Basics of financial management Week 2

Programme Programme across the several weeks: Class 1: ch1, 2, 3, 4 Class 2: ch5, 9, exercises class 1 Class 3: ch11, 12, 14, exercises class 2 Class 4: ch15, 16, 17, exercises class 3 Class 5: exercises class 4, Short recap Class 6: mock examination Examination

Today Goals for today Recap and exercises of class 1 Assessment of capital budgeting projects Ratios, ratios, ratios Exercises to prepare for next class

Recap: Aspects of the choice of a legal form Management and ownership Financing possibilities Continuity Liability Tax consequences Disclosure of financial information

Recap: Financial Management disciplines Corporate Finance Management accounting Financial accounting

Recap: The balance sheet Serve the business for more than one year Fixed assets Equity * Owners * Unlimited period * Reward depends on profit * Risk-bearing Time between purchase and use is shorter than one year Current assets Liabilities * Creditors * Temporary * Fixed reward * Risk-avoiding

Recap: Profit determination Balance sheet at start of period Increase of Equity = Profit (Except for private contributions and private drawings) Balance sheet at end of period Profit and loss account specifies the composition of profit

Recap: Receipts/expenditure vs. Revenue/costs Difference on balance sheet Sales Receipt Payment by cystomer Revenue Activities for customer Receivables Fixed assets Expenditure Purchase Depreciation Book value Loans/Credit Amount Repayment Interest Liabilities --- Provisions Increase provision

Recap: Depreciation

Exercises of previous class Warm-up questions 2.2 3.4

Assessment of capital budgeting projects Average book rate of return On the basis of profitability Pay back period On the basis of cash flow Net present value Internal rate of return Taking into account the time value of money

Average book rate of return Average annual profit ABR = Average invested capital Ignores time value of money Disadvantage

Pay back period Time it takes a project to recover its initial investment from the cumulative cash flow Only partly takes into account the time value of money Does not calculate profitability Disadvantages

Criteria that take into account the time value of money Discount rate whereby the present value of the expected cash flows equals the initial investment Internal rate of return > weighted average cost of capital  project acceptable Internal rate of return Present value of the expected cash flows NPV > 0  project acceptable Net present value

Interest calculation methods Interest calculated on the initial amount only Simple interest Interest calculated on the total initial amount and on the accumulated past interest Compound interest

Financial statement analysis • Profitability ratios • Solvency ratios • Liquidity ratios

Earnings before interest and taxes Profitability Relationship between profit and capital Return on assets On business level Return on equity Equity providers Earnings before interest and taxes Average total assets Profit after tax Average equity

Earnings before interest and taxes Solvency A company’s ability to meet its financial obligations in the event of liquidation D TA E D TA E Ratios Debt ratio of Other financial leverage ratios Indicator Earnings before interest and taxes Interest Interest coverage ratio Financial resilience

Liquidity Dynamic Period Cash flow forecast Static Moment A company’s ability to meet its short-term financial obligations Dynamic Period Cash flow forecast Static Moment Balance sheet

For next class Exercises E5.3 E9.6