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Managerial Finance

Program Magister Manajemen Universitas Gunadarma

Manajemen Keuangan
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Refferences: Principles of Managerial Finance, Lawrence J. Gitman, Harper Collins Publishers

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Managerial Finance

Chapter 1

The Role of Finance and The Financial Manager

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The Role of Finance and The Financial Manager Finance? The art and Science of managing money Concerned with the process, institution, markets, and instrument involved in the transfer of money among and between individuals, businesses, and governments Financial Services
Areas& Opportunities? The area of finance concerned with the design and delivery of advice and financial product to individual, business, and governments

Managerial Finance
concerned with the duties of the financial manager in the business firm.
Financial forecasting Cash management Credit administration Investment Analysis Funds procurement
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Actively manage the financial affairs of many tipes of business- financial and nonfinancial, private and public, large and small, profit-seeking and not-for-profit
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Basic Forms Of Business Organization

Sole Proprietorship

A Business owned by one person and operated for his or her own profit
Small firm, unlimited liability


A Business owned by two or more persons and operated for profit

Written contract (article of partnership), unlimited liability, Limited partership


An Intangible business entity created by law (often called a legal entity)

Stockholders, board of directors, Chief executive officer (CEO)

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Basic Forms Of Business Organization

Legal Form
Sole Propriatorship
Owner receives all profits (as well as losses) Low organizationak costs Income taxed as personnel income of proprietor Secrecy Ease of dissolution

Can raise more more funds than sole proprietorships Borrowing power enhanced by more owners More available brain power and managerial skill Can retain good employees Income taxed as personnel income of partners

Owners have limited liability which guarantees they cannot lose more than invested Can achieve large size due to marketability of stock (ownership) Ownership is readily transferable Long-life of firm- not dissolved by detah of owners Can hire professional managers Can expand more easily due to access to capital markets Receives certain tax advantages Taxes generally higher since corporate income is taxed and dividends paid to owners ara again taxed More expensive to organize than other business forms Subject to greater government regualation Employees often lack personnel interest in firm Lack secrecy since stockholders must receive financial reports

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Strength Weaknesses

Owner has unlimited liabilitytotal wealth can be taken to satisfy debts Limited fund-raising power tends to inhibit growth Propietor must be jack-of-alltrades Difficult to give employees long run career opportunity Lacks continuity when propitor dies

Owners have unlimited liability and may have to covers debts of other less financially sound partners When a aparter dies, partership is dissolved Difficul to liquidate or transfer partership Difficult to achieve largescale operations

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Managerial Finance

The Managerial Finance Function

Since most business decisions are measured in financial terms, the financial manager plays a key role in the operation of the firm

Managerial Finance is closely related to, but quite different from, Economics and Accounting

Organizational View
The size and importance of the managerial finance depend on the size of the firm In small firm the finance function generally performed by the accounting department In medium-to-large-size firm
Financia Separate department, vice-president of finance (CFO), l Treasurer, Controller Manage r The officer responsible for the firms financial activities: financial The officer responsible for the firm planning and fund raising, managing cash, making capital accounting activities: tax management, data expenditure decision, managing credit activities and managing processing, and cost and financial the investment portfolio accounting
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Managerial Finance

The Managerial Finance Function Relationship to Economics

The Financial Manager must understand the economic framework, and be alert to the consequences of varying levels of economic activity and changes in

economic policy

Supply-demand analysis Profit-Maximazing strategies Price Theory

Must be able to use economic theories as guidelines for efficient busineness operation

Marginal Analysis

Economic principle which states that financial decisions should be made and actions taken only when the added benefit exceed the added costs


Benefits with new computer Less: Benefits with old computer (1) Marginal (Added) benefits

$100.000 35.000 $65.000

Cost of new computer $80.000 Less: Proceeds from sale of old com 28.000 (2) Marginal (added) costs $52.000 Net Benefit [(1) (2)]
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Managerial Finance

The Managerial Finance Function Relationship to Accounting

The finance and accounting function are closely related and generally overlap; indeed, managerial finance and accounting are not often easily distinguishable. In smal firm the controller often carries out of the finance function, and in large firms many accountants are intimately involved in various finance activities
Two Basic Differences Emphasis of cash flows

Decision Making

Accrual Method


Cash Method

Recognizes revenue at the point of sale and recognized expenses when incurred
Accounting View

Recognized revenues and expenses only with respect to actual inflow and outflows of cash
Financial View

The accountant devotes the majority of attention to the collection and presentation of financial data The financial manager evaluates the accountants statements, develops additional data, and makes decisions based on subsequent analyses This does not mean that accountant never make decision, or that financial manager never gather data
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Income statement ABC Corporation For the year xxxx Sales Revenue Less: Costs Net Profit
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Income statement ABC Corporation For the year xxxx Cash inflow $ 0 Less: Cash Outflow 80.000 Net Profit ($80.000)

$100.000 80.000 $ 20.000

The Managerial Finance Function

Key Activities of The Financial Manager Primary Activities Performing Financial Analysis and Planning
1. Transforming financial data into a form that can be used to monitor the firms financial condition Evaluating the need for increased (or reduced) productive capacity Determining what additional (or reduced) financing is required

Managerial Finance

Performing Financial Analysis and Planning Balance Sheet Making Investment Decision Making Financing Decision

2. 3.

Making Investment Decisions

Determine both the mix and the type of assets found on the firms balance sheet The left-hand side of the balance sheet

Current Assets

Current Liabilities

Fixed Assets

Long-Term Funds

Making Financing Decision

Deals with The right-hand side of the balance sheet and involves two major area: 1. Most appropriate mix of short-term and longterm financing must be established 2. Which individual short-term or long-term sources of financing are the best at given point in time
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The Managerial Finance Function

Goal of The Financial Manager

Managerial Finance

Maximize Profit? Some pepople believe that the owners objective is always to maximize profits The Financial Manager are expected to make a major contribution to the firms overall profit For Corporation, profit are commonly measured in terms of Earnings per Share (EPS) EPS: The amount earned during the period on each outstanding share of common stock

periods total earnings avaliable for the firms common stock holders The number of shares of common stock outstanding

Earning per share (EPS) Investment year 1 year 2 year 3 total


$1.40 0.60

$1.00 1.00

$0.40 1.40

The chance that actual outcomes $2.80 3.00 may differs from those expected Basic primises in managerial finance is that trade-off exist between return (cash flow) and risk Return and risk are in fact the key determinant of share price which represents the wealth of the owners in the firm
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Profit maximization fails for reason: 1. Timing of return 2. Cashflow avaliable to stockholder 3. Risk
Stockholder are risk-averse ?
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Managerial Finance

The Managerial Finance Function

Goal of The Financial Manager Maximizing Shareholder Wealth

The goal of the financial manager is to maximize the wealth of the owners for whom the firm is being managed
Timing of return (cash flow)
Measured by the share price of the stock

magnitude Risk

Financial decisions and share price

Financial Manager

Financial Decision Alternative or action

Return? Risk?

Increase Share Price ?




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The Managerial Finance Function

Goal of The Financial Manager The Agency Issue

The goal of the financial manager should be to maximize the wealth of the owners of the firm

Management can be viewed as agents of the owners who have hired them and given them decision-making authority to manage the firm for the owners benefit
In practise However, managers also concern with their personnel wealth, job security, lifestyle, and privilege

In theory Most financial managers would agree with the goal of owner wealth maximization Agency problem The likelihood that managers may place personnel goals ahead of corporate goals

To prevent or minimize problem

Agency Cost Monitoring expenditure Bonding expenditure Structuring expenditure Opportunity cost

Audit&control Fidelity bond Managerial compensation: stock option, performance share, cash bonuses
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The Managerial Finance Function

Goal of The Financial Manager The Role of Ethics

Ethics Standard of conduct or moral judgement Corporate Ethics and Policies Guidelines


Responsibility Fairness Transparency

Ethics and share price

Issues Update

Accountability Good Corporate Governance

Corporate Social Responsibility

Certified Financial Analyst
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Managerial Finance

Chapter 2

The Operating Environment of The Firm

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Business Taxation
Ordinary Income

Income earned through the sale of a firms goods and services

Corporate Tax Rate Schedule Tax Calculation Range of taxable income $ 0 to $ 50.000 50.000 to 75.000 75.000 to 100.000 100.000 to 335.000 over $335.000 Example PT X has before-tax earnings of $250.000 Total Tax due = $22.250 + [0.39 x ($250.000-100.000)] = $22.250 + (0.39 x $150.000) = $22.250 + $58.500 = $80.750 Base Tax $ 0 7.500 13.750 22.250 113.900 + + + + + + (rate x amount over base bracket) (15% x Amount over $ 0) (25 x Amount over 50.000) (34 x Amount over 75.000) (39 x Amount over 100.000) (34 x Amount over 335.000)

Indonesia ?
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Business Taxation
Ordinary Income Average Tax Rates

A Firms taxes divided by its taxable income

Average tax rate ranges from 15 to 34%, reaching 34% when taxable income $335.000
Average tax rate for PT X = $80.750 / $250.000 = 32.3%

Pretax Income (1) $ 50.000 75.000 100.000 200.000 335.000 500.000 1.000.000 2.500.000

Tax Liability (2) $ 7.500 13.750 22.250 61.250 113.900 170.000 340.000 850.000

Average Tax rate [(2) : (1)] (3) 15.00% 18.33% 22.25% 30.63% 34.00% 34.00% 34.00% 34.00%

Marginal Tax Income

The rate at which additional income is taxed

If PT Xs earnings go up to %300.000, the marginal tax rate on the additional $50.000 of income will be 39%. The company will therefore have to pay additional taxes of $19.500 (0.39 x $50.000)

Total Taxes on the $300.000

= $80.750+$19.500 = $100.250

Using Taxe rate schedule: Total Taxes = $22.250+[0.39x($300.000 - $100.000)] = $22.250+$78.000 =$100.250
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Business Taxation
Ordinary Income Interest and Dividend Income

Managerial Finance


received by corporation is included



ordinary income

Devidend received on common and preferred stock held in other corporation, and representing less than 20% ownership in them, on the other hand, are subject to a 70% exclusion for tax puposes

Only 30% of these intercorporate dividends are included as ordinary income Avoid triple taxation

Example Charnes Industries received $100.000 interest on bonds it held and $100.000 in dividends on common stock it owned in other corporation. The firm is subject to a 40% marginaltax rate and is eligible for 70% exclusion on its intercorporate dividend receipts Interest Income (1) Before-tax amount Less: Applicable Exclusion
Dividend Income

$100.000 $100.000 0 (0,70x$100.000) = 70.000 $100.000 40.000 $ 60.000 $ 30.000 12.000 $ 88.000

Taxable amount (2) Tax (40%)

After-tax amount (1)-(2)

Indonesia ?
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Business Taxation
Ordinary Income Tax-Deductible Expenses Corporation are allowed to deducti operating expenses. The taxdeductible expenses reduces their after-tax cost. Advertising expenses Sales commision Bad debt Interest expenses Example

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Company X and Y each expect in the coming year to have earnings before interest and taxes of $200.000. Company X during the year will have to pay $30.000 in interest; Company Y has no debt and therefore will have no interest expenses. Calculate the earnings after taxes for these two firm, which pay 40% tax on ordinary income

Interest Income Earning before interest&tax Less: Interest expenses Earnings before tax Less: Taxes (40%) Earnings after taxes Difference in earning after taxes $200.000 30.000 $170.000 68.000 $ 102.000

Dividend Income

$200.000 0 $200.000 80.000 $120.000


Dividends are not tax-deductible expense

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Business Taxation
Capital Gains Amount by which the price at which an asset was sold exceeds the assets initial purchase price For corporation, capital gain are added to ordinary corporate income and taxed at the regular corporate rates Example

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The Ross Company earnings of $500.000 sold for $40.000 a initially purchased two $36.000.

has operating and hast just capital asset years ago for

Since the asset was sold for more than its initial purchased, there is capital gain of $4000

($40.000 sale price - $36.000 initial purchase price)

The corporations $504.000 taxable income will total

($500.000 ordinary income plus $4.000 capital gain) Since this total is above$335.000, the capital gain will be taxed at the 34%, resulting in tax of $1.360 (0,34 x $4000)

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Financial Institutions and Markets: An Overview Financial institutions and markets are important elements in a firms operating environment

Firms that require funds from external sources can obtain them in three ways
Financial Institution That accept savings and transfers them to those

needing funds
Financial Market Organized forum where the suppliers and demanders of various type of funds can make transaction Private placement

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Financial Institutions and Markets: An Overview

Financial Institution
An intermediary that channels the savings of individuals, businesses, and governments into loans or

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Major Financial Institutions

USA Commercial Bank
Accepts both demand (checking) and time (savings) deposits. Makes loans directly to borrowers or through the financial market

Indonesia Bank Umum BPR Asuransi Dana Pensiun Reksa dana Modal Ventura Anjak-Piutang Sewa guna usaha

Savings Bank
Not hold demand (checking) deposits. Generally lends or invest funds through financial markets

Savings and Loan

Similar to a saving bank. Also raise capital through the sale of securities. Lends funds for real estate mortgage loans and some funds are channeled into financial market

Credit Union
Deals primarily in transfer of funds between consumers. Accept members deposit and lends to other members

Life Insurance Company

Receive premium payments that are placed in invesments to accumulate funds to cover future benefit payment

Pension Fund
Money is sometimes transferred directly to borrowers, but the majority is lent or invested via the financial markets

Mutual Fund
Pools funds of savers and makes them available to business and government demanders. Creates a portfolio of securities to achieve a specified investment objective
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Financial Institutions and Markets: An Overview

Financial Markets

Provide a forum in which suppliers of funds and demanders of loans and investments can transact business directly

Money Market Transactions in short-term debt instruments, or marketable securities, take place in the money market Capital Market

Long-term securities (bonds and stocks) are

traded in the capital market Primary market

Financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction
Secondary Market

Financial market in which preowned securities (those that are not new issues) are traded
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Financial Institutions and Markets: An Overview

Financial Markets Flow of funds for financial institutions and market

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Funds Deposits/Shares
Financial Institutions

Funds Loans


Suppliers of Funds



Private Placement Securities

Demanders of Funds

Funds Securities
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Financial Markets

Funds Securities
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Financial Institutions and Markets: An Overview

The Money Market

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A financial relationship created between suppliers and demanders of short-term funds, which have maturities of one year or less
Certain individuals, businesses, governments, and financial institution have temporary idle funds that they wish to place in some type of liquid asset or shortterm, interest earning instrument
Money Market exists

Other individuals, businesses, gevernments, and financial institution find themselves in need of seasonal or temporary financing

Most money market transactions are made in marketable securities Short-term debt instruments, such as US Treasury Bill, Commercial Papers, and Negotiables Certificate of Deposits issued by government, business, and financial institution Indonesia?

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Financial Institutions and Markets: An Overview

The Capital Market

Managerial Finance

A financial relationship created by institutions and arrangements that allows suppliers and demanders of long-term funds- funds with maturiry of more than one year- to make transactions. The backbone of the capital market is formed by the various securities exchange that provide a forum for debt and and equity transaction Key Securities

Bond Long-term debt instrument used by business and governments to raise large sums of money Common stock Units of ownership interest, or equity. In a corporation

Common stockholders expect to earn a return by receiving Dividend

Periodic distribution of earnings to the owners of stock in a firm Preferred stock A special form of ownership having a fixed periodic dividend that must be paid prior to payment of any common stock dividends
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Financial Institutions and Markets: An Overview

The Capital Market

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Major Securities Exchange

Provide the marketplace in which firms can raise funds through the sale of new securities and in which purchasers can resell securities 1. Organized Securities Exchanges Tangible organozations on whose premises outstanding securities are resold
New York Stock Exchange (NYSE)

To make transaction on the floor, individual or firm must own a seat on the exchange For listing, a firm must file an application and meet a number requirements
Have at least 2000 stockholders with 100 shares Min 1,1 million share of publicly held stock Earning power of $2,5 million before taxes Net tangible asset of $16 million A total of $18 million in market value of publicly traded shares, etc Jakarta Stock Exchange (JSX)

Persyaratan listing?

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Financial Institutions and Markets: An Overview

The Capital Market

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Major Securities Exchange

2. The-Over-the-Counter Exchange (OTC) Not an organization, but an intangible market for the purchase and sale of securities not listed by the organized exchange The market price of OTC securities results from a matching of the forces of supply and demand for securities by traders known as dealer
National Association of Securities Dealers Automated Quotation (NASDAQ)

Sophisticated telecommunications system that provide current bid and ask prices on thousands of actively traded

The bid price is the highest price offered by dealer to purchase a given security

Automated matched

The ask price is the lowest price at which the dealer is willing to sell the security

Jakarta Automated Trading System (JATS) ?

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Managerial Finance

Interest Rates and Required Return

Interest rates and required returns represent the costs of obtaining various forms of financing

The level of funds flow between suppliers and demanders can significantly affect economic growth

Growth results from the interaction of variety of economic factors, such as the money supply, trade balance, and economic policy, that affect the cost of money the interest rate or required return

The level of interest rate acts as regulating device that controls the flow of funds

The lower the interest rate, the greater the funds flow and therefore the greater the economic growth, and vice versa

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Interest Rates and Required Return

Interest Rate Fundamentals Interest rate

Managerial Finance Rate that creates an equilibrium between the supply of savings and the demand for investments funds in perfect world, without inflation, where funds suppliers and demanders have no liquidity preferences, and all outcomes are certain

The compensation paid by the borrower of funds to the lender; from the borrowers point of view, the cost of borrowing funds
Required Return

The level of return expected on equity investment

D So

Ignoring risk factors, the nominal or actual interest rate (cost of funds) results from the real rate of interest adjusted for inflationary expectation and liquidity preferences

General investors securities

preferences of for shorter-term

Real Rate of Interest

ko* k1* So S1 D So=D S1=D

The required return on a risk-free asset, tipically a three-month US Treasury Bill (Obligasi Pemerintah)

The actual rate of interest chargeb by the supplier of funds and paid by demander

k1= k* + IE + IC1 k1= RF + IC1

Risk-free rate Risk Premium

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Funds supplied/demanded

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Interest Rates and Required Return

Term Structure of Interest Rates

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The relationship between the interest rate or rate of return and the time to maturity
Yield to maturity Annual rate of interest earned on a security purchased on a given day and held to maturity Yield Curve A Graph that depicts the relationship between the yield to maturity (y-axis) and the time to maturity (x-axis)

Inverted Yield Curve A Downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs
15 14 13 May 22, 1981

10 9 8 7

October 30, 1987

September 29, 1989

It reflects similar borrowing costs for both short- and longer-term loans






Normal Yield Curve An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-termborrowing costs
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Interest Rates and Required Return

Term Structure of Interest Rates Theory of Term Structure 1. Expectation Hypothesis Theory suggesting that the yield curve reflects investor expectations about future interest rates; an increasing inflation expectation results in upward-sloping yield curve, and vice versa 2. Liquidity Preference Theory Theory suggesting that for any given issuer, longterm interest rates tend to be higher than sortterm rates due to the lower liquidity and higher responsiveness to general interest rate movements of longer term securities; causes the yield curve to be upward-sloping 3. Market Segmentation Theory Theory suggesting that the market for loans is segmented based on maturity and that the sources of supply and demand for loans, within each segment, determine its prevailing interest rate; the slope of yield curve is determines by the geberal relationship between the prevailing rates in each segment
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Managerial Finance

Nominal interest Rate, RFt Maturity, t 3 Months 1 years (1) 5,17% 6,51 8,38 9,05 Real interest Rate, k* (2) 2,00% 2,00 2,00 2,00 Inflation Expectation, IEt

[(1) - (2)]
3,17% 4,51 6,38 7,05

5 years
30 years

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Interest Rates and Required Return

Term Structure of Interest Rates Risk and Return Risk-Return Trade-off The expectation that for accepting greater risk, investors must be compensated with greater returns

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Speculative Common Stocks Qualtiy Common Stocks Preferred Stocks Annual Return (cost to issuer) Medium-Grade Bonds Investment-Grade Bonds Investment-Grade Notes Prime-Grade Commercial Paper US Treasury Bills

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Managerial Finance

Chapter 3

Financial Statement

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The Stockholders Report

Managerial Finance

A Stockholders report summarizes and documents a publicly held corporations financial activities over the year. Who receives theses reports? What types of informastion do you think they typically include? Why are they important?
1. 2. 3. 4. Regulator or Goverments Creditor (lenders) Owners Management




The letter to stockholders Events, management philosophy, strategy, and action Financial statements (a) the income statemnet, (b) the balance sheet, (c) the statement of retained earnings, and (d) the statements of cash flows Other feature Firm activities, new product, R&D, etc

An important vehicle for influencing owners perceptions of the company and its future outlook. The stockholders report may effect expected risk, return, stock price, and the viability of the firm

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Basic Financial Statements

Income Statement

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Provide a financial summary of the operating results during a specified period

ABC Corporation Income Statement ($000) for the year Ended December 31, 2000
Sales revenue Less: Cost of goods sold Gross profits Less: Operating expenses Selling expense General and administrative expense Depreciation expense Total operating expense Operating profits Less: Interest expense Net profits before taxes $ 1.700 1.000 $ 700 $ 80 150 100 $ $ $ $ $ 330 370 70 300 120 180 10 170 1,70

Less: Taxes (rate = 40%) Net profits after taxes Less: Prefered stock dividends Earning available for common stockholders Earning per share (EPS)

The number of common stock= 100.000

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Basic Financial Statements

Balance Sheet Summary statement of the firms financial position at given point in time ABC Corporation Balance Sheets ($000)
December 31

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Current assets Cash Marketable securities Account receivable Inventories Total current assets Gross fixed assets (at cost) Land and buildings Machinery and equipment Furniture and fixtures Vehicles Other Total gross fixed assets (at cost) Less: Accumulated depriciation Net fixed assets Total assets

2000 $ 400 600 400 600 $ 2000 $ 1200 850 300 100 50 $ 2500 1300 $ 1200 $ 3200 $

2001 300 200 500 900 $ 1900 $ 1050 800 220 80 50 $ 2200 1200 $ 1000 $ 2900

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Basic Financial Statements

Balance Sheet Summary statement of the firms financial position at given point in time ABC Corporation Balance Sheets ($000)

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December 31

Liabilities and stockholders equity

Current liabilities Accounts payable Notes payable Accruals Total current liabilities Long-term debt Total liabilities Stockholders equity Preferred stock Common stock- $1,20 par, 100000 shares outstanding in 2000&2001 Paid in capital in excess of par on common stock Retained earnings Total stockholders equity Total liabilities and stockholders equity

2000 $ 700 600 100 $ 1400 $ 600 $ 2000 $ 100 120 380 600 $ 1200 $ 3200 $

2001 500 700 200 $ 1400 $ 400 $ 1800 100 120 380 500 $ 1100 $ 2900

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Basic Financial Statements

Statement of Retained Earning

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Reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and end of that year

ABC Corporation Statement of Retained Earnings ($000) for the end year Ended December, 2001 Retained earnings balance (january 1, 2001) Plus: Net Profit after taxes (for 2001) Less: Cash dividend (paid during 2001) Preferred stock Common stock Retanined earnings balance (Dec 31, 2001) $500 180

($10) ( 70)

80 $600

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Basic Financial Statements

Statement of Cash Flows

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Provides a summary of the firms operating, investment, and financing cash flows, and reconciles them with changes in its cash and marketable securities during the period of concern
ABC Corporation Statement of Cash Flows ($000) for the end year Ended December, 2001 Cash Flow from Operating Activities Net Profits after taxes $ 180 Depreciation 100 Decrease in account receivable 100 Decrease in inventories 300 Increase in account payable 200 Decrease in accruals (100) Cash provided by operating Cash Flow from investment activities Increase in gross fixed asset ($300) Changes in business interest 0 Cash used for investment activities Cash Flow from financing Activities Decrease in notes payable ($100) Increase in long-term debts 200 Changes in stockholders equity 0 Dividends paid (80) Cash provided by financing activities Net increase in cash and marketable securities
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20 $500

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