Level 1 CFA® Exam:
Corporate Financing Methods
Internal Financing Explained to CFA Candidatesstar content check off when done
Operating Cash Flows
After-tax operating cash flows (less interest and dividends paid) can be used by a company to finance the purchase of new assets. The higher and more stable the operating cash flows the higher the company’s ability to use the operating cash flows as a source of its internal financing.
In the company’s balance sheet there often appears an asset referred to as accounts receivable. This asset results from the company’s sales. With respect to paying for the goods and services provided by the company, to simplify things a bit we can say that the customer can pay:
- either immediately upon delivery of the goods,
- or later.
If the buyer decides to pay at a later date, accounts receivable appear on the seller's balance sheet. We can say that the company sells the product to the buyer and gives him a trade credit, which he is obliged to repay in the future.
Inventory is an asset and it reflects goods ready to be sold. The company should aim to keep its inventory at a relatively constant level of appropriate size. The inventory level should be neither too low nor too high. If the level of inventory is too low, the company will not be able to sell as much as it would be if the stock was big enough. On the other hand, if the level of inventory held by the company is too high, the costs associated with maintaining this inventory are also too high. Moreover, some products may lose value if they are stored too long.
Financial Intermediaries in CFA Examstar content check off when done
Financing offered by banks includes:
- lines of credit, for example, uncommitted line or regular line, or overdraft line,
- revolving credit agreement,
- banker's acceptances,
- secured (collateralized) loan, and
- discounted receivables.
Capital Marketstar content check off when done
Sources of financing from capital markets include:
- commercial papers – short-term financial instruments issued by large companies with high creditworthiness,
- long-term debt,
- common equity,
- preferred equity,
- hybrid securities, e.g. convertible debt or convertible preferred shares.
Leasingstar content check off when done
Leasing is an agreement based on which the lessor, that is the owner of the asset, conveys a right to use the asset to the lessee for a specified period of time in exchange for periodic payments.
Major types of leases:
- finance lease (aka. capital lease),
- operating lease.
Financing Considerationsstar content check off when done
Level 1 CFA Exam Takeaways: Corporate Financing Methodsstar content check off when done
- The total amount that has not yet been paid to suppliers in exchange for goods and services provided is called accounts payable.
- If the buyer decides to pay at a later date, accounts receivable appear on the seller's balance sheet.
- Financing offered by banks includes lines of credit, revolving credit agreements, and more.
- Sources of financing from capital markets include commercial papers, long-term debt, common equity, preferred equity, and hybrid securities.
- The choice of particular sources of external financing by a company is influenced by many factors, including the geographic location of the company, industry in which the company operates, company-specific considerations, and macroeconomics factors.