Course Content
Organizational Forms, Corporate Issuer Features, and Ownership
This is Reading 22 of CFA Level 1, Corporate Issuers, 2024 course. This reading consists of three LOSs, i.e.,: a. compare the organizational forms of businesses b. describe key features of corporate issuers c. compare publicly and privately owned corporate issuers
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LOS A: Compare the organizational forms of businesses.
LOS B: Describe key features of corporate issuers
LOS C: Compare publicly and privately owned corporate issuers
INTRODUCTION TO CORPORATE GOVERNANCE AND OTHER ESG CONSIDERATIONS
This chapter is covered under study session 10, reading 31 of the study materials as provided by the CFA Institute.
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Introduction
LOS A: Describe corporate governance
00:00
LOS B: Company’s Stakeholders
08:17
LOS C: Principal-Agent Relationship
08:13
LOS D: Stakeholder’s Management
02:39
LOS E: Mechanisms of Stakeholders Management
09:25
LOS F: Board of Directors and Committees
06:57
LOS G: Factors Affecting Stakeholders Relationship and Corporate Governance
04:43
LOS H: Risks of Poor Corporate Governance & Benefits of Corporate Governance
03:14
LOS I: Analysts’ Consideration
04:32
Factors Affecting Company & ESG Implementation Methods
05:00
USES OF CAPITAL
This chapter is covered under study session 9, reading 28 of the study materials as provided by the CFA Institute. After reading this chapter, the candidate should be able to: a. a describe the capital allocation process and basic principles of capital allocation; b. demonstrate the use of net present value (NPV) and internal rate of return (IRR) in allocating capital and describe the advantages and disadvantages of each method; c. describe expected relations among a company’s investments, company value, and share price; d. describe types of real options relevant to capital investment; e. describe common capital allocation pitfalls.
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Introduction
LOS A: Capital Budgeting Process
20:19
LOS B: NPV and IRR
19:58
LOS C: Company’s Investment, Value, and Share Price
06:42
LOS D: Real options
08:54
LOS E: Capital Allocation Pitfalls
05:42
Sources of Capital
This topic is covered under LOS 29 of study session 9. After reading this chapter, you should be able to: a. describe types of financing methods and considerations in their selection; b. describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position; c. compare a company’s liquidity position with that of peer companies; d. evaluate choices of short-term funding.
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Corporate Financing Options
24:21
Sources and Factors That Influence Liquidity
10:28
Comparing Liquidity Position
08:23
Short Term Funding
06:59
Cost of Capital
This chapter is covered under study session 10, reading 30 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a) calculate and interpret the weighted average cost of capital (WACC) of a company; b) describe how taxes affect the cost of capital from different capital sources; c) calculate and interpret the cost of debt capital using the yield-to-maturity approach and the debt-rating approach; d) calculate and interpret the cost of noncallable, nonconvertible preferred stock; e) calculate and interpret the cost of equity capital using the capital asset pricing model approach and the bond yield plus risk premium approach; f) explain and demonstrate beta estimation for public companies, thinly traded public companies, and nonpublic companies; g) explain and demonstrate the correct treatment of flotation costs.
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Introduction
LOS A: Weighted Average Cost of Capital
12:25
LOS B: The Effect of Taxes on Capital Budgeting Decision
08:33
LOS C: Calculating Cost of Debt
08:27
LOS D: Calculating Cost of Preferred Stock
04:01
LOS E: Calculating Cost of Common Equity
12:40
LOS F: Estimating Company & Project β (Beta)
11:16
LOS J: Country Risk
LOS K: Marginal Cost of Capital Schedule
LOS L: Floatation Cost
Measures of Leverage
This chapter is covered under study session 11, reading 34 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a. Define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk, given a description. b. Calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage. c. Analyze the effect of financial leverage on a company’s net income and return on equity. d. Calculate the breakeven quantity of sales and determine the company’s net income at various sales levels. e. Calculate and interpret the operating breakeven quantity of sales.
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Introduction
LOS A: Risk and Components of Risk
LOS B and C: Degree of Leverage
LOS D: Break-Even Points
Impact of Leverage on Bankruptcy
Working Capital Management
This chapter is covered under study session 11, reading 35 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a. describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position; b. compare a company’s liquidity measures with those of peer companies; c. evaluate the working capital effectiveness of a company based on its operating and cash conversion cycles, and compare the company’s effectiveness with that of peer companies; d. describe how different types of cash flows affect a company’s net daily cash position; e. calculate and interpret comparable yields on various securities, compare portfolio returns against a standard benchmark, and evaluate a company’s short-term investment policy guidelines; f. evaluate a company’s management of accounts receivable, inventory, and accounts payable over time and compared to peer companies; g. evaluate the choices of short-term funding available to a company and recommend a financing method. 
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Introduction
LOS A: Liquidity Management
LOS C: Cash Conversion Cycle
LOS D: Impact of Cash Flow on Net Daily Cash Position
LOS E: Yield, Returns, and Policies
LOS F: Accounts Receivables, Inventories & Accounts Payable
LOS G: Short Term Funding
Corporate Issuers
About Lesson

LOS B requires us to:

describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position

1.  What is Liquidity?

Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. The most liquid asset of all is cash itself. Then in line, come the tangible assets.

1.1.  What is liquidity contingent upon?

The degree of liquidity is dependent upon two things:

1.  Type of Assets. The nearer the number of assets to cash, the more liquid is the company.

2.  Convertibility of Assets. The speed at which the assets of the company can be converted to cash impacts the liquidity of the company immensely.

For example, short-term assets like temporary investments and stocks can be easily converted into cash, so the more the number of these assets, the more is the liquidity. You can convert the temporary assets into cash immediately, whereas it may take a few weeks to convert accounts receivables to cash.

The long-term assets can also be converted into cash for the need of liquidity. But one, they are not easily convertible (conversion may take time). And two, they put certain costs on the company, as it may damage the financial and operating strength of the company.

1.2.  Sources of Liquidity

There are basically, two sources of liquidity: primary and secondary sources.

Primary Sources of Liquidity

These include cash or near cash items that can easily be converted into cash to generate liquidity at a very low cost. Some of the primary sources of liquidity are:

a.  Cash Balances (including the bank balances). These items are shown in the balance sheet as “cash and cash equivalents” which include the short-term securities (having maturity of fewer than 90 days), apart from cash and bank balances.

b.  Short Term Funds. These include accounts receivables, bank credit, and other short-term securities.

c.  Cash Flow Management. It refers to the ability of the company to manage the liquidity and cash flow effectively, and the level of decentralization of cash flows.

Secondary Sources of Liquidity

These are the assets that provide liquidity to the company at a higher cost and impact the financial and operating stability of the company. These are those sources of cash that are liquidated once the company has exhausted its primary sources of cash.

Some of the secondary sources of liquidity are:

a.  Negotiating Debt Contracts. The company can negotiate its debt contracts for repayments, its timing, and size, interest rates, etc.

b.  Liquidating Long-Term Assets. The company can liquidate its assets such as long-term investments, real estate assets, plant, equipment, etc. in case, it runs out of primary sources of finance and is in dire requirement of cash.

c.  Bankruptcy Protection and Reorganization. Here the company can file for protection and hence the law puts restrictions on the amount that the company must pay to its creditors. And reorganization involves the restructuring of the company’s finances.

1.3.  Drags and Pulls on Liquidity

Drags and pulls are the factors that negatively impact the liquidity position of the company. A drag on liquidity refers to delay in receipts while a pull on liquidity refers to an acceleration in disbursements.

1.3.1.  Drags on Liquidity

The drag on liquidity is there when the cash inflows straggle and the company has difficulty collecting its debt. Some of the major sources of drags on liquidity are:

a.  Uncollected Receivables. Sometimes the companies, under pressure to increase the sales, compromise the terms on which the sales are made. This compromises the collectability or receivability of payments. Once the receivables and collectible begin to pile on, the liquidity position of the companies begins to look a little shady. This causes a drag on liquidity.

This drag on liquidity is often visible in the financial statements of the company. And it can be seen through the financial statements and an analysis of balance sheet trends. For example, a deterioration in days sales outstanding (DSO) is often an indication of negative developments acting as drags on liquidity. Increasing levels of bad debt expenses are also a useful indicator to identify issues in the collection of receivables.

b.  Inventory Obsolescence. When the inventory of a company is turning obsolete, it means that the company is finding it difficult to convert it into cash (though sales). Thus, it acts as a drag for liquidity as there is less cash flow than expected.

Not just, the low levels of inflows, but low conversion also leads to increased cost in terms of storage cost. And a good indicator of increased inventory obsolescence is the decrease in the inventory turnover ratios.

c.  Tighter Credit. When there is a reduction in the amount of credit available to businesses from banks or other financial intermediaries, the inflows of the company suffer a hit.

There may also be reduced credit limits due to certain changes in business fundamentals such as decreased creditworthiness, unfavorable trends in the industry, or macroeconomic conditions such as rising interest rates, or recessionary environments.

1.3.2.  Pulls on Liquidity

The factors that act as pull-on liquidity are the high frequency of cash outflows and reduced access to financial and commercial credit.

Some of the factors that pull liquidity down are:

a.  Early Payments. Sometimes companies voluntarily make early payments to their suppliers, or they may be forced to do so (for any reasons such as decreased creditworthiness). This makes outflows quick and thus acts as a pull on the liquidity of the company. It should be noted that there is usually a commercial credit period (ranging differently for each industry). And payments are usually not made immediately but after this period. This delay in payment helps maintain liquidity.

b.  Reduced Credit Limit. When there is a low amount of credit available or available on tighter terms from the suppliers, it reduces the payment lag and may act as a pull on liquidity. Due to tighter credit terms, the time to repay the credit is less, whereas the time of receivables does not change. So, there is an increased frequency of outflows.
There may also be reduced credit limits from banks as well, or the credit may be available at higher rates. This also increases the outflows and impacts the liquidity.

c.  Low Liquidity Position. The liquidity position is the ability of the company to raise cash when needed. It is determined by two factors. One is its ability to convert assets to cash to pay the current liabilities. And second is its debt capacity. When either is low, the company has a low liquidity position.

 

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