Executive Summary
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Corporate finance has evolved over many years to become a sophisticated specialism, for which the fees may be substantial.
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The principles are the same for SMEs (small and medium enterprises) as for any larger company.
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Often transaction-led, it is recommended that a wider full balance sheet approach be adopted because of the strategic financial significance.
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SMEs often originate as owner/proprietor businesses, and this structure can often trigger transactions such as change of ownership or disposal for tax purposes.
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By applying the same basic principles, there is no reason why similar sophistication should not be available to SMEs at affordable rates.
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Working capital is a fundamental need in a recession. In order to survive, SMEs should strategically review and simplify the business, exploring all available sources of capital.
Introduction
The term “corporate finance” is widely, and sometimes loosely, used in business. In accounting firms it typically relates to a department or function that primarily deals with:
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mergers, acquisitions, and disposals (M&A);
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raising finance (early stage through to mature businesses);
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flotations;
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management buyouts and buy-ins;
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business valuations;
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due diligence;
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succession planning and exit strategies.
These might represent the practical application of corporate finance. In theory, however, its primary role is to maximize the value of the business while minimizing the financial risks. The essence of the present article is that the practice of corporate finance has become oversimplified—potentially to the detriment of the business.
Furthermore, while corporate finance is usually a specialized department in larger accounting firms and in some smaller ones, its application in SMEs can often be quite different. Here, accessing and managing sources of working capital becomes a fundamental need, especially in a recession.
We shall propose a wider approach to corporate finance, based on asset/liability management principles and the full balance sheet approach, that is just as applicable to SMEs as it is to larger, more sophisticated companies.
A Full Balance Sheet Approach
A full balance sheet approach is recommended as the underlying principle of applying corporate finance. This involves looking at each and every asset in the context of the liabilities that actually or notionally finance them. Two key measures are:
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The amount by which the profit would increase or decrease as the overall result of a 1% change in interest rates.
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The difference between the average duration (i.e. asset life weighted by value) of the assets and the average duration of the liabilities that fund them. The importance of this is that, if the duration of the liabilities is shorter than that of the assets and, for example, interest rates rise, there will be an additional cost to the profit and loss account that cannot be recovered by the assets.
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