1. Chapter 1
1.1. Functions of Financial Management
1.1.1. • Financial management has to do with how a business obtains the funds required to operate, how it uses the funds, and how it uses the income it earns.
1.1.2. •External forces affect the decisions a business makes.
1.2. Forms of Business Organization
1.2.1. Partnership
1.2.1.1. Multiple people working together to run a business
1.2.2. Corporation
1.2.2.1. Seperate legal entity, with 'shares' owned by individuals
1.2.3. Sole Proprietorship
1.2.3.1. 'One' person running a business
1.3. Sources of Capital
1.3.1. Owners
1.3.1.1. • The owners invest their own capital in the business. • The profits made by the business belong to the owners. • The two items above constitute equity capital.
1.3.2. Creditors
1.3.2.1. The business may borrow from outsiders: this is called debt capital.
1.3.2.2. A very important aspect of finance is the relative importance of debt and equity to the business.
1.3.2.3. More debt means more risk – will the company be able to generate enough income as a result of the borrowings to pay the interest on the debt and still be able to provide a return for the owners?
1.4. Incorporation Process
1.4.1. Must appeal for charter, adopt bylaws, file annual reports
1.4.2. Legal Fees
1.5. Types of Shareholders
1.5.1. Common
1.5.1.1. Not guaranteed a dividend, but might get one Higher risk, if company has a bad year they may never get anything; Higher reward, if company does well, they get higher dividends or higher share value
1.5.2. Preferred
1.5.2.1. Will get first dibs on any dividends paid
1.5.2.2. Usually lower risk as they're paid first and get a set rate of return (usually $ per share)
1.5.2.3. Typically don't get anything extra over the dividends they were promised
1.5.2.4. Non- Cumulative
1.5.2.4.1. Preferred shareholders get their current year dividends before common shareholders
1.5.2.5. Cumulative
1.5.2.5.1. Preferred shareholders get their current and all past unpaid dividends before common shareholders
1.5.3. Shareholders Equity
1.5.3.1. 1. Contributed Capital
1.5.3.2. 2. Retained Earnings
1.5.4. Dividends
1.5.4.1. Distribuation of retained earnings to a companies shareholders
2. Chapter 3
2.1. Debt Utilization Ratios
2.1.1. Debt to Total Assets: = Total debt (Same as total liabilities) / Total Assets
2.1.1.1. - May be expressed as a % - We want it to be relatively low - Higher ratio = higher risk (investors will want a higher return from the company, but creditors may not lend more credit)
2.2. Recevable turnober
2.2.1. Recevablies average collection period
2.3. Inventory Turnover
2.3.1. Capital asset turnover
2.3.2. Total Turnover
2.4. Times Interest Earned
2.5. Using Ratios Investor/ Lender Perspective
2.5.1. Longterm credit
2.5.2. Short-Term Credit
2.5.3. Invest in shares
2.6. Ratios
2.6.1. Ratio Analysis - This is for comparison on other companies, the industry, and previous years - This indicates the overall health of the company
2.6.1.1. Asset Utilization Ratio
2.6.1.1.1. - Looks at specific types of assets - Looks at how well the asset is utilized - May look at whether the assets are 1. Efficient/ Generating Sales 2. Contributing to value of company 3. Contributing to cash flow - We want them to be greater than or equal to other companies
2.6.1.1.2. Types of asset utilization ratios
2.6.1.1.3. Chapter 1 Connection With shareholders
2.6.1.2. Liquidity Ratio
2.6.1.3. Debt Utilization Ratio
2.6.1.4. Prof ability Ratio
3. Chapter 4
3.1. Financial Forcasting
3.1.1. Attempts to project into the future what the financial results of company will be
3.1.2. Cash Flow , Strategic plan, Compare actual results
3.1.3. Required now funding (RNF):
3.1.3.1. = (CA-CL) x % increase in sales - increase in RE
3.1.3.2. = INcrease capital assets + (CA-CL) x % increase in sales - increase in RE
3.1.3.3. =(A-CL) x 5 increase in sales - income in RE
3.2. Pro- Forma Financial Statements
3.2.1. Income statement, Balance sheet, Statement of retained earnings
3.2.2. Pro Forma Steps
3.2.2.1. 1. Establish sales projections and total revenues/ collections 2. Determine production 3. Prepare a cash budget 4. Prepare pro-forma statements of income and retained earnings 5. Prepare a pro-forma balance sheet
3.2.2.1.1. 1. Establish sales projections and total revenue/ collections
3.2.2.1.2. 2. Determine production schedule and costs of production
3.2.2.1.3. 3. Prepare a cash budget
3.2.2.1.4. 4. Prepare pro-forma statements of income and retained earnings
3.2.2.1.5. 5. Prepare a pro0forma balance sheet
4. Legend
4.1. PURPLE=CHAPTER 2
4.2. RED= CHAPTER 3
4.3. YELLOW = CHAPTER 4
4.4. BLUE = CHAPTER 5
4.5. ORANGE: CHAPTER 6
4.6. DARK GREEN: CHAPTER 7
4.7. DARK BLUE: CHAPTER 8
4.8. RED: CHAPTER 1
5. Chapter 7
5.1. Current asset management
5.1.1. Current assets are an investment Require financing (see Chapter 6) Affect ability to make other investments Resources “tied up” in current assets Goal Maximize return (increase shareholder wealth), with acceptable level of risk Low levels of current assets Higher level of risk But greater potential return from the ability to invest elsewhere
5.2. A/R and inventory – how much to carry? Making the decisions that we set out in Chapter 6
5.2.1. Maintained to ensure short term debts can be paid Cost Could pay off debt and save interest, or pay dividends Opportunity cost Keeping cash low can help maximize returns BUT - need to ensure the bills can be paid! Management of receivables and inventory is key to managing cash
5.3. Effects of Change in A/R Policy
5.3.1. Automatic balance sheet change One time change in A/R and cash Can create income statement change Result from having more cash Creates additional revenue or reduced expense Has an ongoing effect
5.3.2. Evaluating a change in A/R Policy
5.3.2.1. Step 1.Compare New Plan and Old Plan (figure out change in AR) Decrease in A/R Change is a benefit, funds freed up to invest elsewhere and make money, or save on interest expense, etc. Increase in A/R Change is a cost, increased funds used for A/R How much more (or less) cash do we have? Need to conduct a cost-benefit analysis
5.3.2.2. Step 2: Determine the income statement changes Income Statement Change: Consider the income that could be generated (effect on annual income) Change in A/R x rate of return Consider the cost of the new policy - Fees, discounts, changes in sales Is the net income effect positive? If so, we should do it Rate of return (return the company can get) Can also use company’s interest rate on financing This is the “Opportunity cost of funds
5.3.3. Other Considerations
5.3.3.1. Credit limits Credit applications/checks Follow up on A/R Sending statements/reminders Phone calls When to start limiting/refusing credit Accepting credit cards
5.4. Inventory
5.4.1. One of the least liquid current assets – must be sold first, and usually becomes AR, and then AR must be collected before it finally converts to cash Amount of inventory held is not completely within management’s control. Why? Customer demand / competitors Other market and economic conditions Let’s think about the auto industry…… Control over inventory policy is generally shared between finance, operations and marketing
5.4.2. Inventory Managmenet
5.4.2.1. Cash flow management – depends on inventory management Issues: Inventory needs Seasonal vs level production Time it takes to get/produce Just in time (JIT)
5.4.2.2. Costs associated with the amount of inventory held: Too much inventory – costs of holding it, obsolescence, spoilage Too little inventory – stock-out, lost sales The inventory decision – Do we want to have: Large amount on hand (large orders, less often)? Small amount on hand (small orders, more often)?
5.4.3. Costs of Inventory
5.4.3.1. Cost of the inventory itself Incur it no matter what Ordering cost Cost of placing an order and receiving the goods Processing, receiving, shipping, stocking Order small amounts = more orders = higher ordering costs Carrying costs Interest costs, warehouse costs, insurance, spoilage
5.4.3.1.1. Carrying and ordering costs: Inverse Relationship
6. Chapter 2 Connection Statement of retained earnings it used in chapter 4 Pro-Forma Statements
7. Chapter 2 Connection Found and explained in chapter 1 both Income Statement and Balance Sheetç
8. Chapter 3 Connection Since creditors are concerned about being repaid, the debt ratio is a critical solvency ratio when lending money. Companies with higher debt ratios are better off looking to equity financing
9. Chapter 3 Connection Short Term Credit
10. Chapter 3 Connection Liquidity Ratio
11. Chapter 3 Connection Long Term Credit
12. Chapter 3 Connectin Invest in Shares
13. Chapter 4 Connection: Pro-Forma statements use retained earnings
14. Chapter 1 Connection Balance sheets explained in chapter 1 Including how they are formed
15. Chapter 1 Connection Statement of retained earnings uses projected cash flow
16. Chapter 2
16.1. Four types of Statements
16.1.1. Income Statement
16.1.1.1. Earning Per Share
16.1.1.1.1. EPS = Earnings available to common shareholders = EAT – preferred dividends Number of common shares Number of common shares
16.1.1.1.2. Affected by amount of earnings, # of common shares, and any dividends to be paid to preferred shareholders
16.1.1.2. Dividened Payout Ratio
16.1.1.2.1. Payout Ratio =Dividend per share (common) Earnings per share
16.1.1.3. Price Earnings Ratio
16.1.1.3.1. High Ratio- Investors confident in company growth (willing to pay high price)
16.1.1.3.2. P/E Ratio = Price per Share Earnings per Share
16.1.1.4. Gross Profit Ratio= Gross Profit/ Sales
16.1.1.5. Gross Profit: Less selling and administrative expense Less Depreciation expense
16.1.1.5.1. Sales - Cost of Goods Sold= COGS
16.1.1.6. Operating Profit (EBIT: Earnings Before Interest and Tax) Less Interest expense
16.1.1.6.1. EBT: Earnings Before Taxes: Less Income Taxes
16.1.1.6.2. EAT: Earnings After Taxes
16.1.1.7. Sales Revenue Less: Cost of goods sold =Gross profit Less: Amortization expense Less: selling expense = EBIT Less: Interest expense =EBT Less: Tax =EAT
16.1.2. Balance Sheet, or Statement of Financial Position
16.1.2.1. Assets= Liabilities+ Equity
16.1.2.1.1. Net assets (Assets- Liabilities)
16.1.2.1.2. Current Assets and Liabilities
16.1.2.2. Working Capital
16.1.2.2.1. Current Assets- Current Liabilities
16.1.2.2.2. If negative, cash flow there may be difficulties like "insolvent"
16.1.2.3. Book Value of Common Stock
16.1.2.3.1. Net assets "owned" by each common share
16.1.2.4. Book Value Per Share
16.1.2.4.1. Book value (calculated above)/ # of common shares
16.1.2.5. Different accounting standards: - IFRS (international financing reporting standards) - ASPE ( Accounting standards for privet enterprise
16.1.3. Statement of Cash Flow
16.1.3.1. Indicates the change in cash for the year and what the cash balance changed
16.1.3.2. Components
16.1.3.2.1. Operating Activites
16.1.3.2.2. Investing Activities
16.1.3.2.3. Financing Activities
16.1.3.3. Net Income PLUS: Items that don’t require cash = Cash flow from operations LESS: net chance in noncash working capital = Cash used in *operating activities Less: cash used in *investing activites Less: cash used in *financing activities = Net decrease/ increase in cash during the year Plus: cash at the beg of year =Cash at the end
16.1.4. Statement of Retained Earnings
16.2. Income Statement
16.2.1. Affect financial decisions
16.2.2. After tax costs = Expense – tax savings
17. Chapter 5
17.1. Fixed Costs
17.1.1. Are the same at all levels of production and/ or sales
17.1.2. The more we produce/sell - decrease the cost per unit
17.1.3. Calculate the Costs per unit = Total fixed costs/# unites sold
17.2. Variable Costs
17.2.1. Vary with the level of output
17.2.2. Variable costs INCREASE, as output INCREASE (more units produced, higher total variable costs)
17.2.3. Per unit cost is typically constant at all levels of sales or production
17.3. Contribution Margin (CM)
17.3.1. =Sales price less variable cost per unit
17.3.1.1. CM is the amount per unit : After variable costs are paid, Go towards covering fixed costs, And then generating profit
17.3.1.2. CM per unit/ selling price
17.3.2. Contribution Margin Ratio (CMR)
17.3.2.1. =Total CM (from Income Statement/ Total Sales (from Income Statement
17.3.2.1.1. Chapter 2 Connection From Income statement which is found and explained in chapter 1
17.3.2.2. Break even in $ of sales = Fixed costs/CMR
17.4. Break Even Point (BEP)
17.4.1. The point (in units sold or dollars of sales)
17.4.1.1. Where fixed costs are paid
17.4.1.2. When company becomes profitable
17.4.2. BEP in UNITS
17.4.2.1. = Fixed costs/ CM per unit
17.4.3. BEP in SALES/REVENUE DOLLARS
17.4.3.1. =BEP in units x selling price
17.5. Target Profit Point
17.5.1. To achieve a specified profit, CM must cover fixed costs PLUS the specified profit
17.5.2. Sales (UNITS) : Fixed costs+ required profit/CM per unit
17.6. Leverage
17.6.1. The use of a tool to magnify an effect
17.6.2. Increased Leverage= Increased risk
17.6.2.1. Fixed=commitment
17.6.2.2. Fixed costs, fixed debt (interest payments)
17.6.2.3. Increased risk potential for negative effects
17.6.2.4. Increased potential for high returns (RISK/REWARD)
17.6.3. Operating Leverage
17.6.3.1. How fixed costs and capital assets are utilized in a business
17.6.3.2. Example: Machines and automation
17.6.4. Financial Leverage
17.6.4.1. The amount of debt used for financing
17.6.4.2. Degree of finical financial leverage (DFL) = EBIT (before interest)/ EBT (after interest)
17.6.4.3. Can be used to calculate % change in EBT or EAT ------- % change in EBIT x DFL= % change in EBT or EAT
17.6.5. Degree of operating leverage
17.6.5.1. Degree to which a % change in sales, will produce a larger % change in EBIT
17.6.5.2. DOL (free of Operating Leverage) = CM/EBIT
17.6.6. Combined Leverage
17.6.6.1. DOL x DFL= combined leverage (DCL) = CM/EBT
18. Chapter 6
18.1. Financing assets
18.1.1. Long Term Assets (Plant and Equipment)
18.1.1.1. Usually financed- long term sources
18.1.1.2. Long term debt or equity
18.1.2. Current assets (Cash, AR, Inventory)
18.1.2.1. Choice: Short term sources, combination ST and LT
18.1.2.2. If Financied entirely with current liabilities:
18.1.2.3. Working capital is zero (Current ratio of 1)
18.1.2.4. Decision 1: how much to hold in current assets
18.1.2.4.1. - Risk/cost tradeoff
18.1.2.5. Decision 2: Do we fund current assets with long or short-term debt
18.1.2.5.1. Long term debt financing- more expensive/ less risk
18.1.2.5.2. Short term debt financing- Less expensive/ more risk
18.2. Minimum Cash balance
18.2.1. Maintained to ensure ability to pay short term liabilities
18.2.2. May be required by bank
19. Chapter 1 Connection: Common Shareholders se the Dividend payout ratio: It shows a % of the EPS that are paid out to common shareholders as a dividend
20. Chapter 2 Connection Plant and Equipment is one of the items under financing activities
21. Chapter 2 Connection Income Statement
22. Chapter 5 Connection Degree of operating leverage and Degree of Financial Leverage
23. Chapter 8
23.1. SOURCES OF SHORT TERM FINANCING The two main sources of short term financing for businesses are: 1. Bank credit – loans, lines of credit 2. Trade credit – accounts payable
23.2. Bank Credit: Banks are happy to supply short term financing to businesses with proven track records. They charge interest based on the prime bank rate and the borrower’s credit rating. They charge an amount above prime on loans to businesses; how much above prime is based on the bank’s perceived risk of not being repaid.
23.3. Different Possible Costs of Borrowing
23.3.1. 1. Interest rate: always expressed on an annual basis. 2. Lender’s (or administration) fee – there could be a flat fee for extending the loan. This amounts to additional interest cost. If paid at the beginning of the loan period this also reduces the useable funds available to the borrower, thus increasing the effective rate of borrowing. 3. Compensating balance – the bank may require a certain base amount be kept by the business in their bank account. This represents a certain amount of the loan that the business can’t use, reducing the amount of useable funds available to the borrower and thus increasing the effective rate of borrowing. 4. Discounted interest – in some cases, the interest is deducted from the loan proceeds up front, which also increases the effective rate of borrowing by reducing the useable funds available. 5. The bank may require periodic repayments (for example monthly), which also affects the effective rate of borrowing. Periodic repayments are not covered in this course.
23.4. There is one basic formula, which can be used to solve all the problems of this chapter. The formula is just a rearrangement of the basic interest formula i = prt. The rearrangement is: r = i pt Where r is the effective annual interest rate (or cost of borrowing), i is the amount of interest paid to the lender in dollars. It is calculated with i = PRt, where P is the full amount of the loan, and R is the rate stated by the lender. p is the useable amount of funds received from the loan from the borrower’s point of view t is the time period over which the interest is accrued, expressed in years.
23.5. Trade Credit
23.5.1. Each supplier has its own terms for repayment of amounts owing on purchases – e.g. n/60, or 2/10 n/30. Recall that 2/10 n/30 means a 2% discount if paid within 10 days, final due date 30 days. When temporarily low on cash, a business has a choice to make – should they: 1. Forgo the discount and pay at the end of the credit term? 2. Borrow money and use it to pay the supplier, thus getting the discount? We can decide on the better course using the same rate formula as in the interest questions above. Essentially we are calculating the rate of interest that would increase the discounted amount to the full amount over the time period that the discount is offered.