Week 3 Dr. Jenne Meyer

 Work as a group to come up with a business concept  What is the concept?  How would you organize? Why?  Check out Legalzoom.com for more info.

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 Accounting  organizes a system of financial records  records financial data  prepares, analyzes and interprets financial statements  work is guided by Generally Accepted Accounting Principles (GAAP)  Finance  saving, investing, and using money by individuals, businesses, and governments  is broader than accounting

 Accounting focuses on history  Finance focuses on the future.  Decision-makers must understand the financial past to plan for the financial future.

 money and capital markets  determining monetary needs and obtaining adequate cash  investments  analyzing and choosing among investment alternatives while considering returns and risks  financial management  applies management principles to financial decision-making for organizations

 Equities  the financial claims on a company’s resources  Fundamental accounting equation  Assets = Liabilities + Owner’s Equity ▪ Assets - resources used by a business in its operations ▪ Liabilities - claims against the business resources by those to whom the business has financial obligations ▪ Owner’s equity - financial interest in the business held by all owners

 Accounts - the financial records for each of the specific assets, liabilities, and categories of owner’s equity  Accounting transaction  the act of recording a financial activity that results in a change in the value of an organization’s resources  financial activities are recorded as entries in the accounts

 Historic Costs  Revenue Recognition  accrual accounting ▪ recognizing revenue and expenses when they are incurred rather than when cash is received or spent  Expense and Revenue Matching  Full Disclosure  Standard Practice and Conservatism

 Developing and maintaining a financial records system that has integrity requires decisions in several areas.

 Each user of financial information has specific concerns.  Managers need to operate a profitable business and maximize shareholder value.  Investors want to maximize the value of their investment.  Creditors want to be sure the company has assets sufficient to cover debt.  The government requires accurate financial disclosure and tax payments.

 Privately owned companies are not required to disclose financial information.  Public companies must report financial information.  Annual Report – a statement of a company’s operating and financial performance issued at the end of its fiscal year  Form 10-K - a form required by the SEC that may be even more detailed than an annual report

 The primary objective of financial management is to maximize the wealth of owners.

 Board of directors  provide business oversight  establish corporate policy  hire key executives  review major business decisions

 Chief Executive Officer (CEO) ▪ the top manager of a corporation ▪ executes the strategy and the policy of board of directors ▪ leads management and employees ▪ sets long-term operational direction  Chief Operating Officer (COO) ▪ directs business operations  Chief Financial Officer (CFO) ▪ plans and manages financial resources

 Treasurer  manages cash, investments, and other financial resources  manages relationships with investors and creditors  Controller  in charge of accounting and financial records

 Three major decisions define the work of financial managers:  what investments need to be made  how investments should be financed  how to efficiently manage investments

 retained earnings  profits earned by a company that are not paid to shareholders as dividends  working capital  working capital = current assets – current liabilities  shareholder’s equity  the value of all classes of stock and retained earnings

 Comparing income statements over multiple time periods provides a strong assessment of a company’s performance.  improvements in efficiencies of generating revenues  cost containment

 Cash flow is the movement of cash into and out of a business.  Solvency  the ability of a company to meet its financial obligations as they become due  A company with an increasing positive cash flow is a healthy company.

 financial ratios  comparisons of financial data used to evaluate business performance  ratio analysis  the study of relationships in a company’s finances in order to understand and improve financial performance

 An important measure of a company’s health is its ability to pay debts on time.  need a favorable liquid position

 Current ratio = current assets current liabilities  The current ratio shows how well the company is prepared to pay current liabilities.  due within a year  A ratio of 2:1 represents a strong position in most industries.

 Quick Ratio = current assets – inventory current liabilities  A more precise liquidity measure that reduces the value of current assets by the value of inventory  Inventory is a particular problem in some industries.  A ratio of 1:1 is acceptable in many industries.

 Asset management ratios compare the value of key assets to sales performance.

 Inventory Turnover = net sales avg inventory  Measures the efficiency of a company in maintaining inventory to generate sales  A company doesn’t earn money until its inventory is sold.  If a business has a low inventory ratio:  inventory should be reviewed to determine if it is obsolete

 Total Assets Turnover = Sales Total Assets  Measures how efficiently all assets generate sales  Used to determine if a company has a reasonable amount of assets for the sales being produced.  A low value suggests assets are not being used efficiently.  Fixed asset turnover ratio - examines the efficiency of land, buildings, and major equipment

 Accounts Receivable = total credit sales/accts receivable  Measures how quickly credit sales are converted to cash  Higher ratios mean that accounts receivable are collected quickly.  Lower ratios might indicate losses.  when older accounts are not paid  Average collection period ratio  (accounts receivable) ÷ (average daily sales)  identifies how many days on average it takes to collect accounts receivable ▪ a small number of days shows effective credit procedures

 financial leverage  using debt financing to increase the rate of return on assets

 Debt Ratio = Total Debt (current & long-term liabilities Total Assets (current and long term)  Measures how much a company’s assets are owned by creditors.  The appropriate ratio is guided by  the industry in which the company operates  the financial stability of the company

 Times-Interest-Earned = Operating Income Total Interest Charges  Shows how well-positioned the company is to pay interest on its debt  A high ratio means the company has a high margin of safety in being able to pay creditors.

 Ratios are used to track bottom-line performance.  useful for comparison with competitors  a tool to asses performance relative to other possible investments

 Profit Margin on Sales Ratio = Net Profit Net Sales  Measures the profit generated by each dollar of sales  Gross profit margin ratio  (gross profit) ÷ (net sales)  Operating profit margin ratio  (operating income) ÷ (net sales)  Operating income - earnings before interest and taxes

 Return on Total Assets = Net Income Total Assets  Measures the company’s earnings on each dollar of assets  This ratio evaluates the efficiency of the assets of the company.

 Return on Equity = Net Profit Stockholder’s Equity  Measures how each dollar of investment by stockholders contribute to net income

 Market performance ratios serve a variety of functions  examine the overall financial performance of a business in contributing to shareholder value  a metric of the effectiveness of executive leadership  helps compare multiple companies

 Earnings per share ratio = Net Income # of Shares Issued  Measures the amount of profit earned by each share of stock  If preferred stock is issued  the dividends paid to preferred stockholders are subtracted from net income ▪ before dividing by the number of shares of common stock issued

 Price Earnings Ratio = Market Stock Price Earnings per share  A measure of the strength of a company’s earnings in affecting the price of its stock  Anticipated earnings on investments  help investors decide what price to pay for a company’s stock

 Market to Book Ratio = Market Price per share Book Value per share  When this ratio is greater than 1, investors are willing to pay more for the stock than it is valued by the company

 Comparing ratios over several time periods provides a better picture of the company’s financial condition.  Industry trends can also be analyzed using financial ratios.

1. Organize financial records. 2. Determine key financial ratios. 3. Develop baseline data. 4. Identify comparative information sources. 5. Identify benchmark companies (a competitor with outstanding performance) 6. Calculate ratios regularly. 7. Use ratio analysis as a tool to establish financial goals.

 Financial information is relatively easy to obtain for public corporations.  Information provided by trade associations  may be provided only to members  may have a usage fee

 Pick two comparative companies (ie, Coke and Pepsi) and compare their financial ratios.  How do they differ?  Why do you think they differ?  How do you think they compare in the marketplace?

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 cash budget - an estimate of future cash receipts and cash payments for a specific time period  A cash budget has three main components  cash receipts  cash payments  cash excess or shortage

 Cash Sales  products and services are sold for cash  Collections on Account  account receivable ▪ the money owed for purchases bought on credit  Other Cash Receipts  variable, non-routine sources of cash

 Variable Cash Expenses  expenses that vary monthly  Fixed Cash Expenses  business payments that are consistent each month  Other Cash Payments  cash expenses that are not related to day-to-day operations

 cash excess  when receipts exceed payments  cash shortage  when payments exceed receipts  A sufficient amount of cash should be available at all times to cover expenses for at least one month.

 (current assets) – (current liabilities)

 current assets  items of value in an organization that will likely be converted into cash within a year  current liabilities  amounts owed that need to be paid within the next year  accounts payable  amounts owed to suppliers and others for items bought on credit

 current ratio (liquidity ratio) ▪ (current assets) ÷ (current liabilities)  If (current ratio) ≥ 1, then the company has adequate current assets to cover debts coming due shortly  If (current ratio) < 1, then the company may not be able to pay upcoming bills on time  Three factors should be considered when assessing current ratio.  The current ratio of the company in the past few years  The current ratios of other companies in the same industry  Current economic conditions

 Inventory (merchandise inventory)  the merchandise an organization plans to sell to customers  part of a company’s current assets  fairly liquid  Inventory turnover  (sales) ÷ (inventory)  an indication of how many times the average inventory has been sold

 Inventory loss can be controlled by:  documenting the amounts of each product type that is incoming and outgoing  separating responsibilities for authorizing, order preparation, and shipping of inventory  conducting an annual physical inventory  using technology to update records and monitor locations  opportunity cost  the money and space consumed by inventory cannot be used for other business needs

 Breakeven point - the approximate sales volume required to just cover costs ▪ gross profit = selling price – variable costs ▪ breakeven units = total fixed costs ÷ gross profit per unit  Variable costs - business expenses which change in proportion to the level of production ▪ labor costs ▪ production materials ▪ utilities  Fixed Costs - business expenses that stay constant regardless of production levels ▪ rent ▪ property tax ▪ managers’ salaries ▪ insurance

1. Why must a company look at current financial records before making changes to reach new financial goals? 2. Why would employees resist earning a commission? 3. Why does offering a store credit card increase possible sales? 4. What new threats are associated with offering the store credit card?

 Based on your defined new business establish prices, inventory, and a sales projection.  What is your break even analysis? Chapter 2Slide 57

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 capital project (capital expenditures)  the construction or purchase of a long-term asset  capital spending  the process of spending money to pay for capital projects  Why would you do capital projects?

 Replacement project  Cost savings project  New product or new market  Government required project  Social benefit project

 The purchase of long-term assets is vital for the current and future success of every organization.  capital budgeting - the process of selecting long- term assets

 cost of capital (required rate of return)  the rate required by lenders and investors who are letting the company use their money

 cost of debt  the rate of return required by creditors  Benefits associated with using debt include:  The company is using the money of others, allowing the business to keep its funds available for other uses.

 cost of equity  the required return of the owners of a company  the percent the company owners expect to earn based on the money they have invested in the company  return might be in ▪ dividends ▪ increased market value of company

 Optimal capital structure  an appropriate balance between the amount of debt and the amount of equity  the financing combination of a low cost of capital and maximum market value  Factors to consider when seeking optimal cash structure include  The company’s current debt obligations  The company’s ability to borrow additional funds or issue additional bonds  Stockholders’ sensitivity to current risk because of existing debt  Historical and projected profitability of the company

 weighted average cost of capital (WACC)  calculated by multiplying the proportions of debt and equity times the capital cost for each  Every organization attempts to minimize its WACC.  occurs when a certain combination of debt and equity are used  the exact combination varies across companies and changes as risk and interest rates change

 Net Present Value (NPV) - calculates the present value of cash flows for a project minus the initial investment  initial investment (start-up cost) cost of the project  cash flows ▪ annual amounts of increased sales or decreased costs ▪ the financial benefits of the project  cost of capital (discount rate) ▪ the interest rate the company will use to calculate the present value of the cash flows

 Step 1  Calculate the present value of cash flows.  Step 2  Subtract the initial cost from the total in Step 1.  Step 3  Evaluate the result.

 Internal Rate of Return (IRR)  the discount rate at which the net present value is zero  provides a rate of return for a capital project  reports a percentage rather than a dollar amount

 Organizational Strategies  Centralized organization  Decentralized organization  Horizontal integration  Vertical integration  Diversification  Joint venture

 Horizontal integration a merger between two or more companies in the same type of business  Vertical integration a company expands through increased involvement in different stages of production and distribution  Product variations (new flavors, different package sizes, varied brands)  diversification  offering a variety of products or services  allows a company to balance lower sales in one division with higher sales in its other product lines  joint venture an agreement between two or more companies to share a business project

1. Why is it important for a company to know what the competition offers for customer service? 2. Why is accurate marketing research so important?

 What type of capital expensitures might you have?  What are your business expansion strategies?

 Any remaining questions?  Next week’s assignments