Each week, you will be asked to respond to the prompt or prompts in the discussion forum. Your initial post should be 300 words in length, and you should respond to two additional posts from your peers.
Review and Apply
Consider all that you have learned in this course. How can you apply what you have learned? Look at the financial statements or perform basic research on your current or previous employer. What can you deduce about their financial standing that you would not have known before taking this class?
Chapter 1. An Overview of Financial Management and the Financial Environment
Finance – Week 1 Lecture
Introduction to Financial Management
This week you will be introduced to a wide variety of topics all pertaining to finance. Your goal is to get your feet wet, learn basic terms and concepts to prepare you for the rest of the course, and perhaps most importantly: find a reason to really want to learn more about finance. The truth is, all organizations, even your household, are impacted by finance. From small start-up companies, the local barber shop, to large multi-national organizations, they all rely on basic concepts of finance to function successfully.
You’ll learn about a lot of very important concepts throughout the next eight weeks. Financial analysis, the time value of money, debt, equity, stocks, and how much it costs to finance a business are all key topics you will dive into. Before you can approach all of these successfully, however, it’s important to find value in them. Take a bit of time in your first week and consider your current employer, your career path, and even your financial state at home. What do you currently know about how your employer finances their operations? Are you involved in the budgeting process or in choosing new projects to invest in? Do you know how much it costs your employer to obtain money to invest in and grow the business? Look at your own personal finances. Do you have any large projects you are considering? A new home, new car, additional education? How might you assess the return on these things to choose the best option? The concepts you will learn in this course will have a place in all of those situations and so many more. Once you can clearly see how beneficial the course concepts are, you’re far more likely to see useful and immediate application for what you are learning!
Take another moment to consider your current or previous employer. Do you know what kind of business structure it is? Is it owned and operated by just one person (maybe even you!)? If so, it’s a sole proprietorship. Is it owned and operated by two or more individuals? If so, it’s likely a partnership. Is it a large organization that has stockholders? That’s a corporation! Each type of business formation has very distinct advantages and disadvantages. It’s one of the first decisions we face when starting a business and will have a significant impact on the financial decisions that follow.
Sole proprietorships are a very common form of business structure and are very easy to establish. There are no required forms to file or complex partnership contracts to create. If you wake up one morning and say “I’m going into business by myself”, then you’re a sole proprietor. It’s that easy! Though easy to form, there are some key disadvantages as well. You are in it alone, so the financial burden falls squarely on your shoulders alone. You are also the only person to offer expertise and ideas for the business as well.
Now, if you head out to dinner with your neighbor and write down all your great ideas on a napkin you’ve also formed a new business, a partnership! Partnerships are also easy to form. Written partnership agreements are strongly encouraged, but not required, to start a partnership. You get the benefit of more people to share the financial burden and a wider mix of expertise and experience in the business. As a downside, however, now you also have the potential for more conflict or disagreement. You aren’t the only one running the show any more!
Finally, we could choose to form a corporation. Corporations offer a wide variety of benefits, but they are a bit more difficult to form. We can’t just wake up one morning say, “I’m incorporated”. Articles of incorporation must be written and filed with the Secretary of State. The extra work is often worth the effort though. Corporations enjoy limited liability, which standard partnerships and sole proprietorships do not. Limited liability means that the investors are limited in the amount of money they can lose. They can lose no more than the amount they have invested in the company. So, if a shareholder owns a few shares and the company suffers a fire and burns down, the shareholder will lose no more than the amount of their original investment. If, on the other hand, it was a sole proprietorship and the fire caused the whole block to burn down, the sole proprietor is solely responsible for the losses. This means that the proprietor’s personal assets are also fair game in being responsible for the loss. They are not limited to the amount they invested in the business.
Choosing a business structure is just one of many financial decisions businesses must make. Pay attention to your personal and professional life as you move through the course, trying to spot the concepts you are learning at work all around you!
Chapter 2. Financial Statements, Cash Flow, and Taxes
Chapter 3. Analysis of Financial Statements
Finance – Week 2 Lecture
Financial Statement Analysis
This week the focus will be on financial statements and how to use them to assess the performance of an organization. Before we can use them successfully, we need to know the basics. While we certainly do not need to be accounting experts, we do need to have baseline knowledge of what we are looking at. There are four basic financial statements: the income statement, balance sheet, statement of stockholder’s equity, and the cash flow statement. All four provide important information about the organization. While some financial statement users tend to prefer one statement over the other, all four are necessary in order to get a full picture of an organization’s health.
Let’s begin our exploration with the income statement. Though every income statement may look slightly different than the next, they will all still have the same basic elements: revenues and expenses. Income statements show us how much a company had for the period in sales and how much they spent in order to achieve those sales. Hopefully there are some funds left over, resulting in a profit. If we spend more on expenses than we bring in for sales, we end up with a net loss rather than a profit. It’s important to note that the income statement shows us performance over time. The most common time periods for income statements or any financial statement, is a month, quarter, or year. There are lots of ways that we can use the income statement to analyze an organization. We can look at several years of income statements to identify trends (trend analysis) to see if performance is improving or declining. We can translate the dollar figures on the income statement into percentages of sales and compare the organization to competitors, other organizations in the industry, or to industry averages. We can also calculate a wide range of profitability ratios to see how well the organization is performance in terms of profits. Ratios are a handy analysis tool as well. They allow us to easily compare the organization to others, history, and industry benchmarks.
Unlike the income statement, the balance sheet shows us only a snapshot in time. It does not show performance over a period of time. It does show us what the organization has for assets, liabilities, and equity on a given date. The balance sheet earns its name by doing just that: balancing. The balance sheet supports the accounting equation: assets = liabilities plus equity. I like to think of the equation as everything we have (assets) and where we got it from (liabilities or equity) = borrow money or someone invested money in us. Just as we are able to use the income statement for analysis, the balance sheet is just as helpful. We can also look at several periods of data for the balance sheet to identify trends. We can also translate our balance sheet dollar figures into percentages of assets to make comparisons to other organizations more meaningful. There are also many ratios we can use to analyze items on the balance sheet. For example, we might look at the debt-to-equity ratio to see how heavily the firm is financed by debt. Since debt is more risky than equity, knowing how heavily the firm relies on debt is a helpful ratio in measuring performance. We can also put the income statement and balance sheet data together to calculate several additional ratios such as return on assets which measures how profitably we are using the assets we own.
The statement of stockholder’s equity helps us see how what has happened in the equity section of the balance sheet in more detail. In this helpful statement we can see the beginning balance of stockholder equity, any dividends issued, stocks issued or retired, and income earned, and the ending balance for stockholder equity.
Finally, we have the statement of cash flows. This financial statement is often overlooked but holds crucial information about an organization. There is a common misconception that if an organization is profitable, they must have cash and if they are not making a profit then they will not have any cash. This actually isn’t true! An organization can be highly profitable but if they do not track and manage their cash flow properly, they can be profit rich and cash poor. The statement of cash flows shows where the organization’s cash came from and where it went. It allows investors to see the difference between profit (or loss) and cash flows of the organization. The statement is broken down into three categories: operating, investing, and financing. This allows anyone reviewing the statement of cash flows to easily see what type of business activities are providing or using the organization’s cash. A new creditor, for example, would be interested in the organization’s cash from operations which can provide an indication of the sustainability of the organization’s short term cash flow.
Chapter 4. Time Value of Money
Chapter 5. Bonds, Bond Valuation, and Interest Rates
Finance – Week 3 Lecture
Time Value of Money
The time value of money is a very important concept in the business world and in your own personal finances! Many students struggle with the underlying concepts when they first begin to explore this area. However, with a little patience, the time value of money can be a fun and highly useful concept to master. The elements are simple, the calculations are sometimes not so simple. The time value of money is based on the interest rate, how much time has passed, and the amount we started with or want to end with. A change in any of these three elements can significantly change the outcome of our calculation.
A great example that you may very well be able to relate to is your home mortgage or auto loan or student loan. The mortgage is a great one to pick on because they are generally so long. A standard mortgage is often 30 years long. The longer we have money invested or borrowed, the more powerful the time value of money is. Each period we accrue interest on the amount we owe on our mortgage. When we go to make our monthly mortgage payment, it must first cover the new interest that has accrued. Anything left over then goes to reduce the principle amount we borrowed. So the more interest we owe, the less principle we pay each month and the longer it takes to pay off the mortgage. Adding just $25 per month to your mortgage payment to pay extra on your principle can reduce the length of your loan potentially by years!
This is the power of the time value of money. It works the same way in business. When our investors put money into our organization they are expecting a return in exchange for allowing us to use their funds for a period of time. The same is true of a business loan. No matter where we get our capital, someone will be expecting a return! The longer we have their money tied up, the greater the return. Later in the course we’ll look at the capital budgeting process which relies heavily on time value of money calculations. We’ll see how we can evaluate potential projects we would like to complete all the while taking into consideration how much it costs us to tie up funds.
There are several different types of time value of money calculations and it’s important to understand which one to use in each situation. First, we must decide if we are looking to find the value of money right now (present value) or the value of money at some point in the future (future value). Then we have to assess how often the cash flow will occur: once (lump sum) or many times (annuity). Annuities are payments or receipts of money that happen more than once, always in the same time increments, and always in the same amount. For example, if we receive $100 for our birthday every year on the same day, that’s an annuity. Another common example of annuities in business would be capital lease payments or annual cash flows from a project.
Once we identify the type of calculation we need, we can use several different tools to help us calculate the time value of money. We may be looking for the present value of a lump sum ($10,000 to be received 2 years from now), the present value of an annuity ($1,000 received every year for ten years – what is it worth right now?), the future value of a lump sum ($10,000 invested right now, what is it worth in 5 years?) or the future value of an annuity ($1,000 received every year for ten years – what is it worth in ten years?). The time value of money factor charts can help us perform these calculations manually. A financial calculator can do all of these and more if we know the right buttons to push. There are also formulas for each one that we can perform long hand. No matter what approach works best for you, keep your resources handy (your time value of money charts or your financial calculator) since these calculations and concepts are at work in many areas of business and your personal finances.
We don’t have to look far to find the time value of money. It plays a role in how much you pay to use your credit card, your monthly mortgage payments, auto loans, student loans, bond interest, lease payments, the selling price of bonds, and various methods used to assess capital projects. Even winning the lottery requires time value of money calculations. The time value of money can be used to identify the rate of return offered by the lump sum versus annuity pay out on a large lottery win! Then you can decide which rate is more advantageous to you and whether or not you can invest your winnings and earn a rate higher than the lottery is offering in their annuity payments.
Chapter 9. The Cost of Capital
Chapter 10. The Basics of Capital Budgeting: Evaluating Cash Flows
Finance – Week 5 Lecture
Cost of Capital and Capital Budgeting
Capital projects can be a lot of fun and a lot of work. A capital project is generally a project that requires a significant investment into something that will last a significant amount of time. For example, assume we are running our own small town bakery and wanted to invest in some new aprons. The aprons are low cost and will last only a few months before they are stained or worn and will need to be replaced. This is not a capital project for our bakery. We also would like to invest in a new, larger oven that will allow us to produce more baked goods daily and hopefully increase our sales. The oven requires a large investment and is expected to have a useful life of ten years or more. The oven is a great example of a capital project!
Now we have to figure out if our oven is worth the investment! Most organizations have a wish list of projects they would like to invest in that is a mile long. The funds they have available to spend on their projects, however, is not a mile long. Therefore they must assess each project and decide in which projects to invest.
Many methods are available to help us assess the possibility of investing in our new oven. The net present value method takes into the consideration the present value of all the future cash flows our oven might produce for us then compares that amount to how much we have to invest in our oven today. If the result is positive we would likely approve the project and get our oven. If the result is negative that means that the investment we make today is greater than the present value of all the funds we hope to gain from the project. Thus, we would reject the project and not get our new oven.
We could also choose to use the internal rate of return calculation to assess our oven project. The internal rate of return reflects the amount of return we could possible earn on our project given the rate at which our firm must borrow capital. If the internal rate of return is higher than our firms cost of capital (how much it costs us to use or borrow funds) then we would likely accept the project. If the internal rate of return is lower than our cost of capital that means our oven would be earning us less than what it costs us to borrow money. If that is the case we would likely reject the project.
It’s key to note that both the net present value and internal rate of return take into consideration the time value of money. In an earlier lecture we talked about the basic concepts of the time value of money and learned that it costs money to use money. If we use debt to fund our projects we will have to pay interest. If we use equity to fund our investments we will have to pay dividends. If we use our own idle cash we have to earn more on our project than we could have earned on other investments. No matter what source of funds we use, we have to ensure that our project is earning more than the funds are costing us.
Another popular method of assessing projects is the payback method. Unlike net present value and internal rate of return, the payback method is quite basic and does not take the time value of money into consideration. The payback method reflects how many periods it takes to recoup our initial investment. This helps management understand how long their funds will be tied up in the project before they come back in the form of higher sales or lower costs. While the payback method is helpful, it doesn’t take into consideration the time value of money nor does it give any indication of how profitable the project is after it reaches the point of payback.
Now that we know some of the basic assessment methods we could do some calculations to help us determine if our oven is a good investment or not and whether or not it’s a better investment than other projects we would like to do on our limited capital budget. It’s key to note that while the assessment methods are very helpful, there are other items that should be considered as well. Employee and customer safety is a key concern. For example, if our current oven were malfunctioning and posed a hazard to our employees, we may still want to invest in the new oven even if the calculations we perform show that the oven doesn’t provide a high return. The calculations used to assess capital projects are a great starting point but should be used in conjunction with other elements that are important to the organization such as long term strategy and customer and employee safety and satisfaction.
Chapter 11. Cash Flow Estimation and Risk Analysis
Chapter 12. Corporate Valuation and Financial Planning
Finance – Week 6 Lecture
Risk and Financial Planning
Many business managers and financial managers often find themselves wishing they had a crystal ball. Assembling a forecast, a short term plan, and a strategic plan all require some fancy footwork and lots of research in order to accurately plan what may happen in the future. There are lots of tools, however, that can help make the fancy footwork a bit easier without the use of a magic crystal ball.
In our sixth week we will be covering Chapters 11 and 12 (Part 6) in our text. We’ll cover distribution to shareholders, dividends, repurchases, and capital structure decisions. There is a fine line for all organizations on how much debt is too much. It’s also important for each organization to carefully consider what type of debt will best fit their needs. We’ll talk about forms of debt and how it impacts an organization’s capital structure. Be sure to review the learning objectives, weekly schedule, and other resources available for week 6. Start by reviewing the learning objectives as it will give you a good overview of what topics we’ll be discussing this week!
For example, sensitivity analysis is a very frequently used tool in many situations. Have you ever found yourself playing the what-if game? What if I move the sofa over here, then I would have to move the chair over here…. But what if I left the sofa where it is and moved the television over there… Or perhaps you are looking at your own personal financial plan. What if you paid off the car loan first, then used the extra monthly funds to apply towards your student loan. Or, what if you chose to pay down the student loan first, then…. You get the point. Sensitivity analysis, in its most basic form, is simply a game of what-if. When it comes to assessing risk and financial planning it’s generally a lot more complicated than choosing which debt to pay off first or how to rearrange the furniture in your living room. Sensitivity analysis, however, is a way to take a large number of variables and assemble them in a way that makes sense and allows us to ‘play’ with them. For example, I worked for a large firm years ago that was struggling financially. We were assembling a 12-month plan that would try to get us to a point of profitability. It wasn’t easy since it involved massive lay-offs, some divisions closing, some product lines being discontinued, and many other difficult decisions. We built our entire 12 month financial plan in a spreadsheet. Yes, accountants love spreadsheets! There are far more sophisticated software programs available, but at the time we had Excel. The beautiful thing, however, was that I built the entire (massive) plan in Excel using formulas. Everything was linked and tied together. So we made 15 copies of the file and began to ‘play’. What happens if we reduce our workforce by 20? A click on the personnel” tab in the spreadsheet, a minus twenty in the headcount cell, and the entire plan updated and kicked out new figures. Just one small change allowed us to see how everything else changed based on a change in just one factor. The other beautiful thing about sensitivity analysis is that we can change one thing or lots of things and then see the end result. We could cut pay rates by 10%, cut 20 headcount, eliminate training programs, discontinue one product line, then look at the ending financial figures and see the outcome. It’s a lot of work and a lot of data, but by having sensitivity analysis we were able to assemble a large amount of information and make an informed decision in how to move forward with our very difficult decisions.
Unfortunately not every organization has the knowledge and skills necessary to employ tools like sensitivity analysis. These types of tools can add a lot of value to the decision making process in both good and bad times.
The process is helpful not only in assessing options in a downsizing, but in lots of
