Scarica Understanding the Structure of a Balance Sheet: Assets, Equity, and Liabilities e più Dispense in PDF di Finanza solo su Docsity!
FINANCIAL MANAGEMENT
Lesson 1 – Financial statements
There are three basic financial statements summarizing information about a company:
- Balance sheet : Summarize the assets of a company (What the company owns), the value of these assets and
the mix of financing used to finance these assets at a given point in time.
Balance sheet structure:
Assets of a company : Assets are generated either by purchase (investing activities), business activities
(operating activities) or financing activities. Assets classification:
o Fixed assets:
▪ Long-term assets (Used by a company over a period longer than one year)
▪ Relatively long life
▪ Relatively low liquidity
Categorization:
▪ Tangible assets (Equipment, land, buildings, etc.)
▪ Intangible assets (Trademark, patents, goodwill, etc.)
▪ Financial investments (Investments in securities and assets of other firms: shares, bonds, ...)
o Current assets:
▪ Short-term assets
▪ Relatively short life
▪ High liquidity. In the form of cash or can be relatively quickly converted into cash
Categorization:
▪ Accounts receivable (Represent money owed the firm by individuals or by other firms on the
sale of products (goods) on credit
▪ Inventories (Raw material, goods for sale held by a firm for eventual sale, etc.)
▪ Cash and cash equivalents (Short-term tradeable securities)
Equity and liabilities of a company : Mix of capital for financing of company´s assets
o Equity:
▪ Represents the shareholder´s investment s into company
▪ Capital belonging to the owners or shareholders of the company
▪ Contribution of the owners (Buying shares) or by company´s profit (Retained earnings)
Categorization:
▪ Registrated capital (Shares outstanding * Nominal value)
▪ Share premium (Paid-in capital)
▪ Retained earnings
o Liabilities (debt):
Represents money (Capital), that has been borrowed and must be repaid back at some
predetermined date. Source of capital provided by creditors. Liabilities classification:
▪ Current liabilities: Includes borrowed money that must be paid back within 12 months:
❖ Accounts payable (Credit extended by suppliers to a company when it purchases
inventories)
❖ Accrued expenses (Short-term liabilities but not yet paid)
❖ Short-term notes (Money borrowed from a bank payable within 12 months)
▪ Long-term liabilities: Includes money that has been borrowed by company for longer than 12
months (Loans from banks, issued bonds, …)
From above definition follows this formula:
- Income statement (Profit/Loss statement, P/L statement): Provides information on the revenues, costs and
expenses of the company and resulting profit or loss during a particular period, often an year.
Basic equation underlying the income statement is:
o Revenues : Amounts charged for the delivery of goods or services in the ordinary activities of the
company
o Costs and expenses : Amounts that must be spent in the ordinary activities of the company
Two main subtotals are usually calculated:
o Operating income : Calculated as a difference between the sum of operating revenues and operating
costs and expenses: Operating income/loss (EBIT)
▪ Operating revenues: Revenues from sale of products, goods, and services
▪ Operating costs and expenses: Costs associated with generating operating revenues (Raw
material consumption, electricity consumption, depreciations, costs of good sold, salaries
and wages paid to employees, administrative costs, other operating costs,…)
o Financial income : Calculated as a difference between financing revenues and financial costs.
▪ Financial revenues: Interests received, revenues from owned securities (Dividends received,
coupons received, etc.)
▪ Financial costs: Interests paid, coupons paid (If bonds are issued), …
The sum of operating and financing income is profit before taxes (EBT).
Next, company´s tax 𝑇 is calculated by applying corporate tax rate 𝑡:
Resulting number: Profit after tax (net income, net profit , EAT )
Levels of earnings:
o EBITDA – Earnings before interest, taxes and depreciation and amortization
o EBIT – Earnings before interest and taxes
o EBT – Earnings before tax
▪ Cash outflows: Cash used in the purchase of plants, property, equipent, …, Payments for
purchase of equity instruments of other entities, Payments for purchase of debt instruments
of other entities
o Cash flow from financiang activities
Involve all inflows and outflows from transactions between company and its owners and creditors.
Examples:
▪ Cash inflows: Proceeds from the issuance of the equity securities (common and preferres
shares), Proceeds from the issuance of the bonds, Proceeds from the short-term and long-
term borrowings (Bank loans)
▪ Cash outflows: Payment of dividends and other distributions for a company owner,
Repayments of bank loans
Preparing the cash flow statement, net cash provided (or used) by each activity is calculated.
Net cash provided (or used) by operating activities can be calculated in two different ways:
o Direct method
For each category of cash flows (Operating, investing, financing), cash outflows are subtracted from
cash inflows to determine the net cash flow of each category. The net cash flows are then summed
up to obtain the net increase in cashe, which added to the cash balance (beginning of period)
generates the cash balance (end of period).
o Indirect method
Enables to explains the difference between net income and net cash flow from operating activities.
Instead of subtracting cash payments from receipts (Direct method), net income is adjusted to
exclude the amounts that were included in determination of net income but did not provide
operating inflows and operating outflow during particular period.
This method must provides the same result as the direct method.
There are three types of adjustments:
I. Adjustments in non-cash current assets (for example accounts receivable) and non-cash
current liabilities (for example accounts payable) that relate to operating activities
Assume simplified income statement of a company:
The initial value of the non-cash current asset (Accounts receivable) is 2000 USD, the value of
the non-cash current liabilities (Accounts payable) is 500 USD and don’t change durig the
year. Net cash from operating activities is equal to +8.000 USD. Net cash flow from operating
activities and net income are identical.
Assume that part of the company production is sold on credit (500 USD), other being the
same. Now, cash inflows are not 20.000 USD, but 19.500 USD. Current assets (Namely
accounts receivable) will increase from 2.000 to 2.500 USD. Net income is still the same
+8.000 USD
With the indirect method net income of 8.000 USD is adjusted for the 500 USD increase in
accounts receivable to get the net cash from operating activities.
Assume the value of accounts receivable decreased from 2.000 USD to 1.200 USD. Now,
cash inflows are 20.000 USD plus 800 USD as a result of decrease in accounts receivable. Net
income is still the same +8.000 USD.
With the indirect method net income of 8.000 USD is adjusted for the 800 USD decrease in
accounts receivable to get the net cash from operating activities.
Assume the value of accounts payables increased from 500 USD to 900 USD. Now, cash
inflows are still 20.000 USD, operating expenses 12.000 USD (Net income 8.000 USD), but
cash payments for operating expenses were only 11.600 USD. Net income is still the same
+8.000 USD.
With the indirect method net income of 8.000 USD is adjusted for the 400 USD increase in
accounts payable to get the net cash from operating activities.
Assume the value of accounts payables decreased by 200 USD to 300 USD. Now, cash
inflows are still 20.000 USD, operating expenses 12.000 USD (Net income 8.000 USD), but
cash payments for operating expenses are 12.200 USD (12.000 + 200 USD).
- Taking an amount of 1.100 USD out of the business for personal use.
Lesson 2 – Financial analysis
Financial analysis is the process of selecting, evaluation and interpreting financial data. The aim is to formulate the
assessment of the company´s present and future financial position (financial health).
Source of information for financial analysis:
- Financial data (From balance sheet, income statement, cash flows statement)
- Market data (Securities prices, industry statistics, …)
- Economic data (GDP, producer price index, consumer price index, …)
- Credit methods
Financial analysis allows to:
- Evalute results over time
- Compare with competition or industry statistics
- Compare true results with the plan
- Compare with recommended values (Rating agencies, …)
Methods of financial analysis can be divided into four groups:
- Common-size analysis (Horizontal, vertical)
Analysis of financial statements data and their changes over the time. The aim is to identify the trends and
major differences. There are two types:
o Horizontal common-size analysis : Analysis of the evolution of financial statements data over the
time or their changes with respect to a given period as a benchmark.
o Vertical common-size analysis : Analysis of the changes in the proportions of selected benchmarks.
Ex. Total assets:
Comparison of financial data in the form of financial ratios to asses the financial health of the company. They
are calculated from financial data and market data, among which is relationship.
Groups of financial ratios:
o Profitability ratios : Analyze the company´s ability to generate profit from invested capital in the
form of return during a period (in %). The higher the profitability ratios, the better competitive
position of the company. Basic ratios:
▪ Operating profit margin
Indicate how well the company manages its operations, how well the revenues are being
generated and operating costs controlled. Measures operating profit per one unit of
revenues.
▪ Net profit margin
Measures net profit (as a percentage) per one unit of revenues
▪ Return on assets ROA
How many times the accounts receivable are “rolled over” during a year.
▪ Inventory turnover IT
It’s a measure of the number of times inventory is sold or used in a time period such as a
year.
▪ Total assets turnover TAT
It is an efficiency ratio which tells how successfully the company is using its assets to
generate revenue. For example TAT of 1,5 means each unit invested in assets generates
revenues of 1,5.
o Market ratios
Enables to analyze what drives the value of financial ratios (Which factors have impact on its value or
evolution). The principle is to express selected (basic) ratio as a product of component ratios.
The fundamental example of the pyramidal decomposition is the DuPont analysis (Decomposition of ROE
ratio by three component ratios):
o
𝐸𝐴𝑇
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
o
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
o
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦
If we want to separate the effects of taxes and interest, we can decompose the profit margin as follows:
o
𝐸𝐴𝑇
𝐸𝐵𝑇
o
𝐸𝐵𝑇
𝐸𝐵𝐼𝑇
o
𝐸𝐵𝐼𝑇
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
After substitution into DuPont analysis we get:
Enables to analyze indicators, whose change have caused change in the basic ratio. Quantify, how the
component ratios contribute to the change in basic ratio. Methods for quantification of influence:
o Methods of gradual changes
Works with absolute changes in component ratios.
Number of the component ratios = Number of equations for influence quantification (Each equation
serves for given component ratio)
The advantage is that can be applied regardless of positive or negative values in component ratio or
basic ratio. The disadvantage is that the order in decomposition can influence the results.
In the case of decomposition with 3 component ratios:
𝑎
1
1
2 , 0
3 , 0
𝑎
2
1 , 1
2
3 , 0
𝑎 3
1 , 1
2 , 1
3
▪ 𝑥: Basic ratio
▪ ∆𝑥: Absolute change in the basic ratio
▪ 𝑎: Component ratio
▪ ∆𝑎: Absolute change in the component ratio
𝑎
1
: Absolute change in the basic ratio caused by the change in the first (𝑎
1
) component
ratio
o Logarithmic decomposition method
The advantage is that it’s needed just one formula for the impact quantification regardless of how
many component ratios we have. Impact of the i-th component ration on the change in the basic
ratio is calculated as follows:
𝑎
𝑖
𝑎
𝑖
𝑥
▪ 𝑥: Basic ratio
▪ ∆𝑥: Absolute change in the basic ratio
𝑥
𝑥
1
𝑥
0
: Index of change in basic ratio
𝑎
𝑎 𝑖, 1
𝑎
𝑖, 0
: Index of change in component ratio
o Functional decomposition method
Works with the relative changes in basic and component ratios. It’s applicable regardless of the signs
of the relative changes.
𝑟𝑒𝑙𝑎𝑡
𝑥
𝑥
1
−𝑥
0
𝑥
0
𝑖
𝑟𝑒𝑙𝑎𝑡
𝑎 𝑖
𝑎
1
−𝑎
0
𝑎
0
Impact (influence ) of the i-th component ratio on the basic ratio (in the case of three component
ratios):
o Integral decomposition method
Procedure is similar as in the case of functional method. In the case of decomposition with three
component ratios:
𝑎
1
𝑅 𝑎
1
𝑅
𝑥∗
𝑎
2
𝑅 𝑎
2
𝑅
𝑥∗
𝑎
3
𝑅
𝑎
3
𝑅
𝑥∗
𝑥∗
𝑎
𝑗
𝑁
𝑗= 1
Generally, the influence of j-th component ratio is given as:
𝑎 𝑗
𝑎
𝑗
𝑥∗
▪ Method of gradual changes
1
0
𝑎
1
1
2 , 0
3 , 0
𝑎 2
1 , 1
2
3 , 0
𝑎
3
1 , 1
2 , 1
3
▪ Logarithmic decomposition method
𝑎
1
0
𝑅𝑂𝐸
1
0
𝑎
𝑖
𝑎
𝑥
1
0
▪ Functional decomposition method
𝑎
1
0
0
𝑥
𝑅𝑂𝐸
1
−𝑅𝑂𝐸
0
𝑅𝑂𝐸
0
1
0
▪ Integral decomposition method
𝑎
1
0
0
1
0
𝑎𝑖
𝑎
𝑎
1
𝑎
2
𝑎
3
o Logarithmic decomposition method
𝑎
1
0
𝑅𝑂𝐴
1
0
𝑎
𝑖
𝑎
𝑅𝑂𝐴
1
0
o Functional decomposition method
𝑎
1
0
0
𝑅𝑂𝐴
𝑅𝑂𝐴
1
−𝑅𝑂𝐴
0
𝑅𝑂𝐴
0
1
0
o Integral decomposition method
𝑎
1
0
0
1
0
𝑎𝑖
𝑎
𝑎
1
𝑎
2
𝑎
3
Lesson 3 – Working capital management
Working capital: Company´s investment in current assets
Net working capital : Difference between the company´s current assets and its current liabilities
o Cash and marketable securities: Most liquid assets, are in the form of cash or can be quickly
converted into cash at a low cost
o Inventories: Holding raw material, work-in-process and finished goods. Usually turns over at
frequent intervals and thus, can be expected to be converted into cash rather quickly. The speed
with which inventory is turned into cash depends on the sector in which the company operates.
o Account receivables: When the goods is sold on credit, when the customers makes the payments on
the credit sales, the accounts receivable are converted into cash.
- Current liabilities include:
o Short-term credits: All the bank credits and loans payable within one year
o Other short-term liabilities: Wages and salaries payable, …
o Account payables: When the company buys goods or services on credit, which is payable in one year
or less.
Working capital management: Managing the company´s liquidity (Company´s ability to pay all the short-term
liabilities on or before maturity), which includes:
- Investment in current assets (how much, structure)
- The use of current liabilities (how much, structure of capital sources)
The company can reduce the risk of illiquidity holding more current assets by investing in larger cash or marketable
securities. But the current assets earn low or zero return compared with other company´s assets, which has negative
impact on company´s total rate of return. Increased liquidity must be trade-off against the company´s reduction in
rate of return on investments. The greater the company´s usage of current liabilities in assets financing, the greater
the risk of illiquidity. On the other hand, current liabilities have specific advantages compared to long-term liabilities:
- Less costly (Interest rates on short-term debts are lower than on the long-term debt for the same borrower)
- Offer flexible source of financing (Short-term sources match better the timing of the company´s needs)
Disadvantages of current liabilities:
- Must be repaid in a shorter period
- Uncertainty of interest costs (rates) from year to year
Working capital management:
- Cash and marketable securities management
Cash is held to cover the day-to-day operation needs of the company. The level of cash that the company
need depends primarily on:
o The business in which the company operates (Restaurant vs. production company)
o Size of the company (Larger companies keep lower cash level than smaller companies. Large
companies have greater bargaining power with banks, suppliers and customers than smaller
companies)
o Banking technologies and payment systems (In economies with developed banking and payment
systems companies can keep lower level of cash, most of the payments can be undertaken as a non-
cash payment, for example bank transfers, credit cards, …)
o Investments availability (Companies can keep part of cash in marketable securities. They bring return
and can be quickly converted into cash at no costs).
Model of estimation of optimal cash level:
o Baumol model
Model assumes the company can hold either cash or marketable securities. Cash is associated with
foregone interest 𝑟 (yield of securities). The conversion (selling) of marketable securities is
associated with costs 𝐶. Optimal cash level:
Marketable securities
Sometimes called near, cash investments (Earn return with little or no risk and can be quickly converted into
cash). The most common marketable securities are:
o Treasury bills: Short term obligations issued by the government, carry no default risk, maturity less
than one year, are issued as discount securities
o Commercial Papers: Short-term notes issued by corporations to increase their funds, issued by
financial and non-financial corporations
o Repurchase agreements (REPO): Sale of a security with an agreement that the security will be bought
back at a specific price at the end of agreement period.
Manufacturing companies may have inventories at different stages in the production process:
o Inventories of raw material (Are held to ensure the production process)
o Inventories of partially finished goods (Work-in-process inventories, the more complicated
production process, the higher are work-in-process inventories)
o Inventories of finished goods (Because of the time gap between the production is finished and the
goods meet the customers)
Inventory management techniques:
In inventory management, company solves two problems:
o The order point problem (when)
o The order quantity (how much)
Involves determining the optimal order size for the inventory item if expected consumption, carrying
costs and ordering costs are known:
▪ Carrying costs (C): If the inventory can fall to zero and then immediately new delivery of the
size Q (in units) arrive, the average inventory is Q/2. If the average inventory is Q/2 and the
carrying costs per unit is C, the total carrying costs is:
▪ Ordering costs (O): Costs associated with ordering of the delivery of goods (e.g. inventory).
If the total consumption over a given period is S and the size of one delivery is Q, then it
follows, that:
The Economic Order Quantity (EOQ) model determines the order size that will minimize total
inventory costs:
▪ S: Total consumption of inventory item during period
▪ O: Ordering costs
▪ C: Carrying costs
Example: Calculate economic order quantity if following information is available:
▪ Expected total consumption over a given period is 𝑆 5000 units
▪ Ordering costs per one order is 𝑂 USD 200
▪ Carrying costs per one unit is 𝐶 USD 2
- Account receivable management
Company sales for cash or on credit. Account receivables: if the goods or service is sold on credit.
o Sales on credit: Increase in accounts receivables.
o Collecting the payments for sales: Decrease in account receivables
Terms of sales on credit: Invoce: Accounting document specifying the terms of the sales on credit:
o Name of seller and buyer
o Goods or service description incl. quantity (units, hours, etc.)
o Price per unit
o Total amount to be paid
o Credit period (net 30 = must be paid within 30 days)
o Possible discount for early payment (2/10, net 30 = 2% discount if paid within 10 days, otherwice
within 30 days)
Costs and benefits of selling on credit:
Benefits:
o Increase of sales (Customers do not have to pay immediately the cash)
o Depends on business sector (Typical for high-priced items and less typical for non-expensive items)
Costs:
o Probability the customer default within the credit period
o Money tied up in account receivables (Foregone interest)
Account receivables classification:
o Short-term, long-term receivables
o Business receivables, receivable to employees, tax office, …
