Finance for non-finance Executives is a famous title for various books and min-courses which enable non-finance managers engaged in other functions like marketing , operations, etc to understand the basics of finance and how everything else in an organisation boils down to finance.
In India, Dr. Prasanna Chandra runs a book titled “Finance Sense” covering the below broad areas :
Understand the financial and accounting reports used in the business
Appreciate the financial implications of your decision
Communicate meaningfully with your colleagues in the language of accounting and finance
A typical finance for non-finance executives course is positioned as follows :
This comprehensive 5 day programme brings to you essential concepts to understand and predict the financial implications of your managerial decisions. The programme provides frameworks to help you interpret and analyse financial statements and understand how business decisions are reflected in financial reports. A key objective of this programme is to show how theoretical concepts and methods are applied in real business situations for effective decision making.
• Financial Statement Analysis
• Evaluating Financial Health of Companies
• Time Value of Money
• Financial Forecasting and Cash Flow Analysis
• Capital Budgeting
• Sources and Cost of Capital
• Linking Finance and Business Strategy
Who Should Attend
This programme is designed for managers responsible for functional areas such as operations, finance, IT, marketing, production, human resources, law and government affairs. Managers with some financial background who would like to refresh their understanding of the essential concepts can also attend.
Finance for Non Financial Managers - A book by Pierre G Bergeron Chapter 1 Overview of Financial Management
Accounting, Financial Statements and Ratio Analysis
Chapter 2 Accounting and Financial Statements
Chapter 3 Statement of Cash Flows
Chapter 4 Financial Statement Analysis
Chapter 5 Profit Planning and Decision-Making
Chapter 6 Working Capital Management
Chapter 7 Planning, Budgeting, and Controlling
Chapter 8 Sources and Forms of Financing
Chapter 9 Cost of Capital, Capital Structure and Financial Markets
Chapter 10 Time Value of Money Concepts
Chapter 11 Capital Budgeting
Chapter 12 Business Valuation
Reading Financial Statements : What is cash flow statement and how to use it
THE ESSENTIALS OF CASH FLOW
If a company reports earnings of $1 billion, does this mean it has this amount of cash in the bank? Not necessarily. Financial statements are based on accrual accounting, which takes into account non-cash items. It does this in an effort to best reflect the financial health of a company. However, accrual accounting may create accounting noise, which sometimes needs to be tuned out so that it's clear how much actual cash a company is generating. The statement of cash flow provides this information, and here we look at what cash flow is and how to read the cash flow statement.
What Is Cash Flow? Business is all about trade, the exchange of value between two or more parties, and cash is the asset needed for participation in the economic system . For this reason - while some industries are more cash intensive than others - no business can survive in the long run without generating positive cash flow per share for its shareholders. To have a positive cash flow, the company's long-term cash inflows need to exceed its long-term cash outflows.
An outflow of cash occurs when a company transfers funds to another party (either physically or electronically). Such a transfer could be made to pay for employees, suppliers and creditors, or to purchase long-term assets and investments, or even pay for legal expenses and lawsuit settlements. It is important to note that legal transfers of value through debt - a purchase made on credit - is not recorded as a cash outflow until the money actually leaves the company's hands. A cash inflow is of course the exact opposite; it is any transfer of money that comes into the company's possession. Typically, the majority of a company's cash inflows are from customers, lenders (such as banks or bondholders) and investors who purchase company equity from the company. Occasionally cash flows come from sources like legal settlements or the sale of company real estate or equipment.
Cash Flow vs Income It is important to note the distinction between being profitable and having positive cash flow transactions: just because a company is bringing in cash does not mean it is making a profit (and vice versa).
For example, say a manufacturing company is experiencing low product demand and therefore decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer for the used equipment, but the manufacturing company is definitely losing money on the sale: it would prefer to use the equipment to manufacture products and earn an operating profit. But since it cannot, the next best option is to sell off the equipment at prices much lower than the company paid for it. In the year that it sold the equipment, the company would end up with a strong positive cash flow, but its current and future earnings potential would be fairly bleak. Because cash flow can be positive while profitability is negative, investors should analyze income statements as well as cash flow statements, not just one or the other.
What Is the Cash Flow Statement? There are three important parts of a company's financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet gives a one-time snapshot of a company's assets and liabilities .And the income statement indicates the business's profitability during a certain period .
The cash flow statement differs from these other financial statements because it acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all those lovely revenues booked on the income statement have actually been collected. At the same time, however, remember that the cash flow does not necessarily show all the company's expenses: not all expenses the company accrues have to be paid right away. So even though the company may have incurred liabilities it must eventually pay, expenses are not recorded as a cash outflow until they are paid (see the section "What Cash Flow Doesn't Tell Us" below).
The following is a list of the various areas of the cash flow statement and what they mean:
Cash flow from operating activities - This section measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company. For example, Microsoft's normal operating activity is selling software.
Cash flows from investing activities - This area lists all the cash used or provided by the purchase and sale of income-producing assets. If Microsoft, again our example, bought or sold companies for a profit or loss, the resulting figures would be included in this section of the cash flow statement.
Cash flows from financing activities- This section measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see.
When you look at a cash flow statement, the first thing you should look at is the bottom line item that says something like "net increase/decrease in cash and cash equivalents", since this line reports the overall change in the company's cash and its equivalents (the assets that can be immediately converted into cash) over the last period. If you check under current assets on the balance sheet, you will find cash and cash equivalents (CCE or CC&E). If you take the difference between the current CCE and last year's or last quarter's, you'll get this same number found at the bottom of the statement of cash flows.
In the sample Microsoft annual cash flow statement (from June 2004) shown below, we can see that the company ended up with about $9.5 billion more cash at the end of its 2003/04 fiscal year than it had at the beginning of that fiscal year (see "Net Change in Cash and Equivalents"). Digging a little deeper, we see that the company had a negative cash outflow of $2.7 billion from investment activities during the year (see "Net Cash from Investing Activities"); this is likely from the purchase of long-term investments, which have the potential to generate a profit in the future.Generally, a negative cash flow from investing activities are difficult to judge as either good or bad - these cash outflows are investments in future operations of the company (or another company); the outcome plays out over the long term.
The "Net Cash from Operating Activities" reveals that Microsoft generated $14.6 billion in positive cash flow from its usual business operations - a good sign. Notice the company has had similar levels of positive operating cash flow for several years. If this number were to increase or decrease significantly in the upcoming year, it would be a signal of some underlying change in the company's ability to generate cash.
Digging Deeper into Cash Flow All companies provide cash flow statements as part of their financial statements, but cash flow (net change in cash and equivalents) can also be calculated as net income plus depreciation and other non-cash items.
Generally, a company's principal industry of operation determine what is considered proper cash flow levels; comparing a company's cash flow against its industry peers is a good way to gauge the health of its cash flow situation. A company not generating the same amount of cash as competitors is bound to lose out when times get rough.
Even a company that is shown to be profitable according to accounting standards can go under if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to outstanding debt, known as the operating cash flow ratio, illustrates the company's ability to service its loans and interest payments. If a slight drop in a company's quarterly cash flow would jeopardize its loan payments, that company carries more risk than a company with stronger cash flow levels.
Unlike reported earnings, cash flow allows little room for manipulation. Every company filing reports with the Securities and Exchange Commission (SEC) is required to include a cash flow statement with its quarterly and annual reports. Unless tainted by outright fraud, this statement tells the whole story of cash flow: either the company has cash or it doesn't. What Cash Flow Doesn't Tell Us Cash is one of the major lubricants of business activity, but there are certain things that cash flow doesn't shed light on. For example, as we explained above, it doesn't tell us the profit earned or lost during a particular period: profitability is composed also of things that are not cash based. This is true even for numbers on the cash flow statement like "cash increase from sales minus expenses", which may sound like they are indication of profit but are not.
As it doesn't tell the whole profitability story, cash flow doesn't do a very good job of indicating the overall financial well-being of the company. Sure, the statement of cash flow indicates what the company is doing with its cash and where cash is being generated, but these do not reflect the company's entire financial condition. The cash flow statement does not account for liabilities and assets, which are recorded on the balance sheet. Furthermore accounts receivable and accounts payable, each of which can be very large for a company, are also not reflected in the cash flow statement.
In other words, the cash flow statement is a compressed version of the company's checkbook that includes a few other items that affect cash, like the financing section, which shows how much the company spent or collected from the repurchase or sale of stock, the amount of issuance or retirement of debt and the amount the company paid out in dividends.
Conclusion Like so much in the world of finance, the cash flow statement is not straightforward. You must understand the extent to which a company relies on the capital markets and the extent to which it relies on the cash it has itself generated. No matter how profitable a company may be, if it doesn't have the cash to pay its bills, it will be in serious trouble.
At the same time, while investing in a company that shows positive cash flow is desirable, there are also opportunities in companies that aren't yet cash-flow positive. The cash flow statement is simply a piece of the puzzle. So, analyzing it together with the other statements can give you a more overall look at a company' financial health. Remain diligent in your analysis of a company's cash flow statement and you will be well on your way to removing the risk of one of your stocks falling victim to a cash flow crunch.
All you need to know Annual report can reveal the secrets a
company wants to hide: Here's how to uncover People who invest on the basis of
tips are investing blindly.
But even investors
who study the fundamentals of companies before buying stocks usually restrict
the research to basic details such as revenues, net profit, earnings per share
(EPS) and price to earnings ratio (PE ratio). This information is available in the
quarterly numbers declared by companies, so most investors don’t feel it
necessary to read the bulky annual report that comes once in a year. However,
experts say that reading annual reports is necessary because they contain a lot
of information that is not available otherwise. “Reading annual reports becomes
an advantage because very few people do it,” says Nilesh Shah, Managing
Director, Kotak Mahindra Mutual Fund.
Read it in full
The annual report is
a bulky document, sometimes running into 180200 pages. Experts say one should
read the full document. “Investors should go through each line of the annual
report,” says Daljeet S. Kohli, Director & Head of Research, India Nivesh
Securities. To begin with, focus on the first part of the report. “Most companies
give financial highlights of the past 10 years. While these numbers may not be
of much use to institutional investors, they are useful for retail investors to
understand how the company has grown in the past,” says Anand Shah, Deputy CEO
& CIO, BNP Paribas Mutual Fund. “Read the notice because it gives lot of
information and sets the agenda of the annual general meeting. Investors should
also read the chairman’s speech that gives a clear vision about the future and
the directors’ report (along with management discussion and analysis) which
explains current business structure before going to the net profit figure,”
says Deven Choksey, Managing Director, KR Choksey Securities. Other experts
also highlight the importance of the management discussion. “The management
discussion tells where the company is headed in future,” says Kunj Bansal,
Executive Director & CIO, Centrum Capital. “Management commentary is very
important because they usually talk about plans for the next 35 years,” says
Anand Shah of BNP Paribas Mutual Fund. Investors should also read notes to
accounts, schedules, cash flow statements, etc also because they give
information in more detail.
large cash flows
A large cash flow from operating activities is a healthy
sign and shows that all is well with the company Investors should question if
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Recommended By Colombia Deciphering the numbers Investors also need to
understand the difference between what the company says and what it means.
“While some companies tell outright lies, others tell truths that are
convenient to them. Since no company is going to tell the whole truth, you
should be able to read between lines,” says Nilesh Shah. However, the average
investor may find it difficult to read an annual report in detail and
understand it in its entirety. Here are a few key points that an investor needs
to look at.
Continuity is key
Continuity is an important parameter. Compare each figure
with that of the previous years to get an idea of how the company has done. “If
any figure is significantly higher or lower than that of previous years,
investors need to delve deeper. Don’t assume that something is wrong, but
certainly check the reasons behind this deviation,” says Kohli. “There should
also be continuity and coherence between all parts of annual reports. For
example, the numbers in the other parts of the annual report should match those
mentioned in the chairman’s speech or directors’ report,” says Nilesh Shah.
There can be instances where the management says the industry and the company
are doing well, but the company has reported lacklustre revenue and net profit
growth. Similarly, management might have talked about the successful capacity
addition, but the same is not reflected in the sales volume. If there is a
deviation, you need to understand the reasons behind it.
Is the sales real?
Companies declare sales figures in their quarterly results.
But are these sales real? Several sales based ratios (market cap to revenues)
are used for valuations. The first check is to add up sales of the four
quarters to see if they match the annual sales figure. Checking sales growth
with that of increase in debt is another way. “If the debt is also rising with
the sales, it may mean the company is buying sales (giving away goods without
bothering to collect money,” says Bansal of Centrum Capital. Also check the
notes of account to make sure that the company follows conservative accounting
policies. This is especially true when you deal with real estate companies
which are allowed to have more flexible revenue recognition rules. “It is
better if real estate companies recognise revenues after completing the
project. But most companies follow percentage completion method to smoothen out
sales and net profit,” says Viraj Mehta, Head & Fund Manager, Equirus PMS.
When you compare the sales figures of two real estate companies, make sure that
you are making an apple to apple comparison.
Is the profit real?
Just like sales, you
also need to cross check the net profit figure because price to earnings (PE)
ratio is the most commonly used valuation tool. Companies manipulate the profit
figure by providing for excessive (or even less) depreciation. While quarterly
numbers give just a consolidated figure, annual reports give a detailed breakup
of the depreciation provided for each asset. The depreciation provided should
be reasonable. Be alert if there is a sudden increase or decrease in the
depreciation figure. “If a company is providing BACK TO TOP 10 years of
depreciation for computers, it is a clear case of inflating the profit,” says
Nilesh Shah. Research and development (R&D) expenses is another head that
needs close verification. “Ideally, the R&D expenses should be written off
in that financial year itself. However, companies usually capitalise it and
then write it off over a period of time. It’s a red flag if the write off
period is more than four years,” says Mehta of Equirus. Capitalising interest
(instead of showing it as expense, it is added to the cost of project) is
another strategy used by companies. Some even capitalise the mark to market
losses on forex positions on loans taken for buying assets and usually add this
loss to the loans. Another trick to inflate profit is by avoiding the profit
and loss account altogether and taking expenses directly to the balance sheet.
“Investors should raise a red flag if companies deduct some big expenses
directly from the reserves, instead of showing it in profit and loss account,”
says Jaspreet Singh Arora, Senior VicePresident, Systematix Shares &
Stocks. The relationship between the profit declared and the tax paid can also
generate some hints about the quality of profits. “Investors need to verify
whether the company has paid proper tax after declaring high profit,” says Nilesh
Shah. Here again, don’t assume wrongdoing by companies because it may be
because of some tax incentives given by the government. For example,
infrastructure major Adani Ports enjoys several tax benefits. Indian law allows
companies to have separate books for investors and for income tax department
and that is another reason for this anomaly.
Companies with low
tax outgo as % of profit
A low tax outgo is not always a sign of something amiss. The
company may be eligible for certain tax breaks offered by the government to
some sectors. Investors should question if the tax paid is not in sync with its
net profit. Should companies provide for the disputed demands such as excise
duty, sales tax, income tax and water tax or show them only as contingent liabilities?
Most companies take the conservative view and provide now and show as gain in
year if the verdict comes in their favour. However, there are also cases where
the companies decide to keep these as contingent liabilities till the final
verdict is out. The Orient Paper annual report for 201516 shows an accumulated
contingent liability of Rs 206.57 crore as against its cash and bank balance of
Rs 59.15 crore and net profit of Rs 21.35 crore for the year.
Companies use Employee Stock Option Plan (ESOP) to motivate
the employees to perform better and improve shareholders’ value. While ESOP
creates a sense of belonging and ownership amongst the employees, it can create
computation of net profit difficult. Companies in India usually use ‘intrinsic value
method’ for determining the cost of ESOP. For example, if a company grants
right to buy shares at Rs 100 after 3 years against the current market price of
Rs 150, the cost of that ESOP is treated as Rs 50 (Rs 150 minus Rs 100). The
‘fair value method’, on the other hand, uses advanced option pricing models
like BlackScholes model and takes into account the various other factors like
time value, interest rate, volatility, dividend yield etc. Since these two
computations are different, the impact on net profit can be significant. This
detail will be given in the ‘Notes to Accounts’ section. Investors must
consider outstanding ESOPs while computing earnings per share (EPS). While EPS
is computed normally with the existing outstanding number of shares, one needs
to consider the outstanding ESOPs (ie which will become shares in future) also
for correct computation. Companies provide these details (total number of
shares, including ESOPs, for computing diluted EPS) in their annual reports.
Companies with large revaluation reserve Since valuation tools use the
company’s net worth as the denominator, make sure that the value given out in
the balance sheet is a fair one. Investors should remove revaluation reserve
and goodwill while computing net worth.
Cash is king As
the old idiom says, ‘revenue is vanity, profit is sanity and cash is reality’.
Since cash is king, cross check the net profit with that of cash generated.
Since Sebi has made cash flow statement mandatory for listed companies, this
information is readily available in the annual report. “If there is no cash
flow behind profit, the company will get into trouble in the future,” says
Anand Shah. The best way here is to compare the net profit with that of cash
from operations (see the list of BSE 100 companies with large cash from
operations). Analysts now closely track a parameter called free cash flow
(FCF). It is computed by bringing in capital expenditure (such as investments
in buildings or property, plant and equipment, etc) also (ie free cash flow =
operating cash flow – capital expenditures). While free cash flow is good, be
careful when it comes to companies generating very high free cash flow and not
distributing the same to shareholders through higher dividends or share
buybacks. “Most differ foreign companies with high FCF use it to pay dividends
or buy back, but that is not frequent in India. Independent directors should
add more value in this,” says A. Balasubrahmanian, CEO, Birla Mutual Fund.
Similarly, companies with negative FCF are not bad either. They may be in the
initial phase of growth (ie setting up large plants for future growth). So,
don’t assume that something is wrong if there is a big divergence between
profit and cash generation and as mentioned earlier, investors need to question
and understand the difference between profit and cash flow.
Is the net worth
real? Since several valuation tools like price to book (PB) ratio use
the company’s net worth as the denominator, investors should make sure that the
value given out in the balance sheet is a fair one. “Ideally, reserves should
be built from accumulated profits. But some companies have the habit of
inflating the reserves by revaluing the assets. So investors should avoid
revaluation reserves while computing net worth,” says Balasubrahmanian.
Goodwill is another asset that gets into the books due to mergers and
acquisition activity (see table for BSE 100 companies with large revaluation
reserves + goodwill). Here again, this is allowed by the law, but investors
need to look at the true future potential of the company and a large balance
sheet size due to revaluation doesn’t generate that confidence. Companies try
to show balance sheet strength by not providing some possible liabilities. For
example, the balance sheet of PSU banks will look totally different if all the
non performing assets (NPAs) were written off. Similarly, the balance sheet of
most PSUs will shrink significantly if one accounts for the possible pension
liability in future.
transactions Most Indian companies are family owned. Investors must
scan annual reports for any related party transactions, which may be in
conflict with the interest of minority shareholders. There are several cases of
related party transactions like goods sold or bought from entities owned by
directors, subsidiary borrowing and giving it to parent or vice versa, etc. The
recent proposal for transfer of JK House to family members of Raymond promoters
was mentioned in the notes to accounts of the company’s annual report. The
proposal, which sought to transfer apartments at 10% of the prevailing market
price, came up for voting at the AGM on 5 June. The promoters, being interested
parties, abstained from voting on this matter and shareholders voted against
the resolution. If approved by shareholders, the loss to the company could have
been around Rs 650 crore. Raymond’s annual report had mentioned the proposal to
sell JK House to family members of the promoters. Investors should watch out
for such red flags. Commenting on the development, Gautam Hari Singhania,
Chairman and Managing Director said, “I am happy with the outcome of voting
against the resolution as this decision by shareholders is in the best interest
of the company and shareholders and is aligned to my personal opinion on this
issue expressed earlier. Protecting shareholders interest is of paramount
importance to me.” Though things ended happily at the AGM, experts are not
amused. “Not able to understand the logic of the chairman’s action He first
proposed the land sale for shareholders’ approval and then welcomed the voting
down of the same by shareholders. If the same was against investor interest,
this proposal should have been rejected at the board meet itself,” says a
Mumbai based mutual fund manager.
“Investors need to watch out for the management remuneration. It is a red flag
if the remuneration is very high,” says Mehta of Equirus
Recently, Infosys cofounders have raised the issue of high
salaries to some management personnel because they had access to the
information. However, retail investors need to wait till the arrival of annual
report to get this information. There is nothing wrong if the top management is
paid according to market rates. However, investors need to be worried if the
top management is extracting significant funds in the form of salary and
commissions. Since the Companies Act restricts total remuneration of management
personal to 10%, investors can use any payment above 5% as the red flag.
Balakrishna Industries is a good case of it crossing this 5% mark.
Cashflow Direct vs Indirect
Cashflow VS Fundflow
Learning ObjectivesDefine finance and its major areas and opportunities.Review the basic forms of business organization.Describe the managerial finance function and its relationship to accounting and economics.Identify the financial manager's key activities.Explain the wealth maximization goal of the financial manager and the role of ethics in the firm.Discuss the agency issue.
2 What is Finance?At the macro level, finance is the study of financial institutions and financial markets and how they operate within the financial system in both the U.S. and global economies.At the micro level, finance is the study of financial planning, asset management, and fund raising for businesses and financial institutions.3What is Finance?
4 What is Finance?A well-developed financial system is a hallmark and essential characteristic of any modern developed nation.Financial markets, financial intermediaries, and financial management are the important components.Financial markets and financial intermediaries facilitate the flow of funds from savers to borrowers .Financial management involves the efficient use of financial resources in the production of goods.
5Career Opportunities in Finance Capital Budgeting AnalystProject Finance ManagerCash ManagerBanking & Financial InstitutionsPersonal Financial PlanningInvestmentsPension Fund ManagerReal EstateInsuranceFinancial Analyst
6 Managerial FinanceManagerial finance is concerned with the duties of the financial manager in the business firm.The financial manager actively manages the financial affairs of any type of business, whether private or public, large or small, profit-seeking or not-for- profit.Increasing globalization has complicated the financial management function.Changing economic and regulatory conditions also complicate the financial management function.
7Basic Forms of Business Organization Sole ProprietorshipsPartnershipsCorporations
8Sole Proprietorships Account for majority of small businesses Most Businesses start out as Sole Proprietorships75 percent of all businesses in the U.S. are sole proprietorships
9Advantages of Sole Proprietorships Inexpensive to StartComplete Management ControlIncome "flows through" to Owner and is taxed at Owners Personal Marginal Tax Rate
10Disadvantages of Sole Proprietorships Limited Availability of CapitalUnlimited Legal Liability of the OwnerDifficult to Transfer OwnershipLimited Life
11Partnerships Two or more owners Account for 10 percent of all businesses.Finance, insurance, and real estate firms are the most common types of partnerships.
12Advantages of Partnerships Easier and Greater Access to capitalPooling of expertise
13Disadvantages of Partnerships More expensive and difficult to manage and control than proprietorshipEach partner is liable for all of the debts of the partnership.Cannot change ownership compositionDifficult to transfer ownership
14Corporations Separate legal entity Although only 15% of all businesses are incorporated, corporations account for nearly 90% of receipts and 80% of net profits.Most growing small businesses eventually become corporations
15Advantages of Corporations Limited Liability (but not necessarily for small firms)Greater Access to CapitalUnlimited LifeEase of Transfer of Ownership
16Disadvantages of Corporations Double TaxationMore Complex to ManageMore Expensive to Maintain
18The Managerial Finance Function The size and importance of the managerial finance function depends on the size of the firm.In small companies, the finance function may be performed by the company president or accounting department.As the business expands, finance typically evolves into a separate department linked to the president.
19The Managerial Finance Function Relationship to EconomicsThe field of finance is actually an outgrowth of economics.In fact, finance is sometimes referred to as financial economics.Financial managers must understand the economic framework within which they operate in order to react or anticipate to changes in conditions.
20The Managerial Finance Function Relationship to EconomicsThe primary economic principal used by financial managers is marginal analysis which says that financial decisions should be implemented only when benefits exceed costs.
21The Managerial Finance Function Relationship to AccountingThe firm's finance (treasurer) and accounting (controller) functions are closely-related and overlapping.In smaller firms, the financial manager generally performs both functions.
22The Managerial Finance Function Relationship to AccountingOne major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method while in finance, the focus is on cash flows.The significance of this difference can be illustrated using the following simple example.
23The Managerial Finance Function Relationship to AccountingThe Zasloff Corporation experienced the following activity last year:Sales: $100,000 (50% still uncollected)Cost of Goods: $ 60,000 (all paid in full under supplier terms)Expenses: $ 30,000 (all paid in full)Now contrast the differences in performance under the accounting method versus the cash method.
25The Managerial Finance Function Relationship to AccountingFinance and accounting also differ with respect to decision-making.While accounting is primarily concerned with the presentation of financial data, the financial manager is primarily concerned with analyzing and interpreting this information for decision-making purposes.The financial manager uses this data as a vital tool for making decisions about the financial aspects of the firm.
26Key Activities of the Financial Manager Relationship to Accounting
27Goal of the Financial Manager Maximize Profit???Profit maximization fails to account for differences in the level of cash flows (as opposed to profits), the timing of these cash flows, and the risk of these cash flows.
28level & timing of cash flows Goal of the Financial ManagerMaximize Shareholder Wealth!!!Why?Because maximizing shareholder wealth properly considers cash flow level, the timing of these cashflows, and the risk of these cash flows.This can be illustrated using the following simple valuation equation:level & timing of cash flowsShare Price = Future DividendsRequired Returnrisk of cash flows
29Cash flow level: High tech firm cuts R&D expenses, then stock price falls but EPS rises. Timing: Intrim cash inflows can be investedRisk: Actual outcomes may differ from expected
30Goal of the Financial Manager Maximize Shareholder Wealth!!!It can also be described using the following flow chart:
31Goal of the Financial Manager Economic Value Added (EVA)Economic value added (EVA) is a popular measure used by many firms to determine whether an investment - proposed or existing - positively contributes to the owners wealth.EVA is calculated by subtracting the cost of funds used to finance an investment from its after-tax operating profits.Investments with positive EVAs increase shareholder wealth and those with negative EVAs reduce shareholder value.
32Goal of the Financial Manager What About Other Stakeholders?Stakeholders include all groups of individuals who have a direct economic link to the firm including:EmployeesCustomersSuppliersCreditorsOwnersThe "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions that could be detrimental to the wealth position of its stakeholders.Such a view is considered to be "socially responsible."
33The Role of Ethics Ethics Defined Ethics - the standards of conduct or moral judgment - have become an overriding issue in both our society and the financial communityEthical violations attract widespread publicityNegative publicity often leads to negative impacts on a firm
34The Agency Issue The Problem Whenever a manager owns less than 100% of the firm's equity, a potential agency problem exists.In theory, managers would agree with shareholder wealth maximization.However, managers are also concerned with their personal wealth, job security, fringe benefits, and lifestyle.This would cause managers to act in ways that do not always benefit the firm shareholders.
35The Agency Issue Resolving the Problem Market Forces such as major shareholders and the threat of a hostile takeover act to keep managers in check.Agency Costs may be incurred to ensure management acts in shareholders interests.
36The Agency Issue Resolving the Problem Agency costs include 1. bonding expenditure2. monitoring expenditure3. opportunity cost：4. structuring expenditure(1) incentive plan：stock option(2) performance plan： performance shares、cash bonuses