The Corporation
Lecture of Corporate Finance
Ing. Tomáš Heryán, Ph.D.
Corporate Finance
FIU/BAFIK
Outline of the lecture
• The balance sheet model
• Financial statements
• Balance sheet
• Profit and Loss statement
• Cash flow
The Balance Sheet model
Suppose we take a financial
snapshot of the firm and its
activities at a single point in time.
Graphic conceptualization of the
balance sheet would help introduce
you to corporate finance. Balance
sheet is divided into assets as well
as liabilities, on the other side.
The assets of the firm are on the left
side of the balance sheet. These
assets can be thought of as current
and fixed.
Fixed assets are those that will last a
long time, like buildings. Some fixed
assets are tangible, such as machinery
and equipment. Other fixed assets are
intangible, including patents and
trademarks. The other category, current
assets comprises those that have a short
lives, such as inventory.
Before a company can invest in an asset,
it first have obtain financing, which
means that it must raise the money to
pay for the investment. The forms of
financing are represented on the right
hand side of the balance sheet. A firm
will issue (sell) pieces of paper called
debt (loan agreements), or equity shares
(stock certificates.
Assets & Liabilities
Both assets and liabilities can be classified as long-lived or short-lived. A short-term
debt is called a current liability. Short-term debt represents loans and other obligations
that must be repaid within one year.
Long-term debt is debt that does not have to repaid within one year. Shareholders’
equity represents the difference between the value of the assets and the debt of the firm.
In this sense, it is a residual claim on the firm’s assets.
The balance sheet model of the firm = why finance can be seen from these 3 questions:
• In what long-lived assets should the firm invest? (the answer = capital budgeting
• How can the firm raise cash for required capital expenditures? (via capital structure)
• How should short-term operating cash flows be managed? (via net working capital)
Financial Manager
In large firms, the financial activity is usually associated with a top officer of the firm,
such as the vice president or Chief Financial Officer (CFO), and some lesser officers.
It is called a general organizational structure emphasizing the finance activity within
the firm.
Reporting to the CFO are the treasurer and controller. The treasurer is responsible for
handling cash flows, managing capital expenditure decisions, and making financial
plans.
The controller, on the other hand, handles the accounting function, which includes
taxes, cost, revenues and financial accounting, as well as information systems
The Corporate Firm
The firm is a way of organizing the economic activity of many individuals. A basic
problem of the firm is how to raise cash. The corporate form of business-that is,
organizing the firm as a corporation-is the standard method for solving problems
encountered in raising large amounts of cash.
However, business can take other forms. We will distinguish between three basic forms
of organizing firms, the sole proprietorship, the partnership, the corporation.
• The Sole Proprietorship
• The Partnership
• The Corporation
Financial statements
Financial Statements represent a formal record of the financial activities of an entity. These are written
reports that quantify the financial strength, performance and liquidity of a company. Financial
Statements reflect the financial effects of business transactions and events on the entity.
The objective of financial statements is to provide information about the financial position, performance
and changes in financial position of an entity that is useful to a wide range of users in making economic
decisions.
Financial
statement
Balanced
sheet
Profit and loss
statement
Cash flow
statement
Statement of
changes in
equity
Financial statement – consolidated, individual and separate
• Consolidated financial statements are the financial statements of a group of enterprises that combine
the assets and liabilities and the results of the parent's holding with its interest in other entities that control
or have a significant influence or controlling interest within the meaning of the Commercial Code, has
significant or decisive influence.
The objective of the consolidated financial statements is to provide the shareholders of the parent and the
professional public with comprehensive information on the total assets, liabilities, equity, costs and
revenues of the economic and economic groupings of the enterprises that are linked to the capital.
• Individual (unconsolidated) financial statements are compiled by enterprises that do not have
subsidiaries to be consolidated.
• Separate financial statements are prepared by an enterprise at the request of an institution (for example,
a country's accounting regulator) or by its own will.
Qualitative characteristics of financial statement
The four principal qualitative characteristics are:
• Understandability - it is essential that the information provided in financial statements is readily
understandable by users. Users are assumed to have a reasonable knowledge of business and economic
activities and accounting, and a willingness to study the information with reasonable diligence.
Information on complex matters should not be omitted from financial statements merely on the grounds
that some users may find it difficult to understand.
• Relevance - information has the quality of relevance when it influences the economic decisions of users
by helping them evaluate past, present or future events or confirming, or correcting, their past
evaluations. Information has a predictive role in helping users to look to the future. Predictive value does
not necessarily require a forecast.
• Reliability - Information has the quality of reliability when it is free from material error and bias and can
be depended upon by users to represent faithfully what it either purports to represent or could reasonably
be expected to represent.
• Comparability - means that users must be able to compare the financial statements of an enterprise over
time to identify trends in its financial position and performance. Users must also be able to compare the
financial statements of different enterprises to evaluate their relative financial position, performance and
changes in financial position. Financial statements should show corresponding information for the
previous period.
Objective and main reasons for preparing of financial statement
• The objective of the financial statements is to provide information on the financial position, performance
and changes in the financial position of the entity that are useful to a wide range of users in making
economic decisions.
• The main reasons for the preparation of the financial statements are:
• The liability to prepare the financial statements imposes legislation on the entity.
• Presentation of the financial statements is a condition of the exchange in the issue of securities of the
company.
• An enterprise shall present its financial statements in public, in particular to shareholders / investors.
• Entities that are issuers of securities registered in a regulated securities market in the Member States of
the European Union shall use the accounting and financial statements for the entity and the consolidated
IFRS financial statements.
• Other entities must account for and prepare the financial statements for the entity in accordance with the
Accounting Act and the related implementing regulation; For consolidated financial statements, IFRSs
may be used instead of the Czech accounting rules in condition the Czech republic.
Supplements to the Financial Statements
Supplement to the
financial statement
Relevant entity data
Information on
accounting methods
Additional information
to the balance sheet
and profit and loss
account
Cash flow
statement
Balanced sheet
Statement of Financial Position, also
known as the Balance Sheet, presents
the financial position of an entity at a
given date.
It is comprised of the following three
elements:
• Assets: Something a business owns
or controls
• Liabilities: Something a business
owes to someone
• Equity: What the business owes to
its owners.
Information resulting from the
balance sheet
About the property
situation
About financial sources
About the financial
situation
Assets
An asset is something that an entity owns or controls in order to derive economic benefits from its use.
Assets must be classified in the balance sheet as current or non-current depending on the duration over
which the reporting entity expects to derive economic benefit from its use.
Assets are also classified in the statement of financial position on the basis of their nature:
• Tangible & intangible: Non-current assets with physical substance are classified as property,
plant and equipment whereas assets without any physical substance are classified as intangible
assets. Goodwill is a type of an intangible asset.
• Inventories balance includes goods that are held for sale in the ordinary course of the business.
Inventories may include raw materials, finished goods and works in progress. Trade receivables
include the amounts that are recoverable from customers upon credit sales.
• Trade receivables are presented in the statement of financial position after the deduction of
allowance for bad debts.
• Cash and cash equivalents include cash in hand along with any short term investments that are
readily convertible into known amounts of cash.
Factors affecting the property structure
There are three main factors influencing the total assets of the company:
• Range of corporate performance,
• The total utilization rate
• Property price
Growth in corporate performance increases requirements for the size of assets at the same level of
utilization and the same prices. Better use of property reduces the need for such property. The price change
affects the amount of the total assets directly.
The property structure also depends on:
• Technical difficulty of production - affects the share of fixed tangible assets (technologically more
demanding chemical or energy plants will have a share of fixed assets higher than those of the
consumer industry or agriculture), but also the share of intangible and investment property in the form
of license patents, Software, etc.
• The development of the money and capital markets - the impact on the financial assets of the company
• Influenced by the specific economic situation of the enterprise and the orientation of its economic
policy (for example, the effort to secure a higher proportion of current assets is also reflected in the
fact that fixed assets are acquired through leasing)
Financial structure
The company's financial structure is the corporate capital structure from which the company's assets are
financed. It is captured in balance sheet liabilities. Liabilities include:
• equity - equity, capital funds, profits/loss, past performance and current period economic results,
• debt capital - reserves, long-term and short-term liabilities and bank loans and debt
• other liabilities - in which accruals and deferred income, exchange rate differences, passive
The financial structure shows the structure of the increase in corporate capital from which the increase in
assets is funded.
In addition to the term financial structure, there is also the concept of a capital structure - it captures the
structure of corporate capital, from which fixed assets and a permanent part of the current assets are
financed. It is therefore a structure of long-term capital. Within the financial structure, it is necessary to
analyze especially the relationship between own and debt capital.
For an optimal financial structure, it considers a capital distribution that is linked to the minimization of
all the costs of its acquisition and is in line with the expected revenue and profits and property structure of
the enterprise.
Types of financial analysis of balanced sheet statement
• Horizontal analysis – trend analysis - evaluation of year-on-year development trend. The result as a
percentage allows the comparison between enterprises.
(𝑡ℎ𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑠ℎ𝑒𝑒𝑡 𝑖𝑡𝑒𝑚𝑠 𝑖𝑛 𝑛 − 𝑦𝑒𝑎𝑟) − (𝑡ℎ𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑠ℎ𝑒𝑒𝑡 𝑖𝑡𝑒𝑚𝑠 𝑖𝑛 (𝑛 − 1) − 𝑦𝑒𝑎𝑟))
(𝑡ℎ𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑠ℎ𝑒𝑒𝑡 𝑖𝑡𝑒𝑚𝑠 𝑖𝑛 (𝑛 − 1) − 𝑦𝑒𝑎𝑟)) ∗ 100
• Vertical analysis – structure of assets, liabilities and equity - evaluation of asset structure and
financial sources. Vertical analysis allows you to evaluate the structure of items in relation to the
main business activity.
𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑠ℎ𝑒𝑒𝑡 𝑖𝑡𝑒𝑚
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
x 100
Problems with balance sheet analysis
The balance sheet describes the situation on the basis of historical prices, and it is precisely the pitfalls in
terms of the information capabilities of the data:
• Displays the state of the values ​​contained therein, can not give information about the company's
dynamics;
• does not work with the time value of money; it does not affect exactly the present value of assets and
liabilities
• An estimation must be used to determine the realistic value of some items, for example:
• actual quality of fixed assets - the balance between the carrying amount and their current value;
• stocks - there are important changes in the level of stocks between the periods and the causes of
their change; It is mainly the relationship between the prices at which the stocks are valued and
the actual prices, the interesting structure of the stocks and their adequacy in relation to the
achieved performances;
• securities - Recommend analysis of individual portfolio components; Prudence in relation to lowliquid
securities;
• overstated receivables - the creditworthiness of receivables;
• underestimated liabilities.
Profit and loss statement
• Income Statement, also known as the
Profit and Loss Statement, reports the
company's financial performance in
terms of net profit or loss over a
specified period.
• The income statement is one of the
major financial statements used by
accountants and business owners.
• The profit and loss statement is
important because it shows the
profitability of a company during the
time interval specified in its heading.
Structure of profit and loss
statement
Revenues
Expenses
Net profit or loss
Profit and loss statement - revenues
Revenue is defined as the gross inflow of economic benefits during the period arising in the course of
the ordinary activities of an enterprise when those inflows result in increases in equity, other than
increases relating to contributions from equity participants
Revenues from primary activities are often referred to as operating revenues. The primary activities
of a retailer are purchasing merchandise and selling the merchandise. The primary activities of a
manufacturer are producing the products and selling them. For retailers, manufacturers, wholesalers,
and distributors the revenues resulting from their primary activities are referred to as sales revenues or
sales. The primary activities of a company that provides services involve acquiring expertise and selling
that expertise to clients.
It's critical that you don't confuse revenues with receipts. Under the accrual basis of accounting, service
revenues and sales revenues are shown at the top of the income statement in the period they are earned
or delivered, not in the period when the cash is collected. Put simply, revenues occur when money is
earned, receipts occur when cash is received.
Revenues from secondary activities are often referred to as non-operating revenues. These are the
amounts a business earns outside of purchasing and selling goods and services. For example, when a
retail business earns interest on some of its idle cash, or earns rent from some vacant space, these
revenues result from an activity outside of buying and selling merchandise. As a result the revenues are
reported on the income statement separate from its primary activity of sales or service revenues.
Profit and loss statement - expenses
Expenses involved in primary activities are expenses that are incurred in order to earn normal
operating revenues. Under the accrual basis of accounting sales commissions expense should appear on
the income statement in the same period that the related sales are reported, regardless of when the
commission is actually paid. In the same way, the cost of goods sold is matched with the related sales
on the income statement, regardless of when the supplier of the merchandise is paid.
The income statements or profit and loss statements of merchandisers and manufacturers will use a
separate line for the cost of goods sold. The other expenses involved in their primary activities will
either be grouped together as operating expenses or subdivided into the categories "selling" and
"administrative".
Expenses from secondary activities are referred to as non-operating expenses. For example, interest
expense is a non-operating expense because it involves the finance function of the business, rather than
the primary activities of buying/producing and selling.
Types of costs
• Costs independent of the quantity produced
Fixed costs
• Costs dependent on the quantity produced
Variable costs
• Costs that can not be assigned directly to a particular performance
• It is necessary to budget them in a certain way
Indirect costs
• The cost of the last produced unit
• An increase in the total cost of producing one extra product
Marginal costs
• The cost of sacrificing opportunities
Opportunity costs
Types of economic results
Operating profit/loss
Profit or loss from financial operations
Profit or loss from ordinary activity
Extraordinary profit/loss
Profit/loss from current accounting period
Profit/loss before taxes
Profit and loss statement – using and problems
The P&L statement is used by businesses in three ways:
• As one of the financial statements in a business plan, for the purpose of showing profits of the
business over time. In this case, the P&L statement might be a pro forma (projected) document, for
an application for a startup business loan.
• As a tool for internal analysis of the health of the business. As described above, the percentages of
each expense to the gross income are useful in analysis. In other ways, some P&L statements
compare figures for sales and expenses to budgeted figures, to show whether projected goals have
been met.
• As a tool for taxes. A detailed P&L statement is prepared for an entire year, ending at the date of the
end of the fiscal (financial) year, and it is used by the tax preparer to compile the income and
expenses for the business tax return.
Problems associated with the profit and loss statement:
• Contains flow variables;
• Revenues earned over a certain period and the associated costs may not be incurred in the same
period - accruals and deferred income;
• Cost and revenue items do not rely on actual cash flows.
Cash flow statement
• The statement of cash flows is one of the
financial statements issued by a business,
and describes the cash flows into and out
of the organization.
• Its particular focus is on the types of
activities that create and use cash, which
are operations, investments, and
financing.
• It is especially useful when there is a
divergence between the amount of
profits reported and the amount of net
cash flow generated by operations.
Areas of cash flow statement
Operating activities
Financial activities
Investing activities
Areas of cash flow statement
Cash flow statement, when used in conjunction with the rest of the financial statements, provides users
with information on solvency and liquidity. It shows how cash is generated in the business and helps
users to understand how much flexibility is available to adapt to changing circumstances and
opportunities.
• Operating activities. These constitute the revenue-generating activities of a business. Examples of
operating activities are cash received and disbursed for product sales, royalties, commissions, fines,
lawsuits, supplier and lender invoices, and payroll. Cash flow from operating activities allows to
determine to what extent profit from ordinary activities to truly earned money and how money
influenced the production of changes in working capital and its components.
• Investing activities. These constitute payments made to acquire long-term assets, as well as cash
received from their sale. Examples of investing activities are the purchase of fixed assets and the
purchase or sale of securities issued by other entities. The investment area shows us not only the
expenses related to the acquisition of investment property and the structure of these expenses, but
also the extent of the proceeds from the sale of investment property, which is reported precisely in
this financial statement.
• Financing activities. These constitute activities that will alter the equity or borrowings of a business.
Examples are the sale of company shares, the repurchase of shares, and dividend payments.
Thank you for
your attention!
