Financial Management Uiowa Exam 1

Financial Management

-Financial statement analysis/ratio's

-Valuation (cash flows, bonds, stocks)

-Risk and return

- Capital Structure < Finance decision

- Capital Budgeting < Investment decision

Liquidity

Ability of an asset to be quickly converted to cash with little to no loss

Main forms of Business Organization

sole proprietorship, partnership, hybrids (LLC, S-Corp), corporation

Main Goal of Financial management within a Corp (EXAM Question)

To maximize current stock price (maximize shareholders wealth)

Sources for Financing a Corp

-Internally: Retained earnings

- Externally: Debt, Common Stock, Preferred Stock

money market

the short-term (1 year or less) debt security market (EX: overnight reserves, commercial paper)

Capital Market

long-term debt securities market (EX: stocks, Bonds)

Primary Market

the market in which new securities are originally sold to investors (Apple issues Stock options)

Secondary Market

the market in which previously issued securities are traded among investors (Will sells shares of Apple)

Balance Sheet Equation (Fundamental Relationship)

Assets = Liabilities + Owner's Equityterm-9

Liquidity Tradeoff

Liquid assets reduce probability of financial distress, but is often less profitable

Market Value

The fair value today

Book Value

Value on the books (cost - accumulated depreciation)

DPR (dividend payout ratio)

(Dividends Paid)/Net Income

EX: 0.3333 (high ratio is more attractive to investors)

Retention Ratio (Plowback Ratio)

1 - DPR

EX: 0.667 (indicates how much profit is retained in a business)

EPS (Earnings Pre Share)

NI/(Shares Outstanding)

EX: $1.80/Share

DPS (Dividends Per Share)

(Dividends Paid)/(Shares Outstanding)

EX: $0.60/share

EBIT

earnings before interest and taxes (operating income) (high number means company is generating good returns)

EBITDA

Earnings before interest, taxes, depreciation, and amortization (EBIT+dep & amort exp.) (High number means operating expenses are low compared to total revenue)

EBT

earnings before taxes (EBIT-int exp.)

NOPAT or EBIAT

Net Operating Profit After Taxes (EBIT-Taxes)

Accounting for income vs cash flow

-Cash flow means exactly how much cash is going in or out

-Accounting for income doesn't only include cash. Things like AR are recognized as revenue prior to them being cash in hand

Liquidity Ratios

a) Current ratio = Current assets/Current liabilities

b) Quick ratio = (Current assets - Inventory) / Current Liabilities

-Higher ratio means a company is more capable of paying its obligations

Leverage Ratios

a) total debt ratio = Total Liabilities/Total assets

(high total debt ratio indicates risk of bankruptcy)

b) debt equity ratio = Total Liabilities/Total owners equity

(high debt equity ratio indicates risk of bankruptcy)

c) equity multiplier = Total assets/Total owners equity or 1 +debt equity ratio

(high equity multiplier indicates high risk of bankruptcy)

d) Long-term debt ratio = Long-term debt/Total assets

(high LT debt indicate risk of bankruptcy)

e) Times-Interest-earned (TIE) Ratio = EBIT/Int exp.

(High TIE ratio indicates LOW risk of bankruptcy)

f) Cash coverage = (EBIT + Depr exp)/Int exp

(High cash coverage indicates LOW risk of bankruptcy)

Asset Management Ratios

a) Inventory turnover = Sales/Inventory

(high means good asset management)

b) Day Sales Outstanding = AR/(Sales/365)

(High means poor asset management)

c) Fixed Asset Turnover = Sales/Net Fixed Assets

(high means good asset management)

d) Total Asset Turnover = Sales /Assets

(high means good asset management)

Profitability Ratios

a) Profit Margin = Net Income/ Sales

(High ratio means more profitable relative to costs)

b) Return on Assets = Net Income/ Assets

(High ROA means a company is more efficient and productive at managing its balance sheet to make a profit)

c) Return on Equity = Net Income/ Equity

(High ROE indicates a company is good at converting its equity into profits)

d) Basic Earning Power = EBIT/ Assets

(high ratio indicates a company is more effective on generating income from its assets)

DuPont ROA & ROE Analysis

ROA = Profit Margin x Total Assets Turnover

ROE = Profit Margin x Total Assets Turnover x Equity Multiplier

Agency Problem in Public Corporations

Managers are supposed to act in Shareholders interests BUT they own 100% of stock.

Possible Result: Managers acting in their own self-interest at expense of shareholders and long-run performance of the company

What makes execs work for share-holders

Innate work ethic, receiving a promotion, Structure of a pay package, risk of being fired, threat of a hostile takeover

Executive pay controversy

in 1980 CEO's made 40 x more than avg workers

in 2000 CEO's made 525 x more than avg workers

* in 2006 SEC rule change required more transparency about executive pay

Enron Scandal

-Overstated profits for years

-Covered up evidence (shredding documents) Arthur Anderson helped

-Personal loans on company expense

- Ken Lay & Jeff Skilling were CEO's and both sentenced to prison

WorldCom Scandal

-Overstated profits by about 11 billion

-3rd largest bankruptcy

-Arthur Anderson was also their Audit Firm

CSR (corporate social responsibility)

a business's obligation to pursue policies, decisions, and actions that align with the objectives and values of society

2002 Sarbanes-Oxley Act

-Requirements that executives are accountable for what's going on in their companies (signing of on financial statements

-Lead auditors are required to change for companies every 5 years

-independent Audit committee on board of directors

2010 Dodd-Frank Act

(post 2008-09 financial crisis)

-Regulation of troubled banks

-Consumer protection agency was created (stops unfair or deceptive business actions toward consumers)

-More exec pay regulations

Possible exam question

A study showed 11% of firms value stems from good ethical behavior

Time value of money

A dollar in hand today is worth more than a dollar tomorrow

Simple VS Compound Interest

1.The amount of interest based on a principal amount and not on earned interest.

VS.

2. Interest earned on both the principal amount and any interest already earned.

Relationship between present value or future value and interest rate

-Lower interest rates = higher present value (inverse relationship)

-Lower interest rates = lower future value (positive relationship)

Market Value Ratios

- P/E = (Price/Sh)/EPS

(High means stock price is expensive and may fall in future)

- Market/Book = (Price/Sh)/BV of equity per Sh

(High means stock price is trading at a premium to the companys BV)

- Price/Cash flow = (Price/Sh)/Cash flow/Sh

(High means stock trading price is high)

- Price/Sales = (Price/Sh)/Sales/Sh

(indicates how much one must pay for a share relative to how much that share generates in revenue for the company)