyze and choose.
Finance is all about the sources and uses of funds and keeping track of how those decisions are performing.
Accounting and Financial Reporting are retrospective activities. They provide a detailed account of what has happened. Its the rear view mirror.
Ratios are a way to take accounting information over time and compare if the numbers are getting better or worse. This helps you uncover the direction things are going.
This is called horizontal analysis. Vertical ratio analysis is comparing one company to another. Using ratios normalizes the numbers so you are comparing apples to apples. It eliminates size differences.
What gets measured gets managed
So measure what matters
Current financials represent a picture of where the company is today. Its a picture of how the company has performed in the most recent reporting period. This is how the present is connected to the past in business.
The present is connected to the future in business through interest rates or discount rates. These take into account all the uncertainty and risks inherent in the business’s future prospects.
“The importance of money flows from it being a link between the present and the future”. — John Maynard Keynes
Financial Projections are the best guesses about what the company is going to do and how it is going to perform going forward. This is the view through the windshield.
Financial projections are sometimes called pro formas because they are presented in the form of financial statements.
Tie it all together
We use discount rates in order to discount future cash flow projections back into today’s dollars. The Present Value of Future cash flows is essentially the valuation of the enterprise. Here is a video on the concept of Discounting Cash Flows DCF
In publicly traded stocks, the present value of future cash flows is what is being guessed at by all the participants (investors) in the market for that stock.
Yesterday’s tomorrow is today.
Budgets are the best guesses about how much money will come in to a company through sales and how much will go out via expenses.
Budgets are then measured against the actual revenues and expenses and any differences (called variances) are then examined and explained.
Budgets, actuals and variance analysis are a basic management technique.
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