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Reviewer - FM
Reviewer - FM
SIGNIFICANCE OF FM
Chapter 1 Broad Applicability
NATURE, PURPOSE, AND SCOPE OF FM - Principles of finance are applicable wherever there is cash
flow
- Cash Flow
NATURE OF FINANCIAL MANAGEMENT
o Central elements of financial analysis, planning,
- Managerial finance
- Corporate finance control, and resource allocation decisions
- Business finance o Fin health depends on its ability to generate
- Decision making process sufficient amounts of cash for payments
- Concern with planning, acquiring, and utilizing funds - FM – equally applicable to all forms of business
- Process for and analysis of making fin decisions o Sole traders
o Partnerships
FINANCE o Copro
- Larder discipline o NPO
- Under nito ang FM
- Body of facts, principles, theories relating to raising and Reduction of Chances of Failure
using money - Strength of business lies in its financial discipline
- FM – primordial which enables the other functions to be
GOAL OF FM effective in achievement of org goals
- VAGUE - Make money and add value for the owners
Measurement of Return on Investment
- Maximize the current value per share of the existing - FM – study risk-return perception of owners and the time
stock or ownership in a business firm value of money.
o Shareholders – residual owners o Considers amount, risk attached, and timing of
If residual portion is growing, others cash flows expected to be generated for the
benefit too benefit of owners
o Learn how to identify investments, arrangements o Time and Risk with Cash flow = ROR required
and distribute satisfactory amount of share in
profits that favorably impact value of share REL BETWEEN FM / ACCNTG / ECON
FM ACCNTG
o FManger should best serve the owners by Help managers to make Discharges the function of
identifying g/s that add value to the firm business decisions (use of cash, systematic recording of trans
attainment of efficient ope, relating to the firm’s activities in
SCOPE OF FM allocation of funds among the books, summarizing, and
- TRADITIONAL: FManager will perform: assets, effective financing of inv. presenting in the FS
o Procurement of short-term & long-term funds from And ope)
financial institutions Capital Budgeting techniques Its info is used in making
o Mobilization of funds thru fin inst. Stat and math models financial decisions
Equity Shares Computer Applications
Pref Shares Key function
Debentures Control on finances
Bonds / Notes Fin function can be
o Compliance w/ legal and regulatory provisions decentralized with adoption of
relating to funds procurement, use, and distri and responsibility accntg – for
coordination with accntg function speeding up of info
FM is distinct and separate rather than an extension of accntg
Globalization Centralization / Decentralization of Accntg and Finance
- Caused to integrate the ntl economy with global economy depends on attitude of top-level management
- Created new fin environment
- Led to total reformation of finance function and FM ECONOMICS
responsibilities Can make better decisions if Econ Theory – seek the best
basic economic principles will allocation of resources
- MODERN: FM is expected to analyze the business firm be applied
and determine the ff: FManagers responsible to find Supply
o Total funds reqs of the firm the best and least expensive – control of production costs
o Assets / resources to be acquired sources of funds and invest into Hold cost down so prices can be
o Best pattern of financing the assets the best efficient mix of assets set at competitive levels
FManagers – better if they Demand
TYPES OF FINANCING DECISIONS understand how to respond to - Changes
Investment Financing Dividend changes of supply, demand,
Determine how Assert that the mix Determination of prices
scarce resources in of debt and equity quantum of profits Understanding changes in
terms of funds of chosen to finance to be distributed to demand allows FM to take
business are inv should the owners, advantage of market condi
committed to maximize the value frequency, and Must be familiar w/ micro and
projects. of inv made amounts retained. macroeconomic env aspects
Choose those inv Consider cost of Retained – Thru microecon: helps FM in Microeconomics – econ
with positive net finance available appropriations for decisions like: decision of indi
PV, and risks attached financing its future Pricing
growth Taxation
Consider the ROR Consider principle Determination of capacity and
that exceeds of fin leverage / ope levels
marginal cost trading on equity Breakeven analysis
Consider Reduced cost of CVP
profitability of each capital – overall Capital Structure decisions
project proposal weighted ave cost Dividend Distri Decisions
of capital and Profitable Product-Mix etc.
minimization of Gov’ fiscal and monetary Macroeconomics – looks at
risks will lead to policies influence strat financial economy as whole
profitability planning
FM should look macroecon
factors:
inflation,
real interest rates, Long-Term
level of economic activity - Growth in the market value of the equity shares thru
trade cycles maximization of the firm’s market share and sustained
market competition growth in dividend to shareholders
etc. - Survival and sustained growth of the firm
FM PUBLIC RESPONSIBILITY Competing Viewpoints what the Primary Fin Obj should be:
Plan future growth and direction of a firm which can affect the - Owner’s perspective
community in which it is based o Only appropriate goal is to maximize SH / owner’s
Behave ethically and must follow the law and other society-imposed wealth
constraints Thru providing sh with target attainable
FM must reconcile social and environmental reqs with profit-making combi of:
motive Dividends per share
maintaining social needs when pursuing the goal of maximizing the Share price appreciation
wealth of the form – primary responsibility
- Stakeholder’s perspective
o Emphasized social responsibility over profitability
Chapter 2
RELATIONSHIP OF FINANCIAL OBJECTIVES TO Financial practitioners believe that manager’s primary
ORGANIZATIONAL STRAT AND OBJ responsibility should be to maximize sh’ wealth and give only
secondary consi to stakeholder’s welfare
OBJECTIVES OF FIRMS
To be a leader in technology in the industry, Adam Smith (18th century economist)
To achieve profits thru a high-level manufacturing efficiency - Argued: in capitalism, an individual pursuing his own interest
To achieve a high-degree of customer satisfaction tends also to promote the good of his community
- Acting thru compe and free price system, only those most
- In measuring perf/ degree of control: efficient and beneficial to society as a whole would survive
o Necessary to set obj in more precise / quantitative
terms within a time frame Wealth Maximization Goal is advocated on the ff:
1. Considers risk and time value of money
STRATEGIC FM 2. Considers all future cash flow, dividends, and EPS
Strategic Planning – long-range in scope 3. Suggest the regular and consistent dividend payments to
- Concept base on obj and assessment of present situation SHE
4. Fin decisions are taken with a view to improve the capital
Strategic Financial Planning appreciation of the share price
- Financial Planning 5. Maximization of firm’s value is reflected in the market price of
- Financial Forecasting share since it depends on sh’s expectations regarding
- Provision of finance profitability, long-run prospects, timing difference of returns,
- Formulation of finance policies risk distri of returns of the firm
- Enable the firm to:
o judicious allocation of funds Optimal allocation of the society’s resources should result in
capital formation and growth of the economy which should
o capitalization of relative strengths
ultimately lead to maximization of economic welfare and society.
o mitigation of weaknesses
o identification of shifts in envi RESPONSIBILITIES TO ACHIEVE THE FIN OBJ:
o counter possible actions of competitor etc Investing Financing Operating
- Needed to counter the uncertain and imperfect market Allocate funds wisely Ways in financing Concerns Working
conditions and highly competitive business env. within firm firm needs to Capital management
- Should concentrate on multidimensional obj like: support (Short term A and L)
o Profitability investments
o Expansion growth Asset Mix – amount Good knowledge of Day-to-day
o Survival of pesos invested in costs of raising responsibility
o Leadership etc current and fixed funds, hedging risk
assets
Responsibility of FManager: Return > Hurdle How and where to Receipts and
- Provide basis and info for strategic positioning of the firm Rate (min raise money disbursements of
- Should take the inv and fin decisions in consonance with the acceptable return) Debt-equity mix cash
corp strategy
Decisions of FM Issues that have to
Strategic / Business Plan - Reflects how it plans to achieve its goals be resolved
and obk Eval and selection of Determination of Level of cash, secu,
capital inv proposal financing pattern of and inventory that
Historical FS SMLterm funds reqs should be kept on
- provide insights into success of company’s strat plan hand
- Important input of planning process Determination of Determination of best Credit policy
- Reveal areas that are less effective amnt of funds that capital structure or
- Provide info to help managers dev remedial action firm can commit for mixture of debt&
inv equity finan
Understanding a company’s strat plan helps focus our analysis of Prioritization of inv Procurement of funds Source of short-term
the company’s short and long-term financial obj by placing them alternatives financing
in proper context Funds allocation and Arrangement with Financing purchases
rationing bankers, suppliers of goods
SHORT AND LONG-TERM FIN OBJ OF BUSINESS ORG Determination of Eval of alternative
Short and Medium Term levels of inv in sources of funds
- Maximization of return on capital employed or return on inv working capital
- Growth in EPS and price/earnings ratio thru maximization of Determination of fixed
assets to be acquired
net income and adoption of optimum level of leverage
Asset replacement
- Minimization of finance charges
- Efficient procurement and utilization of short-term, medium- Purchase / Lease
term, long-term funds
Restructuring, Treasurer Controller
mergers and acqui Cash and Credit Cost and Fin Accounting
Securities analysis Financial Planning Tax Payments
and portfolio mngt Capital Expenditures Management Info System
ENVIRONMENTAL “GREEN” POLICIES AND THEIR IMPLICATIONS
FOR THE MGT OF THE ECONOMY AND FIRM
- External Cost Cases
o Gov may be able to improve accountability and
protect rights more efficiently by regulation
- Courts help owners protect their property against invasions
by others, including polluters.
- Gov regulation is an alternative method of protecting the
environment
- Regulatory approach has a number of deficiencies
o Gov regu sought precisely because the harms are
uncertain and the source of the problem cannot be
demonstrated uncertain din yung benefits or
reducing them
o Regu overrides info and incentives provided by
market signals
o Regu allows special interests to use political power
to achieve obj that may be quite different from env
goals
- Market-like schemes can reduce the costs of reaching a
chosen environment goal, but the programs provide little help
in choosing the right goal.
Other Areas
- Could noy operate without funds
CORPORATE GOVERNANCE
- Process of monitoring managers
- Aligning their incentives with the SH goals
- Managers
o Handle day-to-day ope
o They know that their work is mostly unknown to
investors
Lack of supervision = need for
monitors
- People / Org that help monitor corp Activities:
Appointed to
represent
SH’s interest
Financial Decision making should take a longer-term perspective
- Why? Because in the long run, increased prices of the firm’s
stock reflect an increase in the value of the firm.
FINANCIAL STATEMENTS
Articulation – linkage of 4 different statements across time
RE / Earned Capital / Reinvested Capital– updated each period and
reflect cumulative income not yet distributed to SH
- Ending RE = Beg + NI - Dividends Chapter 6
Net Income – explains all the change in RE reported in SSHE
Working Capital – currents assets (these assets turn over / used and ASSESSMENT OF FIRM’S OPERATING EFFICIENCY
then replaced throughout the yr) AND FinPos THRU FS ANALYSIS
Net Working Capital – CA less CL
Net Operating Capital – CA less non-interest-bearing CL FINANCIAL STATEMENT ANALYSIS
- Process of extracting info from FS to better understand a
1. SFPos company’s current and future perf and financial education.
- At a point in time - Involves:
- Linked with SCI via RE o Comparing the firm’s perf to that of other firms in
- 2 Ways to Finance its Assets the same industry
o Owner / Equity Financing o Evaluating trends in the firm’s fin pos over time.
from SHE - Help managers identify deficiencies and take corrective
along with profit retained actions.
no obligation for repayment
o Nonowner / Liability / Creditor / Debt Financing ANALYZING THE BROADER BUSINESS ENVIRONMENT
from banks / creditors / suppliers 1. Life Cycle
borrowed money 2. Outputs
entails legal obligation to repay with 3. Buyers
severe consequences if failed 4. Inputs
5. Competition
o Both hold claims on assets 6. Financing
o Investing = Financing 7. Labor
o A = L+OE 8. Governance
9. Risk
- We must assess the broader business context in which a
- Investing Activities (A)
company operates as we read and interpret its FS.
o Represented by assets
- FS Analysis can only be effectively undertaken within the
o Assets are financed by OF and NONOF
framework of a thorough understanding of the broader forces
- Financing Activities (L & SHE) that impact company performance.
o Assets must be paid for
BASICS OF PROFITABILITY ANALYSIS
- FS are used to improve firm’s stock price, by lenders to eval
2. SCI credit if able to pay, by security analysis to forecast earnings,
- Over a period of time dividends and stock prices.
- Linked with SCI via RE
- Measures the change in company value as measured in LIMITATIONS OF FS ANALYSIS
accordance with Fin Rep standards 1. Infos are only indicators of degrees of profitability and
- List amount for rev / sales, expenses and OCI fin strength. Info are not absolute measures of perf in all
- COGS / COS – expense account areas.
- Gross Profit / Gross Margin = Rev less COGS 2. Inherent limitations in accntg data the analyst works
with.
- Operating Activities a. Variation and lack of consistency in the application
o Use resources to produce, promote, sell p/s of accntg principles
o Input markets (suppliers / labor) Output b. Too condensed presentation of ddata
Markets (customers) c. Failure to reflect change in purchasing power
Input – generate most expenses 3. Limitations of the perf measures or tools and techniques
(inventories, salaries, mats, logistics) used in the analysis.
Output – generate revenue / sales to a. Quantitative measures – not absolute measures
customers b. Timing of transactions / use of ave – can affect the
Also generate expenses such results obtained in applying the techniques in Fin
as marketing and distri Analysis
- Effective management = increase profitability of company 4. Potential for mgt to influence the outcome of FS to
- Business models = play large part in determining appeal,
profitability
FINANCIAL RATIO ANALYSIS
3. SSHE
- Comparison in fraction, proportion, decimal or percentage of - Measures movement and utilization of current resources to
2 significant figures from FS. meet ope requirements
- Expresses direct rel between 2 or more quantities in the
SFPos and SCI 7. Payable TO
- Measures efficiency of company in meeting trade payable
1. Liquidity Ratios
o ability to pay off maturing debts within 1 yr or next 8. Operating Cycle
ope cycle - Measures length of time required to convert cash to finished
2. Asset Mgt Ratios goods, then to receivable and then back to cash
o How efficiently the firm is using its assets
o To keep costs low, net income high 9. Days Cash
3. Debt Mgt Ratios - Measures availability of cash to meet ave daily cash req.
o How firm financed its assets - Excess of ope cash flow over basic needs
o Ability of firm to repay its long-term debt
o Indicates how risky the firm & how much its ope 10. Free Cash Flow
- Excess of ope cash flow over basic needs
income must be paid to bondholders rather than
stock.
11. Investment or Assets TO
4. Profitability
- Measures efficiency of firm in managing all assets
o In ope and utilizing its assets
o Combine asset and debt mgt categories
12. Sales to Fixed Assets (Plant Assets TO)
o Show their effects on return on equity - Test roughly the efficiency of mgt in keeping plant properties
5. Market Book Ratios employed
o Consider stock price and give us an idea of what
investors think about firm and future prospects. 13. Capital Intensity Ratio
- Measures efficiency of firm to generate sales thru
ROE employment of its resources
- Tends to be the main focal point
- High ROE depends on maintaining liquidity, on efficient asset DEBT MGT RATIOS
mgt, and on the proper use of debt Ratios used to Evaluate Long-term FinPos or Stability / Leverage
1. Debt Ratio
LIQUIDITY RATIOS - Show proportion of assets financed with debt
Ratios Used to Evaluate Short-Term Fin Pos
(Short-term Solvency and Liquidity) 2. Equity Ratio
1. Current Ratio - Indicates proportion of assets provided by owners
- Primary test of solvency to meet current oblig from CA as a - Reflects financial strength and caution to creditors
going concern.
- Measure of adequacy of working capital 3. Debt to Equity Ratio
- Measures debt relative to amounts of resources provided by
2. Acid-test ratio / Quick Ratio owners.
- More severe test of immediate solvency
- Test of ability to meet demands from CA 4. Fixed Assets to Long-term Liabilities
- Reflects extent of investment in long-term assets financed
3. Working Capital to Total Assets from long-term debt
- Indicates relative liquidity of TA and distribution of resources
employed. 5. Fixed Assets to Total Equity
- Measures proportion of owner’s capital invested in fixed
4. Working Capital (CA – CL) assets
- Measures investment in long-term capital assets
5. Cash Flow
- Measure of short-term liquidity by considering as cash 6. Book Value per share of OS
resources (numerator) cash + CE + cash flow from ope acts. - Measures recoverable amount in the event of liquidation if
assets are realized at their BV.
6. Defensive Interval Ratio
- Measures length of time in days the firm can ope on its 7. Times Interest Earned
present liquid resources. - Measures how many times interest expense is covered by
ope profit
ASSET MGT RATIOS
Ratios used to Evaluate Asset Liquidity and Mgt Efficiency 8. Times Preferred Dividend Requirement Earned
1. Trade Receivable TO - Indicates ability to provide dividends for preference SH.
- Velocity of collection of trade accnts and notes
- Test of efficiency of collection 9. Times Fixed Charges Earned
- Measures coverage capability more broadly than times
2. Ave Collection period or no. of Days Sales Uncollected interest earned by including other fixed charges.
(Day Sales Outstanding)
- Eval liquidity of AR and the firm’s credit policies PROFITABILITY
Ratios used to Measure Profitability and Returns to Investors
3. Inventory TO 1. Gross Profit Margin
a. Merch TO – efficiency in managing & selling invent - Measures profit generated after consideration of COGS
b. FGI – same
c. Goods in process Inventory – same 2. Operating Profit Margin
d. Raw Mat TO – no. of times RMI was used and - Measures profit generated after consideration of ope cost
replenished during the period
e. Days Supply in inventory – ave no. of days to 3. Net Profit Margin
sell or consume the ave. inventory. - Measures profit generated after consideration of all expenses
4. Working Capital TO and revenues
- Indicates adequacy and activity of working capital
4. Cash Flow Margin
5. Percent of each CA to TCA - Measures ability of the firm to translate sales to cash
- Indicates relative investment in each CA
5. Rate of return on Assets
6. Current Assets TO - Measures overall efficiency of the firm in managing assets
and generating profits
- Reports the amount of cash that the firm generated and
6. Rate of return on Equity distributed during a particular period.
- Measures rate of return on resources provided by owners
- Its bottom line equals the change in cash on SFPos from
7. Earnings per share the previous year’s cash account balance
- Peso return on each OS.
- Indicative of ability to pay dividends - Reconciles the Income Statement and noncash statement of
Financial Position items
8. Price/Earnings Ratio
- Measures relationships between price of OS in open market
and profit earned on a per share basis USEFULNESS OF SCF
1. Creditors examine it. They are concerned about being paid
2. Analysts use cash-flow-based measures of income. They
9. Dividend Payout question accrual-accounting-based NI,
- Shows percentage of earnings paid to SH PAS 7 States that the info in SCF is used with info in the other FS,
should help users to assess and evaluate:
10. Dividend Yield 1. Company’s ability to generate positive future net cash flows
- Shows the rate earned by SH from dividends relative to 2. A company’s ability to meet its obligations and pay dividends
current price of stock 3. A company’s need for external financing
4. The reasons for differences between a company’s net
11. Dividends per share income and associated cash receipts and payments
- Shows portion of income distributed to SH on a per share 5. Both the cash and noncash aspects of a company’s financing
basis and investing transactions during the accounting period
12. Rate of return on average CA Other info that can be Obtained from CFS:
- Measures the profitability of CA invested
Financial Liquidity
- Measures to cash of assets and liab
- Assessment thru current cash debt coverage ratio
1. Profit Margin
o To increase:
- Indicates whether the company can pay off its CL from its
o Increase Gross Profit Margin | Reducing its ope in a given yr
expenses, other than cost of Sales
Financial Flexibility
2. Asset Turnover - Company’s ability to respond and adapt to financial adversity
o To increase: and unexpected needs and opportunities
o Increase Sales volume with no increase in - Cash Debt Average Ratio – provides info about financial
assets flexibility
o Reducing the Asset Investment without
reducing sales
3. Financial Leverage
- Indicates whether the company to repay liab from net cash
ROE AND ROA provided by operating activities, without having to liquidate
- Maximized by a joint focus on both profitability and the assets employed in its ope.
productivity
Free Cash Flow
1. Profitability - Amount of discretionary cash flow a company has.
- Measured by profit margin - It can use this cash flow to:
o Gross Profit Margin – measures GP for each sale o purchase additional investments
o Expense Management – reducing manu and o retire its debt
admin OH expense to increase profitability o purchase treasury shares
2. Productivity o Add to liquidity
- Volume of sales resulting from invested in assets
- If declined, solutions are:
o Increase sales from existing asset base, or
o Decrease inv in assets w/o reducing sales volume
Chapter 7
CASH FLOW ANALYSIS Classification of Cash Flow Activities
Operating Investing Activities Financing
FIRMS NEED CASH
Activities Activities
- Not an accounting profit to pay obligations
Key indicator of the Represent the Useful in predicting
- To fund firm’s ope and growth
extent to which the extent to which claims on future
- Compensate firm’s ultimate owners
ope of the enterprise expenditures have cash flows by
have generated been made for providers of capital
CASH FLOW ANALYSIS
sufficient cash flow resources intended to the enterprise
to repay loans, to generate future
maintain the ope income and cash
capability, pay flows
dividends, make
new investments
OPE:
Indirect Method:
INVESTING
FINANCING
DIRECT METHOD