The Firm Structural Set up

In the chapters that follow, we will use firm generically to refer to any business, large or small, manufacturing or service, private or public. Thus, a corner grocery store and Microsoft are both firms.

The firm's investments are generically termed assets. While assets are often categorized by accountants into fixed assets, which are long-lived, and current assets, which are short-term, we prefer a different categorization. The assets that the firm has already invested in are called assets-in-place, whereas those assets that the firm is expected to invest in the future are called growth assets. While it may seem strange that a firm can get value from investments it has not made yet, high-growth firms get the bulk of their value from these yet-to-be-made investments.

To finance these assets, the firm can raise money from two sources. It can raise funds from investors or financial institutions by promising investors a fixed claim (interest payments) on the cash flows generated by the assets, with a limited or no role in the day-to-day running of the business. We categorize this type of financing to be debt. Alternatively, it can offer a residual claim on the cash flows (i.e., investors can get what is left over after the interest payments have been made) and a much greater role in the operation of the business. We term this equity. Note that these definitions are general enough to cover both private firms, where debt may take the form of bank loans, and equity is the owner's own money, as well as publicly traded companies, where the firm may issue bonds (to raise debt) and stock (to raise equity).

Thus, at this stage, we can lay out the financial balance sheet of a firm as follows:


Existing Investments Generate cashflows today Includes long lived (fixed) and short-lived(working __capital) assets__

Expected Value that will be created by future investments

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