Financial Thinking Lesson (II) Financing and Management

I. Financing principle: the double of "matching"

Financing and management are both related to finding money. Financing is an enterprise looking for money from the outside, and management is an enterprise looking for money from the inside through cost reduction and efficiency.

There are two main types of financing for an enterprise: one is debt financing, such as looking for a bank loan; and the other is equity financing, which is looking for investors.

The first principle of the financing decision is that there must be a match between the financing method and the investment project. This match has two meanings: one is a match in time; rather, it is a match in risk.

1, the duration of the match

The practice of short-term debt for long-term projects, financial management, called "short-term loans and long term investment". Short-term loans and long-term investment is a very dangerous financial operation.

In the eyes of financial experts, the primary focus of financing decisions, not whether the funds are cheap enough, but the risk behind the funds. The financial risks associated with "short-term loans and long-term investment" are far greater than the use of short-term loans, saving the financial costs of the little gain.

2, risk matching

Generally speaking, low-risk, profitability assurance projects can be more consideration of debt financing; no profitability assurance, high risk projects usually rely on equity financing.

Because investors have a higher degree of risk tolerance than creditors.

In summary: financial experts look at the financing method has three points:

1, the first principle of financing decision-making is the match between the financing method and the investment project.

2, "short-term loans and long investment" financing strategy can solve the financial costs, but it will greatly increase the risk of business.

3. Shareholders have a higher degree of risk tolerance than creditors. Low-risk, guaranteed profitability of the project can be more consideration of debt financing, there is no guarantee of profitability, high risk projects usually rely on equity financing.

Second, the financing relationship: creditors and shareholders of the checks and balances

In the choice of funds on this issue, there is a classic theory of finance, called the theory of financing order. This theory suggests that when a company is financing, it will first choose to use internal funds, because its own money, the use of the lowest cost. Debt financing is chosen second, and equity financing is chosen last.

Not every shareholder makes investment decisions based on maximizing the overall interests of the business. When a company is facing financial difficulties, shareholders will invest more aggressively and will be more willing to invest in risky projects.

What is the best way to balance the relationship between creditors and shareholders so that a company can access more external capital?

1. Strengthen the protection of creditors in the loan contract, such as adding some restrictive clauses.

2, the use of recent years more popular, innovative financial instruments, called convertible bonds. Convertible bonds for short is to run creditors by a certain percentage, the bonds will be converted into ordinary shares of the company.

Third, the equity structure: how to finance can keep control?

Equity dilution means changes in the shareholding structure and the reduction of the right to speak.

What does a significant reduction in equity mean?

1. It is the impact on earnings. Shares represent cash earnings rights.

2. It is the impact on control.

How is this conflict resolved?

When designing a shareholding structure, use a two-tier shareholding structure, also called an AB share system. That is, the company can simultaneously issue AB and two classes of common stock, both of which can enjoy cash earnings, but their voting rights are completely different. class A shares, one share has one vote; and class B shares, one share has multiple votes. Class A shares are usually held by outside investors, while Class B shares are held by the founder and his team.The AB share system essentially separates cash flow rights from control. This allows the founder to hold a small stake in the company and still be able to rely on very high voting power to keep a firm grip on his company.

AB shares can significantly boost R&D investment and the output of patents, as founders value long-term growth drivers.

Potential Risks of AB Shares

If the founding team makes a bad decision, the rest of the shareholders are "on the hook" for that decision.

The financial information of a company with an AB share structure is more opaque, and there is more surplus falsification. Therefore, from the perspective of corporate governance, the AB share structure is a double-edged sword that needs to be used with caution. If you use it well, you can improve your company's performance, but if you don't use it well, you will damage the interests of minority shareholders.

To summarize: dual shareholding structure allows the founder of the company to hold a small portion of the equity in the case of the company has the right to control. The essence of the dual equity structure is the separation of cash flow rights and control. It is a double-edged sword that needs to be used with caution.

Fourth, a single share: the real motivation behind the associated transactions

The short-term payment of large shareholders to support and enhance the performance of the listed company is not the ultimate goal, they support these companies is the hope that the company continues to survive to retain the opportunity to carry out the hollowing out in the future, and their real purpose is to maximize their own long-term interests.

So how do companies prevent being hollowed out by major shareholders?

1. If you can ensure that there are more than two major shareholders enjoying control in the distribution of equity.

2, the introduction of institutional investors role. There are two types of shareholders in the company, one is individual investors and the other is institutional investors. Generally, institutional investors are studying these companies and investing every day. So they will be able to make good use of their professional advantages to supervise the management of listed companies in their business operations and participate in corporate governance to make the company's operations more standardized and effective. In this way, the chances of major shareholders infringing on small and medium-sized shareholders can be reduced.

V. Financing innovation: the sum of local optimization is less than the overall optimization

It is easy for large enterprises to get loans, so how should SMEs get loans?

This is a very popular financing method in the past few years, supply chain finance.

Banks are reluctant to lend to small and medium-sized enterprises because they have a low level of credit and are afraid that they will not be able to recover after lending. So the core is to solve the information problem.

That leading core enterprise in the supply chain has a higher credit level.

The competition in the market is no longer between single enterprises, but between supply chains.

Through the upstream and downstream of the supply chain of different enterprises between the capital coordination arrangements, reasonable dispersion of capital costs, so as to achieve the entire supply chain to minimize the financial costs. This wave of operation is called "financial supply chain management".

Behind the financial supply chain management embodies an important way of thinking: the optimization of each part is not equal to the optimization of the whole.

Supply chain finance model, how to operate?

1. A common model is accounts receivable financing.

The bank needs the core enterprise to commit to paying the suppliers' accounts receivable and to provide a counter-guarantee for their loans. In case of problems, the bank can ask the core business to bear the losses.

2. There is also a common model of financing through warehouse financing, which is simply inventory financing. This method is commonly used in the medical device industry. Use the goods as collateral.

The core idea of solving the financing problem of small and medium-sized enterprises in the supply chain is to utilize third-party partners with high credit to endorse these enterprises and reduce the problem of information asymmetry.

The core of supply chain finance is the endorsement effect of the core enterprise.

Six, listing pricing: leave the money on the table

When the two sides of the game is a "hammer deal", most people will choose to maximize their personal interests. But if the two sides are a repeated game, they will repeat the overall interests of the game as a more important measure.

So the pricing of financing is not as high as it could be. This is because most companies have to continue to raise money after they go public.

Financial and non-financial impacts of wrong financing decisions

The biggest impact of pricing mistakes on companies is not really financial, but talent.

Research has shown that the higher the quality of the company and the more confident it is in its future development, the more likely it is to choose to go public at a discount rather than with the mindset of "making a buck".

There are two ways that financial experts look at financing pricing:

1. Financing is a repeated game. Repeated games, the overall benefit is more important than a single financing gain.

2, the company can "leave money on the table" discounted issuance, to the capital markets to signal that they are high-quality business.

VII. Efficiency management: DuPont analysis

This is about how to reduce costs and increase efficiency through management.

In financial terms, we use the return on net assets to measure the company's operating performance and the rate of return to shareholders.

The return on equity determines a company's ability to grow in a self-sustainable manner.

Self-sustainable growth rate is the maximum growth rate that a company may achieve without issuing new shares and without changing its business policy.

Self-Sustainable Growth Rate - = Return on Net Assets x Retained Earnings Yield

Retained Earnings Yield represents how much of the company's profit stays with the company and is used for redevelopment rather than being returned to shareholders in the form of dividends.

So when a company has a high yield, the more the company is able to feed itself and maintain self-growth without relying on external funding, the more confidence everyone has in the future of that business.

So what can a company do to improve its return on equity?

This method of breaking down the return on equity is called "DuPont analysis" in financial management.

The sales margin represents whether the product sold by the enterprise is profitable, and whether the profit is high.

The equity multiplier is related to the gearing ratio. The higher the gearing, the higher the equity multiplier and the higher the return on net worth.

Asset turnover, the core is one word - "fast". The higher the turnover rate, the more efficiently the company utilizes its assets.

In the past two years, real estate companies have suddenly begun to transform the financial logic behind the implementation of high turnover mode.

When external sales can not be increased, improve the turnover rate is an important way to internally improve earnings, that is, to find money within the enterprise.

The contribution of DuPont Analytics lies in an important piece of financial thinking called the "partition strategy". It takes a big, complex problem that you don't know how to solve, and breaks it down into smaller problems, and then you can determine which aspect of the business can be improved. The solution of any aspect of the problem can lead to overall improvement.

Eight, business decision-making: how to screen effective financial information?

Cost relevance

Financial experts will divide the information into two categories: one is decision-making relevant information, and the other is decision-making irrelevant information.

Decision-relevant information is information that changes with different scenarios II.

Decision irrelevant information, refers to those information that remains the same regardless of which scenario.

How are decisions categorized in captive and outsourced?

Decision-relevant information is only that which can be saved as a result of outsourcing.

Decision-irrelevant information refers to costs that would still be incurred regardless of whether or not outsourcing is done.

When making the decision to outsource, in addition to cost, the financial wizards will consider whether there is only one supplier for the product. If so, then produce it yourself, and only choose the optimal solution from a cost perspective if there are many high-quality suppliers who can do it.

In fact, any business decision is very complex, and finance is only one dimension of the decision.

There are two criteria for whether a piece of information is relevant in a decision:

One is that the information must vary with the chosen solution, otherwise it is not relevant.

There is another criterion, which is that the information must be a prediction of the future, not historical data.

This is why analyzing financial statements does not make 100% of investment decisions right. Because the data in the financial statements is historically based, it is lagging, while the stock price reflects the investor's expectation of the company's future business performance.

P/E ratio = price per share/profit per share

The profit per share used by financial experts is not the realized profit of the company, but the expected profit of the company for the next 12 months.

Future profits are the most relevant information for investment decisions.

Nine, cost identification: the decisive factor in business decisions

In finance, the enterprise to produce products and these non-direct costs, collectively referred to as "overhead". Overheads are also part of the cost of the product.

Wrong financial analysis can lead directly to wrong business decisions.

It has been the traditional practice to use production volume as a criterion for allocating overhead costs.

Job costing: the fundamental reason that drives costs is because an activity occurs behind it. So the basis of cost allocation is not the volume of production, but what activities are involved behind it.

Summary: In the eyes of managers, there are two ways of looking at costs:

1. Production costs include direct and indirect costs.

2. Accurate costing starts with accurate "cost drivers", which are the measurement dimensions that best match an activity.

X. The backlash effect: how to judge the good and bad of a financial decision?

The first input, the later need to amortize the cost, is called the backlash.

Although the capitalization of R&D investment improves current profits, it actually leaves a series of "after-effects".

Some companies with a large number of fixed assets, in order to reduce the annual depreciation of fixed assets, to enhance the current profit, may deliberately longer depreciation life, slow down the rate of depreciation. But a longer depreciation life also means that more years of profits will be affected in the future. This is the backfire effect of changing depreciation policy.

The human resources backlash

The relationship between the proportion of skilled employees and business performance is inverted "U" shaped. When the number of technical staff starts to increase, it is indeed beneficial to the enterprise; however, after the ratio is too high, it will start to have a "backlash effect" on the enterprise's innovation generation and overall performance. The higher the proportion of skilled employees, the more their voice and importance will increase. They will demand higher wages and salaries, resulting in additional costs to the organization. In addition, too many skilled employees are prone to "free-riding", which can also have a negative effect on business performance.

The backlash against valuation

With each round of financing, valuations are pushed higher than the value of the business itself. When a company goes public, the stock price breaks down. This phenomenon is known as the "valuation inversion of the primary and secondary markets", which is also known as the "reverse" effect of enterprise valuation.

Eleven, management change: everyone is a profit table

The enterprise as a whole is a large profit table, the staff is one of the small profit table, if everyone contributes to the enterprise's maximum profit, of course, the enterprise will be able to shareholders to contribute to the maximum profit.

The company's departments are divided into "profit centers" and "cost centers" according to whether they generate revenue. Profit center departments assess profits, and cost center departments assess costs.

There are problems with this.

1, the goal of the department is not consistent.

2, between departments invariably build a wall.

Where walls are doors.

Internal market chain mechanism. How exactly is it implemented?

1, transfer pricing (pricing according to the external market)

2, cost plus. It is the price of adding a little profit to the cost of production and transferring it to other external sectors.

Management masters use financial literacy to manage their businesses in this way:

1, regardless of the attributes of the department, whether or not it is directly market-oriented, each department is a profit center.

2, when everyone wants to maximize profits, the overall profit of the enterprise is maximized.

3. The establishment of an internal trading market, through the method of transfer pricing, can make all departments become profit centers.