HR 6910
WACC calculation
[Cost of equity TIMES proportion of equity] PLUS [cost of debt after tax TIMES proportion of debt]
Balaance sheet = shows the condition at
a particular point in tmie
Present value of a fixed perpetuity
annual cash flow / discount rate
❏✓Uncertainties are present in
any forecast, and management must decide how to deal with those uncertainties to minimize the risk of making a decision that harms the company.
depreciation and amortization expenses do not represent cash outflows during the period in which they
appear on the income statement.
How does risk-free interest rate impact option value?
The value of an option increases when the interest rate increases. One benefit of an option is that you get to hold onto your money until the option is exercised.
returns above WACC
competitive advantage
the matching princple
expenses are matched with the revenues they helped produce (for example, salaries of employees are recognized when the product is sold, NOT when the wages were paid)
When the ROE is greater than the ROA, the financial leverage is
beneficial
does operating profit incorporate interest expense?
no - Interest expense is not subtracted out in this calculation because it is a not a cost of operating the business —> It is a cost of financing the business.
Return of capital
(net profit before tax DIVIDED BY capital invested) times 100
Stock options are similar in that the option purchasers pay for the right to make a transaction at a future date if they decide it is in their interest to do so. The option sellers receive a fee for agreeing to those terms. The amount paid to purchase an option is usually referred to as the
premium
Stock appreciation rights (SAR):
provide the employee a payoff equal to the appreciation in a specified number of shares of employer stock
which forms of equity pay do not result in dilution
stock appreciation rights, restricted stock units, and performance share units
there's one element of the decision that can't be forecast accurately:
the risk that the company's assumptions may be wrong.
The objective of he procedure (for determining which budget to fund) is to select the bundle of projects that maximize
the total NPV that can be achieved within the budget
If a liability category decreases,
funds used to pay down that debt are subtracted
Revenues minus COGS
gross profit
Gross Profit Margin
gross profit DIVIDED BY gross sales
what si the connection betwween financial statements and organization design
P&Ls are the building blocks of organizatons
example of risk-free
US bond
whenever you see a company whose ROE is different from its ROA, that difference is the result of
leverage
SE is NOT a reflection of the dollar amount that would be realized if the company were liquidated... BECAUSE
liquidation produces a cash return that differs from the originally recorded amounts
Current assets are presented in the order of
liquidity
vertical analysis
lookiing within a siingle time period tto see how revenue relates to net income or how revenue looks at COGS
It is certainly possible for EBITDA to be positive while EBIT is negative; that is, the firm is
losing money
if inventories become too lean, there is a risk of
losing sales because some products may not be available for immediate delivery.
Measures of productivity metrics
backlog, sales per customer, sales per employee, sales per square foot
Price/Earnings Ratio - P/E -
Price of stock compared to slice of the company's earnings attributable to the same share of stock
ROI
(PV benefits MINUS PV cost) divided by PV cost
WACC =
(cost of equity TIMES proportion of equity) plus (cost of debt after tax TIMES proportion of debt)
Quick Ratio
(current assets MINUS inventory) divided by current liabilities
EBITDA
(earnings before interest taxes depreciation and amortization have been subtracted out)
how much you depreciate an asset over multiple years
(original cost MINUS salvage value) DIVIDED BY years of useful life
convertible preferred stock
a class of shares that can be converted int common stock
greater financial leverage may boost a firm's ROE, but it also makes the firm
riskier
2 primary areas of responsibility?
safeguard company assets & organized the data about transactions/present data in reports
asset turnover
sales divided by total assets
lease contracts
shows commitments made by a company in order to lease equipment or other assets at favorable payment terms, usually followed by a modest buyout option at the end of the contract
why does the quick ratio not need to be as high as the current ratio?
since it will become cash more readily, so less of a safety margin is required for prudent management.
cash squeeze
squeezing more working capital out of balance sheet by delaying payment to creditors — while making sure that customers don't delay payment to you
KPIs - key performance indicators... accompanied by a benchmark
standard against which the metric is compared tto see if the company is doing better or worse than expected
Naked options
term used to describe trades in which the option purchaser does not also own shares of the underlying stock.
leverage
the ability to borrow and thereby to put more money into a business than has been invested by its owners, thus earning more than is invested capital could earn alone
what does earnings per share allow you to do?
determine how companiies are doing compared to others, even if there are signifcant dfferences in the function of the businesses......
Calculating operating cash flows involves two steps. The first is to
determine what the income statement tells you about cash flows
Capital budgeting
determining whether long-term investments are worth pursuing (calculating the DCF valuation of each potential project)
When the ROE is less than the ROA, the financial leverage turned out to be
detrimental
Earning a gross profit is important - because the
difference between sales and the cost of sales normally pays all the operating expenses
possibility that here will be more people dividing up the nett income than there are now
dilution
horizontal analysis
lookiing across categorries and time perods
Working capital is the
net amount of cash the firm has tied up in inventories and accounts receivable.
which do you want to grow faster: net income or revenue?
net income
ROA =
net income / assets
calculate EPS
net income DIVIDED BY # of shares outtstandinig
net profit margin
net income DIVIDED BY sales revenue
return on assets
net income DIVIDED BY total assets
Return on equity:
net income annualized DIVIDED BY stockholder equity
returns on equity
net income divided by equity
calculate earnings per share
net income/shares outstanding
gross profit MINUS operating expenses
net operating income
NPV
net present value
Net Profit Margin
net profit DIVIDED BY gross sales
does land have a finite useful life?
no
Performance share unit (PSU)
not stock, but cash payments equal in value to one share of stock that are made to employees if specified financial performance or stock performance targets are achieved
Restricted stock unit (RSU)
not stock, but cash payments equal in value to one share of stock. Units do not represent any actual ownership interest and have no voting or dividend rights.
General Ledger
principal accounting record to which all company transacttions are recorded and summarized (record from which basic financial reports is drawn *****)
the cost of taking the fruits of that research to develop products that can be sold, e.g. a cure for the common cold in simple pill form
product development
a firm's ROA is always a function of
profit margin & asset turnover
return on assets
profit margin MULTIPLIED BY asset turnover
a firm's ROA is always a function of
profit margin and asset turnover
the finance department safeguards company assets by
properly accounting for the, instituting internal controls to prevent their misuse/loss, and monitoring their proper use
financial reports should be accurate, BUT without
requiring such high degree of accuracy as tto make them too expenseive or too time-consuming to produce...
Competitive advantage
returns in excess of peerrs over time
two most important aspectts of growth
revenue and net income
Revenue Recognition Principle
revenue shouuld be included in the income statement of the period in which the goods/services exchanged for cash or accounts receivable OR the firm has completed what it must do to be entitled to cash
order of appearance on income statement
revenue, COGS, gross profit, operating expenses, net operating income, interest expense, earnings before taxes, income taxes, net income
Calculating operating cash flows involves two steps. The second is to
review the assets and liabilities shown on the balance sheet to determine whether there were any changes during the year in these items that had cash flow implications
To judge the ROI from training, you must determine whether
the present value of the future performance increases is greater than the upfront training costs
For a call option, the intrinsic value is the current stock price minus the exercise price. The exercise price is
the price at which you have the right to exercise your option to purchase the stock
net income is always the result of two things:
the profitability of the firm's business operations (which is measured by EBIT) and the way those operations were financed, that is, how much was borrowed at what interest rate
partnership
unincorporated, 2+ owners////earnings are taxable, so the earnings are typically paid out to the owner each year as dividends or distributions of profits
proprietorship
unincorporated, one owner////earnings are taxable, so the earnings are typically paid out to the owner each year as dividends or distributions of profits
Sales per employee is
useful in sales-driven environment
the world as you define it, rearranged as you would like to see it
vision
Dilution can come in other ways, including
warrants, convertible prefered stock, and convertible bonds/debentures
ratio analysis
ways of seeing different ratios to determine how a company is overall
revenue recognition
when the event actually happens, you can recogniize the revenue
Common Size Statement
lists everything as a % of revenue
Shareholder value
long-term returns in excess of cost of capital
what is solvency
ability to pay debt
Dividing annual sales revenue from the top line of the income statement by the accounts receivable balance yields
accounts receivable turnover ratio
Accounting rules in GAAP require most companies to keep their accounting records on what is called the
accrual basis
what to do from income statement to balance sheet
add net income, add/subtract valuation changes, subtact withdrawals, and add capital contributions
If a liability category increases, the funds obtained through that borrowing are
added
if a company's business has a very high rate of product returns, then revenue should only be recognized ______
after the return period expenses
ROIC =
after-tax operating profit / assets = [EBIT × (1 - the tax rate)] / assets
For the purpose of calculating WACC, what do you use?
aftertax cost of debt --> percent of debt financing and estimated cost of equity --> percent of equity financing
Companies no longer amortize (write down the value of) goodwill over a specified number of years. Instead, goodwill remains
as an asset on the balance sheet until the company has evidence that its value has decreased.
financial leverage
assets DIVIDED BY equity
Order of chart of accounts
assets, liabilities, SE, revenue, expenses
roll-up costs
associated costs of payroll (benefits)
Sales per customer is useful when
cost to process an order is fixed or controllable
Market value added
positive if the present value of the future stream of expected return
current ratio
Current assets DIVIDED BY current liabilities
.. the balance concept in financial reporting is called
MATERIALITY
calculate return spread
Return spread = ROIC minus WACC
Backlog of order
all orders received MINUS orders shipped and inivoiced
Costs per sales dollar:
"sales and marketing costs" DIVIDED BY gross sales
financial report card
The financial plan
What is WACC?
Weighted average cost of capital
DCF analyses must be based on
changes in cash flow
HRB = R + T + C + A
HRB = HR budget R = recruitment and selection costs T = training and development costs C = compensation costs A = HR admin costs
Causes of problems for cash flow in small business
- Difficulty collecting A/R - Seasonal sales patterns - Unexpected variations in sales - Weak sales
An ideal performance management system is one that energizes the people in an organization to focus effort on:
- Improving things that really matter - One that gives people the information and freedom that they need to realize their potential within their own roles and aligns their contribution w/the success of the enterprise
for DSO, a standard anywhere in the _____ range is probably acceptable in most cases.
40 day to 50 day
whatt are the 3 steps of making the operatting plan
- outlines goals - P&L budget - planned capital expenditures
Most companies offer 30-day credit terms, yet the average DSO for companies nationwide is in the neighborhood of
45 days
Calculate tax effect
1 minus tax rate
If the current ratio should typically be 2:1 or better, the quick ratio might need only to be
1.3:1 or better
Return on capital
100 TIIMES (net profit before tax, DIVIDED BY capital invested)
Ideally, a company sells its products or services with 30-day terms, and customers pay the invoices 30 days later, so the DSO would consistently be
30 days
The recorders of a company's financial data carry heavy responsibility to provide info that is
ARTistic: Accurate, Relevant, Timely
Accounting measures can create management myopia?
Accounting is short-term earnings/returns Focusing only on the short-term is inappropriate
Why are accounting measures of performance not adequate?
Accounting measures are lagged indicators Dependent on the choice of measurement method
Why does EVA differ from accounting profits?
Accounting profit, the net income figure on the bottom line of the income statement, is after subtracting out interest expense. Interest expense is the cost of debt, but an income statement does not include the cost of the equity capital used. EVA is after subtracting a capital charge based on WACC, which is the weighted average of the cost of debt and the cost of equity. It is therefore quite possible for accounting profits to grow while no value is created
benefits of NPV
Accounts for the time value of money Considers the businesses' cost of capital or "hurdle" Provides answer in today's dollars, making investment and yield dollars equivalent regardless of time
Big 3 of cash management
Accounts receivable - collect early Accounts payable - stretch payments Inventory - don't tie up cash in wrong inventory
Monthly revenue divided by 30 EQUALS
Accounts receivable DIVIDED BY average revenue per day
averaage sales collection period in weeks
Accounts receivable turnover ratio, divided by 52
When did companies start operating globally?
After the end of WW2
high-risk acquisition.
An acquisition that would not make economic sense without the projected synergies
What is importantt about synergy?
Anticipated synergies between the purchasing company and the acquired company are often a primary motivation for undertaking an acquisition. Synergies may increase revenues and/or decrease costs
Why do we need financial statements?
Assess current performance through finanaciaal statement analysis (Provides more tools for the analysis), Monitor and control operations (Both insiders and outsiders do this), Forecast future performance → models are typically built uusng the financial staatmenets
Leverage Multiplier
Assets/Equity
Benefits of a plan
Clarity, roadmap, communication, empowerment
NPV method criteria
Considers all CFs Considers TVM Adjusts for risk •Can rank mutually exclusive projects-
Which synergies are easy to quantify/deliver/project/attain
Cost reduction synergies
Calculate operating margin
EBIT/sales
Debt Service Coverage Ratio
EBITDA divided by debt service
what has the most correlation with MVA?
EVA
what is return spread
EVA
EBIT is an acronym for
Earnings Before Interest and Taxes are subtracted ou
EBITDA is an acronym for
Earnings Before Interest, Taxes, Depreciation and Amortization are subtracted out.
What is EVA and why is it better?
Economic profit includes the cost of capital, so it is not the same as accounting profit (don't need to follow GAAP).....cost of capital is specific for accounting
What judges the financial effectiveness of a company's management efforts?
GAAP
What are the 2 main Qs from the class
How does my firm create value What does HR need to do to support/enhance it
When calculating cash flow you attempt to answer the question,
How much cash did your business operations actually bring in during the period and how much cash did your business operations actually pay out during that period?
what's important about straight line depreciation
If Home Depot were using straight line depreciation to allocate this $60 million construction cost over a 30-year life of the building, it would on its income statement subtract a $2 million ($60 million / 30) depreciation expense in each of those 30 years. In the first year $60 million would have been paid to construct the building but only a $2 million expense would be included on the income statement. In the second and later years, no cash would be been paid out for this construction, but a $2 million expense would be included on the income statement. This method of calculating profits can produce large differences between the profit a company reports in a given a year and its actual net cash flow in that year
NPV Decision Rule
If NPV is positive, accept the project•NPV > 0 means: -Project is expected to add value to the firm-Will increase the wealth of the owners•NPV is a direct measure of how well this project will meet the goal of increasing shareholder wealth.
IRR analyses are popular with CFOs and line executives for at least two reasons.
In many cases, they enable you to avoid having to make estimates of the appropriate discount rate. A second way IRR analyses are often used is to rank alternative investments. Giving up a project with an IRR of 20% would make economic sense if that were necessary to undertake a project with an IRR of 30%.
3 primary financial statements
Income statement → how much money did you make last year Balance sheet → what is a snapshot of your current financial situation Statement of cash flow statement → how did the cash come and go?
The performance measurement concept indicates that employees can increase the value of the firm by
Increasing the size of a firm's future cash flows By accelerating the receipt of those cash flows By making them more certain or less risky
Money Has Time Value Because of
Interest Rates
Shareholder value creation is NOT
Maximizing share price Managing for earnings Doing 'anytthiing' to make a profit
Objectives for for-profit organizations?
Measure changes to stakeholders wealth (value) Reward an employee for contributing to increase in firm value
Components of EVA
NOPAT - net operrating profitt after tax Operating capital Cost of capital Capital charge (cost of capital percentage TIMES operating capital) Economic value added
among the methods - more complicated but more powerful, generally a finance person's first choice.
NPV
Discounted ROI
NPV of benefits DIVIDED BY total present value of costs
When alternatives are mutually exclusive (if you purchase one, you won't purchase the other), you should rank them using
NPV, not IRR.
income statement --> balance sheet
Net income PLUS depreciattion MNUS ncrease in accounts receivable MINUS increase in inventory, MINUS increase in long-term assets, MINUS cash flow from operations
Pretax ROIC (calculate it)
Operating margin times capital turnover ----- same as (EBIT divided by inverted capital)
Operating statement =
P&L = income statement
determine if the price of the stock is too high in relation to the amount of money the company is earning
P/E ratio
Benefits from understanding Financial Excel Models
Provides a framework for thinking about the choices managers must make Creating a spreadsheet can let you identify the subset of projects that maximize return on the budget without needing to use a trial-and-error process HR managers must understand models to be successful as strategic partner
a cost of doing business that must be financed out of the gross profit
R&D
greater financial leverage might boost a firm's
ROE
the difference between _______ could be an important factor when evaluatting the peformance of CFO or the CEO
ROE & ROA
❏✓Discounted cash flow (DCF) is the
ROI calculation that takes into account the time value of money, using either present value or future value calculations, to place the comparison of cash inflows and cash outflows on an equal footing.
Calculate return spread
ROIC minus WACC
An increase in an asset category requires
Requires to purchase those additional assets, so subtract from the cash generated the amount of any asset increase.
Financial accounting is a department with processes that need a high degree of
STABILITY
Calculate capital turnover
Sales divided by inverted capital
Which synergies are hard to quantify/deliver/project/attain
Sales growth synergies
SG&A
Selling, General, and Administrative Expense
Why do organizations choose accounting data as measures of performance?
Short-term measures keep employees in check Accurate
Performance Measures should be
Simple to operate Simple to understand Simple to enact
NPV steps
Step 1: Estimate the expected future cash flows.Step 2: Estimate the required return for projects of this risk level.Step 3: Find the present value of the cash flows and subtract the initial investment to arrive at the Net Present Value.
Weighted average cost of capital (WACC)
The calculated cost of all the capital employed by the KEY TERM business, including capital obtained from trade credit, all other liabilities, and stockholder investment (via dividends paid).
What is the cost of investing a dollar?
The WACC (percentage) plus the dollar
Interest Rate
The compensation paid to a lender (or saver) for the use of funds expressed as a percentage for a period (normally expressed as an annual rate)
How does vesting periods and forfeiture rates impact option value?
The cost to the firm to grant employees stock options declines when the forfeiture rates increase.
How does dividend yield impact option value?
The value of an option decreases when the dividend yield on the underlying stock increases. The dividend yield is measured as the annual dividend paid divided by the average stock price in that year
How does volatility impact option value?
The value of an option increases when the volatility in the price of the underlying stock increases. Volatility is measured as the standard deviation in annual stock price changes expressed as percentage. A large standard deviation means there are large swings in the price of that stock. A lower standard deviation would mean the price fluctuations remain within a narrower range. For stock owners, higher price volatility means a greater chance of big gains and a greater chance of big losses. For option holders higher volatility means a greater chance of big gains, but not a greater chance of big losses. The value of an option increases as the stock price rises further above the exercise price
How does years to maturity impact option value?
The value of an option increases when the years to maturity or the expected life of the option increases. Options have value for two reasons. They enable you to wait to see what happens to the stock price before making a decision about whether to purchase shares, and they enable you to hold onto your money until the option is exercised. Both of those benefits increase as the length of the option increases. With longer options, there is more time for the share prices to grow, and you get to retain your cash for a longer period.
How does stock price/exercise price impact option value?
The value of the option increases when the amount by which the current stock price exceeds the exercise price increases. Employee stock options are typically granted with an exercise price equal to the current stock price. Their value depends upon how much the company's stock prices will rise in the future.
Who benefits and who loses after a stock repurchase?
These remaining shareholders will have benefited if at the time of the repurchase the stock was undervalued in the external market. The remaining shareholders will have incurred an economic loss if at the time of the repurchase the shares were overvalued in the external market.
Why would a company elect the LIFO accounting option which, during periods of rising prices, lowers reported profits?
They might select LIFO precisely because lower taxable profits mean lower tax payments. The choice between LIFO and FIFO is more significant during periods of rapid inflation. If in this example the price per hammer had been the same in both the first and second purchases, the choice of FIFO versus LIFO would have no effect. With today's computerized inventory control systems, it is often possible to at all times know the exact cost of the items currently in inventory. That makes it possible to avoid both LIFO and FIFO and use an average cost method for inventory costing
Why is WACC weighted?
To determine how much is debt vs. how much is equity
Market Value Added
Total market value = share price times shares
how to determine whether a firm has difficulty collecting from its customers
Tracking the average collection period from year to year
What is finance?
Understanding risk and return is a major part of finance, Most of what we do in finance always comes back to understanding this simple tradeoff
debt vs. equity: discuss risk for lender
Very low risk for lender in a debt situation, Very high risk for lender in an equity situation
he overall required return on the firm as a whole - NOT the actual return
WACC
Final questions before CFO makes a decision —>
What are the chances that the stamping work this machine does won't be needed in 10 years as a result of technology advances, prod- uct obsolescence, process evolution, etc.? ■ How certain can we be that the vendor can honor the maintenance commitment for the entire period without significantly increasing the price? ■ How sure are we that the machine will consistently produce the projected savings?
Who started the GAAP?
Who started the GAAP? FASB - Financial Accounting Standaards Board
If a firm has a 20-year mortgage, 1 year of it is shown as
a current liability, and the other 19 years as a long-term liability.
convertible bonds/debentures
a debt that can be converted into common stock
Economic value added (EVA) is just
a firm's after-tax operating profit minus the cost of financing the assets used to make that profit
When there is evidence that the value of goodwill has declined
a goodwill impairment charge is subtracted on the income statement, and the value of the goodwill asset shown on the balance sheet is reduced
warrants
a kind of option given to banks and other financial institution as extra payment for a loan or a public stock offering
Performance shares contingent upon stock market performance (for example, stock price change or TSR) are usually valued using
a lattice model or Monte Carlo simulation.
A stock's beta coefficient is
a measure of volatility over time compared to a market benchmark. A beta of 1 means that a stock's volatility matches up exactly with the markets. A higher beta indicates greater volatility, and a lower beta indicates less volatility
IRR = The internal rate of return is
a metric used in financial analysis to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.
SARs provide
a payoff to the employee only if the stock price appreciates. RSUs provide a payoff to the employee even if the stock price is flat or declines.
A firm should undertake every investment that has
a positive NPV
Purchase of long-term asset
also decrease cash but may or may not affect profits
applies to the decline in value of an INTANGIBLE assets w/a multiyear life, such as a website, a patent, or a license to use someone else's intellectual property
amoritization
ROI
amount of financial gain DIVIDED BY cost of investment
Capital stock
amount paid into the company by investors to purchase stock at some nominal amount per share; the par value printed on each share of stock
To make investment decisions using NPV analyses, you must start with
an assumption about the appropriate discount rate.
Dividing the Cost of Goods Sold expense from Home Depot's income statement by the value of inventories shown on its balance sheet yields a measure known as
an inventory turnover ratio
For stock options and stock appreciation rights, fair value is estimated using
an option-pricing model such as Black-Scholes.
until recently, the term amortization referred to an
analogous process used to allocate the cost of an intangible asset, for example, a purchased patent or brand name over an estimate of its useful life
Monte Carlo simulation gives you a way to
answer the questions, "What would the distribution of NPVs be if you undertook projects like this one many times? What would be the average outcome? How much could you lose if things go badly, and what is the likelihood of that? How much could you make if things go well, and what is likelihood of that?"
how could you calculate net worth?
balance sheet
Instead of starting with an estimate of the appropriate discount rate, the IRR
calculates the largest rate that could be used and still have the investment be an attractive one.
If EBITDA were negative,
cash infusions would be required just to sustain the units operations.
Remember that depreciation and amortization expenses do not represent
cash outflows during the period in which they appear on the income statement
Remember that depreciation and amortization expenses do not represent
cash outflows during the period in which they appear on the income statement.
what is the exact order of current assets
cash, temporary investments, accounts receivable, inventory, supplies, and prepaid expenses
loan covenant
clauses in a loan agreement that require the borrower to do certain things (affirmative covenants) or NOT do other things (negative covenants)
Earnings Per Share Fully Diluted
common stock earnings per share when calculated as if all sttock options and warrants were exercised and if all convertible preferred stock and convertible debt were converted into common stock
If the question you are interested in at the moment is, "Which business model is more successful?"
comparing the two firms on EBIT would be the best choice.
If the question you are interested in at the moment is, "Which firm generated the greatest profit for its shareholders?"
comparing the two firms on net income would be the best choice.
higher free cash flows
competitive advantage
Firms do not typically use their own WACC when valuing a potential acquisition. To more accurately reflect the risk level associated with the target company, it is common to use the target company's
cost of capital or the cost of capital for a group of companies comparable to the target company.
second most commonly-used KPI in business (after the P/E earnings ratio)
current ratio
Two types of capital:
debt and equity
A reduction in any category of liabilities would mean
debts were being paid off
Stock prices are a function of earnings-per-share. The denominator in the EPS ratio is the number of shares outstanding. Other things equal, if equity compensation programs increase that denominator, EPS and the stock prices will
decline
Repayment of loan principal
decrease cash buut may or may not affec profits
an increase in WACC notes a
decrease in valuation and a higher risk
In addition to improving cash flow, acquisitions also have the potential to
decrease the riskiness (volatility) in the cash flow of the combined firm.
how to have more cash on balance sheet
delay payables/get receivables earlier
Often investment advisors look at ROE to
demonstrate the superior earning power of one growth company over another.
Allocate your budget first to the
division offering the highest IRR and then work down the list until your budget is exhausted
what happens with cash when granting employees stock options or other forms of equity
does not require a cash outlay at the time of the grant
if the company has too little debt, management risks criticism that it
doesn't have enough capital at work earning profits for the company
Common Size statement has no
dollar amountts
net operating income MINUS interest expense
earnings before taxes
calculate net income
earnings before taxes MINUS income taxes
EPS
earnings per share
What contributes to sustainability of growth
economic/political/social environments, market structure, competitive advantages and core competencies
Restricted stock:
employer stock granted to employees at no cost. It is subject to vesting requirements and transferability restrictions
Performance shares
employer stock provided to employees if company performance reaches target levels.
Capital accounts MEANS
equity which also means owner's equity which also MEANS "SE"
The goal of ROI analysis is to
estimate the cost, the risk, and the return when considering a capital investment.
M&A, attracting capital, IPO -->
finance
who makes the operating plan - with help from other departments
finance and/or planning
average payout period for payables, cash balances, bank credit line status, invoicing timeliness, financial reporting timeliness, purchase discounts taken vs. dis- counts offered, etc
financial trends
The purpose of a discounted cash flow calculation is to
fine-tune the basic ROI analysis by adjusting for the time value of money.
primary purpose of financial reports
give a snapshot of a company's financial condition TO people outside the organization
the first measure of profitability
gross profit
Why do you put more money into a business?
growth
The purpose of strategic plan
guide organiizaton's diirectioin: purpose, what it wants to achieve, and general strategeis
Debt-to-equity ratio - there's no REAL right number for the ratio. Itt's dependent upon a number of factors including:
how effectively a company can use additional working capital and put it to work increasing profits by more than the cost of the addi- tional resources; ■ the amount of long-term vs. short-term debt, since long-term debt gives a company more time to put the money to work before having to deliver the added profits to repay the debt; ■ interest rates that impact the cost of money, since long-term debt is typically borrowed under formal lending agreements that bear inter- est, as opposed to trade creditors' balances, which are generally inter- est-free; and ■ how profitable the company can be in its industry, since a low-mar- gin business can ill afford to pay high interest rates for additional capital, while a high-margin, high-growth business may be able to profit handsomely from every dollar it can get
The NPV is an estimate o
how much value will be created and how much shareholder wealth will be increased, as a result of that project.
Inventory turnover
how quickly inventory leaves the plant and is replaced by new inventory
stock option
ight to purchase employer stock at a fixed price during a specified period of time
Payback Method
initial investment divided by cash generated per year = number of years until "payback".
Finance Dept
insurance/risk, pricing/admin, internal auditing, investor relations
Average cost of goods sold DIVIDED BY average inventory
inventory turnover
****IRR decision criteria: Invest if IRR ______
is greater than WACC
****NPV decision criteria: Invest if NPV______________
is greater than zero
Days sales outstanding (DSO) is
is the calculation of the number of days of average sales yet uncollected in accounts receivable.
Cash basis accounting is bad b/c
it doesn't reflect debts that we owe, it doesn't reflect debts others owe us, and it's not considered indicative of economic reality
Interest expense is not subtracted out in this calculation because
it is a not a cost of operating the business
what does capital structure mean?
it means either debt or equty
A reduction in an asset category would mean
it would mean assets were sold, so you would add the cash received from selling those assets
Comparables approach - If a comparable company's P/E ratio (stock price divided by earnings per share) was, say, 14, that would imply that
its market cap (the value of its outstanding stock) is 14 times its net income. You might then conclude that the appropriate price to pay for the target company is an amount equal to 14 times the target company's net income. In addition to price to net income, other comparable measures that might be used include a price to EBIT, price to EBITDA, price to sales, price to book value of assets, and price to book value of equity
After a stock repurchase, each of the remaining shareholders will own a
larger percentage of the company.
the need for international standards led to the creation of International Accounting Standards Board.. when
late 1990s
debt service coverage ratio measures a company's ability to
make the payments on its interest-bearing debt through its cash flow (as approximated by its earnings before interest, taxes, depreciation, and amortization—EBITDA
Two functions of finance
managing financial resources - finance recording and reporting transactions - accounting
After calculating the return, the last item on the CFO's checklist
minimize the risk
the role of the organization in achieving the vision
mission
historical cost principle
most assets and liabilites are reported in the financiial statementts at historical cost (the price the firm paid to acquire them)
Of course, the purpose of going to a lattice model is that it
offers the flexibility to use different input assumptions. For each year, you could use a different estimate of the stock price volatility, the risk-free interest rate, and the dividend yield. The biggest difference is that with the lattice models, you can specifically model early exercise behavior and forfeitures due to employee exits.
Another name for EBIT is
operating profit.
Average days to ship an order, overtime or pre- mium hours paid (manufacturers), percent of jobs proceeding on time (job shops), number of orders shipped on time or late, backlog in dollars, etc.
operations trends
when considering nett profit margin, you need to compare with
other companies ni the same industry AND compare with the company's historical profit margins
Basic financial reports were designed for use by
outsiders
When the company has well-informed investors, management must keep an eye on MATERIAL CONSIDERATION IN ASSESSING THE COMPANY'S OVERALL VALUE, determined by these 2 things
overall return the company pays for the capital it has attracted, including the cost of its debt (typically interest expense) and the cost of its equity (usually through dividends).
ROE is artificial because
owner's equity bears no relation to what the owners actually paid AND owner's equity bears no relation to what they could sell it for
Trend percentages
patten of revenue over time
Calculate WACC
percent of debt financing & percent of equity financing
Finance is a
policing activity and an information provider
only _____companies have to comply with rules published by Securities and Exchange Commission
publically traded companies
Bank loans =
put cash in the bank but don't help profits unti later
Determining what portion of the change in employee performance was the result of a training program or other HR initiative is only one of two challenges you will face. The second is
putting a dollar value on the change that occurred as a result of this training.
:company valuation is critical to strategic initiatives like
raising investor capital for growth, negotiating new credit lines, mergers and acquisitions, and ultimately, the exit strategy of the com- pany's current owners
Monte Carlo simulations use
random draws from a standard normal distribution to generate a sequence of random stock price movements and then calculate the stock price that would result. Each time that process is repeated, it generates one possible value of the stock price at expiration. That process is then repeated many thousands of times. The average of all these price possibilities is then used to calculate the expected payoff from the option. That expected payoff is then expressed in present value terms.
balance sheet helps us assess
rates of return, capital structure, liquidity, solvency, flexibility
the annual depreciation expenses are not additional cash outflows but just
reallocations for accounting and tax purposes of cash used in earlier periods to purchase long-term assets such as plant and equipment
A firm's WACC is the overall ____ return on the firm
required
The objective of each accounting rule is to
record a transaction so that it makes economic sense for the company and for readers of the company's reports
Present value tables are tools that were created to
reduce the amount of arithmetic involved in DCF calculations. They are seldom still used for that purpose because financial calculators and spreadsheets are now much better alternatives
When you start modeling corporate operating and strategic investments, it will be important to remember that, other things equal, a longer time period always
reduces the present value of a future amount, and a lower interest rate always increases the present value of a future amount.
The appropriate discount rate is the one that
reflects the decision-maker's opportunity cost of capital, in other words how much the decision-maker could have benefited from the use of this money had it not been committed to this project
Stock-related measures are, however, only one tool for aligning executive and shareholder interests. The alternative is to
replace or combine stock market-based measures with financial statement-based measures of the increase in shareholder value.
Cost of sales
represents all the costs of manufacturing or buying the products sold during the period, including raw materials, manufacturing labor, and related overhead costs
DCF techniiques are also used to value financiaal instruments such as
stocks, bonds, and stock options
There are various ways to calculate depreciation expense, but the simplest to illustrate is called
straight line depreciation
For a non-profit organization, the term is NOT stockholder's equity, it is
surplus
Long-term goals & strategy: USE
swot
what should the CHRO do before hiring 248 people?
talk with the CFO (ex. Cornell medical college)
Overhang
the aggregate of the equity awards currently outstanding plus those authorized but not yet granted, divided by the fully diluted number of shares outstanding.
Materiality happens when
the amount of money involved, relative to the whole, of a transaction, would influence the reader of a financial report
Additional contributed capital = additional paid-in capital
the amount paid into the company by investors to purchase stock, above is par value.
TTthe faster the inventory is sold,
the better for everyone watching the income statement and the bank account.
Net profit margin presents interesting analysis opportunities, but it doesn't tell you
the business's profit performance.
Having a diversified portfolio of products will reduce volatility by the greatest amount when
the cash flow from different products are negatively correlated.
Trend percentages show
the changes over time in given financial statement item
typical loan covenantts
the companay must maintain adequate insurance, the company must furnish the lender with financial statements quarterly and annually, the company cannot allow other liens on company assets the company cannot merge with another company OR acquire another company, the company must make enough profit to cover loan payments
To be conservative, inventories are shown on a company's balance sheet at
the company's cost of acquiring that merchandise or the current market value of that merchandise, whichever is smaller.
Firms depreciate the cost of buildings and other improvements on the land but not
the cost of the land itself
At any given point in the life of a project, the only two things that should influence a continuation decision are
the costs to complete the project and the present value of the cash flow that will be obtained if the project is completed.
You should focus on the maximum NPV you can generate wiith the budget BUT you should increase the budget if
the decision to increase the budget causes an increase in NPV
❏✓Internal rate of return (IRR) is
the determination of that point, expressed as a percentage, where the cost of capital invested in a project equals the return of capital from that project, both measured in present value terms.
The operating plan is for
the executive managers and staff
a lease would be treated as a purchase if
the lease covers 75% or more of the asset's useful life or if the present value of the lease payments is greater than 90% of the asset's market value.
❏✓Payback period is
the number of time periods it takes for a given investment to return enough gain (profit) to fully return the investment's original cost, again before considering the time value of money or risks.
Chart of accounts
the organization (of data) necessary to make the entire recording process of the accounting system
The payback period is usually defined as
the original investment divided by the annual benefi
❏✓Weighted average cost of capital (WACC) is
the percentage that demonstrates the overall cost to a company of all the capital it employs in its business, both debt and equity.
Finance, at a minimum, is responsible for
treasury activities/cash management, bank relations, investments, paying bills
If the cash is already on hand, the appropriate discount rate is
the rate of return you could have earned on alternative investments.
If cash must be raised to undertake this project, the appropriate discount rate is
the rate that must be paid to obtain those funds
The operating plan is
the short-term playbook
Gross property plant and equipment
the total ORIGINALLY paad for the property, plant, and equipment.
WACC helps management evaluate
the value to the company of some investment with a given return by comparing it to the overall cost the company pays for the capital it employs before making the investment
Beta
the volatility of the stock (how much it moves)
Then long-term assets are shown at
their original purchase price minus accumulated depreciation
You should base your choice on the NPV measures because
there is no risk that they will be distorted by an unrealistically high unrealistic reinvestment rate assumption
Typically lenders look at the quick ratio if
they believe a company's inventory carries a higher-than-normal risk or is a higher percentage of current assets than they consider wise
operating expenses are ____
things not directly related to production of inventory (unlike COGS)
Probably the most challenging choices most companies must make are
those that involve capital investment—allocating cash to R&D, manufacturing, sales and marketing, and administration
future value is a function of
time, rate, and the compounding period, that is, how often the bank applies interest to your account so the interest can earn interest along with the principal.
How could two companies be so different on net profit margin and so similar on return on assets
to answer that question, you need the ratio defined as sales revenue divided by total assets (asset turnover)
Debt & equity capital PLUS premium
total market value
FIFO —> first-in, first out —>
when you buy the same inventory multiple times, but at different costs, and bought it at a lower cost initially, and then you sell some, you can say that you sold the "cheaper" inventory (even though it's the same product), so you can say you have more valuable remaining inventory, for the purpose of your balance sheet/////so you have lower COGS for your income statement
LIFO —> last-in, first-out
when you buy the same inventory multiple times, but at different costs, and bought it at a lower cost initially, and then you sell some, you can say that you sold the more recent inventory which is more expensive (even though it's the same product), so you can say you have lower taxable reported profits
An increase in any category of liabilities would mean
would mean additional funds were borrowed, so add the amount of cash obtained through any additional borrowing
is a project worh pursuing?
yes if present value
When calculating cash flow from operations
you do not make timing adjustments
The 6 inputs of black-scholes
• Current stock price • Price at which the option can be exercised • Risk-free interest rate • Years to maturity or expected life of the option • Standard deviation in the price of the underlying stock • Dividend yield on the underlying stock.
Think of turnover costs as the sum of the following five components
• Separation costs • Replacement costs • Training costs • Change in compensation costs • Change in performance
