PRINCIPLES OF MANAGERIAL FINANCE, Exercises of Finance

Download PRINCIPLES OF MANAGERIAL FINANCE and more Exercises Finance in PDF only on Docsity! FREDDIE PEREZ ID #: UD4080BBA9273 PRINCIPLES OF MANAGERIAL FINANCE A Phase II Course Presented To The Academic Department Of The School Of Business and Economics In Partial Fulfillment of the Requirements For The Degree of Doctorate in Business Administration ATLANTIC INTERNATIONAL UNIVERSITY TABLE OF CONTENTS 1. Introduction 2. Basic Concepts in Principles of Managerial Finance a. Managerial Finance b. Financial Statements and Analysis c. Cash Flow and Financial Planning d. Time Value of Money e. Risk and Return f. Interest Rates and Bond Valuation g. Stock Valuation h. Capital Budgeting Cash Flows i. The Cost of Capital j. Leverage and Capital Structure k. Dividend Policy l. Working Capital and Current Assets Management m. Current Liabilities Management 3. General Analysis 4. General Recommendations 5. Conclusions 6. References 1. Balance sheet: also referred to as statement of financial condition, reports on a company's assets, liabilities and net equity as of a given point in time. 2. Income statement: also referred to as Profit or loss statement, reports on a company's results of operations over a period of time. 3. Cash flow statement: reports on a company's cash flow activities, particularly its operating, investing and financing activities. 4. Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period. For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements. According to Gitman, Lawrence (2003), "The objective of financial statements is to provide information about the financial strength, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to an organization’s financial position. Reported income and expenses are directly related to an organization’s financial performance”. Financial statements are intended to be understandable by readers who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently. The difference between these inflows and outflows is the net income, also shown in the income statement. Financial statements are used by a diverse group of parties, both inside and outside a business. Generally, these users are: 1. Internal Users: are owners, managers, employees and other parties who are directly connected with a company. Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analyses are then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's report to its stockholders, as it form part of its Annual Report. 2. External Users: are potential investors, banks, government agencies and other parties who are outside the business but need financial information about the business for a diverse number of reasons. Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions. Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures. Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company. Media and the general public are also interested in financial statements for a variety of reasons. The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non- profit organizations. They may use either of two accounting methods: accrual accounting, or cash accounting, or a combination of the two. A complete set of chart of accounts is also used that is substantially different from the chart of a profit-oriented business. Although the legal statutes may differ from country to country, an audit of financial statements are usually, but not exclusively required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report. According to Gitman, Lawrence (2003), “Fundamental analysis of a business involves analyzing its income statement, financial statements and health, its management and competitive advantages, and its competitors and markets. The analysis is performed on historical and present data, but with the goal to make financial projections. There are several possible objectives: to calculate a company's credit risk, to make projection on its business performance, to evaluate its management and make internal business decisions, to make the company's stock valuation and predict its probable price evolution When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies. 1. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprise the security. 2. Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns”. Cash flows cannot be forged. This presumption may be inaccurate. Cash liquidity is necessary for survival. This is true, and even truer for businesses with limited access to financing. Cash is tangible proof of income Cash flow planning is critical to financial success. It is useful to consider three aspects of cash flow planning: 1. Cash flow analysis - researching historical cash flows to understand the current situation. 2. Cash flow planning - considering where changes should be made to cash flows in order to accomplish prioritized goals. 3. Cash flow management - having the discipline to stay with the plan. According to Brigham, Eugene and Johnson, Ramon (1980), “Financial planning is the task of determining how a business will afford to achieve its strategic goals and objectives. Usually, a company creates a Financial Plan immediately after the vision and objectives have been set. The Financial Plan describes each of the activities, resources, equipment and materials that are needed to achieve these objectives, as well as the timeframes involved”. The Financial Planning activity involves the following tasks: Assess the business environment Confirm the business vision and objectives Identify the types of resources needed to achieve these objectives Quantify the amount of resource (labor, equipment, materials) Calculate the total cost of each type of resource Summarize the costs to create a budget Identify any risks and issues with the budget set Performing Financial Planning is critical to the success of any organization. It provides the Business Plan with rigor, by confirming that the objectives set are achievable from a financial point of view. It also helps the CEO to set financial targets for the organization, and reward staff for meeting objectives within the budget set. d. Time Value of Money According to Brigham, Eugene and Johnson, Ramon (1980), “The time value of money is the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In other words, the present value of a certain amount of money is greater than the present value of the right to receive the same amount of money at time t in the future. This is because the amount could be deposited in an interest-bearing bank account (or otherwise invested) from now to time t and yield interest. (Consequently, lenders acting at arm's length demand interest payments for use of their financial capital. Additional motivations for demanding interest are to compensate for the risk of borrower default and the risk of inflation, as well as other, more technical considerations.)” All of the standard calculations are based on the most basic formula, the present value of a future sum, "discounted" to a present value. Some standard calculations based on the time value of money are: Present Value (PV) of an amount that will be received in the future. Future Value (FV) of an amount invested (such as in a deposit account) now at a given rate of interest. Present Value of an Annuity (PVA) is the present value of a stream of (equally-sized) future payments, such as a mortgage. Future Value of an Annuity (FVA) is the future value of a stream of payments (annuity), assuming the payments are invested at a given rate of interest. Present Value of a Perpetuity is the value of a regular stream of payments that lasts "forever", or at least indefinitely. Formulas; According to Brigham, Eugene and Johnson, Ramon (1980), Present value of a future sum The present value formula is the core formula for the time value of money; each of the other formulas is derived from this formula. For example, the annuity formula is the sum of a series of present value calculations. The present value (PV) formula has four variables, each of which can be solved for: 1. PV is the value at time=0 2. FV is the value at time=n 3. i is the rate at which the amount will be compounded each period 4. n is the number of periods Future value of a present sum The future value (FV) formula is similar and uses the same variables. Present value of an annuity The present value of an annuity (PVA) formula has four variables, each of which can be solved for: 1. PVA the value of the annuity at time=0 2. A the value of the individual payments in each compounding period Note that this is a geometric series, with the initial value being a = C, the multiplicative factor being 1 + r, with n terms. Applying the formula for geometric series, we get the following: The present value of the annuity (PVA) is obtained by simply dividing by (1 + r)n: Another simple and intuitive way to derive the future value of an annuity is to consider an endowment, whose interest is paid as the annuity, and whose principal remains constant. The principal of this hypothetical endowment can be computed as that whose interest equals the annuity payment amount: Principal = C / r Note that no money enters or leaves the combined system of endowment principal + accumulated annuity payments, and thus the future value of this system can be computed simply via the future value formula: FV = PV(1 + r)n Initially, before any payments, the present value of the system is just the endowment principal (PV = C / r). At the end, the future value is the endowment principal (which is the same) plus the future value of the total annuity payments (FV = C / r + FVA). Plugging this back into the equation: Perpetuity derivation Without showing the formal derivation here, the perpetuity formula is derived from the annuity formula. Specifically, the term: can be seen to approach the value of 1 as n grows larger. At infinity, it is equal to 1, leaving as the only term remaining. Time value of money formulae with continuous compounding Rates are sometimes converted into the continuous compound interest rate equivalent because the continuous equivalent is more convenient (for example, more easily differentiated). Each of the formulae above may be restated in their continuous equivalents. For example, the present value of a future payment can be restated in the following way, where e is the base of the natural logarithm: See below for formulaic equivalents of the time value of money formulae with continuous compounding. Present value of an annuity Present value of a perpetuity Present value of a growing annuity Present value of a growing perpetuity Present value of an annuity with continuous payments e. Risk and Return According to Gitman, Lawrence (2003), “Risk adjusted return on capital (RAROC) is a risk based profitability measurement framework for analyzing risk-adjusted financial performance and providing a consistent view of profitability across businesses. Note, however, that more and more Risk Adjusted Return on Risk Adjusted Capital (RARORAC) is used as a measure, whereby the risk adjustment of Capital is based on the capital adequacy. Broadly speaking, in business enterprises, risk is traded off against benefit. RAROC is defined as the ratio of risk adjusted return to economic capital. Economic capital is a function of market risk, credit risk, and operational risk. This use of capital based on risk improves the capital allocation across different functional areas of banks, insurance companies, or any business in which capital is placed at risk for an expected return above risk-free.” f. Interest Rates and Bond Valuation According to Gitman, Lawrence (2003), “Interest is a fee paid on borrowed assets. By far the most common form these assets are lent in is money, but other assets may be lent to the borrower, such as shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. In each case the interest is calculated upon the value of the assets in the same manner as upon money. The fee is compensation to the lender for foregoing other useful investments that could have been made with the loaned money. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of the use of the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as is commonly and mistakenly believed. The percentage of the principal which is paid as fee (the interest), over a certain period of time, is called the interest rate.” Simple interest Simple Interest is calculated only on the principal, or on that portion of the principal which remains unpaid. The amount of simple interest is calculated according to the following formula: where A is the amount of interest, P the principal, r the interest rate as a percentage, and n the number of time periods elapsed since the loan was taken. Compound interest In the short run, compound Interest is very similar to Simple Interest, however, as time continues the difference becomes considerably larger. The conceptual difference is that the principal changes with every time period, as any interest incurred over the period is added to the principal. Put another way, the lender is charging interest on the interest. Assuming that no part of the principal or subsequent interest has been paid, the amount of compound interest incurred is calculated by the following formula: Where; A, P, r and n have the same meanings as before. A problem with compound interest is that the resulting obligation can be difficult to interpret. To simplify this problem, a common convention in economics is to disclose the interest rate as though the term were one year, with annual compounding, yielding the effective interest rate. However, interest rates in lending are often quoted as nominal interest rates. In economics, continuous compounding is often used due to its particular mathematical properties. Fixed and floating rates Commercial loans generally use compound interest, but they may not always have a single interest rate over the life of the loan. Loans for which the interest rate does not change are referred to as fixed rate loans. Loans may also have a changeable rate over the life of the loan based on some reference rate (such as LIBOR), usually plus (or minus) a fixed margin. These are known as floating rate, variable rate or adjustable rate loans. Combinations of fixed-rate and floating-rate loans are possible and frequently used. Less frequently, loans may have different interest rates applied over the life of the loan, where the changes to the interest rate are governed by specific criteria other than an underlying interest rate. According to Gitman, Lawrence (2003), “Theoretical composition of interest rates, in economics, interest is considered the price of money, therefore, it is also subject to distortions due to inflation. The nominal interest rate, which refers to the price before adjustment to inflation, is the one visible to the consumer. Nominal interest is composed by the real interest rate plus inflation, among other factors. A simple formula for the nominal interest is: i = r + π Where i is the nominal interest, r is the real interest and π is inflation. This formula attempts to measure the value of the interest in units of stable purchasing power. However, if this statement was true, it would imply at least two misconceptions. First that all interest rates within an area that shares the same inflation. Second, that the lender knows the inflation for the period of time that he/she is going to lend the money.” According to Gitman, Lawrence (2003), “Bond valuation is the process of determining the fair price of a bond. As with any security or capital investment, the fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the price or value of a bond is determined by discounting the bond's expected cash flows to the present using the appropriate discount rate.” The fair price of a straight bond is determined by discounting the expected cash flows: Cash flows: The periodic coupon payments C, each of which is made once every period; The par or face value F, which is payable at maturity of the bond after T periods.(NB final year payment will include the par value plus the coupon payment for the year) Discount rate: the required (annually compounded) yield or rate of return r. r is the market interest rate for new bond issues with similar risk ratings last dividend paid $ or € or £ discount rate % the growth rate of the dividends % The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio. Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis. On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large. Thus, in addition to fundamental economic criteria, market criteria also have to be taken into account market-based valuation. Valuing a stock is not only to estimate its fair value, but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price. h. Capital Budgeting Cash Flows According to Brigham, Eugene and Johnson, Ramon (1980), “Capital budgeting (or investment appraisal) is the planning process used to determine a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research and development projects.” Many formal methods are used in capital budgeting, including the techniques such as: Net present value Profitability index Internal rate of return Modified Internal Rate of Return, and Equivalent annuity. These methods use the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period. According to Brigham, Eugene and Johnson, Ramon (1980), “Net present value; “Each potential project's value should be estimated using a discounted cash flow (DCF) valuation, to find its net present value (NPV). This valuation requires estimating the size and timing of all of the incremental cash flows from the project. These future cash flows are then discounted to determine their present value. These present values are then summed, to get the NPV. The NPV decision rule is to accept all positive NPV projects in an unconstrained environment, or if projects are mutually exclusive, accept the one with the highest NPV.” The NPV is greatly affected by the discount rate, so selecting the proper rate sometimes called the hurdle rate is critical to making the right decision. The hurdle rate is the minimum acceptable return on an investment. It should reflect the riskiness of the investment, typically measured by the volatility of cash flows, and must take into account the financing mix. Managers may use models such as the CAPM or the APT to estimate a discount rate appropriate for each particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. A common practice in choosing a discount rate for a project is to apply a WACC that applies to the entire firm, but a higher discount rate may be more appropriate when a project's risk is higher than the risk of the firm as a whole. The internal rate of return (IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency. The IRR method will result in the same decision as the NPV method for independent (non-mutually exclusive) projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at the start of the project, followed by all positive cash flows. In most realistic cases, all independent projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually exclusive projects, the decision rule of taking the project with the highest IRR which is often used may select a project with a lower NPV. In some cases, several zero NPV discount rates may exist, so there is no unique IRR. The IRR exists and is unique if one or more years of net investment (negative cash flow) are followed by years of net revenues. But if the signs of the cash flows change more than once, there may be several IRRs. The IRR equation generally cannot be solved analytically but only via iterations. One shortcoming of the IRR method is that it is commonly misunderstood to convey the actual annual profitability of an investment. However, this is not the case because intermediate cash flows are almost never reinvested at the project's IRR; and, therefore, the actual rate of return is almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of Return (MIRR) is often used. Despite a strong academic preference for NPV, surveys indicate that executives prefer IRR over NPV, although they should be used in concert. In a budget- constrained environment, efficiency measures should be used to maximize the overall NPV of the firm. Some managers find it intuitively more appealing to evaluate investments in terms of percentage rates of return than dollars of NPV. The equivalent annuity method expresses the NPV as an annualized cash flow by dividing it by the present value of the annuity factor. It is often used when The sensitivity to market risk for the security RM The historical return of the equity market (RM-Rf) The risk premium of market assets over risk free assets. The expected return (%) = risk-free return (%) + sensitivity to market risk * (historical return (%) - risk-free return (%)) The market risk premium has historically been between 3-5% According to Gitman, Lawrence (2003), “The Weighted Average Cost of Capital (WACC) is used in finance to measure a firm's cost of capital.” The total capital for a firm is the value of its equity (for a firm without outstanding warrants and options, this is the same as the company's market capitalization) plus the cost of its debt (the cost of debt should be continually updated as the cost of debt changes as a result of interest rate changes). Notice that the "equity" in the debt to equity ratio is the market value of all equity, not the shareholders' equity on the balance sheet. Formula: The cost of capital is then given as: Kc= (1-δ)Ke+δKd Where: Kc The weighted cost of capital for the firm δ The debt to capital ratio, D / (D + E) Ke The cost of equity Kd The after tax cost of debt D The market value of the firm's debt, including bank loans and leases E The market value of all equity (including warrants, options, and the equity portion of convertible securities) “WACC = (1 - debt to capital ratio) * cost of equity + debt to capital ratio * cost of debt” Because of tax advantages on debt issuance, it will be cheaper to issue debt rather than new equity (this is only true for profitable firms, tax breaks are available only to profitable firms). At some point, however, the cost of issuing new debt will be greater than the cost of issuing new equity. This is because adding debt increases the default risk and thus the interest rate that the company must pay in order to borrow money. By utilizing too much debt in its capital structure, this increased default risk can also drive up the costs for other sources (such as retained earnings and preferred stock) as well. Management must identify the "optimal mix" of financing the capital structure where the cost of capital is minimized so that the firm’s value can be maximized. j. Leverage and Capital Structure According to Gitman, Lawrence (2003), “Capital structure refers to the way a corporation finances itself through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, the value of a firm is unaffected by how that firm is financed. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs and asymmetric information. This analysis can then be extended to look at whether there is in fact an 'optimal' capital structure: the one which maximizes the value of the firm.” Their analysis was extended to include the effect of taxes and risky debt. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure, then would be to have virtually no equity at all. If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model. Agency Costs There are three types of agency costs which can help explain the relevance of capital structure. Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders. Underinvestment problem: If debt is risky (for instance in a growth company), the gain from the project will accrue to debt holders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value. Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management. l. Working Capital and Current Assets Management According to Gitman, Lawrence (2003), “Working capital (also known as net working capital) is a financial metric which represents the amount of day by day operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities”. A company can be endowed with assets and profitability, but short of liquidity, if these assets cannot readily be converted into cash. Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact: Accounts receivable (current asset) Inventory (current assets), and Accounts payable (current liability) A positive change in working capital indicates that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for example has paid off some short term creditors. Working capital refers to the firm's current assets while net working capital refers to current assets less current liabilities. Current Ratio and Quick Ratio both attempt to measure a firm's liquidity and management of working capital. Current Assets Current Assets Accounts - Cash, Marketable Securities (short term investments), Accounts Receivable, and Inventory Risk-Return Trade-off of Current Asset Investment - having lots of cash, marketable securities, inventory, and a generous accounts receivable terms makes the company very “safe” but all of these assets earn very low rates of return compared to investing in long term assets. Current Liabilities Current Liability Accounts - Accruals, Accounts Payable, Notes Payable, and Commercial Paper A firm’s working capital policy has two components: 1. Policies regarding the appropriate level of current assets (Current Asset Investment Policy) 2. Policies regarding the use of short term financing (Current Asset Financing Policy) Alternative Current Asset Investment Policies According to Gitman, Lawrence (2003),”There are general policies strategies that firms may follow with regard to their overall level of current assets investment or holdings. 1. Relaxed Current Asset Investment Policy; relatively large amounts of cash, marketable securities and inventories are carried and sales are stimulated by a liberal (generous) trade credit policy resulting in high levels of receivables. This is a low risk strategy because the firm always has plenty of cash and inventory on hand. The return is low because more money is invested in low yielding assets. 2. Restricted Current Asset Investment Policy; holdings of cash securities, inventories, and receivables are minimized. This is a high risk strategy because the firm tries to keep the bare minimum of cash and inventory. The potential return is high because less money is invested in low yielding assets. 3. Moderate Current Asset Policy; balance between relaxed and restricted current asset investment policies”. Asset allocation The different asset classes are stocks, bonds, real-estate and commodities. The exercise of allocating funds among these assets (and among individual securities within each asset class) is what investment management firms are paid for. Asset classes exhibit different market dynamics, and different interaction effects; thus, the allocation of monies among asset classes will have a significant effect on the performance of the fund. Some research suggests that allocation among asset classes has more predictive power than the choice of individual holdings in determining portfolio return. Long Term Returns It is important to look at the evidence on the long term returns to different assets, and to holding period returns (the returns that accrue on average over different lengths of investment). Diversification Against the background of the asset allocation, fund managers consider the degree of diversification that makes sense for a given client and construct a list of planned holdings accordingly. The list will indicate what percentage of the fund should be invested in each particular stock or bond. Investment Styles There are a range of different styles of fund management that the institution can implement. For example, growth, value, market neutral, small capitalization, indexed, etc. Each of these approaches has its distinctive features, adherents and, in any particular financial environment, distinctive risk characteristics. For example, there is evidence that growth styles (buying rapidly growing earnings) are especially effective when the companies able to generate such growth are scarce; conversely, when such growth is plentiful, then there is evidence that value styles tend to outperform the indices particularly successfully. Performance measurement Fund performance is the acid test of fund management, and in the institutional context accurate measurement is a necessity. For that purpose, institutions measure the performance of each fund under their management, and performance is also measured by external firms that specialize in performance measurement. obligation that can be inferred from a set of facts in a particular situation as opposed to a contractually based obligation. Classification of liabilities Liabilities are reported on a balance sheet and are usually divided into two categories: Current liabilities: these liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations (e.g. from purchase of equipment), and others. Long term liabilities: these liabilities are reasonably expected not to be liquidated within a year. They usually include issued long term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties. 3. GENERAL ANALYSIS In the case of a company, managerial or corporate finance is the task of providing the funds for the corporation's activities. It generally involves balancing risk and profitability. Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hope that it will maintain or increase its value. In investment management one has to decide what, how much and when to invest. In doing so, one needs to: Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations; Identify the appropriate strategy: active v. passive, hedging strategy Measure the portfolio performance Financial management is a duplicate with the financial function of the Accounting profession. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm. 4. GENERAL RECOMMENDATIONS Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. Management must therefore identify the "optimal mix" of financing, the capital structure that results in maximum value. The sources of financing will, generically, comprise some combination of debt and equity. Financing a project through debt results in a liability that must be serviced and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt, and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk. Management must also attempt to match the financing mix to the asset being financed as closely as possible, in terms of both timing and cash flows. Working capital management entails short term decisions, generally, relating to the next one year period which is "reversible". These decisions are therefore not taken on the same basis as Capital Investment rather they will be based on cash flows and / or profitability. In this context, the most useful measure of profitability is Return on capital (ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; Return on equity (ROE) shows this result for the firm's shareholders. Firm value is enhanced when, and if, the return on capital, which results from working capital management, exceeds the cost of capital, which results from capital investment decisions as above. ROC measures are therefore useful as a management tool, in that they link short term policy with long term decision making.