For the remainder of July, I’m going to focus on a 3 part Corporate Finance series which will build up to evaluating Microsoft’s first earnings call with Satya Nadella as CEO. I took a Financial Management course last summer 2013, and my final valuation project was on Microsoft about the time Steve Ballmer announced his resignation as CEO. Upon reading Nadella’s Microsoft employee memo which he planned in tandem to the earnings call to take place on the 22nd, I couldn’t help but feel there isn’t a better time to do so.
The Corporate Finance structure encompasses the stakeholders of the company. In a publicly traded corporation, the stakeholders commonly include the board of directors, management, employees, shareholders, investors, creditors, government, suppliers, customers and the public. The shareholders of the company are those who legally own a share of stock, and their purchasing of such stock entitles them part ownership of the company. Stocks are usually divided into a common or preferred class which may grant special privileges, these may include voting, nomination, and entitlement to dividends. In this series however, we are going to focus on the perspective of the Finance Manager. The Finance Manager would usually be the CEO or CFO of the corporation and who would be hired by the Board of Directors and shareholders to ensure their return on investment in the corporation.
The Finance Manager and the shareholders must agree on three particular areas of finance which influence the company’s future performance: Capital Budgeting, Capital Structure, and Working Capital. Capital Budgeting involves the investment decision which resides on the left side of the Balance Sheet in Assets, managing the size, timing, and risk of future cash flows. Capital Structure encompasses the finance decisions inhabiting the right side of the Balance Sheet in Liability and Stockholder Equity, managing the mix of debt and equity. Working Capital incorporates the operating decisions which occupies both the left and right side of the Balance Sheet in Assets and Liabilities, managing the day-to-day finance operations. In this intro Finance lesson, I’ll be covering Capital Budgeting.
Capital Budgeting helps a company make future investment decisions based on previous Financial Statements as a past reference. In accounting, the Financial Statement focuses on previous reports encompassing the Income Statement, Balance Sheet and statement of Cash Flows. The Income Statement is a statement of the company’s financial performance over a period of time, calculating their income which is naturally the company’s revenues minus expenses. The Balance Sheet is a snapshot of the company’s financial position at a given point in time, evaluating its assets which equate to the sum of liabilities and equity. And the statement of Cash flow emphasizes the company’s Cash Flow operating, investing and financing activities.
Capital Budgeting utilizes methods like Net Present Value (NPV), Internal Rate of Return (IRR), and Discounted Cash Flows (DCF). NPV of an investment is the difference between the investment’s market future value and it’s cost. IRR of an investment is the discount rate that makes the NPV of an investment equal to zero, the higher the IRR the more desirable the investment. DCF of an investment is the length of time until the sum of discounted cash flows is equal to the initial investment, If the value is higher than the current cost of the investment the opportunity may be most fruitful. If the Finance Manager is successful in achieving worthwhile returns through such techniques, the sum of its revenue will accumulate to improving the company’s cash flows.
In the next lesson I’ll cover Working Capital, Capital Structure and how a Finance Manager goes about calculating a company’s valuation.
Image:http://cdn.phys.org/newman/gfx/news/hires/2013/studyshowsmo.jpg
