FINANCIALMANAGEMENTEkrem Tufanetufan@yahoo.comhttp:etufan.wordpress.comCanakkale Onsekiz Mart UniversitySchool of Tourism and Hotel Management
What will we learn?1. An overview of managerial finance-Managerial finance in the 1990s-The financial manager’s responsibility-The goals of the corporation
What will we learn?2. The financial environment: TurkishMarkets, institutions- Financial markets- Financial institutions
What will we learn?3. Analysis of financial statements- The income statement- The balance sheet- Ratio analysis4. Risk and rates of return-Defining and measuring risk-Expected rate of return
What will we learn?5. Strategic long-term investmentdecisions-Generating ideas for capital projects-Project classifications-Similarities between capitalbudgeting evaluation techniques
What will we learn?6. Capital budgeting evaluationtechniques-Payback period method-Net present value method-Internal rate of return method
What will we learn?6. Practice of NPV and IRR methods-Example of NPV-Example of IRR-Example of sensitivity analysisContinuation of examples…So on, so far…
What kind of resources can weuse when we doing research?1. All finance books2. All articles about finance3. www.ssrn.com4. www.makalem.com5. www.ceterisparibus.com6. Essentials of Managerial Finance, J. FredWeston and Eugene Brigham, HarcourtBrace&Company International Edition, 1992. (Themain book of our lesson!)
What is the finance?• Money• Stock exchange• Banks• What else?• How about the companies?• Balance sheetBalance sheet.xls
What is the finance?To achieve the goals of company;1. Finding funds from the most suitablesources2. Using them effectively and3. Control the results…
An Overview of ManagerialFinanceA Short History of Managerial Finance• 1930s: Liabilities and equity• 1940 and 1950s: Assets, quantitative methods,discounted cash flow methods• 1960 and 1970s: Optimization of assets andliabilities and equity, statistical methods• 1980s: Globalization, interest rate and exchangerisk• 1990s to today: More risk, more computer, newfinancial instruments and methods
Today’s WorldKaynak: www.economywatch.com/world_economy (2011 estimation)World GDP (PPP): $78.092 trillionGDP Growth Rate: 3.3%GDP Per Capita (PPP): $11,100GDP By Sector: Services 63.4%, Industry 30.8%, Agriculture 5.8%Growth In Trade Volume: 6.953%Industrial Production Growth Rate: 4.6%Population: 6.768 billionPopulation Growth Rate: 1.133%Urban Population: 50.5%Urbanization Rate: 1.85% (125 million people move to cities every year)The Poor (Income below $2 per day): Approx 3.25 billion (~ 50%)Millionaires: Approx 10 million (~ 0.15%)Labor Force: 3.232 billionInflation Rate - Developed Countries: 2.5%Inflation Rate - Developing Countries: 5.6%Unemployment Rate: 8.8%Investment: 23.4% of GDPPublic Debt: 58.3% of GDPPlease also have a look at http://worldbank.tumblr.com/day/2013/02/12/
An Overview of ManagerialFinanceThe Financial Manager’s Responsibility• Forecasting and planning• Major investment and control• Coordination and control• Dealing with the financial markets
An Overview of ManagerialFinanceThe goals of the corporation• Managerial incentives to maximizeshareholder wealth• Social responsibility• Stock price maximization and socialwelfare
The Financial Environment:Markets, InstitutionsThe Financial Markets• Physical asset markets• Spot markets and futures markets• Money markets• Mortgage markets• World, national, regional and local markets• Primary markets-secondary markets
The Financial Environment:Markets, InstitutionsFinancial Institutions in Turkey1. Commercial banks2. Pension funds3. Mutual funds4. Life insurance companies5. Stock exchange (ISE)6. Gold exchange (IGE)7. Turkish Derivatives Exchange
The Financial Environment:Markets, Institutions in TurkeyStock Exchanges• Istanbul Stock Exchange ISE• Istanbul Gold Exchange IGE• Turkish Derivatives Exchange TD• Over the counter market OCM
Istanbul Stock ExchangeThe Istanbul Stock Exchange was established on December 26, 1985 for thepurpose of ensuring that securities are traded in a secure and stableenvironment, and commenced to operate on January 3, 1986. The ISE hascontributed to the development of Turkish capital markets and Turkisheconomy since the date of its establishment.Established as per the Governmental Decree in Force of Law (KHK) No.91,the ISE is a public corporation operating as an autonomous andprofessional institution. The ISE is entitled to issue legal regulationsrelated to the subjects and fields within the scope of its authority.The General Assembly comprising of the ISE Members is the supremedecision making body. The Executive Council of the ISE comprises of theChairman and four members. While the Chairman is appointed as per atripartite decree, members of the Executive Council and auditors areelected by the General Assembly of ISE.Hüseyin ERKAN was appointed Chairman&CEO of the ISE on November 2,2007.
Turkish Derivatives ExchangeTURKDEX, started its operation right after the company wasregistered in Registry of Commerce. This registration wasofficially announced through the Gazetta of Registry ofCommerce, dated July 4, 2001.Futures and options exchanges are one of the main institutions ofliberal economic systems. Although negative developments hurtthe financial markets in recent years, trading volumes of futuresexchanges have continued to increase during that period. 2007figures indicate that trading volume of futures exchanges hasexceeded USD 2.2 quadrillions and approximately 15 billionscontracts have been traded.
Turkish Derivatives ExchangeIn a free market economy prices are determined by supply anddemand. In Turkey, privatization has been gradually increasingand the governments implement policies to provide such a freemarket. In addition to that free capital flows between countriesare encouraged and the restrictions on this are being abolishedin relevance with new legislations enacted. As a result of suchdevelopments in terms of a free market economy almost everycompany in the country is becoming more sensitive to globaleconomic fluctuations. Therefore the need for risk managementtools is obvious and with this intention Turkdex is offeringsignificant opportunities and instruments to those who need tomanage such risks.
Over the Counter MarketWithin the derivatives markets, many products are traded throughexchanges. An exchange has the benefit of facilitating liquidity andalso mitigates all credit risk concerning the default of a member of theexchange. Products traded on the exchange must be wellstandardised to transparent trading. Non-standard products aretraded in the so-called over-the-counter (OTC) derivatives markets.OTC derivatives have less standard structure and are tradedbilaterally (between two parties). In such bilateral contract, each partyshould have credit risk concerns with respect to the other party. OTCderivatives are significant in the asset classes such as interest rate,foreign exchange, equities and commodities.Over-the-counter (OTC) or off-exchange trading is to trade financialinstruments such as stocks, bonds, commodities or derivativesdirectly between two parties. It is contrasted with exchange, whichoccurs via facilities constructed for the purpose of trading (i.e.,exchanges), such as futures exchanges or stock exchanges.(Source: http://en.wikipedia.org/wiki/Over-The-Counter_Market)
The Income StatementFinancial performance is assessed by giving a summaryof how the business incurs its revenues andexpenses through both operating and non-operatingactivities. It also shows the net profit or loss incurredover a specific accounting period, typically over a fiscalquarter or year.The income statement is divided into two parts: theoperating and non-operating sections.
Analysis of Financial StatementsCompanies should deliver annual reports totheir stockholders.These reports aredivided into two part:• First part: Verbal presentation• Second part: Financial statements (Theincome statement, the balance sheet, thestatement of retained earnings and thestatement of cash flows)
The Income Statement• Operating section: Operating items are interesting toinvestors and analysts alike because this section disclosesinformation about revenues and expenses that are a directresult of the regular business operations. For example, if abusiness creates sports equipment, then the operatingitems section would talk about the revenues and expensesinvolved with the production of sports equipment.Non-Operating section: The non-operating items sectiondiscloses revenue and expense information about activitiesthat are not tied directly to a companys regular operations.For example, if the sport equipment companysold a factory and some old plant equipment, then thisinformation would be in the non-operating items section.• (Resource: www.investopedia.com/terms/i/incomestatement.asp, Quoted: 08.08.2011)
The Income Statement• Net sales are shown at the top of each statement, afterwhich various costs, including income taxes, aresubtracted to obtain the net income avaible to commonstock holders. A report on earnings per share (EPS) isgiven at the bottom of the statement which is the mostimportant item in the statement.• EPS= Net income/Common shares outstanding• Dividends per share = Dividends paid to commonstockholders/Common shares outstanding
The Balance SheetA financial statement that summarizes a companysassets, liabilities and shareholders equity at a specificpoint in time. These three balance sheet segments giveinvestors an idea as to what the company ownsand owes, as well as the amount invested by theshareholders.The balance sheet must follow the following formula:Assets = Liabilities + Shareholders’ EquityBalance sheetSource:www.investopedia.com/terms/b/balancesheet.asp#ixzz1Ug1wVtMZ
The Balance Sheet• The assets are listed in order of their liquidity, or thelength of time it typically takes to convert them to cash.• The claims are listed in the order in which they must bepaid: Accounts payable must generally be paid with in 30days, notes are payable within 90 days, and so on, downto the stockholders’ equity accounts, which representownership and need be paid off.Source: Essentials of Managerial Finance, J. Fred Weston and EugeneBrigham, 1992, Harcourt Brace&Company International Edition, pp.35.
Statement of Cash FlowsCash flows are more important than net income, becausedividends must be paid in cash and because cash is necessaryto purchase the assets required to continue operations.Statement of cash flows is designed to show how the firm’soperations have effected its cash position and to help answerquestions such as these:• Is the firm generating the cash needed to purchase additionalfixed assets for growth?• Is growth so rapid that external financing is required both tomaintain operations and for investment in new fixed assets?• Does the firm have excess cash flows that can be used torepay debt or to invest in new products?• Source: Essentials of Managerial Finance, J. Fred Weston and Eugene Brigham, 1992,Harcourt Brace&Company International Edition, pp.43.
Türk Demir Döküm FabrikalarıAnonim Şirketi• Our example company is a Turkish company and nameis Türk Demir Döküm Fabrikaları Anonim Şirketi. Lt. TheCompany is engaged in the manufacture and trade ofdurable consumer goods such as iron panel and steelradiators, cast iron radiators, instant and storage waterheaters, central heating systems, iron stoves, individualheating equipment.• The average number of employees is 1.562 out of which221 white collared and 1.341 blue collared• Türk Demir Döküm
Financial AnalysisPeople go to doctor for two reasons: First is being cured,second is control before the illness. It is also same forthe companies.Who will interested in this analysis?(Potential) shareholders, managers but for what?Financial analysis is started with ratio analysis. Ratios aredesigned to show relationship between financialstatement accounts. So, we need balance sheet, incomestatement and statement of retained earnings at leasttwo consecutive years.
Ratio AnalysisTaking some factors into consider ratio analysis:• The ratios should be compared with industryaverage or past results of the company• Be aware of economic conditions betweenyears which are chosen as periods• Not use just one ratio to make common aboutthe company• Do not divide unrelated numbers to calculate aratio
Ratio AnalysisSource: Boone Louis E. And David L. Kurtz, 2011, Contemporary Business, John Wiley&Sons Pte Ltd., ISBN: 978-0-470-873762, pp.517.Category Ratio DescriptionLiquidity ratios Current ratio Current assets divided by current liabilitiesQuick (acid test) ratio Current assets (minus inventory) dividedby current liabilitiesEfficiency ratios (Assetmanagement ratios)Inventory turnover Cost of goods sold (or sales) divided byaverage inventoryReceivables turnover Credit sales divided by average accountsreceivableTotal asset turnover Revenue or sales divided by average totalassetsLeverage ratios Debt ratio Total liabilities divided by total assetsLong term dept to equity Long-term debt divided by owners’ equityProfitability ratios Gross profit margin Gross profit divided by revenue or salesNet profit margin Net profit divided by revenue or salesReturn on equity Net profit divided by average owners’equity
Ratio AnalysisMarket Value Ratios should be added list of ratios.These are:Price / Earning (P/E) Ratio = Price per share / Earnings pershareMarket / Book Ratio = Common equity / Shares outstanding
Liquidity RatiosCurrent ratio = Current assets/Current liabilities= 399.462.670 / 315.931.014= 1.26 times (2005) and 2004 = 1.49 timesQuick ratio = Current assets – Inventories / Currentliabilities= 399.462.670- 91.808.536 /315.931.014= 0.97 times (2005) and 2004 = 1.09 times
Efficiency ratiosInventory turnover = Cost of goods sold / Inventories= 189.641.615 / 91.808.536= 2.06 (2005) and 1.98 (2004)Receivables turnover = (Credit) sales / Average AccountsReceivables= 261.588.631 / 265.918.406= 0.98 (2005) and 1.10 (2004)Total asset turnover = Sales / (Average) total assets= 261.588.631 / 489.834.716= 0.53 (2005) and 0.57 (2004)
Leverage RatiosDebt ratio = Total liabilities / Total assets= 342.964.466 / 489.834.716= 0.70 (2005) and 0.61 (2004)Long term debt to equity = Long-term debt / owners’ equity= 24.302.307 / 146.870.250= 0.16 (2005) and 0.24 (2004)
Profitability RatiosGross profit margin = Gross profit / Sales= 71.947.016 / 261.588.631= 0.27 (2005) and 0.27 (2004)Net profit margin = Net income / Sales= 10.929.320 / 261.588.631= 0.04 (2005) and 0.04 (2004)Return on equity = Net profit / Average owners’ equity= 10.929.320 / 45.000.000= 0.24 (2005) and 0.22 (2004)
Market Value RatiosPrice / Earning (P/E) Ratio = Price per share / Earningsper share= 5.80 / 0.24= 24.16 (2005)Earnings per share = Net profit / Number of shares= 10.929.320 / 45.000.000= 0.24
Market Value RatiosMarket / Book Ratio = Market price per share /Book value per share= 5.80 / 1= 5.80Book value per share = Common equity (sharecapital)/Shares outstanding=45.000.000 / 45.000.000= 1
Risk And Rates Of ReturnDefining and measuring risk• Expected Rate of Return• Measuring Risk: The StandardDeviation• Measuring Risk: Coefficient ofVariation
Strategic Long-Term InvestmentDecisionsGenerating ideas for capital projects• Who creates the capital budgeting projects?• Do we need to be an entrepreneur?• Two questions for testing being entrepreneur(CV and address book)
Strategic Long-Term InvestmentDecisionsProject classifications1. Replacement: Maintenance of business2. Replacement: Cost reduction3. Expansion of existing products or markets4. Expansion into new products or markets5. Safety and/or environmental projects6. Other
Strategic Long-Term InvestmentDecisionsSimilarities between capital budgetingevaluation techniques1. Project cost2. Expected cash flows estimation3. Estimation of project riskiness4. Cost of capital decision5. Measurement of present value of cash inflows6. Present value of the expected cash inflowsand required outlay
Capital Budgeting EvaluationTechniquesPayback periodProject S :Net Cash FlowCumulative NCF
Capital Budgeting EvaluationTechniquesPayback periodProject L :Net Cash FlowCumulative NCF
Capital Budgeting EvaluationTechniquesNet Present Value (NPV)nnkCFkCFkCFCFNPV)1(..............)1()1( 22110+++++++=∑= +=ntttkCF0 )1(
Capital Budgeting EvaluationTechniquesInternal rate of return (IRR)0)1(..............)1()1( 22110 =+++++++ nnIRRCFIRRCFIRRCFCF0)1(0=+=∑=ntttIRRCF