BU121 Study Guide - Final Guide: Dog Walking, Mind Map, Physical Examination

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Sidra Khan’s Final Notes April 11 2012
Finance and CVP 24 marks
Chapter 12(16) Managing the Firm’s Finances – 4 marks
The Role of Finance and the Financial Manager
Financial Management: The art and science of managing a firm’s money so that it can meet its goals
Closely related to accounting
Roles include the following
Plan and monitor firms cash flows to ensure cash is available when needed by focusing on cash flows
Track day to day operational data such as cash collection and disbursement to ensure company has enough cash
Accountants* main function is to collect and present financial data, then financial managers use the statements and info
prepared by the accountants to make financial decisions
Responsibilities and Activities include
Financial planning preparing financial plan, which project revenues, expenditure and financing
Investment investing the firm’s fund in project and securities for high returns
Financing obtaining funding for the firm’s operations and investments and seeking best balance between debt and equity
The Goal: maximize the value of the firm to its owner consider both short and long-term consequences
Financial planning, and How organizations use funds
FINANCIAL PLANNING
Forecasting
Short term forecasts (operating plans): project revenues, cost of goods sold, and operating expenses over a one year
period
Long term forecasts (strategic plans): cover a period that is longer than a year, typically 2-10 years and take a broader view
of the firm’s financial activities.
Budgets
Cash Budget: Forecast the firms cash inflows and outflows, and help the firm plan for cash surpluses and shortages.
Capital budget: Forecast outlays for fixed assets. They usually cover a period of several years and ensure the business has
enough money to buy the plant and equipment it needs
Operating Budget: Combing sales and forecasts with estimates of production costs and operating expenses to forecast
profits
MANAGING FUNDS
Short term Expenses aka operating expenses, outlays used to support current selling and production activities
Cash Management: Assuring liquidity: The process of making sure that a firm has enough cash on and to pay bills as they
are due, and to meet unexpected expenses
o Companies will try to keep current account balance low due to low interest, so financial managers invest in low-
risk marketable securities
o Financial managers look for low risk investment that offer high returns, most popular securities; treasury bills,
certificates of deposits and commercial papers
o Also tries to shorten the time between purchase of inventory or service and collection of cash flows
Manage A/R: Managers goal is to collect A/R as fast as possible while offering credit terms attractive enough to increase
sales
o Involves setting credit policies, guidelines on offering credit and credit terms balancing act
Inventory: Purchase of inventory needed by the firm
o Want least inventory possible without harming production efficiency or sales, must work closely with production
to balance conflicting goals
Long Term Expenditures
Capital Expenditure: Investments in long lived assets that are expected to provide benefits extending past one year. These
include Building, Land, Equipment and machinery
o Why? To expand and to replace or renew fixed assets and to develop new products;
o Capital budgeting: process of analyzing long term project and selecting those that offer best returns
Obtaining short-term financing, and Raising long-term financing
Unsecured Short-term Loans : Loans for which the borrower does not have to pledge specific assets as security
Trade Credit: The extension of credit by the seller to the buyer between the time the buyer receives the goods or service
and when they pay for them. Buyer enters the books as A/P
Bank loans: usually used to finance seasonal businesses
o Line of Credit: An agreement between a bank and a business or an individual specifying maximum amount of short
term borrowing available to the firm or individual
o Revolving Credit Agreement: Allows the borrower to continue to have access to funds as long as the maximum has
not been exceeded
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Sidra Khan’s Final Notes April 11 2012
Commercial Paper: Unsecured sort-term debt issued by a financially strong corporation. Issued in multiples of $100,000 for
anywhere from 3-270 days
Secured Loans: Loans for which the borrower is required to pledge assets as collateral or security
Factoring - A firm sells it’s A/R outright to a factor, a financial institution (usually a chartered bank or commercial finance
company) that buys accounts receivable at a discount
Raising Long-Term Financing Debt versus Equity Financing
Debt Financing : Advantage deductibility of interest expense for income tax purposes, overall lowers cost
Disadvantage financial risk; if firm is unable to make scheduled interest and principle payment
Equity: form of permanent financing that places few restrictions on the firm, firm not required to pay dividends or repay the
investment gives common shareholders voting rights that provide them with voice in management, more costly than debt
Differences
Debt Financing
Equity Financing
Voice in Management
Creditors typically have none, unless borrowers
default on payments. Creditors may be able to
place restraints on management in event of default
Common shareholders have voting rights
Claim on income and
assets
Debt holders rank ahead of equity holders.
Payment of interest and principle is a contractual
obligation of the firm
Equity owners have residual claim on income
(dividends are paid only after interest and any
scheduled principle payments are paid and assets)
The firm has no obligation to pay dividends.
Maturity
Debt has stated maturity and requires repayment
of principle by a specified maturity date
The company is not required to repay the equity
which has no maturity date
Tax Treatment
Interest is a tax-deductible expense
Dividends are not tax-deductible and are paid from
after-tax income.
Trends
CFO Role continues to expand beyond ordinary finance responsibilities, joined top management in developing and
implementing firm’s strategic direction. More highly visible and active in companies than ever before
Weighing the Risks more companies consider enterprise risk management (ERM) approach to identifying, monitoring, and
managing all components of a company’s risk.
o Credit Risk: Exposure to a loss as a result of default on a financial transaction, or a reduction is a securities market
value due to decline in the credit quality of the debt issuer
o Market Risk: Risk Resulting from adverse movements in the level or volatility of market prices of securities,
commodities, and currencies
o Operational Risk : Risk of unexpected losses arising from deficiencies in a firm’s management systems and
procedures
Lecture Ratio Analysis (not including liquidity) and CVP 20 marks
Debt to equity short answer, but thinking applies to stability rations
When to use this tool: measures the relationship between the amount of debt financing (borrowing) and the amount of equity
financing (owner’s fund)
How to use it: calculated by dividing total liabilities by owner’s equity
What does it mean: indicates how much debt in ratio with equity, ratio above 100% means firm has more debt than equity
therefore lenders are providing more financing than the owners

 

Rule of thumb: <1:1
investors or shareholders? Have to pay off debtors, investors only get liquidation priority
Stability, profitability, and marketability ratios problems
Stability Ratios
Measure a company’s ability to meet it long-term obligations by measuring the relationship between components of a firms capital
structure - Shows a long term viability -Shows the results of the financial decisions that are made
capital structure = long term liabilities + owner’s equity finance through equity or debt
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Sidra Khan’s Final Notes April 11 2012
Leverage
When to use this tool: Measures degree of which a company has locked itself into fixed financial costs
implies that given change in sales will result in a greater change in profit
How to use it:


What does it mean: Implies that given change in sales results in greater chance of profit The Rule of thumb:
<5:1 low - Lower risk but higher cost of capital = lower return
5:1 1:1 average
>1:1 high - Higher risk but lower cost of capital = higher return
Advantage: Long term debt is cheapest source of capital because interest is tax deductible, and dividends are not
Higher return
Disadvantage: - long term debt = higher interest payments which is a legal obligation, where dividends are not
Greater Risk of insolvency
Example: Currently each firm has $3,000,000 in common stock Outstanding, and each needs to finance an additional
$1,500,000…
A 10% bonds
EBIT 1 500 000 interest of 150 000 = 1350 000
EBT taxes @ 50% (1350 000-675 000 = 675 000 EAT)
B equity with10% div. 1,500,000 - 0 = EBT of ,500,000 -
taxes @ 50% 750,000 = 750,000
interest cost $150,000 - tax savings $75,000 = real interest $75,000 / $1,500,000 debt = 5%, not 10% -- lower cost of capital
•if return on capital is 15%: A 15% return - 5% cost = 10% overall and B 15% return - 10% cost = 5% overall
•but what about Bs greater net profit?
Interest Coverage Ratio
When to use it: to figure the risk, can we pay the interest?
How to use it:


What does it mean: Helps asses risk characteristics of being highly levered
Rule of Thumb: >3x, but should look at long run trends in earnings and variability in earnings
Profitability Ratios
When to use it: measures how well the firm is using its resources to generate profit and how efficiently its being managed
How to use it:
Gross Profit margin Used to asses a firms financial health, Serves as the source of paying additional expenses and future saving,
measures what is left over out of sales after the direct cost of sales is deducted, compare between years


Net Profit margin aka return on sales, measure percentage of each sales dollar remaining after all expenses are deducted


Return on Investment/Equity Used to evaluate efficiency of an investment, Most important Profitability ratio for investor, compares
income to which shareholders are entitled to the finance they supplied, measured on an after tax basis, leverage increase t, taxes
decrease the he return on equity
= 

Growth measures the rate of growth of any Balance Sheet or Income Statement account
= present yrs “------- past yrs “------/ past yrs “------
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Document Summary

Chapter 12(16) managing the firm"s finances 4 marks. The role of finance and the financial manager. Financial management: the art and science of managing a firm"s money so that it can meet its goals. Plan and monitor firms cash flows to ensure cash is available when needed by focusing on cash flows. Track day to day operational data such as cash collection and disbursement to ensure company has enough cash. Accountants* main function is to collect and present financial data, then financial managers use the statements and info prepared by the accountants to make financial decisions. Financial planning preparing financial plan, which project revenues, expenditure and financing. Investment investing the firm"s fund in project and securities for high returns. Financing obtaining funding for the firm"s operations and investments and seeking best balance between debt and equity. The goal: maximize the value of the firm to its owner consider both short and long-term consequences.

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