Study Guides (238,526)
Canada (115,195)
Business (1,198)
BU121 (198)
Laura Allan (106)

BU121 Final Exam Finance review

20 Pages
Unlock Document

Wilfrid Laurier University
Laura Allan

Finance  Financial Management is made up of: o Accounting – Provides Information o Finance – Makes decisions about the acquisitions, disposition and management of capital with help of accounting information  Objective – Maximize Shareholder Wealth  Goals o Viability  Liquidity – Keeping the money in a form that can pay bills  Stability – Making decisions that keep the business alive o Profitability  Operate the business to be as profitable as possible  Risk-Return Tradeoff o Must find a balance between Risk (Viability) and Return (Profitability) to maximize return to shareholders Finance Department Responsibilities  Determining financial resources required o Aides budgeting - Disposition (How the capital is used)  Obtaining Financial Resources required o This is financing – The acquisition of capital (Getting money)  Managing the financial resources effectively for: o Working capital management  Inflows and outflows on a daily basis o Investing  Management of long-term funds Decisions – Balance Sheet Budgeting (Plan that involves numbers)  3 Steps: o Forecasting Financial Needs  Short Term – Cash flow forecast  Long Term o Develop budgets to meet those needs  Master Budget  Operating Budget  Capital Budget  Cash Budget o Establishing Financial Control (Measuring to see if you have reached that budget)  Find any deviations from budget Budgeting – Advantages  Encourages managers to plan  Helps stay organized by promoting communication and coordination to the subunits of the organization – “Systems Approach”  Source of Motivation o Motivates by clarifying goals and providing yardstick for rating performance  Facilitates Control o Establishes goals or standards that serve as a means to measure actual performance Budgeting – Cons  Budgeting is NOT bad, but people do bad things with it  Often used as a means to reward waste (give too much money) and penalize thrift (under budget)  Individuals subject to the guidelines are not consulted o They should be part of the decision making  Evaluative Device – Perceived as a threat as people try to blame others if something goes wrong  Convenient scapegoat or lost opportunities o Often budgets are treated as rigid, they should be flexible Cash Budgeting  Management of cash flows  Management of Working Capital Cycle Step 1  Determine the cash balance before any additional debt is taken on or any existing debt is paid off. Let’s call this CBBDT [Cash Balance Before Debt Transactions] o Beginning Cash + receipts from sales and collections on account – expenditures for payroll, purchases, utilities, fixed assets, interest. The result is the CBBDT Step 2  Determine the minimum cash balance allowed  The minimum cash balance may simply be a preference of management (Just “In-Case” Money), or it may be a condition imposed by our bank  Let’s call this the MCB [Minimum Cash Balance] Step 3  Determine the excess or deficiency of cash  If CBBDT > MCB: We have the possibility of repaying debt if it is necessary to do so.  If CBBDT < MCB: We must borrow in order to bring the balance up to the required minimum.  If CBBDT = MCB: No repayment is possible and no further borrowing is necessary  Call the result of this calculation the EoDoC [Excess or Deficiency of Cash]  EoDoC > 0 = Excess  EoDoC < 0 = Deficiency Step 4  Is new borrowing required?  The formula to calculate any new borrowing required is:  CBBDT – MCB < 0  Let’s call this NB [New Borrowing] (To differentiate between additional borrowing and any existing indebtness) Step 5  Is repayment needed?  Beginning Debt Balance is greater than zero [= debt at the beginning of the current period]  We call the resulting amount RN [Repayment Needed] o It may not or it may not be possible to pay off the entire existing debt. This is just Potential Repayment. Step 6  Is repayment possible?  If EoDoC > 0, and RN > 0, then reduce RN by the amount of EoDoC  Logic: We need to satisfy both conditions o Money is owed o Sufficient money exists to repay at least some of it  We call this amount the PR [Possible Repayment] Step 7  Calculated Repayment  If there is nothing to repay, forget it, but if we do owe something and there is enough in the piggy bank to pay some of it off, enter the amount that we can pay off or the amount that we owe, whichever is smaller.  Call this the RED [Repayment of Existing Debt] Step 8  Ending Debt Balance  Beginning Debt Balance + New Borrowing – Repayment of Existing Debt = EDB Step 9  Cash Balance After Debt Transactions  CBBDT + New Borrowing – Repayment of Existing Debt = CBADT Step 10  Interest Accrued o Interest Rate * EDB o Be sure to use a rate that is appropriate to the length of the fiscal period. If the annual rate is, say 8%, the monthly rate is 0.08/12, or 0.006666666 Step 11  Interest Paid  The interest paid in a given fiscal period will depend on the specific requirements of the analysis. Interest may be o Accrued, but paid only when the full amount of the debt is retired, or o Accrued monthly but paid monthly, or o There may be a variety of other options.  READ the directions! Notations Used  CBBDT: Cash Balance Before Debt Transactions  MCB: Minimum Cash Balance  EoDoC: Excess or Deficiency of Cash  NB: New Borrowing  BDB: Beginning Debt Balance  RN: Repayment Needed  PR: [Amount of] Possible Repayment  RED: [Amount of] Repayment of Existing Debt  CBADT: Cash Balance After Debt Transactions  EDB: Ending Debt Balance Beginning Cash Balance + Receipts * Total Cash Available - Expenditures * (Payroll, purchases, utilities, fixed assets, interest) Cash Excess/(Deficiency) Compare to Minimum Cash Balance Desired to get Borrowing Required/Surplus or Repayment. Ending Cash Balance Worksheet (Likely Patterns)  Based on historical measures of amounts and timing of cash flows in working capital cycle Example  You need to prepare a cash budget for the months of June, July and August; minimum cash balance = $6,000  Assume that sales are forecasted at $10,000, $20,000, $30,000, $15,000, $25,000, and $20,000 from April to September respectively  Assume also that you expect to collect 30% in month of sale, 60% in month following sale, and 10% in the 2nd month after sale  Assume that purchases are 75% of the next month’s sales  Assume also that you pay for 20% of purchases in the month of purchase, and 80% in the month following Worksheet April May June July August September Net Sales $10,000 $20,000 $30,000 $15,000 $25,000 $20,000 Collections 30% Month of $3,000 $6,000 $9,000 $4,500 $7,500 Sale 60% $6,000 $12,000 $18,000 $9,000 $1,500 Following 10% 2 nd $1,000 $2,000 $3,000 Month Total Receipts $22,000 $24,000 $19,500 Net Purchases 75% Next $22,500 $11,250 $18,750 $15,000 Month Sales Payments 20% of $4,500 $2,250 $3,750 $3,000 monthly purch. 80% Month $18,000 $9,000 $15,000 $12,000 follow Total $20,250 $12,750 $18,000 Disbursements for purchases Cash Budget June July August Beginning Cash $6,000 $6,000 $7,050 Balance Add: Receipts $22,000 $24,500 $19,500 $28,000 $30,500 $26,550 Total Cash Available Less: $20,250 $12,750 $18,000 Disbursements for Purchases Selling & Admin $4,000 $3,000 $3,500 Interest $150 $200 $210 Dividends $600 Capital $7,500 Expenditures Taxes $6500 Total $31,500 $23,450 $21,710 Disbursements Cash $(3,500) $7,050 $4,840 Excess/(Deficiency) Minimum Cash $6,000 $6,000 $6,000 Balance Desired Borrowing $9,500 $1,160 Required Surplus Cash $1,050 Ending Cash $6,000 $7,050 $6,000 Balance *Clicker Question* Your sales revenue for January is forecasted to be $100,000. Historically, 20% of your sales are in cash, the remaining 80% are credit. 60% of credit sales are from customers that pay within prescribed payment period – in month of following sale, & remainder is from customers paying late before 90 days. Answers  You would need your sales revenue from October through December to determine total receipts for January  You would receive $20,000 in January, $48,000 in February, and $32,000 in March or on January Sales  May need to forecast sales revenue from February and later months to complete cash budget for January  All of the Above  B & C Only Three Possibilities 1. Deficiency o Borrow for Deficiency + Minimum Requirement o Ending Balance = Minimum Requirement 2. Excess > Minimum o As in July from the example o You have a surplus from funds  Can repay Borrowing (Look for Relationship with bank)  If you do, ending balance = Minimum Requirement  Assume the loan is > surplus (Only reducing amount owed)  If you can’t, the ending balance = Minimum + Excess 3. Excess < Minimum o Borrow enough money to equal minimum requirement o Ending balance equal to minimum requirement Note: Interest on Borrowing = Borrowed Amount * Interest Rate/12 *Clicker Question* You have total Cash Available in January of $10,000, total disbursements in January of $8,000, and require a minimum balance of $5,000 each month. Which of the Following is Correct? Answers  You will have an excess of $2,000 and will still have to borrow $3,000  You have an excess of $2,000 and will have to borrow $7,000 *Clicker Question* Assuming the answer to the last question, an outstanding balance on your credit line with the bank at the beginning of January of $1,000 an interest rate of 6% and all borrowing done at the beginning of the month, what is your interest charge for January? Answers  240  20  180  15  10 *Study Break*  Objectives  Goals  Trade Off  Budgeting o Advantages & Negative Aspects  Cash Budget o What months are included o What is the Minimum Cash Balance o Beginning Cash Balance o Sales forecasted for a period of time o How is the money collected – If accounts receivable, when will you receive o Purchases and when they will be paid EBIT Analysis  Used to determine the best mix of debt and equity in the firm’s capital structure o Do you SELL bonds or SELL stocks  Objective is to maximize shareholder wealth o This tool gives the best debt financing vehicle  Measured by Earnings per Share of common stock holder Formula Earnings before Interest & Taxes  EBIT - Interest Earnings before Taxes - Taxes EAT (Net Income) - Preferred Dividends Earnings Available to Common Stock Holder / Number of Common Shares Earnings Per Share  EPS (EATC/# of Shares) Example  ABC Company requires an additional $4 million in external long-term financing  Earnings before interest and taxes are assumed to be $6 million next year, and ABC’s tax rate is 50%  The existing capital structure consists of: o $5,000,000 in 10% bonds  10% is the Coupon/Interest Rate o $3,000,000 in 6% preferred stock o 1,000,000 shares of common stock at $10/share o $500,000 in Retained Earnings  ABC has 2 alternatives with which to raise the money: o $3,000,000 in 11% bonds, and $1,000,000 in 7% preferred stock o $2,000,000 in 8% preferred stock, and $2,000,000 in common stock at $10/share Need to know the effect that each element of the capital structure has on EPS  Debt o Interest = Debt ($) * Interest Rate (%)  Preferred Stock o Preferred Dividends = Preferred Stock ($) * Dividend Rate (%)  Common Stock o Number of Shares = Common Stock ($) / Price Back to Example  $5,000,000 Bonds * 10% = $500,000 Interest Charges  $3,000,000 Preferred Stock * 6% = $180,000 Dividends  1,000,000 Shares of Common Stock Alternative 1 to raise $4 Million  $3,000,000 Bonds * 11% = $330,000 Interest Charges  $1,000,000 Preferred Stock * 7% = $70,000 Dividends Alternative 2 to raise $4 Million  $2,000,000 Preferred Stock * 8% = $160,000 Dividends  $2,000,000 Common Stock / $10 Per Share = 200,000 Common Shares *Clicker Question* If, as calculated, you have $500,000 in interest charges currently, but are considering the 1 alternative to raise the $4 Million which involves $330,000 in interest charges, how much will your annual interest charge be? Answers  $330,000  $830,000  It depends on the total amount of debt and the interest rate  Cannot be calculated from the information given  None of the Above Existing Structure Alternative #1 #2 EBIT $6,000,000 $6,000,000 $6,000,000 - Interest $500,000 $830,000 $500,000 EBT $5,500,000 $5,170,000 $5,500,000 - Taxes (50%) $2,750,000 $2,585,000 $2,750,000 EAT $2,750,000 $2,585,000 $2,750,000 - Preferred $180,000 $250,000 $340,000 Dividends Earnings Available $2,570,000 $2,335,000 $2,410,000 to Common Stock Holders Divided by Number 1,000,000 1,000,000 1,200,000 of Common Stock Earnings Per Share $2.57 / Share $2.34 / Share $2.01 / Share Second most common mistake – If you are not given EBIT, work back with whatever you are given through the existing structure. Whatever number you end up for EBIT, project it across the alternatives *Clicker Question* Which of the alternativ
More Less

Related notes for BU121

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.