BUS601: Financial Management

Read this article, which provides a summary description of the role of managers and the importance of exercising financial oversight to a business.

A good starting point for our course is to improve your understanding of the importance of accounting and finance to business. Of particular interest is the difference between accounting and financial management. When you have completed reading the following sections, you should be able to discuss the differences between accounting and financial reporting, and why the information contained in these reports is of interest to key stakeholders.

In this chapter, you will learn more about the importance of accounting and financial management. Specifically, we will discuss the application of accounting analysis to various business decisions. After you read, you will have a better understanding of the differences between accounting reports and financial reports. Also, you should be able to describe how accounting and finance support the management decision-making process.

Watch this video, noting the difference between managerial accounting and financial accounting. Managerial accounting is for internal consumption and is used to make decisions concerning business operations. Financial accounting is put together for external information users, including stakeholders, lenders, suppliers, and others.

Read this review of how much information can be obtained from a firm's statements. These are useful for management as they review the results against the forecasted outcomes and provide helpful information for decision-making. Read this brief overview on Return on Equity (ROE) to better understand the effects of debt, or leverage, on performance.

Read these sections, which provide a good overview of the statements that make up the financial package for a firm. When you have completed this review, you should be able to identify the income statement, statement of retained earnings, the balance sheet, and the statement of cash flows. You will also be able to discuss the value of each statement.

The first statement of the financial package is the income statement. It is also known as the profit and loss (or P&L) statement. It is a financial representation of the revenue and expenses of the firm and whether it has generated a profit. Watch this video that describes the multi-step income statement.

Briefly, the balance sheet represents everything a company owns and what they owe. The difference in Owner's Equity, which is what's left after the assets have been liquidated and the debts have been paid. After reading these sections, you will understand how revenue that the firm generates is recognized from an accounting view.

Assets are a list of everything a company owns, and a large asset account for many companies is their inventory. Inventory represents something that the company either made, using labor and materials, or something that they purchased from an outside supplier. These sections will prepare you to explain how inventory is defined, how it is valued, and its effect on the balance sheet.

Read these sections to continue our discussion on assets. Assets are classified as current (can be liquidated in one year or less) and long-term (will take longer than one year to liquidate). Pay attention to the balance sheet treatment of long-term assets, and also the process for depreciating those assets.

The next part of the balance sheet is a record of the form's liabilities, or debts. These sections will give you a better understanding of short-term liabilities and how they are accounted for. After reading this material, you will be able to discuss short-term liabilities and their treatment on the balance sheet.

To continue your review of liabilities, read these sections on how long-term liabilities are treated on the balance sheet. Common long-term liabilities include loans and bond issues. By the end of this chapter, you will be able to discuss how long-term liabilities affect the balance sheet, and the implications for management decisions.

As you have learned, the accounting and financial reports are essential to a firm's stakeholders. In this chapter, you will see what actions a firm takes to ensure that the reports presented to the stakeholders are a true and accurate representation of their financial status. Pay particular attention to the discussion on disclosure issues.

For publicly-traded corporations (those who have stock traded on the public exchanges), there is a legal requirement to have their financial reports audited. The use of an independent auditor is to provide assurances to the stakeholders that the information that they have been given complies with the guidelines established by the Generally Accepted Accounting Principles (GAAP). The material in this section will provide a detailed description of how the independent auditor's report is prepared.

One way to assist stakeholders in their analysis of the financial performance of a firm is to provide a methodology that allows for a meaningful insight into historic trends, future forecasts, and a comparison of performance between firms.

A business goal is to not only generate revenue from its products and services, but also to do so profitably. The analysis of profitability ratios allows us to evaluate how well the firm is doing in allocating resources to generate returns. Pay particular attention to the review of return on total assets (ROTA) and return on common equity (ROCE) which are of interest to shareholders.

A key question for management is how good their decisions are to invest the firm's capital in various assets. Assets should be used to generate revenue for the company, and a return on the investment for shareholders. Watch this short video to see an explanation of the Asset Turnover Ratio.

Companies take in money from shareholders and invest in assets, like plants and equipment, that will be used to support the business goals. Now, we will learn about turnover ratios. Note that the higher the turns, the more efficiently the company managed its resources.

Inventory is a critical asset that requires consistent management by the firm. Too much inventory and the carrying costs will erode profitability, while too little inventory can impact production and customer satisfaction. There are a few methods for determining costs, and a review of the section on inventory costs will be helpful.

At its most basic level, liquidity represents how quickly a company can convert assets to cash. Consider the asset section of the balance sheet. The categories of assets are listed in order of their liquidity. That's why cash is the first asset listed. After you read, you should be able to explain the idea of liquidity, especially the current ratio (CR).

Suppliers and lenders are interested in the liquidity of the business, or how easy it is for the company to pay its short-term obligations. Watch this short video on the Current Ratio for a better understanding.

Certainly, every business needs to monitor its cash position and record all transactions where cash comes into the firm and goes out. The cash ratio is a way to evaluate this position and determine the amount of cash available to meet the firm's obligations. Take a look at this short review of the Cash Ratio.

Potential lenders are interested in determining the ability of a borrower to cover the interest charges on the amount of money that is loaned out. One way to measure this is to calculate the Times Interest Earned financial ratio. This short video demonstrates this calculation. 

Most of us are pretty familiar with the concept of debt. We use debt to buy a car, finance our education, or buy a house. Businesses do the same, although the debt is much higher! Every business must answer: "do we have too little, or too much debt?" This text explains two critical ratios: total debt to total assets and the times-interest-earned ratio. After you read, you should be able to explain how debt impacts a firm's ability to perform.

We have already discussed the need for management to make decisions on investing capital to secure assets to generate a return for shareholders. The debt ratio is a way to determine how much of these assets have been financed using debt.

A business needs capital to finance the acquisition of assets, support ongoing operations, and invest in new opportunities. One of the critical financial decisions that a manager must make is to determine how much of the required capital will come from equity and how much will come from debt. One measure of this is the calculation of the Debt to Equity ratio. Watch this brief video on the Debt-to-Equity ratio to gain a better understanding. 

We can look to the market to assess how well a company is doing in creating value for shareholders. For publicly traded firms, the stock price is one indicator that we look at. You will learn how to calculate two ratios that reflect how the market views the firm's performance and future prospects.

Earlier, you learned how to calculate the return on equity or the return generated for shareholders on their investments in the company. Improving the firm's ROE is important to management and shareholders, and it is worth learning what basic management actions affect this ratio. In this text, you will see how specific decisions can influence this ratio.

Managers strive to find ways to provide information to the various parts of the operation that will assist those decision-makers in focusing their efforts on activities that can produce the greatest returns for shareholders. One method is through the DuPont Equation described in this video.

If you have more than one investment opportunity but can only afford one, which one will you choose? You are presented with a chance to acquire new equipment that can improve your operating efficiency and help you to increase your sales, but is it worth the cost? After reading the material in this section, you will be able to calculate the value of an investment using discounted cash flows.

Every investment made by a firm or an individual carries some degree of risk. The investor must evaluate risk as a determination is made on whether to invest their funds. Read this section to learn more about the different types of risks you may face.

Recall that financial risk is the possibility that an investment will return less than expected. Different investors, projects, and investment requirements will carry different levels of risk. Each investor, or investment group, will determine what level of risk is acceptable. Read this section to learn more about measuring risk.

One consideration that an investor in corporate bonds must make is the degree of risk they will assume with the investment. There are different classifications of bonds, and this section will offer some descriptions of the types of bonds and their risks.

Corporations can issue two types of stocks, common and preferred. Each type of stock has unique characteristics and will be reviewed for the advantages and disadvantages for the shareholder. For example, common shareholders have the right to vote on company policies and for the board of directors. This article discusses these differences.

Not all stocks pay dividends, and those that do will vary in the amount and frequency of payments to shareholders. The potential for receiving dividends represents a value-added for these stocks. The dividend discount model is often used in valuing stocks that offer dividends.

We use the term portfolio to represent a package of investment products, such as a stock portfolio. A company can also have a portfolio of products or market segments that they serve. In this section, you will learn how to evaluate a portfolio of various stocks/products, and how you can diversify the holdings in a portfolio to mitigate the implied risks that come with these investments.

We have discussed the implications of risk on investments. When certain factors are known, such as the risk-free rate, the beta of a stock, and the current market risk premium, we can calculate its potential return using the Capital Asset Pricing Model (CAPM). Read this section to learn more about this model.

A widely used method for reducing the risk of an investment portfolio is to ensure a diversification of stocks or not by not putting "all your eggs in one basket". An additional consideration is the weight or amount of the different stocks included. This process allows for a diversified portfolio. Read this chapter for a discussion of portfolio diversification and weighting.

Part of creating and maintaining a diversified stock portfolio is reviewing and evaluating what is happening with each stock in the portfolio. Stocks are dynamic and will rise and fall over a given period. Deciding when to buy and sell stocks requires a thorough analysis of their performance in the market. Read this section on the implications for expected returns to learn more.

You need to be able to determine the rate of return on an investment. After reading this section, you will be able to calculate the real rate of return, not the expected rate, on an investment.

We have discussed the implications of risk on investments. When certain factors are known, such as the risk-free rate, the beta of a stock, and the current market risk premium, we can calculate its potential return using the Capital Asset Pricing Model (CAPM). Read this section to learn more about this model.

When evaluating firms for investment opportunities, shareholders are keenly interested in knowing how well the company is doing in generating returns on the capital that they invest. Watch this video that discusses the return on capital.

As we have already discussed, a company raises capital from debt and equity financing. This capital is invested in projects that will generate a return for the investors. But every project has a degree of risk, risk that the returns will not be as expected. This chapter reviews the concept of estimating these risks, and how that is used in the evaluation of potential investment opportunities.

When companies achieve a degree of financial success, which we will define as consistently generating a profit from their operations, some decisions need to be made that recognize the requirements for ongoing operations and a return for investors. The company will keep part of the profit (earnings) to continue operating the business, which are retained earnings. The amount of earnings left belongs to the shareholders and can be distributed to them as dividends. Read these sections, which discuss dividends for common stock and for preferred stock.

Companies have used stock buyback programs more frequently as they provide a reasonable approach to meet the financial expectations of their diverse shareholder groups. These programs are important to the firm and the shareholders; after reading this section, you will be able to explain why stock buyback programs are used.

Firms must maintain and grow their business to provide the expected returns of shareholders. When financing a project, a mix of debt and equity financing will position the firm to generate the maximum return. Analyzing this decision involves determining the Weighted Average Cost of Capital (WACC) to achieve the firm's goal. This article explains this theory.

One of the most important functions of corporate finance is the creation and management of the company's capital plan. We know that the firm requires capital to invest in projects, and that the capital comes from debt and equity financing. These sections address the decisions that are made regarding the capital plan. After reviewing this material, you will be able to explain how a company determines what the optimal capital plan should be.

A critical component in developing the firm's capital plan is determining what the cost of capital is. This reading will provide you with an introduction to this topic.

A critical component in developing the firm's capital plan is determining what the cost of debt and equity is. When you have completed reading these sections, you will be able to calculate the cost of debt and the cost of equity.

In this reading, you will learn how to calculate the actual cost of capital by providing a weighted average of the sources of capital, the amount of each, and their respective costs.

The Capital Asset Pricing Model is used to calculate the excess rate of return that investors expect. It is an essential requirement for creating an optimal capital plan. Once you have read this section, you can use the CAPM formula to calculate a shareholder's expected rate of return on the money that they invest.

Consider that companies will invest in projects that will generate more revenue for the business. This revenue is represented by a stream of future cash flows from the project. We introduced this topic in 3.3: Net Present Value, but it is worth reviewing the idea of future cash flows. When you have studied this section, you will be able to explain how a future stream of cash flows can be appropriately discounted to determine what the value is today.

To learn more about the process for capital budgeting, watch this video.

Operating budgets are developed to meet the day-to-day needs of the business. A capital budget is created to address the long-term needs of the business, future expansion, and development, and requires a larger commitment of funds. After reading this section, you will be able to describe the elements of a capital plan and discuss the evaluation process for making capital investment decisions.

The capital budget intends to forecast where the business is going in the future and to make determinations on what will be needed to support the firm's plans to get there. Read this chapter to gain a better understanding of the decisions that are required to conduct long-range planning.

One of the most basic requirements for any business is the need for a regular flow of cash to support its operational requirements. This section describes how the business accounts for cash flow and monitors the cash that comes into and goes out of the business.

Watch this short video on Free Cash Flow to start this conversation. Let's take this one step at a time. First, we'll go through the parts of calculating free cash flow. It starts with identifying the net operating profit after taxes (NOPAT). You can find or calculate your EBIT from the income statement. That's where you'll find the tax rate.

One key measure that a company uses to demonstrate the financial success of its decisions is the creation of free cash flows. As you read, pay attention to the formulas used to calculate free cash flows, as shown in the example.

This video discusses the Accounting Equation. We should note that this calculation is not a perfect representation of corporate value. Some assumptions are being made, such as the value of assets in today's market given their depreciation over time. It also places no value on intangible assets such as goodwill. In this unit, we will consider these questions on corporate value and look at alternative ways to calculate this value.

We can use three methodologies to determine the value of a corporation. They include an income, an asset-based, and a market approach to valuation. After you read, you will be able to explain the various approaches to valuation.

Earlier, we discussed the need for management to make decisions that improve the firm's financial performance. The dividends paid and the potential for future dividends are indicators of performance. After you read, you will be able to explain the dividend discount model and how it is used in stock valuations.

Growing a business to produce favorable results for shareholders requires detailed and actionable strategies. One strategy for growth involves the area of M&A activity. Read this section to explore some of the options available to a firm.

A firm will make investments that will generate additional revenue and cash flows in the future. To analyze the potential benefits of these investments, the company recognizes the impact of time on the value of money, especially when the money or cash flows will occur in the future. This section discusses the effects of time on these investments.

This article gives a brief overview of Market Value Added (MVA) and Economic Value Added (EVA).

The balance sheet in a company's financial package is, in brief, a summary of everything the firm owns and the total of what they owe. The difference is Owner's Equity, and shareholders are very interested in the trend of this account. The value of assets is determined by evaluating the book value and the market value. Read this chapter to learn more, and pay particular attention to the market value vs. book value section.

Companies can create value for their shareholders by paying cash dividends. There are also other methods for addressing the value of a share of stock. Read this chapter, which discusses some of these methods.

Read this article. You must be able to explain how market value added (MVA) is an element of shareholder value.

Watch this video, which discusses the basic components of strategic planning in a company.

A critical element of any strategic plan is to develop the goals and objectives that the firm has decided are necessary for its short-term and long-term success. Goals represent the long-term results that the company seeks, while the objectives are the individual tasks that must be completed if the goals are to be reached. This video discusses goals and objectives.

The first step in considering developing a strategic plan is understanding its basic elements. It is important to know what strategy is and what it is not. These sections will provide a foundation for an understanding of business strategy. When you have completed these sections, you will be able to define strategy and explain how it is used in a business setting.

Creating a powerful strategic plan requires a concerted effort to understand the qualitative and quantitative factors that exist in the market. There is also a need to conduct a thorough review of the firm's internal and external influences. This section introduces several approaches to this process.

Earlier, we discussed the importance of the control function and monitoring the firm's progress in meeting the goals and objectives contained in that plan. This section reviews the ways that a company assesses performance. Be sure to pay attention to the use of the Balanced Scorecard, which includes not only financial performance goals but operational goals as well.

This brief video introduces the benefits of the Sales Forecasting process. Even though actual results will probably differ from the forecast, it is a useful way to help us list and consider internal and external factors that can affect sales.

Forecasts must be as dynamic as the business environment. That means it is not set in stone but will be routinely evaluated for necessary corrections. These sections will explain the importance of budgets and forecasting to the business. This material will enable you to explain the budgeting and forecasting process and discuss its benefits to the company.

Companies are routinely evaluating investment opportunities that can support their strategic plans for growth and improved financial performance. At any point in time, the demands for capital can exceed the capital that is available. In this section, you will learn about calculating if there is a requirement for additional funds. When you have studied the formula shown, you will be able to calculate the additional funds needed to support a specific project.

We reviewed the complexities of creating a strategic plan for the business. By definition, strategy is a forward-looking process that considers where the company wants to be and what it will take to get there. The same applies to preparing future financial forecasts or pro formas. This chapter covers the process for determining future financial performance. It is important to understand the use of common sizing and the percentage of sales methods.

This article will help reinforce what you've learned about pro forma statements and walk you through an example.

Corporate governance is concerned with the operation of a corporation according to the rules. Those rules can include the corporation's charter, operating guidelines, and the legal agencies with authority for business oversight. Reading this section will prepare you to be able to discuss the idea of governance, and to explain the interests of the many stakeholders involved.

Read this section, where you will learn of the ongoing debate regarding a corporation's Board of Directors and their responsibilities to shareholders in particular and stakeholders in general.

The executives of a corporation, as well as the board of directors, have legal, ethical, and moral responsibilities to the firm and the firm's stakeholders. After reading this section, you will be able to explain the principles of fiduciary responsibility and the need to apply due diligence to business decisions.

This chapter reviews the opportunities and issues a company will face when conducting business in the global marketplace. With the ever-increasing dynamics of international trade, you should read this chapter carefully. It is an excellent starting point to consider the skills required to expand your business internationally.