CORPORATE FINANCE RELATED TO - Eskimo



CORPORATE FINANCE RELATED TO

PROJECT MANAGEMENT FINANCE

There are significant differences in the monetary sources between the public and private sectors of our economy. The public sector is the portion that is going work for a governmental or quasi judicial agency, these agencies are not designed to make a profit, they are principally designed to serve the public. In many cases the development of “infrastructure.” The private sector is designed and dedicated to make a profit, not just an economic profit of breaking even, a real profit in which they can reward their investors for the risk taken in investing in the organization, pay their employees fairly, contribute to the community through more than just paying taxes - through actual participation in civic affairs, and still has money left over to invest in the future. The future most likely will not look like the past - if it doesn’t then the policies, procedures, plants, equipment and technology will probably have to look different as well. Finance is concerned with the future and how do we get there, what resources will be needed? what type of equipment? what type of buildings? where? what type of people? and many other concerns unique to each industry.

Projects and project management is financed by these organizations. The money for our project normally comes from the organizational sources, be they public or private. For us to accomplish our task we need a comprehensive understanding of these source and the exceptions they have of us in out roles in projects. Our role must fit within the basic mission and objectives of our sponsor, we need to return to the sponsor ‘value.’ Value itself acquires meaning relative to the company and industry. The Project Manager has the expectation and role responsibility to find the definition of value from the sponsor and focus on it as the project develops until the final closure and paper work wrap up.

Initially the money comes either from debt or equity. Debt is money that is borrowed to finance an organization, equity is the money that investors invest into the corporation. The lenders (debt) expect to be repaid with interest, this interest should be at a rate higher than the most safe debt capital. The most safe debt capital in investment into treasury bonds, the earned interest is low because the risk is low. Money invested in government bonds is as safe as our government, we sometimes laugh at this statement, but in reality if our government is so unstable that the federal debt cannot be paid our problems are much larger than the money at risk. Investors expect to earn more from the investment than could be earned through the purchase of treasury notes. They earn in two different ways from their investments, the first is in terms of dividends the second method of earning is called growth.

Dividends are paid to the “owners” of the corporation. Dividends are payments made by the corporation to the owners from earnings. After the corporation calculates the income for the representative time period they subtract all of the associated expenses of building the product or service. This net income is the basis for determining corporate income tax, what ever is left over after expenses and taxes is retained earning. If the corporation declares dividends they are paid to the owners from the money that is in retained earnings. Normally dividend payment is a matter of corporate policy - some organizations do not pay dividends in their early existence, instead is reinvested into the corporation. Once the growth is stable the policy may be to pay dividends, these dividends are paid quarterly and normally the rate is better than the investor would have gotten had they invested in treasury bonds. There are groups of investors who seek this type of investment because it provides a constant stream of income (an example could be a retiree).

Other ways that owners of the corporation make money is through “growth” of the stock. Growth is not a scientific nor calculable number. Growth is determined by “what the owners and potential owners are willing to pay for the stock.” Expected return on investment. The owners purchase the stock at a specific price and hope and expect that it will increase in value, increase so that they can make money if they sell the stock. This growth is often determined by the activities of the corporation in making money doing business, and indication of this can be the dividends they pay.

In outline form is some of the activities within the organization relative to finance;

I. The Managers Job

Make a profit

Control the capital invested in assets needed for making a profit and to decide on the sources

of capital for asset investment (the laws of economics apply - that is there is a limited

amount of resources available, and management is charged with the responsibility of

selecting those that will maximize the return to the investor).

Generate profit from cash flow and vice versa

Managers are judged by:

Profit

Cash flow

Financial

health

Accounting prime functions;

Scorekeeping

Attention directing

Problem solving

Roles

Internal - help make decisions

External - taxes and external financial reports (per standards). These reports are used by; owners (and potential owners), creditors

and the government.

GAAP is generally accepted accounting practices - it does not imply that there

is a standard set of accounting practices and rules that everyone must

follow, instead it certifies that the audited customer is following one of

the accepted policy and format procedure and that they are consistent

in following this policy.

Profit depends on how it is measured and the accounting methodology

accepted. Factors such as how to value the inventory (at the replace

ment cost of the materials or at the original cost of the materials) affect

profitability, there are many factors. These are determined by the

accounting standards adopted by the corporation,.

Managers have a fiduciary responsibility to both the organization and to the outside world.

Profit stimulates innovation, profit is the reward for taking risks.

II.Financial Statements - provide information that managers use in making decisions. The are

snapshots of the financial conditions at some instant in time. The organizations are so

dynamic that the snapshot is always looking at the past, changes occur before we have time

to look at the statements. They are useful because they are compared to other snapshots normally representing some prior time or condition, in this they provide us with information

relative to our changing conditions - are we getting better or worse? by how much? Two

portions of organizations get routing “report cards” the financial analysis and financial

statements. These are production and projects, these two get routinely reported because they

are constructed in measurable activities. The principle financial statements are:

Income Statement (sometimes called the P&L or Profit and Loss statement)

The Cash Flow Statement

The Balance Sheet

The Income Statement tracks the moneys generated through “shipment” of our product or

service, often times the item is called sales on the balance sheet - a follow through

from the time when credit was not a normal way of doing business. Sales and

shipments are the same thing when all shipments are paid in cash and are delivered at

the moment of transaction. This is and internal tool that shows “how we are doing.”

The Balance Sheet is a reflection of all monetary concerns of the corporation, it takes the

numbers from the Income Statement and adds the long term situation in terms of

finance (assets are things that the corporation owns which have monetary worth,

liabilities are a reflection of the committed payments or payments due, owners equity

(sometimes called retained earnings) is the amount that is left after using assets to pay

for the liabilities.

The balance sheet gets its title from the fact that:

Assets = Liabilities plus owners equity

The Cash Flow statement is the details of when cash should arrive, when bills are due for

payment and identifying unmet needs. The essence of need for this tool is rooted in

the allowance of credit in the corporate financial world. Allowing customers a longer

period of time to pay their due does not remove the obligation of the corporation to

pay what is due of them. This results many times in the corporation paying their bills

before collecting for the service rendered. The expenses for financing of this type are

passed on to the customers. Either in the form of higher pricing or in interest

charges.

Depreciation expense is the portion of the total expense for a capital asset that is allowed to

be written off each year. The portion the corporation that the corporation can claim

as a part or expense of doing business so it is not taxable. There are several methods

of calculating the depreciation expenses, work with your own corporation or account

for determining the method most appropriate for your activities.

Double entry accounting sometimes gets confused with a notion of keeping two sets of

books. They are not the same. Double entry accounting is a very logical accounting

procedure, it identifies (1) where the funds come from and (2) where the funds go to -

nothing tricky nor fancy - just sound tracking of our money.

Cash flow is the lifeblood of the organization (necessary for survival). It is normally

measured as cash from sales (shipments) and other sources minus the usage of cash

equals the change in cash position. The uses of cash start with:

Operations

Capital Expenditures

Payment to Owners

When looking at a balance sheet under each of the categories we would normally find;

Assets which contain; cash, inventory, accounts receivable, prepaid expenses, some

property and equipment and an amount for depreciation.

Liabilities which contain; accounts payable, short term notes payable, accrued

expenses, income tax, and notes payable.

Owners Equity which contains; the paid in equity and the amount of profit that has

been placed into this category for future usage.

III. Income Statement

A picture of the profit and loss activities - it is not a what if analysis or any future oriented

tool, it is a measure of performance.

Normally has two versions - the numbers are the same on both versions, but the version that

management (internal) uses for review and decision making does not have detailed

explanations. The external version the goes to owners and investors has detailed

notes and explanations.

The Gross Margin (sometimes called the Contribution Margin) is the first line toward profit.

This is the difference in the amount of revenue brought in and the direct cost and

expenses involved in these activities. This number is further processed when the

general and overhead (the cost of being in business) cost are considered.

Inventory turnover is a measure of the number of times you purchase the same item during a

specified time frame. The higher the turn ratio without affecting shipments the better.

This means that the money invested in inventory is not sitting idle. Money needs be

active - generating more money.

Variable operating expenses are the expenses you incur only when you build the product or

provide the service.

Fixed operating expenses are those that are incurred even when no productive activity is

being transacted (an example would be the lease on the property, payment is due for

Saturdays, Sundays, holidays and days when inclimate weather forces a shut down).

IV. Financial Conditions and Cash Flow Statements, another group on outline form to jog memories, a typical balance sheet may look something like this:

|Balance Sheet |

|Your Corporation |

|Statement as of 31 December 1998 |

| | |

|Assets |Liabilities |

| Cash | Accounts payable |

| Accounts receivable | Accumulated expenses |

| Inventory | Income tax |

| Prepaid expenses _____________ | Short term notes _______________ |

| total current assets | total current liabilities |

| | |

| Plant, property & equip | Long term notes _______________ |

| Accum depreciation _____________ | Total liabilities |

| total assets | |

| |Owners Equity |

| | Capital stock |

| | Retained earnings ______________ |

| | total |

| | |

| | Total Liabilities & Owners Equity |

Reported as the close of the business activity during a specific time frame.

Identifies sources of capital, debt and equity; Stocks and types

Capital expenditures

Operation Assets - materials and inventory methods (fifo/lifo/actual/average/standard)

Current assets and liabilities are those that are requiring service during the current accounting

time period.

Terms of payment, interest expense and rate

Sources of capital

Short term debt

Long term debt

Paid in capital

Retained earnings

Identifies collateral pledged against debt

V. Ratios - ratios are tools of measurement that bankers and investors look at in order to see if

management is running the business correctly. Bankers, owners (investors) and lenders are

not experts in running the business itself. They would not (most likely) understand what was

going on even if told from the technical standpoint. For most industries there have been

developed a series of performance measurements call ratios. These are easily compared to

other organizations in the same industry, benchmarking is established in the measurement and

comparison to the industry averages as well as to the best in class. Some of the more

common and the involved parameters are listed below.

Current Ratio = current assets divided by current liabilities

Quick Ratio = quick assets divided by quick liabilities

(quick denotes the money that could be spend or obtained from these transactions by

someone not familiar with the industry, example a bank selling electronic parts).

Accounts Receivable = Total sales (shipments) divided by ending inventory

Return on Assets = Total sales divided by total assets

Return on investment = Total sales divided by total investment

There are others, but these represent the basic.

VII. Capital Needs

Planning begins with the sales forecast to determine the anticipated income from operations.

Determine needs - if investment for the future exceeds capital available by how much? when

is it needed? how do we finance this activity?

Look at the Master Budget to see if the task assigned can be done - can it be done better and

more economically through other methods? points to review;

Sales growth, from increased quantity, price change or new customers

Equipment utilization and availability

Operating ratios

Debt situation

Cash dividend policy and expectations

New equipment costs

Depreciation expenses

Is the budget feasible?

Organizations want to grow - most cannot look to the internal environment to supply all the

cash needs.

VIII. Breaking Even and Making a Profit - going back to the introduction and over view, it is

essential that you pay your own way and contribute something back to the organization. In

private industry if you do not make a profit you do not survive.

In order to accomplish this we must know;

1) the profit margin per item or project

2) the sales volume or number of projects

3) the fixed expenses

Set prices

Control costs

Compute profit

Build a monitoring system that allows you to be proactive in decision making, make decisions

when they are timely and effective, don’t wait.

Have several contingency plans available - run ‘what-if’ situation analysis to look at the

potential best and worse case possibilities. Have plans available in the event you are

heading toward either.

XIII. Survival Analysis - Plan to survive, survive to plan. Things normally do not follow the plan,

the external environment follows its own fickle course of actions and events. Who could

have predicted the recent change in the value of money? The strengthening of the dollar

against the currencies of Thailand, Indonesia and Germany? not just minor changes but

values of twenty to thirty percent. What effect does this have on customers buying from us?

What effect does it have on the supply from those countries?

Is your area of responsibility a profit center? Do you have enough financial control to make

changes needed in order to make a profit?

Is your area of responsibility a cost center? Do you have enough control to manage these

cost effectively?

Concerns to review when managing cost:

Determine where the most is spend and look at cutting in that area. Do not look for

the easiest - look for the most effective,

Reduce cost,

Increase sales,

Reallocate cost.

FIND AND FIX THE PROBLEM NOT THE SYMPTOM.

XVI. Management Control and Budgeting

Reports available? Control? Exception? Timely?

Accessibility to internal accounting information.

Comparative reports

Frequency of reports

Profit control reports

Forecast (fixed or rolling)

When do we make adjustments?

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doing their job well

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