Within economics as a discipline, it is difficult to find literature that dedicates chapters to explaining the conceptual structure of financial statements. Topics such as supply and demand curves, economic growth, fiscal policy, economic inequality, international trade, unemployment, inflation, and others are commonly addressed, but rarely is there discussion of the difference between net income and free cash flow.
In this short text, I argue that corporate finance can enhance economics as a discipline, by strengthening its conceptual classifications, potentially reshaping longstanding debates and opening new ones. It is worth noting that I chose to focus on corporate finance rather than accounting—and financial accounting in particular—due to the complexity of debates surrounding the correct interpretation of financial reporting standards such as IFRS or US GAAP.
Why Do We Need to Get Educated about Corporate Finance?
It can be argued that corporate finance studies the evolution of various variables of profitability, liquidity, leverage, and solvency within a company. A definition offered by the CFI on this discipline is the following:
Corporate finance deals with a corporation’s capital structure, including its funding and the actions management takes to increase the company’s value. Corporate finance also includes the tools and analyses used to prioritize and allocate financial resources.
While a solid knowledge of financial accounting is necessary, the concepts that make up corporate finance appear to have a lower degree of mutability than those of financial accounting—likely due to the constant changes across the diversity of financial reporting standards. Some examples of these more immutable concepts, largely drawn from corporate finance, are WACC, FCF, and IRR, among others.
More Consistent and Precise Classifications
Classifications are the foundation of our knowledge, since only through classifications—especially epistemological ones—can we establish the limits of knowledge itself and generate analytic statements about it. If, however, the definitions of concepts within economic classifications are constantly shifting, what holds true today may not tomorrow.
This is why the non-synthetic knowledge produced by authors of the Austrian School of economics is universal and requires no empirical verification: it rests on precise definitions, coherent sets of concepts, and the use of deductive inferences. A clear example is the claim that, in the absence of prior agreements or violations of property rights, any transfer of assets from a human individual to the government through coercion is theft—including the payment of wealth or income taxes by human individuals.
However, does this also include the payment of taxes by corporations? Is the corporate income tax a form of theft? Descriptively—that is, non-prescriptively—I would argue it is not. As I explained in “Don’t Confuse the Rights of Corporations with the Rights of Human Persons,” corporations are not human persons; they are juridical persons (legal persons), and therefore, regulating them only amounts to regulating a legal benefit—in this case, the benefit of limiting the legal liability of its human investors with respect to the corporation’s operations.
Thus, one clear way in which economics as a discipline can draw from corporate finance is by adopting one of its fundamental classifications: the distinction between the assets of human persons (natural persons) and juridical persons (legal persons). Even for purely statistical reasons, the effect on employment of a minimum wage increase in Mexico is not the same for businesses whose owners are human persons as for those whose owners are juridical persons.
More Financial Variables in Economic Policy Analysis
In various debates on the minimum wage, arguments tend to focus almost exclusively on effects on unemployment and inflation. Beyond that, profitability, liquidity, and solvency variables are omitted—ones that could provide a more precise picture of this economic policy. Similarly, in the case of tax reforms, particularly in Latin America, arguments tend to center on economic growth, public deficits, and tax revenue in absolute and relative terms (e.g., tax revenue as share of GDP).
What happens to a small grocery store operating under the legal structure of a natural person when such reforms take effect? If none of the previously-mentioned macroeconomic variables show any change and the store continues to operate, it may appear that opponents of these reforms were mere alarmists. Yet only by examining in detail the effects on the financial variables mentioned above can we determine with greater certainty whether the economic impact was truly negligible.
Conclusion
As examined throughout this short essay, corporate finance—even in its most basic form—can radically change the way economic and public policy analysis is conducted. This is achieved not only by introducing classifications such as the distinction between the assets of a natural person and a legal person, but also by incorporating profitability, liquidity, and solvency variables into economic policy analysis.
