financial management re vie we

8/8/2019 Financial Management Re Vie We

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Financial Management

By

PASCUAL B. SAN JOSE, JR.

cpa, mba, dba (cand.)


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Goals ofFinancial Management

1. Stockholder Wealth Maximization.

2. Pr ofit Maximization.

Stockholder Wealth Maximization translateinto maximizing the price of the firmscommon stock.

Profit Maximization means themaximization ofprofits within a givenperiod of time.


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The Role ofFinancial Managers

1. Management offinancial resources.

2. Financial analysis and planning.

3. Investment Decisions. 4. Financing and capital structure

decisions


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Forms ofBusiness Organizations

1. Sole Proprietorship.

2. Partnership

3. Corporation

The financial managers role is delineated

in part by the type ofbusinessorganization in which he operates.


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Single Proprietorship

Is a business owned by one individual.

Advantages:

1. Noformal charter is required.

2. Organizational costs are minimal.

3. Pr ofits and control are not shared.

Disadvantages:

1. Capital is limited. 2. Unlimited liability of owner.

3. Limited life (co-terminus with owner)


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Partnership

Is an association of twoor more persons

who bind themselves to contribute money,

pro

perty,o

r indu

stry to

a co

mmo

nfu

nd,with the intention ofdividing the profits

among themselves.


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Corporation

Is an artificial being created by operation

of law, having the right ofsuccession and

the po

wers, attribu

tes and pro

pertiesexpressly authorized by law or incident to

its existence.


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Basic Documents Required by SEC

Partnership

1. Articles ofCo-Partnership

Corporation

1. By-Laws of the Corporation.

2. Articles of Incorporation


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Distinctions ofCorporation and

Partnership 1. MannerofCreation.

2. Commencement ofJudicial Personality.

3. Right ofSuccession. 4. Term ofExistence.

5. Transferability of Interest


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Financial Statements

Are summaries offinancial data that areintended to communicate an entitysfinancial position at a point in time and its

results ofoperations for a period thenended.

3 Basic Financial Statements

1. Balance Sheet 2. Income Statement

3. Cash Flow Statement


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Anatomy ofa Balance Sheet

Assets = Liabilities + Networth/Equity

Assets Liabilities = Networth/Equity

Assets are economic resources of the company.

Liabilities are everything with money value that

the company owes to a creditor.

Networth/Equity represents the excess ofassets

over liabilities (owners equity). Balance Sheet shows the financial position of

the company as ofparticular date.


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Anatomy ofan Income Statement

Sales Cost ofSales= Gross Profit

Gross Profit Operating Expenses=Operating Profit Interest Taxes=NetProfit (Loss) + Retained Earnings (Beg) Preferred stocks dividends=RetainedEarnings (End).

Income Statement shows the results ofoperations of the company over aspecified period of time.


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Anatomy ofa Cash Flow Statement

Cash flow statement refers to the flow ofcashinto and out of the business over a specificperiod of time.

Elements ofCash Flow Statement

1. Cash flows from operating activities.

2. Cash flows from Investing activities.

3. Cash Flows from financing activities.


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Financial Analysis

Involves the assessment and evaluation of

the companys past and present financial

performance including its future business

potentials. It analysis the meaningful and

significant relationship among the

financial data of the financial statements.


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Techniques in Financial Analysis

1. Horizontal Analysis which involves

comparison offigures shown in the financial

statements of twoor more accounting periods.

2. Vertical Analysis is the process of relatingfigures in the statement to a common base.

3. Ratio Analysis which indicates the significant

relationship between items in the financial

statements expressed in mathematical forms (in

percentage, decimal, fraction or times).


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Financial Ratios

1. Liquidity Ratios

2. Pr ofitability Ratios

3. Solvency/Stability Ratios (Leverage)

4. Turnover/Efficiency Ratios


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Liquidity Ratios

Measure the companys capability to pay

its maturing short-term debts/obligations

out of its current assets.

Current Ratio

Equ

als to

cu

rrent assets divided by cu

rrentliabilities.


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Liquidity Ratios

Quick (Acid-Test) Ratio

Equals to most liquid current assets (cash,

marketable securities, and receivables)divided by current liabilities. (Inventory is

not included in the current assets. Prepaid

expenses are also not included because

they are not convertible into cash to paycurrent liabilities).


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Profitability Ratios

Measure the companys ability to earn a

satisfactory profit and return on investment.

1. Gross Profit Margin

Reveals the percentage each peso left

over after the business has paid its

goods.

Equals Gross Profit divided by Net Sales.


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Net Profit Margin Ratio

Indicates the bottom line profitability

generatedfrom reven

ue.

Equals Net Profit divided by Net Sales.


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Return on Investment IROI)

1. Return on Total Assets (ROA)

Indicates the efficiency with whichmanagement has used its resources to

generate income.

Equ

als Net Income divided Average

TotalAssets


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Return of Investments (ROI)

2. Return on Equity (ROE)

Measures the rate of return earned onthe common stockholders investments.

Equals Earnings Available to Common

Stockh

olders divided by AverageStockholders Equity


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Dupont ROA Formula:

Equals Net Profit Margin x Total Assets

Turnover

= (Net Income over Net Sales) x (Net Sales over

Average Total Assets)

Note:

The ROA can be raised by increasing either theprofit margin or the assets turnover.


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Earning Per Share (EPS)

Indicates the amount ofearnings for each

co

mmon share held.

Equals Net Income Preferred Dividends

divided by Co

mmon St

ocks O

utstanding.


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Price/Earnings Ratio

Evaluates the companys relationship with its

stockholders.

Equals to Market Price per Share ofstock

divided by the Earning Per Share (EPS).

A high P/E ratio indicates that the investingpublic considers the companys stocks as a

profitable investments and vice-versa.


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Book Value Per Share

Is the net assets available to common

stockholders .

Equals (Total Stockholders Equity Preferred

Stocks) divided by Total Shares Issued and

Outstanding.

Comparing the b

ook val

ue per share with themarket price per share gives an indication of

how investors regard the companys stocks.


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Dividend Ratios

1. Dividend Yield = Dividend per Sharedivided by Market Price per Share

2. Dividend Payout = Dividends per Sharedivided by Earnings per Share (EPS)

Note:

A decline in these ratios signals a declinein value ofdividends and would causeconcerns to stockholders.


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Leverage (Solvency) Ratios

Measure the companys ability to meetmaturing long-term obligations.

Debt Ratio

Compares total liabilities to total assets. Itshows the percentage of total funds

obtained from creditors. Equals Total Liabilities divided by Total

Assets. Creditors prefer low debt ratio.


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Leverage Ratios

Debt/Equity Ratio

Measures the solvency of the company

that ensures the high

or lo

w degreeof

safety to creditors.

Equals toTotal Liabilities divided by

Stockholders Equity.

A low debt/equity ratio is favored by

creditors.


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Leverage Ratios

Times Interest Earned (Interest Coverage) Ratio

Reflects the numberof times before-tax earnings

cover interest expense.

Equals to Earnings before Interest and Taxes

(EBIT) divided by Interest Expense

It is a safety margin indicator since it shows howmuch decline in earnings can a company absorb

and still be able to pay interest charges.


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Activity (Turnover/Efficiency) Ratios

Accounts Receivable Ratios

Measure collection efficiency/

1. Accounts Receivable Turnover

Gives the numberof times accounts

receivable is collected during the

year.

Equals to Net Credit Sales divided by AverageAccounts Receivable. A high receivable

turnover is favorable to the company.


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Receivable Ratios

Average Collection Period

Measures the numberofdays it takes to

co

llect the receivables. Equals to 365 or 360 days divided by the

Account Receivable Turnover.

Note:

The average c

ollecti

on peri

odshould be compared against the

companys credit term.


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Inventory Ratios

Inventory Turnover

This measures the overorunder stocking

ofgoo

ds.

Equals to Cost ofGoods Sold divided by

Average Inventory.

A high inventory turnover is favorable to

the company.


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Inventory Ratios

Average Age of Inventory

Measure the holding period of inventory.

Equals to 365 or 260 divided by Inventory

Turnover.


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Efficiency Ratios

Operating Cycle

Indicates the numberofdays it takes to

co

nvert invento

ry and receivables to

cash.

Equals to Average Collection Period+

Invento

ry Ageof

Invento

ry.

A short operating cycle is desirable.


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BUDGETING

The BUDGET is the companys financialplan. It is a set ofproforma statementsabout the companys finances and

operations. It is a tool for a) planningb) coordination and c) control.

T

he pro

cessof

translating thisfinancialplan intofinancial terms is called

BUDGETING.


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Types ofBudgets

1. Sales Budget

2. Pr oduction Budget

3. Capital Expenditures Budget 4. Master Budget


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Types ofBudget

Sales Budget

This budget details the total sales

expectedo

ver a given period.

Sales will be shown in terms of their

qu

antities and/o

r values and are

oftenviewed by product groups.


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Production Budget

It specifies the various quantities ofgoods

to be produced throughout the period in

question, as well as the costs of the direct

materials, direct labor and factory

overheads involved in producing these

amounts.


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Capital Expenditures Budget

Is concerned with the estimated

expenditures on capital investments

(assets ofpermanent, long-term value to

the company, like land, building,

equipment, machinery, etc.)


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Master Budget

Budgeted Income Statement

Shows the firms estimated sales revenueover a given period of time and all

expected relevant costs and expenses to

be incurred in order to generate that

revenue, leaving a profit or a loss.


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Master Budget

Budgeted Balance Sheet

Sets out the firms assets, liabilities andequity accounts at the end of the given

period.


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Master Budget

Cash Budget

Sets down the on-going cash position ofafirm by anticipating cash inflows and

outflows during the given period.


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The Budget Committee

Basic Functions:

1. Formulate general policies relating to thebudgetary system.

2. Review and revise (ifnecessary) budgetestimates from different segments of theorganization.

3. Approve budgets.

4. Evaluate and analyze budget reports. 5. Recommend necessary actions to improve

operational efficiency and effectiveness.


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Working Capital Management

Working capital is equal to current assets.

Net working capital is equal to current

assets less current liabilities.

Working Capital Management and Risk-

Return Trade-off:

Too much working capital reduces

profitability while too little working capital

decreases liquidity.


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Cash Management

Involves having the optimum, neither

excessive nor deficient amount ofcash on

hand at the right time.

The objective ofcash management is to

invest excess cash for a return while

retaining sufficient liquidity to satisfy future

needs.


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Rationale for Holding Cash

1. Transaction Balance

2. Precautionary Balance

3. Speculative Balance

4. Compensating Balance


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Cash Management Techniques

1. Cash Flow Synchronization.

2. Playing the Float.

3. Lockbox Plan

4. Concentration Banking

5. Automatic Bank Credits

6. Payables Centralization

7. Zero-Balance Accounts

8. Overdraft System


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Rationale for Holding Marketable

Securities

1. Marketable securities as a substitute

for cash or temporary investments:

a.To

finance seas

onal

or cyclicaloperations.

b. To meet future financial

requirements.

Factors Influencing the Choice of


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Factors Influencing the Choice of

Marketable Securities

1. Default Risk

2. Interest Rate Risk

3. Inflation Risk 4. Marketability Risk


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Baumol Model for Balancing Cash

and Marketable Securities

An economic model that determines the optimalcash balance by using economic orderingquantity (EOQ) concepts.

Form

ula:

Optimal Cash Balance

= Square Root of2(F)(T)/k

Where: F is the fixed cost of trading a security; T

is the annual cash requirements and k interestrate ofmarketable security (opportunity cost)


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Receivable Management

Formulation ofCredit Policy

1. Credit Standards

2. Credit Terms (2/10, net 30) -Credit Period

-Discount

3. Collection Policy 5. Discount Policy


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The Five (5) Cs ofCredit

1. Character

2. Capacity

3. Capital 4. Collateral

5. Conditions


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Inventory Management

Involves a trade-offbetween the costsassociated with keeping inventory versusthe benefits ofholding inventory.

High inventory level results in increasedinventory costs but low inventory level canresult to possible stockouts and lost sales.

T

he go

al is to

pro

vide inventories req

uiredforoperation at the lowest possible

inventory costs.


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Types of Inventories

1. Raw Materials

2. Goods-in-Process

3. Finished Goods


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Inventory Costs

1. Ordering Costs

The costs ofplacing and receiving the

orders.

2. Carrying Costs

T

he co

sts associated with carryinginventory (storage, depreciation, etc.)


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Inventory Mgt. Models Economic Order Quantity (EOQ) Model

To determine the particular quantity toorder

which will minimize the total inventory costs.

Formula:

EOQ=Square Root of2SP/C where: S is the estimated annual sales

P is the fixed cost perorder

C is carrying cost per

unit


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Reorder Point

The inventory level at which an ordershould be placed.

Formula:

Reorder Point

=Lead Time Usage plus Safety Stock

Where Lead time usage is the normal sale

or consumption during lead time whilesafety stock is the additional inventorycarried to guard against stockout.


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Basic Strategies ofWorking Capital

Management

1. Accelerate collection of receivables

2. Stretching accounts payables

3. Accelerate Inventory turnover


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Short-Term Financing

Is essentially to provide capital deficit businessfunds for short-term period ofa yearor less.

Can be classified as Secured and Unsecured.

Four major types ofshort-term financing:

Accr uals

Trade Credit (Accounts Payable)

Bank Loans

Commercial Papers

Receivable Financing (with or without recourse)

Inventory Financing