Financial management notes

Financial accounting

Definition: Process of recording, summarising, and reporting financial transactions to provide a historical view.

Objective: Prepare accurate and consistent financial statements (e.g., balance sheet, income statement) that reflect current and past transactions.

Decision-making role: Limited decision-making; focuses on reporting financial information.

Time horizon: Past and present transactional data.

Key tools/Reports: Balance Sheet, Income Statement, Cash Flow Statement, Statement of Equity.

Scope and Users: They are carried out by internal agents, but the targets may be both internal and external recipients (e.g. tax authorities, investors, ...).

Financial analysis

Definition: Involves evaluating financial data to assess performance and make forecasts.

Objective: Analyse financial data to assess (make a diagnosis) on profitability, liquidity, and financial health.

Decision-making role: Supports decision-making through data analysis and financial insights.

Time horizon: Uses historical data to make diagnoses and create forecasts for the future.

Key tools/Reports: Ratios (liquidity, profitability), trend analysis, cash flow analysis, forecasting models.

Scope and Users: It can be done by internal or external agents and can be targeted for internal or external audiences.

Financial management

Definition: Focuses on managing the finances of a company for future growth and stability.

Objective: Optimise the financial performance of the company and maximize the firm’s value.
Decision-making role: Actively involved in making strategic financial decisions.

Time horizon: Focused on the present and future financial planning. Past decisions are not relevant to the decision process.

Key tools/Reports: Budgeting, capital structure planning, working capital management, dividend policy.

Scope and Users: Internal decision-making related to investments, funding, and budgeting.

ACCOUNTING REPORTING:

Balance sheet

Purpose: Shows the company’s financial position at a specific point in time.

Formula: Assets = Liabilities + Equity

● Assets: What the company owns

● Liabilities: What the company owes

● Equity: Owners’ claim after liabilities are paid

Income statement / Profit & Loss (P&L)

Purpose: Shows the company’s financial performance over a period (profit or loss).

Formula: Revenue - Expenses = Profit

● Revenue: Money earned from sales or services

● Expenses: Costs incurred to earn revenue

– OPEX (Operating Expenses): Day-to-day business costs (salaries, rent, utilities)

– DA (Depreciation & Amortisation): Non-cash costs representing asset usage or intangible asset value reduction

● Profit:
 – Gross profit: Revenue – COGS (Cost of goods sold)
– Operating profit (EBIT): Gross profit – Operating expenses
– Net profit: Profit after all expenses, taxes, and interest

Cash flow statement

Purpose: Shows cash movement in and out of the company over a period.

● Cash flow from operations (CFO): Cash earned or spent from the company’s main business activities (selling products/services, paying salaries, utilities).

● Cash flow from investing (CFI): Cash spent or received from buying or selling long-term assets (machines, buildings, investments).

● Cash flow from financing (CFF): Cash received or paid for funding the business (loans, repaying debt, issuing or buying back shares).

Shareholders equity statment

Purpose: Shows changes in owners’ equity over a period.

Value (Intrinsic Value):

● Subjective; varies by person.

● Products/Services: Usefulness + joy/utility.

● Financial Assets: Expected future worth (cash/returns).

● Firms: Worth = future cash + optional factors (e.g., social responsibility).

Price (Market Value):

● Money paid to acquire something.

● People buy if perceived value ≥ price.

Other Uses of “Value”:

● Market Value: Price.

● Book Value: Accounting value.

● Liquidation Value: Immediate sell price.

Firm’s Value:

● Defined as the firm’s ability to create value for shareholders.

● Forward-looking: Focus on:

-Future sales potential

-Cost reduction & profitability
-Investment decisions to grow business

● How shareholders extract value:

-Dividends
-Capital gains (selling shares at higher price)

Short-term

This usually means <1 year

The company's needs focus primarily on maintaining financial liquidity and operational efficiency to ensure smooth day-to-day operations.

Long-term

This usually means >1 year

(some define medium-term as 1-10 years and long-term as a period longer than that).

In the longer term, the company's needs focus on sustainable growth, strategic planning and overall financial health.
Firm’s Liquidity Position:

Liquidity shows if a firm can pay its short-term debts (within 1 year) and stay stable.

Current Assets: things that turn into cash within 1 year (cash and cash equivalents, accounts receivable, inventory).

Current Liabilities: debts to be paid within 1 year (accounts payable, accrued wages/taxes, short-term bank loans).

Net Working Capital: Current Assets – Current Liabilities.

Current Ratio: Current Assets ÷ Current Liabilities.

Above 1 = Safe
Around 1 = Okay but tight
Below 1 = Danger

Firm’s cash flow

Cash flow from operating activities reflects the company's ability to generate cash.

Cash flow from:

1. operating activities
2. investing activities
3. financing activities

Change in cash and equivalents = (1) + (2) + (3)

Firm’s solvency position

It refers to whether it can continue its operations in the long run, considering its ability to pay off all debts as they mature.

Ratios:
 liabilities liabilities
proportion of assets that are financed by
● Liabilities to Assets assets
debt

● Debt to Equity
&ebt
ratio indicating the relative proportion
how much of equity is
financing by
Equity
Long tern debt tern debt
● Long-term debt to Assets assets
proportion of assets
financing by long

Type of ratios

Liquidity ratios; firm’s ability to pay off debts that are maturing within a year.

Asset management ratios; how efficiently the firm is using its assets.
Benefits of ratios
Debt management ratios; how the firm has financed its assets as well as the firm’s
ability to repay its long-term debt.
·
trends

Profitability ratios; how profitably the firm is operating and utilising its assets.
·

comparability
· simplifies complex data
Market value ratios; what investors think about the firm and its future prospects.

Asset management ratios

Show if assets are appropriate, too high, or too low for current/future sales.

Too many assets → need more capital → higher costs → lower profit.

Too few assets → can’t support sales → missed profit.

Goal = find the right balance → ratios help decide.

Inventory Turnover Ratio = COGS ÷ Average inventory

It measures how efficiently a company manages its inventory by showing how

many times inventory is sold and replaced over a specific period, usually a year.

Fixed Assets Turnover Ratio = Revenue ÷ Tangible non-current assets

Measures how efficiently a company uses its fixed assets, like property, plant,
and equipment, to generate sales. Capital-intensive businesses have higher ratios.

Limitations: important
● Tangible assets are reported at historical cost – depreciation.

● Newer assets = higher values.

● In inflation, historical values distort comparisons between periods/industries.

Total Assets Turnover Ratio = Revenue ÷ Total Assets

It indicates the amount of sales produced for each euro of assets owned by the company.

(Same limitations as in previous one)

Day Sales Outstanding = Receivables ÷ Revenues/365

The average length of time the firm must wait after making a sale before receiving cash.

Profitability ratios

Operating Margin = EBIT ÷ Revenues

Measures what portion of revenues represents operating profit remaining after covering all operating costs, but before deducting interest and taxes.

Profit Margin = Net Incomes ÷ Revenues

Shows how much of each € of revenue remains with the company as net profit after all expenses have been covered.

Return on Assets (ROA) = Net Incomes ÷ Assets

How much net profit the company generates from each € of assets it holds.

Return on Equity (ROE) = Net Incomes ÷ Equity

It measures how much net profit the company generates from every euro of shareholders’ equity.

Return on Invested Capital (ROIC) = NOPAT (Net Operating Profit After Tax) ÷ Invested Capital (Debt + Equity) OR EBIT × (1 − tax rate) ÷ Invested Capital (Debt +
Equity)

Measures the total return that the company has provided for its investors.

Dupont Analysis

ROE = Profit Margin × Total Assets Turnover × Equity Multiplier

(Net Income ÷ Equity) = (Net Income ÷ Revenues) × (Revenues ÷ Total Assets) × (Total Assets ÷ Equity)

Allows us to see why ROE is higher or lower than the industry average. Differences can come from profit margin, asset efficiency, or financial leverage. Helps
identify strengths and weaknesses in operations, asset management, and funding structure.

The ROE of a project must be combined with its size and risk to determine its impact on shareholder value

Value based management

Corporate scope: Corporate scope defines what businesses a firm will operate in and where geographically it will act. Some firms intentionally keep a narrow
scope so managers can focus on a limited set of activities instead of many unrelated ones. Whatever scope is chosen must be logical and aligned with the firm’s
capabilities.

Corporate objectives: Specific qualitative and quantitative objectives that operating managers are expected to meet and that, usually, are linked to a reward
system.

Corporate strategies: Strategies/Approaches developed for achieving a firm’s goals.

These three things combine into Strategic Plan:

● Long-term vision and overall direction of the firm

● Usually prepared for 3, 5, or 10 years
● This includes the mission, values, and main goals for the near future, which might consist of entering a new market, creating a new business line, and
changing the business model to make it more sustainable.
● Defined by the high-level management, meaning the Executive Commission, the Board of Directors, and the Senior Management.
● It is the Guidance for the firm!

Operational Planning
● Provides detailed guidance to implement corporate strategy and achieve objectives.
● Time horizon: any, but often 5 years.
● Includes: responsibilities for each function, deadlines for tasks, sales and profit targets
● Focus: day-to-day activities and short-term goals aligned with strategy (e.g., quarterly sales targets by product/region).
● Defined by: middle management, department heads, team leaders, operational staff.

Integrated Management System

Uses internal and external audits to check performance and find areas for improvement. It looks at management quality, service, environmental impact, health
and safety, and information security. Procurement and supplier management are also included in these audits. The system helps ensure continuous improvement
across all key business areas.

Cost Volume Profit (CVP)

It's an essential financial tool that supports management decisions and financial planning.
• understand the relationship between costs, sales volume, and profit
• can make informed decisions about price policy, production levels, cost management, and how it impacts profitability.

Sales:
● Sales Volume: number of units sold
● Sales Price per Unit
Costs:
● Variable Costs per Unit: costs that change with production/sales (e.g., raw materials, shipping, electricity)
● Fixed Costs: costs that remain constant regardless of production/sales (e.g., rent, equipment)
● Contribution Margin: Sales Price per Unit − Variable Cost per Unit; represents the amount available to cover fixed costs and generate profit

The break-even point

Represents the number of units that need to be sold—or the amount of sales revenue that has to be generated—to cover the costs required to make the product.

Breakeven point (units) = Fixed Costs ÷ Contribution Margin per Unit

Breakeven point (€) = Fixed Costs ÷ Contribution Margin ratio

Short-Term Financial Planning
Short-term financial planning ensures a firm has enough cash to meet obligations within the next year. Its purposes include:

● Maintaining daily operations by covering operating costs, payroll, and immediate expenses.
● Preventing cash flow problems and avoiding missed payments.
● Supporting the strategic plan and allowing flexibility for unexpected opportunities or challenges (e.g., market shifts, demand changes, unplanned costs).
● Avoiding excessive debt and reliance on high-interest borrowing.
● Providing stability as a foundation for long-term growth.

Working capital: current assets are often called working capital because these assets “turn over” (i.e.,
are used and then replaced during the year)

Net working capital: is defined as current assets minus current liabilities.

Cash Conversion Cycle (CCC)

Measures the time funds are tied up in working capital—from paying for inputs to collecting cash from sales.

(CCC) = (Inventory Conversion Period) + (Receivables Collection Period) − (Payables Deferral Period)

Inventory Conversion Period: time to turn raw materials into finished goods and sell them.

Average Collection Period (DSO): time to collect cash from customers after a sale. CcC
"

Payables Deferral Period: time between purchasing inputs and paying suppliers.

+
Inventory Conversion Period = Inventory ÷ Cost of Goods Sold per Day

Average Collection Period (DSO) = Receivables ÷ Sales per Day _

Payables Deferral Period = Payables ÷ Cost of Goods Sold per Day

DPO)

Cash Budget
Detailed plan projecting future cash inflows and outflows over a set period (monthly, quarterly, or yearly).

Uses:
○ Monthly budget → plan cash needs for the year.
○ Daily budget → manage day-to-day operations.

Key terms:
○ Net Cash Flow = Total Inflows − Total Outflows
○ Target Cash Balance = desired cash level to maintain smooth operations.

Accounts Receivable & Credit Policy

● Credit Policy: rules covering credit period, discounts, credit standards, and collection procedures; usually stated in credit terms.

● Credit Period: time allowed for buyers to pay. Longer periods increase the Cash Conversion Cycle, costs, and default risk.
● Discounts: price reductions for early payment. Benefits:

○ boost sales
○ accelerate cash collection, reducing the CCC.
● Credit Standards: assess customer’s ability and willingness to pay on time.

● Collection Policy: procedures to collect overdue accounts; determines strictness in enforcing credit terms.

Short-Term Financing Instruments

● Lines of Credit: banks agree to lend up to a set maximum during a specific period.
○ Informal Line of Credit: bank may lend, but has no legal obligation; no fee on unused portion.
○ Formal Line of Credit / Revolving Credit Agreement: bank is legally committed to lend up to the limit; borrower pays a fee on unused portion and
interest on borrowed funds.

Short-Term Financing Instruments

● Secured Loans (Collateralised Loans): loans backed by assets (e.g., inventory, accounts receivable).
○ Higher bookkeeping costs, but may allow borrowing when unsecured debt is unavailable or at a lower interest rate.

● Unsecured Loans: no collateral required; generally preferred if available.

● Commercial Paper: short-term promissory note issued by financially strong firms, usually unsecured, sold to other companies, banks, or insurers.