Rotman School of Management’s David Goldreich discusses business finance, valuation, and planning for a post-pandemic recovery
Although capital markets have been booming since the turn of the year, a global recession is predicted, if one is not already underway. In this uncertain business environment how should companies plan their corporate finances?
The good news is that funding will be available. “Even if we went into a recession, there will be funding―as long as the value is really there,” asserts David Goldreich, Professor of Finance, at the University of Toronto’s Rotman School of Management. As he points out, the Covid economic crisis―unlike the 2008 crisis when financial institutions failed and finance dried up―will not paralyze the financial sector. So, both debt and equity markets will be ready to supply capital to companies planning their post-Covid exit.
The essential thing, as Goldreich will be emphasizing on his Corporate Finance for Executives online program later this year, is for leaders to get a realistic view of the current and potential future value of their business. The significant effect of the pandemic, in terms of managing corporate finance, will be in how it has changed the value of a business, and how associated risks may have changed too. The dramatic fall in the value of airlines and high-street retailers and the rise of companies like Peloton and Zoom are potent examples of how values have changed.
“Nobody knows what's going to happen in the post-Covid world,” notes Goldreich. “The important thing going forward, is that people can demonstrate, whatever world we find ourselves in, that they are in a profitable business―that the value is there. Then they will be able to get the capital.” Of course, if we do enter a deep recession where economic activity slows right down, fewer businesses will be viable and, as Goldreich puts it, “Capital will be less available because there will be fewer places for the capital to go to.”
“I know a lot of people think about it as the capital markets driving what can get done in business. I like to view it the other way around,” says Goldreich. “You take a look at the business. Is the business profitable? Is it valuable? This will drive whether or not the capital markets are willing to provide capital. It works in both directions.”
Join David Goldreich and colleagues on Rotman School of Management’s ‘Corporate Finance for Executives’
Dates: August 10-26, 2021 │ Format: 100% online
The two main sources of capital―equity and debt―are legally very different and have different costs but they are also similar. Investors in equity (both large institutions and small investors) and providers of debt finance (banks and bond markets) are looking for safe returns, either as capital growth or from interest payments. How safe depends on their appetite for risk and this is reflected in the costs involved.
Here Goldreich perceives another aspect to the Covid aftermath―the way people think about risk. “There is evidence from previous crises that, even when the crisis had become ancient history, it changed the way people viewed risk. It changed the way that people thought about the possibility of something going wrong. Even if it doesn't affect your business directly, everybody will be having this extra bit of caution―that there is a small probability of something going horribly wrong.”
Central to this is the need for businesses to understand their value. “You’ve got to really think about where your business will be post-Covid. Suppliers of capital give money because of what they are going to get back in the future. They are in the job of predicting the future and that's become a little bit more difficult.” Businesses need to prove their ongoing value and for this, while intuition must play a part, Goldreich suggests, “the basic tools―forecasting cashflows, forecasting potential value, remain the same―the applications change.”
“If you have a very stable business, very stable cashflows year after year, then forecasting is not hard. When you have something that is brand new then it just becomes harder. The principles remain the same. The application can be very difficult.” Goldreich recalls how Warren Buffett famously steered clear of the Dot.com bubble, “Warren Buffett's tools are very similar to the ones we use in business schools―forecasting cashflow and valuing them. His argument was that he's not against the internet. But he can’t figure out where the valuation is coming from. It was something he couldn't understand, so he stayed out. Let's understand where the value is and how we can create value. Those tools are timeless.”
“There's no magic formula,” says Goldreich. You assess value by asking: What are the possible outcomes? What is the best-case scenario? What is the worst-case scenario? And what is the average? “A lot comes down to judgement. Forecasting the future is not simply about extrapolating straight from the past. Start from the past, extrapolate, and then think: How will the future be different?” Planning a post-Covid recovery is an amplified example of this basic approach to corporate finance―it starts with valuation.
Leaving aside the pandemic, as far as how corporate finance is managed more generally, Goldreich sees a mixed picture. “Corporate finance and business in general have been wonderfully successful over the last couple of hundred years at creating this amazingly positive quality of life for people. The prosperity many of us have comes from private businesses that have successfully taken capital and allocated it to the most value-creating ideas.”
On the other hand, “We can always do better, both overall as a society―by managing the allocation of capital better―and as individual businesses by managing finances better,” says Goldreich. “There's a lot of wasted resources in businesses―when someone smart comes up with a great idea, but doesn't quite get there, doesn't get the financing because he or she is not running it properly, or doesn’t figure out where the value is coming from. Improved estimation of value can certainly help. Overall though I am quite positive.”
Another aspect of measuring value that has recently come into focus is the idea of integrated reporting―providing corporate reports that value business not just in terms of financial return but by other social and environmental metrics. Goldreich does not believe this gets away from the use of the fundamental tools of corporate finance in forecasting and measuring value. It does however encourage transparency which is a prerequisite to truly understanding a business’s potential.
Goldreich believes that “The idea of being able to be transparent about things, labelling things, and people really knowing what you're doing, is a good thing. Furthermore, suppliers of capital will demand it if they think it's necessary to understand the potential returns and risks.”
Understanding how corporate finance works is central to having a broad and in-depth understanding of any business. Consequently Rotman’s Corporate Finance for Executives program is aimed, not just at finance executives, but at any senior executive involved in board-level decision making.
As Goldreich describes it, the program focuses on: “How to value a potential project; discounted cash flow as part of valuation; valuing businesses; valuing companies; valuing stocks and bonds. And sources of capital; how do you think about your cost of capital? How do you think about the cost of debt? Cost of equity?” After some adjustment Goldreich says he has found running online sessions for his MBA students extremely successful and predicts, for a slightly smaller executive cohort, this fully online program will be similar. It will also be very timely for the many businesses navigating their way from pandemic survival mode to a prosperous future.
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