I. Introduction to Financial Management
Financial management deals with two activities, raising money and managing a company’s finances a way that achieves the highest rate of return. Regardless of the quality of a product or service, a company can’t be viable in the long run unless it is successful financially.
II. Financial Objectives of a Firm
l Profitability: The ability to earn a profit.
l Liquidity: A company’s ability to meet its short-term financial obligations.
l Efficiency: How productively a firm utilizes its assets relative to its revenue and its profits.
l Stability: The strength and vigor of the firm’s overall financial posture.
III. The Process of Financial Management
1) Preparation of Historic Financial Statements (A written report that quantitatively describes a firm’s financial health): Income Statement, Balance Sheet, and Statement of Cash Flows.
2) Preparation of Forecast (An estimate of a firm’s future income and expenses, based on its past performance, its current circumstances, and its future plans): Income, Expenses and Capital Expenditure.
3) Preparation of Pro Forma Financial Statements
4) Ongoing Analysis of Financial Results (Budgets are itemized forecasts of a company’s income, expenses, and capital needs): Ratio Analysis, Measuring results vs plans and vs industry norms.
IV. Financial Statements
l Historical Financial Statements reflects past performance and are usually prepared on a quarterly and annual basis.
l Pro Forma Financial Statements are projections for future periods based on forecasts and are typically completed for two to three years in the future.
1. Historical Financial Statements
a. Income Statement
Reflects the results of the operations of a firm over a specified period of time. It record all the revenues and expenses for the given period and shows whether the firm is making a profit or is experiencing a loss.
b. Balance Sheet
A snapshot of a company’s assets, liabilities, and owners’ equity at a specific point in time.
c. Statement of Cash Flows
Summarizes the changes in a firm’s cash position for a specified period of time and details why the change occurred. It reveals how much cash is on hand at the end of the month as well as how the cash was acquired and spent during the month.
d. Ratio Analysis
The most practical way to interpret or make sense of a firm’s historical financial statements.
e. Comparing a Firm’s Financial Results to Industry Norms
Help a firm determine how it stacks up against its competitors and if there are any financial “red flags” requiring attention.
V. Forecasts
Predictions of a firm’s future sales, expenses, income and capital expenditures. A firm’s forecasts provide the basis for its pro forma financial statements.
1. Sales Forecast
A projection of a firm’s sales for a specified period, most firms forecast their sales for two to five years into the future. It is the first forecast developed and is the basis for most of the other forecasts.
2. Forecast of Cost of Sales and Other Items
The most common way to do this is to use the percent-of-sales method, which is a method for expressing each expense item as a percentage of sales.
VI. Pro Forma Financial Statements
Similar to its historical financial statements except that they look forward rather than track the past. The preparation of pro forma statements also help firms rethink their strategies and make adjustments if necessary.
1. Pro Forma Income Statement
Once a firm forecasts its future income and expenses, the creation of the pro forma income statement is merely a matter of plugging in the numbers.
2. Pro Forma Balance Sheet
Provides a firm a sense of how its activities will affect its ability to meet its short-term liabilities and how its finances will evolve over time.
3. Pro Forma Statement of Cash Flows
Shows the projected flow of cash into and out of the company during a specified period.
4. Ratio Analysis
The same financial ratios used to evaluate a firm’s historical financial statements should be used to evaluate the pro forma financial statements.
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