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Foundations of Finance

Chapter2

Financial Statements, Taxes, and Cash Flow

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND1Pearson Prentice HallFoundations of Finance1 - 2 The Balance Sheet

Is a Financial Statement showing a firms accounting value on a particular date.

It is a snap shot of the firm

A means of organizing, summarizing:1. Assets what the firm owns2. Liabilities- what a firm owes3. Equity the difference between the twoChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2Pearson Prentice HallFoundations of Finance1 - 3Assets : The left hand side

Classification of Assets1. Current Asset assets that have a life of less than one year.One that is converted to cash within 12 months.InventoryCashAccounts receivable

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3Assets: The left hand side2. Fixed Assets One that has relatively long life

Classification:1. Tangible A truck or a house2. Intangible-- a trademark or patentPearson Prentice HallFoundations of Finance1 - 4Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDPearson Prentice HallFoundations of Finance1 - 5Liabilities & Owners EquityThe right hand side 1. Current Liabilities - have a life less than one year.Accounts payable

2. Long term Debt A de that is not due in the coming year.- A loan payable in five yearsChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND5Pearson Prentice HallFoundations of Finance1 - 6Owners Equity/ Shareholders Equity/Common Equity

The difference between the total value of assets and the total value of liabilities

ASSETS = LIABILITIES + SHAREHOLDERS EQUITYChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND6Pearson Prentice HallFoundations of Finance1 - 7 Networking capitalThe difference between the firms current assets and current liabilities

Positive working capital when current assets exceed current liabilitiesChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND7Pearson Prentice HallFoundations of Finance1 - 8Building the Balance SheetExample: Venice company has current assets of P100, net fixed assets of P500, short term debt of P70, and long term debt of P200.

What does the balance sheet look like? What is the shareholders equity? What is net working capital?

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND8Pearson Prentice HallFoundations of Finance1 - 9

ASSETSLiabilities & Owners Equity

Current Assets P100 Current LiabilitiesP 70Net fixed Asset 500 Long term Debt 200 Shareholders Equity 330

Total Liabilities& Shareholders Total Asset P600 EquityP600

Net working Capital = P100 70 = P 30Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND9Pearson Prentice HallFoundations of Finance1 - 10 LIQUIDITYRefers to the speed and ease with which an asset can be converted to cash.Example:Gold is a liquid asset Manufacturing facility is not.2 dimensions of liquidity:Ease of conversionLoss of valueChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND10Pearson Prentice HallFoundations of Finance1 - 11DEBT VERSUS EQUITY

Equity holders are only entitled to the residual value, that portion left after creditors are paid.

SHAREHOLDERS EQUITY= Assets - Liabilities

Financial Leverage - The use of DEBT in a firms Capital structureIt increases the potential reward to shareholders, but also increases the potential for financial distress and business failure.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND11MARKET VALUE VS BOOK VALUEMarket value - is the true value of an asset(actual amount of cash when sold)Book Value the value of an asset as shown in the balance sheet (amount that owners paid for the asset)Pearson Prentice HallFoundations of Finance1 - 12Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDTHE INCOME STATEMENTA financial statement summarizing a firms performance over a period of time. ( a quarter or a year)

Income statement equation:Revenues Expenses= IncomePearson Prentice HallFoundations of Finance1 - 13Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND Venice corporation2011 income statement

Net Sales P1,509Cost of goods sold 750Depreciation 65Earnings before interest And taxes 694Interest paid 70 Taxable income 624Taxes 212Net Income 412

Pearson Prentice HallFoundations of Finance1 - 14Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3 things to remember when looking at Income Statement1. GAAP Generally accepted Accounting Principle- shows revenue when it accrues(Recognition Principle)When earning process is completed, value is known/determined.Revenue is recognized at time of sale

Pearson Prentice HallFoundations of Finance1 - 15Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDExpenses are based on the matching principle(recognized at the time they are incurred)

Therefore: Figures in the income statement does not represent actual cash inflows and outflows.Pearson Prentice HallFoundations of Finance1 - 16Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. NON- CASH ITEMSThese are expenses charged against revenues that do not directly affect cash flow.Example: DepreciationAn asset bought for P5000 , the firm has 5000 cash outflow .Depreciation = P5000/5yrs = P1,000(1,000 is deducted as an expense every yearPearson Prentice HallFoundations of Finance1 - 17Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3.Time and Costs

1.short run and long run(time periods)2.Variable and fixed (cost)Example :Short time horizon some cost are fixed (property taxesWages and payments to suppliers are variablePearson Prentice HallFoundations of Finance1 - 18Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDPearson Prentice HallFoundations of Finance1 - 19Computing Taxable IncomeTaxable IncomeGross income less tax deductible expenses, plus interest income and dividend incomeGross IncomeDollar sales from a product or service less cost of production or acquisitionTax Deductible ExpensesOperating expenses (marketing, depreciation, administrative expenses) and interest expenseDividends paid are not deductible Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND19Pearson Prentice HallFoundations of Finance1 - 20Computing Taxable Income ($000s)Sales $50,000Cost of Goods Sold 23,000Gross Profit $27,000Operating ExpensesAdministrative Expenses $4,000Depreciation Expense 1,500Marketing Expenses 4,500Total Operating Expenses$10,000Operating Income $17,000Other Income 0Interest Expense 1,000Taxable Income $16,000Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND20 CASH FLOW

It is the difference between the number of pesos that came in and the number that went out.Cash flow from assets = Cash flow to creditors + Cash flow to stockholdersChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND21Cash flow from Assets (cash flow to creditors & stockholders)Three components :1. Operating cash flow refers to the cash flow that results from the firms day to day activities of producing ans selling2. Capital spending refers to the net spending on fixed assets(purchase of fixed assets less sales of Fixed assets)

Pearson Prentice HallFoundations of Finance1 - 22Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Change in net working capital is the amount spent on net working capital. Venice CorporationOperating Cash flow 2011

Earnings before int. & exp P 694+ depreciation 65- taxes 212Operating cash flow P 547

Pearson Prentice HallFoundations of Finance1 - 23Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDOperating cash flow tells us whether or not a firms cash inflows from its business operations are sufficient to cover its everyday cash outflows.Pearson Prentice HallFoundations of Finance1 - 24Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCapital SpendingNet capital spending is the money spent on fixed assets less money received from the sale of fixed asset.

Pearson Prentice HallFoundations of Finance1 - 25Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDFINANCIAL ANALYSISAnalysis as defined by Webster is a consideration of anything in its separate parts and their relation to each other. The relationships arrived at are interpreted by determining their significance.Pearson Prentice HallFoundations of Finance1 - 26Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND Financial analysis refers to examination of financial data of an entity to determine its profitability, growth, solvency, stability and effectiveness of its management.Relationships are interpreted and significance are used as guide in decision making process Pearson Prentice Hall.Foundations of Finance1 - 27Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDTOOLS AND TECHNIQUESA. Short term Decision Making (do not consider time value of money)1. Horizontal Analysis two or more sets of financial statements are useda. comparative statementsb. Trend ratiosc. gross profit variationPearson Prentice HallFoundations of Finance1 - 28Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDd. Analysis of change in net income2. Vertical Analysis only one set of financial statements is useda. common size statementb. Financial ratiosB. Working Capital and cash flow analysisPearson Prentice HallFoundations of Finance1 - 29Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDC. Cost-volume profit(breakeven analysis)FOR LONG TERM DECISION MAKING (Time value of money is needed)A. Payback periodB. Discounted cash flow (DCF method)1. Internal rate of returnPearson Prentice HallFoundations of Finance1 - 30Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDb. Discounted payback periodc. Net present valued. Profitability indexPearson Prentice HallFoundations of Finance1 - 31Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDStandards in Financial Statements AnalysisIn analyzing and interpreting financial statements of a particular entity, the analyst must have standards with which he may compare the contents of said statements. These standards may be the figures, ratios, or percentages, Pearson Prentice HallFoundations of Finance1 - 32Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND`Or changes indicated in budgets, industry averages, competitors financial statements and the companys own financial statements for prior periods.Pearson Prentice HallFoundations of Finance1 - 33Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDFUND MANAGEMENT

How well do you know Cash?-Before a person can manage cash, he/she should have a sound knowledge of what cash is all about.Pearson Prentice HallFoundations of Finance1 - 34Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDPearson Prentice HallFoundations of Finance1 - 35 Types of cash1. Cash on Hand This represents the cash collection waiting to be deposited the following banking day.2. Cash in Bank this represents the cash already deposited in the bank.a. Savings Account this is an account where the money deposited will earn interest income for the meantime while it is not in use.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND35Pearson Prentice HallFoundations of Finance1 - 36Types of CashThis is evidenced by a passbook.b. Demand Deposit sometimes called checking account or current account. Normally this does not earn interest. This is evidenced by a checkbook. c. Combo Account This is a combination of savings and current account, but requires a bigger compensation balance.

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND36Pearson Prentice HallFoundations of Finance1 - 37Compensating balances are maintaining balances required by bank whenever you open an account.3. Cash Fund this is a fund maintained to comply with other fund requirements of the company.

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND37Pearson Prentice HallFoundations of Finance1 - 38Cash Fund Classificationa. Petty Cash Fund- this is the fund that will cater the small expenditures of the company.It is handled by a Petty Cash Fund Custodian.b. Change Fund The fund is used to maintain loose change to address the concern for small bills n coins. It is handled by the company cashier.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND38Pearson Prentice HallFoundations of Finance1 - 39c. Dividend Fund A fund used to pay for the dividends which the board of directors have declared and payable in the future. It is handled by the cashier.4. Cash Equivalent a short term and highly liquid investment ( those acquired 3mos before maturity)are readily convertible to cash.( cash placed in the bank, time deposit which are short term and pre terminable.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND39Pearson Prentice HallFoundations of Finance1 - 40Criteria for valuation of cash equivalentIf term is three months or less, such is classified as cash equivalent.If the term is more than three months but within 1 year, such is a short term or temporary investment.If term is more than 1 year, such investment is non-currentChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND40Pearson Prentice HallFoundations of Finance1 - 41Or long term investment.Bank products:

Overnight placementsWeekly Time depositMonthly time deposit or 30day deposit60day,90days,180days,one year,2years,3years,Trusts

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND41Pearson Prentice HallFoundations of Finance1 - 42Government SecuritiesTreasury BillsTreasury NotesTreasury WarrantTreasury Bond

Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND42Pearson Prentice HallFoundations of Finance1 - 43How do we Document CashDocumenting cash is essential for it is in this way that we are assured that our cash is properly documented with evidence to support the transactions as it is entered in the book of accounts.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND43Pearson Prentice HallFoundations of Finance1 - 441. Provisional ReceiptThis receipt is issued by collectors, whether cash or check collection.must be surrendered to the cashier everyday.This receipt will also be issued by the office cashier in case of check payments.because checks require 3days clearing.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND44Pearson Prentice HallFoundations of Finance1 - 45Provisional receipt must be in triplicateOriginal must be given to the person payingThe duplicate must be given to the cashier together with the collectors remittance formTriplicate is left in the booklet for reference,audit purposes.Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND452. Official Receipta. issued by the cashier incase of cash paymentsb. Issued when the collector remits the cash collection to the office cashierc. Issued for check collections for which a provisional receipt was issued.Pearson Prentice HallFoundations of Finance1 - 46Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDOfficial receipt is in triplicate copya. original copy is given to the person payingb. duplicate must be given to the accounting department for recording.C. triplicate is left in the booklet for the cashiers copy.Pearson Prentice HallFoundations of Finance1 - 47Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Sales InvoiceThis is considered as cash sales invoice or sales on account.4. daily Collectors Remittance formThis is the summary of the collection made by a specified collector for the day.this is submitted to the office cashier together with the duplicate copy of the provisional receipt.Pearson Prentice HallFoundations of Finance1 - 48Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDTips in formatting forms and documentary evidence1. What are the information necessary:DateSerial numberIs it thru manual or mechanical operationPurpose2. How big will the form bePearson Prentice HallFoundations of Finance1 - 49Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Filing4. Distribution5. Responsible employee who will handle it

* The bigger the cash the bigger the risk and the more control measures should be implemented.Pearson Prentice HallFoundations of Finance1 - 50Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDHow is Cash Handled?Duties & responsibilitiesPosition: CollectorDuties:Reviews account receivables that are due for collection.Follow ups thru phone calls/emailIssues provisional receipts to customersPearson Prentice HallFoundations of Finance1 - 51Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND4. Remits collections to the office cashier together with daily remittance form.Responsibilities:1.Early & on time collection 2. Report difficult to collect customers3. Reports feedback from customersPearson Prentice HallFoundations of Finance1 - 52Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDControl Mechanisms for CashThe VP for Finance should establish the policy on cash handling.The head of the accounting department should prepare the procedure.The implementation of the procedure is subject to the review and the audit by thePearson Prentice HallFoundations of Finance1 - 53Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDthe internal audit group or department so that continuous improvement on the control mechanism maybe done to address the continuous and fast changing technology.

Pearson Prentice HallFoundations of Finance1 - 54Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDPearson Prentice HallFoundations of Finance1 - 55Collectors collect the receivablesOf the companyCustomers may pay directly to the officeCashier receives the money from Collectors and customersJunior accountant willJournalize the receipttransactions Depository bankAccounting supervisor will checkThe entry and check the Reconciliation statementGeneral accountant will record The transaction..Receives the Bank statement & prepares bank reconciliationChapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDPolicy on Cash Handling

1.

The company should adopt the imprest system of handling cash.The company should maintain the combo account for easier checking of banking transactionPearson Prentice HallFoundations of Finance1 - 56Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. The company should place its money in various banking companies so as to distribute the risk involved in banking.4. The following bank signatories will be observed:a. If the amount of disbursement is P50,000 and belowPearson Prentice HallFoundations of Finance1 - 57Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDthe Comptroller or head of accounting department to be countersigned by the treasurer or VP Financeb. If the amount is more than P50,000The comptroller or head of accounting department countersigned by the president or treasurer.Pearson Prentice HallFoundations of Finance1 - 58Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND5. Official receipts can only be used when cash is received. Checks are covered by provisional receipts.6. All funds should be kept and maintained by the office fund custodian. For petty cash fund the amount should be replenished once the fund is 40% used to avoid disruption of operations due to insufficiency of the fund. Pearson Prentice HallFoundations of Finance1 - 59Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCommon misuses of Cash

LAPPING this is the case of misappropriating a collection from one customer and concealing this defalcation by applying a subsequent collection made from another customer.This involves postponements of entries on

collection of a receivable and is made possible because of poor controlPearson Prentice HallFoundations of Finance1 - 60Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDcollection of a receivable and is made possible because of poor control. 2. KITING This happens when a check drawn from one depository bank and deposited in another bank at the end of the month or year.

Pearson Prentice HallFoundations of Finance1 - 61Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDThere will be no entries made on this drawing and depositing.As a result the cash in the a depository bank increases to cover the shortage while on the other depository bank , it has not yet posted the check deposited to the other bank. Pearson Prentice HallFoundations of Finance1 - 62Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. FRAUDULENT documents and evidence employees will make documents and pieces of evidence which are not really true.Pearson Prentice HallFoundations of Finance1 - 63Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND INVENTORY MANAGEMENT CASH

Receivable Inventory Pearson Prentice HallFoundations of Finance1 - 64Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDWhat are Inventories

Assets which are held for sale in the ordinary course of business, in the process of production for such sale or in the form of materials or supplies to be consumed in the production process or in rendering of services. Pearson Prentice HallFoundations of Finance1 - 65Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDForms of business organizationSole ProprietorshipPartnershipCorporationTYPES of OrganizationServiceTradingManufacturing

Pearson Prentice HallFoundations of Finance1 - 66Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDInventory Accounts to maintainSuppliesMerchandise Inventory those items that the company purchased and intended for sale to its customersRaw materials inventory materials which the company purchased and is for use in the productionPearson Prentice HallFoundations of Finance1 - 67Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND

4. Work in Process Inventory these are the partially finished products at the end of the month5. Finished Goods Inventory- these are products already finished , ready to be sold to customers.Pearson Prentice HallFoundations of Finance1 - 68Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDWhy do we manage Inventory?Under-stocking a serious problem that could result to:a. missed deliveriesb. lost salesc. unsatisfied customersd. production bottlenecks or worst work stoppage

Pearson Prentice HallFoundations of Finance1 - 69Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Overstocking

holding cost might be too highFunds could have been used for a more productive ventureMajor concerns to address:a. Timing of orderb. size of order

Pearson Prentice HallFoundations of Finance1 - 70Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDFor effective Inventory managementA system to keep track of the inventory on hand and on orderA reliable forecast of demandKnowledge of lead timeReasonable estimates of inventory holding cost, ordering cost and shortage costClassification system for inventory itemsPearson Prentice HallFoundations of Finance1 - 71Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDBeginning InventoryThe beginning inventory must be enough until the next delivery of the raw materials.Estimate the lead time. The lead time must be based on the past experience of the company relative to traffic condition, supplier culture and procedures.Pearson Prentice HallFoundations of Finance1 - 72Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. SupplierThe accredited supplier of choice must be objectively selected by a committee so that quality of raw materials can be easily procured.Pearson Prentice HallFoundations of Finance1 - 73Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDThe Freight ChargesThe contract that the company have entered into in purchasing the merchandise inventory.1. FOB Destination this contract says that the supplier will deliver the merchandise inventory from the suppliers warehouse free of charge. Title is passed when merchandise is delivered from truck to buyers warehouse.Pearson Prentice HallFoundations of Finance1 - 74Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. FOB Shipping Point this contract says that the supplier will deliver the merchandise inventory from suppliers warehouse to the shipping point only. Which is the pier or airport.Title passes when merchandise is transferred to the boat or plane.Pearson Prentice HallFoundations of Finance1 - 75Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCIF cost insurance freightThe buyer will pay the lump sum amount of cost of goods sold, insurance and freight charges.FAS means free alongside. A seller who ships FAS must bear all expenses and risks involved in delivering the goods to the dock next to or alongsidePearson Prentice HallFoundations of Finance1 - 76Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDThe buyer will shoulder the cost of loading expenses and shipment as the buyer takes possession of the merchandise.Ex-ship A seller who delivers the goods ex ship bears expenses and risks of loss until the goods are unloaded at the time the title shall pass to the buyerPearson Prentice HallFoundations of Finance1 - 77Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDWho handles Inventory1. Purchaser the staff that procures the inventory. It must be at the cheapest price but with quality.2. Warehouseman- this is the staff who receives and safekeep at the warehouse and issues whenever there is a need.Pearson Prentice HallFoundations of Finance1 - 78Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Stock card clerk This staff usually is an accounting clerk, who records the receipt and issuance made by the warehouseman.Bookkeeper records the purchase made by the purchaser - Pearson Prentice HallFoundations of Finance1 - 79Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND5. Auditor- the staff that checks the inventory in the warehouse, the documents that support the purchases.Pearson Prentice HallFoundations of Finance1 - 80Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDThree methods on how to value material issuance1. FIFO- First in First Out materials that were received fist should be the ones used first.

2. LIFO The last raw material received by the warehouseman are the first to be used

Pearson Prentice HallFoundations of Finance1 - 81Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Weighted Average We get the average cost of the materials received and such cost will be the basis for those issued

Pearson Prentice HallFoundations of Finance1 - 82Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDRECEIVABLESThese are financial assets that represent a contractual right to receive cash or other financial assets from another customer.

Pearson Prentice HallFoundations of Finance1 - 83Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDExamples of receivables Traditional Receivables or sometimes called trade debtors or trade accounts. This is not supported by a promissory note.1. Trade receivables this is normally supported by a a credit invoice issued by the company and has credit termsPearson Prentice HallFoundations of Finance1 - 84Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Notes ReceivableThis is supported by a formal promise to pay in the form of a note.

3. Loans Receivable this is a receivable arising from banks and other financial institutionPearson Prentice HallFoundations of Finance1 - 85Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND DISCOUNTS1. Trade Discount It is a discount not recorded in the books of account.Example: this is the discount given to a customer for bulk order they made. Normally expressed in percentages.Pearson Prentice HallFoundations of Finance1 - 86Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Cash Discount- this is the discount that is recorded in the books. This will encourage your customers to pay early so they get more discounts.Pearson Prentice HallFoundations of Finance1 - 87Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDMaterials Quantitative ModelsRaw materials are not just purchased anytime.It is plannedNecessary blueprints, designs and specifications should be prepared.Pearson Prentice HallFoundations of Finance1 - 88Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDFactors to consider in Planning and controlling raw materials1. Forecast demand for next month, quarter or year2. Determine the lad time3. Plan usage during the lead time4. Establish quantity on hand5. place units in order6. safety stock requirement

Pearson Prentice HallFoundations of Finance1 - 89Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDThe Economic Order QuantityIt means the most economical order of raw materials that the company can make.Factors affecting economic purchase:1. Annual required units requirements for a specific raw material.Pearson Prentice HallFoundations of Finance1 - 90Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Cost per Order the cost that will be incurred if the company will purchase raw materialsExample:A. clerical cost of ordering the raw materialsB. Handling and transportation chargesPearson Prentice HallFoundations of Finance1 - 91Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Cost per unit of materialsThis represents the unit price of the raw materialsA. Unit price at gross(no discount)B. Unit price at net (with discount)4. Carrying Cost cost incurred for maintaining inventory in the warehouse.Example: storage cost, property tax, insurance interest on funds invested in inventoriesPearson Prentice HallFoundations of Finance1 - 92Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDHow to compute EOQE = 2QP CWHERE:

E = Economic Order QuantityQ = annual quantity usedP = Cost of placing an orderC = Annual Carrying cost

Pearson Prentice HallFoundations of Finance1 - 93Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDAssuming Venice Company have the following information relating to their purchase of raw materials. Q = 5,000; P10/ order. C = P0.80

To compute for EOQ

E = 2(5000) (10)0.80E = 100,000 0.80125,000E = 353.55 0r 354 unitsPearson Prentice HallFoundations of Finance1 - 94Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDRECEIVABLESThese are financial assets that represent a contractual right to receive cash or other financial assets from an entity or customer.

Examples of receivables:1. Traditional accounts receivable or sometimes called trade debtors or trade accounts receivable. These are not supported by promissory note.Trade receivable this is normally supported by a credit invoice issued by the company and has credit terms, which is the basis of whether the account is due or past due.Pearson Prentice HallFoundations of Finance1 - 95Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Notes receivable this is supported by a formal promise to pay in the form of a note.3. Notes receivable - This is a receivable arising from banks and other financial institution The accounting elements affecting receivables1. Trade Discount a discount that is not recorded in the books of accounts. This is granted to customers with bulk orders. these are expressed in percentages.2. Cash discount this is recorded in the books. This is the kind of discount that will encourage our customers to pay on time.Pearson Prentice HallFoundations of Finance1 - 96Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDRETURNS1. Sales returns These are the goods, which the customers have physically returned. This may be a matter of wrong shipment or wrong deliveries. or substandard merchandise were delivered.2. Sales allowances these are the goods that were delivered to customers but defective. This will make the company agree to reduce the receivable account from the customers by granting sales allowance.Pearson Prentice HallFoundations of Finance1 - 97Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCollection Techniques Cash management involves collection of receivables as quickly as possible. Customers maybe paying their accounts promptly but there maybe delays in the conversion of their payments to spendable form.Pearson Prentice HallFoundations of Finance1 - 98Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCollection techniques1. Direct sends checks received as part of collection are sent directly to banks on which they are drawn by customers. this reduces the clearing float for the said checks.Pearson Prentice HallFoundations of Finance1 - 99Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Concentration Banking-Bank accounts are maintained for provincial outlets so they may collect from customers and deposit their collections with the local banks. Provincial banks may then be instructed to transfer funds periodically to the main office.Pearson Prentice HallFoundations of Finance1 - 100Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Lock-box System Customers are instructed to send remittances to a post office box which is serviced by the companys bank. The latter opens payment envelopes, deposits remittances received to the account of the company making the collection.Pearson Prentice HallFoundations of Finance1 - 101Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND4. Direct Payments to depository bank- special arrangements are made with banks to accept payments from customers with collections directly credited to the collecting companys bank account.Pearson Prentice HallFoundations of Finance1 - 102Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND5. Direct deposits to a Companys bank account- The prevalence of computerized systems in banking, customers maybe allowed to make deposits to the main office bank account through the banks provincial branches.Pearson Prentice HallFoundations of Finance1 - 103Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDSources of short term FinancingSources of short term financing1. Unsecured or secured these may include trade credits, accruals, commercial papers, bankers acceptances, receivable financing and inventory financing.Pearson Prentice HallFoundations of Finance1 - 104Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2. Spontaneous Sources of Short term Financing This term refers to those sources that automatically arise from normal operations of a business firm.example are trade credits and accruals.Pearson Prentice HallFoundations of Finance1 - 105Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND

Deliberate Sources of Short term financing-This refers to sources that can be made use of by the deliberate act, on the part of the borrower, of negotiating for the availment of the particular source.Pearson Prentice HallFoundations of Finance1 - 106Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDAdvantages of short term financingShort term financing as compared to long term financing is easier to arrange, is less expensive, and provides the borrower more flexibility.Pearson Prentice HallFoundations of Finance1 - 107Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDFactors to consider in choosing Short term financing1. Cost2. Restrictions. Lenders often require minimum level of working capital and or minimum account balances in bank accounts3. Flexibility-adjustments in the amount borrowed4. Reliability of lender as future source of borrowingPearson Prentice HallFoundations of Finance1 - 108Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDTrade CreditsThis refers to acquisition of merchandise(or raw materials) on open account that is (without any formal note signed to evidence the liability)which gives rise to the current liability accounts payable. Pearson Prentice HallFoundations of Finance1 - 109Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCredit terms(indicated on the suppliers invoice)2/10, N/30 2% discount if paid within ten days from date of invoice, account is due in 30 days.2/10,1/20, N/30 2% discount if paid within ten days from date of invoice, 1% discount if paid after ten days up to the 2oth,account is due in 30 days.Pearson Prentice HallFoundations of Finance1 - 110Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND2/10, N/30 EOM 2% discount if paid within ten days from end of month, account is due in 30 days from end of month.Pearson Prentice HallFoundations of Finance1 - 111Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDForegoing discounts on Purchases Cost of foregoing discount- The implicit cost of foregoing discounts is computed taking into account the percentage of discount foregone based on the discounted amount ,the number of days by which payment is postponed and the number of times this postponement can be made in one year.Pearson Prentice HallFoundations of Finance1 - 112Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDVenice purchases merchandise for 2000, 2/10,N/30Discount = 2% of 2000 = P 40Discounted amount =2000-40 -1,980No. of days payment is postponed= 20 days(or 30-10 days)No.of times payment is postponed in one year =360 days/20days =18xPearson Prentice HallFoundations of Finance1 - 113Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCost of foregoing the discount= discount Discounted amt. X no. of times payment can be postponed in one year

= P40/P1960 X 360/20 = 37%Pearson Prentice HallFoundations of Finance1 - 114Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDOpportunity cost This refers to the benefit or profit that the company fails to enjoy by availing of the discount

Pearson Prentice HallFoundations of Finance1 - 115Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDCost of Bank BorrowingThis refers to the cost of borrowed money from financial institutions. If the prevailing cost of borrowed money were 25%, this would be much lower than the 37% implicit cost of foregoing the discount. In this case availing the discount is a better choice.Pearson Prentice HallFoundations of Finance1 - 116Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDStretching accounts PayableScheduling payments for accounts payable beyond their due dates reduces the implicit cost of foregoing discounts.Bank Loans- a borrower must have sufficient equity and good liquidity to be eligible for bank loans.Pearson Prentice HallFoundations of Finance1 - 117Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BINDForms of bank Financing1. Single Payment note Granted on the assumption that the need for additional funds will not continue.2. Line of credit an agreement between a bank and client . The bank makes loans available to the client. Pearson Prentice HallFoundations of Finance1 - 118Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND3. Installment Loans This requires periodic paymentsPearson Prentice HallFoundations of Finance1 - 119Chapter 1 AN INTRODUCTION TO FINANCIAL MANAGEMENT THE TIES THAT BIND