Introduction to Corporate Finance

LEARNING OBJECTIVES

After studying this chapter, you will be able to:

understand the key financial statements

that companies are required to provide to

their shareholders

evaluate the company’s cash flows using

its financial statements, including the

statement of cash flows

calculate and interpret liquidity, activity

and debt ratios

review the popular profitability ratios and

the role of the DuPont system in analysing

the company’s returns

compute and interpret the price/earnings

and market/book ratios

discuss the basics of corporate taxation of

both ordinary income and capital gains.

LO2.1

LO2.2

LO2.3

LO2.4

LO2.5

LO2.6

Accounting is called the language of business.

Corporate finance relies heavily on accounting

concepts and language, but the primary focus

of finance professionals and accountants differs

significantly. Usually, accountants apply generally

accepted accounting principles (GAAP) to construct

financial statements using an accrual-based approach.

This means that accountants record revenues at the

point of sale and costs when they are incurred, not

necessarily when a company receives or pays out

cash.

In contrast, finance professionals use a cash flow

approach, which focuses on current and prospective

inflows and outflows of cash. The financial

manager must convert relevant accounting and

tax information into cash inflows and cash outflows

so that companies and investors can use this

information for analysis and decision making.

This chapter describes how finance

professionals use accounting information and

terminology to analyse the company’s cash flows

and financial performance. We begin with a brief

review of the four major financial statements, then

use these to demonstrate some of the key concepts

involved in cash flow analysis. We give special

emphasis to the company’s cash flows, free cash

flows, the classification of inflows and outflows

of cash and the development and interpretation

of statements of cash flows. Then, we discuss

some popular financial ratios used to analyse the

company’s financial performance. Finally, we review

the basics of Australian corporate taxation.

2-1 FINANCIAL STATEMENTS

The Australian Accounting Standards Board (AASB) was set up by the Australian government, under the

Australian Securities and Investments Commission Act 2001, as an independent body with the mission to:

■ create principle-based external reporting standards for Australia that meet user needs

■ contribute to the development of international external reporting standards.^1

1 ‘About the AASB.’ Australian Accounting Standards Board, http://www.aasb.gov.au/About-the-AASB.aspx. Accessed 7 March 2016. © 2015

Australian Accounting Standards Board (AASB). No part of the publication may be reproduced, stored or transmitted in any form or by any

means without the prior written permission of the Australian Accounting Standards Board except as permitted by law.

accrual-based approach
Revenues are recorded at
the point of sale and costs
when they are incurred, not
necessarily when a company
receives or pays out cash

cash flow approach
Used by financial professionals
to focus attention on current
and prospective inflows and
outflows of cash

PArT 1: INTrODuCTION