Fin 101 ch 1-3

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SusanneS28
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Fin 101 ch 1-3
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2013-03-12 21:05:00
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Fin 101 ch 1-3
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  1. Four Basic areas
    • 1. Corporate finance
    • 2. Investments
    • 3. Financial Institutions
    • 4. International Finance
  2. Corporate Finance
    Business finance more applicable.
  3. Investments
    • Work with financial assets such as stocks and bonds
    • Value of financial assets, risk versus return, and asset allocation
    • Job opportunities
    • Stockbroker or financial advisor
    • Portfolio manager
    • Security analyst
  4. FINANCIAL INSTITUTIONS
    • Companies that specialize in financial matters
    • Banks – commercial and investment, credit unions, savings and loans
    • Insurance companies
    • Brokerage firms
  5. INTERNATIONAL FINANCE
    • An area of specialization within each of the areas discussed so far
    • May allow you to work in other countries or at least travel on a regular basis
    • Need to be familiar with exchange rates and political risk
    • Need to understand the customs of other countries; speaking a foreign language fluently is also helpful
  6. BUSINESS FINANCE
    Some important questions that are answered using finance
    • What long-term investments should the firm take on?
    • Where will we get the long-term financing to pay for the investments?
    • How will we manage the everyday financial activities of the firm?
  7. FINANCIAL MANAGER
    • Financial managers try to answer some, or all, of these questions
    • The top financial manager within a firm is usually the Chief Financial Officer (CFO)
    • Treasurer – oversees cash management, credit management, capital expenditures, and financial planning
    • Controller – oversees taxes, cost accounting, financial accounting, and data processing
  8. Capital budgeting
    What long-term investments or projects should the business take on?
  9. Capital structure
    • How should we pay for our assets?
    • Should we use debt or equity?
  10. Working capital management
    How do we manage the day-to-day finances of the firm?
  11. SOLE PROPRIETORSHIP
    • Business owned by one person
    • Advantages
    • Easiest to start
    • Least regulated
    • Single owner keeps all of the profits
    • Taxed once as personal income

    • Disadvantages
    • Limited to life of owner
    • Equity capital limited to owner’s personal wealth
    • Unlimited liability
    • Difficult to sell ownership interest
  12. PARTNERSHIP
    • Business owned by two or more persons
    • Advantages
    • Two or more owners
    • More capital available
    • Relatively easy to start
    • Income taxed once as personal income

    • Disadvantages
    • Unlimited liability
    • General partnership
    • Limited partnership
    • Partnership dissolves when one partner dies or wishes to sell
    • Difficult to transfer ownership
  13. CORPORATION
    A legal "person" distinct from owners and a resident of a state

    • Advantages
    • Limited liability
    • Unlimited life
    • Separation of ownership and management Transfer of ownership is easy
    • Easier to raise capital

    • Disadvantages
    • Separation of ownership and management (agency problem)
    • Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible)
  14. INTERNATIONAL CORPORATE FORMS
    • Joint stock companies
    • Public limited companies
    • Limited liability companies

    • All share:
    • Public ownership
    • Limited liability
  15. GOAL OF FINANCIAL MANAGEMENT
    What should be the goal of a corporation?

    • Maximize the current value per share of the company’s existing stock
    • Maximize the market value of the existing owners’ equity
  16. SARBANES-OXLEY ACT
    • Driven by corporate scandals
    • Enron, Tyco, WorldCom, Adelphia
    • Intended to strengthen protection against accounting fraud and financial malpractice
    • Compliance very costly

    • Firms driven to:
    • Go public outside the U.S.
    • Go private ("go dark")
  17. THE AGENCY PROBLEM
    • Agency relationship
    •    Principal hires an agent to represent its interests
    •    Stockholders (principals) hire managers (agents) to run the company 
    • Agency problem
    •    Conflict of interest between principal and agent
    •    Management goals and agency costs
  18. DO MANAGERS ACT IN THE SHAREHOLDERS’ INTERESTS?
    • Managerial compensation
    •    Incentives can be used to align management and stockholder interests
    •    Incentives need to be carefully structured to insure that they achieve their goal

    • Corporate control
    •    Threat of a takeover may result in better management
    •    Other stakeholders
  19. FINANCIAL MARKETS
    Cash flows to the firm

    • Primary vs. secondary markets
    •    Dealer vs. auction markets  
    •    Listed vs. over-the-counter securities
    •        NYSE 
    •        NASDAQ 1
  20. THE BALANCE SHEET 
    • A snapshot of the firm’s assets and liabilities at a given point in time ("as of …)
    • Assets
    •    −Left-hand side (or upper portion)
    •    −In order of decreasing liquidity
    • Liabilities and Owners’ Equity
    •    Right-hand side (or lower portion) 
    •    In ascending order of when due to be paid
    • Balance Sheet Identity
    •     Assets = Liabilities + Stockholders’ Equity
  21. net working capital (balance sheet)
    • current assets - current liabilities
    • Usually positive for a healthy firm
  22. Liquidity (balance sheet)
    • Speed and ease of conversion to cash without significan loss of value
    • Valuable in avoiding financial distress
  23. Debt vs. equity (balance sheet)
    Shareholders equity = assets - liabilities
  24. Book value
    the balance sheet value of the assets, liabilities, and equity.
  25. Market value
    true value; the price at which the assets, liabilities, or equity can actually be bought or sold.
  26. INCOME STATEMENT
    • The income statement measures performance over a specified period of time (period, quarter, year).
    • Report revenues first and then deduct any expenses for the period
    • End result = Net Income = "Bottom Line" 
    •    Dividends paid to shareholders
    •    Addition to retained earnings
    • Income Statement Equation:
    •    •Net Income = Revenue - Expenses
  27. GAAP Matching Principle
    • Recognize revenue when it is fully earned
    • Match expenses required to generate revenue to the period of recognition
  28. Noncash Items
    • Expenses charged against revenue that do not affect cash flow
    • Depreciation = most important
  29. Time and Costs
    • Fixed or variable costs
    • Not obvious on income statement
  30. Earnings Management
    • Smoothing earnings
    • GAAP leaves "wiggle room" 2
  31. TAXES
    Marginal vs. Average tax rates
    •  Marginal – % tax paid on the next dollar earned
    •  Average – total tax bill / taxable income
  32. CASH FLOW
    • Cash flow = one of the most important pieces of information that can be derived from financial statements
    • The accounting Statement of Cash Flows does not provide the same information that we are interested in here
    • Our focus: how cash is generated from utilizing assets and how it is paid to those who finance the asset purchase.
  33. CASH FLOW FROM ASSETS
    • Cash Flow From Assets (CFFA)
    • = Operating Cash Flow (OCF)
    • – Net Capital Spending (NCS)
    • – Changes in NWC (ΔNWC)

    • Cash Flow From Assets (CFFA)
    • = Cash Flow to Creditors (CF/CR)
    • + Cash Flow to Stockholders (CF/SH)
  34. OCF Operating cash flow (income statement)
    • = EBIT + depreciation – taxes
    • = $694 + 65 – 212 = $547
  35. NCS Net Capital Spending (Balance sheet & Income Statement)
    • = ending net Fixed Assets (FA) – beginning net FA + depreciation
    • = $1709 – 1644 + 65 = $130
  36. ΔNWC Change in Net Working Capital
    = ending NWC (CA-CL 2012) – beginning NWC (CA-CL 2010) = ($1403 – 389) – ($1112 – 428) = $330
  37. CFFA Cash Flow from Assets
    • CFFA = OCF – NCS - ΔNWC
    • Cash Flow From Assets CFFA
    • = Operating Cash Flow OCF
    • - Net Capital Spending NCS
    • - Change in Working Capital ΔNWC
    • $87 = 547 – 130 – 330 = $87
  38. CF/CR Cash Flow to creditors
    • = interest paid – net new borrowing
    • = $70 – ($454 – 408) = $24
  39. CF/SH Cash Flow to Stockholders
    • = dividends paid – net new equity
    • = $103 – ($640 – 600) = $63
  40. CFFA = Cash Flow from Assets
    • CFFA = CF/CR + CF/SH
    • interest paid – net new borrowing
    • + dividends paid – net new equity
    •  CFFA = $24 + $63 = $87
  41. The cash flow identity
    • Cash flow from assets =
    • cash flow to creditors (bondholders)
    • + cash flow to stockholders (owners)
  42. Cash flow from assets
    • Cash flow from assets =
    • - Operating cash flow (EBIT+ Dep - Taxes)
    • - Net capital spending (NCS)
    • - change in net working capital (NWC).

    Where

    • Operating Cash flow = EBIT +dep - Taxes
    • Net capital Spending = Ending net fixed assets - beginning net fixed assets + Dep

    Change in NWC = Ending NWC - Beginning NWC
  43. Cash flow to creditors (Bondholders)
    Cash flow to creditors = interest paid - net new borrowings
  44. Cash flow to stockholders (owners)
    • Cash flow to stockholders =
    • dividends paid - net new equity raised
  45. Common-Size Balance Sheets (standardized financial statement)
    All accounts = percent of total assets (%TA)
  46. Common-Size Income Statements (standardized financial statement)
    All line items = percent of sales or revenue (%SLS)
  47. Standardized statements are useful for:
    • Comparing financial information year-to-year
    • Comparing companies of different sizes, particularly within the same industry
  48. RATIO ANALYSIS
    • Allow for better comparison through time or between companies
    • Used both internally and externally
    • For each ratio, ask yourself:
    •    What the ratio is trying to measure
    •   Why that information is important
  49. Current Ratio
    CA / CL
  50. Quick Ratio
    (CA – Inventory) / CL
  51. Cash Ratio
    Cash Ratio
  52. Total Debt Ratio
    (TA – TE) / TA
  53. Debt/Equity
    TD / TE
  54. Equity Multiplier
    TA/TE = 1 + D/E
  55. Times Interest Earned
    EBIT / Interest
  56. EBIT / Interest
    (EBIT + Deprec) / Interest
  57. Inventory Turnover
    COGS / Inventory
  58. Days’ Sales in Inventory
    COGS / Inventory turnover
  59. Receivables Turnover
    Sales / AR
  60. Days’ Sales in Receivables
    365 / Receivables Turnover
  61. Total Asset Turnover
    Sales / Total Assets
  62. Capital Intensity Ratio
    1/TAT
  63. Profit Margin
    NI/Sales
  64. Return on Assets (ROA)
    NI/TA
  65. Return on Equity ROE
    NI/TE
  66. PE Ratio
    PPS / EPS
  67. Earnings Per Share EPS
    NI/shares outstanding
  68. Price/Sales Ratio
    PPS/Sales per share
  69. Market-to-book ratio
    PPS / Book value per share
  70. The Dupont Identity
    • ROE = NI / TE (basic formula)
    • ROE = PM * TAT * EM (Dupont Idenity)

    •  PM = Net Income / Sales
    •  TAT = Sales / Total Assets
    •  EM = Total Assets / Total Equity

    • ROE - NI/Sales x Sales/TA x TA/TE = NI/TE
    • ROE=  Profit Margin   x Asset use x Leverage
  71. ROE = PM * TAT * EM
    • Profit margin
    •    Measures firm’s operating efficiency
    •    How well does it control costs
    • Total asset turnover
    •    Measures the firm’s asset use efficiency
    •    How well does it manage its assets
    • Equity multiplier
    •    Measures the firm’s financial leverage
    •    EM = TA/TE = 1+D/E ratio 3
  72. Dividend payout ratio
    cash dividends DIV / NI
  73. Retention ratio or Plowback ratio
    Additions to retained earnings/NI

    Must equal 1 between the dividend payout and the retention ratio.

    If Retention ratio is 60% then the dividend payout ratio is 40% or 1-b (plowback)
  74. Internal Growth Rate
    • ROA x b/
    • 1-ROA x b
  75. Sustainable Growth Rate
    • ROE x b/
    • 1-ROE x b
  76. DETERMINANTS OF GROWTH
    • Profit margin – operating efficiency
    • Total asset turnover – asset use efficiency
    • Financial leverage – choice of optimal debt ratio
    • Dividend policy – choice of how much to pay to shareholders versus reinvesting in the firm
  77. PROBLEMS WITH FINANCIAL ANALYSIS
    • Conglomerates
    • No readily available comparables
    • Global competitors
    • Different accounting procedures
    • Different fiscal year ends
    • Differences in capital structure
    • Seasonal variations and one-time events

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