Financial Management Final for MONDAY

Finance is concerned with decisions about

money (cash flows)

Finance decisions deal with how money is

raised and used in the future

Everything else being equal

• More value is preferred to less

• the sooner cash is received, the more valuable it is

• less risky assets are more valuable than (preferred to) riskier assets

Financial markets and institutions

• banks, insurance companies, savings and loans, and credit unions

• stock markets, bond markets, derivatives markets

Investments

• determining the values, risks, and returns associated with financial assets as stocks and bonds

• determining the optima combination of securities that should be held in a portfolio of investments, such as a retirement fund

Financial services

functions provided by organizations that deal with the management of money

Managerial finance

how firms (large and small) manage inflows and outflows of cash

All areas of business are impacted by finance

• marketing

• management

• accounting

• operations

• information systems

Proprietorship

unincorporated business with one owner.

Partnership

unincorporated business with two or more owners

Corporation

• legal entity separate and distinct from its owners; can conduct business for its owners.

• incorporated in a state

• has owners (shareholders)

• managers operate the company separately from its owners

Advantages of proprietorship

• Ease of formation.

• Subject to few government regulations.

• Taxed at the individual level.

Limitations of proprietorship

• Unlimited personal liability.

• Limited life.

• Transferring ownership is difficult.

• Difficult to raise large amounts of capital.

Partnership

• two or more owners

• same advantages and limitations as proprietorship

• partnership can raise more capital than a proprietorship, b/c there are more owners w/more credit

Corporation advantages

• Unlimited life.

• Easy transfer of ownership.

• Limited liability- owners are only responsible for the amount they invested, not personal debts of the corporation.”

• Ease of raising capital—can issue stocks and bonds.

Corporation disadvantages

• Cost of creating and report filing.

• Double taxation- taxed once to the corporation and again to shareholders through dividends.

Hybrid forms of business

• Limited Liability Partnership (LLP).

• Limited Liability Company (LLC).

• S Corporation—no more than 100 stockholders.

Primary goal of a company

maximizing owner’s wealth

Capital structure decisions

• How are the assets financed?

• The mix of debt and equity used to finance a business

Capital budgeting decisions

what assets (investments) should the firm purchase?

Dividend Policy decisions

How much of the firm’s income should be distributed (paid) to stockholders and how much should be retained and reinvested in the firm?

Factors Influenced by Managers that Affect Firm Value

• Projected cash flows.

• Timing of cash flow streams.

• Risk of projected cash flows (earnings).

• Use of debt (capital structure).

• Dividend policy.

Mechanisms to motivate managers to act in shareholder’s best interest

• Managerial compensation (incentives)

• Shareholder intervention: Shareholders can influence or replace management

• Threat of takeover: Poor management may lead to another company taking over and replacing managers

Discussion of operations

• Usually, a letter from the chairman

• Provides highlights, strategy, news about the company

• Financial statements

Balance sheet

Represents a picture taken on a specific date (one point in time) that shows a firm’s assets and how those assets are financed (debt or equity).

Items on the balance sheet are shown as:

• Lower of cost or market

• not market value

• Assets are reported at the lower of original cost or current market value, not increased to higher market prices

Items on the balance sheet are listed in order of

liquidity

Net fixed assets

represents what the asset is really worth from an accounting perspective. We would refer to this as the ‘book value’ of the assets.

• gross fixed assets - accumulated depreciation

Accrued expenses

expenses that have been made but not yet paid.

Preferred stock

is a form of equity that has both debt and equity-like features. Often, it is described as a “hybrid.

Common stock

represents the owners’ initial investment in the company

Retained earnings

represent the cumulative total of all net income that has been reinvested in the company

Income Statement (profit and loss statement)

Summarizes the revenues generated and the expenses incurred during a particular period, such as one year or a quarter or a month.

Top line

refers to a company's gross sales (or revenues)

For a retail company, the COGS is

the cost of materials purchased for resale.

Gross profit

are the funds available to meet the company’s operating expenses

Bottom line

net income - standard measure of company’s profitability

Net income can “go to” two places

1. it is paid out as dividends to shareholders

2. added to or subtracted from retained earnings

Statement of cash flows

cash generated by firm is different than reported on the income statement

• depreciation

• increased/retiring debt

• investments

Cash flows from operations

• Net Income + Depreciation

• Changes in A/R and A/P

• Changes in Inventory

• Changes in Pre-paid and Accrued Balances

Cash flows from investment activities

Transactions involving buying and selling :

• Property, Plant and Equipment.

• Investments (current and non-current).

• Notes Receivable (current and non-current).

Cash flows from financing activities

Funds secured by borrowing funds or issuing Stock

• cash received from issuance of CS, bonds, or NP

• cash outflows from paying off stock, NP, dividends, or repurchasing stock

Ratio analysis

• provides an idea of how well the company is doing

• highlights weaknesses and strengths

• indicates the future financial health of the firm

What sets a base for which all items are compared on the BS and IS when doing ratio analysis?

• Sales

• Assets

  • This is 100%

Liquidity Ratios

How well the company is able to meet current obligations

Asset Management Ratios

Measure how effectively a firm is utilizing its assets.

Debt Management Ratios.

• Indicate the amount of debt a firm has and whether it can take on more.

• Is the firm using debt wisely?

Profitability Ratios

Measure how much of each sales dollar is going to the shareholders.

Market Value Ratios

How the company’s stock price is doing relative to its earnings and book value

Liquidity ratios

• Current ratio

• Quick ratio

Liquidity ratios indicate

• Ratio should yield about 1.25 - 1.50

• lower numbers suggest a liquidity crunch- not enough cash or easy-to-access money available

• larger numbers suggest lost opportunities - company may be holding too much cash instead of using it to grow the business.

Asset Management ratios

• inventory turnover

• days sales outstanding

• fixed asset turnover

• total asset turnover

Inventory turnover

Measures how quickly a company is selling it’s inventory

Days sales outstanding

Measures how quickly a company is being paid by customers

Fixed & Total asset turnover

measures how efficiently a company is utilizing it’s assets

Debt management ratios

shows how well a company can meet its debt obligations

• debt ratio

• times interest earned

• fixed charge coverage

Profitability ratios

• Gross profit margin

• net profit margin

• return on assets

• return on equity

Market Value ratios

Measure a firm’s market value (stock price) to its earnings and book value

• PE Ratio

• Market to book ratio

PE ratio

• 𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒 ÷ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

• Measures how much investors are paying for each $$ of earnings.

• High expectations for growth in earnings yield higher P/E ratios.

Market to book ratio

• 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 ÷ 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

• Shows how investors value the company relative to its Balance Sheet (Book Value)

Limits of financial statement analysis

• “Window dressing” can make ratios look better than they really are.

• Different operating and accounting practices distort comparisons.

• Sometimes hard to tell whether a ratio is “good” or “bad.”

• Difficult to tell whether company is, on balance, in strong or weak position.

The most important, as well as the most difficult, ingredient of successful financial statement analysis is the _______ that is used to reach final conclusions about a firm’s _____ financial position.

judgement, future

Users or capital are

individuals, corporations, governments.

Providers of capital are

individuals and companies

Financial markets

where financial assets are traded between investors

debt markets

where short and long term loans/bonds are traded

• not an exchange

equity markets

where public stocks are traded

Money markets

• Used by companies to borrow for short term needs < 1 yr.

• Typically for working capital requirements.

• Always are debt instruments.

Capital markets

• Used by companies to attract funds for longer term > 1yr.

• Can be debt or equity instruments

Primary markets

• where companies go to issue new debt/equity instruments

• where companies go “public”

• Initial Public Offering (IPO).

• Secondary Offering.

• Where companies receive the $$ from purchasers.

Secondary markets

where investors trade debt or equity instruments

• Existing shareholders trade shares among themselves.

• Corporation does not receive the funds.

Derivatives markets

where options, futures, commodities are traded

Stock markets

Stock exchanges where Equity Shares are traded.

• NYSE

• Chicago Stock Exchange

• Over The Counter Exchange

• NASDQ Exchange

What kind of listing requirements do stock markets have?`

• size of company

  • income, assets, # of shares

Securities and Exchange Commission (SEC).

• Jurisdiction over most interstate offerings of new securities to the general public.

• Regulation of national securities exchanges.

• Power to prohibit manipulation of securities’ prices.

• Control over stock trades by corporate insiders.

Investment Banker

• Assist in bringing users and investors together.

• Helps corporations' issue new debt/equity.

• Helps corporations design securities attractive to investors.

  • Offering Price.

  • # of securities

The Investment Banking Process

• Companies decide:

  • Dollars to be raised (how much does it need).

  • Type of securities used to raise funds (debt/equity).

  • Selection of an investment banker.

• Investment Bankers:

  • Files registration with the SEC.

  • Prospectus.

• Road Show

road show

presentations by a company and its investment bankers to potential investors before issuing securities.

Investment banker role

• reevaluate initial decisions

• vest efforts or underwritten issues

• issuance (floatation) costs

Underwritten Arrangement

investment bank guarantees the sale by purchasing the securities from the issuer.

Best Effort Arrangement

investment bank gives no guarantee that the securities will be sold.

Intermediaries

are “middle men” between providers of capital and users of capital.

Types of Financial Intermediaries

• Commercial banks.

• Credit unions .

• Mutual funds.

• Whole life insurance companies.

• Pension funds.

When financial markets perform poorly, Congress tends to regulate financial activities

more than normal

When financial markets are performing efficiently and producing above-normal returns, Congress tends to

deregulate financial activities

U.S. stock markets represent ____ of the total value worldwide.

35% - 40%

International Financial Markets

• U.S. markets dominate the stock markets in other countries.

• Not as heavily regulated.

Financial Organizations in Other Parts of the World

• U.S. financial institutions are more heavily regulated.

• Historically, U.S. financial institutions have faced greater limitations on branching, services offered, and relationships with non-financial businesses.

Monday today is worth _____ than money in the future

MORE

Opportunity cost

The cost of the ability to do something.

Lump Sum Amount

a single payment (received or made) that occurs either today or at some date in the future.

Annuity

payments of the same amount over equal time periods.

• Annually, semi-annually, quarterly, monthly, daily.

Uneven Cash Flows

payments of different amounts over a period of time

Compounding

What is the Future Value of the cash flows?

Discounting

What is the Present Value of the cash flows?

Perpetuity

Streams of equal payments that are expected to go on forever

EX: Preferred Stock, Real Estate, Bonds

Net Present Value

• Discounting investment’s projected cash inflows at the investor’s required rate of return and then subtracting the original investment (initial cash outflow) from this figure.

• Positive-Accept

• Negative-Reject

Internal rate of return

• In IRR you are solving for the discount rate.

• Solves for the interest rate which makes the Net Present Value $0

• If the IRR is > than the rate required by the investor accept the project.

APR = Annual Percentage Rate

Only the true annual rate if interest is compounded annually

EAR or EAY = Effective Annual Rate or Effective Annual Yield.

• Takes into account that interest is being compounded more frequently than annually.

• If compounding is annual> APR=EAR