Principles of Management Week 6 / 7

The Finance Department Unit 8 The Finance Department

The finance department Finance Director Accounting Financial reporting Tax and investment Auditing Payroll Financial Administration Controller Billings and collections Purchasing Financial Analysis and Planning Planning and forecasts Corp. finance Financial analysis

Review – how profit is calculated Accounting Measure of net income (net profit) Sales revenues 1,000,000 - Cost of goods sold (500,000) = Gross profit 500,000 - Operating expenses (420,000) = Operating income (operating profit) 80,000 - Other income and expenses (interest) ( 30,000) - Taxes payable ( 20,000) = Net income (net profit, earnings, bottom line, etc.) 30,000

Forecasting and planning Financial Analysis and Planning Operating budget Year plan, quarterly estimates All projected revenues and current expenses Includes cash Capital expenditure budget All long-term capital asset investments Accounted for differently Cash budget Daily, weekly, quarterly, yearly Cash on hand or needed How much credit available to extend Cash allocation Operating budget = the plan for the year. Usually done by department, combined into a master budget (includes more than just operating expenses! Includes all costs related to running the business, including interest payments) Capital budget = expenditures that will be consumed over more than one year Cash budget = credit terms, cash collections, credit extensions

Cash flow issues from speculative production

The importance of liquidity Financial Administration Cash and cash equivalents (marketable securities, accounts receivables) Inventory Furniture, machinery, buildings Intellectual property, brand value

Capital budgeting Capital budgeting Financial Analysis and Planning Strategies New investment project Viability and feasibility analysis (Investment appraisal) Alternatives comparative analysis Capital expenditure budget, corp. finance and strategy Financial Analysis and Planning Consider the operating leverage of each project, how much will it change the underlying structure and availability of working capital and cash?

Questions If Popco sales projections look slow for April-June (2nd quarter), what sources of funds should we consider to manage our cash flow in 2013? Why? For our expansion plans into Brazil (“Popco II”), we want to raise $2,000,000. What sources of funds should we consider? Why?

Raising finance – in simple terms How much money do we need? When do we need the money Where do we get money? (sources of funds) What is the least expensive money we can get?

Raising finance Sales revenues Debt capital Equity capital Sources of funds Sales revenues Debt capital Equity capital Sale of assets

Raising finance

Main way to raise finance: revenues! Clearly this is the best way, so why would you need any other?

If the debtor cannot pay, the creditor takes ownership of the asset Security A secured loan means that there is some asset of value the loan is based on If the debtor cannot pay, the creditor takes ownership of the asset The asset used for security is often called collateral

Short term and long-term debt financing Short term debt financing Long-term debt financing Trade credit* Promissory notes* Line of credit* Unsecured bank loan* Loan secured by inventory† Loan secured by receivables† Factoring† * Unsecured † Secured Long-term loans Corporate bonds Factoring is selling the receivables due to a third party at a discount to raise cash They pay commission and fees, the factor does collecting from the customer Remember the role of interest in the profit statement…where it is collected! Bonds are a promise to pay a face (par) value at a future date, with regular interest payments in between (coupons) Yield is what you reap (like as in agriculture): coupon, current (interest rate as a % of the current price of the bond), and yield to maturity (estimate what you get if you hold it until maturity, including interest and the par value).

Types of equity financing Selling stock IPO and high cost of floatation Low ongoing cost (no dividend obligation, free to trade, deferred liability = no need for cash) Retained earnings (undistributed profits) Cost free Increases value of stock In small firms and partnerships, raise money from owners (sole proprietor, partners)

Selling assets Assets make inventory and revenues End of life assets Underperforming assets

Back to our questions… If Popco sales projections look slow for April-June (2nd quarter), what sources of funds should we consider to manage our cash flow in 2013? Why? For our expansion plans into Brazil (“Popco II”), we want to raise $2,000,000. What sources of funds should we consider? Why?

Question 1: Know your inventory requirements! What inventory do you need to keep in stock? Too much inventory = higher costs and expenses Too little inventory = lost sales opportunities When and where do you need more inventory, when less? When is your peak season? Low season? Where are your inventories required? Find this information out from chamber of commerce sources, online, from market research reports, from your bank’s small business desk, industry trade magazines, or the best way – ask someone who runs a similar business! In general, try to reduce your fixed costs as much as possible if they are not essential when starting out!

Question 1: Know the industry benchmarks! What are the typical revenues? Gross margins? Operating margins? What are operating costs as a % of revenues in your industry? What are fixed costs as a % of total costs? What are the typical % of operating expenses (Opex) Find this information out from chamber of commerce sources, online, from market research reports, from your bank’s small business desk, industry trade magazines, or the best way – ask someone who runs a similar business! In general, try to reduce your fixed costs as much as possible if they are not essential when starting out!

Question 2: Comparative finance exercise What’s the best way to raise $2,000,000? In other words, what is the return on shareholders equity of $2,000,000? Popco Popco II

Summary The Finance department manages all the financial needs of the company (its managers and employees), and of its customers and suppliers, as well as all the reporting needs of its stakeholders: Current (short-term) Day-to-day Future (long-term) Past

Financial reporting: the accounting team and financial statements