💰Corporate Finance Analysis Unit 1 – Corporate Finance & Financial Statements

Key Concepts and Terminology

• Corporate finance focuses on the financial decisions and management of a company, including capital structure, investments, and risk management
• Financial statements provide a snapshot of a company's financial health and performance over a specific period (quarterly or annually)
• Generally Accepted Accounting Principles (GAAP) establish standards and guidelines for financial reporting to ensure consistency and transparency
• Accrual accounting recognizes revenue when earned and expenses when incurred, regardless of when cash is exchanged
• Liquidity refers to a company's ability to meet short-term obligations using current assets (cash, accounts receivable, inventory)
• Solvency measures a company's capacity to meet long-term financial commitments and sustain operations over an extended period
• Profitability ratios, such as return on equity (ROE) and return on assets (ROA), evaluate a company's ability to generate profits relative to its resources
• Valuation methods, including discounted cash flow (DCF) and comparable company analysis, help determine the intrinsic value of a company or its stock price

Financial Statements Overview

• The three primary financial statements are the income statement, balance sheet, and cash flow statement, each serving a unique purpose in evaluating a company's financial performance
• The income statement reports a company's revenues, expenses, and net income over a specific period, demonstrating its profitability
• The balance sheet provides a snapshot of a company's assets, liabilities, and shareholders' equity at a particular point in time
• Assets include current assets (cash, accounts receivable, inventory) and non-current assets (property, plant, and equipment, intangible assets)
• Liabilities consist of current liabilities (accounts payable, short-term debt) and non-current liabilities (long-term debt, deferred tax liabilities)
• Shareholders' equity represents the residual interest in a company's assets after deducting liabilities, comprising contributed capital and retained earnings
• The cash flow statement tracks the inflows and outflows of cash from operating, investing, and financing activities, revealing a company's ability to generate and manage cash

Income Statement Deep Dive

• The income statement follows a top-down format, starting with revenue and subtracting various expenses to arrive at net income
• Revenue represents the total amount earned from the sale of goods or services during the reporting period
• Cost of goods sold (COGS) includes direct costs associated with producing the goods or services sold, such as raw materials and direct labor
• Gross profit is calculated by subtracting COGS from revenue, indicating the profit earned before accounting for operating expenses
• Operating expenses encompass selling, general, and administrative (SG&A) costs, such as salaries, rent, and marketing expenses
• Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a measure of a company's operating performance, excluding the impact of financing and accounting decisions
• Interest expense reflects the cost of borrowing funds, while interest income represents earnings from cash deposits or investments
• Income tax expense is based on the applicable tax rate and the company's taxable income
• Net income, also known as the "bottom line," is the final profit earned after accounting for all revenues and expenses

Balance Sheet Breakdown

• The balance sheet adheres to the fundamental accounting equation: Assets = Liabilities + Shareholders' Equity
• Current assets are expected to be converted to cash or consumed within one year (cash, accounts receivable, inventory, prepaid expenses)
• Non-current assets have a useful life exceeding one year (property, plant, and equipment, intangible assets, long-term investments)
• Intangible assets lack physical substance but provide long-term value (patents, trademarks, goodwill)
• Current liabilities are obligations due within one year (accounts payable, short-term debt, accrued expenses)
• Non-current liabilities are long-term obligations (long-term debt, deferred tax liabilities, pension obligations)
• Shareholders' equity consists of contributed capital (funds invested by shareholders) and retained earnings (accumulated profits reinvested in the company)
• The balance sheet provides insights into a company's financial position, liquidity, and solvency

Cash Flow Statement Essentials

• The cash flow statement categorizes cash inflows and outflows into operating, investing, and financing activities
• Operating activities involve cash flows directly related to a company's core business operations (cash received from customers, cash paid to suppliers and employees)
• Investing activities include cash flows from the acquisition or disposal of long-term assets (capital expenditures, investments in securities)
• Financing activities encompass cash flows related to the company's capital structure (issuance or repurchase of stock, borrowing or repayment of debt, dividend payments)
• Free cash flow (FCF) represents the cash generated by a company after accounting for capital expenditures, available for distribution to stakeholders or reinvestment
• The cash flow statement helps assess a company's ability to generate cash, fund operations, and meet financial obligations
• Positive cash flow indicates a company's ability to sustain and grow its operations, while negative cash flow may signal financial distress or the need for external financing

Financial Ratio Analysis

• Financial ratios provide a standardized way to compare a company's performance over time or against industry peers
• Liquidity ratios, such as the current ratio ($\frac{Current Assets}{Current Liabilities}$) and quick ratio ($\frac{Current Assets - Inventory}{Current Liabilities}$), measure a company's ability to meet short-term obligations
• Profitability ratios, including gross margin ($\frac{Gross Profit}{Revenue}$), operating margin ($\frac{Operating Income}{Revenue}$), and net profit margin ($\frac{Net Income}{Revenue}$), evaluate a company's ability to generate profits at various levels
• Return on equity (ROE) ($\frac{Net Income}{Shareholders' Equity}$) and return on assets (ROA) ($\frac{Net Income}{Total Assets}$) measure the efficiency of a company's use of its resources to generate profits
• Debt ratios, such as the debt-to-equity ratio ($\frac{Total Liabilities}{Shareholders' Equity}$) and interest coverage ratio ($\frac{EBIT}{Interest Expense}$), assess a company's leverage and ability to service its debt obligations
• Efficiency ratios, like inventory turnover ($\frac{COGS}{Average Inventory}$) and receivables turnover ($\frac{Revenue}{Average Accounts Receivable}$), measure how effectively a company manages its assets

Valuation Techniques

• Valuation techniques help determine the intrinsic value of a company or its stock price
• Discounted cash flow (DCF) analysis estimates the present value of a company's future cash flows using a discount rate that reflects the risk of those cash flows
• The weighted average cost of capital (WACC) represents the average cost of a company's debt and equity financing, used as the discount rate in DCF analysis
• Comparable company analysis (or "comps") values a company based on the multiples (price-to-earnings, EV/EBITDA) of similar publicly traded companies
• The capital asset pricing model (CAPM) estimates the required rate of return for an investment based on its systematic risk (beta) relative to the market
• Dividend discount models (DDM) value a stock based on the present value of its expected future dividend payments
• Valuation multiples, such as the price-to-earnings (P/E) ratio and enterprise value to EBITDA (EV/EBITDA), provide a quick way to compare a company's valuation to its peers or the broader market

Real-World Applications and Case Studies

• Corporate finance principles are applied in various contexts, such as capital budgeting, mergers and acquisitions (M&A), and initial public offerings (IPOs)
• Capital budgeting involves evaluating and selecting long-term investments based on their expected cash flows and risk profile (net present value, internal rate of return)
• M&A transactions require extensive due diligence, valuation analysis, and negotiation to determine the fair value of the target company and potential synergies
• IPOs allow private companies to raise capital by selling shares to the public, requiring detailed financial disclosures and valuation analysis to set the initial offering price
• Restructuring and turnaround situations involve analyzing a company's financial statements to identify areas for improvement and develop strategies to restore profitability
• Financial statement analysis is crucial for investors, creditors, and other stakeholders to assess a company's financial health, performance, and valuation
• Case studies, such as Apple's capital allocation strategy or Amazon's growth and profitability, provide real-world examples of how corporate finance concepts are applied in practice