Manual e-Book FIN 430 Part 1(students) PDF

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PART 1: TOPIC 1 UNTIL 5 ONLY2. Capital structure to analyst on how much should the firm borrow to pay for its assets and the best mixture of debt and equity also the least expensive sources of funds 3. Working capital management to analyst on how to manage the day-to-day finances of the firm.AGENCY ...

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PART 1: TOPIC 1 UNTIL 5 ONLY

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THE DIFFERENCES BETWEEN ACCOUNT AND FINANCE Account

Finance

Describe accrual accounting data

Look beyond financial statements to obtain insight into existing or developing problems

Devote for collection and presentation of

Evaluate accounting statements; make

financial data

assessment of associated return and risk.

CORPORATE FINANCE It involves a Firm‟s decision in managing the financial resources efficiently and effectively in order to provide maximum benefits to the owners or the shareholders. GOALS OF ORGANIZATION2 •

Value for money – seek higher return to cover cost of capital for any investment that they venture

•

Maximizing Shareholders wealth- increasing firm value via profitable investment

• Financial Manager roles and decision: 1. Capital Budget to manage which long-term investments or projects should the business takes on. 1

Topics in these notes are according to chapters in the main text required for the course- Stephen A. Ross,Randolph W. Westerfield,Bradford D. Jordan,Joseph Lim,Ruth Tan 2016, Fundamentals of Corporate Finance, 11 Ed., 27, Mcgraw-Hill. Penn Plaza, New York [ISBN: 9789814595049] 2 Organization in our discussion here refer to organizations or corporations with the objective of making profit such as AIR ASIA, DRB-HICOM, MAS etc. On the other hand, Non-Profit Organization such as UITM is not relevant to our discussion

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2. Capital structure to analyst on how much should the firm borrow to pay for its assets and the best mixture of debt and equity also the least expensive sources of funds 3. Working capital management to analyst on how to manage the day-to-day finances of the firm.

AGENCY PROBLEM3 The problem created by you as a financial manager in which the problem that may arises when a Finance manager may take a decision that does not provide benefit to organization or make wrong decision. This is due to the financial manager is not the shareholder, instead, only an employee. Agency problem could lead to Value Destruction.

FINANCIAL MARKETS Key of financial markets: 

Money market- short term debt instrument or marketable securities



Capital market- long term securities like bonds and stocks

Types of financial markets: 1. Primary market- A market where the firm sells its securities to public for the first time. „New‟ securities are sold. 2. Secondary markets- A market in which the securities issued by firms are traded. •

Listed securities trade in an organized exchange, e.g. the stock market (NYSE)

3

Islam stresses on ‘Amanah in order to address the problems and issues

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Class Discussion: Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal?

Islamic Ethics for financial manager: The importance of ethics in Islam is obvious when God said to Prophet Muhammad in chapter 68 (Surah al-Qalam) of the Quran, verse 4: “And verify, you (O Muhammad) are on an exalted standard of character” (Translation by Yusuf Ali) Tafseer by Ibn Kathir: “Allah gave him the exalted character, which included the qualities of modesty, kindness, bravery, pardoning, gentleness and every other good characteristic.” 2 Equally reported by Sahih Muslim, Book 6, Hadith 168: “Aishah (RA) said: The character of the Messenger of Allah (SAW) was the Qur'an.” The above Surah and Hadith elucidates the basis knowledge of the Islamic ethics which offers a set of Islamic moral values include goodness, righteousness, truth, justice and equity which have been prescribed fundamentally in the Quran and implemented by Prophet Muhammad during his life. The Islamic ethical dimension can be incorporated in management accounting practices. If you are employed by a company, your duty is to ensure that you perform to the best of your ability …... no wastage of resources, no “couldn‟t care less” attitude and always perform your work sincerely.

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ALA Inc.: Income Statements (thousands of RM

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Sources and Uses of Funds Company: Hexza Inc. Balance Sheet Analysis for Funds Flow Statement (RM) ASSETS 2014 2015 CASH MARKETABLE SECRT. ACCOUNT RECEIVABLES/DEBTORS INVENTORIES PREPAID EXPENSES NET FIXED ASSET=GROSS FIXED ASSETDEPRECIATION

36000 29925 48150

39375 25875 42750

Changes Direction ↑ ↓ ↓

75600 7650 103950

74250 8325 148500

↓ ↑ ↑

Changes in amount 3375 4050 5400

Sources

1350 675 44550

√

Uses √

√ √ √

CHANGES IN ACCUMULATION DEPRECIATION= DEP1-DEP0 =64350-44550=19800@Use new depreciation if the question provide the information. NET CAPITAL EXPENDITURES (NCE)= NET FIXED ASSET1-NET FIXED ASSET0+DEP1 =44550+19800=64350 TOTAL ASSETS 301275 339075 CLAIMS ON ASSETS ACCOUNT PAYABLE 58275 44325 13950 TAXES PAYABLE 46125 36000 10125 NOTES PAYABLE 22500 0 22500 OTHER CURRENT LIABILITIES EQUITY: LONG TERM DEBT 47250 47250 PREFERRED STOCK 0 72000 12000 COMMON STOCK 101125 101250 PAID IN CAPITAL 0 4950 4950 RETAINED EARNINGS 25875 33300 7425 TOTAL EQUITY AND 301275 339075 LIBILITIES DIVIDEND PAYMENT= EAT @ NET INCOME- CHANGES IN R/E =30000- 7425= 22575 CHANGE IN NET WORKING CAPITAL= NWC1 – NWC0 = (CA1-CL1)-(CA0-CL0) =110250-70425=39825

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↓ ↓ ↓

↑ ↑

√ √ √

√ √

Sources and Uses of Funds Company: Hexza Inc. Funds Flow Statement (CASH BASIS) For the Year Ending December 31, 2015 (RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) 30000 DEPRECIATION 19800 TOTAL FUNDS FROM OPERATIONS

49800

PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK 72000 NEW PAID IN CAPITAL 4950 TOTAL SOURCES OF LONG TERM FUNDS

76950

PROCEED FROM CHANGES IN WORKING CAPITAL: DECREASE IN CASH DECREASE IN A/RECEIVABLES DECREASE IN INVENTORIES SALE/DECREASE IN SHORT TERM SECURITIES DECREASE IN PREPAID EXPENSES INCREASE IN A/PAYABLE INCREASE IN TAXES PAYABLE INCREASE IN NOTES PAYABLE INCREASE ACCRUED EXPENSE/ OTHER LIABILITIES

5400 1350 4050 TOTAL SOURCES OF SHORT-TERM FUNDS TOTAL SOURCES OF FUNDS

10800 137550

USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) 64350 DIVIDENDS PAID TO SHAREHOLDERS 22575 CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGES IN WORKING CAPITAL: INCREASE IN CASH INCREASE IN A/RECEIVABLES INCREASE IN INVENTORIES INCREASE IN SHORT TERM SECURITIES INCREASE IN PREPAID EXPENSES DECREASE IN A/PAYABLE

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3375 675

86925

DECREASE IN TAXES PAYABLE DECREASE IN NOTES PAYABLE DECREASE ACCRUED EXPENSE/ OTHER LIABILITIES

13950 10125 22500

TOTAL USES OF SHORT-TERM FUNDS TOTAL USES OF FUNDS

50625 137550

Sources and Uses of Funds Company: Hexza Inc. Summary of Funds Flow Statement (WORKING CAPITAL BASIS) For the Year Ending December 31, 2015 (RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) 30000 DEPRECIATION 19800 TOTAL FUNDS FROM OPERATIONS PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK 72000 NEW PAID IN CAPITAL 4950 TOTAL SOURCES OF LONG TERM FUNDS TOTAL SOURCES OF FUNDS

49800

76950 126750

USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) 64350 22575 DIVIDENDS PAID TO SHAREHOLDERS CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGE IN NET WORKING CAPITAL TOTAL USES OF FUNDS

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86925 39825 126750

Prepare a Statement of Sources and Uses of funds, ending 31 December 2019 on a cash basis and working capital basis.

Sri Mutiara Company Consolidated Balance Sheet (RM „000)

Cash Accounts receivable Inventory Prepaid expenses Fixed assets Less: Accumulated Depreciation Patents Total assets Accounts payable Taxes payable Mortgages Preferred shares Paid in capital Common stock Retained earnings Total liabilities and Equity Net income

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2019 82.5 90.0

2018 75.0 102.0

165.0 13.5

168.0 12.0

468.0 129.0

325.5 94.5

52.5 742.5 112.5

61.5 649.5 65.6

105.0

92.0

225.0

56.9 150.0

6.0 225.0

10.0 225.0

69.0

50.0

742.5

649.5

34.5

Sources and Uses of Funds Company: ………………………… Balance Sheet Analysis for Funds Flow Statement (thousands of RM) ASSETS 20….. 20….. Changes Changes Sources Direction in amount CASH PATENTS ACCOUNT RECEIVABLES/DEBTORS INVENTORIES PREPAID EXPENSES NET FIXED ASSET=GROSS FIXED ASSET- DEPRECIATION CHANGES IN ACCUMULATION DEPRECIATION= DEP1-DEP0 = NET CAPITAL EXPENDITURES (NCE)= NET FIXED ASSET1-NET FIXED ASSET0+DEP1 = TOTAL ASSETS CLAIMS ON ASSETS ACCOUNT PAYABLE TAXES PAYABLE NOTES PAYABLE OTHER CURRENT LIABILITIES EQUITY: LONG TERM DEBT PREFERRED STOCK COMMON STOCK PAID IN CAPITAL RETAINED EARNINGS TOTAL EQUITY AND LIBILITIES DIVIDEND PAYMENT= EAT @ NET INCOME- CHANGES IN R/E = CHANGE IN NET WORKING CAPITAL= NWC1 – NWC0 = (CA1-CL1)-(CA0-CL0) =

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Uses

Sources and Uses of Funds Company: ………………………… Funds Flow Statement (CASH BASIS) For the Year Ending December 31, 20……(IN Thousands of RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) DEPRECIATION TOTAL FUNDS FROM OPERATIONS PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL SOURCES OF LONG TERM FUNDS PROCEED FROM CHANGES IN WORKING CAPITAL: DECREASE IN CASH DECREASE IN A/RECEIVABLES DECREASE IN INVENTORIES SALE/DECREASE IN SHORT TERM SECURITIES DECREASE IN PREPAID EXPENSES INCREASE IN A/PAYABLE INCREASE IN TAXES PAYABLE INCREASE IN NOTES PAYABLE INCREASE ACCRUED EXPENSE/ OTHER LIABILITIES TOTAL SOURCES OF SHORT-TERM FUNDS TOTAL SOURCES OF FUNDS USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) DIVIDENDS PAID TO SHAREHOLDERS CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGES IN WORKING CAPITAL: INCREASE IN CASH INCREASE IN A/RECEIVABLES INCREASE IN INVENTORIES INCREASE IN SHORT TERM SECURITIES INCREASE IN PREPAID EXPENSES DECREASE IN A/PAYABLE

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DECREASE IN TAXES PAYABLE DECREASE IN NOTES PAYABLE DECREASE ACCRUED EXPENSE/ OTHER LIABILITIES TOTAL USES OF SHORT-TERM FUNDS TOTAL USES OF FUNDS

Sources and Uses of Funds Company: ………………………… Summary of Funds Flow Statement (WORKING CAPITAL BASIS) For the Year Ending December 31, 20……(IN Thousands of RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) DEPRECIATION TOTAL FUNDS FROM OPERATIONS PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL SOURCES OF LONG TERM FUNDS TOTAL SOURCES OF FUNDS USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) DIVIDENDS PAID TO SHAREHOLDERS CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGE IN NET WORKING CAPITAL TOTAL USES OF FUNDS

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ALA Inc.: Income Statements (thousands of RM

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Sources and Uses of Funds Company: ………………………… Balance Sheet Analysis for Funds Flow Statement (thousands of RM) ASSETS 20….. 20….. Changes Changes Sources Direction in amount CASH PATENTS ACCOUNT RECEIVABLES/DEBTORS INVENTORIES PREPAID EXPENSES NET FIXED ASSET=GROSS FIXED ASSET- DEPRECIATION CHANGES IN ACCUMULATION DEPRECIATION= DEP1-DEP0 = NET CAPITAL EXPENDITURES (NCE)= NET FIXED ASSET1-NET FIXED ASSET0+DEP1 = TOTAL ASSETS CLAIMS ON ASSETS ACCOUNT PAYABLE TAXES PAYABLE NOTES PAYABLE OTHER CURRENT LIABILITIES EQUITY: LONG TERM DEBT PREFERRED STOCK COMMON STOCK PAID IN CAPITAL RETAINED EARNINGS TOTAL EQUITY AND LIBILITIES DIVIDEND PAYMENT= EAT @ NET INCOME- CHANGES IN R/E = CHANGE IN NET WORKING CAPITAL= NWC1 – NWC0 = (CA1-CL1)-(CA0-CL0) =

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Uses

Sources and Uses of Funds Company: ………………………… Funds Flow Statement (CASH BASIS) For the Year Ending December 31, 20……(IN Thousands of RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) DEPRECIATION TOTAL FUNDS FROM OPERATIONS PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL SOURCES OF LONG TERM FUNDS PROCEED FROM CHANGES IN WORKING CAPITAL: DECREASE IN CASH DECREASE IN A/RECEIVABLES DECREASE IN INVENTORIES SALE/DECREASE IN SHORT TERM SECURITIES DECREASE IN PREPAID EXPENSES INCREASE IN A/PAYABLE INCREASE IN TAXES PAYABLE INCREASE IN NOTES PAYABLE INCREASE ACCRUED EXPENSE/ OTHER LIABILITIES TOTAL SOURCES OF SHORT-TERM FUNDS TOTAL SOURCES OF FUNDS USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) DIVIDENDS PAID TO SHAREHOLDERS CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGES IN WORKING CAPITAL: INCREASE IN CASH INCREASE IN A/RECEIVABLES INCREASE IN INVENTORIES INCREASE IN SHORT TERM SECURITIES INCREASE IN PREPAID EXPENSES DECREASE IN A/PAYABLE

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DECREASE IN TAXES PAYABLE DECREASE IN NOTES PAYABLE DECREASE ACCRUED EXPENSE/ OTHER LIABILITIES TOTAL USES OF SHORT-TERM FUNDS TOTAL USES OF FUNDS

Sources and Uses of Funds Company: ………………………… Summary of Funds Flow Statement (WORKING CAPITAL BASIS) For the Year Ending December 31, 20……(IN Thousands of RM) SOURCES OF FUNDS FUNDS FROM OPERATIONS: EARNINGS AFTER TAX(EAT) DEPRECIATION TOTAL FUNDS FROM OPERATIONS PROCEED FROM THE SALE OF: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL SOURCES OF LONG TERM FUNDS TOTAL SOURCES OF FUNDS USES OF FUNDS LONG-TERM USES OF FUNDS: NET CAPITAL EXPENDITURES(NCE) DIVIDENDS PAID TO SHAREHOLDERS CHANGES IN EQUITY: NEW LONG TERM DEBT NEW COMMON STOCK NEW PREFERRED STOCK NEW PAID IN CAPITAL TOTAL USES OF LONG TERM FUNDS CHANGE IN NET WORKING CAPITAL TOTAL USES OF FUNDS

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Market and Per Share Data Shares outstanding Closing market price on Dec. 31,

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2014 165,000 RM12.00

2015 315,000 RM13.50

Current ratio It shows a firm’s ability to cover its current liabilities with its current assets. CR = Current assets Current liabilities

Quick ratio It shows a firm‟s ability to meet current liabilities with its most liquid assets. Ratio of less than one is common, and should not cause an alarm because not all current liabilities are due at once. QR = (Current assets – Inventory) Current liabilities

Net Working Capital the absolute measure of the firm's liquidity. This is because it measures solvency in terms of Ringgit and not ratio. In addition, positive NWC indicates the amount of current assets that are financed with long-term financing. On the other hand, if the NWC is negative, it represents the amount of fixed assets that are financed with current liabilities. NWC = Current assets – Current liabilities

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Inventory Turnover ITO measures how effectively the firm is using its inventory to generate sales. Low ITO ratio indicates that the firm is holding excess and unproductive stocks, or that it has a very high sales service level to avoid out of stock. This is a low risk strategy as there is a low chance of stock out to meet the production and sales need. ITO = Cost of good sold (COGS) Inventory

Total assets turnover It shows the firm‟s effectiveness of total assets to generate sales. Similar to TATO, higher ratio is preferable. TATO = Net sales Total assets

Fixed assets turnover It shows the firm’s effectiveness of fixed assets to generate sales. Higher ratio is better as it indicates that more revenues can be generated per Ringgit of investment in fixed asset. FATO = Net sales Net fixed assets

Average collection period It shows the firm’s indication on problem towards collecting debt. Shorter period is preferred as the cash cycle is lower and more cash is available in the company to meet cash requirements. ACP = Accounts Receivable (360) Net sales

Debt ratio It shows the firm‟s higher amount of debt to finance assets. Higher ratio, normally indicates higher financial risk, and vices versa. Total debt is defined as total liabilities plus long term debt. DR = Total debt Total assets

Debt to Equity Ratio (DER). It is a measure the relative funds provided by creditors as compared to owners or net worth in the firm‟s capital structure. Net worth is defined as total assets minus total debt minus preferred stock. A ratio of more than one, indicates that creditors provided more funds compared to owners. On the other hand, a less than one ratio indicates more funds provided by owners. DER = Long-term debt Net worth

Times Interest Earned (TIE). It shows the firm‟s ability to meet loan requirement and lower risk of default. Note that this measure does not consider either lease payments or the repayment of principal on loans. TIE = Earnings before Interest and taxes (EBIT) Interest

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Gross Profit Margin (GPM). This measures the firm's ability to control cost of goods sold relative to its sales revenue; the relative contribution margin from sales. GPM = Gross profit Net sales

Operating Profit Margin (OPM). It is also known as basic earnings power ratio. OPM measures the productivity of assets in providing returns to both creditors and stockholders. Higher ratio indicates better productivity. OPM = Earnings before interest and taxes (EBIT) Total assets

Net Profit Margin (NPM). It shows the firm‟s ability to indicate better income to shareholders. The ability of the firm to get higher returns indicates a better growth prospect, and therefore higher margin is preferable. NPM = Earnings after tax (EAT) Net sales

Return on Total Assets (ROA). This ratio measures a firm's overall return on all of its assets investment. ROA indicates the productivity of assets in producing revenues and the firm's ability to control costs in its operations. Therefore, higher ratio is better. ROA = Earnings after tax (EAT) Total assets

Return on Common Equity (ROE). It shows the firm‟s ability to indicate higher return to shareholder. Higher return is better as it indicates higher return for the owners of the firm. ROE = Earning after tax (EAT) Net worth

Higher earning is better as it indicates better performance for the firm

Higher price to earning is better as it indicates better performance for firm

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You are required to: a. Calculate the relevant ratios as indicated above. b. Comment on the performance of the company based on your calculations in (a). c. State two limitations in using financial ratios analysis. Solution (Please provide the answers in the table below):

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Current ratio CR = Current assets Current liabilities

Quick ratio QR = (Current assets – Inventory) Current liabilities
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