Chapter1. An Overview of Financial Management* Why Business? To make money* What are needed? 1) Idea(s) = Project(s)2) Money = Capital = ResourcesNeed money to make money? Sounds contradictory? Capitalism – Capital = Ism according to Rev Jesse Jackson. In Communism, the government provides resources, but less incentive to do a project. Here, strong incentives, but difficult to get started.* What is Finance? Financial Management? (p.4 – p.6)It is all about Money, Money Management => How much you need? Why? How to come up with the money? Where to invest your money, How to allocate money among stakeholders (participants of the business)?Finance within an organization: BOD > CEO > CFO > Accounting, Treasury, Credit, Investor Relations. Fig 1-1 p.4* Relationship with economics and accounting (p.4)Applied economics. In Eco, we are dealing with resource allocation. In Finance, resource allocation over time.Finance=decision making, Accounting records and provides the data/information we need to make informed decisions.* Major Financial Decisions (p.4 – p.6)1) Examine whether the idea(s) you have is “good” or which one(s) is the best= Capital Budgeting2) How to come up with the money = how to finance (fund) the project(s) = how much from Equity (owner’s contribution) and Debt = Capital StructureEx. $50 million, 40% equity => $30 million from debt.3) Short-term (working capital) and long-term (investment) managementWorking capital management is for day to day activities like A/R, A/P, Inventory, etcStrategic investment is M&As, issuing new shares, etc4) What to do with profits (net earnings)? Dividends or addition to retained earnings? = Dividend PolicyEx. $5 million net earnings, $3 million dividends => 60% dividend payout ratio Aside) (Net)Sales=Revenue > Gross Margin>EBIT>EBT>Net earnings(=Net income)EBITDA*finance.yahoo.com* Firm’s objectives and goals (P.8)Traditional “Normative” in the capitalistic society Making the most for owners (=shareholders) = Maximizing shareholders’ wealth = Maximizing stock price (share price)Aside) Profit maximization is not a good objective?Goals are more specific to achieve the objectives like increase sales 10% and reduce the expenses5%, etc* Career opportunities: Corporate officer (see the corporate structure chart in the book), Investments, Financial institutions, Sales, Education – requirements (math, stat, econ, accounting,etc) licensing (NASD Series 6, 64, 7, Actuary exams), certification exams (CFA, CFP, CLU, etc) (p.6)* Real assets (are used to produce output, intangible (patents, technology, etc) as well) vs. Financial assets (claims on real assets like currencies, stocks, bonds, etc)* Major issues in Finance: Time value of money, risk-return trade-off, security valuation, capital budgeting, short-term and long-term asset management, inflation, interest rates, exchange rates, etc (p.5, p.10 – p.13)* New world : Globalization, Technology (P.14 – p.15), Liberalization or Reverse-liberalization? * And New Problems and Issues (Contagion effects, fraud, confidentiality and privacy issues) (P.14 – p.15)* Types of Business Organization (p.6 – p.8)1) Sole Proprietorship: Easy to set up, prompt decisions, single taxation (1040 schedule C), usually lower tax personal tax rate, Disadvantages: unlimited liability, mortal, difficult to raise capital, difficult to transfer ownership 2) Partnership: A typical partnership is similar to sole proprietorship3) Corporation (choosemayrland.com) : a legal entity created by state law. The entity creased is called C-corporation. Advantages and disadvantages are exactly the opposite of Sole ProprietorshipC vs. Sub S. CorpNonprofit* Firm’s Objectives and Agency Conflicts (p.18 – p.21)What is that? The agent (managers) may not work in the best interest of the principal (owners)What to do to mitigate the conflict? 1) active monitoring=direct shareholder intervention, performance based incentives such as stock shares or stock options (to buy shares), hostile takeover threats when market value (price) is less than the intrinsic value. Corporate Governance (act or system of governing, control) – major issue since the collapse of Enron, WorldCom, etc – check and balance between BODs and ManagementEx. Sarbanes-Oxley Act* Market value of the firm = (market) capitalization = stock price * # shares outstanding* Market value (=price) vs. Intrinsic (=true) valueMarket < Intrinsic => undervalued, good buyMarket > Intrinsic => overvalued, don’t buy (no hostile takeover)* Social responsibility and Ethical behavior (p.15 – p.18)View: a firm is a nexus of diverse interests of many stakeholders. Maybe, making them all happy can lead to shareholder wealth maximization?- Shareholder wealth vs. stakeholder welfare maximization, Sequenced goal approach (Wal-Mart vs. Costco)Chapter3. Financial Statements, Cash Flow, and Taxes* Financial Statements (p.55 – p.56)Balance Sheet (p.57 – p.61)Income Statement (p.61 – p.63)Statement of Cash Flow (p.63 – p.67)* Free Cash Flow (p.68 – p.70) – concept and measurement* EVA (P.108, p.290)Financial Planning and Budgeting (as part of raising money) (p.511 – p.512)- A systematic way to organize the firm’s sources and uses of resources and determine the amountof financing the firm needs=> * Pro Forma Financial Statement? (Chapter 16)* Forecasting 1) Specific-Item (p.514 – p.518)2) Related to Sales (p.518 – p.522) (1) Good Sales Forecast(2) Identify Accounts That Relates to Sales(3) Establish the Relationship to Sales - The Percentage-of-Sales Method - Pro-Forma Statements - ExampleChapter4. Analysis of Financial Statements*Financial manager is responsible for the financial health of a business. Need data to diagnose (analyze) and make “good” financial decisions.* Types of data-Caveats: important, but imperfect. Need theory – why?1) Accounting data – financial and managerial2) Other data – about economy, industry, people, etc* Financial Accounting Data – used to produce financial statements, which are prepared subject to FASB, SEC constraints1) GAAP Limitations (1) Different valuation methods between monetary (cash value) and non- items (historical costs) (2) Different numbers for the same event depending on the choice of accounting methods. E.g. LIFO and FIFO. (3) Important information omitted. E.g., quality of business, human resources=> despite all its imperfections, excellent source of info.2) Need to put into a
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