book

The Complete CFO Handbook

Name: The Complete CFO Handbook
ISBN: 9780470099261

by Yale Univ. Frank J. Fabozzi School of Management, Pamela Peterson Drake, Ralph S. Polimeni

November 2007

Intermediate to advanced

864 pages

21h 3m

English

Wiley

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Copyright
Dedication
Preface
Acknowledgment
About the Authors
1. The Changing Role of the CFO: From Accounting to Accountable
SOX Act of 2002 and the CFOExpanded Responsibilities of the CFOCompliance: tax, legal, and regulatoryCommunicationsStrategic planningPerformance EvaluationRisk ManagementFiduciary DutyOur AgendaEndnotes
2. Capital Structure Decisions
Debt Versus EquityConcept of LeverageLeverage and operating RiskLeverage and Financial RiskCapital Structure and Financial LeverageFinancial Leverage and RiskLeverage EffectLeverage and Financial FlexibilityGovernance value of Debt FinancingCapital Structure and TaxesInterest Deductibility and Capital StructureInterest Tax ShieldUnused Tax ShieldsCapital Structure and Financial DistressCosts of Financial DistressRole of limited liabilityBankruptcy and bankruptcy CostsFinancial Distress and Capital StructureCost of CapitalAgency RelationshipProblems with the Agency RelationshipCosts of the Agency RelationshipAgency Relationship and Capital StructureOptimal Capital Structure: Theory and PracticeCapital Structures among Different IndustriesCapital Structures within IndustriesOther Possible ExplanationsA Capital Structure PrescriptionBottom LineAppendix: Capital Structure Theory—the Modigliani‐Miller Theory and BeyondM&M Irrelevance PropositionM&M with Tax Deductibility of interest Paid on DebtCapital Structure Theory and Costs of Financial DistressEndnotes
3. Types of Debt Financing
General Features of Debt ObligationsTerm LoansSyndicated Bank LoansNotes and BondsIssuance of new BondsFeatures and Provisions of a Bond IssueDenominationTerm to MaturityInterestSecuritySeniorityDebt RetirementHybrid SecuritiesConvertible SecuritiesTrust‐Preferred SecuritiesDesigning a Bond IssueFixed‐Rate versus Floating‐RateMedium‐Term noteShort‐Term FinancingUnsecured FinancingTrade CreditBank FinancingCommercial PaperBankers' AcceptancesSecured FinancingAccounts ReceivableInventoryLoan‐to‐Value for Secured FinancingOff‐Balance‐Sheet FinancingFin 46Section 401(a) of the Sarbanes‐Oxley Act of 2002Bottom LineNotes
4. Equity Funding
Common StockPrivately Held versus Publicly Held SharesClassifed StockDividendsDividend Reiavestment PlensStock DistributionsDividend PolicyThe Dividend Irrelevance TheoryThe “Bird in the Hand” TheoryThe Tax‐Preference ExplanationThe Signaling ExplanationThe Agency ExplanationSumming Up: To Pay Dividends or NotStock RepurchasesPreferred StockFeatures of Preferred StockPar and Liquidation ValuesDividendsCumulative versus Noncumulative DividendsParticipating versus NonparticipatingConvertibilityCallabilityVoting RightsSinking FundsPackaging FeaturesCorporate Use of Preferred StockBottom LineNotes
5. Structured Financing: Asset Securitization and Structured Notes
Asset SecuritizationIllustration of an Asset Securitization TransactionReasons for Using a Securitization TransactionPotential for Reducing Funding CostsDiversifying Funding SourcesAccelerating Earnings for Financial Reporting PurposesWhat Rating Agencies Look at in Rating Asset‐Backed SecuritiesCredit Quality of the CollateralQuality of the Seller/ServicerCash Flow Stress and Payment StructureCredit EnhancementThird‐Party GuaranteesOvercollateralizationSenior‐Subordinate StructureReserve FundsStructured NotesMotivation for InvestorsCreating Structured NotesTwo Examples of Structured NotesInterest‐Rate Linked Structured NotesEquity‐Linked Structured NotesBottom LineEndnotes
6. Strategy and Financial Planning
Strategy and ValueComparative and Competitive AdvantagesStrategy and Adding ValueFinancial Planning and BudgetingImportance of Financial PlanningBudgeting ProcessSales ForecastingForecasting with Regression AnalysisMarket SurveysManagement ForecastsSeasonal ConsiderationsBudgetingCash BudgetPro Forma Financial StatementsAnalysis of AccountsPercent‐of‐Sales MethodLong‐Term Financial PlanningFinancial ModelingPerformance EvaluationEconomic Value AddedEconomic Profit/Economic Value AddedMarket Value AddedBalanced ScorecardThe ProcessThe MeasuresHow Do Companies Use the Balanced Scorecard?Scorecard for the Balanced ScorecardStrategy and Value CreationRole of the CFOSources of Value CreationBottom LineEndnotes

7. Basics of Corporate Taxes and Tax Risk Management
Tax ManagementTax RiskTransactional RiskOperational RiskCompliance RiskFinancial Accounting RiskPortfolio RiskManagement RiskReputational RiskU.S. Tax Law and Taxation of CorporationsFederal Corporate Tax RatesCorporate Taxable IncomeDividends‐Received DeductionInterest Expense DeductionDepreciation for Tax PurposesCapital GainsTax CreditsTax Credit versus Tax DeductionNet Operating loss Carrybacks and CarryoversState and Local TaxesNon‐U.S. TaxesCorporate Income Tax RatesDetermining Taxable IncomeInterest ExpenseIntercompany Transactions and Transfer PricesBottom LineNotes
8. Corporate Risk Management
Risk DefinedEnterprise Risk ManagementDefnitions of ERMERM ProcessThemes of ERMSpecifying the Firm's Risk PolicyManaging RisksRetained Risk and Risk FinanceRisk NeutralizationRisk TransferRisk TransferTraditional InsuranceDerivativesFutures ContractsMechanics of a Futures ContractHow Futures Are Used to Manage RiskForward ContractsOptionsExchange‐Traded versus OTC OptionsDifferences between Options and Futures ContractsSwapsInterest Rate SwapCurrency SwapsCommodity SwapsCap and Floor AgreementsCredit DerivativesCredit Default SwapsCredit‐Linked Notes23Alternative Risk TransferInsurance‐Linked NotesCaptivesFinite InsuranceMultiline InsuranceContingent InsuranceBottom LineNotes
9. Financial Ratio Analysis
Ratios and their ClassificationReturn‐on‐Investment RatiosRecap: Return‐on‐Investment RatiosDuPont SystemLiquidityOperating CycleMeasures of LiquidityRecap: Liquidity RatiosProfitability RatiosRecap: Profitability RatiosActivity RatiosInventory ManagementAccounts Receivable ManagementOverall Asset ManagementRecap: Activity RatiosFinancial Leverage RatiosComponent Percentage RatiosBook Value Versus Market ValueCoverage RatiosRecap: Financial Leverage RatiosCommon‐Size AnalysisUsing Financial Ratio AnalysisIllustration: Pfizer, Inc., 1990–2005Company Description, Industry, and Major FactorsFinancial RatiosLiquidityActivityProfitabilityFinancial LeverageReturn and the DuPont AnalysisOther FactorsCommon‐Size AnalysisLimitations from the Use of Accounting DataUse of Historical CostsDifferent Methods of AccountingChanges in Accounting PrinciplesEextraordinary and Special ItemsThe Difficulty in Classifying “Fuzzy” ItemsRestatementsSelecting and Interpreting RatiosChoosing a BenchmarkUsing Ratios in ForecastingBottom LineEndnotes
10. Cash Flow Analysis
Difficulties with Measuring Cash FlowCash Flows and the Statement of Cash FlowsFree Cash FlowCalculating Free Cash FlowNet Free Cash FlowUsefulness of Cash Flows in Financial AnalysisRatio AnalysisUsing Cash Flow informationBottom LineNotes
11. Decentralized Operations and Responsibility Accounting
IntroductionOrganization Structures and ConceptsExamples of Types of Organization Structure and Responsibility ReportingFunctional ApproachProduct ApproachGeographical ApproachDecentralization ProblemsAdvantages of DecentralizationCost of DecentralizationResponsibility AccountingResponsibility Accounting DefinedEssentials of ControlOrganization StructureResponsibility CentersResponsibility Accounting SystemLevel 1: DepartmentsLevel 2: PlantsLevel 3: Vice PresidentsLevel 4: PresidentResponsibility Accounting ReportsLevel 1: Assembly Department SupervisorLevel 2: Plant Manager—Plant CLevel 3: Vice President—ManufacturingLevel 4: PresidentControllable CostsCosts of Service DepartmentsExecutive Incentive Compensation Plans and Dysfunctional Decision MakingTheoretical Overview—Principal‐Agency TheoryExecutive Incentive Compensation PlansExample 1Example 2Some ConclusionsBottom LineEndnotes
12. Responsibility Center Performance Evaluation
Basis for ComparisonCost Center Performance EvaluationCost Center Decision MakingProfit Center Performance EvaluationCost AllocationProfit Center Decision MakingInvestment Center Performance EvaluationReturn on InvestmentInvestment Turnover and Earnings Ratio (Margin)Strengths and Weaknesses of ROIIllustration of ROI and a Lack of Goal CongruenceResidual IncomeValuation and Allocation of Controllable AssetsInvestment Center Decision MakingBottom LineAppendix: Gross Profit AnalysisChange in Gross ProfitAnalyzing Change in Gross ProfitMultiple ProductsManagement AnalysisEndnotes
13. Transfer Pricing
Transfer Pricing MethodsComprehensive IllustrationCostCost PlusNegotiated PriceMarket PriceDual Transfer Pricing SystemInternational Transfer PricingBottom LineEndnotes
14. Capital Budgeting and Cash Flow Analysis
The Investment ProblemInvestment Decisions and Owners' Wealth MaximizationCapital BudgetingClassifying Investment ProjectsClassification According to Economic LifeClassification According to RiskClassification According to Dependence on Other ProjectsCash Flow From InvestmentsIncremental Cash FlowsInvestment Cash FlowsAsset AcquisitionAsset DispositionDisposition of New InvestmentDisposition of Existing Asset(s)Operating Cash FlowsChange in RevenuesChange in ExpensesChange in TaxesChange in Working CapitalClassifying Working Capital ChangesPutting it All TogetherNet Cash FlowsSimplifcationsBottom LineAppendix 14.A: Expected Cash Flows From the Disposition of an AssetCase 1: Sell the asset for $8,000 [Original cost > Expected sales price > Tax basis]Case 2: Sell the asset for $12,000 [Expected sales price > Original cost > Tax basis]Case 3: sell the asset for $1,000 [tax basis > expected sales price]Appendix 14.B: Expansion of the Williams 5 & 10The ProblemThe AnalysisEndnotes
15. Capital Budgeting Techniques
Evaluation TechniquesCost of Capital, Required Rate of Return, and Discount RateNet Present ValueCalculating the net present valueInvestment ProfileSolving for the Cross‐Over RateProfitability indexInternal Rate of ReturnIRR and Mutually Exclusive ProjectsIRR and Capital RationingMultiple Internal Rates of ReturnModified Internal Rate of ReturnCalculating the Modified Internal Rate of ReturnPayback PeriodDiscounted Payback PeriodCalculating the Discounted Payback PeriodIssues in Capital BudgetingScale DifferencesMutually Exclusive ProjectsCapital RationingUnequal LivesComparing TechniquesCapital Budgeting Techniques in PracticeConflicts With Responsibility Center Performance Evaluation MeasuresCapital Budgeting and the Justification of New TechnologyBottom LineEndnotes
16. Capital Budgeting and Risk
Project RiskDifferent Types of Project RiskMeasurement of Project RiskRangeStandard DeviationCoeffcient of VariationTools That Can Be Used to Evaluate Total RiskMeasuring a Project's Market RiskMarket Risk and Financial LeverageUsing a Pure‐PlayAdjusted Present ValueIncorporating Risk in the Capital Budgeting DecisionRisk‐Adjusted RateProject's Cost of Capital Based on the CAPM MethodAdjusting the Company's Cost of CapitalReal OptionsOptions on Real AssetsReal Options: An ExampleChallengesCertainty EquivalentsAssessment of Project Risk in PracticeBottom LineEndnotes
17. Leasing
How Leasing WorksTypes of Equipment LeasesNontax‐Oriented LeasesTax‐Oriented True LeasesSingle‐Investor Leases versus Leveraged LeasesFull‐Payout Leases Versus Operating LeasesReasons for LeasingCostConservation of Working CapitalPreservation of Credit Capacity by Avoiding CapitalizationRisk of Obsolescence and Disposal of EquipmentRestrictions on ManagementImpact on Cash Flow and Book EarningsTypes of LessorsLease Brokers and Financial AdvisersLease ProgramsFinancial Reporting of Lease Transactions by LesseesClassification of LeasesAccounting for Operating LeasesAccounting for Capital LeasesLeveraged Lease FundamentalsParties to a Leveraged LeaseLesseeEquity ParticipantsLoan Participants or LendersOwner TrusteeIndenture TrusteeManufacturer or ContractorPackager or BrokerGuarantorStructure of a Leveraged LeaseClosing the TransactionParticipation AgreementOther Key DocumentsIndemnities by the LesseeCash Flows During the LeaseDebt for Leveraged LeasesFederal Income Tax Requirements for True Lease TransactionsSynthetic LeasesValuing a Lease: The Lease or Borrow‐to‐Buy DecisionDirect Cash Flow from LeasingValuing the Direct cash Flow from LeasingConcept of an Equivalent LoanComparison of Alternative LeasesAnother Approach to Lease ValuationTax Indemnifcation for Future Changes in Tax LawNeed for a Financial AdviserSteps in Structuring, Negotiating, and Closing a Leveraged LeaseBottom LineEndnotes
18. Managing Short‐Term Assets
Cash ManagementMonitoring Cash NeedsReasons for Holding Cash BalancesCosts Associated with CashDetermining the Investment in CashOther ConsiderationsCash Management TechniquesLockbox SystemCurrent Advances in LockboxesControlled DisbursementsHow Much Cash Do Companies Really Hold?Marketable SecuritiesMarketable Securities and RiskTypes of Marketable SecuritiesReceivables ManagementReasons for Extending CreditCosts of CreditCredit and the Demand for a Firm's Goods and ServicesCredit and Collection PoliciesMonitoring Accounts ReceivableEestablishing and Changing Credit PoliciesAccounts Receivable Management in PracticeInventory ManagementReasons for Holding InventoryCosts Associated with InventoryModels of Inventory ManagementThe Economic Order Quantity ModelJust‐in‐Time InventoryOther ConsiderationsMonitoring Inventory ManagementInventory Management in PracticeBottom LineEndnotes
19. Classifying Costs
Elements of a ProductMaterialsLaborFactory OverheadAn Example of Production CostsRelationship to ProductionRelationship to VolumeVariable CostsFixed CostsMixed CostsSemivariable CostStep CostAbility to TraceDepartment Where IncurredFunctional AreasPeriod Charge in IncomeRelationship to Planning, Controlling, and Decision MakingStandard and Budgeted CostsControllable and Noncontrollable CostsCommitted and Discretionary Fixed CostsRelevant and Irrelevant CostsDifferential CostsOpportunity CostsShutdown CostsTechniques for New Product Cost EstimationBasics of Cost EstimationCost Estimation TechniquesBottom lineEndnotes
20. Costing and Control of Materials, Labor, and Factory Overhead
Materials (Stores)Accounting for MaterialsPurchase of MaterialsPurchase RequisitionPurchase OrderReceiving ReportIssuance of MaterialsSystems of Accounting for Materials Issued to Production and Ending Materials InventoryAccounting by the Periodic Inventory SystemAccounting by the Perpetual Inventory SystemControl ProceduresLaborCosts Included in LaborAccounting for LaborTimekeepingComputation of Total PayrollAllocation of Payroll CostsSpecial Problems Relating to the Accounting for LaborEmployee TaxesEmployer Taxes and Fringe Beneft CostsShift PremiumsOvertime PremiumIdle TimeGuaranteed Wage and Incentive PlansFactory Overhead CostsActual Versus Normal Costing of Factory OverheadEstimated Level of ProductionComparison of Productive CapacitiesIdle Capacity and Excess CapacityEstimated Factory Overhead CostsDetermination of Factory Overhead Application RatesUnits of ProductionDirect Materials CostDirect Labor CostDirect Labor HoursMachine HoursSingle Plantwide Versus Multiple Departmental Factory Overhead Application RatesSeparate Variable and Fixed Factory Overhead Application RatesApplied Factory Overhead CostActual Factory Overhead CostsAccounting for Actual Factory Overhead CostsJournalizing Factory OverheadAnalysis of Underapplied or Overapplied Factory OverheadAccounting for the Difference Between Applied and Actual Factory OverheadActivity‐Based CostingImplementation of an Activity‐Based Costing SystemSteps Involved in ApplicationTraditional Cost Allocation System Versus ABC SystemExample of Activity‐Based CostingBottom LineEndnotes
21. Job Order and Process Costing
Comparison of Job Order and Process Cost Accumulation SystemsJob Order CostingPurchase of MaterialsIssuance of MaterialsLabor CostFactory OverheadJob Order Cost SheetOperation CostingProject CostingProcess CostingObjectives of Process CostingCharacteristics of a Process Cost SystemProduction by DepartmentSystem FlowConstant‐Flow ManufacturingProcedures: Direct Materials, Direct Labor, and Factory OverheadDirect MaterialsDirect LaborFactory OverheadCost of Production ReportDepartment A: Cost of Production ReportDepartment B: Cost of Production ReportDirect Materials Added after the First DepartmentBeginning Work‐In‐Process InventoriesBackflush CostingBottom LineAppendix: Spoiled Units, Defective Units, Scrap Material, and Waste Material in Job Order and Process Costing SystemsAccounting for Spoiled UnitsNormal SpoilageAbnormal SpoilageAccounting for Defective UnitsNormal Defective UnitsAbnormal Defective UnitsAccounting for Scrap MaterialAccounting for Waste MaterialEndnotes
22. Joint Product and By‐Product Costing
Joint ProductsJoint Costs and the Split‐Off PointAccounting for Joint ProductsPhysical Output MethodMarket Values at Split‐Off MethodNet Realizable Value MethodBy‐ProductsAccounting for By‐ProductsCategory 1: By‐Products Recognized When SoldCategory 2: By‐products Recognized When ProducedEffects of Joint Cost Allocation Upon Decision MakingBottom LineEndnotes
23. Master Budget
Conventional Master Budget SystemZero‐Based Budget SystemProgram Planning and Budget SystemDeveloping the Master BudgetBudgeted SchedulesSales BudgetProduction BudgetCost of Manufacturing BudgetsDirect Materials Purchases BudgetDirect Materials Usage BudgetDirect Labor BudgetFactory Overhead BudgetEnding Inventories BudgetCost of Goods Sold BudgetSelling and Administrative BudgetsSelling Expenses BudgetAdministrative Expenses BudgetCash BudgetBudgeted SummariesBudgeted Income StatementBudgeted Statement of Cash FlowsBudgeted Balance SheetBottom Line
24. Standard Costing
Actual, Normal, and Standard CostingUses of Standard CostsCost ControlInventory CostingBudgetary PlanningProduct PricingRecord‐KeepingTypes of StandardsEstablishment of StandardsDirect Materials StandardsDirect Materials Price (Rate) StandardsDirect Materials Efficiency (Usage) StandardsDirect Labor StandardsDirect Labor Price StandardsDirect Labor Efficiency StandardsFactory Overhead StandardsEstablishing Standards for a Process Cost and Job Order Cost SystemQuality and Quality CostsDefnitions of QualityZero DefectsPolicies and Objectives of Quality ControlQuality CostsJust‐in‐Time Philosophy and Cost AccountingStrategies for Reducing Waste TimeVariance AnalysisDirect materials VariancesDirect Materials Price VarianceDirect Materials Efficiency (Quantity or Usage) VarianceEffect of Efficiency on the Direct Materials Price VarianceDirect Labor VariancesDirect Labor Price (Rate) VarianceDirect Labor Efficiency VarianceFactory Overhead VariancesOne‐Factor Analysis of Factory Overhead VarianceTwo‐Factor Analysis of Factory Overhead VariancesThree‐Factor Analysis of Factory Overhead VariancesDisposition of All VariancesBottom lineEndnotes
25. Direct and Absorption Costing
Meaning of Direct CostingDirect Costing Versus Absorption CostingCost of Goods Manufactured StatementIncome StatementBalance SheetDirect Costing and External Financial StatementsAdvantages of Direct CostingOperations PlanningBreak‐Even or Cost‐Volume‐Profit AnalysisManagement DecisionsProduct PricingManagement ControlDisadvantages of Direct CostingAdjusting Financial Statements for External ReportsBottom Line

Content preview from The Complete CFO Handbook

Chapter 10. Cash Flow Analysis

Agenda Items
Item 1
Discuss the importance of cash flow and its usefulness in financial analysis.
Item 2
Identify the difficulties associated with measuring cash flow.
Item 3
Explain the different cash flow measures and how they can be used: discretionary cash flow, free cash flow, and net free cash flow.
Item 4
Describe how to use cash flow information.

One of the key financial measures that a CFO should understand is the company's cash flow. This is because the cash flow aids the CFO in assessing the ability of the company to satisfy its contractual obligations and maintain current dividends and current capital expenditure policy without relying on external financing. Moreover, a CFO must understand why this measure is important for external parties, specifcally stock analysts covering the company. The reason is that the basic valuation principle followed by stock analysts is that the value of a company today is the present value of its expected future cash flows. In this chapter, we discuss cash flow analysis.

Difficulties with Measuring Cash Flow

The primary difficulty with measuring a cash flow is that it is a flow: Cash flows into the company (cash inflows) and cash flows out of the company (cash outflows). At any point in time there is a stock of cash on hand, but the stock of cash on hand varies among companies because of the size of the company, the cash demands of the business, and a company's management of working capital. So what is cash flow? Is ...

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The Complete CFO Handbook

by Yale Univ. Frank J. Fabozzi School of Management, Pamela Peterson Drake, Ralph S. Polimeni

Chapter 10. Cash Flow Analysis

Difficulties with Measuring Cash Flow

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