Working capital management
Three major forms
Goal of financial management
The primary financial goal is shareholder wealth maximization which translates to maximizing stock price.
Stock price relates to projected cash flows to shareholders na timing of the cash flow stream; riskiness of the cash flows
The original sale of securities – money goes to corporations; IPO
Transaction between owners no money goes to the corporation
Net working capital – CA-CL
+ve when the cash that will be recived over the netxt 12 months exceed cash that will be paid out. Usually positive in a healthy firm
Speed and ease of converting an asset into cash
Liquid asset earn a lower return
Trade off to find balance between liquid and illiquid assets
Debt v Equity
Debt has precedence over equity to a firm’s cash flows
Stockholders’ equity = assets – liabilities
Debt is referred to as financial leverage.
Accounting income is not the same as cash flow.
eg. Sell on credit, the revenue is realized depreciation
Marginal v average tax rates
Marginal – the extra tax you would pay if you earned one more dollar
Average – the tax bill
Average tax rate = total tax/taxable income
Working with financial statements
The Du Pont identity
There are five categories of ratios:
Short term solvency or liquidity ratios
Long term solvency, or financial leverage ratios
Market value ratios
Each category measures a different dimension of a firm’s performance
Current ratio – CA/CL
Quick ratio – (CA-inventory)/CL
Cash ratio – Cash/CL
A high ratio indicates liquidity but too high may mean the firm is inefficient
Financial leverage ratio – measures the firms long-run ability to meet its obligations
Total debt ratio – TA-TE/TA
Equity multiplier = TA/TE = 1+ TD/TE
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