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1-2. Key Concepts and Skills. Have a good understanding of:The basic types of financial management decisions and the role of the financial managerThe goal of financial managementThe financial implications of the different forms of business organizationThe conflicts of interest that can arise bet
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1. 1-1
2. 1-2 Key Concepts and Skills Have a good understanding of:
The basic types of financial management decisions and the role of the financial manager
The goal of financial management
The financial implications of the different forms of business organization
The conflicts of interest that can arise between owners and managers
3. 1-3 Basic Areas Of Finance Corporate finance = Business Finance
Investments
Financial institutions
International finance
4. 1-4 Investments Work with financial assets such as stocks and bonds
Value of financial assets, risk versus return, and asset allocation
5. 1-5 Financial Institutions Companies that specialize in financial matters
Banks commercial and investment, credit unions, savings and loans
Insurance companies
Brokerage firms
6. 1-6 International Finance An area of specialization within each of the areas discussed so far
May allow you to work in other countries or at least travel on a regular basis
Need to be familiar with exchange rates and political risk
Need to understand the customs of other countries; speaking a foreign language fluently is also helpful
7. 1-7 Finance and
Marketing
Budgets, marketing research, marketing financial products
Accounting
Dual accounting and finance function, preparation of financial statements
Management
Strategic thinking, job performance, profitability
Personal finance
Budgeting, retirement planning, college planning, day-to-day cash flow issues
8. 1-8 Business Finance Some important questions that are answered using finance
What long-term investments should the firm take on?
Where will we get the long-term financing to pay for the investments?
How will we manage the everyday financial activities of the firm?
9. 1-9 Financial Management Decisions Capital budgeting
What long-term investments or projects should the business take on?
Capital structure
How should we pay for our assets?
Should we use debt or equity?
Working capital management
How do we manage the day-to-day finances of the firm?
10. 1-10 Forms of Business Organization Three major forms in the United States
Sole proprietorship
Partnership
General
Limited
Corporation
S-Corp
Limited liability company
11. 1-11 Sole Proprietorship Advantages
Easiest to start
Least regulated
Single owner keeps all of the profits
Taxed once as personal income Disadvantages
Limited to life of owner
Equity capital limited to owners personal wealth
Unlimited liability
Difficult to sell ownership interest
12. 1-12 Partnership Advantages
Two or more owners
More capital available
Relatively easy to start
Income taxed once as personal income Disadvantages
Unlimited liability
General partnership
Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
13. 1-13 Corporation Advantages
Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital Disadvantages
Separation of ownership and management (agency problem)
Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible)
14. 1-14 International Corporate Forms Joint stock companies
Public limited companies
Limited liability companies
All share:
Public ownership
Limited liability
15. 1-15 Goal Of Financial Management What should be the goal of a corporation?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value per share of the companys existing stock
Maximize the market value of the existing owners equity
16. 1-16 Goal Of Financial Management Does this mean we should do anything and everything to maximize owner wealth?
Outsourcing?
Off-shoring?
Enron?
Corporate support of charities?
17. 1-17 The Agency Problem Agency relationship
Principal hires an agent to represent its interests
Stockholders (principals) hire managers (agents) to run the company
Agency problem
Conflict of interest between principal and agent
Management goals and agency costs
18. 1-18 Do Managers Act in the Shareholders Interests? Managerial compensation
Incentives can be used to align management and stockholder interests
Incentives need to be carefully structured to insure that they achieve their goal
Corporate control
Threat of a takeover may result in better management
Other stakeholders
19. 1-19 Cash Flows Between the Firm and the Financial MarketsFigure 1.2
20. 1-20 Financial Markets Cash flows to the firm
Primary vs. secondary markets
Dealer vs. auction markets
Listed vs. over-the-counter securities
NYSE
NASDAQ
21. 2-21 Key Concepts and Skills Know:
The difference between book value and market value
The difference between accounting income and cash flow
The difference between average and marginal tax rates
How to determine a firms cash flow from its financial statements
22. 2-22 The Balance Sheet A snapshot of the firms assets and liabilities at a given point in time (as of
)
Assets
Left-hand side (or upper portion)
In order of decreasing liquidity
Liabilities and Owners Equity
Right-hand side (or lower portion)
In ascending order of when due to be paid
Balance Sheet Identity
Assets = Liabilities + Stockholders Equity
23. 2-23 The Balance Sheet Net working capital
Current Assets minus Current Liabilities
Usually positive for a healthy firm
Liquidity
Speed and ease of conversion to cash without significant loss of value
Valuable in avoiding financial distress
Debt versus Equity
Shareholders equity = Assets - Liabilities
24. 2-24 Market vs. Book Value Book value = the balance sheet value of the assets, liabilities, and equity.
Market value = true value; the price at which the assets, liabilities, or equity can actually be bought or sold.
Market value and book value are often very different. Why?
Which is more important to the decision-making process?
25. 2-25 Income Statement The income statement measures performance over a specified period of time (period, quarter, year).
Report revenues first and then deduct any expenses for the period
End result = Net Income = Bottom Line
Dividends paid to shareholders
Addition to retained earnings
Income Statement Equation:
Net Income = Revenue - Expenses
26. 2-26 Financial Statements GAAP Matching Principle:
Recognize revenue when it is fully earned
Match expenses required to generate revenue to the period of recognition
Noncash Items
Expenses charged against revenue that do not affect cash flow
Depreciation = most important
27. 2-27 Financial Statements Time and Costs
Fixed or variable costs
Not obvious on income statement
Earnings Management
Smoothing earnings
GAAP leaves wiggle room
28. 2-28 Taxes Marginal vs. Average tax rates
Marginal % tax paid on the next dollar earned
Average total tax bill / taxable income
If considering a project that will increase taxable income by $1 million, which tax rate should you use in your analysis?
29. 2-29 The Concept of Cash Flow Cash flow = one of the most important pieces of information that can be derived from financial statements
The accounting Statement of Cash Flows does not provide the same information that we are interested in here
Our focus: how cash is generated from utilizing assets and how it is paid to those who finance the asset purchase.
30. 2-30 !! Cash Flow !!
31. 3-31 Key Concepts and Skills Know:
How to standardize financial statements for comparison purposes
How to compute and interpret important financial ratios
The determinants of a firms profitability and growth
Understand the problems and pitfalls in financial statement analysis
32. 3-32 Standardized Financial Statements Common-Size Balance Sheets
All accounts = percent of total assets (%TA)
Common-Size Income Statements
All line items = percent of sales or revenue (%SLS)
Standardized statements are useful for:
Comparing financial information year-to-year
Comparing companies of different sizes, particularly within the same industry
33. 3-33 Prufrock CorporationBalance Sheets - Table 3.1
34. 3-34 Prufrock CorporationCommon-Size Balance Sheets Table 3.2
35. 3-35 Ratio Analysis Allow for better comparison through time or between companies
Used both internally and externally
For each ratio, ask yourself:
What the ratio is trying to measure
Why that information is important
36. 3-36 Categories of Financial Ratios Liquidity ratios or Short-term solvency
Financial leverage ratios or Long-term solvency ratios
Asset management or Turnover ratios
Profitability ratios
Market value ratios
37. 3-37 Table 3.5
38. 3-38 Liquidity Ratios Current Ratio = CA / CL
708 / 540 = 1.31 times
Quick Ratio = (CA Inventory) / CL
Acid Test
(708-422) / 540 = 0.53 times
Cash Ratio = Cash / CL
98/ 540 = .18 times
39. 3-39 Financial Leverage Ratios Total Debt Ratio = (TA TE) / TA
(3588-2,591) / 3588 = 0.28 times
Debt/Equity = TD / TE
(0.28/0.72) = 0.39 times
Equity Multiplier = TA/TE = 1 + D/E
($1 /0.72) = 1.39
40. 3-40 Financial Leverage Ratios Times Interest Earned = EBIT / Interest
691/141 = 4.9 times
Cash Coverage = (EBIT + Deprec) / Interest
(691 + 276) / 141 = 6.9 times
41. 3-41 Asset Management: Inventory Ratios Inventory Turnover = COGS / Inventory
1344/422 = 3.2 times
Days Sales in Inventory = 365 / Inventory Turnover
365 / 3.2= 114 days
42. 3-42 Asset Management: Receivables Ratios Receivables Turnover = Sales / AR
2311/188 = 12.3 times
Days Sales in Receivables = 365 / Receivables Turnover
365 / 12.3 = 30 days
43. 3-43 Asset Management: Asset Turnover Ratios Total Asset Turnover = Sales / Total Assets
2311/3588 = 0.64 times
Capital Intensity Ratio = 1/TAT
1/0.64 = 1.56
44. 3-44 Profitability Measures Profit Margin = NI / Sales
363/2311 = 15.7%
Return on Assets (ROA) = NI / TA
363/3588 = 10.12%
Return on Equity (ROE) = NI / TE
363 / 2591 = 14.01%
45. 3-45 Market Value Measures Market Price = $88 per share = PPS
Shares outstanding = 33 million
Earnings per Share = EPS = 363/33 = $11
PE Ratio = PPS / EPS
$88 / $11 = 8 times
Price/Sales Ratio = PPS/Sales per share
$88/($2,311/33) = 1.26
Market-to-book ratio = PPS / Book value per share
Book value per share = Total Equity/shares outstanding
= $2,591/33 = $78.52
Market-to-Book = $88/78.52 = 1.12 times
46. 3-46 Prufrock Ratios
47. 3-47 Table 3.6
48. 3-48 The DuPont Identity ROE = NI / TE = Basic Formula
ROE = PM * TAT * EM = Dupont Identity
PM = Net Income / Sales
TAT = Sales / Total Assets
EM = Total Assets / Total Equity
49. 3-49 Using the Du Pont Identity ROE = PM * TAT * EM
Profit margin
Measures firms operating efficiency
How well does it control costs
Total asset turnover
Measures the firms asset use efficiency
How well does it manage its assets
Equity multiplier
Measures the firms financial leverage
EM = TA/TE = 1+D/E ratio
50. 3-50 Prufrocks DuPont Identity ROE = PM * TAT * EM
PM = 15.7%
TAT = .64
EM = 1.39
ROE = .157 x .64 x 1.39
= .139667 = 14%
51. 3-51 Internal and Sustainable GrowthPayout and Retention Ratios Dividend payout ratio (b) = DPS/EPS
= Cash dividends / Net income
Retention ratio (1 b) = (EPS-DPS)/EPS
= (Addition to Retained Earnings) / Net income
52. 3-52 Internal and Sustainable GrowthPayout and Retention Ratios Dividend payout ratio (b) =
Cash dividends / Net income (DIV / NI)
121/363 = 33.3%
53. 3-53 Internal and Sustainable GrowthPayout and Retention Ratios Retention ratio (1 b) = (NI - DIV)/ NI
Addition to Retained Earnings / Net income
$242/363 = 66.7%
54. 3-54 The Internal Growth Rate How much the firm can grow assets using retained earnings as the only source of financing.
55. 3-55 The Sustainable Growth Rate How much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio.
56. 3-56 Determinants of Growth Profit margin operating efficiency
Total asset turnover asset use efficiency
Financial leverage choice of optimal debt ratio
Dividend policy choice of how much to pay to shareholders versus reinvesting in the firm
57. 3-57 Table 3.7
58. 3-58 Why Evaluate Financial Statements? Internal uses
Performance evaluation compensation and comparison between divisions
Planning for the future guide in estimating future cash flows
External uses
Creditors
Suppliers
Customers
Stockholders
59. 3-59 Benchmarking Ratios need to be compared to something
Time-Trend Analysis
How the firms performance is changing through time
Internal and external uses
Peer Group Analysis
Compare to similar companies or within industries
SIC and NAICS codes
60. 3-60 Problems with Financial Analysis Conglomerates
No readily available comparables
Global competitors
Different accounting procedures
Different fiscal year ends
Differences in capital structure
Seasonal variations and one-time events