FINANCIAL MANAGEMENT REVIEWER - indicates how risky the firm is and how much
of its operating income must be paid to bondholders
CHAPTER 6 rather than stockholders.
Assessment of the Firm’s Operating Efficiency & Profitability Ratios
Financial Position through FS Analysis
• These ratios give us an idea of how profitability
FS ANALYSIS – Is the process of extracting information the firm is operating and utilizing its assets.
from financial statements to better understand a
company’s current and future performance and Market book Ratios
financial condition.
• These ratios which consider the stock price give
BUSINESS ENVIRONMENT us an idea of what investors think about the
firm and its future prospects.
Business Environment refers to those aspects of the
surroundings of business enterprise, which affect or DuPont Disaggregation Analysis
influence its operations and determine its effectiveness.
• Formula that shows that the rate of return on
According to Keith Davis: equity can be found as the product of profit
margin, total assets turnover and the equity
“Business environment is the aggregate of all multiplier.
conditions, events and influence that surrounds and • It shows the relationship among asset
affects it” management, financial leverage management
Questions about a company’s business environment and profitability ratios.
are :
• Life Cycle
• Outputs
• Buyers
• Inputs
• Competition
• Financing
• Labor
• Governance
• Risk
FINANCIAL RATIO ANALYSIS
Is a comparison in fraction, proportion, decimal or What Is Dupont Analysis?
percentage of two significant figures taken from DuPont analysis is a financial ratio analysis that breaks
financial statements. down a company’s return on equity (ROE) into its
FINANCIAL RATIO ANALYSIS contributing factors to better understand its financial
performance. The ROE is decomposed into several key
• Liquidity Ratios metrics, such as profitability, leverage, and efficiency,
• Asset Management Ratios allowing a more informed evaluation of the company’s
• Debt Management Ratios financial health and future potential.
• Profitability
• Market book Ratios DuPont Disaggregation Analysis
FINANCIAL RATIO ANALYSIS
Liquidity Ratios
• These ratios give us an idea of the firm’s
ability to pay off debts that are maturing
within a year or within the next operating
cycle.
Asset Management Ratios
- These ratios give us an idea of how efficiently
the firm is using it’s assets. DuPont Disaggregation Analysis
Debt Management Ratios
- These ratios would tell us how the firm has
financed its assets as well as the firm’s ability to repay
its long-term debt.
• A company’s ability to generate positive future
net cash flows
• A company’s ability to meet obligations and pay
dividends
• A company’s need for external financing
• The reasons for differences between a
company’s net income
• And associated cash receipts and payments
• Both the cash and noncash aspects of a
company’s financing
• And investing transactions during accounting
period.
Financial Liquidity
Return on Assets Refers to the “measures to cash” of assets and
liabilities
Measures the return on investment for the company
without regard to how it is financed.
Return on Assets
• Profitability
- Gross Profit Margin
- Expense Management Financial Flexibility
Refers to a company’s ability to respond & adapt to
financial adversity and
Unexpected needs and opportunities.
• Productivity Financial Flexibility
Strong Flexibility
CHAPTER 7
• Take advantage of profitable investment even
CASH FLOW ANALYSIS in tough terms
Questions in Cash Flow Statement • Be free from worry about survival in poor
economic terms
• Is the company generating sufficient positive
cash flows from Free Cash Flow.
• Its ongoing operations to remain variable? • Is the amount of discretionary cash flow a
• Will the company be able to meet its financial company has.
obligations to • It can use to purchase additional investments,
• Creditors? retire debt,
• What expansion activities took place and how purchase treasury shares or simply add to its liquidity.
were those financed?
• Will the company be able to pay its customary CASH
dividend?
• Why did cash decrease even though a net
income was reports?
• To what extent will the company have to
borrow money in
• Order to make needed investment?
• What happened to the proceeds received from
the issuance of • Cash and Cash Equivalents
• Capital stock? CASH FLOW ACTIVITIES
Statement of Cash Flows
• Operating
• Investing
• Financing INDIRECT METHOD
OPERATING ACTIVITIES
INFLOWS
• Sales of goods
• Revenue from services
• Returns on interest earnings assets (interest)
• Returns on equity securities (dividends)
• Receipts from contracts held for dealing and
trading purposes
• Tax refunds unless identified with financing and
investing activities
OUTFLOWS
• Payments for purchases of inventories
• Payments for operating expenses (salaries, rent,
insurance, etc.)
• Payments for purchases from suppliers
• Other than inventory
• Payments for lenders (interest)
• Payments for taxes unless identified with
financial and investing activities
INVESTING ACTIVITIES
CHAPTER 8
OPERATING AND FINANCIAL LEVERAGE
• Represents the use of fixed costs items to
magnify the firm’s result.
1. Operating Leverage
2. Financial Leverage
OPERATING LEVERAGE
Operating leverage is a cost-accounting formula (a
financial ratio) that measures the degree to which a firm
or project can increase operating income by increasing
revenue. A business that generates sales with a high
gross margin and low variable costs has high operating
leverage.
CVP ANALYSIS
• It focused on how profits are affected by the
following elements
a. Selling Prices
b. Sales Volume
c. Unit Variable Costs
d. Total Fixed Cost
e. Mix of products sold
CVP ANALYSIS
BREAK EVEN POINT
Variable Cost
- any expenses that change based on how much
a company produces and sells.
Fixed Cost
- any expenses that remain the same no matter
how much a company produces.
Contribution Margin per unit or Marginal income per
unit
This is the excess of the unit selling price over unit of
variable costs and the amount each unit sold
contributes toward
1. Covering fixed cost
2. Providing operating profits
Contribution Margin per unit or Marginal income per
unit CVP Analysis for Revenue and Cost Planning
CONTRIBUTION MARGIN RATIO
What is the meaning of margin of safety?
• This is the percentage of contribution margin to
total sales. What is the definition of “margin of safety”? The margin
of safety
(MOS) is the difference between your gross revenue
and your
BREAK EVEN POINT Break-even point.
• Is the level of sales volume where total
revenues and total expenses are equal, that is Your break-even point is where your revenue covers
neither profit or loss. your costs
BREAK EVEN POINT But nothing more. In other words, your business does
not make a
Loss but it doesn’t make a profit either.
CHAPTER 9
FINANCIAL FORECASTING FOR STRATEGIC GROWTH
Introduction
BREAK EVEN POINT
Long Range Planning – means of systematically thinking
about the future and anticipating possible problems
before they occur.
Financial Planning – establishes guidelines for change • Asset Requirements
and growth in a firm- concerned with the major • Financial Requirements
elements of a firm’s financial and investment policies. • Additional Funds Needed
A financial forecast PROJECTED FS
is a fiscal management tool that presents estimated
Step 1. Forecast the income statement
information based on past, current, and projected
financial conditions. This will help identify future • Establish a sales projections
revenue and expenditure trends that may have an • Prepare the production schedule & project the
immediate or long-term influence on government • Corresponding production costs; direct
policies, strategic goals, or community services. materials, direct labor and overhead.
• Estimate selling & administrative expenses
• Consider financial expenses, if any.
What is the major purpose of financial forecasting?
• Determine the net profit
Financial forecasting is a vital tool that allows small Step 2. Forecast the Statement of Financial Position
businesses to predict future revenues, expenses and
capital needs. This is based on historical data, market • Project the assets that will be needed to
trends and projected company growth — all the support projected sales.
ingredients necessary for valuable business insights. • Project funds that will be spontaneously
generated (through accounts payable &
accruals) and by retained earnings.
What is financial forecasting for strategic growth? • Project liability & stockholders’ equity accounts
Financial forecasting is the process of using past that will not rise spontaneously with sales (e.g.
financial data and current market trends to make notes payable, long term bonds, preferred stock
educated assumptions for future periods. It is an & common stock)
important part of the business planning process and • Determine if additional funds will be needed.
helps inform decision-making. Effective forecasting
relies on pairing quantitative insight with creative
evaluation.
FINANCIAL PLANNING
• Formulates the way in which financial goals are
to be Achieved.
• A statement of what is to be done in the future. Step 3. Raising the additional funds needed.
• Guidelines for change and growth in a firm.
BENEFITS OF FINANCIAL PLANNING
[Link] a rational way of planning options or
• Target capital structure
alternatives.
• Effect of short term borrowing on its current
[Link] or Linkages between investment ratio
proposals are carefully • Conditions in the debt and equity markets
• Restrictions imposed by existing debt
Examined
agreements.
3. Possible problems related to the proposal
Step 4. Considering financial feedbacks.
projects are identified actions
• Apply the iteration processing using the
To address them are studied.
available financing mix unit AFN would become
[Link] and internal consistency are ensured. so small that the forecast can be considered
complete.
5. Managers are forced to think about goals & establish
priorities.
ILLUSTRATION
ELEMENT’SOF FINANCIAL PLANNING MODEL’S The Millennium Company has the following statements
which are representative of the company’s historical
• Economic Environment Assumptions average.
• Sales Forecast
• Profit Margin
• Dividend Policy
• Financial Policy
• Total Asset Turnover
• Pro forma Statements
Projected Statement of Financial Position
Solution: Supporting Computations:
Step 1: Forecast the Income Statement (1) Cash = 2.5% × 2.4M sales
The projected income statement will show the (2) Accounts receivable = 20% of 2.4M
following:
(3) Inventory = 37.5% × 2.4M
2,400,-2,000= 400/2000= .20, 1,200 x 1.20=
(4) No percentages are computed for fixed assets, notes
payable, long-term debt, ordinary shares and retained
earnings because they are not assumed to maintain a
direct relationship with sales volume. For simplicity,
depreciation is not explicitly considered.
(5) Accounts payable = 12.5% of 2.4M
(6) Accrued expenses = 0.5% of 2.4M
(8) Retained earnings = 300000 + 282100
AFN = 3500
Additional funds needed (AFN) – is the amount of
money a company must raise from external sources to
finance the increase in assets required to support
increased level of sales. Additional funds needed (AFN)
is also called external financing needed.
Additional funds needed – method of financial planning
assumes that the company’s financial ratios do not
change. In response to an increase in sales, a company
must increase its assets, such as property, plant and
equipment, inventories, accounts receivable, etc. Part
of this increase is offset by spontaneous increase in
liabilities such as accounts payable, taxes, etc., and part
is offset by increase in retained earnings.
d. Determine if additional funds will be needed by using
the following formula. CHAPTER 10
ADDITIONAL FUNDS NEEDED = REQUIRED INCREASE IN FORECASTING SHORT-TERM OPERATING FINANCIAL
ASSETS – SPONTANEOUS INCREASE IN LIABILITIES – REQUIREMENTS
INCREASE IN RETAINED EARNINGS
FINANCIAL PLANNING
The additional financing needed will be raised by
borrowing from the bank as notes payable, by issuing Involves making projections of sales, income and assets
long-term bonds, by selling new common stock or by based on alternative production and marketing
some combination of these actions. strategies and then deciding how to meet the
forecasted financial requirements.
CONTROL PROCESS
It moves to the implementation phase dealing with 1. It Budgets tend to oversimplify the real
feedback and adjustments process that is required situation and fail to allow for variations in
external factors. They do not reflect qualitative
A. To ensure that plans are followed variables.
B. To modify existing plans in response to changes 2. It is difficult to prepare a detailed budget for an
in the operating environment. organization that
BUDGET DEFINITION has never existed or for a new division, product, or
a budget is a plan. It takes into account how much department
money of an existing firm.
you make each month and helps you plan how much of 3. There may be lack of higher and lower
it to spend and on what. Your budget also reflects how management commitment because
much money you will need to put towards things like
bills, living expenses and other costs. of lack of understanding of the fundamentals of
budget preparation and
PURPOSE OF BUDGET:
utilization.
a description in quantitative - usually monetary - terms
of a desired future result. The process of preparing the 4. The budget is only a representation of future
budget requires management at all levels to focus on plans or a means to the goal
the future of the business entity.
of profitable activity and not an end in itself. It may
Purpose of Budget interfere with the
1. Defining broad objectives and goals and supervisor's style of leadership and can therefore
formulating strategies to achieve such stifle initiative.
objectives;
2. Coordinating the activities of the organization 5. Budget reports usually emphasize results, not
by integrating the plans of the various parts rreason
thereby pulling every one in the same direction; TYPE OF BUDGET
3. Allocating resources to those parts of the
organization where they can be used most • Operating Budget
effectively; • Financial Budget
4. Communicating management’s approved plans • Capital Investment Budget.
throughout the organization;
5. Uncovering and preparing for potential OPERATING BUDGET
bottleneck in the
operations before they occur; 1. Budgeted Income Statement
6. Motivating managers to achieve the desired A. Sales Budget
results; and B. Production Budget
7. Setting a standard or benchmark for evaluating
- Material cost budget
actual
performance. - Direct labor cost budget
ADVANTAGES - Factory Budget
[Link] forces planning and exposes situations in which - Inventory levels
plans of subcomponents are inadequate to attain the
total organization's objectives. C. Cost of Sales budget
D. Selling and Administrative expenses
[Link] allows a reiterative process to bring the goals of the E. Financial expenses budget
organization and the subcomponents into agreement.
FINANCIAL BUDGET
3. It provides a means of communicating organization
goals down through the organization and sub-unit 1. Budgeted Statement of Financial Position
operational limitations up though the organization. 2. Cash Budget
3. Budgeted Statement of Sources and Uses of
4. It provides a basis for financial planning, sub-unit Funds
coordination, resource acquisition, inventory policy,
scheduling and output distribution. Capital Investment Budget
T. It provides a basis by which activity can be monitored,
with actual results being compared to the planned
results.
LIMITATIONS: