Fundamentals Of Financial Management PDF

FUNDAMENTALS OF FINANCIAL MANAGEMENT  PART 1 THE SCOPE AND ENVIRONMENT OF FINANCIAL MANAGEMENT  Learning Objectives ▪ understand the basic concepts in finance. ▪ describe the financial functions performed in an effective financial system ▪ Understand the relationships of the th...

FUNDAMENTALS OF FINANCIAL MANAGEMENT  PART 1 THE SCOPE AND ENVIRONMENT OF FINANCIAL MANAGEMENT  Learning Objectives ▪ understand the basic concepts in finance. ▪ describe the financial functions performed in an effective financial system ▪ Understand the relationships of the three areas of finance ▪ Discuss the definition, goal and functions of financial management in different forms of business organizations ▪ Explain the importance of ethics in financial management  Overview of Finance Financial Environment -Encompasses the financial system , institutions or intermediaries, financial markets, and individuals that make the economy work efficiently  What is Finance? ▪ Finance is the efficient acquisition, distribution/allocation and utilization of scarce money or fund resources. Six Principles of Finance ▪ Cash Flow is what matters ▪ Money has a time value ▪ Risk requires a Reward (Return) ▪ Market prices are generally right with the existence of efficient market. ▪ Diversification of Risk ▪ Reputation matters MONEY MARKET CAPITAL MARKET PHIL. FINANCIAL SYSTEM FOREX MARKET DERIVATIVES MARKET Financial System  Three Areas of Finance Investments Institutions / Financial Markets Management INVESTMENTS ▪ Investments relate to decisions concerning stocks and bonds and include a number of activities: ▪ (1) security analysis , deals with finding the proper values of individual securities ▪ (2) portfolio theory deals with the best way to structure portfolios, or “baskets,” of stocks and bonds. Rational investors want to hold diversified portfolios to minimize risks, ▪ (3) Market analysis deals with the issue of whether stocks and bonds markets at any given time are “too high,”, “too low” or “about right ▪ Capital Markets relate to the markets where interest rates, stock and bond prices are determined. Financial Institutions are organizations or intermediaries that help the financial system operate efficiently and transfer funds from savers and investors to individuals,businesses and governments that seek to spend or invest the funds in physical assets ( inventories, buildings and equipment) Financial Markets are physical locations or electronic forums that facilitate the flow of funds among investors, businesses and governments.  FINANCIAL MANAGEMENT ▪ Financial Management , also called as corporate finance focuses on decisions relating to : how much and what type of assets to acquire how to raise the capital needed to buy the assets how to run the firm so as to maximize its value Definition , Goals and Functions of Definition, Goals and Functions of Financial Management Financial Management ▪ Financial Management is also called as managerial or corporate finance, and business finance is concerned with planning, acquiring and utilizing funds in a manner that achieves the firm’s desired goals. It is also described as the process for and the analysis of making financial decisions in the business context. Financial Management is part of the larger discipline called FINANCE which is a body of facts, principles and theories relating to raising and using money by individuals, businesses and governments.  Goal of Financial Management The expansive goal of financial management is Maximization of Shareholders’ Wealth by: ▪ Maximizing the overall value of the firm ▪ Risk attached to the investment proposal or the company’s operation ▪ Time design as to when and how profits will flow into the company ▪ Quality and reliability of the profits reported by the firm ▪ Intrinsic Value: An estimate of a stock’s “true” value based on accurate risk and return data. The intrinsic value can be estimated but not measured precisely. ▪ Market Price: the stock value based on perceived but possibly incorrect information as seen by the marginal investor. ▪ Marginal Investor: An investor whose views determine the actual stock price ▪ Equilibrium: the situation in which the actual market price equals the intrinsic value , so investors are indifferent between buying and selling a stock  Financial Management Decisions ▪ Investment Decisions considers the profitability of each individual project proposal that will contribute to the overall profitability of the firm and lead to the creation of wealth. Capital Budgeting- the process of planning and managing a firm’s long- term investments ▪ Financing Decisions assert that the mix of debt and equity chosen to finance investments should maximize the value of investments made. The financial leverage or trading on the equity should be considered when selecting the capital structure. Capital Structure- the mix of debt and equity maintained by a firm. Working Capital Management- management of firm’s short-term assets and liabilities. ▪ Dividend decision is concerned with the determination of profits to be distributed to the owners, the frequency of payments and the amounts to be retained by the firm  Sample Organizational Chart Board of Directors Chairman of the Board and Chief Executive Officer President and Chief Operations Officer ( COO) VP-Marketing VP-Finance VP-Production Treasurer Controller Tax Cost Cash Credit Manager Manager Manager Accounting Manager Financial Financial Data Capital Planning Accounting Processing Expenditures Manager Manager  Functions of Financial Management/ Finance Managers ▪ Acquisition of funds with the least cost from the right sources at the right time. This involves raising capital to support the company’s operations and investment programs. ▪ Efficient management of the firm’s operating cash flows. This involves working capital management, and inventory management. ▪ Effective investment decisions. This involves selecting the best projects in which to invest the firm’s funds based on the expected risk and return. ▪ Proper risk management. This involves identifying , measuring and managing the firm’s exposure to all types of risk to maintain an optimal risk-return tradeoff and therefore maximize share value. ▪ Corporate Governance. This involves developing company-wide structures and incentives that influence managers to behave ethically and make decisions that benefit shareholders.  Financial Tools of the Manager ▪ Financial Policy –Making- selecting financial goals,developing financial policies, and designing the finance organization. ▪ Financial Planning and budgeting- preparing plans to attain set goals, preparing forecasts and budgets, and comparing actual performance with budgets to determine variances and determine actions needed to correct such variances ▪ Financial Analysis- evaluating results of operation and financial condition, investment options and other finance –related activities. Forms of Business Organization ▪ Sole Proprietorship ▪ Partnership ▪ Corporation ▪ Limited Liability Company/Limited Liability Partnership Limited Liability Company( LLC) is a new type of organization that is a hybrid between partnership and corporation Limited Liability Partnership (LLP), similar to LLC for professional firms Both LLCs and LLPs have limited liability like corporations but are taxed like partnerships; Investors of LLC and LLP have votes in in proportion to their ownership interest FINANCIAL MARKETS & INSTITUTIONS  Financial Environment ▪ Participants of the Financial System ▪ Financial Markets ▪ Financial Instruments ▪ Financial Institutions  Financial Markets ❑ Institutions and systems that facilitate transactions in all types of financial claims. ❑ They bridge between those with excess funds and those who need funds. ❑ Financial markets are the heart of the financial system, determining the volume of credit available , attracting savings and setting interest rates and security prices  Classifications of Financial Markets ✔ As to term or maturity ▪ Money Market ▪ Capital Market ✔ As to type of Issue ▪ Primary Market ▪ Secondary Market  Classifications of Financial Markets ❑ Money Market cover markets for short- term instruments. It consists of network of institutions and facilities for trading debt securities with a maturity of one year or less. Debt securities are often called marketable securities. Examples: Treasury bill, commercial paper, banker’s acceptance, deposits, certificates of deposit, bills of exchange.  Classifications of Financial Markets ❑ Capital Markets ▪ Are markets for long-term securities. ▪ The maturity is more than one year ▪ Both equity and debt securities are traded in the capital markets ▪ Long –term equity and debt securities carry greater default and market risks than money market instruments ▪ In return, long-term instruments carry a higher return yield ▪ Examples: Long –term loans, mortgages and financial leases, corporate stocks and bonds, government long-term treasury notes and bonds  Classifications of Financial Markets ❑ Primary Markets ▪ Consists of underwriters ,issuers and instruments ▪ They raise cash for the issuing company ▪ Primary market transactions involves either equity or debt securities ▪ Market transactions are done through an investment bank ▪ Primary market issues could be for public offering or publicly traded securities. Classifications of Financial Markets ❑ Secondary Markets ❑ Are markets for currently outstanding securities ❑ All transactions after the initial issue in the primary market are done in the secondary markets ❑ The role of secondary market is to assure that a holder can sell his security at anytime. FINANCIAl INSTITUTIONS  FINANCIAL INSTITUTIONS ❑ Financial Institutions or intermediaries are firms that act as the bridge between surplus units/lenders and deficit units/ borrowers ❑ Financial institutions also act as lenders or borrowers ❑ Financial institutions are classified as depository or non-depository. Depository institutions includes commercial banks , thrift banks and rural banks Non-depository Institutions include pension funds, life insurance companies, mutual funds and finance companies, pawnshops , security dealers and investors,  Business Ethics Business Ethics are company’s attitude and conduct toward its employees, customers, community and stockholders Most firms today have strong written codes of ethical behavior. When conflicts arise involving profits and ethics, ethical considerations sometimes are so obviously important  Part 2: Financial Statements, Cash Flows , Taxes  Learning Objectives Students will be able to: ▪ Understand the importance of financial statements in business ▪ Prepare the four basic financial statements ▪ Analyze the four basic financial statement using the different analytical tools ( ratio, trend, du pont equation) ▪ Understand the uses and limitations of ratios ▪ Compare Economic Value Added ( EVA) versus Net Income and understand its usefulness in assessing the value of the firm  Financial Statements ▪ Balance Sheet Shows what assets the company owns and who has claims on those assets as of a given date A statement of a firm’s financial position at a specific point in time It shows the firm’s liquidity, solvency , capital structure and capacity for adaptation A snapshot of the firm’s position as of a specific time ▪ Additional points about the Balance Sheet Cash versus Other Assets Working Capital- current assets are often called working capital Net Working Capital- Current Assets minus Current Liabilities ( Accounts Payable & Accruals) Net Operating Working Capital- the difference between current assets and non-interest bearing current liabilities Other Sources of Funds- finance assets with a combination of current liabilities, long –term debt and common equity Depreciation Market Values versus Book Values...\..\FM101_2023\Sample2_BS_IS.xlsx ▪ Statement of Comprehensive Income A report summarizing a firm’s revenue ,expenses and profits during a reporting period Operating Income / EBIT- earnings from operations before interest and taxes Earnings Per Share= Net Income/ Common Shares Outstanding Dividend per Share =Dividends paid to common shareholders/ Common Shares Outstanding Book Value Per Share= Total SHE/ No. of shares outstanding Compute book value per share for each class of stock ▪ EBITDA = Earning before Interest and Taxes, Depreciation and amortization. Used in analyzing the amount of cash the company is generating..\..\FM101_2023\Sample2_BS_IS.xlsx ▪ Statement of Cash Flows Reports the change in a company’s cash balance over a period of time. Reports on cash inflows and outflows from operating, investing and financing activities over a period of time ▪ Operating Activities ▪ Principal revenue producing activities of an enterprise. Cash flows from operating activities is computed by taking up adjustments of net income for depreciation/ amortization and net increase a/ decrease of current assets and current liabilities Investing Activities all activities involving long term assets. this involves acquiring and selling of long term assets Financing Activities this involve obtaining resources from and returning resources to owners as well as obaining resources through borrowings ( short term/ long term) an repayments of amounts borrowed. ▪ Methods in calculating cash flow from operating activities: 1- Direct Method major classes of gross cash receipts and gross cash payments and the net cash from from operating activities are reported 2- Indirect Method- net cash flow from operating activities are reported indirectly by adjusting the net income to reconcile it to net cash flow from operating activities..\..\FM101_2023\SAmple BS_IS_CF.xlsx ▪ Free Cash Flow- the amount of cash that could be withdrawn from a firm without harming its ability to operate and produce future cash flows FCF= EBIT(1-T) + Depreciation- (Capital Expenditures + Increase in Net Working Capital*) * Increase in Net Working Capital= Change in Current Assets – Change in Payable and Accruals 4- Statement of Changes in Owner’s Equity A statement that shows how much a firm’s equity changed during the year and why this change occurred.