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FINANCING AND INVESTMENT IN THE FIRM, Garazi García Antruejo - Coggle…
FINANCING AND INVESTMENT IN THE FIRM
The financial function
purpose of the firm
satisfy consumer needs
requires finacial resources
Firm=sequence of financing + investment decisions over time
Financial function=link between
Financing (obtaining funds)
Investment (using funds)
Objective of financial management
maximize firm value, considering
Risk
Expected returns
stakeholders: owners, employees, suppliers
Main risks of the financial area
obtain financial resources
under best: amount, cost (interest), maturity
goal: achieve an optimal financial structure
decide investments
select viable porjects
NPV, IRR, Payback
balance risk-return
plan, analyze, control investments
Economic & financial structure
balance sheet
accounting equation
assets = liabilities+equity
assets (economic structure)
Non-current assets (>1 year)
intangible fixed assets
Tangible fixed assets
Current assets (<1 year)
Inventories
cash
Trade receivables
Ordered by liquidity
equity and liabilities (financial structure)
equity
Share capital
share premium
Reserves
long-term, non-repayable
liabilities
non-current liabilities (>1 year)
current liabilities (<1 year): suppleir credit, bank loans, credit lines, etc.
Permanent capital= equity+NCL
long-term financing
Lower liquidity risk, higher cost
financial equilibrium
minimum financial equilibrium rule
Non-current assets financed with permanent capital
current assets financed with short-term liabilities
recommended situation
Current assets>current liabilities
difference=working capital (WC)
Provides liquidity cushion
reduces mismatch risk
Working capital
definition
Money available for day-to-day operations
formulas
WC=current assets-current liabilities
WC=permanent capital-non-current assets
interpretation
positive WC: healthy, safe
Zero WC: meets minimum rule but risky
Negative WC: dangerous (financing long-term assets with short-term funds)
depends on sector
retail/discount stores
can operate with low/negative WC
JIT/made-to-order firms
proportional to cycle length and turnover
Business cycles & AMP
two cycles
Long cycle (fixed assets)
recovery via amortization
duration=useful life
Short cycle/operationg cycle
Form purchasing raw materials
production
Sale
Collection
duration <1 year
Average Maturity Period (AMP)
Subperiods
m1: Average storage period
m2: Average production period
m3: Average sales period
m4:Average collection period
m5: Average payment period
Economic AMP
m1+m2+m3+m4
Financial AMP
m1+m2+m3+m4-m5
Effects on working capital
long AMP
More capital tied up
Higher WC needed
Short AMP
faster cash recovery
Less WC needed
Structure ratios
ratios must link meaningful variables
Useful for comparisons over time or across firms
Solvency ratios
Debt-to-equity (D/E)
total liabilities/equity
shows financial autonomy
Long-term solvency ratio
Total assets/total liabilities
Solvent >2
High value=easy comparison; too high=under-leveraged
Liquidity ratio
Current assets/current liabilities
1 recommended
measures short-term solvency
immediate liquidity ratio (acid test)
cash/current liabilities
0.1 acceptable (sector-dependent)
Performance ratios
economic profitability (ROA)
EBI/Total assets x 100
expanded from: ROA=margin x rotation x100
Margin=EBI/sales
Rotation=sales/total assets
Financial Profitability (ROE)
Net income/equity x100
Measures shareholder return
Financial leverage
ROE=ROA+(ROA-cost of debt) x (debt/equity)
positive leverage: ROA>cost of debt
Higher debt—> higher ROE (but higher risk)
Profitability and risk always linked
Garazi García Antruejo