Download 6.00 Understand Financial Analysis

6.00 Understand Financial
Analysis
NC CTE 6.02: Acquire a foundational knowledge of finance to
understand its nature and scope.
Explain the role of finance in business
• Distinguish between accounting and finance
• Accounting - The process of keeping and interpreting financial records.
• Finance - The process of obtaining funds and using them to achieve the goals
of the business
• Financial management deals with the study of procuring funds and its effective and
judicious utilization, in terms of the overall objectives of the firm, and expectations of
the providers of funds.
• Financial management is concerned with optimum utilization of resources.
• Understanding the universality and importance of finance, finance manager is
associated, in modern business, in all activities as no activity can exist without funds.
• Financial Decisions or Finance Functions are closely inter-connected
Explain the role of finance in business
• In business, finance is the function that involves all money and
money management matters.
• It also encompasses all the tools and analysis that financial managers
use to make the decisions involved in that money management.
• A company’s financial managers have a few main goals, including:
• 1. Ensuring that the business is as profitable as it can be
• 2. Reducing the business’s financial risks
Explain the role of finance in business
• The purpose of the finance function is to:
• 1) Boost the company’s growth
2) Reduce its risks
• The purpose of the accounting function is to provide accurate and
timely information about the company’s finances at any point in time.
• It’s easy to see how these two functions work together.
• The accounting function records and generates the information needed to plan
and make decisions in the finance function.
• This is not to say that accountants never make decisions or that financial managers never
keep records—there is just a difference in primary focus and purpose.
Explain the role of finance in business
• Discuss the primary finance activities
• Making investment decisions - Investment decisions relate to the total amount of assets to be
held and their composition in the form of fixed and current assets.
• Capital Investment Decisions - Decisions that determine which projects a business will
invest in, how the investment(s) will be financed, and whether or not to pay dividends to
shareholders.
• Working Capital Management - Management of a firm’s current balance of assets and
liabilities; involves accounts payable and receivable, inventory and cash.
• The trick to remembering the difference between capital investment decisions and working
capital management is to think of them in terms of time.
1. Capital investment decisions are made for the long-term—they involve company projects
that will (in theory) last for years into the future.
Example: If a manufacturing company is considering purchasing a second facility, this
would be considered a capital investment decision.
2. Working capital management involves decisions made for the short-term—in most cases, it
refers to accounts payable and receivable that will be settled within one year.
A key component of managing working capital
is the cash conversion cycle.
• Cash Conversion Cycle of Working Capital Management - Ratio that refers to the number of days
between a company’s paying for raw materials and receiving cash from selling the products made
from those raw materials.
• A. The cash conversion cycle goes by many names, including:
• 1. Asset conversion cycle
• 2. Working capital cycle
• 3. Net operating cycle
• 4. Cash cycle
• B. It is a ratio that refers to the number of days between a company’s paying for raw materials
and receiving cash from selling the products made from those raw materials.
• C. Financial managers want to keep the cash conversion cycle as short as possible because a
longer conversion cycle means that the company’s money is tied up longer.
• D. Of course, financial managers want to have as much free cash to work with as possible!
• E. When investors consider investing in a company, they often look at the cash conversion cycle as
an indicator of whether or not the company has good working capital management.
• F. A downward trend in the cycle is a positive sign, while an upward trend is a negative one.
Return on capital (also known as return on invested capital) is
another key component of managing working capital.
• Return on Capital - A measure of how well a business generates cash flow in relation to
the capital it has already invested in itself.
• A. It is a measure of how well a business generates cash flow in relation to the capital
(both debt and equity) it has already invested into itself.
• B. It is usually expressed as a percentage.
• C. When return on capital is positive, the company is growing in value.
• D. When it is negative, the company is losing value.
• E. Financial managers need to make sure that return on capital remains high.
• 1. Remember, they’re responsible for helping the company to grow in value.
• 2. Example:
a. If the packaged-food company has invested $10 million in itself through both
debt(loans) and equity (financing from within), and its net profit is $1 million, its
return on capital is positive—10 percent—and the company is growing in value.
b. This is a reasonable growth expectation.
c. If the net profit is negative, however, the company is losing value.
Explain the role of finance in business
• Discuss the primary finance activities
• Making financing decisions
• Finance decision is concerned with the mix or composition of the sources of raising the
funds required by the firm. In other words, it is related to the pattern of financing.
• Many firms have failed, not because of inefficiency of production, inability in marketing
or non-availability of funds but due to the absence of competent finance manager. I
Finance serves many important purposes
within a business, including:
• A. Helping to set goals for the future.
• B. Planning and controlling the company’s spending
• C. Ensuring sufficient financing
• D. Making sure customers pay their bills.
• E. Investing company money wisely.
• F. In short, the finance function contributes to the company by
keeping it on track in terms of money—obviously, this is vital to the
success of any business!