Basic Financial Management rev 1.pptx
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The document provides an overview of basic financial management principles, delineating the importance of finance in asset allocation, personal finance, and different business structures. It discusses corporate and international finance, financial markets, key financial ratios, and management of cash flows. Additionally, it highlights the roles and responsibilities of financial managers and the necessary skills required to navigate the financial landscape.
Basic Financial Management rev 1.pptx
- 2. What is Finance? Finance is a field that is concerned with the allocation (investment) of assets and liabilities over space and time, often under conditions of risk or uncertainty. Finance Management can be defined as the art of money management.
- 3. Why necessary to have Financial Knowledge Marketing • Budgets • Marketing financial products/services • Marketing research Accounting • Dual Accounting and Finance function • Preparation of Finance statement Management • Strategic thinking • Job performance • Profitability Personal Finance • Budgeting • Retirement planning • College/University planning • Day to day Cash flow issues
- 4. Areas of Finance • Corporate Finance • Investments • Financial Institutions • International Finance
- 5. Corporate Finance It is the area of finance that deals with providing money for businesses and the sources that provide them. These sources provide capital to corporations to pay for structural improvements, expansion, and other value-added projects and enterprises. Examples – Micro Finance Banks etc.
- 6. Investment • Work with financial assets such as stocks and bonds • Value of financial assets, risk versus return, and asset allocation • Job opportunities Stockbroker or financial advisor Portfolio manager Security exchange analyst
- 7. Financial Institutions • Companies that specialize in financial matters Banks – commercial and investment, credit unions, savings and loans Insurance companies Brokerage firms • Job Opportunities Chartered Accountant firms Finance Advisors
- 8. International Finance • This is an area of specialization within each of the areas discussed so far • It may allow you to work or invest in other countries • Need to be familiar with international financial policies, exchange rates, and political risk • Examples include International Monitory Fund (IMF), International Stock Exchange etc. • Job Opportunities – Foreign Investment companies
- 9. Forms of Business Organizations SOLE PROPRIETORSHIP • Simplest form of business can take • Business owned and operated by single person • Profit generated by this business is owner benefit alone • Capital required to generate this business is owner personal resources or borrowing the owner can access • Owner has unlimited liability • Limited access to resources PARTNERSHIP • Involves two or more people operating a business • Easy to form business • Established on written form of agreement • Each partner responsible for all debts of partnership • Personal wealth of each partner can be accessed to satisfy claims against the partnership • Limited partnership makes single or some partner liable for business issues while rest doesn’t participate in any activity of business. General partnership in which at least one is responsible for all the liabilities of the partnership CORPORATIONS • Legal entity created by law • Owner of corporation are issues shares in that corporation and their liability is limited to the amount invested in the company to purchase those shares i.e. they have personal limited liability • There is more administration involved with a corporation as entity must comply with the regulations of the state • Owners receive profits from the corporation when dividends are declared • Relies profits on the sale of corporation shares • Value of corporation share represents owners profit/loss at the time of sale
- 10. Advantages and Disadvantages of different forms of Business Organization SOLE PROPRIETROSHIP PARTNERSHIP CORPORATION ADVANTAGES Simple to create Simple to create Limited liability of owners Owner has full control over operations Allows for the sharing of skills among partners Ease of transfer of ownership Owner receives all profit Increase access to financing over sole proprietorship due to increased number of owners Increased access to financing Business information is kept confidential Business information is kept confidential among partners but not necessary Can have tax advantages DISADVANTAGES Unlimited liability of the owner Unlimited liability of each partner More expensive to create than other businesses Ownership difficult to transfer Ownership difficult to transfer More administration and reporting Life of business depends upon life of owner Partnership ceases upon death of any of partner May be subject to higher tax Limited access to financing May or may not have limited Owner do not control the
- 11. Important Finance Designations CHIEF FINANCIAL OFFICER (CFO) FINANCE MANAGER ACCOUNTANT / TREASURER CONTROLLER
- 12. Role of Finance Designations • Perform financial analysis • Perform financial functional planning and control • Working capital management • Explore opportunities of finance • Investment decisions • Accrual basis of financial reporting • Following financial statements • Dealing with financial institutions • Keep an eye on the country economical environment
- 13. 10 Basic principals of Financial Management • Organize your finances • Spend less than you earn • Put your money to work • Limit debt to income producing assets • Continuously educate yourself • Understand Risk • Diversification is not just for investment • Maximize your employment benefit • Pay attention to Taxes • Plan for the Unexpected
- 14. Goals of Financial Management Maximizing profit Maximizing market share Minimize Cost
- 15. RelationshipbetweenOrganizationManagement and Share holders • Management team acts as an agent on behalf of the share holders • When organization management act in their best interest over the interest of the owners (shareholders). The conflict of goals is referred to as “Agency Cost”. The management makes the decision that they benefit from but that cost shareholders with no corresponding increase in share price Management makes the decision in the best interest of shareholders • Shareholders control the organizations through voting at shareholder meetings and the elections of the board of directors. • The board of directors of an organization is responsible for ensuring that the organization is properly managed • Board of directors can hire or fire management • Current share holders of an organization can sell their shares to a new shareholder who will than take over control of the company and replace existing management team with managers of their choice.
- 16. Financial Markets EQUITY MARKET DEBT/BOND MARKET COMMON STOCK PREFERRED STOCK MONEY MARKET CAPITAL MARKET Short term securities, e.g: • Bankers acceptances • Treasury bills • Commercial papers • Long term securities e.g: • Shares • Bonds of corporations • Long term government bonds • Debentures
- 17. Financial Markets Primary Market Secondary Market Market where Securities are initially issued Market where Securities are resold Company directly issues the share and receives the net proceed Investor want to resell their shares this occurs in the secondary market Transaction of shares between selling share holders and buying shareholders
- 18. Financial Markets Capital Market Deal with both Shares and Long term debt Bonds are issued by both corporations and government Over the Counter exchange Organized exchange • Deals in Securities and debt instruments • People who trade in this market are called dealers • Price of securities traded based upon competitive bids or negotiated price • Dealer makes money by the difference between the bid and ask price Both Primary and Secondary market • Previously issued securities are sold • Companies to be listed must apply and meet the requirements set by each exchange they are attempting to be listen on • Member is the one who holds seat on the exchange
- 19. Financial Assessments ELEMENT DESCRIPTION Liquidity The firm’s ability to meet its short term commitments as the become due and payable Activity Ratios The firm’s ability to put its assets to productive use Leverage (Debt and other fixed costs) The firms reliance on fixed commitments that can help or hurt its profitability, and the degree to which the firm is financed with borrowed money Profitability The firm’s ability to generate satisfactory profits Shareholder value (Market ratios) The value investors assigns to the firm. It expresses the desirability of the firm in the eyes of its owners. This is for public trading corporations. Private limited companies and unincorporated firms have a value but it is not easy to establish Above mentioned elements represents companies Financial Strength and Weaknesses
- 20. Important Formulas and their relationships LIQUIDITY RATIO Current Liquidity ratio = Current Assets / Current Liabilities Quick Ratio or Acid Test = (Current Assets – Inventory) / Current Liabilities ACTIVITY RATIO Inventory Turn over = Cost of Goods Sold / Average Inventory Days in Inventory = 365 / Inventory turn over Accounts Receivable Turnover = Net credit sales / Average accounts Receivable Average Collection period = 365 / Accounts Receivable turnover Average Payment period = Accounts payable / Average daily purchases Total Asset turnover = Sales / Total Average Assets LEVERAGE (DEBT RATIO) Inventory Turnover = Cost of goods sold / Average Inventory Debt Ratio = Total Liabilities / Total Assets Times Interest Earned = Earnings before interest and Taxes / Interest Expense
- 21. Important Formulas and their relationships MARKET RATIO Price Earning Ratio = Market price per share of common shares / Earnings per share Book Value per Share = Common stock equity / No# of outstanding common shares Market Book Ratio = Market price per shre of common shares / Book value per share PROFITABILITY RATIO Gross Profit Margin = (Sales – Cost of Goods sold) / Sales Operating Profit Margin = Earnings before interest & Taxes / Sales Net Profit Margin = Earnings available for common share holders / Sales Earnings per share = Earnings available for common shareholders / Average number of outstanding common shares Return on Total Assets = Earnings available for common shareholders / Total Average Assets Return on Equity = Earnings available for common shareholders / Average common stock equity RETURN ON EQUITY (ROE) ROE = (Net Margin) x (Asset Turnover) x (Financial Leverage Multiplier)
- 22. Balance Sheet A statement of the Assets, Liabilities, and Capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period.
- 23. Balance Sheet Current Assets: • Cash • Marketable Securities • Prepayments • Accounts Receivable • Inventory Fixed Assets: • Investment • Plant and Machinery • Land & Buildings Current Liabilities: • Accounts Payable • Accruals • Short Term Debt • Taxes payable Long Term Financing: • Debt • Equity
- 24. Working Capital and Net Working Capital • Working Capital: It includes firm’s current Assets which consists of Cash and Marketable securities in addition to Accounts Receivable and Inventories. It also consist of Current Liabilities including Accounts Payable (Trade Credit), Notes Payable (Bank Loans), and Accrued Liabilities. • Net Working Capital: Total Current Assets – Total Current Liabilities
- 25. Trade off between Profitability and Risk Positive Net Working Capital (Low Return and Low Risk) Current Assets Net Working Capital > 0 Fixed Assets Low Return High Return Current Liabilities Long Term Debt Equity Low Cost High Cost Highest Cost
- 26. Trade off between Profitability and Risk Negative Net Working Capital (High Return and High Risk) Current Assets Fixed Assets Low Return High Return Current Liabilities Net Working Capital > 0 Long Term Debt Equity Low Cost High Cost Highest Cost
- 27. Trade off between Profitability and Risk Effect of Changing Ratios on Profits and Risks Ratio Change in Ratio Effect on Profit Effect on Risk Current Assets Increase Decrease Decrease Total Assets Decrease Increase Increase Current Liabilities Increase Increase Increase Total Assets Decrease Decrease Decrease
- 28. Operating Cycle andCash Conversion Cycle • Operating Cycle – Is the time between ordering materials and the collecting cash from receivables • Cash Conversion Cycle – Is the time when firm pays its suppliers (payables) for inventory and collecting cash form the sale of the finished product
- 29. Operating Cycle and Cash Conversion Cycle Operating Cycle and Cash Conversion Cycle can be computed as below: • Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding • Cash Conversion Cycle = Days Inventory Outstanding + Days payable Outstanding (Denoted in negative) + Sales Outstanding
- 30. Cash Conversion Cycle • Permanent Vs Seasonal Funding Needs If a firm sales are constant, than its investment in operating Assets should also be constant, and the firm will have only a permanent funding requirement If Sales are cyclical, than investment in operating assets will vary over time leading to the need for seasonal funding requirements in addition to the permanent funding requirements for its minimum investment in operating assets
- 31. Some Strategies for Managing Cash Conversion Cycles • Turn over inventory as quickly as possible without stock outs that result in lost sales • Collect account receivable as quickly as possible without loosing sales from high – pressure collection techniques • Managing, Mail, Processing, and Clearing Time to reduce them when collecting them from customers and to increase them when paying suppliers • Pay Accounts Payable as slowly as possible without damaging firms credit rating
- 33. Inventory Management Raw Materials Work in Progress Finished Goods • Financial Managers – Would like to keep inventory levels low to ensure that funds are wisely invested • Marketing Managers – Would like to keep inventory levels high to ensure orders could be quickly filled • Manufacturing Managers – Would like to keep raw materials level high to avoid production delays and to make larger more economical production runs
- 34. Inventory Management ECONOMIC ORDER QUANTITY MODEL Economic Order Quantity Model used to evaluate the Total Cost of Inventory EOQ = SQ. ROOT (2 X Usage in Units per period X Order cost per order) Carrying cost per unit per period
- 35. Inventory Management Ordering Cost = Cost order X No# of orders per year Carrying Cost = (Carrying Costs per year X Order Size) / 2 Total Cost = Ordering Cost + Carrying Cost Reorder Point = Lead Time in Days X Daily Usage Daily Usage = Annual Usage / 360
- 36. 5 C’s of Credit • Character – The applicants record of keeping past obligation • Capacity – Applicants ability to repay the requested credit • Capital – Applicants debt relative to equity • Collateral – Amount of Assets the applicant has available for use in securing the credit • Conditions – Current general and Industry specific economic conditions
- 37. Credit Scoring Credit scoring models are statistical analysis used by credit bureaus that evaluate your worthiness to receive credit. Lenders use credit scores to help determine the risk involved in making a loan, the terms of the loan and the interest rate.
- 38. Credit Monitoring Policy The firm’s collection policy is its procedures for collecting a firm’s accounts receivable when they are due. The effectiveness of this policy can be partly evaluated by evaluating at the level of bad expenses. As seen in the previous examples, this level depends not only on collection policy but also on the firm’s credit policy.
- 39. Management of Receipts and Disbursement floats Collection float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the payee actually receives the funds in spendable form. Disbursement float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the funds are actually withdrawn from the account. Both the collection and disbursement float have three separate components.
- 40. Management of Receipts andDisbursement floats Mail float is the delay between the time when a payer places payment in the mail and the time when it is received by the payee. Processing float is the delay between the receipt of a check by the payee and the deposit of it in the firm’s account. Clearing float is the delay between the deposit of a check by the payee and the actual availability of the funds which results from the time required for a check to clear the banking system.
- 41. Management of Receipts andDisbursement floats Wire transfers is a telecommunications bookkeeping device that removes funds from the payer’s bank and deposits them into the payees bank thereby reducing collections float. Automated clearing house (ACH) debits are pre-authorized electronic withdrawals from the payer’s account that are transferred to the payee’s account via a settlement among banks by the automated clearinghouse. ACHs clear in one day, thereby reducing mail, processing, and clearing float.
- 42. Management of Receipts andDisbursement floats Zero-balance accounts are business-oriented bank accounts that usually has a balance of $0 .The purpose is to eliminate non-earning cash balances in corporate checking accounts. Zero balance accounts help companies avoid having money spread out over several different bank accounts, which costs the company interest and creates more bookkeeping work.
- 43. “A wise person should have money in their head, but not in their heart.” Jonathan Swift