UNIVERSIDADE DOS AÇORES

DEPARTAMENTO DE ECONOMIA E GESTÃO

FINAÇAS EMPRESARIAS I

PROFESSOR, STUDENT
PEDRO PIMENTEL LOGHIN MIHAI-LIVIU
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Chapter 1 Finance and Financial Manager

The first chapter of the book is talking about the corporations. First of all we can say
that not all businesses are corporations. We can identify three types of businesses: sole
proprietorships, partnership and corporate finance.
Almost all the large businesses are organized in corporations. The corporation shares
are held by a group of investors who own the corporation but they don’t manage it.
First time when a firm is established in corporation are only a small group of investors,
some managers of the company and a few backers. At this stage the company doesn’t have
shares open for public trade and we can say that the firm is closely held. After some time when
the corporate will grow its shares will be trade on the public market and this corporations are
known as public companies.
Shareholders elect a board of directors, which can be drawn from top of management
for the positions of directors and others can be for the positions of non-directors, representing
them and act in best interest of them.
This separation of ownership and management gives the corporation permanence
because for example, if a shareholder sells his share to a new investors the activity of the
corporation will not disrupt and the other side if a manager is dismissed or quit, he will be
replaced and the activity will be continuous.
Corporations have limited liability, which means that stockholders will not be able to
be responsible for the firm debts unlike partnerships or sole proprietorships which they can.
The corporation is based on articles of incorporation that set out the purpose of the
business, how many shares can be issued, numbers of directors and so on. We can say that a
corporation is a legal “person” that will be able to burrow or lend money, can sue or be sued,
pays taxes but cannot vote.
This type of organization have advantages and disadvantages. For example one
advantage is that it can raise money by selling new shares to investors and it can buy those
shares back. A disadvantage is that a corporation’s legal machinery and communicating with a
shareholders can be time-consuming and costly.
A corporation needs a large variety of tangible goods like machinery, factories, offices
and intangible goods such as technical expertise, trademarks, patents, etc which are called real

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assets. To buy this assets the corporation sells pieces of paper called financial assets or
securities.
Between firm operations and the financial markets stands the financial manager. His
role is to trace the flow of cash from investors to the firm and back to investors again. The
managers from large corporations must decide which assets should invest and also where those
assets should be located.
The big corporations are scattered around the globe. Shares are trade in financial
center such as New York, London, Tokyo. Bond and loans are easily trade in all of the world
moving across national borders. For this kind corporations, day-to-day cash management
becomes a complex task.
Financial manager is a term who refer to anyone responsible for a significant
investment of financing decision. In the smallest corporations is only one person but in most of
the cases responsibility is dispersed.
In small companies there is often only one financial executive which is called treasurer.
But the larger company have also a controller, who prepares the financial statements, manages
the firm’s interval accounting and looks after its tax obligations. The difference between a
treasurer and controller is: the treasurer’s main responsibility is to obtain and manage the
firm’s capital, while the controller ensures that the money is used efficiently. The larger firm
usually appoint a chief financial officer (CFO) which oversee both the treasurer’s and the
controller’s work. The controller of CFO is responsible for organizing and supervising the
capital budgeting process. Sometimes the ultimate decisions for important issues are taken by
the board of directors.
The large corporation the ownership and management are separated because is
absolutely necessary, because this kind of corporation can have hundreds of thousands of
shareholders and is no way them to involve in management of the corporation.
This separation has advantages for example the ownership can hire a professional
manager to accomplish his objectives. But this separation brings and problems when theirs
objectives are different and this is not the only one problem for example the shareholders have
to think how to work with managers so they will accomplish their interests. Another problem is
for example, the interests of shareholders and bondholders that can be different so the company
can have big issue because of this.
We can think at the company’s overall value like a pie divided among a number of
claimants. All this claimants are included in a complex web of contracts and understandings.

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The principal-agent problems can be easily resolved if everyone had the same
information. All the participants on a corporation have different information about the real
value or financial assets.
When a company sells shares and bonds to raise money is creating an issue which is
known as primary issue and it is sold in the primary market. The corporation allow investors to
trade stocks and bonds between themselves so they can raise new cash. This operations are
known as secondary transactions and they take place in the secondary market.
The financial manager is a link between the company and financial institutions such as
banks, pension funds and insurance companies. Also the financial institutions are
intermediaries that gather the savings of many individuals and reinvest them in the financial
markets. In United States the most important financial institutions are insurance companies
more even the banks.
The differences between a manufacturing corporation and financial institutions are: first
of all, the financial institutions raise money from special ways like taking deposits or selling
insurance policies; second, the financial institutions invest in financial assets for example
stocks or bonds or loans whereas the manufacturing corporations raise money investing in real
assets.
The financial intermediaries can contribute in many ways to our individual wellbeing
and the smooth of the economy. Here are some examples:
- the payment mechanism: it is very hard to do all payments in cash, but fortunately
with the financial institutions we have other methods of payment like checks, credit cards,
electronic transfer;
- borrowing and lending: we can buy assets without having money in the time of
transaction what we have to do is just to borrow some money from banks, buy the assets and in
time we will return it in time;
- pooling risk: this can be done with insurances companies which cover the risk for us;
for example in case of automobile accident or household fire or in case if you want to in
securities and their price will fall you will not lose because you are insured.

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Chapter 28 Financial analysis and planning

The chapter 28 is talking about what kind of financial analysis and planning we can do
so we can see the performance of the firm or to understand the policies of a competitor or to
check on the financial health of a customer. Also, the firms need money when they want to buy
assets so than grow the corporation. In this case the firm have to use financial planning models
to help them understand the financial implications of their business plans and the consequences
of alternative financial strategies.
Corporations uses some financial statements to see the situation of the company.
Through this financial statements we will discuss about: the balance sheet, the income
statement, sources and uses of funds.
The balance sheet is a document who show the assets and the resources of the money
that is used to buy this assets. The items from the balance sheet are putted in descending order
of assets that can be turned in to cash. Here is included cash itself and all kind of goods can be
turned in cash which we name this category of assets current assets. The items that remain are
long-term, usually illiquid, assets who don’t show the real value of these date, but show the
original value of this assets and in case of plant and equipment, deducts a fixed annual amount
for depreciation. Intangible value like patents, reputation, a skilled management and well
trained labor force aren’t included in balance sheet.
The income statement can show how profitable the corporate has been over the past
year.
Sources and Uses of Funds are financial statements who show how the funds of the
firm are used.
To grow a corporation, especially one which is already a large one, you have to monitor
a huge amount of data much more complex than you can provided from financial statements.
And the easiest way to do it is with financial ratios. Next are presented five types of financial
ratios:

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– Leverage ratios: it is used to see how many debts have a company, so when a firm
need to take a loan from the bank it will know how much money to burrow and also
in this financial ratio is stated the limits of the dept that bank insist the burrowing
firm to have.
– Liquidity ratios: this financial ratio it is used to determine the liquidity of the firm;
for example is used by credit managers and bankers to see if the firm can repay the
loan or not, also is used by the managers to see how much money their assets worth
and because the value of the assets is changing the managers do this ratio every
year.
– Efficiency ration: it is measures how efficient the firm is by using its assets; when
this ratio is low it can indicate that the firm is efficient.
– Profitability: show to a firm, who invested in some assets, the return that company
earns on this investments.
– Market value ratio: show how highly the company is valued by the investors.

Here are some advice for financial ratio: financial ratio give you the answers, but they
never show you what kind of questions you have to put; don’t base on this formulas because it
isn’t an international standard for this formulas; you will gone need a benchmark for assessing
a firm’s financial position.
The financial ratio provides information about the corporate, but the manager can also
use this financial ratio for planning the future of the company by a financial plan. There are
three kinds of growth:
– a best-case or aggressive growth;
– a normal growth
– a plan of retrenchment;
When a manager prepare a financial planning he have to look at the opportunities and
costs of moving into a new area. The manager faces with two stages decisions in a project: the
first one may be valuable primarily for the options they bring with them and the second one
when the manager faces with capital budgeting problem. Also when a manager conceive a
financial plan he doesn’t look just at the most likely consequences, but they look for
unexpected.

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One manager can develop a plan of growth his company. To conceive this financial
plan the managers usually follow four steps:
-step 1: project next year’s operating cash flow;
-step 2: project what additional investments in net working capital, fix the assets that
need to support the activity and decide how much will be paid as dividends;
-step 3: to raise money from selling securities to cover the difference from step 1,
projected operating cash flow and step 2, the projected uses;
-step 4: this step is for constructing a pro forma balance sheet that incorporates the
additional assets and the increase in debt and equity.
After you did this plan is very easy to run your plan for a several years. You will know
how much to burrow to reach to a percent of annual growth. This financial planning isn’t just
for administrate a company, it is also a method to prepare for unlikely situations.
The model presented is a very simple for practical application. This model is known as
a percentage of sales model, because almost all the forecast for the company are proportional
to sales.
The model can be complicated, but you have to be careful not to add to much
complexity, because you can end up with a complex model which will distract the attention
from important decision.
It isn’t a theory or model to lead you for sure to the optimal financial strategy,
consequently, financial planning proceeds by trial and error.
In financial planning is no finance because they: usually incorporate an accountant’s
view of the world, are designed to forecast accounting statements, do not accentuate the tools
of financial analysis and so on.
Second reason that financial planning is no finance is because they pointing toward
optimal financial decision without letting us to see the alternative choices.

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Exercises

1. Suppose that at year-end 1999 Executive Paper had unused lines of credit which
would have allowed it to burrow a further $300 million. Suppose also it used this line of credit
to raise short-term loans of $300 million and invested the proceeds in marketable securities.
Would the company have appeared the be (a) more or less liquid? (b) more or less highly
levered? Calculate the appropriate ratios.

a) First the cash is 0 because cash not matter if the firm can borrow at short notice. So
the cash ratio will be 0. After the loan and buying the securities the cash ratio will be:
cash ratio=300300=1
So from this we can say that the firm will be more liquid.

b) The level of financial leverage remain unchanged because the firm invest in
securities by money came from short-term loans not from long-term loans and this will not
affect the leverage.

2. United Ratio’s common stock has a dividend yield of 4 percent. Its divided per share
is $2, and it has 10 million shares outstanding. If the market-to-book ratio is 1.5, what is the total
book value of the equity?

dividend yield=dividend per sharestock price⇒stock price=20,04=50$

market-to book-ratio=stock pricebook value per share⇒1,5=50$book value per share⇒ ⇒book
value per share=1,5*50$=33,33$
total book value of the equity=book value per share*number of
shares=33,33$*10.000.000=333.300.000$

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3. As you can see, someone has spilled ink over some of the entries in the balance sheet
and income statement of Transylvania Railroad(Table 1). Can you use the following
information to work out the missing entries?
• Financial leverage: .4
• Times interest earned: 8
• Current ratio: 1.4
• Quick ratio: 1.0
• Cash ratio: .2
• Return on total assets: .18
• Return on equity: .41
• Inventory turnover: 5.0
• Receivables’ collection period: 71.2 days.

DECEMBER 1999 DECEMBER 1998

BALANCE SHEET
Cash 11 20
Accounts receivable 44 34
Inventory 22 26
Total current assets 77 80
Fixed assets, net 38 25
Total 115 105
Notes payable 30 35
Accounts payable 25 20
Total current liabilities 55 55
Long-term debt 24 20
Equity 36 30
Total 115 105

INCOME STATEMENT
Sales 200
Cost of goods sold 120
Selling, general and administrative expenses 10
Deprecation 20
EBIT 50
Interest 8,75
Earnings before tax 41,25
Tax 30,2

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Earnings available for common stocks 11,05
Table 1

Current assets
current ratio=current assetscurrent liabilities⟹1,4=current assets55⟹ ⟹current
assets=1,4*55=77

Receivable
quick ratio=cash ratio+receivablescurrent liability⟹1,0=0,2+receivabeles55⟹
⟹receivables=44

Fixed assets, net

fixed assets, net=total- total current assets=115-77=38

Inventory
current ratio=current assetscurrent liabilities=quick ratio+inventorycurrent liabilities⟹
⟹1,4=1,0+inventory55⟹inventory=22

Cash
cash=total current assets-inventory-receivables=77-44-22=11

Long-term debt
financial leverage=long-term debttotal long-term capital⇒0.4=long-term debt60⇒ ⇒long-term
debt=24

Equity
equity=total long-term debt-long term-debt=60-24=36

Sales
Receivables’ collection period=average receivablessales/365⇒71,2=39sales/365⇒ ⇒sales=200

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Cost of goods sold

inventory turnover=cost of goods soldaverage inventory⇒Cost of goods sold=24*5=120

EBIT
EBIT=sales-costs of goods sold-selling, general and administrative expenses-
Deprecation=200-120-10-20=50

Interest
time interest earned=EBIT+depreciationinterest⇒interest=708=8,75

Earnings before tax

earning before tax=EBIT-interest=50-8,75=41,25

Tax
ROA=EBIT-taxsales⇒tax=50-0,18*200=30.2

Earnings available for common stocks

earning avaible for common stoks=earning before tax-tax=41,25-30,2==11,05

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