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Principle of Finance
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Introduction to Managerial Finance
Introduction to Managerial Finance
WHAT IS FINANCE ?
The science and art of managing money.
financial perspective
Personal level
business level
How much of earnings will spend. How much they save. How will invest the savings.
How firms raise money from investors. How firms invest money to earn a profit. How firms decide whether to reinvest profits in
the business or distribute it back to investors.
LEGAL FORMS OF BUSINESS ORGANIZATION
Sole ProprietorshipPartnership
Corporation
Introduction to Managerial Finance
business owned by one person who operates it for his or her own profit
Sole Proprietorships
of all businesses are sole proprietorships,73%Such as a bike shop, personal
trainer.Advantag
eworking
independently unlimited liabilityWeaknesses
Unlimited liabilityGiving creditors the right to make claims against the owner’s personal assets to recover debts owed by the business.
Lacks continuity when
proprietor dies
Low organizational costs
Ease of dissolution
Introduction to Managerial Finance
A business owned by two or more people and operated for profit.
Partnerships
of all businesses are partnerships,7%
Such as the finance, insurance, and real estate industries.
Advantage More available brain
power and managerial skill
unlimited liabilityWeaknesses
Partnership is dissolved when a
partner diesDifficult to liquidate or
transfer partnership
Borrowing power enhanced by more
owners
Introduction to Managerial Finance
An entity created by law.
Corporation
of all businesses are partnerships,20%Advantag
eOwners have limited
liability, which guarantees that they cannot lose more than they
invested
Taxes generally higher
Weaknesses More expensive
to organize than other business
formsLacks secrecy because
regulations require firms to
disclose financial results
Long life of firm
Introduction to Managerial Finance
Corporate Organization
Introduction to Managerial Finance
Goal of the FirmMaximize shareholder wealth
(increase the share price).Corporations commonly measure profits in terms of
earnings per share (EPS), which represent the amount earned during the period on behalf of each outstanding
share of common stock.
Marginal cost–benefit analysisEconomic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs.
Accrual basisIn preparation of financial statements, recognizes revenue at the time of sale and recognizes expenses when they are incurred.
Cash basisRecognizes revenues and expenses only with respect to actual inflows and outflows of cash.
finance
emphasis on
Accounting
Financial Tools
Financial Tools
THE THREE KEY FINANCIAL STATEMENTS
Balance sheet
Income Statement
Statement of cash flows
provides a financial summary of the firm’s operating results during a specified period.
Summary statement of the firm’s financial position at a given point in time
Summary of the firm’s operating, investment, financing cash flows , reconciles them with changes in its cash and marketable securities during the period
Financial Tools
Income Statement
Income Statement
Sales revenueCOGS
xxx(xxx)
Gross profit xxx
Operating expenses Selling expensesGeneral and admin. ExpensesLease expenses Deprecation expenses
XxxXxxXxxXxx
Total operating expenses (xxx)
Operating Profit ( EBIT) xxx
Interest expense (xxx)
Net profit before taxes xxx
Taxes (xxx)
Net profit after taxes xxx
Preferred stock dividends (xxx)
Earning available for common stockholders xxx
Earning per share (EPS) xxx
Financial Tools
Income StatementExample
:
Financial Tools
Balance Sheets
Balance Sheet
AssetsCashMarketable SecuritiesInventoriesAccount Receivable Prepaid expenses
xxxxxxxxxxxxxxx
Total current assets xxx
Land and building VehiclesMachinery and equipmentFurniture and fixture
xxxxxxxxxxxx
Gross fixed assets xxx
Accumulative deprecation (xxx)
Net fixed assets xxx
Total assets xxx
Assets
Financial Tools
Balance Sheets
Balance Sheet
Liabilities and stockholders equityAccount payableNotes /Taxes /Accrued payableAccruals
xxxxxxxxx
Total current Liabilities xxx
Long term debts xxx
Total Liabilities xxx
Preferred stock xxx
Common stock xxx
Retained earnings xxx
Total stockholder equity xxx
Total Liabilities and stockholder equity xxx
Liabilities
Stockholder equity
Financial Tools
Balance SheetsExample
:
Financial Tools
Statement of cash flows
Cash Flow from Operating activates
Net profit after taxesDeprecation expenses Account receivable Inventories Account payableAccruals
xxxxxx
(increase xxx) or decrease xxx(increase xxx) or decrease xxxincrease xxx or (decrease xxx)increase xxx or (decrease xxx)
Cash provided by operating activates xxx
Cash flow from investment activates Gross fixed assets (increase xxx) or decrease xxx
Cash provided by investment activates xxx
Cash flow from financing activates Note payableLong term debts Dividends paid
increase xxx or (decrease xxx)increase xxx or (decrease xxx)
(xxx)
Cash provided by financing activates xxx
Net increase/decrease in cash and marketable secu. xxx
Financial Tools
Statement of cash flows Example
:
Financial Tools
Using Financial RatiosRatio AnalysisInvolves methods of calculating and interpreting financial ratios to analyze and monitor the firm’s performance.
A firm’s ability to satisfy its short-term obligations as they come due.Current ratioA measure of liquidity calculated by dividing the firm’s current assets by its current liabilities.
liquidity
Current ratio =Current assets
Current liabilitiesA higher current ratio indicates a greater degree of liquidity.
Activity RatiosMeasure the speed with which various accounts are converted into sales or cash inflows or outflows.Inventory Turnover
A measure of liquidity calculated by dividing the firm’s current assets by its current liabilities. Inventory turnover =
Cost of goods sold Inventory
The resulting is meaningful only when it is compared with other firms in the same industry or to the firm’s past inventory turnover.
Financial Tools
Using Financial Ratios
Average collection periodThe average amount of time needed to collect accounts receivable.
Average collection period =Accounts receivable
Annual sales365
The average collection period is meaningful only in relation to the firm’s credit terms.
Average payment periodThe average amount of time needed to pay accounts payable.
Average payment period =Accounts payable
Annual purchases365
This figure is meaningful only in relation to the average credit terms extended to the firm.
Debt RatioMeasures the proportion of total assets financed by the firm’s creditors.
Debt ratio =Total liabilitiesTotal assets
The higher this ratio, the greater the amount of other people’s money beingused to generate profits.
Financial Tools
Using Financial Ratios
Profitability RatiosThere are many measures of profitability. As a group, these measures enable analysts to evaluate the firm’s profits with respect to a given level of sales, a certain level of assets, or the owners’ investment.
Gross profit marginMeasures the percentage of each sales dollar remaining after the firm has paid for its goods.
gross profit margin = Sales - Cost of goods
sold Sales
EARNINGS PER SHARE (EPS)Measures the percentage of each sales dollar remaining after the firm has paid for its goods.
gross profit margin = Sales - Cost of goods
sold Sales
CASH FLOWS
Cash Flows
Classifying Inflows and Outflows of Cash
Operating Flows
Investment Flows
Financing Flows
Cash flows directly related to sale and production of the firm’s products and services.
Cash flows associated with purchase and sale of both fixed assets and equity investments in other firms.
Cash flows that result from debt and equity financing transactions; include incurrence and repayment of debt, cash inflow from the sale of stock, and cash outflows to repurchase stock or pay cash dividends.
The firm’s cash flows fall into three categories: (1) operating flows, (2) investment flows, and (3) financing flows.
Inflows and Outflows of Cash
Cash Flows
Preparing the Statement of Cash Flows
Sources Income Statement
Balance Sheets
Cash Flows
Preparing the Statement of Cash Flows
Cash FlowsSourcesIncome
StatementIncome StatementBalance Sheets
Balance SheetsBalance SheetsBalance Sheets
Balance Sheets
Balance SheetsBalance Sheets
Financial Planning
Financial Planning
Financial planning processPlanning that begins with long term, or strategic, financial plans that in turn guide the formulation of short-term, or operating, plans and budgets.
Financial planning process’ key aspects
Cash planning
Profit planning
Involves preparation of the firm’s cash budget.Involves preparation of pro forma statements.
long-term (strategic) financial plans
Short-term (operating) financial plansPlans that lay out a company’s
planned financial actions and the anticipated impact of those
actions over periods ranging from 2 to 10 years.
Specify short-term financial actions and the anticipated impact of those actions, that most often
cover a 1- to 2-year period.Fixed assets, research and
developmentactivities, marketing and product
development actions, capital structure, and major sources of
financing.
Focu s Sales forecast, production plans,
estimate direct labor requirements, factory overhead
outlays, and operating expenses. Fo
cu s
(Forecasting)
(Accrual)
Financial Planning
The short-term (operating) financial planning process
Short-term financial planning begins with the sales forecast. From it, companies develop production plans that take into account lead (preparation) times and include estimates of the required raw materials. Using the production plans, the firm can estimate direct labor requirements, factory overhead outlays, and operating expenses. Once these estimates have been made, the firm can prepare a pro forma income statement and cash budget. With these basic inputs, the firm can finally develop a pro forma balance sheet.
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A statement of the firm’s planned inflows and outflows of cash that is used to estimate its short-term
cash requirements.
cash
bu
dget
The prediction of the firm’s sales over a given period, based on external and/or internal data; used as the key input to the short-term financial planning
process.
sale
s fo
reca
st