financial management re vie we
TRANSCRIPT
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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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Profitability Ratios
Net Profit Margin Ratio
Indicates the bottom line profitability
generatedfrom reven
ue.
Equals Net Profit divided by Net Sales.
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Profitability Ratios
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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Profitability Ratios
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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Profitability Ratios
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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Profitability Ratios
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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Profitability Ratios
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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Profitability Ratios
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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Profitability Ratios
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