Conclusions 6. References 1. First, finance managers utilized accounting information, cash flows, etc. Secondly, managers use economic principles as a guide for financial decision making that favor the interest of the organization. In other words, finance constitutes an area applied in economics that is supported by accounting information. Since finance reflexes what adds value to a company, finance managers constitute important individuals for the majority of business.
Financial managers measure the development of the company, they determine the financial consequences, the tendencies and recommend on how to use the assets of the organization for the well being and survival of the business in the long run. Decision making based on different scenarios must be done in order to assure the right use of the assets on the company. The difference between a managerial and a technical approach can be seen in the questions one might ask of annual reports.
One concerned with technique would be primarily interested in measurement. They would ask: are moneys being assigned to the right categories? Was generally accepted accounting practice GAAP followed? One concerned with management though would want to know what the figures mean. They might compare the returns to other businesses in their industry and ask: are we performing better or worse than our peers? If so, what is the source of the problem? Do we have the same profit margins? If not, why? Do we have the same expenses? Are we paying more for something than our peers?
Managerial finance is an interdisciplinary approach that borrows from both managerial accounting and corporate finance. Financial Statements and Analysis Financial statements or financial reports are formal records of a business' financial activities. These statements provide an overview of a business' profitability and financial condition in both short and long term. There are four basic financial statements: 1. Balance sheet: also referred to as statement of financial condition, reports on a company's assets, liabilities and net equity as of a given point in time.
Income statement: also referred to as Profit or loss statement, reports on a company's results of operations over a period of time. Cash flow statement: reports on a company's cash flow activities, particularly its operating, investing and financing activities. Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period.
For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail.
Notes to financial statements are considered an integral part of the financial statements. According to Gitman, Lawrence , "The objective of financial statements is to provide information about the financial strength, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.
Financial statements should be understandable, relevant, reliable and comparable. Financial statements are intended to be understandable by readers who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently. The difference between these inflows and outflows is the net income, also shown in the income statement. Financial statements are used by a diverse group of parties, both inside and outside a business. Generally, these users are: 1.
Internal Users: are owners, managers, employees and other parties who are directly connected with a company. Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analyses are then performed on these statements to provide management with a more detailed understanding of the figures.
These statements are also used as part of management's report to its stockholders, as it form part of its Annual Report. External Users: are potential investors, banks, government agencies and other parties who are outside the business but need financial information about the business for a diverse number of reasons.
Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and is prepared by professionals financial analysts , thus providing them with the basis in making investment decisions. Financial institutions banks and other lending companies use them to decide whether to grant a company with fresh working capital or extend debt securities such as a long-term bank loan or debentures to finance expansion and other significant expenditures.
Government entities tax authorities need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company. Media and the general public are also interested in financial statements for a variety of reasons. The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non-profit organizations.
They may use either of two accounting methods: accrual accounting, or cash accounting, or a combination of the two. A complete set of chart of accounts is also used that is substantially different from the chart of a profit-oriented business. Although the legal statutes may differ from country to country, an audit of financial statements are usually, but not exclusively required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy.
The audit opinion on the financial statements is usually included in the annual report. The analysis is performed on historical and present data, but with the goal to make financial projections. There are several possible objectives: to calculate a company's credit risk, to make projection on its business performance, to evaluate its management and make internal business decisions, to make the company's stock valuation and predict its probable price evolution When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies.
Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprise the security. Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns.
Technical analysis does not care what the 'value' of a stock is. Managers may use fundamental analysis to correctly value good and bad companies. Even bad company's stock goes up and down, creating opportunities for profits. Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks.
The analysis of a business' health starts with financial statement analysis that includes ratios. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The determined growth rates of income and cash and risk levels to determine the discount rate are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future dividends received by the investor, along with the eventual sale price. Measurement of cash flow can be used to: To evaluate the state or performance of a business or project.
To determine problems with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable. To generate project rate of returns. The time of cash flows into and out of projects are used as inputs to financial models such as internal rate of return, and net present value. To examine income or growth of a business when it is believed that accrual accounting concepts do not represent economic realities. Alternately, cash flow can be used to 'validate' the net income generated by accrual accounting.
Cash flow as a generic term may be used differently depending on context, and certain cash flow definitions may be adapted by analysts and users for their own uses. Common terms with relatively standardized definitions include operating cash flow and free cash flow. Cash flows can be classified into: 1. Operational cash flows: Cash received or expended as a result of the company's core business activities. Investment cash flows: Cash received or expended through capital expenditure, investments or acquisitions. Financing cash flows: Cash received or expended as a result of financial activities, such as receiving or paying loans, issuing or repurchasing stock, and paying dividends.
All three together are necessary to reconcile the beginning cash balance to the ending cash balance. The cash flow statement is one of the four main financial statements of a company.
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The cash flow statement can be examined to determine the short-term sustainability of a company. If cash is increasing and operational cash flow is positive , then a company will often be deemed to be healthy in the short-term. Increasing or stable cash balances suggest that a company is able to meet its cash needs, and remain solvent. This information cannot always be seen in the income statement or the balance sheet of a company.
For instance, a company may be generating profit, but still have difficulty in remaining solvent. The cash flow statement breaks the sources of cash generation into three sections: operational cash flows, investing and financing. This breakdown allows the user of financial statements to determine where the company is deriving its cash for operations.
Many investors have lost faith in the value of published income statements. One way to by-pass them is to use cash flows instead. The feeling is that: Cash flows cannot be forged. This presumption may be inaccurate. Cash liquidity is necessary for survival. This is true, and even truer for businesses with limited access to financing. Cash is tangible proof of income Cash flow planning is critical to financial success. It is useful to consider three aspects of cash flow planning: 1.
Cash flow analysis - researching historical cash flows to understand the current situation. Cash flow planning - considering where changes should be made to cash flows in order to accomplish prioritized goals. Cash flow management - having the discipline to stay with the plan. Usually, a company creates a Financial Plan immediately after the vision and objectives have been set. The Financial Planning activity involves the following tasks: Assess the business environment Confirm the business vision and objectives Identify the types of resources needed to achieve these objectives Quantify the amount of resource labor, equipment, materials Calculate the total cost of each type of resource Summarize the costs to create a budget Identify any risks and issues with the budget set Performing Financial Planning is critical to the success of any organization.
It provides the Business Plan with rigor, by confirming that the objectives set are achievable from a financial point of view. It also helps the CEO to set financial targets for the organization, and reward staff for meeting objectives within the budget set. In other words, the present value of a certain amount of money is greater than the present value of the right to receive the same amount of money at time t in the future.
This is because the amount could be deposited in an interest-bearing bank account or otherwise invested from now to time t and yield interest. Consequently, lenders acting at arm's length demand interest payments for use of their financial capital. Additional motivations for demanding interest are to compensate for the risk of borrower default and the risk of inflation, as well as other, more technical considerations.
Some standard calculations based on the time value of money are: Present Value PV of an amount that will be received in the future. Future Value FV of an amount invested such as in a deposit account now at a given rate of interest. Present Value of an Annuity PVA is the present value of a stream of equally-sized future payments, such as a mortgage.
Future Value of an Annuity FVA is the future value of a stream of payments annuity , assuming the payments are invested at a given rate of interest. Present Value of a Perpetuity is the value of a regular stream of payments that lasts "forever", or at least indefinitely. Formulas; According to Brigham, Eugene and Johnson, Ramon , Present value of a future sum The present value formula is the core formula for the time value of money; each of the other formulas is derived from this formula. For example, the annuity formula is the sum of a series of present value calculations.
The present value PV formula has four variables, each of which can be solved for: 1. Present value of an annuity The present value of an annuity PVA formula has four variables, each of which can be solved for: 1. A the value of the individual payments in each compounding period 3. Future value of an annuity The future value of an annuity FVA formula has four variables, each of which can be solved for: 1. Present value of a growing annuity Similar to the formula for an annuity, the present value of a growing annuity PVGA uses the same variables with the addition of G as the rate of growth of the annuity A is the annuity payment in the first period.
This is a calculation that is rarely provided for on financial calculators. Present value of a perpetuity The PV of a perpetuity a perpetual annuity formula is simple division. Present value of a growing perpetuity When the perpetual annuity payment grows at a fixed rate g the value is theoretically determined according to the following formula.
In practice, there are few securities with precisely these characteristics, and the application of this valuation approach is subject to various qualifications and modifications. Most importantly, it is rare to find a growing perpetual annuity with fixed rates of growth and true perpetual cash flow generation. Despite these qualifications, the general approach may be used in valuations of real estate, equities, and other assets.
Annuity derivation The formula for the present value of a regular stream of future payments an annuity is derived from a sum of the formula for future value of a single future payment, as below, where C is the payment amount and n the time period. Plugging this back into the equation: Perpetuity derivation Without showing the formal derivation here, the perpetuity formula is derived from the annuity formula.
Specifically, the term: can be seen to approach the value of 1 as n grows larger. At infinity, it is equal to 1, leaving as the only term remaining. Time value of money formulae with continuous compounding Rates are sometimes converted into the continuous compound interest rate equivalent because the continuous equivalent is more convenient for example, more easily differentiated.
Each of the formulae above may be restated in their continuous equivalents. For example, the present value of a future payment can be restated in the following way, where e is the base of the natural logarithm: See below for formulaic equivalents of the time value of money formulae with continuous compounding. Present value of an annuity Present value of a perpetuity Present value of a growing annuity Present value of a growing perpetuity Present value of an annuity with continuous payments e.
Broadly speaking, in business enterprises, risk is traded off against benefit. RAROC is defined as the ratio of risk adjusted return to economic capital.
Economic capital is a function of market risk, credit risk, and operational risk. This use of capital based on risk improves the capital allocation across different functional areas of banks, insurance companies, or any business in which capital is placed at risk for an expected return above risk-free. Risk management 2. Performance evaluation For risk management purposes, the main goal of allocating capital to individual business units is to determine the bank's optimal capital structure. As a performance evaluation tool, it allows banks to assign capital to business units based on the economic value added of each unit.
RAROC is defined as the ratio of risk-adjusted return to economic capital. Economic capital methodologies can be applied across products, clients, lines of business and other segmentations, as required, to measure certain types of performance. The resulting capital attributed to each business line provides the financial framework to understand and evaluate sustainable performance and to actively manage the composition of the business portfolio. This enables a financial company to increase shareholder value by reallocating capital to those businesses with high strategic value and sustainable returns, or with long-term growth and profitability potential.
Economic profit elaborates on RAROC by incorporating the cost of equity capital, which is based on the market required rate of return from holding a company's equity instruments, to assess whether shareholder wealth is being created. Economic profit measures the return generated by each business in excess of a bank's cost of equity capital. Shareholder wealth is increased if capital can be employed at a return in excess of the bank's cost of equity capital.
Similarly, when returns do not exceed the cost of equity capital, then shareholder wealth is diminished and a more effective deployment of that capital is sought. The four standard market risk factors are: 1. Equity risk, or the risk that stock prices will change. Interest rate risk, or the risk that interest rates will change.
Currency risk, or the risk that foreign exchange rates will change. Commodity risk, or the risk that commodity prices i. Market risk is typically measured using a Value at Risk methodology. Value at risk is well established as a risk management technique, but it contains a number of limiting assumptions that constrain its accuracy.
The first assumption is that the composition of the portfolio measured remains unchanged over the single period of the model. For short time horizons, this limiting assumption is often regarded as acceptable. For longer time horizons, many of the transactions in the portfolio may mature during the modeling period. Intervening cash flow, embedded options, changes in floating rate interest rates, and so on are ignored in this single period modeling technique.
Market risk can also be contrasted with Specific risk, which measures the risk of a decrease in ones investment due to a change in a specific industry or sector, as opposed to a market-wide move. Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of credit either the principal or interest coupon or both.
Companies carry credit risk when, for example, they do not demand up-front cash payment for products or services.
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By delivering the product or service first and billing the customer later if it's a business customer the terms may be quoted as net 30 the company is carrying a risk between the delivery and payment. Credit risk is not really manageable for very small companies. This makes these companies very vulnerable to defaults, or even payment delays by their customers. Operational risk was initially defined in the negative as any form of risk that is not market or credit risk. This negative definition is rather vague as it does not tell us much about the exact types of operational risks faced by banks today, nor does it provide banks with a proper basis for measuring risk and calculating capital requirements.
By far the most common form these assets are lent in is money, but other assets may be lent to the borrower, such as shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. In each case the interest is calculated upon the value of the assets in the same manner as upon money. The fee is compensation to the lender for foregoing other useful investments that could have been made with the loaned money.
Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of the use of the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit.
Interest is therefore the price of credit, not the price of money as is commonly and mistakenly believed. The percentage of the principal which is paid as fee the interest , over a certain period of time, is called the interest rate. The amount of simple interest is calculated according to the following formula: where A is the amount of interest, P the principal, r the interest rate as a percentage, and n the number of time periods elapsed since the loan was taken. Compound interest In the short run, compound Interest is very similar to Simple Interest, however, as time continues the difference becomes considerably larger.
The conceptual difference is that the principal changes with every time period, as any interest incurred over the period is added to the principal. Put another way, the lender is charging interest on the interest. Assuming that no part of the principal or subsequent interest has been paid, the amount of compound interest incurred is calculated by the following formula: Where; A, P, r and n have the same meanings as before. A problem with compound interest is that the resulting obligation can be difficult to interpret. To simplify this problem, a common convention in economics is to disclose the interest rate as though the term were one year, with annual compounding, yielding the effective interest rate.
However, interest rates in lending are often quoted as nominal interest rates. In economics, continuous compounding is often used due to its particular mathematical properties. Fixed and floating rates Commercial loans generally use compound interest, but they may not always have a single interest rate over the life of the loan.
Loans for which the interest rate does not change are referred to as fixed rate loans. Loans may also have a changeable rate over the life of the loan based on some reference rate such as LIBOR , usually plus or minus a fixed margin. These are known as floating rate, variable rate or adjustable rate loans. Combinations of fixed-rate and floating-rate loans are possible and frequently used.
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Less frequently, loans may have different interest rates applied over the life of the loan, where the changes to the interest rate are governed by specific criteria other than an underlying interest rate. The nominal interest rate, which refers to the price before adjustment to inflation, is the one visible to the consumer. Nominal interest is composed by the real interest rate plus inflation, among other factors.
This formula attempts to measure the value of the interest in units of stable purchasing power. However, if this statement was true, it would imply at least two misconceptions. First that all interest rates within an area that shares the same inflation. As with any security or capital investment, the fair value of a bond is the present value of the stream of cash flows it is expected to generate.
Hence, the price or value of a bond is determined by discounting the bond's expected cash flows to the present using the appropriate discount rate. NB final year payment will include the par value plus the coupon payment for the year Discount rate: the required annually compounded yield or rate of return r.
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A bond trading below its face value is trading at a discount, a bond trading above its face value is at a premium. Coupon yield The coupon yield is simply the coupon payment C as a percentage of the face value F. Current yield The current yield is simply the coupon payment C as a percentage of the bond price P.
Yield to Maturity The yield to maturity YTM is the discount rate which returns the market price of the bond. It is thus the internal rate of return of an investment in the bond made at the observed price. YTM can also be used to price a bond, where it is used as the required return on the bond. The concept of current yield is closely related to other bond concepts, including yield to maturity, and coupon yield. The YTM is of limited use in valuing bonds with uncertain cash flows, such as mortgage-backed securities or asset-backed securities.
In these instances, other measures such as option adjusted spread should be used instead when comparing yields across different types of bonds. Stock Valuation There are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices.
The Gordon model or Gordon's growth model is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate less than the discount rate forever. The valuation is given by the formula:. Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis. Refresh and try again. Open Preview See a Problem? Details if other :. Thanks for telling us about the problem. Return to Book Page.
Principles of Managerial Finance by Lawrence J. With explanations and real-life case studies, combined with an extensive array of aids to learning, this introductory text integrates features which provide a framework to help students learn the major concepts behind managerial finance. More logically, the chapter on the analysis of financial With explanations and real-life case studies, combined with an extensive array of aids to learning, this introductory text integrates features which provide a framework to help students learn the major concepts behind managerial finance. More logically, the chapter on the analysis of financial statements is now placed immediately after the chapter on financial statements, enabling students to use rational analysis to interpret material while it is still fresh in their minds.
An instructor's manual is also available. Get A Copy. Hardcover , 11th Edition. Published January 7th by Addison Wesley first published More Details Original Title. Other Editions Friend Reviews. To see what your friends thought of this book, please sign up. To ask other readers questions about Principles of Managerial Finance , please sign up. Sayadur Finance is a systematic way of studying investment and related works.
See all 7 questions about Principles of Managerial Finance…. Lists with This Book. This book is not yet featured on Listopia. Community Reviews. Showing Rating details. More filters. Sort order. I think this book is outstanding, the chapters are well organized, the learning goals are highlighted and illustrated and very well presented. The colors, graphics, and illustrations are very helpful. The solved examples are very well designed and explained. This book helped me in my postgraduate diploma in business administration.
View 1 comment. Feb 04, Faysol marked it as to-read. I want to read this book. Jul 26, Tihan added it.
Mar 20, Mia Rarasputri rated it it was amazing. My college book. Bisa dibilang ini buku wajib dibaca dan hapal luar kepala!! Udah kaya pacaran sih klo sm kamu mah Gitman. Dec 17, Farooq added it. Mar 31, Abdul Rehman marked it as to-read. Principles of Managerial Finance.
Principles of Managerial Finance
Lawrence J. Jun 14, Nadeem added it. Managerial Finance is very helpful book for Business Students. Pretty straightforward in presenting new concepts and information. It covered a wide range of topics and would be helpful for students going into a MBA program. The use of examples throughout the text is very helpful.
This is a decent textbook inasmuch as it presents in a straightforward and understandable fashion the basic formulas, concepts and theories associated with managerial finance. It is somewhat dry, but not as bad as some textbooks on primarily technical topics. My low rating for this book is due to the fact that the author attempts to drive home the point that the finance manager's sole job in a firm is to maximize wealth for the shareholder.
Each chapter ends with a reiteration of this point, demo This is a decent textbook inasmuch as it presents in a straightforward and understandable fashion the basic formulas, concepts and theories associated with managerial finance.