SKEMA BUSINESS SCHOOL

LECTURE 1
FINANCIAL MANAGEMENT
AND THE BUSINESS ENVIRONMENT
 READING REQUIREMENTS

Chapter 1 Introduction to corporate finance,

Chapter 2 Corporate governance
Chapter 3 Financial statement analysis
Corporate Finance, European edition,
by Hillier, Ross, Westerfield, Jaffe and Jordan,
McGraw-Hill ed., 4th.
Get access to the book @ https://k2.skema.edu
in the course Corporate Finance

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• Different forms of business organisation

• SOLE PROPRIETORSHIP
• PARTNERSHIP
• CORPORATION

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM
• Sole Proprietorship
• Business owned by one person
• Taxed as personal income
• No distinction between business income and personal income
• Advantage
• easy to start
• Disavdavantage
• Unlimited liability
• Creditors can look beyond business assets to personal asset
• Limited transferability

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• General partnership
• Similar to a sole proprietorship but with multiple owners
• Disavdavantage
• Unlimited liability including for the business dealings of other partners

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• Limited Liability partnership

• Similar to a general partnership but with a separate classification of partners
• Advantage
• Liability can be limited for the "limited partners" as opposed to the "general partners"
• Disadvantage
• More complex administrative requirements
• Limited partners are passive investors and have no control

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• Corporation
• Corporation = legal ‘person’
• Separate and distinct from owners
• Can borrow money
• Enter into contracts
• Own property
• Sue and be sued
• Can own stock in another corporation

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM

• Corporation
• Stockholders elect Board of Directors
• Only Board of Directors has legal power
• To declare a dividend
• To issue securities
• To commit large investment outlays
• Directors elect senior management (CEO, President)
• To run the corporation in interest of stockholders

Lecture 1: Financial Management and the Business Environment

FINANCIAL MANAGEMENT AND
CONTROL OF A FIRM
• That corporations should only maximize shareholder value and
should only be controlled by shareholders is the view that has
prevailed since the 1980s
• However this is a narrow financial perspective that does not
maximize societal welfare
• Pollution
• Unhealthy products
• Monopolies
• Labor exploitation
• This view has started to be questionned after the financial crisis

Lecture 1: Financial Management and the Business Environment

 WHAT’S A FIRM FROM
A FINANCIAL PERSPECTIVE?

• What’s a firm from a financial perspective?

• A pool of resources

In order to finance and run

• Assets and investment projects

Lecture 1: Financial Management and the Business Environment

A VERY CONCRETE EXAMPLE

• What about starting a new business and selling croissants in

the lounge for Skema students?
Mysmallbusiness corp.

Lecture 1: Financial Management and the Business Environment

MYSMALLBUSINESS CORP.

• What about selling croissants in the lounge ?

• What do you need to run this business?
• Fixed assets
• 1 table $50
• 1 cash register $100
• 1 freezer $150
• 1 microwave oven $150
• Current assets
• A stock of 200 frozen croissants $50
• $50 in cash (coins&banknotes) $50

• Total Assets = $550

Lecture 1: Financial Management and the Business Environment

 MYSMALLBUSINESS CORP.

• You need $550 to start this business

• How to finance it?
• For instance let’s assume
• You put $300 from your own savings into this business. You are the
only owner (shareholder) of Mysmallbusiness corp.
• The company Mysmallbusiness corp. borrows from your parents
$250 for five years

Lecture 1: Financial Management and the Business Environment

 MYSMALLBUSINESS CORP.

Balance sheet Mysmallbusiness corp.

ASSETS (investments) LIABILITIES (resources)

• Current Assets • Equity (stockholders)

• Common stock $300
• Cash $50
• Long-Term Debt (debtholders)
• Inventories (croissants) $50 • Long-term notes $250
• Fixed Assets $450
TOTAL ASSETS $550 TOTAL LIABILITIES $550

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• The balance sheet gives a picture of the firm

• What are the assets available to run the business?

• How were these assets financed?

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• The balance sheet gives a picture of the firm

• What are the assets available to run the business?

• How were these assets financed?

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS
Balance sheet
ASSETS (investments) LIABILITIES (resources)
• Equity (shareholders)
• Current Assets – Preferred and Common stock
• Cash – Retained earnings
• Accounts receivable
• Inventories
• Debt
• Fixed Assets – Long-Term Debt
• Machinery • Long-term notes
• Land, etc, etc • Mortgages
• Other Assets – Current Debt
• Patents • Accounts payable
• Goodwill • Accrued expenses

=
• Short-term notes
TOTAL ASSETS TOTAL LIABILITIES

Lecture 1: Financial Management and the Business Environment

 TESLA’S BALANCE SHEET
TESLA Balance sheet 2019 In Millions of USD
Assets Liabilities & Shareholders' Equity
+ Cash, Cash Equivalents & STI 6268 + Payables & Accruals 6448
+ Accounts & Notes Receiv 1324 + ST Debt 2013
+ Inventories 3552 + Other ST Liabilities 2206
+ Other ST Assets 959 Total Current Liabilities 10667
Total Current Assets 12103 + LT Debt 12590
+ Property, Plant & Equip, Net 14061 + Other LT Liabilities 2942
+ LT Investments & Receivables 393 Total Noncurrent Liabilities 15532
+ Other LT Assets 7752 Total Liabilities 26199
Total Noncurrent Assets 22206 Total Equity 8110
Total Assets 34309 Total Liabilities & Equity 34309

A balance sheet must be BALANCED,

if not see what happened to Wirecard (watch the video here or on K2)…

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• Now that we are given the assets, we can run the business and
start to record our activity

• It’s going to be recorded in the

Income statement

Lecture 1: Financial Management and the Business Environment

 INCOME STATEMENT

• What do we record in the income statement?

• Revenues
• Expenses necessary to earn the revenues.
• When do we record in the income statement?
• Revenues are recorded when earned, not when they are paid
• Expenses are recorded when incurred to produce the revenues, not when
they are paid
• Periodicity
• Quarterly, semi-annual, annual

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

Operating Activities
• Income Statement
+ Sales
- Cost of producing or acquiring product/services
= Gross Profit
- Operating Expenses
marketing and selling expenses
general and administrative expenses
depreciation expenses
= Operating Income
- Interest expense
Financing +/- Exceptional revenues/costs
Activities = Earnings before taxes
- Corporate taxes
= Net Income

Lecture 1: Financial Management and the Business Environment

 TESLA’S INCOME STATEMENT
Revenue 24 578
+ Sales & Services Revenue 23 047
+ Other Revenue 1 531
- Cost of Goods and Services 20 509
Gross Profit 4 069
- Operating Expenses 3 843
+ Selling, General & Admin 2 646
+ Research & Development 1 343
+ Other Operating Expense (146)
Operating Income (Loss) 226
- Non-Operating (Income) Loss 596
+ Interest Expense, Net 641
+ Foreign Exch (Gain) Loss (48)
+ Other Non-Op (Income) Loss 3
Pretax Income (Loss), Adjusted (370)
- Abnormal Losses (Gains) 295
+ Disposal of Assets 146
+ Other Abnormal Items 149
Pretax Income (Loss), GAAP (665)
- Income Tax Expense (Benefit), GAAP 110
Income (Loss) from Cont Ops, GAAP (775)
Income (Loss) Incl. MI, GAAP (775)
- Minority Interest, GAAP 87
Net Income, GAAP (862)

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• Mysmallbusiness company was incorporated in August year n. Money was raised at that time, equipments were
purchased as well as frozen croissants.
• The company start its operations on Sept 1, year n and goes until Dec 31, year n. Over this 4 months, it sells for
$100 of croissants (warm not frozen…) destocking for $20 of its frozen croissants.
• In order to inform Skema students about its new business, it makes and distributes flyers for a cost of $8.
• On Dec 6, it decides to replenish its stock of frozen croissant and goes to Carrefour (or Walmart). Bus ticket costs
$2. It buys for $30 of frozen croissants.
• You pay a 10% interest rate to your parents for the money they lent to you. Tax rate is 40%.
• All income and expenses are paid cash (no credit on sale)
• Show the income statement for the period Sep 1, year n up to Dec 31, year n.

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• Depreciation
• Depreciation is the process by which a company gradually records the
loss in value of a fixed asset.
• Depreciation is a cost (recorded in the income statement) and impact
the net value of the assets (recorded in the balanced sheet)
• Depreciation is a non-cash expense

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS

• Let’s recap
• The balance sheet records the assets available in the firm and how are
they financed at a particular time
• The income statement reports the earnings of a company by recording all
income and expenses of the company over a certain period
• Balance sheet and income statement do not reflect the actual
disbursements (cash outflows) made by the firm nor the actual payments
(cash inflows) received by the firm. It is done with a third financial
statement called the cash flow statement

Lecture 1: Financial Management and the Business Environment

 CASH FLOWS
• What are the different kinds
of cash flows circulating in or around a firm?
2°)Cash invested 1°)Cash raised
in projects from investors

reinvested
4°a)Cash
Firm's Financial Financial
operations manager resources

3°)Cash generated 4°b)Cash returned

by operations to investors

Lecture 1: Financial Management and the Business Environment

 CASH FLOW STATEMENT

• Three sections in the cash flow statement

• Cash flow from the operations
• Cash flow from investing
• Cash flow from financing
• Two ways to prepare a cash flow statement
• Direct method:
• Reports all cash receipts and cash disbursements from operating activities. Lengthy and
tedious.
• Indirect method
• The indirect method adjusts net income for items that affected reported net income but
didn't affect cash. Easier and faster.

Lecture 1: Financial Management and the Business Environment

 CASH FLOW STATEMENT
(INDIRECT METHOD)
• Cash flow from the operations
Cash flow from operations
Net income
Additions to cash
+ Depreciation
+ Decrease in accounts receivable
+ Increase in accounts payable
+ Increase in taxes payable
+ Decrease in inventory
Subtractions from cash
- Increase in accounts receivable
- Decrease in accounts payable
- Decrease in taxes payable
- Increase in inventory
= Net cash from operations

Lecture 1: Financial Management and the Business Environment

 CASH FLOW STATEMENT
(INDIRECT METHOD)

• Cash flow from investing Cash flow from investing

- In Fixed assets
Net cash from investing
• Cash flow from financing
Cash flow from financing
- Dividends paid
- Payment of loans
+ Proceeds from loans
Net cash from financing
• Net cash position at the end of the period
• Initial cash position + increase/decrease in cash

Lecture 1: Financial Management and the Business Environment

 TESLA’S CASH FLOW STATEMENT
TESLA Cash flow statement 2019 Cash from Investing Activities Cash from Financing Activities
Cash from Operating Activities + Change in Fixed & Intang (1 377) + Dividends Paid -
+ Net Income (862) + Other Investing Activities (59) + Cash From (Repayment) Debt 585
+ Depreciation & Amortization 2 154 Cash from Investing Activities (1 436) + Cash (Repurchase) of Equity 1 022
+ Non-Cash Items 772 + Other Financing Activities (78)
+ Chg in Working Capital 341 Cash from Financing Activities 1 529
+ (Inc) Dec in Accts Receiv (367)
+ (Inc) Dec in Inventories (429) Effect of Foreign Exchange Rates 8
+ Inc (Dec) in Other 1 137
Cash from Operating Activities 2 405 Net Changes in Cash 2 506

Cash from operating activities + 2 405

Cash from investing activities (1 436)
Cash from financing activities + 1 529
Effect of FX rates + 8
Net change in cash in 2019 + 2 506

Lecture 1: Financial Management and the Business Environment

 FINANCIAL STATEMENTS WRAP-UP

• Balance sheet

• Income statement

• Cash flow statement

Lecture 1: Financial Management and the Business Environment

 THE ROLE OF THE
FINANCIAL MANAGER

• The CFO (Chief Financial Officer) stands between

• Cash flows invested in the real assets of the firm
• Cash flows generated by the real assets of the firm
• Cash flows invested in the firm by the investors
• Cash flows generated by the firm and returned to the investors or
retained into the firm

Lecture 1: Financial Management and the Business Environment

 CFO is in charge of

• Treasurer
• Controller
• Capital budgeting
• Financing • Accounting
• Cash management • Preparation of financial
• Recommending statements
dividend policy • Preparing budgets
• Insurance • Internal auditing
• Pension plans

Lecture 1: Financial Management and the Business Environment

 The Role of the Financial Manager

• The CFO tries to maximize the value of the

firm through
• Investment decision
• Financing decision
• Dividend decision
• But this should not be his/her sole concern…

Lecture 1: Financial Management and the Business Environment

 The Role of the Financial Manager
• Statement on the Purpose of a Corporation
• Delivering value to our customers.
• Investing in our employees.
• Dealing fairly and ethically with our suppliers.
• Supporting the communities in which we work.
• Generating long-term value for shareholders
Published on Aug 19, 2019 by Business Roundtable
https://www.businessroundtable.org/business-
roundtable-redefines-the-purpose-of-a-corporation-to-
promote-an-economy-that-serves-all-americans

Lecture 1: Financial Management and the Business Environment