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Financial Management by Dr. Sahanon Tungbenchasirikul ©1
Financial Management (Part 1 – Basic Practices)
by Dr.Sahanon Tungbenchasirikul
Financial Management by Dr. Sahanon Tungbenchasirikul ©2
Copyrights
With regard to Copyright Act B.E. 2537 (1994):
• All elements in the presentation (i.e., words, clauses, sentences, pictures, symbols, tables, and trademarks) are obtained from textbooks, academic journals, websites, and other sources of knowledge. These have been claimed to have copyrights.
• The presentation is solely used for academic, not for any commercial, purposes.
Financial Management by Dr. Sahanon Tungbenchasirikul ©3
Part 1 (Basic Practices)
• Financial Environment
• CFO Roles
• Financial Statement Analysis
• Financial Planning
Financial Management by Dr. Sahanon Tungbenchasirikul ©4
Financial Environment
by Dr.Sahanon Tungbenchasirikul
Financial Management by Dr. Sahanon Tungbenchasirikul ©5
Financial Market & Economy
The Firms
Consumers and Input Owners
Product MarketsInput Markets Government
Buy Inputs
Pay Input Owners
Sell Products
Pay the Firms
Sell Inputs
Pay Inputs Costs
Pay Product Costs
Buy Products
Buy Inputs
Pay Inputs Costs
Pay Product Costs
Buy Products
Pay Taxes
Budget Spending, Subsidies, Policies
Pay Taxes
Budget Spending, Subsidies, Policies
Financial Management by Dr. Sahanon Tungbenchasirikul ©6
Financial Market & Economy
Financial Market
Product and Input Markets
Consumers Government
Firms Financial Institutes
Lending /
Sources of Funds
Input & Product Support
Save / Invest
Save / Invest
Labor
Budget /
Projects
Goods / Services
/ Inpu
ts
Financial Services
Financial Market Product/Input Market
Financial Management by Dr. Sahanon Tungbenchasirikul ©7
Economic Players Roles Objectives
Consumers Consumption & Labor Maximize Utility
Firms Project Investment Maximize Profit
Financial Institutes Financial Services Maximize Profit
Government Taxation & Spending Maximize Social Welfare
Financial Market & Economy
Economic Players : Objectives
Financial Management by Dr. Sahanon Tungbenchasirikul ©8
Short-term Needs Long-term Needs
Consumers - Daily expense- Emergency payments (e.g. illness, accident)
- Asset investment & daily usage (e.g. house, car, gold, land, government bond, marketable securities).
Firms - Operating expense- Emergency incidents
- Project investment- Long-term revenue growth- Long-term asset growth
Financial Institutes
- Operating expense- Emergency incidents
- Long-term credit growth e.g. business and housing loan growth.- Financial asset investment
Government - Operating expense- Emergency incidents
- Infrastructure project investments- Public debt repayment
Financial Market & Economy
Financial Needs of Economic Players
Financial Management by Dr. Sahanon Tungbenchasirikul ©9
Sources of Funds Fund Allocation Pattern
Consumers - Income - Borrowing- Saving
- Daily spending - Lump-sum or bullet payment- Amortization
Firms - Operating income- Borrowing- Shareholder equity
- Daily business spending - Lump-sum or bullet payment- Amortization
Financial Institutes
- Financial service income- Borrowing- Shareholder equity
- Daily financial transactions- Lump-sum or bullet payment- Amortization
Government - Tax and fee charge income - Borrowing- Fiscal reserve
- Officers’ salary & benefits - Government operating expenses- Lump-sum or bullet payment- Amortization
Financial Market & Economy
Sources of Funds and Fund Allocation Patterns
Fund Matching
Financial Management by Dr. Sahanon Tungbenchasirikul ©10
Primary Sources of Repayment (PSOR)
Secondary Sources of Repayment (SSOR)
Consumers - Net income (free of debt obligation)
- Fixed asset sales- Long-term saving- Borrowing (revolving loan)
Firms - Cash flow from operations - Fixed asset sales- Borrowing- Raising equity
Financial Institutes - Cash flow from operations -Fixed asset sales- Borrowing- Raising equity
Government - Tax collection- Short-term loan (e.g. treasury bill)
- Fiscal reserve - Long-term loan (Govt. Bond)
Financial Market & EconomySources of Repayment (in the case of debt)
Financial Management by Dr. Sahanon Tungbenchasirikul ©11
Financial Market & Economy
Sources of Funds
Fund Allocation Patterns
Sources of
Repayment
Financial Needs
Payback
Search for
Use
Sources of Repayment (in the case of debt)
Financial Management by Dr. Sahanon Tungbenchasirikul ©12
Financial Market & Economy
Summary: Various Roles of Financial Market
- Saving Function- Capital and Liquidity Management Function- Wealth Management Function- Transaction and Payment Function- Credit Management Function- Risk Management Function- Economic Policy Management Function
Financial Management by Dr. Sahanon Tungbenchasirikul ©13
- Money Market and Capital Market- Primary Market and Secondary Market- Auction Market and Negotiated Market- Spot Market and Forward/Future Market- Private Market and Public Market
Financial Market & Economy
Financial Market : Classifications
Financial Management by Dr. Sahanon Tungbenchasirikul ©14
Financial Market & Economy
Money Market and Capital Market Summary
Short-term Funding Sources < 1 Year
- Maturity Date < 1 Year
- Treasury Bills, Government Bond with Repurchasing (Repo)
Medium and Long-Term Funding Sources > 1 Year
- Public Company Common Shares
- Limited Company Shares
- Preferred Shares or Property Funds
- Swaps, Options, Futures
- Interbank Loan
- Private Repurchasing (Repo)
- Short-term Loan, BE, PN, OD, LG, LC TR, PC
- Private Bond, Convertible Bond, Long-term Loan, Long-term Government Bond
- Structure Note
- Securitization e.g. CDO (Collateralized Debt Obligation)
Financial Market
Money Market Debt Capital Market
Debt Instruments (Government)
Short-term Debt Instruments (Private)
Equity Instruments
Long-term Debt Instruments
Derivative Instruments
Financial Management by Dr. Sahanon Tungbenchasirikul ©15
Financial Market & Economy
Primary Market Secondary MarketThe market in which corporations raise new capital by selling their securities to investors for the first time.
There are two routes of raising new capital:- Private Placement (PP)- Initial Public Offering (IPO)
The market in which existing securities are traded among investors who intend to speculate the security returns.
The official secondary market in Thailand is the Stock Exchange of Thailand (SET, MAI, BEX, TFEX).
The unofficial secondary market is called “over the counter market” (OTC).
Financial Management by Dr. Sahanon Tungbenchasirikul ©16
Auction/Open Market Negotiated MarketThe market consists of a large number of security sellers and buyers.
Security brokers play the key role in buying and selling security on the behalf of buyers and sellers.
Security exchanges completed when brokers match the prices and quantities of the security (e.g. PTT).
Official security auction/open markets include SET, MAI, BEX, TFEX.
Direct exchange between security buyer and seller.
Security price is based on the decision of both buyer and seller (e.g. mark to market, below par value), not determined by the market demand and supply.
The operation of primary market is viewed as the direct exchange (contract)
Example of negotiated market include private bond selling to large institutional investors.
Financial Market & Economy
Financial Management by Dr. Sahanon Tungbenchasirikul ©17
Spot Market Forward/Future MarketSecurities/assets are being bought or sold for “on-the-spot” delivery.
Once the buyer and the seller settle a deal, they need to make payment and transfer security/asset to another party immediately or within a few days.
Securities/assets are being bought or sold for “the future” delivery.
Once the buyer and the seller settle a deal, they will make payment and transfer security/asset to another party with regard to the future/forward contract (e.g. 30 days, 60 days).
Forward/future market could aid buyers and sellers to manage risks better. For instance, the company (buyer) completed a deal with the bank (seller) to buy FX forward and will make payment by the end of June 2010.
Financial Market & Economy
Financial Management by Dr. Sahanon Tungbenchasirikul ©18
Private Market Public MarketTransactions of securities/assets are worked out directly between buyers and sellers.
Bank loans and private placement (PP) of new common stocks are examples of private market.
Private market securities/assets are more tailor-made, but less liquid.
Transactions of securities/assets are conducted in term of standardized contracts.
Securities issued in public markets (e.g. common stock, corporate bond) are ultimately held by a large number of individuals.
Public market securities/assets are more liquid and standardized.
Financial Market & Economy
Financial Management by Dr. Sahanon Tungbenchasirikul ©19
Financial Market & Economy
Business
Capital Formation Process
Savers
Business Savers
Business Savers
Direct TransfersSecurities (Stocks or
Bonds)
Money
Indirect Transfers through Investment Bankers
Investment Banking
Companies
Securities Securities
MoneyMoney
Indirect Transfers through a Financial Intermediary (e.g. banks)
Financial Intermediary
Securities Securities
MoneyMoney
Financial Management by Dr. Sahanon Tungbenchasirikul ©20
Generic Financial Market and Institute Role
Economic Players with Borrowing
Needs
(Demand for Capital)
Financial Institutes
Security Purchasing
Security Issuing
Economic Players with Surplus
Saving(Supply of
Capital)
Financial Market
The process of capital and liquidity flow:
Financial Institutes and Financial Market jointly play the key role as Financial Intermediary in an economy.
Lending
Saving
Financial Institutes
Financial Management by Dr. Sahanon Tungbenchasirikul ©21
The Importance of Financial Institutes:- Facilitating financial transaction- Risk reduction through diversification- Reduction in the contracting and negotiation
costs- Financial information production and spillover- Management of payment/settlement systems- Insurance agents
Financial Institutes
Financial Management by Dr. Sahanon Tungbenchasirikul ©22
Generic Types of Financial Institutes (Thailand)
Key Roles Thailand Examples
Commercial Bank A broad range of banking and financial services to serve large corporations, SMEs, and retail customers.
Bangkok BankKrung Thai BankKasikorn BankSiam Commercial Bank
Government Specialized Banks
Financial services in line with government policy (e.g. housing loan, agricultural loan)
Government Housing Bank, Government Saving Bank, SME Bank, EXIM Bank
Security Company Security issuing, financial advisory, common stock broker,
Asia Plus SecuritiesKim Eng SecuritiesPhatra Securities
Mutual Fund Management Company
Institutional investors, which use mutual funds as investment tools.
SCB Asset ManagementKasikorn Asset Management, TMB Asset Management
Financial Management by Dr. Sahanon Tungbenchasirikul ©23
Generic Types of Financial Institutes (Thailand)
Key Roles Thailand Examples
Life Insurance Company
Selling insurance policy to customers and in turn invest money in long-term low risk securities.
AIA, Thai Insurance, &Bua Luang Life Insurance
Leasing Company Offering leasing loan to both organization and retail buyers.
Tanachart, Tisco, Kiatnakin, Phatra, SCB, Toyota, Honda
Cooperatives Lending money to the those members who need liquidity.
EGAT Saving Cooperative, SCB Saving Cooperative
Pawnshop Lending money to retail customers who pledge their assets as collaterals.
Government Pawnshop in Bangkok and Provinces.
Financial Management by Dr. Sahanon Tungbenchasirikul ©2424
Financial Regulators (Thailand)
Key regulators of Thailand financial market:
– Ministry of Finance (MOF)
– Bank of Thailand (BOT)
– Securities and Exchange Commission (SEC)
Financial Management by Dr. Sahanon Tungbenchasirikul ©2525
Financial Regulators: Objectives
- Promote the Stability of Financial Market- Investor Protection- Fair and Healthy Competition)- Support Government Economic Policy
– Appropriate GDP Growth– Minimized Unemployment Rate– Inflation Control– Current Account Surplus (Export > Import)– Positive New Capital Movement
Financial Management by Dr. Sahanon Tungbenchasirikul ©26
Financial Regulators: Capital Market
SEC
MOF
The governance structure of Thailand capital market
Primary Market (PP & IPO)
Secondary Market (SET, MAI, BEX, TFEX)
Financial Institutes• Securities Companies• Mutual Fund Management Companies• Provident Fund
Financial Management by Dr. Sahanon Tungbenchasirikul ©27
Financial Regulators: Financial Institutes
27
BOT
MOF
• Commercial Banks (Thai banks and foreign bank branches)
• Commercial Bank Subsidiaries (e.g. Leasing, Factoring)
• Retail Banks
• Finance Companies
• Leasing Companies
• Credit Foncier Companies
• Asset Management Companies
• Specialized Government Banks
The governance structure of Thailand financial institutes
Financial Management by Dr. Sahanon Tungbenchasirikul ©2828
Information Disclosure- Substantial information- Equality and timeliness- Accuracy- Sufficiency
Risk Control- Risk-Return balance
- Risk calculation and appropriate allocation of company ca pital
Financial Regulators: Policy Trend
Financial Management by Dr. Sahanon Tungbenchasirikul ©2929
1 . Financial Market Efficiency:– Operational efficiency (Cost management) – Allocation efficiency (Appropriate return from investments)– Information efficiency (Equality of information access)
2. Fairness:– Equal opportunity– Single standard
3. Financial Market Stability and Security:– Risk control– Regulations and measures– Investor protection
Financial Regulators: Key Success Factors
Financial Management by Dr. Sahanon Tungbenchasirikul ©30
Interest Rates (Cost of Money Borrowing)
Interest Rate is “the price paid to borrow debt capital. With equity capital, investors expect to receive dividends and capital gains, whose sum is the cost of equity money.”
Interest Rate is affected by four fundamental factors. These are:
– Production Opportunities (rate of return on investment).– Time Preferences for Consumption (the willingness to sacrifice
current consumption in order to secure future consumption).– Risk (the likelihood of loss events take place).– Inflation (price level continually increases).
Interest Rate is affected by various macroeconomic factors. These include:
– Central Bank Monetary Policy– Government Budget Spending Policy– International Economic Factors (e.g. trade surplus, trade deficit)
Financial Management by Dr. Sahanon Tungbenchasirikul ©31
Risk Free Interest Rate (Theoretical Aspects)
The risk-free rate of interest (krf) is defined as the real risk-free rate (k*) plus an inflation premium (IP). Therefore,
krf = k* + IP
Example. A company borrows money from a bank. Bank officers charge the risk-free rate of interest (krf) by assuming the real risk-free rate (k*) = 3% and inflation premium (IP) = 3%. What is krf?
krf = k* + IP krf = 3% + 3% krf = 6%
Financial Management by Dr. Sahanon Tungbenchasirikul ©32
Quoted Interest Rate (Theoretical Aspects)
The quoted (or nominal) interest rate (k) on the debt security is composed of the real risk-free rate (k*) plus an inflation premium (IP) plus default risk premium (DRP), plus liquidity risk premium (LP) and plus maturity risk premium (MRP). Therefore,
k = k* + IP + DRP + LP + MRP
Example. A company borrows money from a bank. Bank officers consider the quoted interest rate (k) by assuming the real risk-free rate (k*) = 3%, inflation premium (IP) = 3%, default risk premium (DRP) = 1%, liquidity risk premium (LP) = 0.5%, and maturity risk premium = 0.5%, What is k?
k = k* + IP + DRP + LP + MRP k = 3% + 3% + 1% + 0.5% + 0.5% k = 8%
Financial Management by Dr. Sahanon Tungbenchasirikul ©33
Interest Rate (Investment vs. Saving)
Interest Rate
Money Amount
SavingInvestment
Investment = Saving
M1
I1
Interest Rate
Money Amount
Saving 1
Investment
M1
I1
Saving
M2
I2
Investment and saving determines interest rate level. If saving increases (investment constant), interest rate is likely to decrease. If investment increases (saving constant), interest rate is likely to increase.
Financial Management by Dr. Sahanon Tungbenchasirikul ©34
Interest Rate: Yield Curve
Source: Thai BMA (for education purpose only)
Example of Government Bond Yield Curve Time to Maturity -
TTM (Yrs.)Yield (%)
0.08 (1M) 1.25
0.25 (3M) 1.36
0.50 (6M) 1.48
1 Y 1.76
2 Y 2.32
3 Y 2.69
4 Y 3.06
5 Y 3.18
6 Y 3.22
7 Y 3.31
8 Y 3.35
9 Y 3.37
10 Y 3.45
15 Y 3.74
20 Y 3.9
25 Y 3.97
29 Y 4.06Long-term interest rates are higher than short-term ones.
Financial Management by Dr. Sahanon Tungbenchasirikul ©35
CFO Roles
by Dr.Sahanon Tungbenchasirikul
Financial Management by Dr. Sahanon Tungbenchasirikul ©36
• Financial Management is necessary for every organization (government, state own enterprises, private companies, cooperatives and so on)
• Intuitively, every organization must create revenue that is sufficient to cover its total cost. In other words, every organization needs to spend money to drive its business, and in turn expects to gain money back from such business (there is no free lunch).
• Financial management significantly influences the success of strategies in both the short- and long-term.
Financial Management
Financial Management by Dr. Sahanon Tungbenchasirikul ©37
Financial Management
The primary goal of management is to maximize
shareholders’ wealth and this implies maximizing
the stock price.
Financial Management by Dr. Sahanon Tungbenchasirikul ©38
Financial Management
Maximize shareholders’ wealth:• Satisfactory long-term stock value.• Strategies that add value to the firm and sustain
competitive advantages.• Sufficient cash in executing the firm’s strategic
plans.• Investment in profitable business/project/product.• Capability to take advantages from money and
capital markets.• Cash flow to finance debt and pay dividend over a
long-term.• Risk–Return Balance.
Financial Management by Dr. Sahanon Tungbenchasirikul ©39
Chief Financial Officer (CFO) roles are as follows:– Financial Planning– Investment Decision– Financing Decision– Working Capital Management– Financial Risk Management
CFO Roles
Maximize shareholders’ wealth
Financial Management by Dr. Sahanon Tungbenchasirikul ©40
CFO Roles
Roles Key Functions
Financial Planning
• Corporate Plan & Budget• Identifying Financial Needs and Sources of Funds.
Investment Decision
• Project Selection• Project Feasibility Analysis• Cash Flow Management
Financing Decision
• Capital Structure• Debt Financing • Capital Financing
Financial Management by Dr. Sahanon Tungbenchasirikul ©41
CFO Roles
Roles Key Functions
Working Capital Management
• Current Asset Management• Short-term Financing
Financial Risk Management
• Identifying Causes of Financial Risks• Financial Risk Prevention and Correction
Financial Management by Dr. Sahanon Tungbenchasirikul ©42
Financial Statement Analysis
by Dr.Sahanon Tungbenchasirikul
Financial Management by Dr. Sahanon Tungbenchasirikul ©43
Financial Statement Analysis
The four basic financial statements in the annual report include:
• Balance Sheet;
• Income Statement;
• Statement of Retained Earning (we do not focus on this one);
• Cash Flow Statement.
Shareholders / investors use these statements to form expectations about the future levels of earnings, profits, dividends, and about the firm’s risks.
Financial Management by Dr. Sahanon Tungbenchasirikul ©44
1. Balance Sheet: Assets = Liabilities + Owner Equities
2. Profit and Loss Statement: Revenue, Costs of Goods Sold, Gross Profit, Selling & Admin Expenses, EBIT, Interest Expenses, Tax, Net Profit.
3. Cash Flow Statement: • Operating Cash Flow • Investing Cash Flow• Financing Cash Flow
Financial Statement Analysis
Students should be familiar with three financial statements above.
Financial Management by Dr. Sahanon Tungbenchasirikul ©45
• Financial ratio calculation based on data in financial statements.• Comparing the firm’s financial ratios for several years (3 Years) to
forecast the business future trend.• Comparing the firm’s financial ratios with key competitors’ to know
whether the firm is as good as, lacks behind, or outperforms them.
1. Liquidity Ratio2. Profitability Ratio3. Efficiency Ratio4. Leverage or Financial Policy Ratio
Financial Statement Analysis: Ratio Analysis
Financial Management by Dr. Sahanon Tungbenchasirikul ©46
Liquidity RatioRatio Formula Definition
Current Ratio Current Assets / Current Liabilities or CA / CL = XX time(s)
Indicates the ability of the firm to meet short-term obligations.
Quick Ratio [Cash + Marketable Securities + Account Receivable] / Current Liabilities = XX time(s)
Indicates the ability of the firm to meet short-term obligations without reliance on inventory.
Working Capital (WC)
Current Assets – Current Liabilities or CA - CL = WC
Measures the excess of current assets over current liabilities in term of money value. If WC > 0, the firm can meet short-term obligations, but it needs support from long-term funding sources.
Financial Management by Dr. Sahanon Tungbenchasirikul ©47
Profitability Ratio
Ratio Formula Definition
Gross Profit Margin [Gross Profit / Revenue] x 100 = XX%
Indicates the per-unit spread between revenue and the cost of good sold
Net Profit Margin [Net Profit / Revenue] x 100= XX%
Indicates the firm’s ability to generate profit from each unit sales.
Earning Before Interest, Tax, Depreciation & Amortization = EBITDA
Profit before Interest and T ax + Depreciation + Amorti
zat i on = EBITDA
[EBITDA / Revenue] x 100= XX%
Indicates the firm’s ability to generate cash flow (interim profit) to pay short-term financial obligations (i.e. tax and interest payment).
Financial Management by Dr. Sahanon Tungbenchasirikul ©48
Indicates the average number of days in the collection period.
[Account Receivable /Revenue] x 360 = XX days
Account Receivable Day on Hand = ARDOH
Indicates the average number of days in the supplier payment period.
[ Account Payable / COGS] x 360 = XX Days
Account Payable Day on Hand = APDOH
Indicates the average number of days that the firm needs financial support to maintain its liquidity.
FN = ARDOH + INVDOH – APDOH = XX daysFN > 0 --> Need more cashFN < 0 --> No need cash
Cash Cycle or Financial Needs (FN)
Indicates the average number of days in inventory holding period.
[ Inventory / COGS] x 360 = XX Days
Inventory Day on Hand = INVDOH
DefinitionFormulaRatio
Efficiency Ratio
Financial Management by Dr. Sahanon Tungbenchasirikul ©49
Indicates the ability of net fixed assets to generate revenue.
Revenue / Net Fixed Ass et s = XX time(s)
Sales to Net Fixed Assets
DefinitionFormulaRatio
Indicates the return on investment based on total assets.
[Net Profit / Total Assets] x1 0 0 = XX%
Return on Assets = ROA
Indicates the rate of return on shareholders’ equity.
10[Net Profit / Equity] x 0 = XX%
Return on Equity = ROE
Indicates the ability of total assets to generate revenue.
Revenue / Total Assets= XX time(s)
Total Assets Turnover
Efficiency Ratio
Financial Management by Dr. Sahanon Tungbenchasirikul ©50
Indicates the company’s proportion of external creditor and shareholder funding.
Total Liabilities / Equi ty = XX time(s)
Debt to Equity Ratio = D/E Ratio
(Very Important)
DefinitionFormulaRatio
Indicates the company’s ability to meet interest payment by operating cash flow.
EBIT / Interest Payme nt = XX time(s)
Time Interest Earned = TIE
Indicates the degree to which the company’s assets are funded by external creditors.
[Total Liabilities / Tot al Assets] x 100 = XX
%
Debt Ratio
Leverage or Financial Policy Ratio
Financial Management by Dr. Sahanon Tungbenchasirikul ©51
Indicates the company’s ability to pay senior debt interests from using operating cash flow.
EBITDA / Interest Payment = XX time(s)
Interest Coverage Ratio = ICR
DefinitionFormulaRatio
Indicates the company’s ability to meet financial obligations (interest and principal) from using operating cash flow.
EBITDA / [Interest Payment + Current P
- ortion of Long Term Li abilities (CPLTL)] =
XX time(s) -- DSCR < 1 > Not goo
d -- DSCR > 1 > Good
Debt Service Coverage Ratio = DSCR
(Very Important)
Leverage or Financial Policy Ratio
Financial Management by Dr. Sahanon Tungbenchasirikul ©52
Example of Profit and Loss Statement
Financial Management by Dr. Sahanon Tungbenchasirikul ©53
Example of Balance Sheet
Financial Management by Dr. Sahanon Tungbenchasirikul ©54
Example of Balance Sheet
Financial Management by Dr. Sahanon Tungbenchasirikul ©55
1( ) Account Receivable and Inventory increase 10%.
(2) Building Premises increases 400 MB.
(3) Account Payable increases 10%.
(4) The company pays dividend 50% of its 25X2 net profit = 616 MB and allocate 616 MB to be the retained earning.
(5) O/D increases 200 MB.
6( ) LTL 200increases MB.
Balance Sheet Changes in 25X2
Financial Management by Dr. Sahanon Tungbenchasirikul ©56
Example of Cash Flow Statement
Student shall try to calculate financial ratios by using data from the company’s annual report.
Financial Management by Dr. Sahanon Tungbenchasirikul ©57
Methods of Financial Statement Estimation
• Trend Analysis - observe average revenue, cost, ROE, ROA over several years and plot the trend line to estimate future revenue and other items in financial statement.
• Common Size Analysis - all income statement items are divided by revenue (as % of revenue) and all balance sheet items are divided by total assets (as % of total assets). We will adopt this method to support our analysis for the rest of this course. Note, no common size analysis for cash flow statement.
• Percent Change Analysis - growth rates are calculated for all income statement items and balance sheet accounts.
Financial Management by Dr. Sahanon Tungbenchasirikul ©58
Limitations of Financial Statement • Some large diversified firms will find it difficult in
conducting performance comparisons with players in each market segment.
• Inflation affects financial statement analysis across different periods.
• Seasonal effects can distort ratio analysis (e.g. real estate, luxurious retail stores).
• Generalization problems across different industries (e.g. financial institutes vs. modern trade retailers).
Ratio analysis is useful, but analysts must be aware of these problems and make adjustment as necessary. Ratio analysis conducted in a mechanical, unthinking manner, is dangerous, but used intelligently and with good judgment, it can provide useful insights into a firm’s business operations and effectiveness.
Financial Management by Dr. Sahanon Tungbenchasirikul ©59
Financial Planning
by Dr.Sahanon Tungbenchasirikul
Financial Management by Dr. Sahanon Tungbenchasirikul ©60
Strategic Management Process
Strategy Control
Strategy Formulation
Strategy Implementati
on
Financial Management by Dr. Sahanon Tungbenchasirikul ©61
Corporate Plan (Strategic Plan)
• In the context of Financial Management, every corporate plan (strategic plan) aims to maximize shareholders’ wealth/common stock price over a long-term.
• The key attributes of Corporate Plan (Strategic Plan) are:– It requires top executive’s commitment. – It is medium- or long-range plan (3 – 5 years).– It has a significant impact on the firm’s business
operations and performances.– It requires new business initiatives and investments in
various business operations (e.g. marketing, R&D, logistics).
– Once the firm has implemented its corporate plan, it is difficult to reverse (unless the firm declines its corporate plan at the formulation stage).
Financial Management by Dr. Sahanon Tungbenchasirikul ©62
Key Components of Corporate Plan
• Corporate Plan is defined as a blueprint specifying the resource allocations, schedules, and overall business master plans necessary for maximizing shareholders’ wealth over a long-term:
• Corporate Plan covers the following details:Corporate Vision Corporate MissionCorporate GoalsCorporate StrategiesOverall Budget RequirementsOverall Manpower RequirementsKey Project InvestmentsKey Business Support Requirements (e.g. IT,
Logistics) Financial Projections (1-3 years, 3-5 years)
Financial Management by Dr. Sahanon Tungbenchasirikul ©63
Corporate Vision
• Corporate Vision can be viewed as the long-term business direction or the most crucial business goal, which shapes the firm’s business scope, strategy, and structure. In other words, vision is a desired future state that the firm attempts to achieve. For examples,
– To be number one in luxurious fashion business in 2015.– To dominate Asia-Pacific beer market in 2015.
Financial Management by Dr. Sahanon Tungbenchasirikul ©64
Corporate Mission
• Corporate Mission is defined as what the firm stands for and its reason for existence. For example,– To provide excellent services for our customers, to build a
good working environment for our employees, and to reinforce satisfactory financial outcomes for our shareholders.
Financial Management by Dr. Sahanon Tungbenchasirikul ©65
Corporate Goal
• Corporate Goal is defined as expected end results of implementing corporate strategies in both the short- and long-term. For examples, – Revenue growth at least 10% per annum.– Customer retention rate equals 90% within 3 years.– Completing back-office process centralization within 3
years.
Financial Management by Dr. Sahanon Tungbenchasirikul ©66
Corporate Plan Summary
Vision
Mission
Corporate Goals
& Strategies
(Senior Management)
(Organization as a Whole)
Business Goals/Plans
(Middle Management)
(Business Units, Divisions, Functions)
Operational Goals/Plans
(Front-line Management)
(Departments, Individuals)
• Overall Budget Requirements
• Overall Manpower Requirements
• Key Project Investments
• Key Business Support Requirements
• Financial Projections
Corporate Plan (Strategic Plan)
Financial Management by Dr. Sahanon Tungbenchasirikul ©67
Corporate/Strategic Plan Metaphor
War Vision, Mission, and Goal
High-Level War Strategy/PlanBattle Strategies
(Tactical Goals/Plans)
Preparation for Battle
(Operational Goals/Plans)
Battle Engagement
Financial Management by Dr. Sahanon Tungbenchasirikul ©68
The Holistic Model of Corporate Plan
Corporate Plan
Vision, Mission
Goals & Strategies
• Overall Budget Requirements
• Overall Manpower Requirements
• Key Investment Projects
• Key Business Support Requirements
• Financial ProjectionsCurren
t Assets
(1)Fixed Assets
(2)
Liabilities
(1)
Equities
(3)
Total Costs
Value Add
Competitive Advantages
Creditors
Shareholders
The Firm’s Financial Needs
Balance Sheet
Profit/Loss
Statement
Sources of Funds
Cash Flow Statement• Operating cash flow
• Investing cash flow
• Financing cash flow
Remuneration
• Retained earning
• Dividend
• Debt repayment
Source: Sahanon Tungbenchasirikul ©
Financial Management by Dr. Sahanon Tungbenchasirikul ©69
Financial Plan Summary
Financial Plan as Part of Corporate Plan:
• Determine financial needs to support Corporate Plan.
• Forecast funds availability over 3 - 5 years.
• Project three financial statements.
• Adopt a financial control system to ensure efficient budget utilization and proper strategic actions.
• Develop procedures for adjusting business plans if economic situation significantly changes.
• Establish a performance-based management compensation in line with shareholders’ goals.
Financial Management by Dr. Sahanon Tungbenchasirikul ©70
Operating Plan Summary
Operating Plan provides:• Detailed implementation guidance based on the stated
corporate strategy in pursuit of corporate goals.
• Operating plans (e.g. launching a new product, branch expansion towards overseas markets, IT system installation) address business actions and tactics, budget disbursement, time schedules, revenue/expense/profit targets, and relevant staff who is responsible for execution.
Financial Management by Dr. Sahanon Tungbenchasirikul ©71
Operating Plan Summary
Operating Plan provides:• Small firms, in many cases, undertake planning informally. It
might be that they don’t need any written plan, but follow their business routines. To grow their business, they depend largely on emergent ideas/strategies.
• For large corporations (e.g. SCC, PTT, CPF), they break down operating plans by units/divisions/departments. As a result, it is likely to that each unit/division/department has its own goals and business investment projects. These plans across various units within the firm are consolidated to form the (concise) corporate plan.
Financial Management by Dr. Sahanon Tungbenchasirikul ©72
Financial Statement Forecasting Methods
In this chapter, we will focus on common size & budgeted expense method.
• Common Size Method - all income statement items are divided by revenue (as % of revenue) and/or all balance sheet items are divided by total assets (as % of total assets). Note, no common size analysis for cash flow statement.
• Budgeted Expense Method – estimating the value of each item in income statement & balance sheet with regard to expected developments in the future period.
• Trend Method - observe average revenue, cost, ROE, ROA over several years and plot the trend line to estimate future revenue and other items in financial statement.
• Percent Change Method - growth rates are calculated for all income statement items and balance sheet accounts.
Financial Management by Dr. Sahanon Tungbenchasirikul ©73
Sales/Demand Forecasts
• Sales Forecast generally starts with a review of sales during the past several years, addressed in graph or average annual growth rate (%).
• One can forecast sales by using simple/multiple regression analysis (i.e. an advanced statistical method).
• The firm’s sales can be considered in terms of units and dollars.
• The higher the firm’s sales growth rate, the greater the need for additional (internal and external) capitals.
• The smaller the firm’s customer retention, the greater the need for additional capitals.
Financial Management by Dr. Sahanon Tungbenchasirikul ©74
Key Drivers of Sales Growth
• Economic Growth (i.e. GDP growth, per capita income growth).
• Inflation (i.e. price levels of inputs/products/services in an economy continue to increase). Hence, inflation will affect the firms’ product prices.
• New Innovations (e.g. new products (R&D), overseas market expansion).
• Marketing Promotion (e.g. promotional discounts (SALE), credit terms, advertising).
• Strategic Resources or Competitive Advantages (e.g. reputation, business relationships, economies of scales, distribution channels, large customer-base, patents, copyrights, trademarks, licenses, concession, high quality employees).
Financial Management by Dr. Sahanon Tungbenchasirikul ©75
Key Drivers of Balance Sheet Growth
• Current Asset Growth (e.g. inventory and account receivable increase).
• Current Liability Growth (e.g. account payable and short-term loan increase).
• Fixed Asset Growth (e.g. new equipment / machine / building / premise investments, goodwill).
• Long-tem Liability Growth (e.g. long-term loan increase, corporate bond issuing).
• Equity Growth (e.g. new preferred stock issuing, retained earning increase, new common stock issuing).
Sales increases --> Balance Sheet Growth (Total Asset Growth).
Financial Management by Dr. Sahanon Tungbenchasirikul ©76
Key Drivers of External Financing Needs.
High Need Low Need
• Rapid Sales Growth (Above 10%)
• Financial Loss (Net Profit < 0) or Low EBITDA & Profit Margin
• Working Capital > 0 (FN > 0)
• Capital Intensity or High Operating Leverage (High Proportion of Fixed Asset Investment).
• Low Retained Earning Ratio
• High EBITDA & Profit Margin
• Working Capital < 0 (FN < 0)*
• Low Operating Leverage (Low Proportion of Fixed Asset Investment)
• High Retained Earning Ratio
Low Internal Cash Flow High Internal Cash Flow
Financial Management by Dr. Sahanon Tungbenchasirikul ©77
Example: 5 Year Corporate Plan & Financial Plan
John Lion has owned the majority (51%) of common stock of Automobile Engine Manufacturing Pcl. (the Company) in Thailand and appointed to be the Chairman of the Board of Directors since 25Y1. The Company has been successful in Thailand automobile industry and become one of the key suppliers of Toyota and Mitsubishi. From 25Y1 - 25X1, the Company has been expanding its automobile engine sales to overseas markets (e.g. Indonesia, Malaysia, Japan, South Korea) with an attractive growth rate of 10 - 12.5% per year. At the fourth quarter/25X1, the Board of Directors approved 5 Year Corporate Plan (25X2 - 25X6), which emphasizes on continuous growth of revenue and total assets.
Financial Management by Dr. Sahanon Tungbenchasirikul ©78
Example: 5 Year Corporate Plan & Financial Plan
John Lion (the Chairman of the Board of Directors) requests the President to announce Corporate Plan and Financial Plan across all business and support units. However, the President suggests that the Company shall keep the details of investment feasibility and capital structure analyses and as the top secret (see Chapter 6 and Chapter 7).
Financial Management by Dr. Sahanon Tungbenchasirikul ©79
Example: 5 Year Corporate Plan & Financial Plan
Vision: The Top Thai Automobile Engine Producer with International Standard within 25X6
Mission:
1. To maximize shareholders’ wealth over a long-term.
2. To produce automobile engines with supreme quality for our customers.
3. To fairly provide rewards and career development for our employees.
4. To promote corporate social responsibility (CSR) in various aspects.
Financial Management by Dr. Sahanon Tungbenchasirikul ©80
Example: 5 Year Corporate Plan & Financial Plan
1. Continuous revenue growth at least 10% per year.
2. Sales proportion from overseas markets to 30% by the end of 25X6.
3. Completion of investment in key logistics systems within 25X4.
4. Control of capital structure (D/E ratio maximum ~ 1.2:1).
5. Employee retention rate 95% per year.
Corporate Goals Strategies
1. Investments to strengthen logistics systems (e.g. warehouse, logistics management software) to compete in overseas market.
2. R&D investment to improve product quality and launch new products.
3. Raising capital from external and internal sources with reasonable WACC over the long-term.
4. HR development and incentive improvement.
Financial Management by Dr. Sahanon Tungbenchasirikul ©81
Sales/Demand Forecasts (Revenue grows 10% per year): • Market Situation Summary
– Automobile markets in Thailand and overseas display the upside trends with average growth 12% per year from 25X2-25X6.
– BRIC group can have a significant market growth > 25% per year in the same period.
– The number of automobile engine producers is supposed to increase slowly (1-2 firms per year) due to large capital investment and industry standards.
• Drivers of Sales Growth– Domestic and world economic growth rate 6% and 3.5%
respectively.– Thailand per capita income level will be higher than $4,500 from
25X2 onwards. – Inflation in Thailand is controlled, ranging from 4% - 5%.– Toyota and Mitsubishi market shares in Thailand automobile market
in 25X2 – 25X6 are forecasted to be 42% and 5% respectively.– The Company has been recognized as top 3 automobile engine
producers certified by Thailand Automobile Association.– The Company pay high attention to R&D in co-operations with
Toyota and Mitsubishi research team. This ensures the solid business relationships with its key buyers.
Example: 5 Year Corporate Plan & Financial Plan
Financial Management by Dr. Sahanon Tungbenchasirikul ©82
Example: 5 Year Corporate Plan & Financial Plan
Investments in logistics systems
R&D investment Raising capital HR development &
incentives
Overall Budget Requirements
Overall Manpower
Requirements
Business Support
Requirements
Key Project Investments
Financial projections
Financial Needs
Strategies
Budget Categories:1. Operating expenditures (OPEX) = XXXXX MB (e.g. salary, R&D, selling & admin.)2. Capital expenditures (CAPEX) = XXXXX MB (i.e. current & fixed asset investments)Hiring New Staff:1. Full-Time Staff (marketing, finance, accounting, engineers, and so on) = XX2. Part-Time & Contract Staff = XX
Logistics software;Overseas units; Warehouses & etc.
New equipment;Market research; & etc.
Financial analysis & invest. team;& etc.
HR master plan; HR support team& etc.
- Logistics support system investments- Marketing campaigns- R&D investments- Financial analysis support systems & etc.
1. Financial statement projections (25X2 - 25X6)2. Cash flow and discount cash flow analysis (Chapter 6 )3. Sensitivity analysis (Chapter 6 )
Financial Management by Dr. Sahanon Tungbenchasirikul ©83
5 Years Financial Statement Projections• Profit and Loss Statement
– Common-Size analysis assumption 10% constant revenue growth from 25X2 – 25X6
– Interest Payment for short-term loan equals 2% and for long-term loan is 6% per year.
• Balance Sheet– Account receivable, inventory, and account payable grow 10% per
year in line with revenue growth.– Fixed Assets/Revenue ~ 40% - 60%.– Current and long-term liabilities will grow with regard to short-term
and long-term financial needs. – Short-term loan grows 10% per year. – Long-term loan is constant at 2,500 MB over 6 years (i.e. new long-
term loan 500 MB replaces CPLTL 500 MB every year). – The key driver of equity growth is retained earning change (both
common and preferred share value are constant). – Cash at the end of financial year in Balance Sheet must equal cash
at the end of financial year in Cash Flow Statement. • Cash Flow Statement
– Report changes in Profit and Loss Statement and Balance Sheet.
Example: 5 Year Corporate Plan & Financial Plan
Financial Management by Dr. Sahanon Tungbenchasirikul ©84
Profit & Loss Statement 25X1 – 25X6 (Unit: MB)
Profit and Loss Statement Assumptions:
1. Common-Size analysis assumption 10% constant revenue growth from 25X2 – 25X62. Interest Payment for short-term loan equals 2% per year and for long-term loan is 6% per year.
Profit & Loss Statement Items 25X1 25X2 25X3 25X4 25X5 25X6
Revenue 10,000 11,000 12,100 13,310 14,641 16,105
Cost of Goods Sold (COGS) (7,000) (7,700) (8,470) (9,317) (10,249) (11,274)
Gross Profit 3,000 3,300 3,630 3,993 4,392 4,832
Selling & Admin. Expenses (1,000) (1,100) (1,210) (1,331) (1,464) (1,611)
Earning Before Int. & Tax (EBIT) 2,000 2,200 2,420 2,662 2,928 3,221
Interest Payment (194) (195) (197) (199) (200) (203)
Earning Before Tax 1,806 2,005 2,223 2,463 2,728 3,018
Tax Payment (30% ) (542) (601) (667) (739) (818) (906)
Net Profit 1,264 1,403 1,556 1,724 1,909 2,113
Dividend Portion (50% ) (632) (702) (778) (862) (955) (1,056)
Retained Earning Portion (50% ) 632 702 778 862 955 1,056
Financial Management by Dr. Sahanon Tungbenchasirikul ©85
Balance Sheet 25X1 – 25X6 (Unit: MB)
Balance Sheet Assumptions (Asset Side):
1. Account receivable and inventory grow 10% per year in line with revenue growth.2. Fixed Assets/Revenue ~ 40% - 60%.3. Cash at the end of financial year (FY) in Balance Sheet must equal cash at the end of financial year (FY) in Cash Flow Statement.
Assets 25X1 25X2 25X3 25X4 25X5 25X6
Cash 782 1,294 1,813 2,340 2,876 3,422
Account Receivable 1,000 1,100 1,210 1,331 1,464 1,611
Inventories 1,400 1,540 1,694 1,863 2,050 2,255
Current Assets 3,182 3,934 4,717 5,534 6,390 7,288
Building & Premise 3,000 3,300 3,630 3,993 4,392 4,832
Equipment 3,000 3,300 3,630 3,993 4,392 4,832
Accumulated Depreciation (400) (900) (1,400) (1,900) (2,400) (2,900)
Fixed Assets 5,600 5,700 5,860 6,086 6,385 6,763
Total Assets 8,782 9,634 10,577 11,620 12,775 14,051
Financial Management by Dr. Sahanon Tungbenchasirikul ©86
Balance Sheet 25X1 – 25X6 (Unit: MB)
Balance Sheet Assumptions (Liability & Equity Side):1. Account payable grows 10% per year in line with revenue growth.2. Current and long-term liabilities will grow with regard to short- and long-term financial needs. 3. Short-term loan grows 10% per year. 4. Long-term loan is constant at 2,500 MB over 6 years (i.e. new long-term loan 500 MB replaces CPLTL 500 MB every year). 5. The key driver of equity growth is retained earning change.
Liabilities & Equity 25X1 25X2 25X3 25X4 25X5 25X6
Short-term Loan 700 770 847 932 1,025 1,127
Account Payable 800 880 968 1,065 1,171 1,288
CPLTL 500 500 500 500 500 500
Current Liabilities 2,000 2,150 2,315 2,497 2,696 2,916
Long-term Loan 2,500 2,500 2,500 2,500 2,500 2,500
Total Liabilities 4,500 4,650 4,815 4,997 5,196 5,416
Common Stock 2,000 2,000 2,000 2,000 2,000 2,000
Preferred Stock 1,000 1,000 1,000 1,000 1,000 1,000
Retained Earning 1,282 1,984 2,762 3,624 4,579 5,635
Equity 4,282 4,984 5,762 6,624 7,579 8,635
Total Liabilities + Equity 8,782 9,634 10,577 11,620 12,775 14,051
Financial Management by Dr. Sahanon Tungbenchasirikul ©87
Cash Flow Statement 25X1 – 25X6 (Unit: MB)Cash Flow Statement 25X1 25X2 25X3 25X4 25X5 25X6
(1) Operating Cash Flow 1,490 1,743 1,880 2,031 2,196 2,379
Net Profit 1,264 1,403 1,556 1,724 1,909 2,113
Depreciation & Amortization 400 500 500 500 500 500
Account Receivable Change YoY (91) (100) (110) (121) (133) (146)
Inventory Change YoY (127) (140) (154) (169) (186) (205)
Account Payable Change YoY 44 80 88 97 106 117
(2) Investing Cash Flow (400) (100) (160) (226) (299) (378)
Fixed Asset Change YoY (400) (100) (160) (226) (299) (378)
(3) Financing Cash Flow (1,068) (1,132) (1,201) (1,277) (1,362) (1,454)
Short-term Loan Change YoY 64 70 77 85 93 102
Long-term Loan Change YoY - - - - - -
CPLTL (500) (500) (500) (500) (500) (500)
Dividend Payment (632) (702) (778) (862) (955) (1,056)
New Stock Issuing - - - - - -
Change Cash Flow (1)+(2)+(3) 22 511 519 527 536 546
Cash at the Beginning of FY 760 782 1,294 1,813 2,340 2,876
Cash at the End of FY 782 1,294 1,813 2,340 2,876 3,422