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Financial activity of a

company

Theme: Financial activity


of
a
company
Questions:

Finance and financial relations of a company.


Financial management.
Financial sources of a company.
Financial statements and the system of financial
indicators (liquidity ratios, profitability ratios,
solvency ratios).
Fiscal pressure at the level of a company. The
impact of taxation on the financial results of a
company(essay)

Finance of a company means a system of


monetary relations, related to the creation, use,
distribution and redistribution of monetary
funds of a company.
Finance fulfills basically two functions:
distribution and control.
The most important goal of the distribution
function is to create and use effectively the
income and assets of the enterprise.
Control function of finance can be realized
through reporting on financial performance.

The finance of a company is based on the


following principles:
autonomy in the field of financial and
economic activity;
self-financing of the activities and
development;
self investing;
reserving funds in order to prevent the
risks;
the use of borrowed funds on the base of
financial stability, commitment to the State
(taxes and duties) and partners (contracts).

Financial management
Financial management refers to
the efficient and effective
management of money (funds) in
such a manner as to accomplish
the objectives of the organization

Financial management is the


management of the financial relations
of the company.
Financial management is carried out
through the financial mechanism,
combining forms, methods, means,
legal, regulatory and information
provision.
Financial management should ensure
satisfactory state of a company, which
is characterized by a set of indicators.

Financial relations include relations with:


counteragents regarding revenue generation and
utilization of funds;
partners regarding the distribution of profit from joint
ventures, purchases (sales) of securities, receiving interest,
dividends, etc.;
customers in accordance with the treaties and regulations;
the banking system's regarding cash-settlement service,
obtaining and repaying loans, provision of temporarily free
funds;
insurance companies about property insurance,
transactions, etc.;
the Government looking to taxation; distribution of
productive transfers.

Suppliers

FINANCIAL
MARKET

Customers

MARKET
PATICIPANTS
Creditors

Debtors
Governme
nt
Financial relations

Financial management is important functional


area of management.
All other functional areas such as production,
management, marketing, personnel management,
etc. depends on the Financial management.
Efficient financial management is required for
survival, growth and success of the company or
firm.
Many firms have failed because their
managers did not pay enough
attention to finances.

Scope of Financial Management


The scope of financial management includes the
following five 'A's.
Anticipation : Financial management estimates the
financial needs of the company.
Acquisition : It collects finance for the company
from different sources.
Allocation : It uses this collected finance to
purchase fixed and current assets for the company.
Appropriation : It divides the company's profits
among the shareholders, banks, etc. It keeps a part
of the profits as reserves.
Assessment : It also controls all the financial
activities of the company

Financial management consists of all those


activities that are concerned with obtaining
money and using it effectively.
Effective financial management begins with
determination of the firms financing needs.
Money is needed both to start a business and to
keep it going.
Short-term financing needs

Long-term financing needs

Monthly expenses

Business start-up costs

Current inventory needs

New-product
development

Speculative production

Lon-term marketing
activities

Short-term promotional
needs

Expansion of facilities

Cash-flow problem

Replacement of capital
assets

Proceeding from the necessity to implement the


financial relations each company need to attract the
financial resources
through their own sources (internal), and
through borrowing money for short term or long
term, and
through government subsidies or grants (external
sources).

Internal sources of financing:


Retained profit (profit kept by company for future
activity);
Selling assets ( money raised by selling off an asset
no longer needed);
The authorized capital of the company;
Reserve funds, and so on.

External sources of the


financing
Equity financing ( money received from the
sales of common and preferred stocks);
Debt financing:
A). money obtained through short-term and
long-term borrowing;
B). Money obtained through issuing
corporate bonds (large corporation);
Government and other financial
institutions subsiding.

There are at least two reasons why


equity financing is attractive to large
corporations;
The corporation need not to repay
money obtained from the sale of
stock, and it need not repurchase the
shares of stock at a later date;
A corporation is under no legal
obligation to pay dividends to
stockholders.
There are two types of stock:
common and preferred. Each type
has advantages and drawbacks as a

Short-term
banking loans

Banking
loans repaid
interest
Taxes
Repaid
dividends
Financing of
nonproductive
sphere

Owned
capital

Long-term
banking loans

FINANCIAL
TR/profit

RESOURCE
S
OF A FIRM

Investments

Financing of
current
activity

Repaid
dividends

Sources and movement of the financial resources of


a company

FINANCIAL
ACTIVITY=
(financial
statements/
information/calculati
ons)
Investment
activity

Credit
operations

Stock
market
transactions

Repaid
Dividends

Accounting can be viewed as a


system for transforming financial
data
into
useful
financial
information.
The
financial
statements based on the accounting
equation,
that
shows
the
relationship
among
the
firms
assets, liabilities and owners equity.
Assets are the things of value that
a firms owns (cash, inventories,
equipment, building, patents)
Liabilities are the firms debt and
obligations what it owes to
others

Current and long-term liabilities


Accounts
payable
are
short-term
obligations that arise as a result of
making credit purchases
Notes payable are obligations that have
been secured with promissory notes
Salaries payable and taxes payable are
expenses that have been incurred
during the current accounting period but
will be paid in the next accounting
period
Long-term liabilities are debt that need
not be repaid at least one year

The standard form of the accounting


equation:

Assets = Liabilities + Owners


equity
Implementation of this equation begins
with the recording of the firms day-today financial transactions.
A balance sheet (or statement of
financial position) is a summary of a
firms assets, liabilities and owners
equity accounts at a particular time. It
shows the monetary amounts that enter
into the accounting equation.

A firms balance sheet provides a


picture

of

the

firm

at

particular time.
Its income statement summarizes
its

operations

during

one

accounting period. Both can be


used

to

answer

variety

of

questions about the firms ability


to

do

business

and

stay

in

Balance sheet
(December 31, 1998)

Northeast Art
supply, inc.
ASSETS

LIABILITIES AND OWNERS


EQUITY

Current assets

Current liabilities
cash
59.000

Accounts payable
35.000

marketable
10.000
securities

Notes payable
25.000

accounts
40.000
receivable

Salaries payable
4.000

() allowance for
2.000
debtful accounts

Taxes payable
6.000

notes receivable
32.000

Total current liabilities:


70.000

merchandise

Northeast Art supply, inc.

Balance sheet (December


31, 1998)

Fixed assets

Long-term liabilities

Delivery
equipment
110.000

mortgage payable on
store equipment
40.000

() accumulated
depreciation
20.000

Total long-term liabilities:


40.000

furniture and store


equipment
62.000

Owners equity
Common stock,
10.000 shares at $15,
Par value
150.000

() accumulated
depreciation
15.000

Retained earnings
(reinvested)
80.000

Total fixed assets:


137.000
Intangible assets

Total owners equity:


230.000
Total liabilities
and owners equity

Northeast Art supply, Inc.


Income statement for Year ended,
December 31, 1998

Revenues
$ 465.000
Gross sales (TR)
() less sales returns and allowances
9.500
() less sales discounts
Net sales
451.000

4.500

Cost of goods sold


Beginning inventory (January, 1998)
40.000
Purchases inventory (January, 1998)
11.000
Net purchases
335.000
Cost of goods available for sale
375.000
() less ending inventory (December 31, 1998)
41.000
Cost of goods sold
334.000

Gross profit on sales


Operating expenses
Selling expenses
Sales salaries
30.000
Advertising
6.000
Sales promotion
2.500
Depreciation store equipment
Miscellaneous selling
1.500
Total selling expenses
43.000

117.000

3.000

General expenses
18.500
Office salaries
8.500
Rent
Depreciation delivery equipment
1.500
Depreciation office furniture
2.500
Utilities expense
500
Miscellaneous expenses
Total general expenses
36.500
TOTAL OPERATING EXPENSES
79.500

4.000

Net income from operations


37.500
() less interest expense
2.000
Net income before taxes
35.500
() less income taxes
5.325
Net income (net profit) after taxes
30.175

Accounting and Finance


Types of Information:
Profit and Loss Account
the revenue and costs of a business
over a time period
Balance Sheet the assets
and liabilities of a business
at a specific point in time
Use these sources to give ratios
the relationship between different aspects
of the business

Financial Ratios
A financial ratio is a number that
shows the relationship between two
elements of a firms financial
statements.
Types of the financial ratios:
Profitability ratios a measure of how
much profit its activities
generate(theme 10)
Short-term financial ratios
(liquidity ratios) ability of a
business to meet its debts

Ratio Analysis

Return on equity or on capital


employed (ROCE)or on investment
A measure of the efficiency of the firm in
using its capital to generate profit.
A ROCE of 15% suggests that the firm
uses every $1 of capital to generate
profits of 15c

Ratio Analysis
Example:
Assume two firms produce identical products
and have identical capital structures:
Firm A Capital Assets = $1,000,000
Profit = $250,000
Firm B Capital Assets = $1,000,000
Profit = $100,000
Easy to see in this instance that firm A is the more
efficient as every $1 of capital generates 25c
in profit whereas for Firm B, every $1 of capital only
generates 10c profit
ROCE allows us to have a measure of efficiency
for firms with different capital structures

Ratio Analysis
Net

Profit
ROCE = ----------------------------------- x100
Owners Equity

Generally the higher the ratio, the


more effective the firm is
in using its capital assets

Earnings per share=NetProfit available to


equity shareholders
Number of issued equity
shares
The average profit earned per ordinary share
Dividends per share=Dividends paid to
equity shareholders
Number of issued
equity shares
The average dividend received per ordinary
share

Ratio Analysis
Liquidity Ratios(short-term financial
ratios):
Look at the ability of a firm to meet its
expenditure and how much cash is tied up in
the business available to pay for that
expenditure
Careful management of its income and
expenditure is important to its cash flow and its
ultimate long term survival

More firms fail through cash flow problems


than any other reason

Liquidity Ratios
Working Capital having sufficient
funds at the right time to be able to
meet liabilities
Working capital management
is crucial to the success of a firm
Working capital = the difference
between current assets and current
liabilities

Liquidity Ratios
The Current Ratio the proportion
of current assets to liabilities.
A current ratio of 2:1 means the firm
has sufficient liquidity to cover its
liabilities twice over
A current ratio of 0.75:1 would suggest
that the firm is unable to meet its
liabilities
and could be in a weak financial position
A ratio below 1 does not mean the firm will
collapse but it will be in a vulnerable
position

Liquidity Ratios
Acid Test Ratio or quick ratio =
(Current Assets - Stocks) : Current Liabilities, or
(Cash + marketable securities + accounts
receivables + notes receivable )/ Current
Liabilities
The Acid Test Ratio is a measure of the firms ability to
pay current liabilities quickly with the cash,
marketable securities, and receivables.
It gives a clear and quick indication of the state of the
firms liquid assets.
Comparing the Current ratio and the Acid Test ratio
therefore gives an indication of the relative size of the
stock holdings of a firm.

Long term debt ratios


They indicate the degree to which a firms
operations are financed to borrowing.
Debt to assets ratio indicates the extent to which
the firms borrowing is backed by its assets. It is
calculated by dividing total liabilities By total
assets:

Debt-to-assets ratio= total


liabilities/total assets
For ex. Ratio of 32% means that slightly less than
1/3 of the assets of a firm are financed by
creditors.

Debt-to-equity ratio compares the


amount of financing provided by
creditors with the amount provided
by owners:

Debt-to-equity ratio = Total


liabilities/owners equity
A ratio of 48% means that creditors
have provided about 48 cents of
financing for every dollar provided by
owners

Summary of financial Ratios for Northeast Art Supply


Ratio

Formula

Northe
ast Art
Supply

Overall
Busines
s
average

Profitability
ratios

Net profit
margin

6,7%

4% - 5%

Return of
equity

13%

12% 15%

Earnings per
share

Short-term
financial ratios
Working
Working
capital
capital
Current
Current ration
ration

Acid-test
Acid-test ratio
ratio

$ 3,02
per
share

Current
Current assets
assets less
less
current
current liabilities
liabilities

$
$
112.00
112.00
2,6
2,6
1,99
1,99

2,0
2,0
1.0
1.0

Ratio

Formula

Overal
l
Northe
Busine
ast Art
ss
Supply
avera
ge

Activity
Rations
Account
receivable
turnover

11,9

Inventory
turnover

8,2

Debt-toassets ratio

32%

33%

Debt-toequity ratio

48%

33% 50%

Long-term
debt rations

Ratio Analysis

The Crooked E ironic logo of


Enron. Statistics do have their
limitations!
Source: reubing, stock xchng

Limitations of Ratio Analysis:


Usefulness dependent on the
accuracy of the figures Enron,
Parmalat?
Only a part of the jig-saw
needs other information to
make full judgement
What has happened in the past
is not necessarily a pointer to
what will happen in the future!
Statistics always have
a limitation in that it depends
when they are used and how
they are used.
No two businesses are fully
comparable as the differences
between them will always
influence the performance of
the business
Ratios do not always reflect the
degree of intuition/genius
that may influence the
performance of a business