FINANCIAL MANAGEMENT

Financial Management

VYSOK? SKOLA POLYTECHNICK? JIHLAVA

Katedra ekonomiky a managementu

FINANCIAL MANAGEMENT

2ND EDITION

Ing. Petr Ji?cek Mgr. Zdeka Dost?lov?

Z?? 2010

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CONTENTS

PREFACE ........................................................................................................................................................ 4

1 INTRODUCTION TO FINANCE ........................................................................................................ 5

1.1 TIME VALUE OF MONEY.................................................................................................................. 5 1.2 INTEREST......................................................................................................................................... 6 1.3 ANNUITY ......................................................................................................................................... 7 1.4 PRACTICAL EXAMPLE...................................................................................................................... 8 1.5 KEY TERMS OF THE THEME ............................................................................................................. 9

2 PROPERTY AND FINANCIAL STRUCTURE OF A COMPANY ............................................... 10

2.1 THE PROPERTY OF A COMPANY AND ITS FINANCING ..................................................................... 10

2.2

BALANCE SHEET - DEPICTION OF PROPERTY AND FINANCIAL STRUCTURE ................................... 12

2.3 PRACTICAL EXAMPLE.................................................................................................................... 13

2.4 KEY TERMS OF THE THEME ........................................................................................................... 14

3 FINANCIAL MANAGEMENT OF THE COMPANY..................................................................... 15

3.1 THE ROLE OF A FINANCIAL MANAGER IN A COMPANY.................................................................. 15 3.2 THE THEORETICAL CONCEPT OF LIQUIDITY .................................................................................. 16 3.3 WORKING CAPITAL MANAGEMENT............................................................................................... 16 3.4 PRACTICAL EXAMPLE.................................................................................................................... 17 3.5 KEY TERMS OF THE THEME ........................................................................................................... 20

4 RECEIVABLES MANAGEMENT .................................................................................................... 21

4.1 TRADE CREDIT AND INVOICE ........................................................................................................ 21 4.2 RECEIVABLES ................................................................................................................................ 21 4.3 PRACTICAL EXAMPLE.................................................................................................................... 22 4.4 KEY TERMS OF THE THEME ........................................................................................................... 26

5 SHORT-TERM FINANCING............................................................................................................. 27

5.1 SOURCES OF SHORT-TERM FINANCING .......................................................................................... 27 5.2 THE BILL TERMS ........................................................................................................................... 27 5.3 DISCOUNT CREDIT......................................................................................................................... 28 5.4 PRACTICAL EXAMPLE.................................................................................................................... 29 5.5 KEY TERMS OF THE THEME............................................................................................................ 30

6 BANK LOANS ..................................................................................................................................... 31

6.1 BANK LOAN ? A SOURCE OF FINANCING ...................................................................................... 31 6.2 THE LOAN INTEREST ..................................................................................................................... 32 6.3 PRACTICAL EXAMPLE.................................................................................................................... 33 6.4 KEY TERMS OF THE THEME ........................................................................................................... 35

7 LEASING, FACTORING, FORFEITING ........................................................................................ 36

7.1 LEASING AND ITS COMPARISON WITH CREDIT............................................................................... 36 7.2 FACTORING AND FORFEITING ....................................................................................................... 37 7.3 PRACTICAL EXAMPLE.................................................................................................................... 37 7.4 KEY TERMS OF THE THEME ........................................................................................................... 39

8 LONG-TERM FINANCING............................................................................................................... 40

8.1 STOCK CAPITAL............................................................................................................................. 40 8.2 DIVIDEND VALUATION MODEL ..................................................................................................... 40 8.3 NET INCOME STATEMENT.............................................................................................................. 42 8.4 DEPRECIATION AND PROVISIONS................................................................................................... 42 8.5 PRACTICAL EXAMPLE.................................................................................................................... 44 8.6 KEY TERMS OF THE THEME ........................................................................................................... 45

9 DEBT FINANCING ............................................................................................................................. 46

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9.1 LONG-TERM DEBT SECURITIES...................................................................................................... 46 9.2 TYPES OF BONDS ........................................................................................................................... 47 9.3 PRACTICAL EXAMPLE.................................................................................................................... 47 9.4 KEY TERMS OF THE THEME ........................................................................................................... 49 10 CASH-FLOW MANAGEMENT ........................................................................................................ 50 10.1 THE CONCEPT OF MANAGING CASH-FLOW ................................................................................... 50 10.2 CASH-FLOW STATEMENT STRUCTURE .......................................................................................... 51 10.3 CREATING OF THE CASH-FLOW STATEMENT ................................................................................. 52 10.4 PRACTICAL EXAMPLE.................................................................................................................... 53 10.5 KEY TERMS OF THE THEME ........................................................................................................... 54 11 LONG-TERM INVESTMENT DECISIONS .................................................................................... 55 11.1 CAPITAL INVESTMENTS ................................................................................................................. 55 11.2 INVESTMENT PROJECTS.................................................................................................................. 55 11.3 STATIC METHODS OF INVESTMENT EFFICIENCY EVALUATION ...................................................... 56 11.4 PRACTICAL EXAMPLE.................................................................................................................... 58 11.5 KEY TERMS OF THE THEME ........................................................................................................... 59 12 CAPITAL BUDGETING - NET PRESENT VALUE METHOD.................................................... 60 12.1 INVESTMENT EFFICIENCY EVALUATION ........................................................................................ 60 12.2 PRESENT VALUE OF FUTURE CASH-FLOWS ................................................................................... 60 12.3 COST OF CAPITAL .......................................................................................................................... 61 12.4 NET PRESENT VALUE METHOD ..................................................................................................... 62 12.5 PRACTICAL EXAMPLE.................................................................................................................... 62 12.6 KEY TERMS OF THE THEME ........................................................................................................... 64 13 OTHER CAPITAL BUDGETING TECHNIQUES.......................................................................... 65 13.1 FINANCIAL LEVERAGE NOTION ..................................................................................................... 65 13.2 TAX SHIELD NOTION ..................................................................................................................... 66 13.3 INTERNAL RATE OF RETURN METHOD .......................................................................................... 66 13.4 OTHER CAPITAL BUDGETING TECHNIQUES..................................................................................... 68 13.5 PRACTICAL EXAMPLE.................................................................................................................... 68 13.6 KEY TERMS OF THE THEME ........................................................................................................... 70 14 FINANCIAL ANALYSIS FUNDAMENTALS.................................................................................. 71 14.1 SUBSTANCE AND AIM OF THE FINANCIAL ANALYSIS..................................................................... 71 14.2 TECHNIQUES OF FINANCIAL ANALYSIS ......................................................................................... 71 14.3 RATIO ANALYSIS ........................................................................................................................... 72 14.4 COMPLEX METHODS OF FINANCIAL ANALYSIS ............................................................................... 74 14.5 PRACTICAL EXAMPLE .................................................................................................................... 75 14.6 KEY TERMS OF THE THEME ............................................................................................................ 76 LITERATURE ............................................................................................................................................... 77

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Preface

Solving particular tasks of economic and financial policy of a company is an important part of management. This study material aims at clarifying basic issues of financial management of a company and deals with factual application of the best known methods used in financial management in market economy, which will enable students of College of Polytechnics to master solving typical tasks they can encounter in practice. In its course it refers to topics which have been dealt with in the subject Company Economy at College of Polytechnics Jihlava and it is part of an overall view of finance and financing on a general level together with subjects Public Finance, Taxes, Financial Analysis, and Money, Banks and Financial Markets.

The study material is conceived for the teaching as one of mutual modules in English language and divided into single themes of financial management. Each theme (chapter) consists of three parts. The first theoretical part explains specialist issues connected with a given theme and it is the basic material for a lecturer's explanation and for the content of seminars. The second part shows key terms and definitions of a given chapter for students to be able to make a short theoretical evaluation of the theme by return. The third part is practical and consists of solved examples. The solution of the tasks is particularized usually on schematic examples taken generally from used literature and information obtained from company sphere. In some exercises practical demonstrations of using important financial instruments are carried out; the instruments are then illustrated in the appendix.

Certain simplification of practical problems will enable students to understand faster and correctly single themes. For every type of exercise there is a procedure and method of solving with an explanation given then. Despite an effort to choose example with a proper predictive ability we have to take into account that the scale of possible alternative states in the sphere of financial management activity is quite wide so it is not possible to cover all the situations that may arise. Moreover we cannot consider this explanation of possible situations very standardized as economy is a living organism, which keeps evolving, and theory (including mathematical description and solution) in the sphere of finance as well only with difficulties follows real situations in the market economy, including the company segment.

The examples that were used to concretize the themes of financial management are thus only a chosen part of examined problems, which we face when financing companies and analyzing economic results and financial situation of companies. Their basic aim is to draw attention to spheres which it is necessary to concentrate on during the study, which are necessary to be further examined and on their basis to strengthen theoretical knowledge needed for managerial functions. We believe that this study material will become a practical aid for students and will enable them to understand better the content and importance of the tools of financial management of a company. The authors

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1 Introduction to Finance

1.1 Time Value of Money The notion that money has a time value is one of the most important concepts in finance and investment analysis. Making decision today regarding future cash-flows requires understanding that the value of money does not remain the same forever. A euro (crown, dollar) today is worth less than a euro (crown, dollar) sometimes in the future. We can give two essential reasons:

cash-flows arising at various points in time have different value relative to any other point in time (inflation influence); this means we ought to use the time value of money to quantify the relation between cash-flows at different points in time

cash-flows in the future are uncertain; uncertainty issues from the nature of forecasts of the timing and of when or what amount of cash-flows (i.e. receipt or expenditures of money) there will be in the future

Translating a current value into its equivalent future value is referred to as compounding. Translating future cash-flows into its equivalent value in a prior period is referred to as discounting. For example, the amount that you are willing to lend today is the loan's present value. The amount that you require to be paid at the end of the loan period is the loan's future value. Therefore, the future value of this financial investment is comprised of two parts:

Future value = Present value + Interest where present value of lending money is referred to as principal and the time value of lending money is expressed by the term interest. Interest rate (i) is defined as a return rate from the principal of the debt. We get the future value from the present value with help of mathematics formula:

: FV PV PV *i

or:

FV PV * 1 i

Solving for present value gives us:

PV FV 1 i

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