Session 1

Introduction to Corporate Finance

Ng Eng Wan
FCPA CIA ACMA CGMA
 Know the basic types of financial management
decisions and the role of the Finance Manager
 Know the financial implications of the various forms
of business organization
 Know the goal of financial management
 Understand the conflicts of interest that can arise
between owners and managers
 Understand the various regulations that firms face

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1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Importance of Cash Flows
1.4 The Goal of Financial Management
1.5 The Agency Problem and Control of the
Corporation
1.6 Regulation

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Corporate Finance addresses the following three
questions:
1. What long-term investments should the firm choose
(capital budgeting)?
2. How should the firm raise funds for the selected
investments (financing)?
3. How should short-term assets be managed and financed
(short-term liquidity management)?
- Can be reflected in the balance sheet model of a firm

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Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventories, Equipment, etc.

LO 3
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Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

LO 3
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Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Owner's Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Capital contribution by owners.
 Retained earnings (profits/losses).
 Dividends, repurchased of shares (-).

LO 3
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Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity

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 Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
What long-term
1 Tangible investments
Shareholders’
should the firm
2 Intangible choose? Equity

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 Current
Liabilities
Current
Assets Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity

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 Current
Liabilities
Current
Net
Assets Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
financed? Shareholders’
2 Intangible Equity

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The Finance Manager’s primary goal is to increase the
value of the firm (value creation) by:
1. Selecting value creating projects
2. Making smart financing decisions

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 Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

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 The corporate form of business is the standard
method for solving the problems encountered in
raising large amounts of cash.
 The firm is a way to organize the business activity
 However, businesses can take different forms.

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 The Sole Proprietorship
 The Partnership
◦ General Partnership
◦ Limited Partnership
 The Corporation

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 Owned by one person
 Cheapest & easiest business to form
 Pays no corporate income tax
 All profits of business taxed as individual

income
 Has unlimited liability. No distinction between

personal and business assets

 Life is limited by the life of the owner

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 Can be formed by 2 or more persons
 Usually inexpensive & easy to form
 Unlimited liability for all debts
 Partnership is terminated when a general

partner dies or withdraws

 Equity contribution is limited to a partner’s

ability and desire to contribute (difficult to

raise cash)
 Income is taxed as personal income

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 Forming a corporation is more complicated
 Is structured into shareholders, board and

management
 Has unlimited life
 Shareholder’s liability is limited to capital

amount (not personally liable)

 Ownership is transferable
 Enhanced ability to raise cash
 Pays company income tax as well as personal

income tax (double taxation)

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 Firm Firm issues securities (A) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Ultimately, the firm
must be a cash
generating activity.
Taxes (D)
The cash flows from the
firm must exceed the cash
Government flows from the financial
markets.
C=A+F-E-D > 0
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 Accounting profit vs cash flow
 Timing of Cash Flow
 Risk of Collection

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 What is the correct goal?
◦ Maximize profit?
◦ Minimize costs?
◦ Maximize market share?
◦ Maximize shareholder wealth?

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• How value is defined by customers, investors
and other stakeholders.
• How value is created through the
organization’s purpose, strategy and business
model taking into account all resources, capitals,
and relationships in an integrated way.
• How value is delivered to customers,
governments and society through responsible
products and services, and new channels to
market, all at an appropriate cost and price.
• How value is sustained by retaining and
protecting value internally in the organization
and distributing value externally by appropriate
reinvestment and distribution to shareholders and
wider society. There needs to be a balanced
approach between the retention of value and the
distribution of value aligned to its purpose and
value objectives.

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Given value creation cannot be sufficiently captured and measured in financial terms,
various other value and performance perspectives need to be tracked, connected and
analyzed. A corporate performance and value scorecard needs to draw on three
perspectives of value creation that are the basis for a comprehensive and integrated
corporate performance measurement and reporting system:
• Traditional accounting perspective: Balance sheet (book) value – an accounting
value derived from capital employed and provided and represented by the financial
statements.
• Investor’s Perspective: Business (expected) value – derived from strategic and
intangible assets that generate future growth and provide the basis for residual income,
sustainable earnings and valuations, and reduced risk.
• Society’s Perspective: Societal (sustained) value – representing the positive and
negative impacts of an organization’s activities on customers, employees, society, and
the environment. External impacts can be quantified and monetized but are not yet
reflected in the cash flows of the company but represent future opportunities and risks.

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 Success and the strong relationships and trust that come with it depend on
a broad and long-term view of value creation that serves many
stakeholders—not just shareholders.
 The Business Roundtable’s statement on the purpose of a corporation—
signed by 181 CEOs— affirmed this idea of meeting the needs of all
stakeholders. Many organizations are pivoting from legacy business
models to meet new needs, as we see with automakers, retailers and others
converting their facilities during covid-19 to make vital medical
equipment.
 It is an excellent example of businesses learning to succeed while meeting
society’s critical and systemic challenges, which include climate change,
inequality, resource scarcity and ecosystem disruption, alongside covid-19.

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 As Professor Mervyn King, Chair Emeritus of the International Integrated
Reporting Council, put it, “the CFO should be known as the CVO – Chief
Value Officer”.

 In this role, the CFO adopts a comprehensive value creation and protection
mindset and focuses the business on optimizing and protecting stakeholder
value.

 A CFO with a broader mandate in value creation accounts for and

communicates all relevant information about value creation and protection
to boards, management, and external stakeholders.

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 Agency relationship
◦ Relationship between stockholders & management
◦ Principal hires an agent to represent his/her interest
◦ Stockholders (principals) hire managers (agents) to run the
company
 Agency problem
◦ Conflict of interest between principal and agent

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 Direct
– high corporate expenses, cost to monitor
management actions
 Indirect

- lost investment opportunity

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 Managerial goals may be different from shareholder
goals
◦ Expensive perquisites
◦ Survival
◦ Independence
 Increased growth and size are not necessarily
equivalent to increased shareholder wealth
 Key challenge is aligning management goals with

stakeholder goals

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 Managerial compensation
◦ Incentives can be used to align management and
stockholder interests
◦ The incentives need to be structured carefully to make sure
that they achieve their intended goal
 Corporate control
◦ The threat of a takeover may result in better management
 Other stakeholders
◦ Conflicting financial interests

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 The Securities Act of 1933 and the Securities
Exchange Act of 1934
◦ Issuance of Securities (1933)
◦ Creation of SEC and reporting requirements (1934)
 Sarbanes-Oxley (“Sarbox”)
◦ Increased reporting requirements and responsibility of
corporate directors

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Section 302: CEOs and CFOs are responsible for accuracy and veracity of financial
reports and have noted any deficiencies in internal controls or instances of fraud. 
Section 401: Firms must release financial reports with full disclosure of entire material
condition of the company, including off balance sheet liabilities and transactions.
Section 403: Principal stockholders and management must disclose any company-
related transactions.
Section 404: The CFO and CEO must personally certify that they stand behind financial
reports. Firms must establish internal financial controls and corporate officers must sign
off that they have verified the effectiveness of the controls within 90 days of publishing
the annual report.
Section 409: If a firm experiences any material changes in their financial or operating
conditions, they must inform shareholders immediately, or as the act says, “on a rapid
and current basis.”
Section 802: Companies can not destroy, alter, or conceal records, documents, and
objects relating to finance and business transactions -  in particular, if these actions
could obstruct a legal investigation. These documents must be kept for a minimum of
five years. Noncompliance could lead to prison. 

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Prescribed penalties for noncompliance with SOX regulations are
severe. They include the following: 

Delisting of stock from public stock exchanges

Fines of up to five million dollars

Invalidation of D&O insurance policies

Up to 20 years in prison (for CEOs and CFOs who willfully submit an

incorrect certification audit)

Clawback of any bonuses paid within a year of any malfeasance

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 What are the three basic questions Financial
Managers must answer?
 What are the three major forms of business
organization?
 What is the goal of financial management?
 What are agency problems, and why do they exist
within a corporation?
 What major regulations impact public firms?

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