block2 2net assets_and_the_cost_of_capital
TRANSCRIPT
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NET ASSETS AND THE COST OF FUNDS
E-LEARNING COURSE: ACCOUNTING & FINANCES
NET ASSETS
Assets
Obviously, investments and funds must match. The larger the investment you want to make, the more funds you will need to obtain. But funds are expensive, aren’t they?
Generally speaking, yes they are.
Investments and funds must match
Liabilities + equity
Cash
Account Receivables
Inventory(or Stock)
Fixed Assets
Account Payables
Short-Term Debt
Long-Term Debt
Equity
NET ASSETS
But funds are not always expensive. When a supplier is offering its products or services, it usually also offers the possibility of deferring payment of the invoice. And it usually does this for free.
So, we can say that certain spontaneous and cost-less sources of financing stem from the fact that the company buys goods and services, pays taxes, etc. Those items are normally recorded as “payables” other liabilities in the balance sheet.
Liabilities + equity
Assets
Cash
Account Receivables
Inventory(or Stock)
Fixed Assets
Account Payables
Short-Term Debt
Long-Term Debt
Equity
Liabilities + Equity
Assets
Cash
Account Receivables
Inventory(or Stock)
Fixed Assets
Spontaneous Funds
Short-Term Debt
Long-Term Debt
Equity
NET ASSETS
But funds are not always expensive. When a supplier is offering its products or services, it usually also offers the possibility of deferring payment of the invoice. And it usually does this for free.
So, we can say that certain spontaneous and cost-less sources of financing stem from the fact that the company buys goods and services, pays taxes, etc. Those items are normally recorded as “payables” other liabilities in the balance sheet.
So, when searching for funds to finance our assets, we do not need to worry about spontaneous funds; they come alone with operations. We just need to fund the NET ASSETS.
Net Assets
NET ASSETS = TOTAL ASSETS – SPONTANEUS FUNDS.
FINANCING NET ASSETS
Liabilities + Equity
Assets
Cash
Account Receivables
Inventory(or Stock)
Fixed Assets
Spontaneous funds
Short-Term Debt
Long-Term Debt
Equity
Net Assets
Net Assets can solely be financed with:
• Debt: be it long term or short term (credit). It has an explicit cost: the interest payable.
• Equity: money contributed by the shareholders and retained earnings obtained previously by the company.
Does equity have a cost for the firm?
Obviously, shareholders expect to get a return on the money they have invested. But shareholders are the residual claimers of the future cash flows of the company, i.e. their investment is riskier than that of debt providers (usually banks). So they are expected to earn more money than banks. From the firm point of view, we can consider that the return expected by shareholders is a cost for equity financing.
FINANCING NET ASSETS
Liabilities + Equity
Assets
Cash
Account Receivables
Inventory(or Stock)
Fixed Assets
Spontaneous funds
Short-Term Debt
Long-Term Debt
Equity
Net Assets
In conclusion:
• Financing Net Assets has a cost. It is usually known as the cost of capital. We will return to this concept later in class during the next on-site module.
• Hopefully, investment in Net Assets will yield a return.
The GOLDEN RULE in finances:
Returns on Net Assets must be higher than the Cost of
Capital
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