FINANCIAL Management

MBA ( Evening) 4311

Chapter 1
MD KAYES BIN RAHAMAN
ASSISTNT PROFESSOR
SCHOOL OF BUSINESS
BOU, GAZIPUR

Overview and Financial

Statement

1
Lecture

Review the Questions from

Principles of Finance
What is Financial management?
What are the goals of Financial
Management? What is the ultimate goal?
What are three decision making finance
functions?
Show the relationship between firms major financial
decisions.

Business Analysis
Evaluate Prospects

Evaluate Risks

Information Sources for Business

Analysis

Component Processes
of Business
Analysis

Business
Environment &
Strategy Analysis
Industry
Analysis

Strategy
Analysis

Financial
Analysis

Accounting
Analysis

Profitability
Analysis

Analysis
of cash
flows

Risk
Analysis

Cost of Capital Estimate

Prospective
Analysis

Intrinsic Value

Accounting Analysis
Process to evaluate and adjust financial
statements to better reflect economic reality
Comparability problems across firms and across time
Manager estimation error
Distortion problems

Earnings management
Accounting Standards

Accounting
Risk

Financial Analysis
Process to evaluate financial position and
performance using financial statements
Profitability analysis Evaluate return
on investments
Risk analysis Evaluate riskiness
& creditworthiness
Analysis of
cash flows

Evaluate source &

deployment of funds

Common tools
Cash
Ratio
flow
analysis
analysis

Prospective Analysis
Process to forecast future payoffs
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis

Intrinsic Value

Dynamics of Business Activities

Business Activities

Time
Beginning of period

Investing

Planning

Financing

Operating
Planning
Investing

Financing
End of period

Business Activities

Financing activities
Owner (equity)
Nonowner (liabilities)

Financing

Business Activities
Investing activities
Buying resources
Selling resources

Investing

Financing

Investing = Financing

Business Activities
Investing
Activities

Planning
Activities

Financial
Activities

Operating Activities
Revenues and expenses from providing
goods and services

Financial Statements Reflect Business

Activities
Planning

Investing

Operating

Current:

Cash
Accounts Receivable
Inventories
Marketable Securities

Noncurrent:

Land, Buildings, &

Equipment
Patents
Investments

Sales
Cost of Goods Sold
Selling Expense
Administrative Expense
Interest Expense
Income Tax Expense

Balance Sheet

Current:

Net Income

Cash Flow

Statement of
Cash Flows

Notes Payable
Accounts Payable
Salaries Payable
Income Tax Payable

Noncurrent:

Income statement
Assets

Financing

Bonds Payable
Common Stock
Retained Earnings

Liabilities & Equity

Balance Sheet

Statement of
Shareholders Equity

Financial Statements
Financial Statements
Firm-issued accounting reports with past
performance information
Filed with the relevant listing authority
Must also send an annual report with financial statements to
shareholders

Financial statements answer basic questions including:

What is the companys current financial status?
What was the companys operating results for the period?
How did the company obtain and use cash during the period?

Financial Statements (Types of Financial

Statements)
Balance Sheet

Balance Sheet or Statement of Financial Position

A snapshot in time of the firms financial position
Summary of the financial position of a company at
a particular date
answer basic questions including:
What are the resources of the company?
What are the companys existing obligations?
What are the companys net assets?

The Balance Sheet Equation:

Assets = Liabilities + Shareholders Equity

Balance Sheet or Statement of Financial

Position(cont'd)

Assets
What the company owns

Liabilities
What the company owes

Shareholders Equity
The difference between the value of the
firms assets and liabilities

Balance Sheet or Statement of Financial

Position(cont'd)

Assets
Current Assets: Cash or expected to be
turned into cash in the next year
Cash
Marketable Securities
Accounts Receivable
Inventories
Other Current Assets
Example: Pre-paid expenses

Balance Sheet or Statement of Financial

Position(cont'd)

Assets
Non-current Assets
Net Property, Plant, & Equipment
Depreciation (and Accumulated Depreciation)
Book Value (or carrying amount) = Acquisition cost
Accumulated depreciation

Goodwill and intangible assets

Amortization or impairment charge

Other Non-current Assets

Example: Investments in Long-term Securities

Table 2.1
Vodafone Group Plc Balance Sheet for 2012 and 2011

Balance Sheet or Statement of Financial Position

(cont'd)

Liabilities
Current Liabilities: Due to be paid within one
year
Accounts Payable
Short-Term Debt/Notes Payable
Current Maturities of Non-current (Long-Term) Debt
Other Current Liabilities
Taxes Payable
Wages Payable

Balance Sheet or Statement of Financial Position

(cont'd)

Net Working Capital

Current Assets Current Liabilities

Balance Sheet or Statement of Financial Position

(cont'd)

Liabilities
Non-current (Long-Term) Liabilities
Long-Term Debt
Capital Leases
Deferred Taxes

Vodafone Group Plc Balance

Sheet for 2012 and 2011

Balance Sheet or Statement of Financial

Position(cont'd)

Shareholders Equity
Book Value of Equity
Book Value of Assets Book Value of Liabilities
Could possibly be negative
Many of the firms valuable assets may not be captured
on the balance sheet

Balance Sheet or Statement of Financial

Position(cont'd)

Market Value Versus Book Value

Market Value of Equity (Market Capitalization)
Market Price per Share x Number of Shares
Outstanding
Cannot be negative
Often differs substantially from book value

Balance Sheet or Statement of Financial

Position(cont'd)

Market Value Versus Book Value

Market-to-Book Ratio
aka Price-to-Book Ratio

Market Value of Equity

Market-to-Book Ratio
Book Value of Equity

Value Stocks
Low M/B ratios

Growth stocks
High M/B ratios

Balance Sheet or Statement of Financial

Position(cont'd)

Enterprise Value
Total Enterprise Value (TEV)
Enterprise Value Market Value of Equity Debt Cash

Example

Example: Solution (cont'd)

Classroom Practice
Problem
Rylan Enterprises has 5 million shares outstanding.
The market price per share is $22.
The firms book value of equity is $50 million.
What is Rylans market capitalization?
How does the market capitalization compare to
Rylans book value of equity?

Solution
Rylans market capitalization is $110 million
5 million shares $22 share = $110 million.
The market capitalization is significantly higher
than Rylans book value of equity of $50 million.

The Income Statement

Shows the results of a companys
operations over a period of time.
answer basic questions including:
What goods were sold or services performed
that provided revenue for the company?
What costs were incurred in normal
operations to generate these revenues?
What are the earnings or company profit?

The Income Statement

Total Sales/Revenues
minus

Cost of Sales
equals

Gross Profit

The Income Statement (cont'd)

Gross Profit
minus

Operating Expenses
Selling, General, and Administrative Expenses
R&D
Depreciation & Amortization

equals

Operating Income

The Income Statement (cont'd)

Operating Income
plus/minus

Other Income/Other Expenses

equals

Earnings Before Interest and Taxes (EBIT)

The Income Statement (cont'd)

Earnings Before Interest and Taxes (EBIT)
plus/minus

Interest Income/Interest Expense

equals

Pre-Tax Income

The Income Statement (cont'd)

Pre-Tax Income
minus

Taxes
equals

Net Income

Vodafone Group Plc Income Statement for 2012 and 2011

The Income Statement (cont'd)

Earnings per Share
EPS

Net Income
Shares Outstanding

Share (Stock) Options

Convertible Bonds
Dilution
Diluted EPS

Statement of Cash Flows

Reports the amount of cash collected and
paid out by a company in operating,
investing and financing activities for a
period of time.
How did the company receive cash?
How did the company use its cash?

Complementary to the income

statement.
Indicates ability of a company to
generate income in the future.

Statement of Cash Flows

Cash inflows
Sell goods or services
Sell other assets or by borrowing
Receive cash from investments by owners
Cash outflows
Pay operating expenses
Expand operations, repay loans
Pay owners a return on investment

Statement of Cash Flows

Net Cash Flows from Operating Activities

The Statement of Cash Flows

Net Income typically does NOT equal the
amount of cash the firm has earned.
Non-Cash Expenses
Depreciation and Amortization

Uses of Cash not on the Income Statement

Investment in Property, Plant, and Equipment

The Statement of Cash Flows (cont'd)

Three Sections
Operating Activity
Investing Activity
Financing Activity

The Statement of Cash Flows (cont'd)

Operating Activity
Adjusts net income by all non-cash items
related to operating activities and changes in
net working capital
Accounts Receivable deduct the increases
Accounts Payable add the increases
Inventories deduct the increases

The Statement of Cash Flows (cont'd)

Investing Activity
Capital Expenditures
Buying or Selling Marketable Securities

Financing Activity
Payment of Dividends
Retained Earnings = Net Income Dividends

Changes in Borrowings

Vodafone
Group Plc
Statement
of Cash
Flows for
2012 and
2011

Example

Example (cont'd)

Other Financial Statement Information

Statement of Changes in Shareholders
Equity
Change in Shareholders Equity = Retained Earnings + Net sale of
shares
= Net Income Dividends
+ Sale of shares
- Repurchase of shares

Other Financial Statement Information

Management Discussion and Analysis
Off-Balance Sheet Transactions

Notes to the Financial Statements

Example

Example: Solution (cont'd)

Classroom Practice
Problem:
PKLCompany reported the following sales revenues by
category:

What was the percentage growth for each category?

If PKL has the same percentage growth from 2012 to
2013, what will its total revenues be in 2013?

Classroom Practice (Solution)

Solution:

Solution (continued)

Ketchup and Sauces

Total

($60000 $40000) 1 =
50.00%

($187000 $153000) 1 =
22.22%

Meals and Snacks

Estimated 2013 Total

Revenue

($45000 $42000) 1 =
7.14%

Infant/Nutrition
($12000 $11000) 1 =
9.09%

Other

$ 187000 (1 + 22.22%)
$187000 1.2222 =
$2,28,551

Financial Statement Analysis

Used to:
Compare the firm with itself over time
Compare the firm to other similar firms

Links between Financial

Statements(1/2)
Financial statements are linked at points in
time and across time.
To recap, Colgates balance sheet is a
listing of its investing and financing
activities at a point in time.
The three statements that report on (1)
cash flows, (2) income, and (3)
shareholders equity, explain changes
(typically from operating activities) over a
period of time for Colgates investing and

Links between Financial

Statements(2/2)
Every transaction captured in these three latter statements
impacts the balance sheet. Examples are (1) revenues and
expenses affecting earnings and their subsequent reporting
in retained earnings, (2) cash transactions in the statement
of cash flows that are summarized in the cash balance on
the balance sheet, and (3) all revenue and expense
accounts that affect one or more balance sheet accounts.
In sum, financial statements are linked by design: the
period-of-time statements (income statement, statement of
cash flows, and statement of shareholders equity) explain
point-in-time balance sheets.
This is known as the articulation of financial statements.

Balance Sheet
Total Investing = Total Financing
= Creditor Financing + Owner Financing

Colgate Financing
(in $billions)
$9.138 = $7.727 + $1.410

Income Statement
Revenues
Gross profit

Cost of goods sold = Gross Profit

Operating expenses = Operating Profit

Colgates Profitability
(in $billions)
$12.238 - $5.536 = $6.701 Gross Profit
$6.701 - $4.5411 = $2.160 Operating profit

The purpose of each of the four major

financial statements
Income StatementThe purpose of the income statement is to provide a
financial summary of the firms operating results during a specified
time period. It includes both the sales for the firm and the costs incurred
in generating those sales. Other expenses, such as taxes, are also
included on this statement.
Balance SheetThe purpose of the balance sheet is to present a
summary of the assets owned by the firm, the liabilities owed by the
firm, and the net financial position of the owners as of a given point in
time. The assets are often referred to as investments and the liabilities
and owners equity as financing.
Statement of Retained EarningsThis statement reconciles the net
income earned during the year, and any cash dividends paid, with the
change in retained earnings during the year.
Statement of Cash FlowsThis statement provides a summary of the
cash inflows and the cash outflows experienced by the firm during the
period of concern. The inflows and outflows are grouped into the cash
flow areas of operations, investment, and financing.

Classroom Practice
The income statement
for the year ended
December 31, 2012,
the balance sheets for
December 31, 2012
and 2011, and the
statement of retained
earnings for the year
ended December 31,
2012, for Technica,
Inc., are given below
and on the following
page. Briefly discuss
the
form
and
informational
content of each of
these statements.

Classroom
Practice
The income statement
for the year ended
December 31, 2012,
the balance sheets for
December 31, 2012
and 2011, and the
statement of retained
earnings for the year
ended December 31,
2012, for Technica,
Inc., are given below
and on the following
page. Briefly discuss
the
form
and
informational content

Classroom Practice
The income statement for the year ended December 31,
2012, the balance sheets for December 31, 2012 and 2011,
and the statement of retained earnings for the year ended
December 31, 2012, for Technica, Inc., are given below and
on the following page. Briefly discuss the form and
informational content of each of these statements.

Solution
Income statement: In this one-year summary of
the firms operations, Technica, Inc. showed a net
profit for 2012 and the ability to pay cash
dividends to its stockholders.
Balance sheet: The financial condition of
Technica, Inc. at December 31, 2011 and 2012 is
shown as a summary of assets and liabilities.
Technica, Inc. has an excess of current assets over
current liabilities, demonstrating liquidity. The
firms fixed assets represent over one-half of total
assets ($270,000 of $408,300). The firm is
financed by short-term debt, long-term debt,
common stock, and retained earnings. It appears

Solution
Statement of retained earnings:
Technica, Inc. earned a net profit of
$42,900 in 2012 and paid out $20,000 in
cash dividends. The reconciliation of the
retained earnings account from $50,200
to $73,100 shows the net amount
($22,900) retained by the firm.

(A) Quiz :Tick () the correct

answer
1.The stockholder's annual
report must include
A) a statement of cash flows.
B) an income statement.
C) a balance sheet.
D) a statement of retained
earnings.
E) all of the above.

2. Total assets less net

fixed assets equals
A) gross assets.
B) current assets.
C) depreciation.
D) liabilities and
equity.

(A) Quiz :Tick () the correct

answer
3. The ________ provides
a financial summary of
the firm's operating
results during a
specified period.
A) income statement
B) balance sheet
C) statement of cash
flows
D) statement of retained
earnings

4. Retained earnings on
the balance sheet
represents
A) net profits after
taxes.
B) cash.
C) net profits after
taxes minus preferred
dividends.
D) the cumulative total
of earnings

Homework-1
Mark each of the accounts
listed in the following table
as follows:
a. In column (1), indicate in
which
statementincome
statement (IS) or balance
sheet (BS)the account
belongs.
b. In column (2), indicate
whether the account is a
current asset (CA), current
liability (CL), expense (E),
fixed asset (FA), long-term
debt (LTD), revenue (R), or
stockholders equity (SE).

Homework-2
Philagem, Inc., ended 2012 with a net profit
before taxes of $218,000. The company is
subject to a 40% tax rate and must pay
$32,000 in preferred stock dividends before
distributing any earnings on the 85,000 shares
of common stock currently outstanding.
a. Calculate Philagems 2012 earnings per share
(EPS).
b. If the firm paid common stock dividends of
$0.80 per share, how many dollars would go to
retained earnings?

Answers for Review Questions

Financial management

involves financial planning,

financial organization, financial coordination and control, financial
reporting, financial mergers, combinations and acquisitions,
insurance and tax management etc considering the activities
mainly consist of properly estimating financial needs; selecting
the proper sources of finances; procuring the requisite
funds; proper utilization of the funds and custody and
safekeeping of funds.

Goals:

Profit maximization determined by EPS and Wealth

maximization determined by share price. The ultimate goal is
wealth maximization.

Dacision Functions:

investment decision;
financing decision and dividend decision.

Relationship between Firms Major Financial

Decisions:

New Projects
Balancing
Modernization
Replacement
Expansion

Capital Investment Decision

Diversification
Internal Funds

Need to Raise Funds (Financing Decision)

Debt

Capital Structure Decision

Existing Capital Structure

Effect on EPS

External Equity
Dividend Decision

Desired Debt-equity Mix (Financing

Mix) Leverage)
Effect on Risk

Effect on Cost of Capital

Growth Rate
Value of the Firm

Dividend Payout
Policy

Dividend Retention
Policy

Optimum Capital Structure

Answer The Quiz (A) :

1. Answer: E, Topic: Stockholders' Report, Question
Status: Revised

2. Answer: B, Topic: Balance Sheet, Question Status:

Revised

3. Answer: A ,Topic: Income Statement, Question

Status: Revised

4. Answer: D, Topic: Balance Sheet, Question Status:

Revised

Md. Kayes Bin Rahaman,

Assistant Professor, SOB,
BOU.