CMA Part 2. Financial Decision Making

Transcription

1 CMA Part 2 Financial Decision Making

2 SU 7.1 Short-term Financing Basics Basis points = 1/100 th of a 1% 300 basis points = 3% Sources of short-term financing include: Market-based instruments Accounts Payable Commercial banks 2

3 SU 7.1 Short-term Financing Sources Spontaneous Forms of Financing Trade credit (A/P), 30, 60 or 90 day terms Example 2/10 net 30. 2% discount if paid within the first 10 days of invoice date or all if between days Accrued expenses Commercial banks, and Market-based instruments Continued 3

4 SU 7.1 Short-term Financing Sources (continued) Spontaneous Forms of Financing Trade credit (A/P), 30, 60 or 90 day terms Example 2/10 net 30. 2% discount if paid within the first 10 days of invoice date or all if between days Discount amount = Inv. Amt. X (1.0 Disc. %) Ø See example of discounted amount paid and also of the cost of not taking a discount 2% discount taken/forgone = approx % effective rate Continued 4

5 SU 7.1 Short-term Financing Short-term bank loans In addition to trade credit sources Increased risk May not renew Contractual restrictions Prime interest rate best customers only Effective Interest Rate on a Loan (see example) Net interest expense Usable funds 5

6 SU 7.1 Short-term Financing Simple interest loans Interest paid at the end of the term; stated rate is same as nominal is the same as the effective rate Total amount of interest is the loan amount times the stated rate 6

7 SU 7.1 Short-term Financing Discounted Loans require the interest to be paid at the beginning of the loan term and therefore increase the effective rate from the stated rate Amount needed (1.0 Stated rate) This is different from the total amount of interest in the loan, which is loan amount x stated rate 7

8 SU 7.1 Short-term Financing Loans with compensating balances increases effective interest rate Borrower have to maintain a balance of funds with the lender, therefore reducing the usable funds and therefore increasing the effective rate Lines of Credit with Commitment Fees Lender charges a (much smaller) fee on unused portion of line of credit 8

9 SU 7.1 Short-term Financing Market-based Instruments, include: Bankers acceptances Understand the who is the drawer Commercial paper Short-term, unsecured notes payable issued in large denominations by large corporations with high credit ratings Lower costs that bank loans Understand advantages and disadvantages 9

10 SU 7.1 Short-term Financing Secured Financing, by pledging: Receivables Inventory Chattel mortgage secured by personal property such as equipment Maturity Matching times the life of an asset with the debt instrument used to finance it 10

11 SU 7.2 Long-term Financing Leases long-term, contractual agreement The lessor (owner of property) allows the lessee (one using the property) the right to use the property for a stated time at a stated rate Can be a purchase-and-financing (capital lease) Long-term rental contract (operating lease) 11

12 SU 7.2 Long-term Financing Convertible Securities debt or pref. stock Contain provisions allowing the holder to convert to specified number of common stocks Stock Purchase Warrants call options on the corp. common stock. Allows holder to exchange the warrant plus specified cash for some number of common stock Retained Earnings cumulative accrual-basis income (net of prior dividends and amounts reclassified as additional paid-in capital from stock dividends) 12

13 SU 7.2 Long-term Financing Question 1 A major use of warrants in financing is to A. Lower the cost of debt. B. Avoid dilution of earnings per share. C. Maintain managerial control. D. Permit the buy-back of bonds before maturity 13

14 Correct Answer: A SU 7.2 Long-term Financing Question 1 Answer Warrants are long-term options that give holders the right to buy common stock in the future at a specific price. If the market price goes up, the holders of warrants will exercise their rights to buy stock at the special price. If the market price does not exceed the exercise price, the warrants will lapse. Issuers of debt sometimes attach stock purchase warrants to debt instruments as an inducement to investors. The investor then has the security of fixed-return debt plus the possibility for large gains if stock prices increase significantly. If warrants are attached, debt can sell at an interest rate slightly lower than the market rate. Incorrect Answers: B Outstanding warrants dilute earnings per share. They are included in the denominator of the EPS calculation even if they have not been exercised. C Warrants can, if exercised, result in a dilution of management s holdings. D A call provision in a bond indenture, not the use of warrants, permits the buyback of bonds. 14

15 SU 7.3 Activity Measures Another way to analyze liquidity is to focus on the management of key current assets, namely inventory and A/R. A manager successfully managing inventory and collecting A/R in a timely manner also will be improving liquidity. Operating activity analysis is done over a period of an operating cycle the time elapsed between when goods are acquired and when cash is received from the sale of the goods. Measures how quickly noncash assets are converted to cash. Over a period of time. Includes I/S data. The Balance Sheet data should always be an average

16 SU 7.3 Activity Measures A/R Turnover = Net credit sales Average accounts receivable Efficiency of A/R collections. High ratio : Customers pay promptly. Highly seasonal should use monthly A/R average.

17 SU 7.3 Activity Measures One of the assumption of this ratio is that sales occur evenly throughout the year, therefore average A/R can be estimated using the average of beginning and ending A/R balances. When sales are seasonal or uneven, the beginning and ending balances may not be indicative of the average A/R balance. This is one of the reasons that most retailers have a fiscal year ending on January 31 and not December 31, because the sales in that industry are seasonal.

18 SU 7.3 Activity Measures Factoring of Accounts Receivables Some firms, in attempt to raise cash, borrow using A/R as collateral. This is called factoring of accounts receivable and is done to avoid recording a payable or a liability. Doing this enables the firm to borrow cash without showing the corresponding liability; hence such transaction is called offbalance sheet financing.

19 SU 7.3 Activity Measures A/R turnover also can be analyzed in days instead of times Days Sales Outstanding (DSO) = Days in year A/R turnover Average collection period in days. May use 365, 360 or 300 days Compared to credit terms to determine if customers pay within terms.

20 SU 7.3 Activity Measures Inventory turnover = Cost of goods sold Average Inventory Measures efficiency of inventory management. High ratio : Quicker inventory turns Inventory not obsolete, not carrying excess. Highly seasonal should use monthly Inv. average. LIFO valuation not comparable to other methods. Inventory turnover is industry specific. Grocery vs. Concrete

21 SU 7.3 Activity Measures Days Sales in Inventory = Days in year Inventory turnover How many days sales are tied up in inventory.

22 SU 7.3 Activity Measures Any judgment regarding payment of current liabilities should be made in light of the degree of urgency of payment. Several measurements can be made to assess the company s policy in paying off current liabilities. Such analysis could be used by new suppliers to assess the timeliness and creditworthiness of the company.

23 SU 7.3 Activity Measures Payables Accounts Payable Turnover = Purchases Average A/P Highly seasonal should use monthly Payables average.

24 SU 7.3 Activity Measures Payables Days Purchases in Accounts Payable (DPO) = Days in year A/P turnover Compared to credit terms to determine if the firm is paying within terms.

25 SU 7.3 Activity Measures Payables Measurement of days purchases in accounts payable usually indicates the payment terms that the company has with its suppliers, assuming that the company is not in default on its payments. Analysts may find it impossible to determine credit purchases. A reasonable approximation is to substitute total purchases instead of credit purchases. Total purchases can be determined by adjusting the cost of goods sold by the changes in inventory balance. A large ratio would indicate that the company either has good relationship with its suppliers and enjoys liberal payment plan or is delinquent in making payments.

26 SU 7.3 Activity Measures Operating Cycle = DSI + DSO The amount of time to convert inventory to cash. ØSee Figure 2-2, Page 67

27 SU 7.3 Activity Measures Cash Cycle = Operating Cycle DPO Is the days that cash is tied up as another asset.

28 SU 7.3 Activity Measures (not in text) Fixed Assets Turnover Ratio = Net Sales Average Net PP&E How efficiently the company deploys its investment in plant assets to generate revenues. Higher turnover is preferable. Affected by the capital intensiveness of the company and its industry, by the age of the assets, and by depreciation method used.

29 SU 7.3 Activity Measures (not in text) Total Assets Turnover Ratio = Net sales Average total assets Higher turnover is preferable. Exclude assets that do not relate to sales. Ex: investments

30 Sample Financial Data

31

32 Calculate: Current Year Net Working Capital

33 Calculate: Current Year Net Working Capital Current Assets Current Liabilities $ = $370,000

34 Calculate: Current Year Current Ratio

35 Calculate: Current Year Current Ratio Current Assets / Current Liabilities 760 / 390 = 1.949

36 Calculate: Current Year Quick (Acid Test) Ratio

37 Calculate: Current Year Quick (Acid Test) Ratio Cash + Mkt Securities + Net Rec / Current Liabilities ( ) / 390 = 1.705

38 Calculate: Current Year Cash Ratio

39 Calculate: Current Year Cash Ratio Cash + Mkt Securities / Current Liabilities ( ) / 390 = 1.256

40 Calculate: Current Year Net Working Capital Ratio

41 Calculate: Current Year Net Working Capital Ratio Current Assets - Current Liabilities / Total Assets ( ) / 1,800 =.206

42 Calculate: CY AR Turnover * All sales are 365 day credit sales

43 Calculate: CY AR Turnover Net Credit Sales / Ave. AR 1,800 / (( ) /2) = 15.3

44 Calculate: CY DSO * All sales are 365 day credit sales

45 Calculate: CY DSO Days in Year / AR Turnover 365 / 15.3 = 23.9 Days

46 Calculate: CY Inventory Turnover * All sales are 365 day credit sales

47 Calculate: CY Inventory Turnover COGS / Ave. Inventory 1650 / (85 +55)/2 = 23.6

48 Calculate: CY DSI Days in Year / Inventory Turnover 365 / 23.6 = 15.5 Days

49 Calculate: CY AP Turnover Purchases *CY = $1,760,000 PY = $1,440,000

50 Calculate: CY AP Turnover Purchases / Ave AP $1,760 / ( ) /2 = 15.6

51 Calculate: CY DPO

52 Calculate: CY DPO Days in Year / AP Turnover 365 / 15.6 = 23.4 Days

53 Calculate: CY Operating Cycle

54 Calculate: CY Operating Cycle DSO + DSI = 39.4 Days

55 Calculate: CY Cash Cycle

56 Calculate: CY Cash Cycle Operating Cycle - DPO = 16.0 Days

57 Calculate: CY Fixed Asset Turnover Ratio

58 Calculate: CY Fixed Asset Turnover Ratio Net Sales / Ave PP&E $1,800 / ( )/2 = 2.05

59 Calculate: CY Total Asset Turnover Ratio

60 Calculate: CY Total Asset Turnover Ratio Net Sales / Ave Total Assets $1,800 / (1, ,600)/2 = 1.06