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Rationale

Learning Objects and Outcomes

Teaching and Learning Resources

The Role of Financial Management
The Business, Tax, and Financial Environments
The Time Value of Money. The Valuation of Long-Term Securities
Risk and Return
Financial Statement Analysis
Funds Analysis, Cash-Flow Analysis, and Financial Planning
Overview of Working Capital Management
Cash and Marketable Securities Management
Accounts Receivable and Inventory Management
Short-Term Financing.Capital Budgeting and Estimating Cash Flows
Capital Budgeting Techniques
Risk and Managerial (Real) Options in Capital Budgeting
Required Returns and the Cost of Capital
Operating and Financial Leverage. Capital Structure Determination
Dividend Policy.The Capital Market
Long-Term Debt, Preferred Stock, and Common Stock
Term Loans and Leases. Convertibles, Exchangeables, and Warrants
Mergers and Other Forms of Corporate Restructuring
International Financial Management

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Financial Management

Rationale

Corporate Finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to enhance corporate value while reducing the firm's financial risks. Equivalently, the goal is to maximize the corporations' return to capital. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading "Working capital management". This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).

The terms Corporate finance and Corporate financier are also associated with investment banking. The typical role of an investment banker is to evaluate investment projects for a bank to make investment decisions.

See also

Related topics by category:

External links

Corporate Finance

Working capital management Cash conversion cycle Return on capital Economic value added Just In Time (business) Economic order quantity Discounts and allowances Factoring (finance)
Capital budgeting Capital investment decisions The investment decision The financing decision Capital investment decisions
Sections Managerial finance Management accounting Mergers and acquisitions Balance sheet analysis Business plan Corporate action
Finance series Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation

Learning Objectives and Outcomes

This is a non-taught unit designed for self-directed study by those intending to enhance their professional or managerial competence, knowledge, understanding, and skills in business finance.

Knowledge

After completing the course, students will understand

Skills

After completing the course, students will be able to

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Teaching and Learning Resources

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Learning Contents

The Role of Financial Management. Financial Environments

Tutorials

Readings

What is financial management?

Introduction

Financial Management can be defined as:

The management of the finances of a business / organisation in order to achieve financial objectives

Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:

Create wealth for the business
Generate cash, and
Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested

There are three key elements to the process of financial management:

(1) Financial Planning

Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.

In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.

(2) Financial Control

Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:

Are assets being used efficiently?
Are the businesses assets secure?
Do management act in the best interest of shareholders and in accordance with business rules?

(3) Financial Decision-making

The key aspects of financial decision-making relate to investment, financing and dividends:

1. Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers

2. A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.

See also

Activities

The Time Value of Money.The Valuation of Long-Term Securities. Risk and Return

Tutorials

Readings

The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time.

For example, 100 dollars of today's money invested for one year and earning 5 percent interest will be worth 105 dollars after one year. Therefore, 100 dollars paid now or 105 dollars paid exactly one year from now both have the same value to the recipient who assumes 5 percent interest; using time value of money terminology, 100 dollars invested for one year at 5 percent interest has a future value of 105 dollars.[1] This notion dates at least to Martín de Azpilcueta (1491-1586) of the School of Salamanca.

The method also allows the valuation of a likely stream of income in the future, in such a way that the annual incomes are discounted and then added together, thus providing a lump-sum "present value" of the entire income stream.

All of the standard calculations for time value of money derive from the most basic algebraic expression for the present value of a future sum, "discounted" to the present by an amount equal to the time value of money. For example, a sum of FV to be received in one year is discounted (at the rate of interest r) to give a sum of PV at present: PV = FV − r·PV = FV/(1+r).

Some standard calculations based on the time value of money are:

Present value The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations[2].

Present value of an annuity An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The payments or receipts occur at the end of each period for an ordinary annuity while they occur at the beginning of each period for an annuity due[3].

Present value of a perpetuity is an infinite and constant stream of identical cash flows[4].

Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today[5].

Future value of an annuity (FVA) is the future value of a stream of payments (annuity), assuming the payments are invested at a given rate of interest.

See also

References

External links

Activities

Financial Statement Analysis. Funds Analysis, Cash-Flow Analysis, and Financial Planning. Accounts Receivable and Inventory Management

Tutorials

Readings

A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. In British English—including United Kingdom company law—a financial statement is often referred to as an account, although the term financial statement is also used, particularly by accountants.

For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements. They typically include four basic financial statements, accompanied by a management discussion and analysis:[1]

Balance sheet: also referred to as statement of financial position or condition, reports on a company's assets, liabilities, and Ownership equity at a given point in time.

Income statement: also referred to as Profit and Loss statement (or a "P&L"), reports on a company's income, expenses, and profits over a period of time. Profit & Loss account provide information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state.

Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period.

Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities.

For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.

See also

External links

Activities

Business Planning Workshop

Overview of Working Capital Management. Cash and Marketable Securities Management. Accounts Receivable and Inventory Management

Tutorials

Readings

Working capital (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization, or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities. It is a derivation of working capital, that is commonly used in valuation techniques such as DCFs (Discounted cash flows). If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.

Working Capital = Current Assets

Net Working Capital = Current Assets − Current Liabilities

A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash.

See also

Marketable securities are investments that are highly liquid, meaning that they can be quickly sold in the secondary financial markets in large amounts for cash. A company might invest in these types of securities as a way to preserve cash for unanticipated events. Investors also select these short-term investment vehicles to seize certain opportunities in the financial markets.

There are different types of marketable securities, and the underlying theme among all of them is that they are traded, or bought and sold, frequently. This is a sign of liquidity. Those marketable securities that are types of bonds or certificates of deposit must have a maturity date or time at which a contract expires of no less than 12 months out. Bonds are debt instruments, while certificates of deposit are savings certificates, although both pay investors an interest rate over the life of the contract. These securities trade in the secondary market, a segment of the financial markets where previously issued securities are bought and sold.

Related topics

Read more..

Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English[1].

In the USA and Canada the term has developed from a list of goods and materials to the goods and materials themselves, especially those held available in stock by a business; and this has become the primary meaning of the term in North American English, equivalent to the term "stock" in British English. In accounting, inventory or stock is considered an asset.

See also

Short-Term Financing. Capital Budgeting and Estimating Cash Flows. Capital Budgeting Techniques

Tutorials

Readings

Capital budgeting (or investment appraisal) is the planning process used to determine whether a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures.[1]

Many formal methods are used in capital budgeting, including the techniques such as

These methods use the incremental cash flows from each potential investment, or project Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.

External links and references

Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 375. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId
=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4

Capital Budgeting

International Good Practice: Guidance on Project Appraisal Using Discounted Cash Flow, International Federation of Accountants, June 2008, ISBN 978-1-934779-39-2

Prospective Analysis: Guidelines for Forecasting Financial Statements, Ignacio Velez-Pareja, Joseph Tham , 2008

To Plug or Not to Plug, that is the Question: No Plugs, No Circularity: A Better Way to Forecast Financial Statements, Ignacio Velez-Pareja, 2008

A Step by Step Guide to Construct a Financial Model Without Plugs and Without Circularity for Valuation Purposes, Ignacio Velez-Pareja, 2008

Long-Term Financial Statements Forecasting: Reinvesting Retained Earnings, Sergei Cheremushkin, 2008

Cash flow is the movement of cash into or out of a business, project, or financial product. (Note that the word cash is used here in the broader sense, where it includes bank deposits.) It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on the companies' value and situation. Cash flow can e.g. be used for calculating parameters:

1. to determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return, and net present value.

2. to determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.

3. as an alternate measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. For example, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares, or raising additional debt finance.

4. cash flow can be used to evaluate the 'quality' of Income generated by accrual accounting. When Net Income is composed of large non-cash items it is considered low quality.

5. to evaluate the risks within a financial product, e.g. matching cash requirements, evaluating default risk, re-investment requirements, etc.

Cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows, or to projected future flows. It can refer to the total of all the flows involved or to only a subset of those flows. Subset terms include 'net cash flow', operating cash flow and free cash flow.

See also

References

External links

International Federation of Accountants International Good Practice Guidance on Project Appraisal Using Discounted Cash Flow

Estimating Cash Flows

Activities

Risk and Managerial (Real) Options in Capital Budgeting. Required Returns and the Cost of Capital

Tutorials

Readings

Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them.

Financial risk management can be qualitative and quantitative. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.

In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.

When to use financial risk management

See also

External links

Activities

Operating and Financial Leverage. Capital Structure Determination

Tutorials

Readings

In finance, leverage is a general term for any technique to multiply gains and losses.[1] Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives.[2] Important examples are:

A public corporation may leverage its equity by borrowing money. The more it borrows, the less equity capital it needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.[3]

A business entity can leverage its revenue by buying fixed assets. This will increase the proportion of fixed, as opposed to variable costs, meaning that a change in revenue will result in a larger change in operating income.[4][5]

Hedge funds often leverage their assets by using derivatives. A fund might get any gains or losses on $20 million worth of crude oil by posting $1 million of cash as margin.[6]

In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. In reality, capital structure may be highly complex and include dozens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a short term loan etc.

The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, how a firm is financed is irrelevant to its value. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. Some other reasons include bankruptcy costs, agency costs, taxes, and information asymmetry. This analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm.

See also

External links

Activities

Dividend Policy. The Capital Market

Tutorials

Readings

Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.[1] When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

For a joint stock company, a dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of after tax profits among shareholders. Retained earnings (profits that have not been distributed as dividends) are shown in the shareholder equity section in the company´s balance sheet - the same as its issued share capital. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are often considered to be a pre-tax expense.

Dividends are usually settled on a cash basis, store credits (common among retail consumers' cooperatives) and shares in the company (either newly created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

See also

External links

Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends – U.S. Securities and Exchange Commission
Dividend policy – Literature class notes from Wharton School of Business
Dividend Policy from studyfinance.com at the University of Arizona
The new U.S. dividend tax cut traps from Tennessee CPA Journal, Nov. 2004
Yield Shares - an explanation of dividend investing
Dividend Policy

A capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year[1], as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market includes the stock market (equity securities) and the bond market (debt). Financial regulators, such as the UK's Financial Services Authority (FSA) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their designated jurisdictions to ensure that investors are protected against fraud, among other duties.

Capital markets may be classified as primary markets and secondary markets. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. In the secondary markets, existing securities are sold and bought among investors or traders, usually on a securities exchange, over-the-counter, or elsewhere.

See also

Center for Audit Quality (CAQ)
Committee on Capital Markets Regulation (United States)
Financial market
Financial regulation
Securities law
Stock exchange

Capital Market Line (CML) – 10 min briefcast

Activities

Long-Term Debt, Preferred Stock, and Common Stock. Term Loans and Leases. Convertibles, Exchangeables, and Warrants

Tutorials

Readings

Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument. Preferreds are senior (i.e. higher ranking) to common stock, but are subordinate to bonds.[1]

Preferred stock usually carries no voting rights,[2] but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. Preferred stock may have a convertibility feature into common stock. Terms of the preferred stock are stated in a "Certificate of Designation".

Similar to bonds, preferred stocks are rated by the major credit rating companies. The rating for preferreds is generally lower since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.[3]

External links

"The Many Flavors of Preferred Stock" at About.com

The terms annual percentage of rate (APR), nominal APR, and effective APR (EAR)[1] describe the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate.[2] Those terms have formal, legal definitions in some countries or legal jurisdictions, but in general:[1]

The nominal APR is the simple-interest rate (for a year).
The effective APR is the fee+compound interest rate (calculated across a year).[1]

The nominal APR is calculated as: the rate, for a payment period, multiplied by the number of payment periods in a year.[1] However, the exact legal definition of "effective APR", or EAR in short, can vary greatly in each jurisdiction, depending on the type of fees included, such as participation fees, loan origination fees, monthly service charges, or late fees. The effective APR has been called the "mathematically-true" interest rate for each year.[3][4] The computation for the effective APR, as the fee+compound interest rate, can also vary depending on whether the up-front fees, such as origination or participation fees, are added to the entire amount, or treated as a short-term loan due in the first payment. When start-up fees are paid as first payment(s), the balance due might accrue more interest, as being delayed by the extra payment period(s).[5]

In some areas, the annual percentage rate (APR) is the simplified counterpart to the effective interest rate that the borrower will pay on a loan. When not using the term "effective APR", the use of "APR" is an early term for nominal APR. In many countries and jurisdictions, lenders (such as banks) are required to disclose the "cost" of borrowing in some standardized way as a form of consumer protection. APR is intended to make it easier to compare lenders and loan options. The APR is likely to differ from the "note rate" or "headline rate" advertised by the lender, due to the addition of other fees that may need to be included in the APR. APRs can be found by asking the lender or by reading the appropriate section in the contract.

In the U.S. and the UK, lenders are required to disclose the APR before the loan (or credit application) is finalized (although the definition of "APR" is not the same in the two countries-–see below). Credit card companies can advertise monthly interest rates, but they are required to clearly state the annual percentage rate before an agreement is signed. APR is a term used with regard to deposit accounts as well. However, when dealing with deposit accounts, the annual percentage yield (APY) or annual equivalent rate (AER) is quoted to consumers for comparison purposes.

See also

Compound interest

References

External links

Interest Rates: An Introduction. Federal Reserve Bank of New York.
http://www.fdic.gov/regulations/compliance/handbook/manual%20197-202.pdf FDIC Finance Charge and APR calculation rules
http://www.investopedia.com/terms/a/apr.asp
http://www.margill.com/white-paper-interest.htm White Paper: More than Math, The Lost Art of Interest calculation
http://www.bbc.co.uk/raw/money/express_unit_percentages/
Mortgage APR Calculator
Mortgage Calculator with APR Function
http://www.federalreserve.gov/reportforms/formsreview/RegZ_20090519_ffr.pdf Mortgage Disclosure Improvement Act or MDIA
Long Term Debt - Financial Glossary
Long Term Debt
Preferred Stock
Common Stock Market Terms Explained
Loans and Leases
- Loan Calculators
State Bank of India
Convertibles Market 2000
New Evidence on the Announcement Effect of Convertible and Exchangeable Bonds

Activities

Mergers and Other Forms of Corporate Restructuring. International Financial Management

Tutorials

Readings

The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.

See also

Activities

Recommended Text

International Financial Management, 2/e
Eun and Resnick

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