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Financial Management (Part 1 – Basic Practices)

by Dr.Sahanon Tungbenchasirikul

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Copyrights With regard to Copyright Act B.E. 2537 (1994): • All elements in the presentation (i.e., words, clauses, sentences, pictures, symbols, tables, and trademarks) are obtained from textbooks, academic journals, websites, and other sources of knowledge. These have been claimed to have copyrights. • The presentation is solely used for academic, not for any commercial, purposes.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Part 1 (Basic Practices) • Financial Environment • CFO Roles • Financial Statement Analysis • Financial Planning

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Environment

by Dr.Sahanon Tungbenchasirikul

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Buy Inputs

Sell Products

The Firms Pay the Firms

Pay Inputs Costs Budget Spending, Subsidies, Policies

Pay Taxes

Buy Inputs

Pay Product Costs

Input Markets

Product Markets

Government Pay Inputs Costs

Buy Products

Pay Taxes

Budget Spending, Subsidies, Policies Pay Product Costs

Pay Input Owners

Sell Inputs

Consumers and Input Owners

Financial Management by Dr. Sahanon Tungbenchasirikul Š

Buy Products

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Financial Market & Economy Financial Market  Product/Input Market Save / Invest

Consumers

Labor

Financial Market Lending / Sources of Funds

Government

Budget / Projects

Firms

Input & Product Support Product and Input Markets

Financial Management by Dr. Sahanon Tungbenchasirikul ©

Goods / Services / Inputs

Save / Invest

Financial Institutes

Financial Services 6


Financial Market & Economy Economic Players : Objectives Economic Players

Roles

Objectives

Consumers

Consumption & Labor

Maximize Utility

Firms

Project Investment

Maximize Profit

Financial Institutes

Financial Services

Maximize Profit

Government

Taxation & Spending

Maximize Social Welfare

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Financial Needs of Economic Players Short-term Needs

Long-term Needs

Consumers

- Daily expense - Emergency payments (e.g. illness, accident)

- Asset investment & daily usage (e.g. house, car, gold, land, government bond, marketable securities).

Firms

- Operating expense - Emergency incidents

- Project investment - Long-term revenue growth - Long-term asset growth

Financial Institutes

- Operating expense - Emergency incidents

- Long-term credit growth e.g. business and housing loan growth. - Financial asset investment

Government

- Operating expense - Emergency incidents

- Infrastructure project investments - Public debt repayment

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Sources of Funds and Fund Allocation Patterns Sources of Funds

Fund Allocation Pattern

Consumers

- Income - Borrowing - Saving

- Daily spending - Lump-sum or bullet payment - Amortization

Firms

- Operating income - Borrowing - Shareholder equity

- Daily business spending - Lump-sum or bullet payment - Amortization

Financial Institutes

- Financial service income - Borrowing - Shareholder equity

- Daily financial transactions - Lump-sum or bullet payment - Amortization

Government

- Tax and fee charge income - Borrowing - Fiscal reserve

-

Officers’ salary & benefits Government operating expenses Lump-sum or bullet payment Amortization

Fund Matching Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Sources of Repayment (in the case of debt) Primary Sources of Repayment (PSOR) Consumers

- Net income (free of debt obligation)

Secondary Sources of Repayment (SSOR) - Fixed asset sales - Long-term saving - Borrowing (revolving loan)

Firms

- Cash flow from operations

- Fixed asset sales - Borrowing - Raising equity

Financial Institutes

- Cash flow from operations

-Fixed asset sales - Borrowing - Raising equity

Government

- Tax collection - Short-term loan (e.g. treasury bill)

Financial Management by Dr. Sahanon Tungbenchasirikul Š

- Fiscal reserve - Long-term loan (Govt. Bond)

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Financial Market & Economy Sources of Repayment (in the case of debt) Financial Needs Search for

Sources of

Payback

Repayment

Sources of Funds Use

Fund Allocation Patterns

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Summary: Various Roles of Financial Market -

Saving Function Capital and Liquidity Management Function Wealth Management Function Transaction and Payment Function Credit Management Function Risk Management Function Economic Policy Management Function

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Financial Market : Classifications -

Money Market and Capital Market Primary Market and Secondary Market Auction Market and Negotiated Market Spot Market and Forward/Future Market Private Market and Public Market

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Money Market and Capital Market Summary Financial Market

Money Market

Short-term Funding Sources < 1 Year

Debt Capital Market

Medium and Long-Term Funding Sources > 1 Year

Equity Instruments Debt Instruments (Government)

- Public Company Common Shares

- Maturity Date < 1 Year

- Limited Company Shares

- Treasury Bills, Government Bond with Repurchasing (Repo)

- Preferred Shares or Property Funds

Short-term Debt Instruments (Private)

Long-term Debt Instruments

- Interbank Loan

- Private Bond, Convertible Bond, Long-term Loan, Longterm Government Bond

- Private Repurchasing (Repo)

- Structure Note

- Short-term Loan, BE, PN, OD, LG, LC TR, PC

- Securitization e.g. CDO (Collateralized Debt Obligation)

Derivative Instruments - Swaps, Options, Futures

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Primary Market

Secondary Market

The market in which corporations raise new capital by selling their securities to investors for the first time.

The market in which existing securities are traded among investors who intend to speculate the security returns.

There are two routes of raising new capital: - Private Placement (PP) - Initial Public Offering (IPO)

The official secondary market in Thailand is the Stock Exchange of Thailand (SET, MAI, BEX, TFEX).

Financial Management by Dr. Sahanon Tungbenchasirikul ©

The unofficial secondary market is called “over the counter market” (OTC).

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Financial Market & Economy Auction/Open Market

Negotiated Market

The market consists of a large number of security sellers and buyers.

Direct exchange between security buyer and seller.

Security brokers play the key role in buying and selling security on the behalf of buyers and sellers.

Security price is based on the decision of both buyer and seller (e.g. mark to market, below par value), not determined by the market demand and supply.

Security exchanges completed when brokers match the prices and quantities of the security (e.g. PTT). Official security auction/open markets include SET, MAI, BEX, TFEX.

Financial Management by Dr. Sahanon Tungbenchasirikul Š

The operation of primary market is viewed as the direct exchange (contract) Example of negotiated market include private bond selling to large institutional investors. 16


Financial Market & Economy Spot Market

Forward/Future Market

Securities/assets are being bought or sold for “on-the-spot” delivery.

Securities/assets are being bought or sold for “the future” delivery.

Once the buyer and the seller settle a deal, they need to make payment and transfer security/asset to another party immediately or within a few days.

Once the buyer and the seller settle a deal, they will make payment and transfer security/asset to another party with regard to the future/forward contract (e.g. 30 days, 60 days). Forward/future market could aid buyers and sellers to manage risks better. For instance, the company (buyer) completed a deal with the bank (seller) to buy FX forward and will make payment by the end of June 2010.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Market & Economy Private Market

Public Market

Transactions of securities/assets are Transactions of securities/assets are worked out directly between buyers and conducted in term of standardized sellers. contracts. Bank loans and private placement (PP) of new common stocks are examples of private market.

Securities issued in public markets (e.g. common stock, corporate bond) are ultimately held by a large number of individuals.

Private market securities/assets are more tailor-made, but less liquid. Public market securities/assets are more liquid and standardized.

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Market & Economy Capital Formation Process Direct Transfers

Securities (Stocks or Bonds)

Business

Savers Money

Indirect Transfers through Investment Bankers Securities

Business Money

Investment Banking Companies

Securities

Savers Money

Indirect Transfers through a Financial Intermediary (e.g. banks)

Business

Securities Money

Financial Intermediary

Financial Management by Dr. Sahanon Tungbenchasirikul Š

Securities

Savers

Money 19


Financial Institutes Generic Financial Market and Institute Role Lending

Financial Institutes

Saving

Financial Market Economic Players with Borrowing Needs

Security Purchasing

Economic Players with Surplus Saving

(Demand for Capital)

Security Issuing

(Supply of Capital)

The process of capital and liquidity flow:

Financial Institutes and Financial Market jointly play the key role as Financial Intermediary in an economy. Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Institutes The Importance of Financial Institutes: - Facilitating financial transaction - Risk reduction through diversification - Reduction in the contracting and negotiation costs - Financial information production and spillover - Management of payment/settlement systems - Insurance agents

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Generic Types of Financial Institutes (Thailand) Key Roles

Thailand Examples

Commercial Bank

A broad range of banking and financial services to serve large corporations, SMEs, and retail customers.

Bangkok Bank Krung Thai Bank Kasikorn Bank Siam Commercial Bank

Government Specialized Banks

Financial services in line with government policy (e.g. housing loan, agricultural loan)

Government Housing Bank, Government Saving Bank, SME Bank, EXIM Bank

Security Company

Security issuing, financial advisory, common stock broker,

Asia Plus Securities Kim Eng Securities Phatra Securities

Mutual Fund Management Company

Institutional investors, which use mutual funds as investment tools.

SCB Asset Management Kasikorn Asset Management, TMB Asset Management

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Generic Types of Financial Institutes (Thailand) Key Roles

Thailand Examples

Life Insurance Company

Selling insurance policy to customers and in turn invest money in long-term low risk securities.

Leasing Company

Offering leasing loan to Tanachart, Tisco, both organization and retail Kiatnakin, Phatra, SCB, buyers. Toyota, Honda

Cooperatives

Lending money to the those EGAT Saving members who need Cooperative, SCB Saving liquidity. Cooperative

Pawnshop

Lending money to retail Government Pawnshop customers who pledge their in Bangkok and assets as collaterals. Provinces.

Financial Management by Dr. Sahanon Tungbenchasirikul Š

AIA, Thai Insurance, & Bua Luang Life Insurance

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Financial Regulators (Thailand) Key regulators of Thailand financial market: – Ministry of Finance (MOF) – Bank of Thailand (BOT) – Securities and Exchange Commission (SEC)

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Regulators: Objectives Promote the Stability of Financial Market - Investor Protection - Fair and Healthy Competition) - Support Government Economic Policy -

– – – – –

Appropriate GDP Growth Minimized Unemployment Rate Inflation Control Current Account Surplus (Export > Import) Positive New Capital Movement

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Regulators: Capital Market The governance structure of Thailand capital market MOF SEC

Primary Market (PP & IPO)

Secondary Market

(SET, MAI, BEX, TFEX)

Financial Management by Dr. Sahanon Tungbenchasirikul ©

Financial Institutes

• Securities Companies • Mutual Fund Management Companies • Provident Fund

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Financial Regulators: Financial Institutes The governance structure of Thailand financial institutes MOF BOT • Commercial Banks (Thai banks and foreign bank branches) • Commercial Bank Subsidiaries (e.g. Leasing, Factoring) • Retail Banks • Finance Companies • Leasing Companies • Credit Foncier Companies • Asset Management Companies • Specialized Government Banks

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Financial Regulators: Policy Trend Information Disclosure - Substantial information - Equality and timeliness - Accuracy - Sufficiency Risk Control - Risk-Return balance - Risk calculation and appropriate allocation of company capital

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Financial Regulators: Key Success Factors 1.

Financial Market Efficiency: – Operational efficiency (Cost management) – Allocation efficiency (Appropriate return from investments) – Information efficiency (Equality of information access)

2.

Fairness: – Equal opportunity – Single standard

3.

Financial Market Stability and Security: – Risk control – Regulations and measures – Investor protection

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Interest Rates (Cost of Money Borrowing) Interest Rate is “the price paid to borrow debt capital. With equity capital, investors expect to receive dividends and capital gains, whose sum is the cost of equity money.” Interest Rate is affected by four fundamental factors. These are: – Production Opportunities (rate of return on investment). – Time Preferences for Consumption (the willingness to sacrifice current consumption in order to secure future consumption). – Risk (the likelihood of loss events take place). – Inflation (price level continually increases).

Interest Rate is affected by various macroeconomic factors. These include: – Central Bank Monetary Policy – Government Budget Spending Policy – International Economic Factors (e.g. trade surplus, trade deficit)

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Risk Free Interest Rate (Theoretical Aspects) The risk-free rate of interest (krf) is defined as the real risk-free rate (k*) plus an inflation premium (IP). Therefore, krf = k* + IP

Example. A company borrows money from a bank. Bank officers charge the risk-free rate of interest (krf) by assuming the real risk-free rate (k*) = 3% and inflation premium (IP) = 3%. What is krf? krf = k* + IP krf = 3% + 3% krf = 6%

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Quoted Interest Rate (Theoretical Aspects) The quoted (or nominal) interest rate (k) on the debt security is composed of the real risk-free rate (k*) plus an inflation premium (IP) plus default risk premium (DRP), plus liquidity risk premium (LP) and plus maturity risk premium (MRP). Therefore, k = k* + IP + DRP + LP + MRP

Example. A company borrows money from a bank. Bank officers consider the quoted interest rate (k) by assuming the real risk-free rate (k*) = 3%, inflation premium (IP) = 3%, default risk premium (DRP) = 1%, liquidity risk premium (LP) = 0.5%, and maturity risk premium = 0.5%, What is k? k = k* + IP + DRP + LP + MRP k = 3% + 3% + 1% + 0.5% + 0.5% k = 8%

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Interest Rate (Investment vs. Saving) Interest Rate

Interest Rate Investment

I1

Saving

Investment = Saving

Saving 1

Investment

Saving

I1 I2

M1

Money Amount

M1

M2

Money Amount

Investment and saving determines interest rate level. If saving increases (investment constant), interest rate is likely to decrease. If investment increases (saving constant), interest rate is likely to increase.

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Interest Rate: Yield Curve Example of Government Bond Yield Curve Time to Maturity TTM (Yrs.) 0.08 (1M)

Yield (%)

0.25 (3M)

1.36

0.50 (6M)

1.48

1Y

1.76

2Y

2.32

3Y

2.69

4Y

3.06

5Y

3.18

6Y

3.22

7Y

Long-term interest rates are higher than short-term ones.

1.25

3.31

8Y

3.35

9Y

3.37

10 Y

3.45

15 Y

3.74

20 Y

3.9

25 Y

3.97

29 Y

4.06

Financial Management by Dr. Sahanon Tungbenchasirikul Š Thai BMA (for education purpose Source: only)

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CFO Roles

by Dr.Sahanon Tungbenchasirikul. For exam

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Management • Financial Management is necessary for every organization (government, state own enterprises, private companies, cooperatives and so on) • Intuitively, every organization must create revenue that is sufficient to cover its total cost. In other words, every organization needs to spend money to drive its business, and in turn expects to gain money back from such business (there is no free lunch). • Financial management significantly influences the success of strategies in both the short- and long-term. Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Management

The primary goal of management is to maximize shareholdersâ&#x20AC;&#x2122; wealth and this implies maximizing the stock price.

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Financial Management Maximize shareholders’ wealth: • Satisfactory long-term stock value. • Strategies that add value to the firm and sustain competitive advantages. • Sufficient cash in executing the firm’s strategic plans. • Investment in profitable business/project/product. • Capability to take advantages from money and capital markets. • Cash flow to finance debt and pay dividend over a longterm. • Risk–Return Balance. Financial Management by Dr. Sahanon Tungbenchasirikul ©

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CFO Roles Maximize shareholders’ wealth

Chief Financial Officer (CFO) roles are as follows: – – – – –

Financial Planning Investment Decision Financing Decision Working Capital Management Financial Risk Management

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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CFO Roles Roles Financial Planning

Investment Decision

Financing Decision

Key Functions • Corporate Plan & Budget • Identifying Financial Needs and Sources of Funds. • Project Selection • Project Feasibility Analysis • Cash Flow Management • Capital Structure • Debt Financing • Capital Financing

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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CFO Roles Roles Working Capital Management

Key Functions • Current Asset Management • Short-term Financing

• Identifying Causes of Financial Financial Risk Management Risks • Financial Risk Prevention and Correction

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Statement Analysis

by Dr.Sahanon Tungbenchasirikul

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Financial Statement Analysis The four basic financial statements in the annual report include: • Balance Sheet; • Income Statement; • Statement of Retained Earning (we do not focus on this one); • Cash Flow Statement.

Shareholders / investors use these statements to form expectations about the future levels of earnings, profits, dividends, and about the firm’s risks.

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Financial Statement Analysis 1. Balance Sheet: Assets = Liabilities + Owner Equities 2. Profit and Loss Statement: Revenue, Costs of Goods Sold, Gross Profit, Selling & Admin Expenses, EBIT, Interest Expenses, Tax, Net Profit. 3. Cash Flow Statement: • • •

Operating Cash Flow Investing Cash Flow Financing Cash Flow

Students should be familiar with three financial statements above.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Statement Analysis: Ratio Analysis 1. 2. 3. 4.

Liquidity Ratio Profitability Ratio Efficiency Ratio Leverage or Financial Policy Ratio

• Financial ratio calculation based on data in financial statements. • Comparing the firm’s financial ratios for several years (3 Years) to forecast the business future trend. • Comparing the firm’s financial ratios with key competitors’ to know whether the firm is as good as, lacks behind, or outperforms them.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Liquidity Ratio Ratio

Formula

Definition

Current Ratio

Current Assets / Current Liabilities or CA / CL = XX time(s)

Quick Ratio

[Cash + Marketable Securities Indicates the ability of the firm + Account Receivable] / Current to meet short-term obligations Liabilities = XX time(s) without reliance on inventory.

Working Capital (WC)

Current Assets â&#x20AC;&#x201C; Current Liabilities or CA - CL = WC

Financial Management by Dr. Sahanon Tungbenchasirikul Š

Indicates the ability of the firm to meet short-term obligations.

Measures the excess of current assets over current liabilities in term of money value. If WC > 0, the firm can meet short-term obligations, but it needs support from long-term funding sources.

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Profitability Ratio Ratio

Formula

Definition

Gross Profit Margin

[Gross Profit / Revenue] x 100 = XX%

Indicates the per-unit spread between revenue and the cost of good sold

Net Profit Margin

[Net Profit / Revenue] x 100 = Indicates the firm’s ability XX% to generate profit from each unit sales.

Earning Before Interest, Tax, Depreciation & Amortization = EBITDA

Profit before Interest and Tax + Depreciation + Amortization = EBITDA [EBITDA / Revenue] x 100 = XX%

Financial Management by Dr. Sahanon Tungbenchasirikul ©

Indicates the firm’s ability to generate cash flow (interim profit) to pay short-term financial obligations (i.e. tax and interest payment).

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Efficiency Ratio Ratio

Formula

Definition

Inventory Day on Hand = INVDOH

[Inventory / COGS] x 360 = XX Days

Indicates the average number of days in inventory holding period.

Account Payable Day on Hand = APDOH

[Account Payable / COGS] x 360 = XX Days

Indicates the average number of days in the supplier payment period.

Account Receivable Day on Hand = ARDOH

[Account Receivable / Revenue] x 360 = XX days

Indicates the average number of days in the collection period.

Cash Cycle or Financial Needs (FN)

FN = ARDOH + INVDOH – APDOH = XX days FN > 0 --> Need more cash FN < 0 --> No need cash

Indicates the average number of days that the firm needs financial support to maintain its liquidity.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Efficiency Ratio Ratio Total Assets Turnover

Formula Revenue / Total Assets = XX time(s)

Definition Indicates the ability of total assets to generate revenue.

Return on Assets = [Net Profit / Total Assets] x ROA 100 = XX%

Indicates the return on investment based on total assets.

Sales to Net Fixed Assets

Indicates the ability of net fixed assets to generate revenue.

Revenue / Net Fixed Assets = XX time(s)

Return on Equity = [Net Profit / Equity] x 100 ROE = XX%

Financial Management by Dr. Sahanon Tungbenchasirikul Š

Indicates the rate of return on shareholdersâ&#x20AC;&#x2122; equity.

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Leverage or Financial Policy Ratio Ratio

Formula

Definition

Debt Ratio

[Total Liabilities / Total Assets] x 100 = XX%

Indicates the degree to which the company’s assets are funded by external creditors.

Debt to Equity Ratio = D/E Ratio (Very Important)

Total Liabilities / Equity = XX time(s)

Indicates the company’s proportion of external creditor and shareholder funding.

Time Interest Earned = TIE

EBIT / Interest Payment Indicates the company’s ability = XX time(s) to meet interest payment by operating cash flow.

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Leverage or Financial Policy Ratio Ratio

Formula

Definition

Interest Coverage Ratio = ICR

EBITDA / Interest Payment = XX time(s)

Indicates the company’s ability to pay senior debt interests from using operating cash flow.

Debt Service Coverage Ratio = DSCR

EBITDA / [Interest Payment + Current Portion of Long-Term Li abilities (CPLTL)] = XX ti me(s) DSCR < 1 --> Not good DSCR > 1 --> Good

Indicates the company’s ability to meet financial obligations (interest and principal) from using operating cash flow.

(Very Important)

Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Example of Profit and Loss Statement

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Example of Balance Sheet

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Example of Balance Sheet

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Balance Sheet Changes in 25X2 (1) Account Receivable and Inventory increase 10%. (2) Building Premises increases 400 MB. (3) Account Payable increases 10%. (4) The company pays dividend 50% of its 25X2 net profit = 616 MB and allocate 616 MB to be the retained earning. (5) O/D increases 200 MB. (6) LTL increases 200 MB.

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Example of Cash Flow Statement

Student shall try to calculate financial ratios by using data from the companyâ&#x20AC;&#x2122;s annual report.

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Methods of Financial Statement Estimation • Trend Analysis - observe average revenue, cost, ROE, ROA over several years and plot the trend line to estimate future revenue and other items in financial statement. • Common Size Analysis - all income statement items are divided by revenue (as % of revenue) and all balance sheet items are divided by total assets (as % of total assets). We will adopt this method to support our analysis for the rest of this course. Note, no common size analysis for cash flow statement. • Percent Change Analysis - growth rates are calculated for all income statement items and balance sheet accounts.

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Limitations of Financial Statement • Some large diversified firms will find it difficult in conducting performance comparisons with players in each market segment. • Inflation affects financial statement analysis across different periods. • Seasonal effects can distort ratio analysis (e.g. real estate, luxurious retail stores). • Generalization problems across different industries (e.g. financial institutes vs. modern trade retailers). Ratio analysis is useful, but analysts must be aware of these problems and make adjustment as necessary. Ratio analysis conducted in a mechanical, unthinking manner, is dangerous, but used intelligently and with good judgment, it can provide useful insights into a firm’s business operations and effectiveness. Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Financial Planning

by Dr.Sahanon Tungbenchasirikul

Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Strategic Management Process

Strategy Formulation

Strategy Control Strategy Implementation

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Corporate Plan (Strategic Plan) • In the context of Financial Management, every corporate plan (strategic plan) aims to maximize shareholders’ wealth/common stock price over a long-term. • The key attributes of Corporate Plan (Strategic Plan) are: – It requires top executive’s commitment. – It is medium- or long-range plan (3 – 5 years). – It has a significant impact on the firm’s business operations and performances. – It requires new business initiatives and investments in various business operations (e.g. marketing, R&D, logistics). – Once the firm has implemented its corporate plan, it is difficult to reverse (unless the firm declines its corporate plan at the formulation stage). Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Key Components of Corporate Plan • Corporate Plan is defined as a blueprint specifying the resource allocations, schedules, and overall business master plans necessary for maximizing shareholders’ wealth over a long-term: • Corporate Plan covers the following details:  Corporate Vision  Corporate Mission  Corporate Goals  Corporate Strategies  Overall Budget Requirements  Overall Manpower Requirements  Key Project Investments  Key Business Support Requirements (e.g. IT, Logistics)  Financial Projections (1-3 years, 3-5 years) Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Corporate Vision • Corporate Vision can be viewed as the long-term business direction or the most crucial business goal, which shapes the firm’s business scope, strategy, and structure. In other words, vision is a desired future state that the firm attempts to achieve. For examples, – To be number one in luxurious fashion business in 2015. – To dominate Asia-Pacific beer market in 2015.

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Corporate Mission • Corporate Mission is defined as what the firm stands for and its reason for existence. For example, – To provide excellent services for our customers, to build a good working environment for our employees, and to reinforce satisfactory financial outcomes for our shareholders.

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Corporate Goal • Corporate Goal is defined as expected end results of implementing corporate strategies in both the short- and long-term. For examples, – Revenue growth at least 10% per annum. – Customer retention rate equals 90% within 3 years. – Completing back-office process centralization within 3 years.

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Corporate Plan Summary Corporate Plan (Strategic Plan) Vision

• Overall Budget Requirements

Mission

• Overall Manpower Requirements • Key Project Investments • Key Business Support Requirements • Financial Projections

Corporate Goals & Strategies (Senior Management) (Organization as a Whole)

Business Goals/Plans (Middle Management) (Business Units, Divisions, Functions)

Operational Goals/Plans (Front-line Management) (Departments, Individuals)

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Corporate/Strategic Plan Metaphor War Vision, Mission, and Goal

Battle Engagement Preparation for Battle (Operational Goals/Plans)

High-Level War Strategy/Plan

Battle Strategies (Tactical Goals/Plans)

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The Holistic Model of Corporate Plan Corporate Plan The Firm’s Financial Needs

Profit/Loss Statement

• Overall Budget Requirements

Vision, Mission Value Add

Goals & Strategies Competitive Advantages

Total Costs

• Overall Manpower Requirements • Key Investment Projects • Key Business Support Requirements

Balance Sheet

• Financial Projections

Current Liabilities Assets (1)

Creditors Sources of Funds

(1) Fixed Assets

Equities

(2)

(3)

Cash Flow Statement

Shareholders Remuneration

• Operating cash flow

• Retained earning

• Investing cash flow

• Dividend

• Financing cash flow

• Debt repayment

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Source: Sahanon Tungbenchasirikul ©


Financial Plan Summary Financial Plan as Part of Corporate Plan: •

Determine financial needs to support Corporate Plan.

Forecast funds availability over 3 - 5 years.

Project three financial statements.

Adopt a financial control system to ensure efficient budget utilization and proper strategic actions.

Develop procedures for adjusting business plans if economic situation significantly changes.

Establish a performance-based management compensation in line with shareholders’ goals.

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Operating Plan Summary Operating Plan provides: â&#x20AC;˘ Detailed implementation guidance based on the stated corporate strategy in pursuit of corporate goals. â&#x20AC;˘ Operating plans (e.g. launching a new product, branch expansion towards overseas markets, IT system installation) address business actions and tactics, budget disbursement, time schedules, revenue/expense/profit targets, and relevant staff who is responsible for execution.

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Operating Plan Summary Operating Plan provides: • Small firms, in many cases, undertake planning informally. It might be that they don’t need any written plan, but follow their business routines. To grow their business, they depend largely on emergent ideas/strategies. • For large corporations (e.g. SCC, PTT, CPF), they break down operating plans by units/divisions/departments. As a result, it is likely to that each unit/division/department has its own goals and business investment projects. These plans across various units within the firm are consolidated to form the (concise) corporate plan.

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Financial Statement Forecasting Methods • Common Size Method - all income statement items are divided by revenue (as % of revenue) and/or all balance sheet items are divided by total assets (as % of total assets). Note, no common size analysis for cash flow statement. • Budgeted Expense Method – estimating the value of each item in income statement & balance sheet with regard to expected developments in the future period. • Trend Method - observe average revenue, cost, ROE, ROA over several years and plot the trend line to estimate future revenue and other items in financial statement. • Percent Change Method - growth rates are calculated for all income statement items and balance sheet accounts. In this chapter, we will focus on common size & budgeted expense method.

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Sales/Demand Forecasts • Sales Forecast generally starts with a review of sales during the past several years, addressed in graph or average annual growth rate (%). • One can forecast sales by using simple/multiple regression analysis (i.e. an advanced statistical method). • The firm’s sales can be considered in terms of units and dollars. • The higher the firm’s sales growth rate, the greater the need for additional (internal and external) capitals. • The smaller the firm’s customer retention, the greater the need for additional capitals.

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Key Drivers of Sales Growth • Economic Growth (i.e. GDP growth, per capita income growth). • Inflation (i.e. price levels of inputs/products/services in an economy continue to increase). Hence, inflation will affect the firms’ product prices. • New Innovations (e.g. new products (R&D), overseas market expansion).

• Marketing Promotion (e.g. promotional discounts (SALE), credit terms, advertising). • Strategic Resources or Competitive Advantages (e.g. reputation, business relationships, economies of scales, distribution channels, large customerbase, patents, copyrights, trademarks, licenses, concession, high quality employees). Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Key Drivers of Balance Sheet Growth Sales increases --> Balance Sheet Growth (Total Asset Growth). • Current Asset Growth (e.g. inventory and account receivable increase). • Current Liability Growth (e.g. account payable and short-term loan increase). • Fixed Asset Growth (e.g. new equipment / machine / building / premise investments, goodwill). • Long-tem Liability Growth (e.g. long-term loan increase, corporate bond issuing). • Equity Growth (e.g. new preferred stock issuing, retained earning increase, new common stock issuing). Financial Management by Dr. Sahanon Tungbenchasirikul ©

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Key Drivers of External Financing Needs. High Need

Low Need

Low Internal Cash Flow

High Internal Cash Flow

• Rapid Sales Growth (Above 10%)

• High EBITDA & Profit Margin

• Financial Loss (Net Profit < 0) or Low EBITDA & Profit Margin

• Working Capital < 0 (FN < 0)*

• Working Capital > 0 (FN > 0) • Capital Intensity or High Operating Leverage (High Proportion of Fixed Asset Investment).

• Low Operating Leverage (Low Proportion of Fixed Asset Investment) • High Retained Earning Ratio

• Low Retained Earning Ratio

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Example: 5 Year Corporate Plan & Financial Plan John Lion has owned the majority (51%) of common stock of Automobile Engine Manufacturing Pcl. (the Company) in Thailand and appointed to be the Chairman of the Board of Directors since 25Y1. The Company has been successful in Thailand automobile industry and become one of the key suppliers of Toyota and Mitsubishi. From 25Y1 - 25X1, the Company has been expanding its automobile engine sales to overseas markets (e.g. Indonesia, Malaysia, Japan, South Korea) with an attractive growth rate of 10 - 12.5% per year. At the fourth quarter/25X1, the Board of Directors approved 5 Year Corporate Plan (25X2 - 25X6), which emphasizes on continuous growth of revenue and total assets.

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Example: 5 Year Corporate Plan & Financial Plan John Lion (the Chairman of the Board of Directors) requests the President to announce Corporate Plan and Financial Plan across all business and support units. However, the President suggests that the Company shall keep the details of investment feasibility and capital structure analyses and as the top secret (see Chapter 6 and Chapter 7).

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Example: 5 Year Corporate Plan & Financial Plan Vision: The Top Thai Automobile Engine Producer with International Standard within 25X6 Mission: 1. To maximize shareholdersâ&#x20AC;&#x2122; wealth over a long-term. 2. To produce automobile engines with supreme quality for our customers. 3. To fairly provide rewards and career development for our employees. 4. To promote corporate social responsibility (CSR) in various aspects. Financial Management by Dr. Sahanon Tungbenchasirikul Š

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Example: 5 Year Corporate Plan & Financial Plan Corporate Goals 1. Continuous revenue growth at least 10% per year. 2. Sales proportion from overseas markets to 30% by the end of 25X6.

Strategies 1. Investments to strengthen logistics systems (e.g. warehouse, logistics management software) to compete in overseas market.

3. Completion of investment in key logistics systems within 25X4.

2. R&D investment to improve product quality and launch new products.

4. Control of capital structure (D/E ratio maximum ~ 1.2:1).

3. Raising capital from external and internal sources with reasonable WACC over the long-term.

5. Employee retention rate 95% per year.

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4. HR development and incentive improvement.

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Example: 5 Year Corporate Plan & Financial Plan Sales/Demand Forecasts (Revenue grows 10% per year): • Market Situation Summary

– Automobile markets in Thailand and overseas display the upside trends with average growth 12% per year from 25X2-25X6. – BRIC group can have a significant market growth > 25% per year in the same period. – The number of automobile engine producers is supposed to increase slowly (1-2 firms per year) due to large capital investment and industry standards.

• Drivers of Sales Growth

– Domestic and world economic growth rate 6% and 3.5% respectively. – Thailand per capita income level will be higher than $4,500 from 25X2 onwards. – Inflation in Thailand is controlled, ranging from 4% - 5%. – Toyota and Mitsubishi market shares in Thailand automobile market in 25X2 – 25X6 are forecasted to be 42% and 5% respectively. – The Company has been recognized as top 3 automobile engine producers certified by Thailand Automobile Association. – The Company pay high attention to R&D in co-operations with Toyota and Mitsubishi research team. This ensures the solid business relationships with its key buyers.

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Example: 5 Year Corporate Plan & Financial Plan Strategies Financial Needs Overall Budget Requirements

Overall Manpower Requirements

Business Support Requirements

Key Project Investments

Financial projections

Investments in logistics systems

R&D investment

Raising capital

HR development & incentives

Budget Categories: 1. Operating expenditures (OPEX) = XXXXX MB (e.g. salary, R&D, selling & admin.) 2. Capital expenditures (CAPEX) = XXXXX MB (i.e. current & fixed asset investments) Hiring New Staff: 1. Full-Time Staff (marketing, finance, accounting, engineers, and so on) = XX 2. Part-Time & Contract Staff = XX Logistics software; Overseas units; Warehouses & etc.

New equipment; Market research; & etc.

Financial analysis & invest. team; & etc.

HR master plan; HR support team & etc.

- Logistics support system investments - Marketing campaigns - R&D investments - Financial analysis support systems & etc. 1. Financial statement projections (25X2 - 25X6) 2. Cash flow and discount cash flow analysis (Chapter 6) 3. Sensitivity analysis (Chapter 6)

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Example: 5 Year Corporate Plan & Financial Plan •

5 Years Financial Statement Projections Profit and Loss Statement – Common-Size analysis assumption 10% constant revenue growth from 25X2 – 25X6 – Interest Payment for short-term loan equals 2% and for long-term loan is 6% per year. Balance Sheet – Account receivable, inventory, and account payable grow 10% per year in line with revenue growth. – Fixed Assets/Revenue ~ 40% - 60%. – Current and long-term liabilities will grow with regard to short-term and longterm financial needs. – Short-term loan grows 10% per year. – Long-term loan is constant at 2,500 MB over 6 years (i.e. new long-term loan 500 MB replaces CPLTL 500 MB every year). – The key driver of equity growth is retained earning change (both common and preferred share value are constant). – Cash at the end of financial year in Balance Sheet must equal cash at the end of financial year in Cash Flow Statement. Cash Flow Statement – Report changes in Profit and Loss Statement and Balance Sheet.

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Profit & Loss Statement 25X1 – 25X6 (Unit: MB) Profit & Loss Statement Items

25X1

Revenue

10,000

Cost of Goods Sold (COGS) Gross Profit Selling & Admin. Expenses Earning Before Int. & Tax (EBIT) Interest Payment Earning Before Tax Tax Payment (30%) Net Profit Dividend Portion (50%) Retained Earning Portion (50%)

25X2

25X3

25X4

25X5

25X6

11,000

12,100

13,310

14,641

16,105

(7,000)

(7,700)

(8,470)

(9,317)

(10,249)

(11,274)

3,000

3,300

3,630

3,993

4,392

4,832

(1,000)

(1,100)

(1,210)

(1,331)

(1,464)

(1,611)

2,000

2,200

2,420

2,662

2,928

3,221

(194) 1,806 (542) 1,264

(195) 2,005 (601) 1,403

(197) 2,223 (667) 1,556

(199) 2,463 (739) 1,724

(200) 2,728 (818) 1,909

(203) 3,018 (906) 2,113

(632)

(702)

(778)

(862)

(955)

(1,056)

632

702

778

862

955

1,056

Profit and Loss Statement Assumptions: 1. Common-Size analysis assumption 10% constant revenue growth from 25X2 – 25X6 2. Interest Payment for short-term loan equals 2% per year and for long-term loan is 6% per year.

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Balance Sheet 25X1 â&#x20AC;&#x201C; 25X6 (Unit: MB) Assets Cash

25X1

25X2

25X3

25X4

25X5

25X6

782

1,294

1,813

2,340

2,876

3,422

Account Receivable

1,000

1,100

1,210

1,331

1,464

1,611

Inventories

1,400

1,540

1,694

1,863

2,050

2,255

Current Assets

3,182

3,934

4,717

5,534

6,390

7,288

Building & Premise

3,000

3,300

3,630

3,993

4,392

4,832

Equipment

3,000

3,300

3,630

3,993

4,392

4,832

(1,400)

(1,900)

(2,400)

(2,900)

Accumulated Depreciation

Fixed Assets

Total Assets

(400)

(900)

5,600

5,700

5,860

6,086

6,385

6,763

8,782

9,634

10,577

11,620

12,775

14,051

Balance Sheet Assumptions (Asset Side): 1. Account receivable and inventory grow 10% per year in line with revenue growth. 2. Fixed Assets/Revenue ~ 40% - 60%. 3. Cash at the end of financial year (FY) in Balance Sheet must equal cash at the end of financial year (FY) in Cash Flow Statement.

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Balance Sheet 25X1 â&#x20AC;&#x201C; 25X6 (Unit: MB) Liabilities & Equity

25X1

25X2

25X3

25X4

25X5

25X6

Short-term Loan

700

770

847

932

1,025

1,127

Account Payable

800

880

968

1,065

1,171

1,288

CPLTL

500

500

500

500

500

500

Current Liabilities

2,000

2,150

2,315

2,497

2,696

2,916

Long-term Loan

2,500

2,500

2,500

2,500

2,500

2,500

Total Liabilities

4,500

4,650

4,815

4,997

5,196

5,416

Common Stock

2,000

2,000

2,000

2,000

2,000

2,000

Preferred Stock

1,000

1,000

1,000

1,000

1,000

1,000

Retained Earning

1,282

1,984

2,762

3,624

4,579

5,635

Equity

4,282

4,984

5,762

6,624

7,579

8,635

8,782

9,634

10,577

11,620

12,775

14,051

Total Liabilities + Equity

Balance Sheet Assumptions (Liability & Equity Side): 1. Account payable grows 10% per year in line with revenue growth. 2. Current and long-term liabilities will grow with regard to short- and long-term financial needs. 3. Short-term loan grows 10% per year. 4. Long-term loan is constant at 2,500 MB over 6 years (i.e. new long-term loan 500 MB replaces CPLTL 500 MB every year). 5. The key driver of equity growth is retained earning change. 86 Financial Management by Dr. Sahanon Tungbenchasirikul Š


Cash Flow Statement 25X1 – 25X6 (Unit: MB) Cash Flow Statement

25X1

25X2

25X3

25X4

25X5

25X6

(1) Operating Cash Flow

1,490

1,743

1,880

2,031

2,196

2,379

Net Profit

1,264

1,403

1,556

1,724

1,909

2,113

Depreciation & Amortization

400

500

500

500

500

500

Account Receivable Change YoY

(91)

(100)

(110)

(121)

(133)

(146)

(127)

(140)

(154)

(169)

(186)

(205)

106

117

Inventory Change YoY Account Payable Change YoY

44

80

88

97

(2) Investing Cash Flow

(400)

(100)

(160)

(226)

(299)

(378)

Fixed Asset Change YoY

(400)

(100)

(160)

(226)

(299)

(378)

(3) Financing Cash Flow

(1,068)

(1,132)

(1,201)

(1,277)

(1,362)

(1,454)

Short-term Loan Change YoY Long-term Loan Change YoY

64 -

70 -

77 -

85 -

93 -

102 -

CPLTL

(500)

(500)

(500)

(500)

(500)

(500)

Dividend Payment

(632)

(702)

(778)

(862)

(955)

(1,056)

New Stock Issuing

-

-

-

-

-

22

511

519

527

536

546

Cash at the Beginning of FY

760

782

1,294

1,813

2,340

2,876

Cash at the End of FY

782

1,294

1,813

2,340

2,876

3,422

Change Cash Flow (1)+(2)+(3)

-

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Financial management part 1