1. What is the key goal that guides the decisions of financial managers? What challenges do financial managers face when they try to find the best sources and uses of funds to meet this goal?
The financial mangers goal is acquisition, financing, and management of assets. The challenges are investment, financing, and asset management decisions.
2. List the four basic types of financial ratios used to measure a company’s performance, give an example of each type of ratio and explain its significance.
Liquidity, Solvency, Profitability, and Efficiency are the basic types of financial ratios. The liquidity ratio is the ratio of current assets to current liabilities. Profitability ratios indicate management’s ability to convert sales dollars into profits and cash flow. Solvency ratios indicate financial stability because they measure a company’s debt relative to its assets and equity. Two common efficiency ratios are inventory turnover and receivables turnover. Business manager needs to determine what the financial health of the firm, he would use liquidity ratio. A business needs to figure out how to pay off the debt to the bank, they would use solvency ratio.
A company makes paper plates; they need to know how much profit they can make. They would use profitability ratio. For example, if the bank cost totaled $5,000,000 and its revenues totaled $10,000,000, then using the formula above, we can calculate that bank’s efficiency ratio is $5,000,000 / $10,000,000 = 50%. This means that it costs the bank $0.50 to generate $1 of revenue. This is an example of efficiency ratio.
3. What are the key questions financial planning must answer? What role does the budgeted income statement and budgeted balance sheet play in finding answers to these questions?
What are your long term goals for the business? What are the most significant risks you are facing? How have you mitigated these risks? How do you expect your market to evolve over the years to come? Those are the four questions. They provide the answers to these questions. It is a plan to predict and show what can happen in time, it is a prediction for theses questions.
4. What is the purpose of a cash budget? How can this tool help firms with rapidly increasing sales? Cash budgets are often used to assess whether the entity has sufficient cash to fulfill regular operations. They can use it to figure out where money needs to go or where they need to gain money. It helps financial managers determine when the firm is likely to need additional funds to meet short term cash shortages, and when surpluses of cash will be available to pay off loans or to invest in other assets.
5. Name and describe 4 commonly used sources of short-term financing.
Trade credit, advances from customers, commercial banks loans, and financial institutions are types of short-term financing. Trade credit is a loan in the form of goods. An advance from customers is the reputed business houses receive a part of the price or payment from the buyers before the supply of goods. The finance institutions can help the business by providing short term funds.
6. What is equity financing and what are its major sources? What advantages and disadvantages of are associated with equity financing?
Equity financing is the sale of an ownership interest to raise funds for business purposes. Personal savings, life insurance policies, home equity loans, and venture capital are major sources of equity financing. The advantages are it doesn’t have to be repaid. They share the liabilities of company with the investors. The disadvantages are you have to share some of the ownership, and you have to also share your profits.
7. What is financial leverage? How, and under what conditions, can financial leverage benefit a company? How, and under what conditions, can it harm a company?
Financial leverage is the use of borrowed money to increase production volume, and sales and earnings. The use of financial leverage also has value when the assets that are purchased with the debt capital earn more than the cost of the debt that was used to finance them. If a company’s variable costs are higher than its fixed costs, the company is said to be using less operating leverage.
8. Is it possible for a firm to have too much money? Explain. What role does cash equivalents play in a financial manager’s strategy to manage cash balances? Yes because it means there can be problems in the future. They get taxed more and they don’t know what to invest the money in. They use it to show the company’s strengths and weakness. The can use it to make balance sheet, cash flow statement, and income statement.
9. Why is the $1,000 you receive today worth more than $1,000 you receive next year? What concept does this illustrate? Why is this concept particularly important when firms evaluate capital budgeting proposals?
It is worth more this year rather than next year because if you receive it this year and you decide to invest in it you will gain interest on the thousand dollars you received this year. It illustrates the concept of interest. It is important for firms because it benefits them in terms of long term investment.
10. What is the net present value (NPV) of a long-term investment project? Describe how managers use NPVs when evaluating capital budget proposals.
The NPV of an investment proposal is found by adding the present values of all of its estimated future cash flows and subtracting the initial cost of the investment from the sum. The managers use NVP’s when evaluating capital budgeting by most likely approving a positive NPV because this means the present value of the expected cash flows from the project is greater than the cost of the project. And a negative NPV means that the present value of the expected future cash flows from the project is less than the cost of the investment.
1. Your company has been struggling financially for quite some time now. You have a chance of making a profit this quarter, which is sure to bolster your stock’s sagging price. But it depends on your using a low cost waste disposal practice. The disposal practice is legal but you’ve also seen some studies indicating that it is likely to harm the environment. What would you decide to do and why?
2. Choose a company and obtain a copy of its most recent annual report. (In most cases, you can access annual reports simply by clicking on the link for investors, usually found on the company’s home page. You can also try the IRIN Annual Report Resource Center at www.irin.com, or Annual Reports.com at http://www.annualreports.com.) Using the financial statements, calculate three of the ratios described in this chapter. What conclusions can you draw from these ratios about the company’s financial strengths and weaknesses?
3. Your small company has $25,000 in surplus cash right now. You don’t want to commit these funds to any long-term investments because you know of some expenses coming up in about 8 months that will require the use of this cash. But you would like to find some safe, liquid interest-earning investments where you could park your cash until it is needed. You’ve decided that T-bills and money market mutual funds are your best options, but you want to find out more about both. Use the Internet to do some research about these cash equivalents, and then answer the questions below.
How do you purchase T-bills? If you want to invest in T-bills, what is the minimum amount you can invest? Can you sell these bills before they mature? How do you receive the interest on T-bills? What is the interest rate earned on the most recent T-bills?
How do you purchase money market mutual funds? How do these funds differ from money market accounts? What are the different types of money funds? Are there any drawbacks to investing in these funds?
Investigate two specific money market mutual funds. What interest rate does each currently offer is the minimum required investment for each?
Based on your research, how much of the $25,000 would you invest in T-bills and how much in money market mutual funds? Why?
4. Suppose that soon after earning your bachelor’s degree you are accepted into an MBA program at a prestigious university. It is an intensive program that would require you to be a full-time student for about eighteen months. What are the major financial costs and benefits of enrolling in this program? (Hint: be sure to consider not just the out-of-pocket costs, but also any other financial sacrifices you might have to make if you became a full- time student.) Describe how you could evaluate whether enrolling in this program is a good financial decision. (Hint: Keep in mind that the benefits of your education will be in the form of higher cash flows over your entire career.)
5. Visit the sites of at LendingClub.com and Prosper.com to find out more about peer-to-peer (P2P) lending. How do these sites match small lenders and borrowers? How are the sites similar, and how do they differ? Do some additional research to find out what others are saying about the pros and cons of these sites. Would you be willing to participate in this type of arrangement as a borrower? Would you participate as a lender? Why or why not?
Select 4 or 5 companies in the same basic market or industry, and print their most recent financial statements before class. Break the class into small groups, give each group the financial statements for one of the firms and have them work together to compute basic financial ratios for that firm. (The formulas for several common ratios are given in Exhibit 9.1. If you have a large class you can assign the same company to more than one group and have the groups compute different ratios.) Then have each group report their results. Compare the ratios reported by each group. In cases where ratios differ significantly among the firms, discuss the implications of these differences.
Avoiding a Cash Crash
Your company’s sales are strong and have been growing rapidly, and your recent income statements show that you’ve earned a solid profit each of the past three years. But despite this good news your firm has faced a series of cash flow problems in recent years. On several occasions you’ve had to scramble to find cash to pay your bills. You feel like you’ve been pushing your luck and you realize unless you make some changes in how you manage your cash and other current assets your problems are likely to continue. In fact, you’ve already identified three major concerns. You believe that once these concerns are addressed you will have gone a long way to reducing the possibility of a real cash crisis.
Your first challenge is to find some way to get a better handle on how your cash flows are likely to vary over the year. In the past you’ve just made “seat of the pants” estimates about the amount of cash you’ll receive each month and the payments you’ll have to make. These estimates haven’t always been accurate, which is a key reason you’ve had to scramble for funds. You want to develop a more rigorous way to predict when you’ll have shortages of cash so that you’ll have more time to make adjustments or find additional sources of funds.
A second problem you have concerns your credit customers. You know that offering credit to customers is a necessity; a “cash only” policy would likely cause many of your customers to take their business elsewhere. But during the recent recession many of your customers began paying late—and some didn’t pay at all. The slow payments clearly contributed to your cash flow problems. You wonder if there are some ways you could still offer credit while doing a better job of collecting payments in a timely fashion.
Finally, even though cash is tight in some months, you know that there are other months when your business generates substantial cash surpluses. You’ve been reluctant to invest these surpluses in the past because, with all of the cash flow problems and uncertainties you’ve faced, you didn’t want to tie up funds. But now you are beginning to realize that such a policy has an “opportunity cost.” You wonder whether there are some safe, liquid assets where you could temporarily invest your excess cash.
How is it possible for a profitable and rapidly growing company like yours to experience cash flow problems? What can you do to improve its forecast of cash shortages and surpluses?
How can your firm deal with its credit customers? What trade-offs are involved if you make changes in your credit policies? Is there any other way you could turn your credit sales into cash more rapidly?
What is the “opportunity cost” of holding cash? What are some short-term investments that would be good choices when your firm has temporary surpluses of cash? Describe these investments and explain why they are good places to temporarily “park” your cash.
“What Are Cash Equivalents?” Wise Geek website: http://www.wisegeek.com/what-are-cash-equivalents.htm; “Cash and Cash Equivalents,” Wikinvest website: http://www.wikinvest.com/metric/Cash_And_Cash_Equivalents; “Cash Budget,” Investopedia website: http://www.investopedia.com/terms/c/cashbudget.asp#axzz1VEzc8Z9U; Cash Budgets/Cash Budgeting,” Accounting for Management website: http://www.accountingformanagement.com/cash_budget.htm; “Credit Policy,” Entrepreneur.com website: http://www.entrepreneur.com/encyclopedia/term/82124.html; “How to Create a Smart Credit Policy,” Inc. magazine website: http://www.inc.com/magazine/20090301/how-to-create-a-smart-credit-policy.html