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WEEK 1
DEFINE AND DIFFERENTIATE FINANCE AND FINANCIAL MANAGEMENT
Finance is the art and science of managing money connotes ‘management of money’. Financial management Also referred to as managerial finance, corporate finance, and business finance is a decision- making process concerned with planning, acquiring, and utilizing funds in a manner that achieves the firm’s desired goals It is described as the process for and analysis of making financial decisions in a business context DISCUSS THE GOAL, SCOPE AND SIGNIFICANCE OF FINANCIAL MANAGEMENT The goal of financial management is to maximize the current value per share of the existing stock ownership in a business firm (Cabrera) Categories of the goals of financial management (Anastacio, Dacany, Aliling) Maximization of the value of the firm (Valuation Approach) Maximization of shareholders’ wealth Social responsibility and ethical behavior Scope of Financial Management Procurement of short-term as well as long term funds from financial institutions Mobilization of funds through financial instruments such as equity shares, preference shares, debentures, bonds, notes, and so forth Compliance with legal and regulatory provisions relating to funds procurement, use and distribution as well as the coordination of the finance function with the accounting function Finance Manager, therefore, should analyze: The total funds requirement of the firm The assets or resources to be acquired, and The best pattern of financing those assets Significance of Financial Management Broad applicability Reduction of chances of failure Measurement of Return on investment DIFFERENTIATE PROFIT MAXIMIZATION AND STOCK HOLDER’S WEALTH MAXIMIZATION
GOAL
OBJECTIVE ADVANTAGES DISADVANTAGES
Profit Maximization Obtain large amount of profits
- Calculating profit is easy
- Determining the link between financial decisions and profit is simple 1. The short-term is more emphasized 2. Risk or uncertainty is ignored 3. The timing of returns does not matter 4. Immediate resources are necessary Stockholder’s Wealth Maximization Achieve highest market value of common stock
- The long term is emphasized
- Risk or uncertainty is recognized
- The timing of returns is taken into account
- Stockholders’ return is considered
- There is no clear relationship between financial decisions and stock price
- Management anxiety or frustration may be experienced EXPLAIN STRATEGIC FINANCIAL MANAGEMENT AND THE VARIOUS COSIDERATIONS FOR PLANNING Strategic Financial Management Long range in scope Focus on the organization as a whole Based on an objective and comprehensive assessment of the present situation of the organization and the setting up of targets to be achieved in the context of an intelligent and knowledgeable anticipation of changes in the environment Strategic Financial Planning Involves financial planning, financial forecasting, provision of finance and formulation of finance policies which should lead to the firm’s survival and success Considerations for financial planning: Should be able to meet the challenges and the competition Should enable the firm to judicious allocation of funds, capitalization of relative strengths, mitigation of weaknesses, early identification of shifts in environment, counter possible actions of competitor, reduction of financing cost, effective use of funds employed, timely estimation of funds requirement, identification of business and financial risk, etc. STATE THE RELATIONSHIP OF FINANCE WITH OTHER FUNCTIONAL AREAS IN THE ORGANIZATION
Strong emphasis on ethical behavior and ethics training and standards are provided by professional associations such as Finance Executives of the Philippines (FINEX), Bankers Association of the Philippines, Investment Professionals, etc. OTHER INFO: Short term and long-term financial objectives of a business organization Short-term and Medium Term Maximization of return of capital employed or return of investment Growth in earnings per share and price/earnings ratio through maximization of net income or profit and adoption of optimum level of leverage Minimization of finance charges Efficient procurement and utilization of short-term, medium-term and long-term funds Long-term Growth in the market value of the equity shares through maximization of the firm’s market share and sustained growth in dividend to shareholders Survival and sustained growth of the firm Role of Finance Manager Financial Manager Makes Decisions Involving: Analysis and Planning Acquisition of Funds
Impact on Risk and Return Affect the Market price of Common Stock Lead to Shareholder’s wealth maximization Finance Organization Controller – common function includes accounting and financial reporting, internal audit, cost accounting, tax accounting, planning for control, evaluating and consulting, government reporting, protection of assets and economic appraisal Treasurer – common functions are cash management, banking relationship, finding sources of financing, financial planning, capital budgeting, risk management, investor relations, and credit and collection Utilization of Funds WEEK 2 Financial Statement Analysis Component of financial statement Statement of financial position Statement of income Statement of owners equity Cash low statement Notes to financial statement Financial statement analysis is the process of analyzing a company's financial statements for decision-making purposes. Financial statement analysis is the use of analytical or financial tools to examine and compare financial statements in order to make business decisions. In other words, financial statement analysis is a way for investors and creditors to examine financial statements and see if the business is healthy enough to invest in or loan to. (myaccountingcourse.com) Role of financial statement analysis in decision-making- For external stakeholders, it is use to understand the overall health of an organization as well as to evaluate financial performance and business value. For internal constituents, it is use as a monitoring tool for managing the finances. Limitations of financial statements as a tool for analysis performance:
- Financial Statements Are Derived from Historical Costs Transactions are initially recorded at their cost. This is a concern when reviewing the balance sheet, where the values of assets and liabilities may change over time. Some items, such as marketable securities, are altered to match changes in their market values, but other items, such as fixed assets, do not change. Thus, the balance sheet could be misleading if a large part of the amount presented is based on historical costs. - Financial Statements Are Not Adjusted for Inflation If the inflation rate is relatively high, the amounts associated with assets and liabilities in the balance sheet will appear inordinately low, since they are not being adjusted for inflation. This mostly applies to long-term assets.
Financial Ratios Liquidity Ratio – is the company’s ability to meet its maturing short-term obligations Working Capital= current assets - current liabilities Current Ratio= current assets / current liabilities Quick Ratio= c&ce +short term investment + current receivables Current liabilities Cash Position Ratio= c&ce + short term investments Current liabilities Activity or Asset Utilization Ratio – is used to determine how quickly various accounts are converted into sales or cash Accounts Receivable Turnover= net sales / ave. Accounts receivables Average Collection Period= 360 / accounts receivable turnover Inventory Turnover= COGS / ave. inventory Average Age of Inventory= 360 / inventory turnover Operating Cycle= ave. Age of inventor y/ave. Age of A/R Fixed Asset Turnover= net sales / ave. Fixed assets Total Asset Turnover= net sales / total assets Leverage Ratio (Solvency) – is the company’s ability to meet its long term obligations Debt Ratio= total liab. / total assets Debt to Equity Ratio= total liab. / total equity Times Interest Earned Ratio= net profit + interest + taxes Total interest charges Profitability Ratio – shows the profitability of the operations of the company. It highlights the firm’s effectiveness in handling its operations Gross Profit Margin= gross profit / net sales Profit Margin= net income / net sales Times Interest Earned Ratio= net profit + interest + taxes Total interest charges Return on Investment: A. Return on assets= (Income Before Tax + Interest Expense) ((Assets at Start of Period + Assets at End of Period) / 2)
B. Return on Equity= (Net Income – Preference Dividends) / ((Common Stockholder Equity at Start of Period + Common Stockholder Equity at End of Period) / 2) Note: In this case, and most cases, Common Stockholder Equity is: All equity minus “Preferred Stock, Total” “Common Stock, Total” is the value of the initial share issue and doesn’t include Retained Earnings and Other Equity C. Dupont Analysis: Return on Total Assets = Profit Margin X Total Asset Turnover Return on Equity: Equity Multiplier = Ave Total Asset/Ave Common Equity ROE = ROA x Equity Multiplier or ROE = NIAT/Nsales X Nsales/ATA X ATA/AComEq Market Value Ratio – relates the firm’s stock price to its earnings Earnings per Share=(net income - pref. Dividends) Weighted ave. Of common shares outstanding Price/Earnings (P/E) Ratio= Stock Price / EPS Book Value per Share= Total Equity - Preferred equity or stocks / ave. Shares outstanding Market to Book Value Ratio= share price / net book value Dividend Ratio Dividend Yield= annual dividend / current stock price Dividend Payout Ratio= total dividends / net income WEEK 3 Discuss the usefulness of the statement of cash flows in decision-making Statement of Cash Flows, along with other statements, help users to assess and evaluate:
- A company’s ability to generate positive future net cash flows
- A company’s ability to meet its obligations and pay dividends
- A company’s need for external financing
- The reasons for differences between a company’s net income and associated cash receipts and payments, and
- Both the cash and non-cash aspects of a company’s financing and investing transactions during the accounting period Identify the classifications of cash flow activities and the various sources and application of cash per activity
Examine the company's financial flexibility using the free cash flow analysis If free cash flow is positive, the business firm could have satisfactory financial flexibility. Companies that have strong financial flexibility can:
- Take advantage of profitable engagement in tough terms, and
- Be free from worry about survival in poor economic terms Formula in FCF Net Cash Provided by Operating Activities XX Capital Expenditures (XX) Dividends (XX) Free Cash Flow (XX) Explain the concept and application of leverage in business Leverage represents the use of fixed cost items to magnify the firm’s results. What fixed cost to use? How to finance the fixed cost? Operating leverage – measures the degree to which a firm or project can increase operating income by increasing revenue Financial Leverage – refers to the use of debt to acquire additional assets Apply CVP Analysis in breakeven planning, revenue planning and cost planning Break-even Planning Break-even Point (units) = Total Fixed Cost/CM per unit Break-even Point (sales) = Total Fixed Cost/(1-Variable Cost/Sales) Break-even sales for Multi-product firm = Total Fixed Cost/Weighted Average Contribution (Combined Units) Margin Weighted contribution margin (unit) = [(Unit CM x No. of Units per mix) + (Unit CM x No. of Units per mix)]/ Total No. of Units per sales mix Break-even sales for Multi-product firm = Total Fixed Cost/Weighted CM ratio (Combined Pesos) Weighted CM Ratio = Total Weighted CM (P) / Total Weighted Sales Revenue and Cost Planning Sales (units) = Total Fixed Cost + Desired Profit Contribution Margin per unit Sales (P) = Total Fixed Cost + Desired Profit Contribution Margin Ratio
WEEK 4
Financial Planning
- formulates the way in which financial goals are to be achieved
- focuses on what the firm intends to do in the future. It is a system that guides the top managers to direct the actions of the different units of the organization in accomplishing its objectives (Kolb & Demong, 1988) Financial Plan
- is a statement of what is to be done in the future.
- is a formal statement prepared by the company with regard to the expected sales, expenses, production, and other related financial transactions for a certain period?
- serves as a control devise that helps measure periodic or annual performance Growth as a Financial Management Goal
- Goal of Financial Manager is to increase the market value of the owners’ equity and not just growth by itself
- If the firm is successful in growing the market value of the owner’s equity, then growth will usually result Perspective of Financial Planning A. Planning Horizon
- Short-run Planning - Covers 12 months
- Long-run Planning - Covers two to five years B. Aggregation
- involves the determination of all individual projects together with the investments required that the firm will undertake to determine the total needed investment which is treated as one big project Benefits of Financial Planning
- Provides a rational way of planning options or alternatives
- Interactions or linkages between investment proposals are carefully examined
- Possible problems related to the proposed projects are identified and actions to address them are studied
- Feasibility and internal consistency are ensured
- Managers are forced to think about goals and establish priorities Elements of Financial Plan
- Economic Environment Assumptions
- Determine the net profit Step 2 – Forecast the Statement of Financial Position o Project the assets that will be needed to support projected sales o Project funds that will be spontaneously generated (through accounts payable and accruals) and by retained earnings o Project liability and stockholders’ equity accounts that will not rise spontaneous with sales but may change due to financing decisions o Determine if additional funds will be needed by using the following formula: AFN = Required increase in assets – Spontaneous increase in liabilities – increase in Retained earnings Step 3 – Raising the Additional Funds Needed The financing decision will consider the following factors: a. Target Capital Structure b. Effect of short-term borrowing on current ratio c. Conditions on the debt and equity markets, ot d. Restrictions imposed by existing debt agreements Step 4 – Consider Financing Feedback o Debt or Common Stock? o Interest or Dividends? o Retained earnings? Week 5 1.) Define Working Capital and Working Capital Management Working Capital is the money used to cover all of a company's short-term expenses, which are due within one year. Working capital is the difference between a company's current assets and current liabilities. Working capital is used to purchase inventory, pay short-term debt, and day-to- day operating expenses. Working Capital Management in an MNE requires managing the repositioning of cash flows, as well as managing current assets and liabilities, when faced with political, foreign exchange, tax and liquidity constraints. The overall goal is to reduce funds tied up in working capital while simultaneously providing sufficient funding and liquidity for the conduct of global business. This should enhance return on assets and return on equity. It also should improve efficiency ratios and other evaluation of performance parameters. Closely related to financial supply chain management
2.) State the importance of Working Capital Management Efficient working capital management helps maintain smooth operations and can also help to improve the company's earnings and profitability. Management of working capital includes inventory management and management of accounts receivables and accounts payables. The main objectives of working capital management include maintaining the working capital operating cycle and ensuring its ordered operation , minimizing the cost of capital spent on the working capital, and maximizing the return on current asset investments. 3.) Explain the types of working capital policies and the factors affecting working capital management of a firm Other names: Restricted- Aggressive Relaxed- Conservative Moderate- Hedging
An increase in cash equivalents indicates that the company has higher liquidity. Companies with higher liquidity are considered healthier and have less risk. Companies can quickly pay off short-term obligations. Acquirers are also pleased to acquire the target company with ample cash and cash equivalents. In a leveraged buyout transaction, the acquirer can use the target company’s cash to pay off its debt. It is easier for acquirers to convince lenders to lend money because the target company has a large and stable cash flow. 7.) Illustrate and explain the approaches to determine the optimal cash balance There are two approaches to derive an optimal cash balance: (i) minimizing cash cost models and (ii) cash budget. The important models are: (1) Baumol Model, (2) Miller-Orr Model and (3) Orgler’s Model. Baumol model. To minimize the total cost associated with cash management comprising total conversion costs (that is, costs incurred each time marketable securities are converted into cash) and the opportunity cost of keeping idle cash balances which otherwise could have been invested in marketable securities. Miller-Orr Model. To determine the optimum cash balance level which minimizes the cost of cash management. Orgler’s model. Requires the use of multiple linear programming to determine an optimal cash management strategy. An important feature of this model is that it allows the financial managers to integrate cash management with production, current assets requirement and other aspects of the corporate. 8.) Identify ways or tools in controlling cash flows Acceleration cash flows- Establishment of collection centers. Lock box system. Slowing disbursements- Avoidance of early payments, centralized disbursements, float (payment through checks), accruals 9.) Explain marketable securities, factors and types of marketable securities Marketable securities are financial instruments that can be sold or converted into cash (at reasonable value) within one year. They are highly liquid investments that are generally issued by businesses to raise funds for operating expenses or expansion. Securities are fungible and tradable financial instruments used to raise capital in public and private markets. There are primarily three types of securities: equity—which provides ownership rights to holders; debt—essentially loans repaid with periodic payments; and hybrids—which combine aspects of debt and equity. 10.) Define Accounts Receivable management, its objectives, and the costs associated with investments in accounts receivable Accounts receivable management (ARM) is a set of policies and procedures to ensure that owed payments are collected on time, in their entirety and credited to the proper account. The collection agency payment process is done in compliance with federal and state laws and regulations.
Objectives: To minimize the days sales outstanding To process costs whilst maintaining good customer relations 11.) Analyze trade credit arrangements = credit policies and credit terms and costs associated with it A trade credit is an agreement or understanding between agents engaged in business with each other that allows the exchange of goods and services without any immediate exchange of money. When the seller of goods or services allows the buyer to pay for the goods or services at a later date, the seller is said to extend credit to the buyer. When granting credit, a firm tries to distinguish between customers who will pay and customers who will not pay. There are a number of sources of information to determine creditworthiness, including the following: Financial statements – A firm can ask a customer to supply financial statements. Rules of thumb based on calculated financial ratios can be used. Credit reports on a customer’s payment history with other firms – Many organizations sell information on the credit strength of firms. Banks – Banks will generally provide some assistance to their business customers in acquiring information on the creditworthiness of other firms. The customer’s payment history with the firm – The most obvious way to obtain an estimate of a customer’s probability of non-payment is whether he or she has paid previous bills with the company granting credit. The 5 C’s of credit: Character – The customer’s willingness to meet credit obligations Capacity – The customer’s ability to meet credit obligations out of operating cash flows Capital – The customer’s financial reserves Collateral – A pledged asset in case of default Conditions – General economic conditions 12.) Explain the need to manage inventories and the costs associated with investment in inventory Inventory Mangement. In order to effectively manage the investment in inventory, two problems must be dealt with: how much to order and how often to order. The economic order quantity (EOQ) model attempts to determine the order size that will minimize total inventory costs. Total Inventory = Total Carrying + Total Ordering Costs 13.) Discuss inventory management techniques Economic order quantity
The sales department of the seller and the purchasing department of the buyer. Both parties consider the early payment discount to be an item worth negotiating as part of a sale transaction. Discount %/(100-Discount %) x (360/Allowed payment days – Discount days) WEEK 6 TIME VALUE OF MONEY - “means that a peso today is worth more than a peso tomorrow” FUTURE VALUE- also known as “compound value” , is the amount to which a present amount of money or a series of payments will grow over time when compounded at a given interest rate. THREE FACTORS AFFECTING FV
1. Principal- is the amount of money borrowed or invested today. 2. Interest- us the amount paid for or earned by the use of money. The percentage of the principal that is paid or earned in interest is called “ interest rate” 3. Time Period- is the length of time or number of periods during which interest is paid or earned SIMPLE INTEREST- is the interest paid or earned on the initial principal only. COMPOUND INTEREST- is the interest paid on both the principal and the amount of interest accumulated in prior periods. FUTURE VALUE (ANNUAL COMPUNDING) FORMULA FV (^) n= PV (1+ i )n Where: FV= future value I= compounded interest rate PV= initial principal amount n= periods PRESENT VALUE- is the current value of a future amount of money, or series of payments, evaluated at an appropriate discount rate. DISCOUNT RATE- sometimes called “ required rate return”, is the rate of interest that is used to find present values. The process of determining the present value of a future amount is called ‘discounting” FORMULA: PV= FVn / (1+ i )n Where: FV= future value I= compounded interest rate PV= initial principal amount n= periods
Primary market — is a market where funds are raised. Where fund are transferred from users to savers. New funds are raised Investors are fund users — the one who sells a financial instrument is called ISSUER. Secondary market —is a market where funds raised by an investor. No new funds are raised; funds are traded between investors between investments. — the one who sells a financial instrument is called INVESTOR. Money market — is a market where money market instruments are traded. (Money market instruments is a short- term financial instrument) Capital market — is a market where capital market instruments are traded.( Capital market instrument is a long-term financial instrument) WEEK 7 ● Explain the concept of risk management Firms can benefit from financial risk management in many different ways, but perhaps the most important benefit is to protect the firm’s ability to attend to its core business and achieve its strategic objectives. By making stake-holders more secure, a good risk management policy helps encourage equity investors, creditors, managers, workers, suppliers, and customers to remain loyal to the business. In short, the firm’s goodwill is strengthened in all manner of diverse and mutually reinforcing ways. This leads to a wide variety of ancillary benefits:
- The firm’s reputation or ‘brand’ is enhanced, as the firm is seen as successful and its management is viewed as both competent and credible.
- Risk management can reduce earnings volatility, which helps to make financial statements and dividend announcements more relevant and reliable.
- Greater earnings stability also tends to reduce average tax liabilities.
- Risk management can protect a firm’s cash flows.
- Some commentators suggest that risk management may reduce the cost of capital, therefore raising the potential economic value added for a business.
- The firm is better placed to exploit opportunities (such as opportunities to invest) through an improved credit rating and more secure access to financing.
