Financial Management Midterm Reviewer PDF

FINANCIAL MANAGEMENT MIDTERM REVIEWER - Non-stock Corporation - no stocks issuances and no distribution of dividends to its members. I. Kinds of Business Organizations:...

FINANCIAL MANAGEMENT MIDTERM REVIEWER - Non-stock Corporation - no stocks issuances and no distribution of dividends to its members. I. Kinds of Business Organizations: D. As to shares being traded in stock exchange: A. Sole Proprietorship - Publicly listed Company - shares are offered to public or traded in the Philippine stock exchange. - is regarded as the simplest form of business organization. - Privately owned Company - shares are not traded in the stock market. - owned by an individual, known as the sole proprietor,who has the full authority in managing the assets of the business. III. Financial Managers of the Corporation: - fewer government regulations as compared to partnership and Financial managers are employees who are responsible for corporation managing the monetary resources of the corporation in order to maximize firm's value. - unlimited liability of a sole proprietor. Board of Directors (B.O.D.) - They are direct owners and are - limited life of the business because the death of the sole elected by the shareholders to manage the corporation. proprietor leads to termination Chief Financial Officer (C.F.O) - also known as the Vice B. Partnership President for Finance (VP-Finance), who has responsibility over financial planning and formulation of financial corporate - Two or more persons may also form a partnership for the strategies. exercise of profession. Treasurer - one who focuses on the financial aspect of the - constituted in any form, whether oral or written, except where corporation; wherein he has the responsibility on raising and immovable property or real rights are contributed managing the capital or funds of the company. - classified as General or Limited partnership. Controller - One who focuses on the accounting and budgeting The following are the usual causes of dissolution of the aspect of the corporation; he is responsible for the custody of partnership: financial records, preparation of the financial statements, and interpretation of financial data. 1. Retirement of a partner/s 2. Admission of a partner/s 3. Incorporation of partnership 4. Death of a partner/s C. Corporation - This juridical entity is composed of five (5) or more natural persons, not exceeding fifteen, who are called incorporators IV. General Role of Financial Manager: - most complex form of business organization because of its Investing Decision - investments made by these financial fund raising capabilities, unlimited life and being subject to managers should provide benefit to the corporation in the stricter government regulations. future. -The owners are referred as shareholders of the corporation who have limited liability. Financing Decision - There are many investment opportunities II. Types of Corporation: that financial managers may encounter as they manage the monetary resources of the corporation. However, one of the A. As to legal status: main constraints of these managers is the scarcity of available - De Jure Corporation - organized in accordance with capital. the law. - De Facto Corporation- exists only in fact but notin Generally, the financial managers accumulate funds through the law because there is a flaw in its incorporation. following means: B. As to functions and governing law: 1.) Performing long term financing through bank loans if the - Public Corporation - organized by the state for the prevailing interest rate is not high; government to promote general welfare of the public. - Private Corporation - these are organized by private 2.) Issuance of financial assets such as share of stocks (equity individuals for the purpose of generating profit. These security) or bonds (debt security) are governed by the Law on Private Corporation. Operating Decision - In order to support the daily transactions C. As to existence of stocks: or operations of the corporation, these financial managers - Stock Corporation - capital stock is divided into shares and is authorized to distribute to the holders should decide on how much funds should be allocated to each The following are the inappropriate ways on how management of its operating units. maximizes the profit of the corporation: V. Ethical Considerations: a. Management wants to accelerate sales by materially increasing the selling prices of the goods offered to the It is true that the ultimate goal of the corporation is maximizing consumers, or the firm's market value or the maximization of the shareholder's b. Management wants to reduce expenses by cutting wealth. This goal should be achieved not through fraudulent wage rates of the laborers or buying cheaper materials for acts but in an ethical manner of doing business. Moreover, the production. company should maintain its Corporate Social Responsibility (CSR) at all times such as avoiding things that has adverse effects in the society and to the people. Ethics and the goal of Stock price or market value per share considers both cash maximizing shareholder wealth generally lean towards similar flows for the current and future years. Profit on the other hand, ends because ethical behavior builds good reputation that will may refer to either current year's profit or future year's profit. benefit the organizationin the long run. However, in case of conflict between ethics and profitgoals, the former shall prevail I. Financial environment because unethical dealings will provide results that taint the - are factors and situations that primarily affect the financial goodwill of the company. aspects of the corporation. The principal factors are the sources VI. Goals of the Corporation of financing through A) Financial Markets People venture into business with the hope of gaining profits and the fear of incurring losses. It is a fact that all forms of B) Financial Intermediaries. business organizations whether sole proprietorship, partnership or corporation has the goal of maximizing earnings or profits. More so, having big profit signals good financial and operating II. Different types of markets performance of the business. Thus, profit maximization, as a A. Financial Markets are the place where financial assets such measure of success of the business, may be the end goal of the as Equity Securities (shares of Stock) and Debt Securities sole proprietor or the partners who personally manage their (Bond certificates) are issued and traded. business. However, for a corporate form of business, this profit maximization is just a means to an ultimate end goal of the 1. Stock Market - equity securities are being issued and traded. corporation. The shareholders of the corporation will earn The the stockholders may sell their stock investments or the income from their capital investments through dividend yield firm may issue additional stocks if the stock price is overvalued and capital gains yield. or may purchase stocks if undervalued. 2. Bond Market - debt securities are being issued and traded. - The former is earned through dividend declarations Also referred as the fixed-income market because the investors approved by the board of directors (BOD) while the latter is or bondholders receive fixed interest payments from their through selling of stocks or ownership to either prospective investments. investors or existing stockholders at a gain. This is when the 3. Money Market - short-term debts with maturities of one stock price is higher than the cost of investment. year or less are used as a source of financing. An example of - The ultimate goal of a corporation is shareholder's wealth this short-term debt security is a Treasury bill which is issued maximization. This is sometimes referred to as stock price by the government with maturity of one year or less. maximization the increase in the value of stock price resulting 4. Capital Market - long-term debt and equity securities are to capital gains that shareholders will yield on their involved, for financing. investments. B. Other markets: The goal of maximizing the market value of the corporation is 1. Physical Market is also known as real asset or tangible more importantthan the goal of maximizing profits because of markets because the products involved are real estate, the following reasons: property plant and equipment, inventories, etc. 2. Spot Market - assets or goods are sold for and delivered on the spot or today. The determination of price and delivery of In maximizing the market value of the corporation, goods is on the same date. discount rate which reflects the risks of capitalization and the time value of money is taken into 3. Future Market - where future contracts are sold. A future consideration while profit maximization does not contract is a contract that gives the purchaser an obligation to consider such. buy an asset (and the seller an obligation to trade an asset) at In maximizing future profits, the company may opt to a predetermined price at a future date. decrease and postpone its dividend declaration and instead, it will reinvest the freed up cash. If the forward contract, the exchange rate used to value the purchase reinvestment is too risky and will not be or sale of foreign currency is a forward rate. successful,this will be detrimental to the shareholders. Thus, shareholder's wealth is not maximized. An option contract is an example of a derivative whose value forming the Philippine Stock Exchange on December 23, 1992 is derived from the price of an "underlying" asset. with eight (8) constituent indices such as: Option contracts are classified as call option (option to buy) PSE Composite Index (PSEi) or put option (option to sell). PSE All shares Index (ALL) PSE Holding Firms Index (HDG) 4. Private Market - where negotiation and agreement takes PSE Industrial Index (IND) place personally between two parties. Hence, making the PSE Financial Index (FIN) contract unique or tailor-made. PSE Mining and Oil Index (M-0) 5. Public Market - where a security or contracts with PSE Property Index (PRO) standardized features are being traded and held by individuals. PSE Services Index (SVC) III. Financial Intermediaries are the organizations that provide financing to the individuals, corporation or other Stock market transaction: organizationsby raising funds or money from investors. 1. Initial Public Offering (IPO) Markets are markets where the stocks of a closely held corporation, going public, are 1. Mutual Funds (MF) - the investment company pools money offered to the public for the first time. from the investors then invests these accumulated amount in a - Generally, the IPO transaction is classified as primary portfolio of securities whether equity (shares of stock), debt market transaction since the new stocks were sold to the public, (bonds) or money market (short term securities). who are new shareholders. The body that regulates these mutual funds is the Securities 2. Seasoned Offering is the issuance of additional shares of and Exchange Commission. stocks of the company after its first time offering in order to finance the capital budget or to improve its capital structure. Unit Investment Trust Fund (UITF) the investment This kind offering may be done by family corporations company sells units of investment to the investors to orpublicly listed corporations. accumulate a trust fund. The regulatory body which supervises these unit investment trust funds is the 3. Primary Markets - are involved with the issuance or selling Banko Sentral ng Pilipinas. of new shares of stocksto the investors through the aid of the Pension Fund- these are pooled contribution from the investment bankers. The cash proceed from primary employees or from the employers that serves as the markettransaction goes to the corporation. Thus, the investment plans for the retirement benefits of the transactions in this market change the size of the capital employees. structure of thecompany. Financial institution this is a kind of financial 4. Secondary Market - are involved with the sale of the intermediary that provide additional financial services outstanding shares of stocks to the existing shareholders or to other than pooling and investing of funds. new Investors. The cash proceed from secondary market transaction goes to the selling shareholders, not the corporation. Transfer of Securities: Stock Market Efficiency Weak form - this level shows that Direct Transfer the information regarding past or historical prices of a In a direct transfer of securities, the equity securities evidenced particular stock is not conclusive in predicting stock prices. by stock certificates and debt securities evidenced by bond Semi-strong - form this level shows that all the available public certificates are issued directly to the investors. information is already incorporated in the stock prices. Strong Indirect Transfer: form - this level show that investors cannot beat the market even with insider information. In an indirect transfer of securities, the issuing company seeks the aid of the financial institution to easily issue their securities The stock prices can be classified as: to the investors, thus there is mediation between the issuer and a) Market value - also known as perceived value, is the the investor. price of the stock which is currently traded in the market. b) Intrinsic value - this is the true value of the stock. This is the price that the willing buyer will bid and willing IV. Stock Market Transaction: - are markets where shares of seller will ask provided that all necessary information about the stocks of corporation are sold to new investors and or existing stock is available. stockholders. The Philippines had two stock markets, namely: The intrinsic value can be estimated using either the 1.) Manila Stock Exchange (MSE) which was established on a) Dividend Discount Model or August 8, 1927; b) Corporate Valuation Model. 2.). Makati Stock Exchange (MkSE), which was established on May 27, 1963. However, these two markets were unified Financial Statement Analysis Horizontal analysis of financial statements is a method of A.1. Current Ratio: is also termed as working capital ratio, comparing the Peso value or amount of the particular line item indicates whether or not the company has sufficient resources in the Statement of Financial Position, Statement of to pay its debt obligations that are due within 12 months. This Comprehensive Income or Cash Flow Statements over a two or ratio shows the liquidity of a company which is the ability of more consecutive accounting period. assets to be easily and quickly converted into cash at the lowest cost. - The acceptable current ratio ranging from 1.5:1 to 2:1. - If the current ratio is higher than the acceptable level (rule of thumb) of 2:1, this may signify that the company is not utilizing its current assets efficiently. - low current ratio means that the company will have difficulty in paying its short term debts. The current ratio is calculated by using the formula: Current Ratio = Total Current Assets Total Current Liabilities II. VERTICAL ANALYSIS p.62-64 Vertical analysis of financial statements is a technique that involves assessment ofthe different line items in a III. FINANCIAL RATIO Financial ratio as a tool and technique in financial analysis is the comparison between one of financial information with other A.3. Cash Ratio: Cash ratio is considered to be the most financial information. stringent and conservative among the liquidity ratios because it only uses cash and cash equivalents in paying the short term obligations of the company. This ratio shows the comparison a. Liquidity Ratio - this measures the ability of the company of the company's most liquid assets such as Cash and to meet its short term obligations. marketable securities over its total current liabilities. b. Leverage Ratio - this measures the ability of the company to meet its long term obligation when they fall due. c. Activity Ratio - this measures how the company The Cash ratio is calculated by using the formula: productively uses or manages its assets. d. Profitability Ratio this measures the overall financial Cash + Marketable Securities performanceof the firm and its return on investments. Cash Ratio = Total Current Liabilities Classifications of Financial Ratios: A. LIQUIDITY RATIOS are the ratios that measure the A 4. Working Capital to Total Asset Ratio: Companies ability of a company to pay its short term debt obligations usually have higher value of current assets over the value of the when they fall due. current liabilities. Working Capital, which measures the company's potential value of cash reserves, is the difference Financial managers or analysts commonly use these following between the total current assets and total current liabilities. liquidity ratios: This is sometimes called as Net Working Capital. Financial - Current Ratio managers often compare this Net Working Capital over the - Quick Ratio value of the Total Assets. - Cash Ratio - Working Capital To Total Asset Ratio Working Capital to Total Asset Ratio = Current Assets - Current Liabilities B.1 Debt Ratio: shows the percentage of the total debt of the Total Assets company compared to its total assets. In addition, this ratio is considered as a component of the capital structure of the company which reflects the proportion of total assets that is funded by total debt. B. LEVERAGE RATIOS are ratios that show the capacity of the company to meet its long term debt obligations when they B.2. Equity Ratio: fall due. Moreover, these ratios indicate the solvency of the company, thus, showing whether or not there are sufficient Equity ratio indicates the proportion of the total equity of the financial resources to insure payment of the principal and company compared to its total assets. This considered as a interests of lenders. Leverage ratio is also known as Solvency component of the capital structure of which shows the ratio. proportion of total assets that is funded by shareholder's equity. Shareholder's equity is the residual interest after deducting the Thus, financial managers should keep track of company's total debt from total assets of or this is sometimes referred as solvency through the analysis of the following leverage ratios: the net worth of the company. Also known as net worth to total asset ratio. Debt to Equity ratio is a ratio that shows the proportion of company's funds financed by debt compared to funds financed by equity. This ratio is a good measure of the financial status of the company. Debt Ratio Equity Ratio Debt to Equity Ratio Times Interest Earned Ratio Cash Coverage Ratio Times Interest Earned Ratio, which is sometimes referred as interest coverage ratio, is a ratio that indicates the degree to which interests are covered by earnings before interest and taxes (EBIT). This ratio measures the number of times the interest payments can be made by the company through the use of EBIT. Cash Coverage Ratio is a ratio that indicates the extent to which interests are covered not only by earnings but by the cash flows generated from operations. Inventory Turnover Ratio measures the number of times the company replaces its average inventories during an accounting period due to sales. This ratio shows how the company manages its inventory efficiently..C. ACTIVITY RATIO measures how efficiently the company produces revenue through the management of its assets. Moreover, this ratio indicates the company's capacity of converting its assets into the sales revenue.Activity ratios are also known as efficiency ratio or asset management ratio. Asset Turnover Ratio, which is also referred as Sales to Asset ratio, indicates the value of peso sales generated by the each peso of asset employed by the company. Accounts Payable Turnover Ratio indicates the number of times the company pays its outstanding average accounts payable during an accounting period. Accounts Receivable Turnover Ratio indicates how many times the company collects its average accounts receivables during an accounting period. Days' Payable Outstanding shows the numberof days it will take for the company to pay its liability from date of purchase. This is also termed as Accounts Payable Period. Days payable outstanding = Average Accounts Payable (AP)/Average Daily Purchase Days payable outstanding= [(Beginning AP + Ending AP)/2] (Purchases=/360)