Critical Success Factors

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Planning
Organizing
Critical Success Factors
Stakeholders
Marketing
Economic
Top Management
INTERNAL
Vision
Operations
Finance
EXTERNAL
Social
Political
Mission
Human Resources
Technological
Strategy
Middle Management
First-Line Management
Controlling
Directing
2
Roles Responsibilities of Finance Dept.

• Roles
• Financial management accounting finance
• Maximize shareholder wealth
• Viability - Short term liquidity, Long term
  stability
• Profitability (return)
• Responsibilities
• Forecasting, obtaining managing financial
  resources
• Sources uses of funds (cash flow capital)
• Dividend decisions
• Risk-return tradeoff

3
Financial Tools

• Budgeting Cash budgeting
• -
• EBIT (Earnings Before Interest and Taxes)
• Ratios

4

• Cash Budget
• Tool for controlling the use and allocation of
  cash

Beginning Cash Balance Receipts Total Cash
Available - Disbursements Cash Excess /
(Deficiency) Minimum Cash Balance
Desired Borrowing Reqd / Surplus or Repayment
Ending Cash Balance


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• Worksheet
• based on historical measures of volatility and
  stability of working capital cycle - time to
  collect and time to pay
• ex you need to prepare a cash budget for the
  months of June, July and August min. cash
  balance 6,000
• assume that sales are forecasted at 10,000,
  20,000, 30,000, 15,000, 25,000, and 20,000
  from April to September respectively
• assume also that you expect to collect 30 in
  month of sale, 60 in month following sale, and
  10 in the 2nd month after sale
• assume that purchases amount to 75 of the next
  months sales
• assume also that you pay for 20 of purchases in
  the month of purchase, and 80 in the month
  following

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Additional expenses

• This company also has additional cash expenses as
  follows
• Selling administrative expenses - 4,000,
  3,000, and 3,500 in June, July August
  respectively
• Interest - 150, 200, 210 in June, July,
  August respectively
• Dividends - 600 paid in June
• Capital Expenditures - 7,500 paid in July
• Taxes - 6,500 paid in June

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• Worksheet
• April May June July Aug. Sept.
• Net Sales
• Collections
• 30 month of sale
• 60 month follow
• 10 2nd month
• Total Receipts
• Net Purchases
• 75 next mth. sales
• Payments
• 20 month of purch.
• 80 month follow
• Total Disbursements for Purch.

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• Cash Budget
• June, July, August, 20XX
• Beg. Cash Balance
• Add Receipts
• Total Cash Available
• Less Disb. for Purch.
• Selling Admin.
• Interest
• Dividends
• Capital Expenditures
• Taxes
• Total Disbursments
• Cash Excess / (Deficiency)
• Min. Cash Balance Desired
• Borrowing Required
• Surplus Cash
• Ending Cash Balance

June
July
August
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• Keys
• 3 possibilities
• 1. Deficiency
• 2. Excess gt Minimum
• 3. Excess lt Minimum

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Budgeting / Financial Planning

• 3 steps
• forecasting financial needs
• short term - cash flow forecast
• long term
• developing budgets to meet those needs
• master budget
• operating budget
• capital budget
• cash budget
• establishing financial control
• deviations from budget

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• Advantages of Budgeting
• compels
• establishes goals or standards against which
  actual performance can be measured
• promotes
• Negative Aspects of Budgeting - Abuses

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Uses of Funds

• Short-term expenses or operating expenses
• Managing accounts receivable
• Managing proper inventory levels
• Long-term expenses or capital expenses

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Sources of Funds

• How do firms raise the funding they need?

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Debt

• Short-term
• Unsecured loans
• Trade credit or accounts payable, Bank loans,
  Commercial paper
• Secured loans
• Bank loans, Factors
• Long-term
• Business loan with a maturity of more than 1 year
• Available from banks, insurance co., pension
  funds, commercial finance companies
• Contract spells out terms borrower aims to
  match repayment schedule to cash flow
• Examples -

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• Equity Financing
• Company obtains funds by selling new ownership
  shares
• Retained Earnings
• No costs involved

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Capital Structure

• The relative mix of a firms debt and equity
  financing
• determined by method of acquiring financial
  resources
• Optimal structure
• Compare
• Ensure

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• Debt financing - bonds and debentures
• Equity financing - ownership
• EXCELLENT CHART P. 720

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• EBIT Analysis

Earnings Before Interest and Taxes - EBIT -
Interest Earnings Before Taxes - EBT - Taxes Net
Income - EAT - Preferred Dividends Earnings
Available to Common Stockholder / shares of
Common Stock Earnings per Share - EPS
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• ex ABC Company requires an additional 4
  million in external long-term financing
• earnings before interest and taxes are assumed to
  be 6 million next year, and ABCs tax rate is
  50
• the existing capital structure consists of
• 5,000,000 in 10 bonds
• 3,000,000 in 6 preferred stock
• 1,000,000 shares of common stock at 10/share
• 500,000 in Retained Earnings
• ABC has 2 alternatives with which to raise the
  money
• 3,000,000 in 11 bonds, and 1,000,000 in 7
  preferred stock
• 2,000,000 in 8 preferred stock, and 2,000,000
  in common stock at 10/share

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• Need to know the effect that each element of the
  capital structure has on EPS
• debt -- interest debt x interest rate
• preferred stock -- preferred dividends
• preferred stock x dividend rate
• common stock -- shares common stock / price
• Existing
• 5,000,000 bonds x 10 500,000 interest
• 3,000,000 preferred stock x 6 180,000
  dividend
• 1,000,000 shares of common stock
• Alternative 1
• 3,000,000 bonds x 11 330,000 interest
• 1,000,000 preferred stock x 7 70,000
  dividend
• Alternative 2
• 2,000,000 preferred stock x 8 160,000
  dividend
• 2,000,000 common stock / 10 200,000 shares
  common

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• ABC Company
• EBIT Analysis (000s)
• Existing Alternative
• Structure 1 2
• EBIT
• - Interest
• EBT
• - Taxes
• EAT
• - Pref. Dividends
• Earnings Avail. C/S
• / shares of C/S
• EPS

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• choose the option which
• think back to leverage
• should be able to determine the degree of
  leverage
• Calculate Interest Coverage Ratio

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• Practice Question
• XYZ needs an additional 8,000,000 in external
  long-term financing. Its EBT next year are
  projected to by 4,000,000, and its tax rate is
  50.
• XYZs existing financial structure consists of
• 15,000 in current liabilities
• 1,000,000 in 10 bonds
• 150,000 in preferred stock at a 5 dividend rate
• 2,100,000 in common stock at 15/share
• 750,000 in retained earnings
• XYZ has three alternatives with which to raise
  the financing
• 6,000,000 in 12 bonds 2,000,000 in pref.
  stock at 7
• 2,000,000 in 9 bonds 4,000,000 in pref.
  stock at 6 2,000,000 in common stock at
  20/share
• 5,000,000 in common stock at 16/share
  3,000,000 in 11 bonds

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Ratio Analysis

• What is it?
• Why use it?
• Who uses it
• Managers
• Credit granting organizations
• Investors/Stockbrokers/Shareholders

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Ratio Analysis - 3 Steps

• Identify relevant ratios
• To assess overall financial well-being, look at
  all 5 types of ratios
• liquidity
• stability
• profitability
• growth
• marketability

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• Compare the ratio to something else
• Pull apart the numerator and denominator into
  component parts

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LIQUIDITY

• measure a companys ability to meet its
  current/short-term obligations
• assess the adequacy of a firms working capital
  management

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• Net Working Capital
• current assets - current liabilities
• objective?
• what is sufficient? - depends on

Inventory
Sales - (Cash) - Credit
Cash
Current Liabilities
Accounts Receivable
29

• Current Ratio
• current assets / current liabilities
• Acid Test / Quick Ratio
• current assets - (inventoriessuppliesprepaids)
  
• current liabilities

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• receivables ratios
• 1. Average Collection Period
• avg.(closing) accounts receivable x 365 days
• annual (credit) sales
• 2. Accounts Receivable Turnover
• annual (credit) sales / avg. (closing) A/R

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• Inventory Turnover
• cost of goods sold / average inventory
• OR sales / average inventory
• tradeoff?
• Note liquidity ratios also called activity or
  efficiency ratios because they help assess how
  efficiently a company employs its resources to
  balance risk and return

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STABILITY

• measure a companys ability to meet its long-term
  obligations by measuring the relationship between
  components of a firms capital structure

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• Debt to Equity OR Debt to Net Worth
• total debt / shareholders equity (net worth)
• current liabilities long-term liabilities
• common stock pref. stock retained earnings
• rule of thumb
• Leverage
• long-term debt / sh. equity (net worth)
• measures
• implies that a given change in sales will result
  in a greater change in profit

34

• rule of thumb
• advantage
• disadvantage

35

• ex presently each firm has 1,000,000 in common
  stock outstanding, and each needs to finance an
  additional 1,000,000
• A B
• 10 bonds equity with
• 10 div.
• EBIT 1,000,000 1,000,000
• -interest 100,000 0
• EBT 900,000 1,000,000
• - taxes _at_ 50 450,000 500,000
• EAT 450,000 500,000

Difference
100,000
- 50,000
50,000 real interest
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• interest cost 100,000 - tax savings 50,000
  real interest 50,000 / 1,000,000 debt 5, not
  10 -- lower cost of capital
• if return on capital is 15
• A 15 return - 5 cost 10 overall
• B 15 return - 10 cost 5 overall
• Summary

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• Interest Coverage Ratio
• EBIT / annual interest

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PROFITABILITY

• Gross Profit Margin (GPM)
• gross profit / sales
• -
• Net Profit Margin (NPM)
• net profit / sales
• ROI
• net income / shareholders equity (net worth)

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• ex
• A B
• Sales 10,000,000 10,000,000
• Net Income 500,000 1,000,000
• NPM 5 10
• Sh. Equity 1,000,000 5,000,000
• ROI 50 20

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GROWTH

• measures the rate of growth of any Balance Sheet
  or Income Statement account
• i.e.
• - look at trend
• - compare to others

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MARKETABILITY

• Earnings per Share (EPS)
• earnings available for common stockholders
• shares of common stock
• net income - preferred stock dividends
• shares of common stock
• calculate fully diluted if P/S convertible

42

• Price/Earnings Ratio
• market price/share
• EPS
• Dividend Yield dividends/share
• price/share
• Payout dividends/share
• EPS