MBS Corporate Finance 2023 Slide Set 2

CORPORATE FINANCE
SLIDE SET 2: EQUITY FINANCING AND WORKING CAPITAL
PROF. DR. ERIK THEISSEN I NOV-DEC 2023

Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
4. Working Capital and
Financial Statements
5. Determinants of Working
Capital Requirements
6. Trade Credit
7. Cash Management
8. Supplementary Material
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Debt and Equity
A financial claim specifies

• cash flow rights (claims to a firm's cash flows) Creditors
• control rights Shareholders
• additional rights (e.g. option or conversion rights)

Debt and Equity
"Standard" Equity "Standard" Debt

Nature of ownership interest cash flow claim
claim:
Size of claim: a residual claim (dividends, the li- a contractual fixed payment
quidation value after debt is repaid) (principal + interest)
Liability depends on legal structure none
Horizon no fixed maturity date fixed maturity
Decision yes (details depend on legal no
rights structure)
Tax treatment dividends are not tax-deductible interest payments are a cost of
(paid out of after-tax income) doing business and are tax-
deductible
Default equity holders cannot force the firm Debt holders can force the firm
into bankruptcy - unpaid dividends into bankruptcy - unpaid debt
are not a liability (principal and interest) is a
liability
Debt and Equity
2022 2021
Source: online ppt slides for BDH

Debt and Equity
Equity is more risky than debt:
cash flow
debt
equity
Equity holders should therefore expect a higher rate of return

(see slide set 4)
Debt and Equity
Equity is a convex claim; debt is a concave claim

→ risk-shifting incentives (in limited liability firms)
Cash flow to claims
Equity
Debt
D Cash flow to firm

Debt and Equity
Significant international differences in capital structure:
Sample consists of
listed firms only
there are a lot of factors which can affect that

tax advantage
some countries prefer more debt as a financing method
cultural factor-some countries are more inclined to use debt tools
Debt and Equity
Which factors cause the international differences in capital

structure?
average leverage ratios (debt to market value of the firm) for many countries. While
countries like Pakistan and Thailand have very high debt levels in general, most other
countries use little debt. The figures are in market value terms and not book value terms.
Given that the value of debt does not change very much, countries with vibrant and
strongly performing equity markets would tend to have lower leverage ratios. Likewise, in
markets where valuations are low, leverage ratios will be higher.
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Raising Equity
Sources of Equity for Start-ups - A Schematic View:

Exit, e.g.
• IPO Owner‘s „life cycle“
• Trade sale wealth
• Write-off
Venture
Equity
Capital
Venture capital- dont want to invest in a firm for a very long time „Family &
Friends“,
Angel
Investors
Newer alternatives: Crowdfunding, Initial Coin Offerings (ICOs)

Raising Equity
Angel investors:
• (Wealthy) individuals who invest into private firms, mostly
at early stages
• Often the first source of outside equity
• Often receive a substantial stake in the firm in return for
their investment
• May be difficult to find
Raising Equity
investment made with a time frame and they need to return the money to the investors
they sought out promising firms from non-promising firms
Venture Capital (VC) Firms:

• Firm that is specialized on financing (mostly) start-ups
Investors Venture Capitalist Start-up firm

- provide capital - screens firms - obtains capital
- expect return - provides - obtains advice
capital+advice - gives up control
- monitors firms
- seeks to profit at exit
• Collect capital from (institutional) investors and charge fees

• Have expertise in valuing startups
• Financing arrangement usually limited in time (3-8 years)
• Usually provide financing and managerial advice
Raising Equity
financing is done in rounds and

they keep a tab on the start-ups
and their financial performance
Source: National Venture Capital Association: 2021 Yearbook
Note: Huge international differences in the importance of VC

Raising Equity
this is the depiction of EU market

—>VC prefer later stage of financing as compared to US
Source: Pitch Book European Venture Report Q3 2021, p. 3

Raising Equity
Empirical evidence suggests that firms funded by VCs are

more innovative and grow faster.
How should we interpret this statement?
This is a correlation feature and not a causation
VC provide funding to the promising firms and
thus this can create selection biases.
Raising Equity
Crowdfunding: investors should be careful while investing in such firms

• Firms seek to obtain small amounts of capital directly(!) from
a large number of investors through the internet
• The investors may or may not get a reward for the capital
they provide (no reward = donation of capital; used e.g. by
not-for-profit start-ups)
• Rewards can be anything, from shares to free products or
price reductions in future purchases
• Internet platforms facilitate the access to crowdfunding
• For more information see Hervé and Schwienbacher (2018)
or Mochkabadi and Volkmann (2020)
Raising Equity
Saudi Aramco Shares Rose 10% on First Trading Day

By Rekha Khandelwal, CFA Dec 11, 2019
Saudi Aramco shares rose 10% on the first day of its listing and hit the daily price
limit. The share price rose to 35.2 Saudi riyals from the IPO price of 32 riyals.
Saudi Aramco, the largest oil company in the world, listed 1.5% of its shares on
Tadawul — the Saudi stock exchange. At 35.2 riyals, the company’s valuation
comes to approximately $1.9 trillion, which makes it the largest publicly traded
company in the world. The company is much bigger than top oil companies
including ExxonMobil (XOM) and Royal Dutch Shell (RDS.A). Also, Saudi Aramco
raised $25.6 billion through the IPO, which makes it the largest IPO in the world.
Source: https://marketrealist.com/2019/12/saudi-aramco-shares-rose-10-first-trading-day/
Raising Equity
day 1 - there was no trading since the price was increased more than 35.2
Aramco Share prices are 18% higher than their open on December 11,
2019, giving the IPO a valuation above $2 trillion dollars.
Source: https://www.forbes.com/sites/arielcohen/2019/12/18/saudi-aramco-ipo-hits-2-trillion-mark-but-forecast-still-
guarded/#3da1db6442e6
Raising Equity
IPOs: Primary Investors- the IPO is offered to investors

• Shares of a company that is not yet exchange-listed
• are offered for sale ("subscription") to the public
• and will thereafter be traded on an exchange
• IPOs are sold in the primary market (as opposed to the
secondary market)
• Shares offered in an IPO can be “primary” (=newly created)
or “secondary” (previously held by pre-IPO shareholders)
shares
• Shares are usually sold through investment banks
(“underwriters”)
Raising Equity
Why Go Public?
Advantages Disadvantages
Capital infusion (only!) if primary shares are Higher publication / transparency requirements
offered
Easier access to equity through SEOs Direct cost (USA: appr. 7%) and indirect cost
Seasonal Equity Offering
(underpricing!)
Allows pre-IPO shareholders to exit from their Pre-IPO shareholders share control with new
investment (VCs!) shareholders
monitoring - what managers actually do , analysis of managers in the annual reports
But after IPO, the shareholdings decreases and thus there monitoring incentives decreases
Higher liquidity of shares More dispersed ownership may decrease

monitoring incentives
Establishes a market value for the firm Business models relying on intangible assets may
be difficult to communicate to investors (Stulz
2019)
May increase awareness / attractiveness of the
business have an intellectual
capital and they fear that IPO can
leak that to the outside world
firm
Raising Equity
IPO puzzles:
• IPOs come in waves
• Underpricing
• Long-run underperformance (at least in the US)
Note:
• Evidence presented here is from the US. The figure is
downloadable from Jay Ritter’s homepage at
http://bear.warrington.ufl.edu/ritter/ipodata.htm
• There is a substantial academic literature on these
phenomena (which we cannot cover in this course)
Raising Equity why underpricing occurs is not very clear in many academic literatures
Raising Equity
(figures for individual years not copied)
this is a critical example of long term under-performance

Raising Equity SEO -Seasonal Equity Offering
Deutsche Bank Seeks $8.6 Billion Selling Shares at Discount

by Steven Arons
19. März 2017, 15:16 MEZ 20. März 2017, 09:15 MEZ
Deutsche Bank AG said it will raise 8 billion euros ($8.6 billion) by selling stock at a
35 percent discount to last week’s closing price as Germany’s largest lender seeks
to shore up its finances and boost growth.
The company will issue 687.5 million new shares at 11.65 euros apiece, it said in a
statement Sunday, in-line with the firm’s March 5 announcement on the planned
sale. The offer compares with the stock’s closing price of 17.86 euros on Friday, and
is almost 41 percent lower than where the stock traded when Bloomberg first
reported that the bank was weighing a capital raising. Existing investors will be able
to acquire one new share for each two they now hold.
Source: https://www.bloomberg.com/news/articles/2017-03-19/deutsche-bank-prices-shares-at-11-65-euros-in-capital-increase
Raising Equity
Assume you are a shareholder of Deutsche Bank. Do you

like the equity issue?
Dilution may be a problem here.
Existing shareholders may get two shares

Raising Equity
Seasoned equity offerings (SEOs):

• Issuance of additional shares by a firm that is already listed
• May result in dilution of shareholdings of existing
shareholders (see below)
• Formal procedures depend on national legislation
(Germany: 75% majority in shareholders’ meeting)
• Note: Please re-read section on “Issuance of new stock” in

FA slides
Raising Equity
Example:
Deutsche Bank is proposing a seasoned equity offering.
There are 1.375 billion shares outstanding trading at €17.86
each. There will be 687.5 million new shares issued at a
€11.65 subscription price:
• 1.375 bn shares outstanding, value € 17.86 each
• 687.5 new shares offered at € 11.65
(note: to analyze the effect on the share price of a stock
dividend, set the offer price to 0)
• Expected share value after equity offering:
p0nold + pSnnew 1,375 ⋅ 17.86 + 687.5 ⋅ 11.65
pex = = 15.79
nold + nnew 1,375 + 687.5
Raising Equity
• Assuming no preemptive rights, new shareholders gain at

the expense of old shareholders
• This is known as dilution 17.86 - 15.79 = 2.07
for every 2 share loss - 2.07*2= 4.14
but if they buy one new share at 11.65 they have a profit of 4.14
Solutions: How can you prevents dilution!

thus this is how they offset the previous sharehol
• Price of new shares close to value of old shares (e.g. US)

• Rights offerings (e.g. Germany):
- The old shareholders are given the right to buy the new
shares (Each old share carries one preemptive right; the
number of rights needed to buy a new share is given by
the ratio old/new shares)
- If they do not want to buy the new shares they can sell
their rights (why does the right have value?)
Raising Equity
What is the value of a right in the Deutsche Bank SEO?
How does the dilution problem relate to the Winfield case?

Raising Equity
An interesting and slightly disturbing empirical finding

(Holderness 2018):
Raising Equity
Private Equity (PE):

• PE firms are organized pretty much like Venture Capital
firms
• They provide equity at later stages of a firm's life cycle
• PE equity may be a substitute for an IPO
• PEs may be involved in transactions where firms are
"taken private"
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Debt
Types of debt:
Standard bank Syndicated loan Private placements Publicly issued

loan • funded by a • bond that is sold bond
group of banks to a small group • Procedures
of (institutional) similar to equity
investors IPOs (but lower
• Less regulated cost)
than regular
issues
In the US and the UK bond financing for non-financial firms

is much more common than in continental Europe
Debt
Characteristics:
• Time to maturity
• Repayment (bullet repayment, installments, line of credit)
• Interest rate (fixed / floating rate)
• Collateral (inside / outside collateral)
• Sources (financial markets, banks, suppliers, others)
Note: The effects of debt on the return on equity and on risk

as well as the "hidden" cost of debt will be discussed later!
Debt
Bonds versus bank loans:

• Bonds and bank loans are close substitutes (however, bank
loans are more expensive, and banks provide additional
services which firms value; see Schwert 2019)
• Main differences:
- because of fixed issuing costs bonds require a certain
minimum volume
- bonds are more easily traded on a secondary market
- bonds are more difficult to renegotiate (however, for for-
mal bankruptcy/workout procedures laws usually specify
that majority decisions are binding for all bond holders)
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Working Capital and Financial Statements
Source: PWC 2013, p. 26 and 39

Firms need to finance

• their fixed assets
• the current assets needed for day-to-day operations
Working Capital Management deals with the short-term
(=current) assets of the firm and with the way these assets are
financed
Current assets: Cash and other assets that are expected to be
converted to cash within a year, most importantly:
- inventories
- accounts receivable
Current liabilities (short-term debt): Obligations that are ex-

pected to require cash payment within a year, most
importantly:
- accounts payable
Working Capital Management

• is often neglected but of great importance for the efficiency
and profitability of the firm’s operations
• closely links operational and financial decisions within the
firm
• is therefore important for divisional and functional managers
of the firm
Assets Liabilities
Non-current
(fixed) assets
Equity
--------
Net
long-term debt
Current assets Working
Capital
-------- short-term debt
The working capital (and resulting financing) needs can be

substantial!
• The balance sheet of

Mackmyra, a Swedish malt
whisky distillery
• Inventories (mostly "pro-
ducts under construction")
account for 62% of total
assets
Source: https://mackmyra.com/wp-
content/uploads/q4-18-20190228-eng-
final.pdf
Why (changes in) working capital are important - a (very)

simple example
• We set up a store
• We use equity of 50 to finance fixed assets worth 50
• Each period we buy a unit from our supplier at 10 and sell it
to the customer at 10
• After 10 periods we terminate our business
• We have a line of credit from our bank
Assets Liabilities
• Initial balance sheet: Fixed assets 50 Equity 50
Inventory 0 Bank debt 0
Accounts receivable 0 Accounts payable 0
Cash 0
Total assets 50 Total liabilities 50
Version 1 - Pay as you go

1 2 3 4 5 6 7 8 9 10 11 sum
Payment to supplier -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 0 -100
Payment from customer 10 10 10 10 10 10 10 10 10 10 0 100
Cash flow 0 0 0 0 0 0 0 0 0 0 0 0
Cumulative cash flow = financing requirement 0 0 0 0 0 0 0 0 0 0 0
Balance sheet after periods 1,2,...

Assets Liabilities
Fixed assets 50 Equity 50
Cash 0
Version 2 - Customers pay after one month

1 2 3 4 5 6 7 8 9 10 11 sum
Payment to supplier -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 0 -100
Cash flow -10 0 0 0 0 0 0 0 0 0 10 0
Cumulative cash flow = financing requirement -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 0

Assets Liabilities
Cash 0
Version 3 - One item on stock (inventory)

1 2 3 4 5 6 7 8 9 10 11 sum
Payment to supplier -20 -10 -10 -10 -10 -10 -10 -10 -10 0 0 -100
Cash flow -10 0 0 0 0 0 0 0 0 10 0 0
Cumulative cash flow = financing requirement -10 -10 -10 -10 -10 -10 -10 -10 -10 0 0

Assets Liabilities
Cash 0
Version 4 - We pay our supplier after 1 period

1 2 3 4 5 6 7 8 9 10 11 sum
Payment to supplier 0 -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 -100
Cash flow 10 0 0 0 0 0 0 0 0 0 -10 0
Cumulative cash flow = financing requirement 10 10 10 10 10 10 10 10 10 10 0

Assets Liabilities
Inventory 0 Bank debt
Cash 10
Version 5 - Everything at once

1 2 3 4 5 6 7 8 9 10 11 sum
Payment to supplier 0 -20 -10 -10 -10 -10 -10 -10 -10 -10 0 -100
Cash flow 0 -10 0 0 0 0 0 0 0 0 10 0
Cumulative cash flow = financing requirement 0 -10 -10 -10 -10 -10 -10 -10 -10 -10 0
Balance sheet after periods 2, 3, ...

Assets Liabilities
Cash 10
Remember from FA:
• Accounts receivable and inventories are non-cash assets

• Accounts payable are liabilities
A firm has increased the amount of accounts receivable

during the previous year. In the firm's cash flow statement
this increase will show up as a cash inflow (i.e. as a source
of cash).
True or False?
Account receivable is the amount of money that is yet to received from the customers in
turn of the inventory that is sold to them . An increase in this amount implies that the
goods are sold at a credit and in future, cash will be received from them.
In present this signifies a decrease in the cash inflow.

Take away:
• The main components of a firm's working capital are cash
and cash equivalents, accounts receivable, inventories (of
raw materials and finished goods) and accounts payable
• Investment projects do not only require investments in fixed
assets but also investments in working capital
• Working capital is recovered when a project is terminated
WC= C.A - C.L
• Working capital requires financing Increase in working capital mean current liabilities
have decreased and that mean cash outflow has
occurred only
• Increases in working capital are cash outflows, changes
decreases in working capital are cash inflows matter!
• Typically working capital requirements increase [decrease]
when a business expands [shrinks].
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Determinants of Working Capital Requirements
The working capital depends on

• the nature of the firm's business
• the scale of the firm’s operations (growth requires increases
in working capital!)
• the firm’s approach to working capital management
(conservative / aggressive policy; see below)
• seasonal patterns
• business cycle factors
Important:
• Remember: Some of the current assets are essentially
("economically") long-term investments (why?)
The cash conversion cycle:

Liquidity
Inventory
Accounts receivable
(raw materials, ...)
Inventory
(Products)
The length of the cash conversion cycle determines the

amount of working capital required and the financing needs
Working capital and the cash cycle: We disregard return

Inventory period and warranty
periods here
Firm pays for inventory
Finished goods sold
adapted from Ross et al. (2008, p. 749)

Payment received
Firm buys
Cash out
inventory
Accounts Accounts
Cash in
payable receivable
period period
Cash cycle Time

Operating cycle
In practice, the inventory period, the accounts receivable

period and the accounts payable period are measured by days
in inventory, days in receivables and days in payables
(Average) Inventory * 365

Days in inventory =
(Also: DIO = Days in Inventories Annual costs of goods sold
Outstanding)
(Average) Accounts receivable * 365
Days in receivables =
(Also: DSO = Days Sales Annual sales
Outstanding)
(Average) Accounts payable * 365

Days in payables =
(Also: DPO = Days Annual costs of goods sold
Payables Outstanding)
Interpretation
• The ratios imply that a firm operates more efficiently when it
achieves a given sales level with lower inventory / accounts
receivable
How to reduce working capital requirements?

• Decrease inventories Reducing working capital can be a risk too. Efficient planning is required!
→ Efficient production planning

→ Efficient inventory management (extreme: just-in-time)
→ Standardization of parts (e.g. car manufacturers)
→ Marketing research
• Make customers pay more quickly
→ Reduces accounts receivable
→ May require costly incentives (e.g. cash discounts)
How to reduce working capital requirements? (contd.)

• Pay suppliers later
→ Increases accounts payable
→ May be costly (e.g. foregone cash discounts)
Approaches to Working Capital Management

1. Short-term investment policy
Short-term investment policy (investments in current assets)

flexible (or conservative) approach restrictive (or aggressive) approach
Focus: avoiding shortages Focus: profitability
Keeping large cash balances, investments in Keeping low cash balances, no investment in
marketable securities marketable securities
Large investments in inventory Making small investments in inventory
Liberal credit terms (→ accounts receivable) Allowing few or no credit sales (thus low accounts
receivable)
Result: high level of WC, less risky, less profitable Result: low level of WC, more risky, more
profitable
Short-term investment policy: Carrying cost and shortage

cost: The relation between carrying costs and shortage costs
determines whether a flexible or a restrictive policy is better
$ Total costs of holding current
Minimum
assets.
point
Carrying costs
Benefits
Shortage costs
Quantity
CA* Investment in
The optimum quantity of current assets at which costs are minimised
Current Assets ($)
2. Short-term financing policy
Short-term financing policy (short-term versus long-term)

flexible (or conservative) approach restrictive (or aggressive) approach
Focus: avoiding shortages Focus: profitability
Low level of short-term debt relative to long term High level of short-term debt relative to long-term
capital (equity, long-term debt) reduces risk of capital
shortages of capital short tertm debt has lower
interest rate
• short-term debt is usually cheaper than long-
• short-term debt requires frequent refinancing term debt (term structure of interest rates)
• short-term debt exposes the firm to interest
rate risk
Result: less risky, less profitable Result: more risky, more profitable
Short-term financing policy: Alternative financing strategies:

in the right graph,
Growth graph of a firm company is using the
In the left graph short term debt to match
when asset requirement is low - long term financing goes to marketable securities with seasonal variations Total Asset
when asset requirement is high - it can fully be financed by long term financing in asset growth and long
term debt to finance the
permanent long term
Requirement
Total Asset assets
$ Requirement $
Marketable
Securities
Short Term
Financing
Long Term
Financing Long Term
Financing
Time Time
The matching principle postulates that short-term assets

should be financed with short-term debt and long-term assets
should be financed with long-term debt (or equity)
But remember: Some current assets (economically) are long-
term assets!
But some current assets are the inventories that the business needs for a long time and does it should be financed using the long term financing
Note: There is also a matching principle in accounting. It

states that expenses should be recorded in the same period
as the related revenues
Sources of short-term financing:

• Line of credit
• Secured Loans
- Accounts receivable financing (common)
→ accounts receivable serve as collateral
→ alternative (“substitute”): factoring
- Inventory loans use inventory as collateral
• Other sources exist (some of which can only be tapped by
large firms)
Go back to the balance sheet (slide 28 in slide set 1) and

income statement (slide 7 in slide set 2) of Global
Corporation.
1) What are the DSO, DIO and DPO of Global Corporation?
2) Why is DSO benchmarked against sales while DIO and
DPO are benchmarked against costs of goods sold?
2. Accounts payable/Inventory(DIO/DPO) ——> the amount we owe our suppliers and it is measured against cost of goods
Accounts receivables(DSO)—> the amount we owe from our customers and since profit has been realised. So we use the annual sales as the denominator
DSO = 30.98
DIO = 35.21
DPO = 66.2
Mini Case Fresenius Medical Care
The figure states that Fresenius Medical

Care managed to reduce the DSO from
106 days to 92 days.
Accounts receivable as of December 31,
2003 have been 1.2 billion.
Assume the opportunity cost of capital is
8%
What are the implications for the financing requirements and

the firm’s profitability?14.61 M pa
PWC (2013, p. 26, 47) estimates a huge potential for

Upper Quartile—> companies which have less working capital
improvement: Lower Quartile—> companies which have more working capital
ROCE = Return on capital empoyed is

essentially a modifierd return on assets
How would you interpret the potential for improvement

identified in the PWC study?
The study doesn’t take into account the shortage costs and thus the study seems to biased
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Trade Credit
What do you prefer

A paying € 98 today
B paying € 100 30 days from now
depends on the interest rate
Trade Credit
• Firms often allow for delayed payment but provide incen-

tives (usually in the form of a discount) for early payment
• Trade-off between the size of the discount and the increased
speed and rate of collection of receivables
• Example “2/10 net 30”: The customer can take a 2% dis-
count if she pays within 10 days; otherwise she has to pay
within 30 days
• These terms essentially imply a 20 day loan:
98
Some customers take the
discount and pay on day 10
0 10 30
100 Other customers pay on
day 30 and forego the
0 10 30 discount (i.e. tale the loan)
Trade Credit
• Consider the buyer's decision to pay after 30 days instead of

paying after 10 days (and taking the discount)
-98
Instead of this
0 10 30
-100
We do that
0 10 30
+98 -100 Our cash flows change

This is what we call an incremental
0 10 30 cash flow (how do the cash flows
change because of a decision.
This is the cash flow pattern of a loan! (Much) more on that in chapter 3)
Note: This figure takes the buyer's perspective. From the seller's perspective the
incremental cash flow is -98, +100 - the cash flow pattern of an investment (lending)
Trade Credit
A customer who foregoes the 2% discount and pays on day 30

is borrowing € 98 for 20 days and pays € 2 interest:
 interest rate 
Interest = 98  
 365 / 20 
With a 10% interest rate the interest would be
 0.1 
98   = 0.537
 365 / 20 
For the interest to be € 2 the rate must be a whopping 37.2%
Conclusion: Trade credit can be very expensive
A note (only) to experts: What we calculated here is the 20-day compounded in-
terest rate. The corresponding annually compounded rate is even higher, at 44.5%.
Trade Credit
A firm’s credit policy is composed of:

• Terms of the sale
- Credit period
- Are incentives (cash discounts) offered?
- Trade-off between size of discount and increased speed
of collection of receivables
- Are credit instruments used? Which?
• Credit analysis
- To whom to grant credit, and how much?
- Requires assessment of the default risk (and of the bene-
fits of granting credit, e.g. increased sales, higher prices)
Trade Credit
• Collection policy
- Which measures are taken to collect overdue accounts?
Credit instruments:
• Most credit is offered on open account — the invoice is the
only credit instrument
• Often the seller retains legal ownership of the goods until
the customer has completed payment
• Special instruments for international transactions (e.g.
letters of credit)
• Insurance can be bought (common in international
transactions)
Trade Credit
On average, accounts payable account for about 10% of

the liabilities of German firms. Does that necessarily imply
that firms accept expensive trade credits?
Trade Credit
Factoring:
• The sale of a firm’s accounts receivable to a financial
institution (known as a factor)
• The firm and the factor agree on the basic credit terms for
Factor buy the recievable at a discount which is similar to the market
each customer interest rate and taking into consideration the customer risk as well.
Note: other arrangements possible

Trade Credit
Factoring (contd.):
• undisclosed versus disclosed factoring
• credit risk remains with the firm or is taken over by the
factor when the customer doesnot pay
if factor takes the risk then it means firm has an

insurance with the factor
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Cash Management
Liquidity:
• Firms need to make sure that they can meet all financial
obligations
Initial cash holdings + cash inflows ≥ cash outflows
t t
Cash0 + ∑ Int ≥ ∑ Out t
=τ 0=τ 0
• Based on cash inflows and cash outflows, not on profits or

losses
• Cash inflows may come from financing decisions. Therefore,
a firm’s liquidity is not independent of its creditworthiness
Cash Management
A cash budget is a primary tool of short-term financial

planning. The idea is simple: Record the estimates of cash
receipts and disbursements
• Cash Receipts
- Arise from sales, but we need to estimate when we
actually collect
• Cash Outflow
- Payments of Accounts Payable
- Wages, Taxes, and other Expenses
- Capital Expenditures
- Long-Term Financial Planning (Debt repayments and
interest payments)
Cash Management
The financial manager can use the cash budget to identify

short-term financial needs. The cash balance tells the manager
what borrowing is required or what lending will be possible in
the short run.
Alternatives to borrowing:
• Sell (non-core) assets
• Delay investments, maintenance etc.
→ May be costly (whenever the delayed action would have
been optimal)
Cash Management
Mini Case: ABC‘s cash budget (all in € mio)

• Cash balance on Dec. 31.2023: 12 Mio. €
• 80% [20%] of the sales in a quarter yield cash inflows in the
same [the next] quarter
Quarter IV/23 I/24 II/24 III/24 IV/24
Sales 120 105 95 95 125
4
Scheduled Borrowing 0 25 0 0 0
Cash outflows to suppliers 85 65 65 90 90
Wages 25 20 20.5 20.5 25.5
Investments 5 25 5 5 5
Interest, dividends, taxes 5 5 15 5 5
• Please forecast the cash balance at the end of each quarter

in 2024
Cash Management
Why do firms hold cash?

• Transactions motive
non-synchronicity of cash in- and outflows
• Precautionary motives firms do not know when the cash inflows will occur. Thus this creates uncertainity.
• Reduction of refinancing risk (Harford et al. 2014)

When firms has a loan due but is uncertain that bank will guarantee the loan amount
• Strategic motives (“war chest”)

to buy other firms and can ease acquisition if you hold cash in hand.
Cash Management
The optimal level of cash balances

• the cost of holding cash:
- the opportunity cost of lost returns (more precisely: the
difference between short-term rates and the return on
long-term investments)
• The cost of not having enough cash:
- trading costs of selling assets to raise cash (worst case:
“fire sales”)
- cost of additional short-term borrowing
Course Outline
1. Debt and Equity

2. Raising Equity
3. Debt
6. Trade Credit
7. Cash Management
Supplementary Material
Source: PWC: 2015 Annual Global Working Capital Survey

Important differences in the amount of working capital across

industries (PWC 2013, p. 14):
Also: Important international differences (PWC 2013, p. 12):

Also: Fluctuations over time
Source: PWC: 2015 Annual Global Working Capital Survey

2. Credit analysis
Credit information
• Financial statement analysis
• Customer’s payment history with the firm
• Credit reports on customer’s payment history with other
firms (offered by service providers)
• Banks
Decisions to be taken
• Do we grant credit?
• If so, what is the credit limit?
Credit reports - example (Creditreform):
Company Credit Check (B2B)

Reliable decision-making for B2B
Creditreform supplies you all the necessary data on your business partner’s solvency, finances, structure and
economic environment.
Source (accessed Oct. 7, 2015):

http://en.creditreform.de/portfolio/commercial-information/company-credit-check-b2b.html
Reading List
Required Reading:
• Berk, J. and P. DeMarzo (2014): Corporate Finance, 3rd edition, chapter
23.
• Hillier, D., St. Ross, R. Westerfield, J. Jaffee and B. Jordan (2020):
Corporate Finance, Fourth European edition, chapters 14, 15, 26, 27.
Supplementary:
• Fan, J., S. Titman and G. Twire (2012): An International Comparison of
Capital Structure and Debt Maturity Choices. Journal of Financial and
Quantitative Analysis 47, 23-56.
• Harford, J., S. Klasa and W. Maxwell (2014): Refinancing Risk and Cash
Holdings. Journal of Finance 69. 975-1012.
• Hervé, F. and A. Schwienbacher (2018): Crowdfunding and Innovation.
Journal of Economic Surveys 32, 1514-1530.
Reading List
Supplementary (contd.):
• Holderness, C. (2018): Equity Issuance and Agency Costs: The Telling
Story of Shareholder Approval Around the World. Journal of Financial
Economics 129, 415-439.
• Mochkabadi, K. and C. Volkmann (2020): Equity Crowdfunding: A
Systematic Review of the Literature. Small Business Economics 54, 75-
118.
• PWC Pricewaterhouse Coopers (2013): Global Working Capital Annual
Review 2013. Download at: http://www.pwc.com/en_GX/gx/financial-
services/publications/assets/pwc-working-capital-final.pdf
• Stulz, R. (2019): Public versus Private Equity. Working Paper.
THANK YOU
VERY MUCH!
PROF. DR. ERIK THEISSEN I NOV-DEC 2023

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CORPORATE FINANCE

SLIDE SET 2: EQUITY FINANCING AND WORKING CAPITAL

PROF. DR. ERIK THEISSEN I NOV-DEC 2023

1. Debt and Equity

1. Debt and Equity

A financial claim specifies

• control rights Shareholders

• additional rights (e.g. option or conversion rights)

"Standard" Equity "Standard" Debt

Source: online ppt slides for BDH

Equity is more risky than debt:

Equity holders should therefore expect a higher rate of return

Equity is a convex claim; debt is a concave claim

D Cash flow to firm

Significant international differences in capital structure:

there are a lot of factors which can affect that

Which factors cause the international differences in capital

1. Debt and Equity

Sources of Equity for Start-ups - A Schematic View:

Newer alternatives: Crowdfunding, Initial Coin Offerings (ICOs)

Venture Capital (VC) Firms:

Investors Venture Capitalist Start-up firm

• Collect capital from (institutional) investors and charge fees

financing is done in rounds and

Source: National Venture Capital Association: 2021 Yearbook

Note: Huge international differences in the importance of VC

this is the depiction of EU market

Source: Pitch Book European Venture Report Q3 2021, p. 3

Empirical evidence suggests that firms funded by VCs are

Crowdfunding: investors should be careful while investing in such firms

Saudi Aramco Shares Rose 10% on First Trading Day

IPOs: Primary Investors- the IPO is offered to investors

Higher liquidity of shares More dispersed ownership may decrease

(figures for individual years not copied)

this is a critical example of long term under-performance

Deutsche Bank Seeks $8.6 Billion Selling Shares at Discount

Assume you are a shareholder of Deutsche Bank. Do you

Dilution may be a problem here.

Existing shareholders may get two shares

Seasoned equity offerings (SEOs):

• Note: Please re-read section on “Issuance of new stock” in

• Assuming no preemptive rights, new shareholders gain at

Solutions: How can you prevents dilution!

• Price of new shares close to value of old shares (e.g. US)

What is the value of a right in the Deutsche Bank SEO?

How does the dilution problem relate to the Winfield case?

An interesting and slightly disturbing empirical finding

Private Equity (PE):

1. Debt and Equity

Standard bank Syndicated loan Private placements Publicly issued

In the US and the UK bond financing for non-financial firms

Note: The effects of debt on the return on equity and on risk

Bonds versus bank loans:

1. Debt and Equity

Source: PWC 2013, p. 26 and 39

Firms need to finance

Current liabilities (short-term debt): Obligations that are ex-

Working Capital Management

-------- short-term debt

The working capital (and resulting financing) needs can be

• The balance sheet of

Why (changes in) working capital are important - a (very)

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