Chapter 14: Financial Analysis and Long-Term Financial Planning
STARTING A BUSINESS
Strategic Plan with a Vision or Mission o A business should begin with a vision or Mission Statement: Statement of a firm’s reason for being. Helps declare the company’s main reason for being. Should not be carved in stone; it should be periodically reviewed to ensure it is up-to-date and reflects market needs in a dynamic, global economy. Business and Financial Goals o Businesses need to stick to what they do best: strategic goals should be related to the firm’s core competencies. o Attracting and acquiring financing is necessary to obtain the factors of production required to conduct business operations.
FORMS OF BUSINESS ORGANIZATION IN THE UNITED STATES
3 major forms of businesses in the United States 1. Proprietorship: Business venture that is owned by a single individual who personally receives all profits and assumes all responsibility for the debts and losses of the business. o The financial capital of proprietorships is many times limited to the saving of the owner and funds that may be borrowed from friends, relatives, and banks. Equity Capital: Investment made by the owner into the company.
1
Chapter 14: Financial Analysis and Long-Term Financial Planning
o Weaknesses of a proprietorship: Owner’s original investment exhausts his or her personal resources and often those of friends and relatives. Life of the company lives and dies with the owner. Large liability: risks personal assets, 2. Partnership: Form of business organization when two or more people own a business operate for profit. o Allows individuals to pool their resources of money, property, equipment, knowledge, and business skills without complications that often accompany incorporation. o Weaknesses of a partnership: Life of the company lives and dies with the partners. Limited Partners: Face limited liability; their personal assets cannot be touched to settle the firm’s debt. Limited Partnership: Has at least one general partner who has unlimited liability; the liability of the limited partners is limited to their investment. 3. Corporation: Legal entity created under state law with unending life that offers limited financial liability to its owners. o A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. In essence, the law has created an artificial being that has the rights, duties, and powers of a person.
2
Chapter 14: Financial Analysis and Long-Term Financial Planning
Many people united into one body that does not change its identity with changes in ownership. o Weaknesses of a corporation: New corporations find it difficult to attract investment funds from outsiders. May not always protect stockholders from personal risk beyond their investment. o Charter: Provides the corporate name, indicates the intended business activities, provides names and addresses of directors, and indicates how a firm will be capitalized with stock. o Bylawas: Rules established to govern the corporation; they deal with how the firm will be managed and the rights of the stockholder. o Subchapter S Corporation: Has fewer than 35 shareholders, none of which is another corporation. Its income is taxed only once, as personal income of the shareholders. o Limited Liability Company (LLC): Organizational form whose owners have limited liability; the firm can have an unlimited number of shareholders; income is taxed only once as personal income of shareholders.
3
Chapter 14: Financial Analysis and Long-Term Financial Planning
THE ANNUAL REPORT
An important component of manager-owner communication is the firm’s financial statements. o Proprietorships and Partnerships are NOT required to prepare financial reports or statements except for tax purposes, while corporations ARE required to. Annual Report: Contains descriptive information and numerical records on the operating and financial performance of a firm during the past year. 3 important financial statements are provided in the annual report: 1. Statement of Income (Statement of Operations) 2. Balance Sheet (Statement of the Financial Position) 3. Statement of Cash Flows
ACCOUNTING PRINCIPLES
The Financial Accounting Standards Board (FASB) created the GAAP’s o Generally Accepted Accounting Principles (GAAP’s): Set of guidelines as to the form and manner in which accounting information should be presented. Flexibility in the GAAP’s is good because not all firms are the same and require more lenient financial rules. Flexibility in the GAAP’s is bad because it can let firms, at first glance, appear healthier that they really are.
INCOME STATEMENT
Income Statement: Reports the revenues generated and expenses incurred by the firm over an accounting period.
4
Chapter 14: Financial Analysis and Long-Term Financial Planning
THE BALANCE SHEET
Balance Sheet: Statement of a company’s financial position as of a particular date “a snap shot in time”. It reveals 2 broad categories of information: 1. Assets: Financial and physical items owned by a business. Assets = Liabilities + Owner’s Equity Current Assets: Cash and all other assets that are expected to be converted into cash within one year. Working Capital: Assets needed to carry out the normal operations of the business. Depreciation: Devaluing a physical asset over the period of its expected life. 2. Liabilities: The debts of a business. (Creditors’ claims on a firm.) Current Liabilities: Those liabilities that need to be paid within 1 year. Example: accounts payable, notes payable, and accrued liabilities that are to be met out of current funds and operations. Long-Term Liabilities: Maturities greater than one year. Examples: Mortgage. Owner’s Equity: Investment of the owners or owner in the business. o Business initially results from a cash outlay to purchase assets to operate the business. Retained Earnings:
5
Chapter 14: Financial Analysis and Long-Term Financial Planning
o Equity: Funds supplied by the owners that represent their residual claim on the firm.
STATEMENT OF CASH FLOWS
Statement of Cash Flows: Provides a summary of the cash inflow (sources) and cash outflows (uses) during a specified accounting period. Contain 3 sections: 1. Operating Activities 2. Investing Activities 3. Financing Activities Cash Flows are determined as follows: Sources o Amount of net income plus amount of depreciation o Decrease in an asset account o Increase in a liability account o Increase in an equity account Uses o Increases in an asset account o Decrease in a liability account o Decrease in an equity account o Amount of cash dividends
FINANCIAL STATEMENTS OF DIFFERENT COMPANIES
Financial statements tell investors of difference in how companies operate. Common-Size Financial Statements: Expresses balance sheet dollar figures as a percent of total assets and income statement numbers as a percent of total revenue to facilitate comparisons between different-sized firms.
6
Chapter 14: Financial Analysis and Long-Term Financial Planning
GOAL OF A FIRM
Measuring Shareholder Wealth o Shareholder wealth is nothing more than the market value of a firm’s common stock. Shareholder Wealth = Common Stock Price x Number of Common Shares Outstanding o Market Value Added (MVA): Measures the value created by the firm’s managers. Linking Strategy and Financial Plans o Important to pay attention to movements in a company’s stock price over time. o Managers can first review the firm’s performance in the financial markets and determined why the firms stock price performed better or worse that its competitors in the eyes of investors.
CORPORATE GOVERNANCE
Principal-Agent Problem o Principals: Owners of the firm. o Agents: Hired by the principals to run the firm. o Principle-Agent Problem: Conflict of interest between the principals and agents. Reducing Agency Problems o Reduce the consequences of managers making self-serving decisions Stock Options: Allow managers to purchase a stated number of the firm’s shares at a specified price.
7
Chapter 14: Financial Analysis and Long-Term Financial Planning
FINANCE IN THE ORGANIZATION CHART
Chief Financial Officer (CFO): Responsible for the controller and treasury functions of a firm. o Managers of 2 areas usually report to the CFO: Treasurer: Oversees the traditional functions of the financial analysis. Controller: Manages accounting, cost analysis, and tax planning.
8