The Essentials of Financial Analysis (GENERAL FINANCE & INVESTING) - Hardcover

WEAVER

Hardcover

ISBN 10: 007176836X ISBN 13: 9780071768368

Publisher: McGraw Hill, 2011

Synopsis

It’s easier than you think to understand the financial reports you face every day . . .

If your job focus is on managing employees and overseeing corporate affairs, financial analysis may sound like a foreign language to you. But, in today’s competitive business environment, it is crucial that managers and business executives have a firm grasp of financial analysis. The Essentials of Financial Analysis simplifies an often difficult-to-understand topic so stakeholders ranging from employees to executives to investors can understand and discuss an organization’s financial workings.

The Essentials of Financial Analysis delivers practical, in-depth coverage on the key components of financial reporting, budgeting, and analysis to help you better relate to the numbers behind the business issues you face every day. By the time you turn the final page of this book, you will be able to command confident discussions on performance, investment, and other financial situations with members of your finance team and senior management.

This hands-on book helps you make better business decisions by showing you how to structure financial analysis, as well as:

• Contribute to an organization’s success and guide others companywide to make better financial decisions
• Reduce cost of capital and hurdle rates by selecting the financial markets, intermediaries, and instruments that work best for your company’s financing needs
• Increase shareholder value by pursuing growth through capital investment, new products, mergers and acquisitions, joint ventures, and other strategies

Your career success and the prosperity of your company depends on your ability to understand and act upon basic financial principles. With The Essentials of Financial Analysis, you can go inside the numbers and get a clear picture of where your company has been, where it is going, and how you can help it get there.

About this title

About the Author

McGraw-Hill authors represent the leading experts in their fields and are dedicated to improving the lives, careers, and interests of readers worldwide

From the Back Cover

The Essentials of Financial Analysis is a practical, in-depth survey of the key elements of financial reporting, budgeting, and analysis to help business managers with little or no background in finance relate to the numbers they deal with every day, boost their performance, and better lead their staff. The Essentials of Financial Analysis explains how to:

• Use a balance sheet, income statement, and cash flow statement to spotlight a company's weaker areas and improve its financial efficiencies
• Implement strategic plans, operational budgets, and financial forecasts as competitive tools for direction setting, communication, and compensation
• Make capital-investment decisions that contribute to a company's success

The Essentials of Financial Analysis has all the critical information you need to ensure your decisions are grounded in sound financial judgment. Whether you're presenting financial results, executing performance comparisons, allocating resources, or budgeting expenses, it helps you transform your know-how into real results.

Excerpt. © Reprinted by permission. All rights reserved.

THE ESSENTIALS OF FINANCIAL ANALYSIS

By SAMUEL C. WEAVER

The McGraw-Hill Companies, Inc.

Copyright © 2012 The McGraw-Hill Companies, Inc.
All rights reserved.

ISBN: 978-0-07-176836-8

Contents

Preface
PART ONE ACCOUNTING AND FINANCE FUNDAMENTALS
Chapter 1 The Role and Functions of Accounting and Finance
Chapter 2 Understanding Financial Statements
Chapter 3 Financial Performance Metrics
Chapter 4 The Impact of Income Taxes on Financial Analysis
PART TWO FINANCIAL PLANNING AND CONTROL
Chapter 5 Short-Term Financial Management and Supply Chain Finance
Chapter 6 Strategic Financial Planning
PART THREE CAPITAL ANALYSIS AND CORPORATE INVESTMENT DECISIONS
Chapter 7 The Time Value of Money
Chapter 8 Interest Rates and Valuation of Financial Securities
Chapter 9 Capital Investment Decisions
Chapter 10 Determining Cash Flows
PART FOUR LONG-TERM FINANCING STRATEGIES
Chapter 11 Cost of Capital, Hurdle Rates, and Financial Structure
Chapter 12 Long-Term Financing
Chapter 13 Leasing as a Financing and Business Alternative
PART FIVE FINANCE AND CORPORATE STRATEGY
Chapter 14 Strategy and Valuation: Creating Shareholder Value
Chapter 15 Mergers and Acquisitions
Index

Excerpt

CHAPTER 1

THE ROLE AND FUNCTIONS OF ACCOUNTING AND FINANCE

Corporate finance is a middle ground between economics and accounting. Corporatefinance is based on theoretical economic concepts applied to the "hard" numbersdeveloped by accountants. Finance uses accounting information to analyzeeconomic events. In a phrase, finance is applied economics. While accounting isthe language of business, finance is its literature. Financial analysis providesa systematic approach to making business decisions.

Finance is not an end in and of itself. It is a tool used to monitor, evaluate,and communicate the results of business decisions. Finance is a tool used toassess past events as well as anticipate the consequences of future decisions.It is a tool that is well suited for the board room and the production-shopfloor, the executive suite and the distribution center, and corporate anddivisional staff offices to a distant sales office. Improving financialperformance is the responsibility of every member of the organization, eitherdirectly or indirectly.

FINANCE IS EVERYONE'S JOB

In order to take on a general management role or become the head of a businessunit or functional unit, every manager must have a working knowledge of finance.He or she must be adaptive in improving day-to-day operations and enhancing thevalue of the organization. Managers must know how to make strategic investmentdecisions as well as operational decisions that use the many tools introducedand illustrated in this book.

Large corporations have specific staff to handle financial analysis and to helpmanagers make business decisions. In many organizations, diverse cross-functional project teams are formed to tackle specific assignments. These teamsmay include members from operations such as sales, marketing, production, andlogistics and staff areas such as human resources, engineering, research anddevelopment, and legal. These teams often will include a finance professional tohelp lead and guide the group's efforts toward financially sound decisions. Itis important for each functional area to better understand the role of financeand for finance to understand the role of the other functional areas as well asthe company's business model, its supply chain, and its strategic direction.

In smaller organizations, it is even more important for functional areas tounderstand finance and financial implications because often there is nodedicated financial analysis staff to assume responsibility.

Both the nonfinancial professional and the financial professional must be ableto understand and clearly communicate financial results and objectives. In away, all managers are financial managers because everyone has an impact on thebottom line and affects the value of the organization. Whatever your position,you need to know about the following necessary topics to be a more effectivemember of any business team:

• Reading, understanding, and using financial statements

• Analyzing financial statements to determine the financial health of a companyand its competitors, suppliers, and customers

• Managing the supply chain

• Planning the financial direction in support of the organization's mission,goals, and objectives

• Investing in the business through new products, new facilities, and cost-saving equipment

• Financing business growth through various techniques

• Determining the intrinsic value of the organization and how to enhance thatvalue

• Growing the business via acquisitions

Many members of an organization have bonuses and other compensation tied toachieving certain specific financial goals as well as the organization's commonfinancial objectives. It is important to understand the drivers for attainingthose goals as well as the other areas that are affected.

For example, sales and marketing often share an objective centered on top-line(sales) growth. This objective can be achieved easily with price reductions,advertising, or promotions (such as a buy-one-get-one-free offer) and so on. Ofcourse, all those "solutions" have income and cash-flow effects that may have anegative impact on the financial health of the organization. By extending theobjectives for the sales and marketing group to include sales and incometargets, the situation is partially resolved. However, sales and marketing willquickly learn about extended dating on accounts receivables. That is, instead of30 days for a customer to pay its bills, customers are given 60 or more days topay. While there are only minimal indirect income statement effects (i.e.,additional interest expense or lost interest income), the balance-sheetimplications and additional investment in working capital add pressure tofinancing availability and even may result in less business reinvestment inother areas.

Engineering, production, logistics, and research may want to manufactureproducts using the latest equipment with the fastest capabilities in a worldclass manufacturing facility. However, the financial implications must beunderstood. That is, does this investment provide an adequate rate of return?What are other business ramifications? Financing limitations may be imposed,balance sheets may be weakened, and business risk may increase substantially.Perhaps a less expensive alternative would provide maximum shareholder valuewithout having a discernible impact on the quality of the product. Capitalinvestment analysis determines the value-enhancement attributes of any capitalproject, whereas financial strategic planning anticipates the financial impactand assists in ranking alternative approaches.

Business is a series of managed conflicts. Marketing and sales want to sell aninfinite variety of products, whereas production would like to produce oneproduct. The conflicts can be resolved through financial information and itsvaluation impact. It is the systematic and common approach that leads toresolving these tensions successfully. Finance provides a common focus on goalattainment and value enhancement.

Real-world examples and discussions about familiar business topics providecomforting links to finance and business. For example, some engineers and otherprofessionals are familiar with capital budgeting from the technical (orequipment) side but do not understand the financial aspects of the process.Through this book, that gap will be closed, and the professional will appreciatethe financial rationale for capital investment analysis.

FINANCE IN THE ORGANIZATIONAL STRUCTURE OF THE FIRM

The nature of finance activities can be explained within the framework of wherefinance fits in the organizational structure of the firm.

An Overview

Figure 1-1 provides a picture of a general organization structure. Theboard of directors represents the shareholders. The chairperson ofthe board therefore has major responsibilities on behalf of theshareholders. The chief executive officer (CEO) is the highest-rankingcompany employee. The CEO is involved with the strategic direction of theorganization. As shown in Figure 1-1, some corporations have a chiefoperating officer (COO). The COO is responsible for the day-to-dayoperations because the divisions and their presidents report directly to theCOO.

One of the top executives is the vice president of finance or chieffinancial officer (CFO), who is responsible for the formulation andimplementation of major financial policies. The title maybe enhanced by thetitle of senior or executive vice president. The CFO interactswith other members of the senior management team, operating managers andprofessionals, external analysts, and a large number of other externalconstituencies. The CFO communicates the financial results and futureimplications of alternative policies and decisions.

All important episodes in the life of a corporation have major financialimplications: adding a new product line or dropping an old one, expanding oradding a plant, broadening the geographic sales of a product, selling additionalnew securities, entering into leasing arrangements, and paying dividends andmaking share repurchases. These decisions have a lasting effect on long-runprofitability and therefore require top-management consideration. Hence thefinance function typically is close to the top in the organizational structureof the firm.

Most of the finance functions are performed by the controller and the treasurer.Other functions, such as the tax department and financial planning and analysis,also, may report to the CFO. In some cases, internal audit also may reportdirectly to the CFO, board, chairperson, or CEO.

The controller's function includes accounting, reporting, and control.The controller's core function is the recording and reporting of financialinformation. This typically includes the preparation of financial statements andbudgets. In fact, the controller is often referred to as the chiefaccounting officer (CAO) of the firm. As depicted in the organizationalchart (Figure 1-1), the corporate controller's office serves more of aconsolidating role, where each division's financials are combined andconsolidated with corporate items and then reported to the public.

Figure 1-1 also shows that each division has its own vice presidentof finance, who reports directly to the president of that division with"dotted" lines to the CFO. The division vice president is responsible for day-to-day transactions processing as well as advising the division's sales,marketing, production, and logistics functions.

In "flatter" organizations without a divisional structure, the corporatecontroller also may be responsible for operational accounting functions such asaccounts receivable, accounts payable, and payroll. This also may be the case ifa divisionally structured organization considers such operational accountingfunctions as part of "shared services" for the entire organization.

The treasurer reports on the daily cash and working-capital position ofthe firm, formulates cash budgets, and generally reports on cash flows and cashconservation. The treasurer handles the acquisition and custody of funds. As apart of this role, the treasurer usually maintains the firm's relationships withcommercial banks and investment bankers. The treasurer is also usuallyresponsible for credit management, insurance, and pension-fund management.

Some large firms include another corporate officer—the corporatesecretary—whose activities are related to the finance function. Thecorporate secretary is responsible for record keeping in connection with theinstruments of ownership and borrowing activities of the firm (e.g., stocks andbonds). The corporate secretary may have a legal training because the duties ofthat officer also may encompass legal affairs and recording the minutes oftop-level committee meetings.

In addition to individual financial officers, larger enterprises use financecommittees. Ideally, a committee assembles persons of different backgroundsand abilities to formulate policies and decisions. Financing decisions require awide scope of knowledge and balanced judgments. For example, to obtain outsidefunds is a major decision. A difference of 0.25 or 0.50 percent in interestrates may represent a large amount of money in absolute terms. When a firmborrows $600 million, an interest-rate difference of 0.50 percent amounts to $3million per year. Therefore, the judgments of senior managers with financebackgrounds are valuable in arriving at decisions with bankers on the timing andterms of a loan. Also, the finance committee, working closely with the board ofdirectors, characteristically has major responsibility for administering thecapital and operating budgets.

In larger firms, in addition to the general finance committee, there may besubcommittees. A capital appropriations committee is responsibleprimarily for capital budgeting and expenditures. A budget committeedevelops and approves operating budgets, both short and long term. A pensioncommittee invests the funds involved in employee pension plans. A salaryand profit-sharing committee is responsible for salary administration aswell as the classification and compensation of top-level executives. Thiscommittee seeks to set up a system of rewards and penalties that will providethe proper incentives to make the planning and control system of the firm workeffectively.

RESPONSIBILITIES OF FINANCIAL MANAGERS

The number one responsibility of financial managers is to interact with allother parts of the organization to help improve operating performance in allareas of the company. By interacting with all activities in a team effort, aswell as understanding the firm's strategies, financial officers develop theskills of overall business leadership. Therefore, the number one responsibilityof financial managers is to bring their expertise to strategic and operatingdecisions.

Partnership with Operations

Through continued interaction with all managers, financial managers increasetheir understanding of operating requirements, manufacturing capabilities, andmarketing challenges. Through this understanding, financial managers can lookfor opportunities to streamline their organization's operations. They also canlend analytical support to these other areas to determine the financialimplications of new policy choices before they are recommended. For example,what are the financial implications of a buy-one-get-one-free product promotion?Should we hedge a commodity purchase? Should we extend credits terms from 30 to45 days? The financial professional must be knowledgeable and available tocouncil operating managers on a day-to-day basis.

Investment Decisions

The first function of financial managers, therefore, is to bring their expertiseto all the decision areas of the firm. A second important function is to takemajor responsibility for capital budgeting decisions. A successful firm isusually a growing firm, which requires the support of increased investments.Financial managers participate in establishing sales growth goals and evaluatingalternative investments to support such growth. Finance helps to decide on thespecific investments to be made and the alternative sources and forms of fundsfor financing those investments. Decision variables include internal versusexternal funds, debt versus owners' funds, and long-term versus short-termfinancing.

Financing Sources, Forms, and Methods

The financial manager links the firm to the money and capital markets in whichfunds are raised and in which the firm's securities are sold and traded.Financing changes throughout the firm's life cycle. At the earliest stages,funds come from owners and their relatives and friends. As the firm grows, itmay receive funds from "angels." Angels are wealthy individuals withexperience in the industry related to the new firm. They invest seed money andalso help the founder to test and refine his or her business model, recommendexperienced managers, and develop business operations. As the firm grows,venture capitalists also may provide additional funds.

As a startup firm develops a track record, it may be able to go public byissuing securities in financial markets. Investment banking firms may contractto bring out an initial public offering (IPO). Once a firm has gone public, awide array of debt and equity forms becomes available.

Business Ethics

Financial executives contribute to a firm's ethical reputation. Business ethicsis the conduct and behavior of a firm's management toward its stockholders,employees, customers, the community, and all stakeholders. Business ethics ismeasured by a firm's behavior in all aspects of its dealings with others.

The case for ethical behavior is based on widely accepted codes of conduct.Without integrity, a person cannot be healthy psychologically. If people cannotbe trusted, the social system cannot function effectively. In addition, though,a reputation for ethical behavior and fairness to all stakeholders is a sourceof considerable organizational value. A reputation for integrity enables a firmto attract employees who believe in and behave according to ethical principles.Customers will respond favorably to business firms that treat them honestly.Such behavior contributes to the health of the community where the firmoperates.

Firms should have codes of ethical behavior in writing and conduct trainingprograms to make clear to employees the standards that the firms seek toachieve. Johnson & Johnson is a shining example of an organization that lives byits very public moral compass, its credo. Hershey captures its values ina code of ethical business conduct. This is an area in which the firm's board ofdirectors and top management must provide leadership. They must demonstrate bytheir actions as well as by communications their strong commitment to ethicalconduct. The company's promotion and compensation systems should reward ethicalbehavior and punish conduct that impairs the firm's reputation for integrity.

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Excerpted from THE ESSENTIALS OF FINANCIAL ANALYSIS by SAMUEL C. WEAVER. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: McGraw Hill
• Publication date: 2011
• Language: English
• ISBN 10: 007176836X
• ISBN 13: 9780071768368
• Binding: Hardcover
• Number of pages: 528