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Chapter 1

The financial environment


Slide 1.2

Learning objectives
• Outline the framework of corporate finance and its
link with financial strategy.
• Illustrate the different types of business entity:
sole traders, partnerships, private limited
companies, public limited companies.
• Explain the role of the finance function within a
business organisational structure.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.3

Learning objectives (Continued)


• Explain the nature and purpose of financial
statements.
• Consider the issues of accountability and financial
reporting.
• Describe what is meant by accounting and corporate
finance.
• Outline how the corporate finance function is
managed to meet business objectives.
• Explain the underlying principles of corporate finance.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.4

Corporate finance and


financial strategy
• A company’s strategy comprises a number of
sub-strategies including a financial strategy.
• Corporate finance is concerned with how
a company will achieve its objectives – specifically
its financial objective of maximisation of
shareholder wealth.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.5

The framework of corporate finance


and financial management

Figure 1.1 The framework of corporate finance and financial management


Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.6

Types of business entity

Figure 1.2 Types of business entity


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Slide 1.7

Business organisational structures


• The board of directors of a limited company delegate
the responsibility for the day-to-day management of
the business.
• The traditional structure of the finance function
in a medium to large sized company would divide
responsibilities between accounting and finance.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.8

The finance function within a


company’s organisation

Figure 1.3 The finance function within a company’s organisation

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Slide 1.9

Accounting
• Accountancy is the practice of accounting

The three questions generally answered by


accounting are:
• How are we doing, and are we doing well or badly?
• Which problems should be looked at?
• Which is the best alternative for doing a job?

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.10

Features of useful financial information

Figure 1.4 Features of useful financial information

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.11

Branches of accounting and finance

Figure 1.5 Branches of accounting and finance

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Slide 1.12

Financial management
• Financial management is the management of all
the processes associated with the efficient
acquisition and deployment of both short- and
long-term financial resources.
• The financial management role assists an
organisation’s operations management to reach
its financial objectives.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.13

Financial statements
The three main financial statements that appear
within a business’s annual report and accounts
are the:
• Balance sheet
• Income statement
• Statement of cash flows.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.14

Balance sheet (or statement


of financial position)
• The balance sheet summarises the financial
position of the business using the following
equation:

total assets (TA)


=
equity (E) + total liabilities (TL)

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.15

The main elements of the


balance sheet

Figure 1.6 The main elements of the balance sheet

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.16

Flatco plc balance sheets as at 31


December 2011 and 2012

Figure 8.3 Flatco plc balance sheets as at 31 December 2011 and 2012

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.17

Valuation of assets and liabilities


• The valuation of assets and liabilities within the
balance sheet is covered by the Companies
Act 2006, and by accounting concepts and
financial reporting standards.
• Problems arise from differences in approach and
alternative methods used to value the
different categories of assets and liabilities.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.18

Income statement (or statement


of financial performance)
• The income statement shows the change in
wealth of the business over a period and
calculates the profit or loss on operations
during the period.
• The net earnings or profit (or loss), is derived
from deducting expenses incurred from
revenues derived throughout the period.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.19

The main elements of the


income statement

Figure 1.7 The main elements of the income statement

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.20

Flatco plc income statements for the


year ended 31 December 2011 and 2012

Flatco plc income statements for the years ended 31 December


Figure 8.4
2011 and 2012
Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.21

Statement of cash flows


• The statement of cash flows lists the inflows
and outflows of cash for a period.
• The statement of cash flows is directly related
to both the income statement and the balance
sheet.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.22

The main elements of the


statement of cash flows

Figure 1.8 The main elements of the statement of cash flows

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Slide 1.23

Flatco plc cash generated from


operations for the years ended 31
December 2011 and 2012

Flatco plc cash generated from operations for the years ended
Figure 8.6
31 December 2011 and 2012
Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.24

Flatco plc statement of cash flows for the


years ended 31 December 2011 and 2012

Flatco plc statement of cash flows for the years ended 31


Figure 8.7
December 2011 and 2012
Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.25

Users of financial and accounting


information

Figure 1.9 Users of financial and accounting information

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.26

Accountability and financial reporting


Accountability is maintained by:
• the reporting to the financial position of the
company to shareholders on a an interim and
an annual basis;
• the adherence to extant national legal
requirements and national and international
guidelines and standards.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.27

Managing corporate finance


The finance function (or the finance director) is
responsible for managing the financial resources
of the business to meet the objectives of the
business, and includes:
• Raising and controlling the provision of funds
• Deciding on the deployment of these funds
• Controlling the resources of the business
• Managing financial risks.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.28

Underlying principles of
corporate finance
• Shareholder wealth maximisation
• Cash flow
• Time value of money
• Risk.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.29

Shareholder wealth maximisation


• The maximisation of shareholder wealth is
the fundamental, prime objective of companies
Shareholder wealth is derived from:
• Dividends paid on their equity, or ordinary, shares
• Capital appreciation from the increase in the
price of their ordinary shares.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.30

Cash flow
It is the cash flows generated by investments in
new projects, which provides the key to the
future growth of:
• Shareholder dividends
• The company’s share price.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.31

Time value of money


It is not only the size of the cash flows
generated by real investment by companies
that is important, but also:
• The timing of cash flows
• The certainty of their being received.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014
Slide 1.32

Risk
• Risk relates to the possibility that an actual
return will be different from an expected return
• The higher the risk of an investment, the
higher the expected return
• The lower the risk of an investment, the lower
the expected return.

Davies and Crawford, Corporate Finance and Financial Strategy PowerPoints on the Web, 1st edition © Pearson Education Limited 2014