USING FUNDS TO MAXIMIZE VALUE Mark Kolta
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LOOKING AHEAD • How does maximizing financial value relate to social responsibility? • How do financial managers use key ratios? • How do financial managers use cash budgets? • Why is working capital management important? • How do financial managers evaluate capital budgeting proposals? • How do financial managers determine the firm’s capital structure? 2
WHAT MOTIVATES FINANCIAL DECISIONS • What types of assets do we need to achieve goals? • How do we get the funds we need? Evaluate financial performance Plan financial resources Manage working capital Evaluate investment opportunities • Determine appropriate strategy • • • •
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EVALUATING PERFORMANCE: WHERE DO WE STAND? • Financial ratios provide insight into financial strengths and weaknesses
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• Use financial data from balance sheet and income statement • Companies can compare their ratios with other businesses
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KEY FINANCIAL RATIOS
RATIO
TYPE
Current Liquidity: ability to pay short-term liabilities. Inventory Asset Management: how firm is using assets to Turnover generate revenue. Debt-to-equity Leverage: extent to which a firm relies on debt.
HOW IT IS COMPUTED Current Assets Current Liabilities Cost of Good Sold Average Inventory Total Debt Total Owner’s Equity
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KEY FINANCIAL RATIOS RATIO
TYPE
Debt-to-assets Leverage: measures the extent to which a relies on debt
HOW IT IS COMPUTED Total Debt Total Assets
Return on equity Profitability: compares the amount of profit compared to resources invested
Net Income – Preferred Div Avg Common Stock Equity
Return on assets Profitability: compares the amount of profit compared to resources invested
Net Income Average Total Assets
Earnings per Profitability: compares the amount of profit share compared to resources invested
Net Income – Pref Dividends Avg # of Shares Out
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BASIC PLANNING TOOLS Pro Forma Income Statement – forecasts the sales, expenses and net income Pro Forma Balance Sheet – forecasts the types and amounts of assets a firm will need to carry out plans.
Cash Budget – detailed projection of cash flows to determine when cash shortages and surpluses will occur.
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CASH BUDGET
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FINANCIAL PLANNING: PROVIDING A ROAD MAP FOR THE FUTURE • What assets must be obtained? • How much additional financing is needed? • How much can the firm generate Internally? Externally? • When will external financing be required?
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MANAGING WORKING CAPITAL: CURRENT EVENTS • Net Working Capital: • Difference between current assets and liabilities
• Working capital must be managed • Appropriate level of current assets • Current liabilities needed to finance activities
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SAMPLE BALANCE SHEET
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MANAGING CASH • Need cash to pay bills • Cash does not earn returns
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CASH EQUIVALENTS • Commercial Paper • Short-term unsecured promissory note (IOUs). • Issued by major corporations with excellent credit rating • Sold at a discount; price plus interest is paid when the paper comes due
• T-bills • • • •
Short-term IOUs issued by the U.S. government. T-Bills normal mature in 4, 13, or 26 weeks Sold at a discount; face value is paid at maturity Good market for T-Bills since they are backed by the government
• Money Market Mutual Funds • Pooled funds to purchase a portfolio of short-term, liquid securities • Affordable way for small investors to get into the market
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MANAGING ACCOUNTS RECEIVABLE Accounts Receivable - Money which is owed to a company by a customer for products and services provided on credit. • Set Credit Terms • Establish Credit Standards • Design Appropriate Collection Policy
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SHORT-TERM FINANCING • Spontaneous Financing • Trade Credit
• Short-Term Bank Loans • Line of Credit • Revolving Credit
• Factoring • Commercial Paper 15
BORROWING MONEY
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“If you want to know the value of money, go and try to borrow some.” - Benjamin Franklin
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CAPITAL BUDGETING: IN IT FOR THE LONG HAUL • Replace machines and equipment • New machines and equipment • Build a new factory, warehouse or office • Introduce a new product line Capital Budgeting – a systematic evaluation of a firm’s major long-run capital investment opportunities. 17
COMPARING CASH FLOWS THAT OCCUR AT DIFFERENT TIMES Managers must evaluate costs and benefits of investment that occur over a period of many years. Time Value of Money – a dollar received today is worth more than a dollar received in the future.
Compounding – earning interest in the current period on interest from previous periods.
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SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS Capital Structure – the mix of equity and debt financing a firm uses for financing needs. Debt Financing – creditors.
Equity Financing – owners. 19
SAMPLE BALANCE SHEET
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SOURCES OF DEBT FINANCING • Long-term loans • Issuing notes or bonds
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SOURCES OF EQUITY FINANCING • Direct contributions by owners • Owners directly contribute resources to unincorporated businesses • Corporations raise equity capital by issuing stock
• Retained earnings
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EQUITY VS. DEBT • Equity doesn’t require payments • Debt has tax advantages • Equity gives up ownership control • Debt had interest
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