Intro to Financial Management

Evaluating a Firm’s Financial Performance

Review

• Homework• What is on an income statement?

– What is common-sized?

– What are gross profit margin, operating profit margin, net profit margin, earnings, and earnings per share?

– What do these terms tell you?

• What is on a balance sheet?– What is common-sized?

– What are book value, working capital, debt and leverage ratios?

– What do these terms tell you?

• What is on a cash flow statement?– What is free cash flow?

– What are the three major areas of cash flow?

• What are the basics of computing corporate taxes?

Review

• What are spot and future markets?• What is a spread?• What are nominal rates?• What are real rates?• What types of risk are involved in interest rates?• What is liquidity?• What is the Yield Curve?

Managing a Firm

• You can’t manage what you don’t measure.• Firm performance

– Liquidity– Management performance– Change in shareholder value

• Financial ratios used to compare firms– Deals with different sized firms– Can compare with industry averages– Each industry may be different

Managing a Firm

• Working capital = current assets• Net working capital = current assets – current liabilities

• Why are these important?

Liquidity RatiosDoes firm have the cash it needs?

• Current ratio = curr. assets / curr. liab.

• Acid test (quick ratio) = (cash + receivables) / curr. liab.

• Inventory turnover ratio= COGS / inventory

• Times Interest Earned= EBITDA / interest expense

• Know the calculations• Know what these ratios tell you!

Liquidity RatiosMeasuring Risk

• Debt ratio= Liabilities / Assets

• Leverage ratio= Assets / Owners’ Equity

• Both are used to assess the risk from using borrowed money•Borrowed money magnifies profits. How?•Borrowed money also magnifies losses. How?

• Leverage in the news

Management RatiosHow well are the operations managed?

• Return on sales (ROS)= net income / sales

• Return on assets (ROA)= net income / assets

• Inventory turnover ratio= COGS / inventory

• Know the calculations• Know what these ratios tell you!

Management RatiosIs management providing good returns and value?

• Return on equity (ROE)= net income / equity

• Price/earnings ratio (P/E)= price per share / earnings per

• Share price/book ratio= market price per share / book value per share

> 1 means creating value, <1 means losing value

• Economic value added

• Know the calculations

Know what these ratios tell you!