MF 722 Financial Management
Financial Calculator (optional) <ul><li>Available from amazon.com for $23.38 (+ ship) or from staples.com (more $ but fast...
Product Market Strategy    Finance
3 Functions in Financial Management <ul><li>Planning   </li></ul><ul><li>Performance   Assessment  </li></ul><ul><li>Val...
Separation of Control from Ownership <ul><li>Managers who set Providers of  </li></ul><ul><li>product market funds </li></...
What Should be the Objective of Corporate Financial Decisions? <ul><li>We will work with: </li></ul><ul><li>Maximizing Sha...
The Importance of Cash Flow
Financial Statements and Cash Flow <ul><li>How can we derive cash flowing in and out of firm from </li></ul><ul><ul><li>In...
Cash Flow Measures <ul><li>Cash flow from assets (also called free cash flow): CF(A) </li></ul><ul><li>Cash flow to credit...
Cash Flow from Assets <ul><li>Operating Cash Flow  -  Capex   -  Δ NWC </li></ul><ul><li>= EBIT = gross capex   = increase...
Cash Flow to Investors <ul><li>Cash Flow from Assets </li></ul><ul><li>Cash Flow to Creditors   Cash Flow to Shareholders ...
A Closer Look at Net Working Capital <ul><li>Let’s focus on: </li></ul><ul><ul><li>Inventory </li></ul></ul><ul><ul><li>Ac...
 
Illustration of Average Collection Period <ul><li>Each day, 1 day of sales goes on the belt (A/R) </li></ul><ul><li>Each d...
Cash Conversion Cycle: Selected Companies -51.2 62.2 11 7.1 3.9 McDonald's 1.4 35.3 36.7 2.8 33.9 Safeway 29.8 37.4 67.2 2...
3 Functions in Financial Management <ul><li>Planning   </li></ul><ul><li>Performance   Assessment  </li></ul><ul><li>Val...
Financial Forecasting <ul><li>How can we use facts and assumptions to construct pro forma financial statements and estimat...
Steps in Financial Forecasting <ul><li>Choosing a model driver </li></ul><ul><li>Making reasonable assumptions as needed <...
Possible Model Drivers <ul><li>Sales </li></ul><ul><ul><li>Assets are needed to support sales, so assets must keep pace wi...
A Simple, Sales-Driven Model <ul><li>Assumptions: </li></ul><ul><li>Sales will grow by 50% (to 150) in 2007 </li></ul><ul>...
2007 Forecasts <ul><li>2007 Pro Forma Income State. </li></ul><ul><li>Sales 150 </li></ul><ul><li>Costs 135 </li></ul><ul>...
External Funds Needed (EFN) <ul><li>2007 Pro Forma Income State. </li></ul><ul><li>Sales 150 </li></ul><ul><li>Costs 135 <...
EFN More Generally (Eq. 3.22, p. 70)
Sustainable Growth Rate <ul><li>Growth rate in sales = g (i.e., S 1  = (1+g)S 0  and  Δ S = S 1  – S 0  = gS 0 </li></ul><...
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Class #1 slides (Powerpoint file)

  1. 1. MF 722 Financial Management
  2. 2. Financial Calculator (optional) <ul><li>Available from amazon.com for $23.38 (+ ship) or from staples.com (more $ but faster shipping) </li></ul><ul><li>Search on “financial calculators” </li></ul>
  3. 3. Product Market Strategy  Finance
  4. 4. 3 Functions in Financial Management <ul><li>Planning  </li></ul><ul><li>Performance  Assessment </li></ul><ul><li>Valuation  </li></ul><ul><li>How much money do we need & when? </li></ul><ul><li>How can we measure and interpret financial performance? </li></ul><ul><li>How is estimated performance translated into market value? </li></ul>
  5. 5. Separation of Control from Ownership <ul><li>Managers who set Providers of </li></ul><ul><li>product market funds </li></ul><ul><li>strategy </li></ul>
  6. 6. What Should be the Objective of Corporate Financial Decisions? <ul><li>We will work with: </li></ul><ul><li>Maximizing Shareholder Value </li></ul>
  7. 7. The Importance of Cash Flow
  8. 8. Financial Statements and Cash Flow <ul><li>How can we derive cash flowing in and out of firm from </li></ul><ul><ul><li>Income Statement </li></ul></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Statement of Cash Flow </li></ul></ul>
  9. 9. Cash Flow Measures <ul><li>Cash flow from assets (also called free cash flow): CF(A) </li></ul><ul><li>Cash flow to creditors: CF(B) </li></ul><ul><li>Cash flow to shareholders: CF(S) </li></ul><ul><li>CF(A) = CF(B) + CF(S) </li></ul>
  10. 10. Cash Flow from Assets <ul><li>Operating Cash Flow - Capex - Δ NWC </li></ul><ul><li>= EBIT = gross capex = increases in CA </li></ul><ul><li>+depreciation - asset sales - increases in CL </li></ul><ul><li>- current taxes </li></ul><ul><li>(Note slight difference from cash flow from operations in accounting statement of cash flow – no interest subtracted from earnings here ) </li></ul>
  11. 11. Cash Flow to Investors <ul><li>Cash Flow from Assets </li></ul><ul><li>Cash Flow to Creditors Cash Flow to Shareholders </li></ul><ul><li>= interest paid = dividends </li></ul><ul><li> + debt repaid + stock repurchased </li></ul><ul><li> - new L.T. debt issued - new stock issued </li></ul><ul><li> </li></ul>
  12. 12. A Closer Look at Net Working Capital <ul><li>Let’s focus on: </li></ul><ul><ul><li>Inventory </li></ul></ul><ul><ul><li>Accounts Receivable </li></ul></ul><ul><ul><li>Accounts Payable </li></ul></ul>
  13. 14. Illustration of Average Collection Period <ul><li>Each day, 1 day of sales goes on the belt (A/R) </li></ul><ul><li>Each day, 1 day of sales falls off the belt (paid) </li></ul><ul><li>The number of days’ sales on the belt at any one time represents average time to collect on A/R </li></ul>
  14. 15. Cash Conversion Cycle: Selected Companies -51.2 62.2 11 7.1 3.9 McDonald's 1.4 35.3 36.7 2.8 33.9 Safeway 29.8 37.4 67.2 2.8 64.4 Wal-Mart Stores 41.7 54.4 96.1 22 74.1 Boeing 89 65.9 154.9 65.1 89.8 Hewlett-Packard Cash Conv. Pay. Def. (DPO) Op. Cycle Ave. Coll. (DSO) Inv. Conv. (DSI) Company
  15. 16. 3 Functions in Financial Management <ul><li>Planning  </li></ul><ul><li>Performance  Assessment </li></ul><ul><li>Valuation  </li></ul><ul><li>How much money do we need & when? </li></ul><ul><li>How can we measure and interpret financial performance? </li></ul><ul><li>How is estimated performance translated into market value? </li></ul>
  16. 17. Financial Forecasting <ul><li>How can we use facts and assumptions to construct pro forma financial statements and estimate how much cash we will need? </li></ul>
  17. 18. Steps in Financial Forecasting <ul><li>Choosing a model driver </li></ul><ul><li>Making reasonable assumptions as needed </li></ul><ul><li>Using the discipline of accounting definitions (e.g., balance sheet must balance) </li></ul><ul><li>Making the forecast </li></ul><ul><li>Interpreting the results </li></ul><ul><li>Sensitivity analysis </li></ul>
  18. 19. Possible Model Drivers <ul><li>Sales </li></ul><ul><ul><li>Assets are needed to support sales, so assets must keep pace with sales and increased assets must be financed </li></ul></ul><ul><li>Financing Policy </li></ul><ul><ul><li>Assets (and thus sales) can only grow as fast as the company’s ability/willingness to finance them </li></ul></ul>
  19. 20. A Simple, Sales-Driven Model <ul><li>Assumptions: </li></ul><ul><li>Sales will grow by 50% (to 150) in 2007 </li></ul><ul><li>Assets/Sales = 2.0 </li></ul><ul><li>Costs/Sales = 0.90 </li></ul><ul><li>Net Income/Sales (Net Profit Margin) = 0.10 </li></ul><ul><li>Liabilities/Sales = 1.0 </li></ul><ul><li>Plowback ratio = 0.60 </li></ul><ul><li>How much new external funding must be provided to support the forecast 2007 sales growth? </li></ul><ul><li>2006 Income Statement </li></ul><ul><li>Sales 100 </li></ul><ul><li>Costs 90 </li></ul><ul><li>Net Income 10 </li></ul><ul><li>Dividends 4 </li></ul><ul><li>Ret. Earnings 6 </li></ul><ul><li>2006 Balance Sheet </li></ul><ul><li>Liabilities 100 </li></ul><ul><li>Assets 200 </li></ul><ul><li>Equity 100 </li></ul>
  20. 21. 2007 Forecasts <ul><li>2007 Pro Forma Income State. </li></ul><ul><li>Sales 150 </li></ul><ul><li>Costs 135 </li></ul><ul><li>Net Income 15 </li></ul><ul><li>Dividends 6 </li></ul><ul><li>Ret. Earnings 9 </li></ul><ul><li>2007 Pro Forma Balance Sheet </li></ul><ul><li>Liabilities 150 </li></ul><ul><li>Assets 300 </li></ul><ul><li>Equity 109 </li></ul><ul><li>whoops! </li></ul>2006 Income Statement Sales 100 Costs 90 Net Income 10 Dividends 4 Ret. Earnings 6 2006 Balance Sheet Liabilities 100 Assets 200 Equity 100
  21. 22. External Funds Needed (EFN) <ul><li>2007 Pro Forma Income State. </li></ul><ul><li>Sales 150 </li></ul><ul><li>Costs 135 </li></ul><ul><li>Net Income 15 </li></ul><ul><li>Dividends 6 </li></ul><ul><li>Ret. Earnings 9 </li></ul><ul><li>2007 Pro Forma Balance Sheet </li></ul><ul><li>Liabilities 150 </li></ul><ul><li>Assets 300 </li></ul><ul><li>Equity 109 </li></ul><ul><li>Total 300 Total 259 </li></ul><ul><li>There is a funding shortfall of 41 (A = 300, L&NW = 259) </li></ul><ul><li>This must be made up by: </li></ul><ul><ul><li>Issuing new equity </li></ul></ul><ul><ul><li>Allowing the ratio of liabilities/sales to rise </li></ul></ul><ul><ul><li>Some combination of (1) and (2) </li></ul></ul>
  22. 23. EFN More Generally (Eq. 3.22, p. 70)
  23. 24. Sustainable Growth Rate <ul><li>Growth rate in sales = g (i.e., S 1 = (1+g)S 0 and Δ S = S 1 – S 0 = gS 0 </li></ul><ul><li>At what rate can we grow without issuing new equity or allowing liabilities/sales to increase (e.g., EFN = 0)? </li></ul>

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