FIN241 Study notes

NTA

(Assets-intangibles-liabilities) / number of ordinary shares

Raising more equity finance rights

- A rights issue is the issue of new shares to existing shareholders in proportion to the number of shares they already hold. - Normally there is a benefit attached to the right in that the new issue of shares is made available at a price that is below the current market price. - The number of rights a shareholder receives depends on how many shares are already owned by the shareholder. - Renounceable rights can be sold on the market if the shareholder does not wish to subscribe to the issue. - Non-renounceable rights cannot be sold on the market. The shareholder has to subscribe to the issue or let the offer lapse. - The value of each right to subscribe to one share naturally depends on the discount implied with the rights subscription price. - An ex-rights price is the share price quoted without the right to purchase further shares attached.

Alternatives to cash dividends; share repurchase

- A share repurchase refers to the company buying back its own shares and is a substitute for a cash dividend. - A share repurchase reduces the number of outstanding shares and usually increases the share price. - A share repurchase can be a perfect substitute for a cash dividend under certain assumptions. - In Australia, under the Corporations Act 2001, a company can generally repurchase up to 10% of its own shares in a 12-month period. - The legislation permits 5 different kinds of buybacks ➢ Equal access purchase ➢ On-market purchase ➢ Selective purchase ➢ Employee share purchase ➢ Odd lot purchase

Share repurchase; rationales for share repurchase

- Buybacks lead to an increase in earnings per share (EPS) and are often accompanied by a share price appreciation or capital gain. - Share buybacks can perform a signalling function. Buybacks provide positive signals to investors about the company's future earnings prospects. - Share buybacks are a more flexible way to return cash to shareholders as, unlike with dividends, investors do not expect a company to repurchase its shares on a regular basis.

Cash Budgeting

- Control over cash is a critical aspect of maintaining a firm's liquidity. - A budget is a plan that includes forecasts of future transactions. - A cash budget involves detailed forecasts of cash inflows and outflows for the firm over the budget period and is a planning tool for the financial manager. - The cash cycle refers to the progression of cash into and out of the business.

Convertible notes

- Convertible notes pay interest and convert before maturity to the issuer's ordinary shares. - Firms issuing convertible notes are generally interested in claiming tax deductions for the interest payable on them. - The notes are normally unsecured and often subordinated. - Most notes have a stated maturity date, but some may be issued as perpetual. - Interest is paid either semi-annually or quarterly with interest rates varying according to the perceived risk profile of the issuer. - Each note normally converts to one ordinary share, although it is not uncommon for notes to convert to two or more ordinary shares. - For investors, the value of a convertible note is calculated by treating the security as a pure debt instrument.

Convertible preference shares

- Convertible preference shares (CPS) pay dividends and convert at maturity to the issuer's ordinary shares. - CPS generally do not convert to ordinary shares in a fixed ratio, such as one for one or one for two, as was the case with convertible notes. - Normally, the conversion ratio is calculated by taking into account volume-weighted average sale price on the ordinary shares on the market in the past 5-20 days before the conversion date - Additionally, a discount rate of 2.5-10% is applied to the average market price to enhance the conversation ratio and increase the benefits to the investor. - Dividends payable on CPS are normally paid semi-annually until maturity in 5-7 years and are franked if the issuer has sufficient franking credits available. - Dividends are normally fixed

interest-loans loans

- interest-only loans are taken out to finance special situations - during the term of the loan only interest is paid, while the repayment of the principal amount is made in full at the expiry of the term - these types of loans are suitable for situations where an assets is bought for a specific period with the expectation that it will be sols at the end of the period - terms usually range form 6 months to 10 years with minimum amounts of $z50,000 and fixed interest rates

Liquidity

- liquidity is a measure of the ease of conversion of an asset into cash - firms are said to have liquidity when they have sufficient cash to pay their bills on time - done through: 1. keep tight rein on cash and use cash budgeting 2. maintain a better safe than sorry policy 3. use a bank overdraft as a cushion to provide cash when needed - 1 required the most time and effort - 2 and 3 normally cost more

types of inventories

- raw materials; are held by all types of manufacturers to ensure that production may be carried on without delay, should there be any interruption in normal receivables - work in progress; consists of goods or services where some of the required work operations have been completed and some have not - finished goods

benefits and costs of holding stock inventories

- sales are made and profits gained - goodwill is built up - costs; ordering costs and holding costs - in making the decision about the level of stocks to be held, a trade-off between costs and benefits must occur

dividend stability

- shows the volatility of dividend yields or dividend per share over time - there is not standard measure of dividend stability - we focus on 2 alternative measures of dividend stability: standard deviation of dividend yields and dividend instability indicator

Managing Working Capital

Concerned with: need to maintain liquidity, the need to earn the required rate of return on the assets and the cost and risk of short-term funding - on the other hand, short term debt normally costs less in interest charges than long term debt - normal yield curve shows investors expect future short-term interest rates to be higher than current rate over the medium term - inverse yield curve shows short-term interest rates are expected to fall over the medium term - in normal circumstances, a firm raising short-term funds can expect to pay less for the money than it would if it raised long-term funds

Sources and costs of informal short-term finance; Factoring or debtor invoice trade finance

Factoring involves business is selling their invoices and discount the cash to another party that takes over the right to collect the amounts owing

Cash

Cash is all the currency that the firm has on hand and is also the liquid assets that a firm holds or has ready access too.

Net debt

Interest bearings borrowings - financial assets

Liabilities

Liabilities include trade creditors and short term debt among other

Times interest earned

Profit before interest and tax/ annual interest expense

Debt to equity

Total liabilities/ ordinary shareholders equity

Working Capital

Working capital is the amount of funds invested in current assets

Sources and costs of informal short-term finance; stock/ inventorying loans or floor plan finance 1

➢ Stock can be used to secure short-term finance ➢ The quality of stock security depends on its nature example age perishability market and marketability ➢ Floor plan finance is the most important example of stock or inventorying finance ➢ There are two types of floor plan lenders, captives and independents ➢ Captive floor plan lenders are often affiliated with manufacturers that were established of the financing to the retail dealer networks and does facilitate sales for manufactures ➢ Floor plan lenders generally write, service and monitor loans to dealers

determinants of the level of debtors; credit sales to debtors

➢ a credit sales increase the value of debtors at any point of time, but collection policies also impact on the value of debtors. Efficient collection decreases the value of debtors

determinants of the level of debtors; rompala causes

➢ are legal conditions included on credit sales documentation to ensure title to the goods described does not pass to the buyer until the goods are fully paid for

determinants of the level of debtors; credit policies

➢ credit policies determine the value of credit sales ➢ 4 parts; deciding whether to offer credit, selecting suitable creditworthy customers, setting credit limits and deciding payment terms

EOQ model resets on several unrealistic assumptions

• Demand is known and constant from day to day • Ordering and holding costs are known and constant • Delivery is instantaneous

Intermediated Finance

• Intermediated finance uses the services of a financial intermediary or financial services provider such as a bank, merchant bank or finance company • While larger business firms with standing in the community have the option to access financial markets directly, smaller firms must approach one or several financial institutions for long term funding

the issues relating to the management of cash; the financial imperative of having sufficient cash

• a firm must always have sufficient cash on hand to met its financial obligations otherwise it could become insolvent • an insolvent firm is unable to pay its bills or meet its financial obligations on time • financial managers face a trade off between risk and return when contemplating how much cash to hold

the issues relating to the management of cash; the timing of cash flows

• major sources: cash sales, credit sales, sales of used or unwanted assets, short term loans and long term loan funding • cash flows out from the firm service; purchase of inventories, purchase of labour, purchase of assets and payment of taxes • the timing of most of these in and outflows is variable, the only expectations being the cash sales and payments by debtors, the payment of wages and the payment of taxes • a budget is a plan that includes forecasts of future transactions • a cash budget is a detailed plan of expected cash receipts and cash payments which highlights any probable cash surpluses and deficits

the issues relating to the management of cash; the cost of not having enough cash

• the cost of not having enough cash at the required time may be the loss of the business • it is possible to put the lack of cash into a continuum and trace the effects • temporary cash shortages may be overcome by arranging emergency loans. However, as a general rule, the more desperate the need, the higher cost of emergency funds • if a firm gains a reputation as a late payer, its suppliers become progressively reluctant to supply • eventually some suppliers will supply only for cash

the issues relating to the management of cash; the cost of holding cash

• the opportunity cost of holding currency, rather than short-term securities or the cost of holding very short-term securities instead of longer term securities • the cost of ensuring physical security of currency

Sources and costs of informal short-term finance; Bank overdrafts

➢ An overdraft is are committed over drawing of funds be on the credit balance in the account ➢ They useful for businesses because they are able to carry on their normal activities without being forced to track cash ➢ They provide a safety of liquidity beyond that that provided by the balance of cash ➢ The interest rate charge on overdrafts normally last with the middle of the range of common interest rates at any period

Motives for holding cash; - transactions motive

➢ Cash is held so transactions - sales and purchases- may be successfully completed ➢ A shortage of change can impact on a business ➢ Larger meaning of cash, it is important that firms have enough liquid assets to pay for their purchase in a timely manner

Sources and costs of informal short-term finance; Trade Credit

➢ Credit arises during the normal course of business and is easily extended without formal agreement and is normally unsecured ➢ Most likely offered on and net 30 days or even net seven day basis ➢ This means the full amount on the invoice must be paid within 30 to 7 days ➢ Sometimes fans offer discounts early payment ➢ Thus, an invoice may be marked '2/10, net 30', which means a 2% discount will be granted if the bill is paid within 10 days, but no discount will be available if the bill is paid within 30 days.

Sources and costs of informal short-term finance; commercial bills promissory notes and commercial paper

➢ Darren only three parties to the issue of a bank accepted commercial (BAB) bill the borrower the discount night and except ➢ promissory notes are similar to BABs but they are not endorsed by an acceptor ➢ As there is no third-party involving the guarantee of a payment promissory notes are generally restricted to larger firms I have good reputations and excellent credit ratings ➢ Commissary note for large amounts transacted by major borrowers and lenders are often called commercial papers

Sources and costs of informal short-term finance; stock/ inventorying loans or floor plan finance 2

➢ Deleting agreement with floor plan Finance involve three parties, the lender, the manufacturer and the borrower ➢ After the contract outlines the parties responsibilities the dealer places an order with the manufacturer who then contacts the lender to see if the dealers credit for that amount is good ➢ If so the order is filled the dealer gets the stock and the lender receives the invoice to pay ➢ Until the stock is sold, the dealer pays interest monthly to the lender and has an obligation to repay principal as soon as the stock is sold

economic order quantity (EOQ);

➢ EOQ tool is based on the knowledge that the cost of stock consists of the holding costs and the ordering costs ➢ EOQ calculates the optimal size of each new order by combining the fixed order cost with the increasing holding costs ➢ EOQ theory combines holding costs, ordering costs and total demand over a planning period to estimate the optimal size of each order ➢ EOQ theory assumes Q is the inventory order size. If no stock were re-ordered until inventory has fallen to zero, the average inventory level over a planning period would be Q/2 ➢ Total inventory costs equal holding costs plus ordering costs ➢ If holding costs per unit equal H, the total holding costs equal QH/2 ➢ Similarly, if total demand over the planning period is D, orders are made in lost sizes of Q and the ordering is O per order ➢ Ordering costs must be a negatively sloped line, as the fixed amount, DO, is spread over ever-increasing order sizes, Q.

Sources and costs of informal short-term finance; Accrued wages, superannuation and taxes

➢ Firms in Australia pay is a weekly or fortnightly ➢ A fortnightly pay cycle may end on a Friday but the pays must be disbursed on the Thursday before ➢ Employees providing finance to the firm until the ninth day of the cycle ➢ The withholding of pay as you go to tax instalment from employees meet Australian taxation more requirements and firms also enjoy a significant source of funding ➢ Many firms pay the total of these instalments to the ATO quarterly with the with the GST returns which another important interest-free source of funding

Dividend relevance arguments; agency costs

- Agency costs arise from the separation of ownership and day-to-day management of companies - managers may make decisions to maximise their own benefits rather than shareholders' wealth. - It has been argued that dividend payments may reduce agency costs in two ways. - First, dividend payments may facilitate external monitoring of a manager's performance. - This is because higher dividend payments can lead a company to raise external capital by issuing new shares or debt instruments. This requires the issuance of a prospectus which is scrutinised by market participants. - Thus, the capital raising process exposes a manager's performance to external monitoring and encourages managers to act in the interest of shareholders. - Second, dividend payments may restrain managers from spending free cash flows on unprofitable activities.

Optimal dividend policy: institutional and market factors

- An Australian firm is prohibited from paying dividends out of its legal capital. - Creditors can protect their claims by a restrictive clause in a loan covenant. This clause might include a prohibition on dividend payout or linking dividend payout with the firm's performance indicators. - Another institutional constraint in determining a dividend policy is the taxation system. The firm must devise a dividend policy that maximises shareholders' wealth within their tax environment. - Apart from taxation, firms also consider other sources of market imperfections such as asymmetric information, transactions costs and agency costs in developing a dividend policy.

Initial public offers

- An initial public offer (IPO) or float is the first issue of capital made to the public. - They are made when the current owners either no longer wish to be in that sort of business, or when the current owners perceive that sharing ownership of their businesses with the public will be an easier and less risky option than continuing to try to raise funds for expansion through debt. - The Corporations Act 2001 and the ASX Listing Rules govern the conduct of floats. - Shares are offered to the public by means of the publication of a prospectus, which includes all of the information that a potential investor is thought to want and need to know in order to make an informed decision about the investment. - In order to ensure that IPOs are successful, issues are often underwritten by brokers or investment bankers. This means that the sponsoring brokers or bankers agree to guarantee that the whole of the required funds will be raised. - Underwriting fees normally are in the order of 2-5%, but the actual fees vary with the size of the float and the relative power of all parties - Directors of issuing firms solve the problem of what offer price to set in 2 ways: ➢ Set a fixed price ➢ Hold a book-build - when a fixed price issue is made, the offer price for the shares are specified in the prospectus - If the issuers choose to use a book-build to set the offer price, they will solicit bids from large investors to determine the price of an issue. - Many investors perceive that IPOs are underpriced and that there will be good profits to be made by applying for shares and selling on the first day of trade. - This practice is known as stagging and such an investor is known as a 'stag'.

Raising more equity finance; options

- An option grants the right but not the obligation to undertake a trade by a given date at a given price. - These company options are issued directly by the firm itself. - Normally the exercise price of options is set at a value which may be near the current market price but which is thought to be at a substantial discount to the expected market price at the time the options may last be exercised. - Companies issue options for 4 main purposes: ➢ to set in place a programmed raising of funds in the future ➢ to reward and motivate employees ➢ as an additional benefit attached to an equity issue to make the current issue more attractive, but also to put in place the opportunity to raise more capital ➢ as an additional benefit attached to a debt contract to secure the funds or benefit from a lower interest rate.

International sources of funding

- Australia as a nation has traditionally relied heavily on overseas capital as a source of funds to assist in our development - Direct investment is defined as capital invested in an enterprise by an investor that has significant influence over the key policies of the enterprise. - A proxy for that definition is that the investor owns at least 10% of the voting stock in the business. - Portfolio investment means that the investor has no control over the key policies of the enterprise. - While finance raised in global financial markets may often bear lower interest rates than those available in Australia for the same terms and maturities, borrowers have to be mindful of exchange rate risk. - If the exchange rate moves against the borrower during the term of the loan, then the periodic interest payments will effectively rise, and the funds will no longer be cheap. The AUD value of the loan will rise. - Investors who do not have large amounts of funds to invest are normally portfolio investors. They want to diversify their holdings. - Eurobonds are debt securities issued outside the domestic capital markets of the issuer in a currency that is neither the domestic currency of the issuer nor the domestic currency of the place of issue. - Foreign bonds are debt securities issued overseas in the currency of the country of issue. - Commercial paper is a generic term for unsecured loans that are normally issued only by borrowers of high repute with excellent credit ratings.

Dividend payment process

- Australian and New Zealand companies generally pay cash dividends twice a year. - A final dividend is paid following the annual general meeting and an interim dividend is paid typically six months prior to the final dividend - The directors take into account the last periods financial performance and dividend payment and future growth opportunities in recommending the amount of dividend to pay - The announcement date is the date of the directors meeting when the dividend is recommended - The record date is used to identify all shareholders on the register of members so they can receive a dividend - The ex-dividend date is 4 working days prior to the record date - On the ex-dividend date, the share price normally drops because investors who purchase shares on or after the ex-dividend date do not receive a dividend - Cum-dividend share are those that have a current dividend entitlement

Bonus shares

- Bonus shares are dividends paid in the form of additional shares. - There are four main motivations for providing bonus shares. - First, a share dividend can be given without cash, which is an attractive way of paying dividends for cash-strapped companies. - Second, a company in a high-growth phase of its life cycle may reinvest most of its earnings on profitable investment projects and offer a share dividend scheme to supplement its low cash dividend policy. - Third, a bonus issue increases the number of shares outstanding and may reflect the company's confidence in future earnings growth and ability to pay dividends on an augmented share base. - Fourth, some managers believe that market liquidity for the company's shares can be improved by making more shares available to potential investors, at a lower price per share, through a bonus issue.

Corporate bonds

- Corporate bonds are debt instruments where the issuer receives the face value of the bonds at the outset and pays a coupon, usually six- monthly. The face value is repaid when the bonds mature. - Corporate bonds are unsecured, so good credit rankings by the ranking agencies are extremely important to potential issuers of bonds. - Credit ratings or rankings of specific bond issues determine the interest rates which must be offered at any given time to make the bonds attractive to the market. - Corporate bonds are traded in the over-the- counter (OTC) market. - The over-the-counter (OTC) market is that part of a market where deals are arranged privately between two parties. - Subordinated debt is debt ranked below other similar classes of debt in the event that a firm is liquidated. - Unsubordinated debt does not take a lower ranking than other debt of similar characteristics. - As a result, subordinated debt should trade at higher yields than otherwise equivalent unsubordinated debt, owing to the additional risks faced by investors.

Dividend relevance arguments; signalling and asymmetric information

- Corporate insiders know more about the firm's capacity to generate cash flows and earnings than outsiders. - This asymmetric information is an important source of market imperfection. - Insiders can convey their private information to markets through announcing a change in dividend payout. - Signalling theories suggest that an increase in dividend gives a signal for a permanent increase in earnings and increases shareholder value

Use of direct entry (DE)

- DE transactions are affected by direct computer-to-computer links - In Australia, DE transactions are processes bilaterally; that is direct from payers terminal to receivers terminal - The great attraction of DE is due to its relatively low cost - Both direct credit and direct debit are possible. Direct credit is currently more widely used than direct debit - The most common examples of direct credit are the payment of wages and salaries by large and medium-sized firms to their employees; the payment of dividends and interest to investors and the payment of suppliers by large firms with thousands of suppliers - Direct debits are currently being used by many types of firms, especially for customers regular payments such as telephone and water bills

Debentures

- Debentures are fixed-term debt securities issued under a prospectus. Debentures are secured by assets. - They may be offered by finance companies and general financiers to the large institutional investors by way of a private issue, or they may be issued to the public after the full details of the issue and the firm are given in the publication of the prospectus. - Debentures are secured by assets and may be offered with either a fixed or floating charge over the assets. - A fixed charge means that specific assets are listed as security. - A floating charge is held over a group of like assets that have not been offered as security to another lender and thus are free to be offered in this particular case. - Unsecured notes are also issued by finance companies and general financiers. Because they are unsecured, they carry a higher coupon to compensate investors for the higher risk.

What is financial ratio analysis

- Financial ratios are data reduction techniques that express one account as a proportion of another. - They allow us to compare different aspects of a company's performance and position to those of other companies or to the same company over time. - Financial ratio analysis employs relative rather than absolute concepts.

Floating rate notes (FRNs)

- Floating rate notes (FRNs) are loans that pay a variable coupon amount that is based on a short-term benchmark rate such as the bank bill swap rate (BBSW). - Normally, a fixed margin of perhaps 1-4% is paid above BBSW and this varies according to market conditions. - FRNs can be secured or unsecured - Many FRNs are perpetual, although some have - fixed, normally long-term maturities such as 30 years.

Hybrid finance from the Australian market

- Hybrid securities are securities that have characteristics of both debt and equity. - The principal hybrid securities are convertible notes and convertible preference shares.

Dividend relevance arguments; transactions costs and the clientele effect

- If a company adopts a high dividend policy, it may have to raise capital by issuing new shares, which involves floatation costs. - Thus, floatation costs may induce a company to adopt a low dividend policy and rely more on retained earnings to meet investment needs. - Transaction costs also constrain shareholders from creating a 'homemade dividend stream'. - If there is a mismatching between a shareholder's consumption needs and dividend payments, the shareholder may buy or sell shares to create a desired stream of cash flows. - However, transactions costs of buying and selling shares limit the shareholder's ability to achieve this goal. - Companies paying a regular stream of dividends may attract investors, such as pensioners, who need additional income to meet their consumption needs. - On the other hand, companies paying low or no dividends typically attract investors at the middle stage of their life cycle who usually have adequate income to meet their consumption needs. - Recognising this 'dividend clientele effect', companies generally try to avoid any significant changes to their dividend payout ratios.

An appropriate level of net working capital 2

- In order to make the hedging principle more useful, it is constructive to think in terms of permanent, temporary and spontaneous sources of funding. - The principals for using the permanent, temporary and spontaneous classifications to advantage are: ➢ Permanent as it should be fun is a permanent and spontaneous sources of funding ➢ Temporary assets should be financed with temporary sources of funding - however getting the funding recipe wrong can lead to Business failure - It is important to note that the hedging principle does not give any guidance as to the level of net working capital that provides the optimum return

leasing and debt in a firms capital structure

- In the past leasing was said to be an off-balance sheet form of finance. This made it attractive to some firms in that they could obtain extra finance but appear, from the financial records, not to have done so - This argument of no structural consequences is no longer true - While lease finance is usually secured by the assets purchased, potential financiers are very interested in obtaining full details of the debt structures and the quality of the equity before advancing lease funding - Accounting standards now recognise that finance leases usually confer valuable rights and some obligations on firms - Leases are classified under AASB117 - Leases are classified as fiancé leases if substantially all of the risks and rewards are transferred from lessor to lessee - Conversely, a lease is considered to be an operating lease if it does not transfer substantially all of the risks and rewards of ownership

Riskiness of capital gains

- It has been argued that shareholders consider dividends to be paid in the distant future more unpredictable and riskier than dividends to be paid in the near future. - Thus, dividends anticipated in the distant future will be discounted at a higher rate to reflect thi8s differential risk. - Put differently, investors prefer 'a bird in the hand' over 'two in the bush'. - Thus, share value might be increased by increasing current dividends at the cost of future growth in earnings and capital gains. - Investors prefer a dollar of current dividends over capital gains anticipated from a dollar of retained earnings because future cash flows are riskier. - However, the fallacy of the 'bird in hand' reasoning can be recognised by focusing on the basic valuation principle. - The risk of a company depends on the riskiness of the cash flows from its assets, not on the temporal pattern of dividend payout. - A change in dividend policy has no impact on the expected cash flows or its volatility. - Thus, where shareholders are rational wealth maximisers, high dividends are not expected to increase the value of the company.

Ordinary shares

- Ordinary shares are evidence of part-ownership of a company. - Ordinary shares have an initial issue price but, after they are issued, their price is set by the secondary market (e.g. the ASX). - Ordinary shares have no fixed maturity date and the shares continue to exist so long as the firm exists. - Ordinary shares conventionally rank last in the event of the winding up of the firm. - One of the major attractions of ordinary shares is their limited liability. - Ordinary shareholders exercise their rights of ownership through their voting powers. An annual general meeting (AGM) must be held under the Corporations Act 2001. - Share consolidations reduce the number of shares on issue in direct proportion to the consolidation ratio. - Share consolidations are undertaken to: ➢ Reduce the number of shares on issue ➢ Increase the share price so that trading takes place within a popular price range ➢ 'hide' past losses ➢ improve public perception of the worth of the film - A major reason for share splits is to increase the liquidity and trading of a firm's shares.

Preference shares

- Preference shares are hybrid equity instruments which have some characteristics of equity and some of debt which normally have a fixed dividend that has the preference over the payment of ordinary shares. - Preference shares cater for investors who do not wish to be confronted with as much risk as is attached to investment in ordinary shares. - Preference shares rank ahead of ordinary shares for repayment in the event of winding up and the payment of dividends. - Among the different rights that may be attached to preference shares are: ➢ Franking; companies can choose whether to attach franking credits ➢ Cumulativeness; preference shares are cumulative when past unpaid dividends accumulate until paid ➢ Non-participation; they do not participate in additional profits or dividends to the stated dividend ➢ Non-redemption; preferences shares are not normally redeemable by the issuer ➢ Voting; preference shares generally do not have voting rights attached, but may gain such rights if the payment of dividends is in arrears or the value of the security is at risk - Some preference shares are issued as converting preference shares so that eventually the shares convert to ordinary capital - Firms issue preference shares to avoid the dilution of ownership rights and the certainty in the cost of this form of funding among others

Pro-forma financial statements

- Pro-forma financial statements contain projections of a future position and of future period performance. - Management use the pro-forma financial statements to map the impact of their decisions on the financial statements. - Companies occasionally specify target levels of performance in their corporate objectives. Before these targets can be announced, management needs to assess if the company is likely to reach the target. Pro-forma financial statements can help them do this. - Pro-forma statements also provide advance warnings when management plans are going to have a negative impact on the key ratios. - Using pro-formas can also indicate if a course of action will result in a breach of the company's debt contracts. - As we've seen, pro-forma financial statements are a tool that allows management to evaluate different alternatives in terms of the impact on profits and other key figures and ratios that are employed by the users of financial statements.

Cash flow statement

- The cash flow statement shows the amount of cash that came into and went out of the company over the reporting period. - Like the income statement, the cash flow statement represents a 'flow' rather than a 'stock' picture of the company's activities. - However, it is not based on accrual accounting. - Transactions in the cash flow statement represent cash payments and receipts that occurred during the reporting period. - Cash inflows and outflows are classified as 'operating', 'investing' or 'financing'. - These categories tell the net cash story for each activity in the reporting period.

Optimal dividend policy; internal factors

- The firm's profitability as well as its borrowing capacity influence its dividend decision. - A firm's investment needs, earnings and dividends generally follow a predictable pattern over its life cycle. - Five stages in the life cycle of the firm are recognised in the literature: start-up, rapid expansion, high growth, mature growth and decline.

Developing the pro-forma financial statements

- The first step in developing our pro-forma financial statements is to get the previous year's financial statements. - We use last period's statements as the base for our pro-forma statements. - The percent of sales method expresses items in the income statement as a percentage of sales. The calculated percentage is applied to the forecast sales figure. - The percent of sales method is best kept for those items that have a direct and predictable relationship to sales and those you have no better forecast for. - The next thing we need is the sales forecast for the coming period. - We then need to collect information from within the firm that will help to produce the most accurate pro-forma statements possible. - It is important to note that the cash budget is an important forecasting source. - This means we need to develop the cash budget first, then the income statement and balance sheet in conjunction with one another

Taxation treatment of lease payments

- The general principle is that the lease payments made periodically are tax deductible provided that (a) the leased asset is used to produce assessable income and (b) the lease is a genuine lease rather than an instalment purchase arrangement. - GST also impacts on lease products. Lease payments are construed as payments for a supply and thus are taxed under the GST legislation. - However, GST-registered entities are able to claim back their net GST payments, so effectively such firms have not paid any GST.

Benefits and costs of granting credit

- increased sales - reduced cost of making sales - costs include: opportunity costs funds tied up, cost of administration and slow payers and bad debts

Income statement

- The income statement shows the revenues and expenses that were generated over the reporting period. - Revenues are inflows of future economic benefits that come from the operations of the firm. - Expenses are the consumption or losses of future economic benefits. - Retained earnings are the accumulated profits (net of dividend payments) that are shown in the equity section of the balance sheet. - Profit is the excess of revenues over expenses and is often used as a measure of performance. - The balance sheet and income statement are linked because the change in net assets over the reporting period is matched by the change in retained earnings. - Accrual accounting is the process of matching revenues to the period in which they are earned and liabilities to the period in which they are incurred. - The balance sheet and income statement are based on an accrual accounting system. - Accountants use accrual accounting because the objective of preparing financial reports is to report on past performance. - Finance, on the other hand, has a forward- looking focus that involves making decisions about the future.

Developing a cash budget

- The key ingredient when preparing a cash budget is the sales forecast figures. - After forecasting sales figures, the next step is to estimate the timing of the cash inflows associated with the level of sales. - Once we have identified and forecast all of the cash inflows for the budget period, we follow the same process for the cash outflows. - After we have collected the best estimates for all cash flows and identified the time period in which they are most likely to occur, the final step is to put the inflows and outflows together to determine the net impact on the firm's cash position.

Planning and forecasting

- The main tools available to help the financial manager in planning are the cash budget and the pro-forma financial statements. - Cash budgets focus on maintaining the solvency of the firm. - Pro-forma financial statements are concerned with forecasting profit for the coming period and the position of the firm at the end of the period.

An appropriate level of net working capital 1

- The principle of self-liquidating debt provides loose guidance to the maintenance of an appropriate level of net working capital. - Permanent funding comprises funding with maturities greater than one year and includes long-term debt, leases and ordinary shares. - Self-liquidating debt occurs when debt-funded investments generate cash inflows that are received when the debt payments are due. - Temporary funding comprises the short-term formal sources of finance such as commercial bills and bank loans. - The hedging principle means matching the maturity of the source of funding with its use. - The spontaneous sources of funding are those that arise in an unplanned way in the ordinary course of business.

Dividend irrelevance theory 1

- Theories of dividend policy are concerned with the potential impact of a dividend decision on share value of a company. - Broadly speaking, these theories can be categorised into two groups: those proposing that dividends are irrelevant to share value, and those proposing that dividends are relevant to share value. - Dividend irrelevance theory argues that what a company pays in dividends has no influence on its share value. - This theory was put forward by Miller and Modigliani (M&M), and is based on the notion that, if there are no taxes, investors will only care about return, not the components of total return - dividend and capital gain. - Companies that pay lower dividends and retain more earnings for reinvestment are likely to provide higher future earnings growth and capital gains than companies paying higher dividends.

Fixed rate business loans

- These types are used for the purchase of many types of business assets - Loans often range from minimum of $100,000 up to $2, 000,000 - Terms are usually given for up to 25 years with the interest rate being fixed for the 3, 5 of 10 years - Financial institutions generally charge a 3-6% per annum margin above the cash rate for these loans

Key ratios and financial statements

- This formula gives the 'basic' EPS. In other words, it does not make any adjustment for the timing of any new issue of shares over the previous financial year. - 'Diluted' EPS calculations, on the other hand, do account for the timing of a new issue of shares over the previous financial year. - We can't use the EPS ratios of two companies to make a comparison, but analysts use the ratio to assess the earnings trend over time for a company.

Optimal dividend policy; alternative dividend policies- stable dividend policy

- This policy is in favour of paying a fixed dollar dividend per share. - Mature firms with a good earnings history are likely to commit themselves to a stable dividend policy. - A minor variation of the stable dividend policy can be a low regular dividend and an occasional 'extra' dividend linked to the company's performance. - In general, managers have significant discretion over dividend payouts and they typically follow a more or less stable dividend policy.

Tax treatment of dividends and capital gains

- Under a classical taxation system, dividends are generally taxed more heavily than capital gains and thus investors would be willing to pay less for shares of firms distributing a high dividend at the expense of a capital gain. - Taxation of dividends ➢ Until 30 June 1987, Australia had a classical tax system, featuring double taxation of dividends. ➢ However, under the imputation taxation system, dividends are taxed at the shareholders' personal tax rate and taxes paid by a company on its taxable earnings are earnings are deducted from the shareholders' personal tax bill under the Australian dividend imputation system. ➢ An imputation tax credit represents the amount of tax on a dividend that has been paid by the company on behalf of a shareholder. ➢ A dividend containing an imputation credit is known as a franked dividend. ➢ Dividend franking is common practice at Australian firms.

Optimal dividend policy; alternative dividend policies- constant payout ratio policy

- Under this policy, dividend payment as a percentage of earnings is constant. The dollar amount of dividend can vary with earnings fluctuations but the payout ratio is fixed. - Many Australian firms have explicit target payout ratios. - Generally, a firm can't maintain a constant payout ratio over its entire life cycle.

instalment loans

- instalment loans have fixed repayment schedules negotiated at the outset - minimum loan amounts can vary between $10,000 and $50,000 with loan terms ranging from 1-15 years - normally, interest rates can increase with the term of the loan - the mount of each instalment to repay such a loan is calculated by means of the PV of an annuity equation

Optimal dividend policy; alternative dividend policies- residual dividend policy

- Under this policy, dividends are paid from residual earnings - the part of earnings left over after financing a firm's investment needs. - In a perfect capital market with no floatation costs of issuing new shares, the firm would indifferent between capital raised through the sale of new shares and retention of earnings. - However, the firm incurs floatation costs and the cost of new shares is more than the cost of retained earnings. - Therefore, the firm will first try to meet its investment needs using internal equity, and then pay a dividend if any earnings are left over after financing all desired projects. - This argument relies on the presence of transactions costs in issuing new shares and gives priority to meeting investment needs over shareholder's dividend needs.

Market value of franked dividends

- Unfranked dividends have no tax advantage over capital gains in Australia. - Franked dividends may have a tax advantage over capital gains resulting from retention of earnings - The market value of this tax advantage should be reflected in share prices and can be measured by the dividend drop-off ratio. - The dividend drop-off ratio is the ratio of the decline in the share price on the ex-dividend day to the cash dividend. - Early Australian studies generally report a drop-off ratio of less than 1, signifying that the market value of $1 of cash dividend is less than $1. - However, newer research tends to suggest that the market value of $1 of fully franked dividend is significantly more than $1.

lease or buy decision

- When analysing lease or buy decisions, firms may find themselves in one of three different positions with regard to their owners' taxation situations: ➢ Their owners are unable to take advantage of dividend imputation so that post-tax values should be used. ➢ Their owners can use dividend imputation to advantage, so that pre-tax values are relevant. ➢ Their owners can only partially take advantage of dividend imputation, so that post-effective-tax values should be used. - when undertaking a lease analysis, it is important to bear in mind which particular taxation situation applies

Dividend reinvestment plan

- a dividend reinvestment plan (DRP) provides shareholders with an option to invest their cash dividends in the company's shares - A DRP has several attractive properties - First, a DRP allows existing shareholders to acquire more shares in the company without incurring transactions costs. - Second, many companies offer a discount of about 5% of the prevailing market price, making the DRP more rewarding to existing shareholders. - Third, participation in a DRP is voluntary. Thus, a DRP offers flexibility to shareholders in making an investment decision. - Fourth, a DRP may be useful in conserving the company's cash balance. - Disadvantages of a DRP include an increase cost of capital for the company where shares are issued at a substantial discount and new shares may dilute EPS of the company.

leases

- a lease is a contract by which an owner of property (the lessor) allows another person or entity (the lessee) the use of the asset - the lessor is the owner of the property that is being leased - the lessee is the person or entity that gains the use of the leased asset by entering the lease contract - a novated lease involves a three party agreement between an employee, an employer and a financial institution to provide a motor vehicle to the employee as part of a salary package - a hire purchase agreement involves a financial institution buying the equipment required by the customer then hiring it to the customer. The customer purchases the asset outright at the end of the lease period - finance leases are non-cancellable contractual obligations to make payments in return for the use of an asset for the majority of its useful life - operating leases are contractual agreements, but they are cancellable upon given notice and tend to be of much shorter term than the useful life of the asset

Variable rate business loans

- amounts vary on these loans up to about $2, 000,000 with terms available up to 25 years - interest rates vary in line with changes in the markets end, in march 2007 were about 2.5 - 4% above cash rate - many financial institutions offer flexible drawdown of the contracted loan amounts meaning that not all of the loan must be taken up at the outset

management techniques;

- anticipatory buying; is undertaken to buy in stock before an anticipated or known shortage or price rise occurs - levels of stock; many mangers maintain either an explicit or implicit minimum safety level of stock. The level is explicit when documented in stock management records or implicit when the requisite level is an idea or 'feeling' on the part of the manager

commercial bills

- apart form being used as a source of short-term funding, commercial bills may also be used as a form of long-term funding by rolling over one bill to another - However, this practice involves extra managerial time and may expose the firm to additional financing risk

benefits and costs of EFTPOS

- businesses can attract more sales, increase turnover, decrease the need for change, be paid faster and reduce currency inflow - negative costs 0.5% cost - with debit card payments, there is no net cost

Just in Time

- encompasses more than merely limited inventories - it emphasises demand-driven production, reduction in setup times, high quality, continuous improvement and multi-skilled workers as well as smaller inventories - the reduction of inventories provides the benefits of savings in carrying costs through reduced spoilage and handling costs, lower insurance costs - however, the reduction of inventories also exposes inefficiencies in the manufacturing system, as the unplanned increase or decrease in inventories no longer makes manufacturing problems - to achieve reduced raw material inventory, long-term relationships with reliable suppliers is important - JIT involves many direct and indirect costs which may offset many of its benefits

Fully drawn advances (FDAs)

- fully drawn advances are loans that are initially drawn down to the full amount and repaid over the term of the loan by means of a fixed repayment schedule - amounts available may vary from $5000 to very large amounts with terms of normally up to 10 years - rates are normally variables - some financial institutions offer capped rates, where the variable rate charged cannot exceed a negotiated maximum rate for a specific term

Potential benefits of leasing

- in evaluating any argument in favour of leasing, one very basic principle must be remembered - a potential lessor takes over some of the ownership duties of the potential lessee. - Potential benefits associated with leasing my include: ➢ taxation benefits ➢ efficiency of asset management and disposal ➢ speed in acquisition of assets ➢ avoidance of obsolescence ➢ improved cash flows and conservation of capital

Tax treatment of dividends and capital gains 2

- taxation of capital gains ➢ In Australia, a capital gains tax is applicable to assets purchased after 19 September 1985. ➢ A capital gain discount is available for assets purchased after 21 September 1999 and held for at least 12 months. ➢ For individuals and trusts, 50% of nominal capital gain is taxable. ➢ Superannuation funds are entitled to a 33.33% discount but companies are not eligible for any discount. ➢ The timing of tax payments is also an important consideration for taxpayers. ➢ Although the introduction of the imputation system eliminated double taxation, dividends still have a tax disadvantage. ➢ Taxes on dividends are payable when investors receive dividend income, but capital gain taxes are payable when gains are realised. ➢ Investors have some control over the timing of receiving a capital gain but they don't have a choice about when they receive a dividend. ➢ The introduction of the dividend imputation system has made dividend income relatively attractive but this has been partly offset by the provision of capital gains tax discount.

Balance sheet:

- the balance sheet shows the assets, liabilities and equity of the company at the end of the reporting period - it gives us 'stock' measure of the company by telling us the book value of the assets controlled by the company and the assets owed by it - Assets are the probable economic benefits that the firm is able to utilise. - Liabilities are the future sacrifices of economic benefits that the firm is obliged to make. - Equity is the book value of ownership interest in the firm. - The book value of equity equals the net assets. - Net assets are total assets less total liabilities.

dividend policy- empirical evidence

- the dividend payout ratio is very high in Australia compared to the USA - since the mid 1980s, dividend yields in Australia have been similar to those of the UK but higher than dividends yields in the USA - The volatility in dividend yields may be attributed to either fluctuations in share prices or fluctuations in dividends per share. - The latter possibility can be ruled because dividends typically tend to follow a more stable path. - Other empirical evidence shows some variations in indicators of dividend policy across Australian firms.

Dividend payout ratio

- the retention ratio is the proportion of earnings retained in the company, not returned to shareholders as dividends - the dividend payout ratio can be used to estimate the firms future earnings growth rates

Current Assets

Current assets are the assets the firm expects to be able to convert into cash in the normal course of business during the next twelve months. Current assets comprise cash, debtors and inventory.

Current Liabilities

Current liabilities are debts that will be paid in the next twelve months or accruals for which the counting entries will be shortly reversed or written out of the books

Dividend payout ratio

Dividend per share / earnings per share

DPS

Dividends paid/ number of shares on issue

Net debt to capital employed

Net debt/ (net debt + ordinary shareholders equity)

EPS

Net profit (loss)/ number of shares on issue

Return on equity

Net profit/ ordinary shareholders equity

Net Working Capital

Net working capital is the excess of current assets over current liabilities

Dividend irrelevance theory 2

The M&M theory relies on this fundamental trade-off between dividends and capital gain and is based on the following assumptions: ➢ The investment decisions of the company are independent of its dividend policy ➢ Capital markets are perfect - Under these assumptions, it can be shown that there is no relationship between a company's dividend policy and its market value. - It is important to remember that, in a perfect - capital market, investors are indifferent to receiving dividends or share price appreciation. - Regardless of the firm's dividend policy, shareholders can create a dividend stream of their choice. - The dividend irrelevance argument relies on the fundamental premise that the value of a company depends on its cash flows, which in turn depend on investment decisions - not dividend decisions. - Arguments for dividend relevance theory are based on the tax treatment of dividends as compared to capital gains, riskiness of capital gains, 'informativeness' of dividend payouts, agency costs, transaction costs and the clientele effect.

Dividend Policy

The dividend policy involves the allocation of profits between dividend payments to shareholders and retention for reinvestment in the company.

Financial Statements

the balance sheet, the income statement and the cash flow statement

Accounting System

the collection of records of financial transactions

determinants of the level of debtors; collection policies and procedures

➢ in order to ensure that it receives the highest proportion of its accounts receivable possible, a supplier must has set policies and procedures in place, monitor the ageing of accounts and apply the procedures vigorously ➢ process follows in pattern like: • send an account rendered statement • post an account overdue letter • telephone to speak to the responsible person • put the unpaid account into the hands of a solicitor or collection agency • in some cases with goods may be reclaimed by the seller ➢ firms may judge the effectiveness of their credit policies and processes by making use of ration analysis ➢ the most useful ratio is the average collection period (ACP) which is average debtors divided by average daily credit sales ➢ a decreasing ACP may indicate more effective collection processes, which is good, but may also indicate that too much time and effort is being put into collections or that credit policy has become so restrictive that firms are missing out one sales ➢ conversely, an increasing ACP may indicate less effectiveness in collections, too little expenditure or too lenient a credit policy

Motives for holding cash;speculative motive

➢ involves holding cash to make speculative purchases when the opportunity arises ➢ speculation involves the purchase of an asset for eventual resale with a view to profit, but where there is a strong element of risk

determinants of the level of debtors; total sales

➢ the total value of sales has an impact on the value of credit sales, so long as the firm exercises a policy of offering sales on credit ➢ it follows that the greater total sales, the greater the credit sales and the greater the value of debtors

Motives for holding cash;precautionary motive

➢ well managed firms need to keep a buffer of cash that is available should it be needed ➢ precaution involves prudent actions taken early to ensure a good outcome or to forestall an adverse effect ➢ however holding cash reserves normally has an opportunity cost though the loss of interest or alternative investment earnings ➢ but can possibly keep some precautionary funds in short-term securities