Financial management (Study Guide, define, notes)

 

Financial management (Study Guide, define, notes)

v  Finance includes three areas

(1)    Financial management:

Deals with decisions making regarding maximizing stakeholder wealth by

Generating Capital from financial market

Invest into operations

Generate real Assets

Generate cash flows.

(2)    Capital markets: Financial markets and institutions, which deals with interest rates, stocks, bonds, government securities, and other marketable securities.

(3)    Investments: study of security analysis, portfolio theory, market analysis, and behavioral finance.

 

v  The Major goal of a firm

To maximize shareholder’s wealth (or firm’s long-run value)

v  Flow of cash between capital markets and firm’s operations

·       Firm sell the financial assets in to capital financial market for raising money

·       Firm used this money in the operation and purchase real Assets

·       Firm generate the cash from operation

·       Firm re-invest some of the part into the firm operation and remaining part return to the investors in the capital financial market.

 

v  Forms of business organization

 

·       Proprietorship: an unincorporated business owned by one individual

·       Partnership: an unincorporated business owned by two or more people

·        Corporation: legal entity created by a state

·       S Corporation: allows small business to be taxed as proprietorship or partnership Restrictions: no more than 100 shareholders; for small and privately owned firms

·       Limited Liability Company (LLC) and Limited Liability Partnership (LLP): Hybrid between a partnership and a corporation - limited liability but taxed as partnership, LLPs are used in professional fields of accounting, law, and architecture while LLCs are used by other businesses

 

v  Intrinsic value

It is an estimate of a stock’s “fair” value (how much a stock should be worth)

v  Market price

It is the actual price of a stock, which is determined by the demand and supply of the stock in the market.

v  Stock in equilibrium: when a stock’s market price is equal to its intrinsic value the stock is in equilibrium

v  Stock market in equilibrium: when all the stocks in the market are in equilibrium

v  stock is under-valued: When the intrinsic value of a stock is higher than the market price of the stock, we say that the stock in the market

v  stock is over-valued. When the intrinsic value of a stock is lower than the market price of the stock

v  Important business trends

·       Globalization

·       Improving information technology

·       Corporate governance

 

v  Business ethics

Standards of conduct or moral behavior toward its employees, customers,  community, and stockholders - all its stakeholders

Measurements: tendency of its employees, adhere to laws and regulations, moral standards to product safety and quality, fair employment practice, fair marketing and selling practice, proper use of confidential information, community involvement, and no illegal payments or practice to obtain business

v  Financial markets

 

·       Physical asset markets: are markets for real (or tangible) assets

·       Financial asset markets: are markets for financial assets.

·       Money markets:  are markets for short-term and highly liquid debt securities (less than one year)

·       Capital markets are markets: for intermediate and long-term debts and stocks (one year or longer)

·       Primary markets: are markets for issuing new securities

·       Secondary markets: are markets for trading existing securities

·       Spot markets: are markets for immediate delivery

·       Futures markets: are markets for future delivery even though the deal is made Today

·       In private markets: transactions are negotiated directly between two parties

·       Public markets: standardized contracts are traded on organized exchanges

·       Derivative markets: for derivative securities

·       A derivative security is a security whose value is derived from the value of an underlying asset. For example, futures contracts and option contracts

 

v  Financial statements:

·       Balance sheet

·       Income statement

·       Cash flow statement

·       Shareholder’s equity statement

· 

 

·       Balance sheet: a statement of a firms’ financial position at a point in time

Total Assets = Total Liabilities + Common equity (Shareholder’s equity)

Total Assets= Current Assets +Net fixed assets + Other Assets

Total Liabilities= Current liabilities + long-term debt

Common equity = common stock (c/s) + retained earnings (R/E)

Net working capital = current assets - current liabilities

 

·       Income statement: a report summarizing a firm’s revenues, expenses, and profits during a reporting period

Sales

(-) Operating cost except depreciation and amortization

(- ) Depreciation and amortization

________________________________________________

=Earnings before interest and taxes (EBIT)

(- ) Interest expenses

______________________________________________

=Earnings before Tax (EBT)

(-) Income tax

________________________________________________

Net income (NI)

 

·       Net income can be used for cash dividend and/or retained earnings

·       Earnings per share (EPS) = Net income/ number of shares outstanding

·       Dividend per share (DPS) = cash dividend / number of shares outstanding

·       Dividend payout ratio = cash dividend / Net Income

·       Retention ratio = retained earnings / Net Income

 

v  Cash flow statement: a report showing how things affect the balance sheet and income statement will affect the firm’s cash flows Cash flow statement has four sections: operating, long-term investing, financing activities, and summary on cash flows over an accounting period

 

v  Shareholder’s equity statement=

Last year’s end balance +  this year’s Retained earnings = Net income - Common stock cash dividend.

v  Financial ratio analysis

Evaluating a firm’s financial statement to predict the firm’s future performance

 

·       Liquidity ratios: show a firm’s ability to pay off short-term debt (the

relationship of a firm’s cash and other current assets to its current liabilities)

 

Current ratio = current assets / current liabilities

Quick ratio (acid test ratio) = (current assets - inventory) / current liabilities

 

·       Asset management ratios: measure how effectively a firm manages its assets

 

Inventory turnover = sales / inventory

Fixed asset turnover = sales / net fixed assets

Total asset turnover = sales / total assets

 

·       Debt management ratios: show how the firm has financed its assets as well as  the firm’s ability to pay off its long-term debt (how effectively a firm manages its debt)

 

Debt ratio = total debt / total assets

 

·       Profitability ratios: show how profitable a firm is operating and utilizing its

assets

Operating profit margin = EBIT / sales

Profit margin = net income / sales

Return on assets (ROA) = net income / total assets

Basic earnings power (BEP) = EBIT / total assets

Return on equity (ROE) = net income / common equity

The higher the returns, the better the performance

 

·       Market value ratios: relate stock price to earnings and book value and show what investors think about the firm and its future prospects

Price / earnings ratio (P/E ratio) = price per share / earnings per share

Market / book ratio = market price / book value.