What is Finance?

Managerial (Business ) Finance

● Finance is concerned with decisions about money (Cash flows) ● deals with decisions that all firms make concerning their cash flows, including both
● Finance decision deal with how money is raised and used inflows and outflows
● everything else being equal:
➔ More value is preferred to less Alternative forms of Business Organization
➔ the sooner cash is received the more value it has ● Proprietorship
➔ less risky assets are more valuable than riskier assets ➔ Advantages:
➔ Ease of formation
What is Finance ➔ Subject to few government regulation
● id defined by Webster’s Dictionary as the system that includes the circulation of ➔ No corporate income taxes
money, the granting of credit, the making of investment, and the provision of banking ➔ Limitations:
facilities. Finance has many facets, which makes it difficult to provide one concise ➔ Unlimited personal liability
definition ➔ limited life
➔ transferring ownership is difficult
Jobs in Finances ➔ Difficult to raise capital
● Finance prepares students for jobs in banking, investments, insurance, corporations, ● Partnership
and government. Accounting students need to know marketing, management, and ➔ Like a proprietorship, except two or more owners
human resources; they also need to understand finance, for its affects decisions in all ➔ A partnership has roughly the same advantages and limitations as a
those areas proprietorship

General Areas of Finance (A partnership is an arrangement where parties, known as business partners, agree to
● Financial Markets and Institutions cooperate to advance their mutual interests. The partners in a partnership may be
● Investments individuals, businesses, interest-based organizations, schools, governments or
● Financial Services combinations.)
● Managerial Finance
● Corporation
Financial Markets and Institutions ➔ Advantages:
● Financial institutions, which include banks, insurance companies, savings and loans, ➔ Unlimited life
and credit unions, are an integral part of the general financial services marketplace ➔ Easy transfer of ownership
➔ Limited liability
Investment ➔ Ease of raising capital
● this are of Finances focuses on the decisions made by businesses and individuals as
➔ Disadvantages:
they choose securities for their investment portfolios
➔ Cost of set-up and report filing
Financial Services ➔ Double taxation
● refers to function provided by organizations that deal with the management money
(A corporation is an organization—usually a group of people or a
company—authorized by the state to act as a single entity and recognized as such in
law for certain purposes. Early incorporated entities were established by charter. Most Balancing Shareholder Value and the Interest of Society
jurisdictions now allow the creation of new corporations through registration. ● it focuses primarily on publicly owned companies; hence, we operate on the
assumption that management’s primary financial goals is shareholder wealth
Corporate charter (GIS) – which provides general information, including the name of maximization. At the same time, the managers know that this does not mean
the corporation, types of activities it will pursue, amount of stock that initially will be maximizing shareholder value “ at all cost”. Managers have an obligation to behave
issued, and so forth, must be filed by the corporate secretary in which the firm ethically, and they must follow the laws and other society-imposed constraints
incorporates. Managerial Actions to Maximize Shareholder Wealth
● Stockholder wealth maximization. The appropriate goal for management decision;
Bylaws – a set of rules drawn up the founders of the corporation that indicates now consider the risk and timing associated with expected cash flows to maximize the price
the company is to be governed; includes procedures for electing directors, rights of of the firm’s common stock
stockholders, and how to change the bylaws when necessary.) Should Earning per Share (EPS) be Maximized?
● Will profit maximization also result in stock price maximization? in answering this
Hybrid Forms of Business question, we introduce the concept of earnings per share (EPS), which equals net
Income (NI) divided by the number of outstanding shares of common stock ( Shares)-
● Limited Liability Partnership (LLP)
that is, EPS= NI/Shares
● Limited Liability Company (LLC)
● Many investors use EPS to gauge the value of a stock
● S Corporation Intrinsic Value
● An estimate of a stock’s “true” value based on accurate risk and return data. The
(Alternative business forms that include some of the advantages, and avoid some of
intrinsic value can be estimated, but not measured precisely
the disadvantages, of the three major forms of business have evolved over time. A
Stock Price
three popular hybrid business forms that exist today.) ● The term stock price refers to the current price that a share of stock is trading for on
Limited Liability Partnership (LLP) the market. Every publicly traded company when its shares are.
● in the earlier discussion of a partnership, we describe the form of business that is
referred to as a general partnership, wherein each partner is personally liable for any Executive Compensation
of the debts of the business ● final compensation
Limited Liability Company ( LLC) ● call options
● is relatively new business form that has become popular during the past couple of ● stock
decades; it combines feature of corporation and partnership ● benefits
● perquisites
S Corporation
● A corporation with no more than 100 stockholders that elects to be taxed in the same Executive Compensation
way as proprietorships and partnerships, so that business income is only taxed once
● (If a corporation elects the S corporation status, then its income is taxed the same as ● Is composed of the Financial compensation and other non-financial benefits received
income earned by proprietorships and partnerships – that is, income “passes through” by an executive from their firm for their service to the organization. It is typically a
the company to the owners so that it is taxed only once.) mixture of salary, bonuses, shares of or call option on the company stock, benefits,
and prequisites, ideally configured to take into account government regulations, tax
law, the desires of the organization and the executive, and rewards for performance.
Importance Business Trends information for personal gain, community involvement, and the use of illegal payments
to obtain business.
● Business trend awareness as a skill refers to one’s ability to be conscious of the
changing ways in which businesses are developing. For example, the vitality of online Stockholders versus Managers
presence for having a business that thrives originated from a mere trend of internet
usage. As a result, it is now believed that small businesses having a website tend to ● Managers are naturally inclined to act in their own best interests.
have a 40% faster growth than those that don’t have a website. ● Mechanisms to motivate managers to act in shareholder’s best interest
● The knowledge of all such trends and the understanding of how they will impact one’s ➔ Managerial compensation (incentives)
business decisions is what eventually brings success to the individual as well as the ➔ Shareholder intervention
company he works for. ➔ Threat of takeover

Why is business trend awareness important? Goals of the Corporation

● If your business is not amongst those that can instigate a trend, the least your ● Primary goal: stockholder wealth maximization — translates to maximizing stock
business can do is to follow such trends. For this reason, people running a business price.
must have business trend awareness skills and be able to reap the following benefits: ● Managerial incentives
➔ Enhanced forecasting ability. ● Social responsibility
➔ Helps in determining the required changes for improvement.
Managerial Actions to Maximize Stockholder Wealth
Enhanced forecasting ability
● Capital Structure Decisions
● If you are able to understand the current trends and predict the future ones ● Capital Budgeting Decisions
surrounding your business, forecasting the future of your business will be a lot easier ● Dividend Policy Decisions
for you. It will enable you to make better strategic decisions, capitalize on good
business opportunities, and overcome the fierce competition that your business might Capital Structure Decisions
face. ● the financial manager makes decisions about the expected cash flows of the firm,
Helps in determining the required changes for improvement which include decisions about how much and what types of debt and equity should be
used to finance the firm.
● If you know all about the current and future business trends, you can compare with
them your current strategies. Anything that does not match must be improved. This Capital Budgeting Decisions
way the business trends become a reliable guide for determining the required changes ● what type of assets should be purchased to help generate expected cash flows.
in one’s business or strategies.
Dividend Policy
Business Ethics
● what to do with net cash flows generated by the firm – reinvest them in the firm or pay
● Webster: “A standard of conduct and moral behavior.” dividends.
● Business Ethics: A company’s attitude and conduct toward its employees, customers,
community, and stockholders.
● Reputations reflect the extent to which firms and people are ethical. Ethics is defined
in Webster’s Dictionary as “standards of conduct or moral behavior.” Business ethics
can be thought of as a company’s attitude and conduct toward its employees,
customers, community, and stockholders. A firm’s commitment to business ethics can
be measured by the tendency of its employees, from the top down, to adhere to laws,
regulations, and moral standards relating to product safety and quality, fair
employment practices, fair marketing and selling practices, the use of confidential
Intrinsic Values, Stock Price, and Executive Compensation The Balance Sheet
● Represents a picture taken on a specific date that shows a firm’s assets and how
those assets are financed (debt or equity)
➔ Assets
➔ Liabilities
➔ Capital or Equity
➔ Stockholders Equity

The Balance Sheet

● Cash & equivalents versus other assets
➔ All assets stated in dollars - only cash and equivalents represent money that
can be spent
● Accounting alternatives
➔ e.g., FIFO versus LIFO•Breakdown of the common equity account–Common
stock at par, paid-in capital & retained earnings
● Book values often do not equal market values
● The time dimension
➔ A snapshot of the firm’s financial position during a specified period of time

The Income Statement

● Presents the results of business operations during a specified period of time
● Summarizes the revenues generated and the expenses incurred
➔ Revenues
➔ Gains
Financial Statement Analysis ➔ Expenses
● involves evaluation of a firm’s financial position to identify its current strength and ➔ Losses
weaknesses and to suggest actions that the firm might pursue to take advantage of ➔ Net Income
those strengths and correct any weaknesses to accomplish its goal of wealth
maximization. Statement of Cash Flows
● Designed to show how the firm’s operations have affected its cash position
The Annual Report ● Examines investment decisions (uses of cash)
● Discussion of Operations ● Examines financing decisions (sources of cash)
➔ Usually a letter from the chairman
● Financial Statements Statement of Retained Earnings
➔ The Income Statement ● Changes in the common equity accounts between balance sheet dates
➔ The Balance Sheet
➔ Statement of Cash Flows What Information Do Investors Use from Financial Statements
➔ Statement of Retained Earnings ● Net working capital
➔ = NWC = Current assets - Current liabilities
Financial Statements ● Operating cash flow
● The Balance Sheet ➔ = NOI (1-Tax rate) + Depreciation and amortization expense
● The Income Statement ➔ = Net operating profit after taxes + Depreciation and amortization expense
● Statement of Cash Flows ● Free cash flow
● Statement of Retained Earnings
 ➔ = FCF = operating cash flow - Investments ● Liquidity ratios suggest that Unilate’s liquidity position is fairly poor
➔ = Operating cash flow - (in fixed assets + NOWC)
● Economic Value Added Asset Management Ratios
➔ =EVA = NOI (1 - Tax rate) - [(Invested capital) X (After-tax cost of capital as a ● Inventory Turnover Ratio
percent)] ● Days Sales Outstanding (DSO)
● Fixed Assets Turnover Ratio
Financial Statement (Ratio) Analysis ● Total Assets Turnover Ratio
● Ratios are accounting numbers translated into relative values
● Ratios are designed to show relationships between financial statement accounts within Unilate’s Inventory Turnover Ratio
firms and between firms ● Inventory turnover=Cost of goods sold/Inventory
● =$1,230.0$270.0=4.66. times
The Purpose of Ratio Analysis ● Industry average =7.4 times
● Gives an idea of how well the company is doing
● Standardizes numbers; facilitates comparisons Unilate’s Days Sales Outstanding Ratio
● Used to highlight weaknesses and strengths ● DSO = Receivables/ Daily Sales= Receivables/ Annual Sales/ 360
● = $180.0/ $1,500.0/360 = $180.0/$4.167= 43.2 days
Five Major Categories of Ratios ● Industry average= 32.1 days
● Liquidity
➔ is the firm able to meet its current obligations Unilate’s Fixed Assets Turnover Ratio
● Asset management ● Fixed assets turnover=Sales/Net fixed assets
➔ is the firm effectively managing its assets ● =$1,500.0/$380.0= 3.9 times
● Debt management ● Industry Average= 4.0 times
➔ does the firm have the right mix of debt and equity
● Profitability Unilate’s Total Assets Turnover Ratio
➔ the combined effects of liquidity, asset and debt management ● Total assets turnover=Sales/Total assets
● Market values ● =$1,500.0$845.0=1.8 times
➔ relates the firm’s stock price to its earnings and the book value per share ● Industry Average = 2.1 times

Liquidity Ratios Debt Management Ratios

● Current ratio ● Debt Ratio
● Quick (Acid test) ratio ● Times-Interest-Earned Ratio
● Fixed Charge Coverage Ratio
Unilate’s Current Ratio
● Current Ratio = Current Assets/Current Liabilities Unilate’s Debt Ratio
● $465.0/$130.0=3.6 times ● Debt Ratio = Total liabilities/Total assets
● Industry average =4.1 times ● $430.0/$845.0=0.509 = 50.9%
● Industry Average= 42%
Unilate’s Quick (Acid Test) Ratio
● Quick Ratio = Current Assets- Inventories/Current Liabilities Unilate’s Times-Interest-Earned Ratio
● = $465.0- $270.0/ $130.0= $195.0/$130.0 = 1.5 times ● TIE = EBIT/Interest charges
● Industry average =2.1 times ● $130.0/ $40.0= 3.3 times
● =Industry Average = 6.5 times
Unilate’s Liquidity Position
 ● Industry average= 15.0 times

Unilate’s Market/Book Ratio

● Market/Book Ratio=Market price per share/ Book value per share
● =$23.00/$16.00= 1.4 times
● Industry Average = 2.5 times

Summary of Ratio Analysis:The DuPont Analysis

● ROA = Net Profit Margin X Total Assets Turnover
● Net Income/Sales x Sales/Total Assets
● =$54.0/$1,500.0 X $1,500.0/$845.0
● 3.6% X 1.8 = 6.4%

Rate of Return on Common Equity (ROE)

● ROE= ROA x Equity Multiplier
● Net income/ total assets x total assets / common equity
● =6.4% x $845.0/ $415.0
Profitability Ratios
● -6.4% x 2.036= 13%
● Net Profit Margin
● Return on Total Assets
DuPont Equation Provides Overview
● Return on Common Equity
● Firm’s profitability (measured by ROA)
● Firm’s expense control (measured by profit margin)
Unilate’s Profit Margin Ratio
● Firm’s asset utilization (measured by total asset turnover)
● Profit margin=Net Profit/Sales
● $54.0$1,500=0.036 = 3.6%
Potential Problems and Limitations of Financial Ratio Analysis
● Industry Average = 4.9%
● Comparison with industry averages is difficult if the firm operates many different
divisions
Unilate’s Return on Total Assets
● Inflation distorts balance sheets
● ROA =Net income/Total assets
● Seasonal factors can distort ratios
● =$54.0/$845.0= 0.064 =6.4%
● “Window dressing” can make ratios look better.
● Industry Average= 10.3%
● Different operating and accounting practices distort comparisons
Unilate’s Return on Common Equity
● Sometimes hard to tell if a ratio is “good” or “bad”
● ROE =Net income/Common equity
● Difficult to tell whether company is, on balance, in strong or weak position
● $54.0/$415.0- 0 = 0.130 = 13.0%
● Industry Average= 17.7%

Market Value Ratios

● Price/Earnings Ratio
● Market/Book Ratio

Unilate’s Price/Earnings Ratio

● Price/Earnings Ratio=Price per share/Earnings per share
● $2.16/$23.00= 10.6 times