TEAMFLY

sesses unique abilities to make clear the arcane that frequently enshrouds topics of finan-
cial management.”
Allen B. Barnes
Past Provost
IBM Advanced Business Institute
(formerly Director of Executive Education, UCLA)
“Erich Helfert’s book is a candidate for every consultant-to-management’s bookshelf. The
underlying agenda is financial management as it pertains to effective resource allocation de-
cisions. Framed in a dynamic model of the Business System, the beauty of Helfert’s presen-
tation lies in its treatment of subsystems that differentiate between investment, operations and
financing decisions, but which are also integrated into the overall managerial fabric.”
Stanley Press CMC
Book review September 2000
C2M Consulting to Management Journal
“Erich Helfert possesses a rare ability to make financial concepts understandable to individu-
als who lack a financial background. As a result we had Dr. Helfert conduct shareholder value
creation classes for all senior managers and create a shareholder value course for all other
salaried and hourly employees. The results of these efforts exceeded our high expectations.”
L. Pendleton Siegel
Chairman and Chief Executive Officer
Potlatch Corporation
“Erich Helfert has played an instrumental role in teaching HP managers of both financial
and non-financial backgrounds in our long-standing Functional Management Program. His
excellent financial overviews and simplified models effectively broaden our managers’
understanding and ownership of their fiscal responsibility to HP and our shareholders.”
Robert P. Wayman
Executive Vice President and
Chief Financial Officer
Hewlett-Packard Company
“Dr. Helfert’s book and his teachings go a long way toward removing the mystery from the

marked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of
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Introduction xxi
Chapter 1
The Challenge of Financial/Economic Decision-making 1
Lessons for the Millennium 2
The New Economy 2
Some Key Questions 3
The Basics Never Change 6
The Economic Manager 7
Understanding Business Economics 8
Appropriate Economic Tools 9
The Practice of Financial/Economic Analysis 10
Day to Day Decisions and Operational Planning 10
Supporting Strategy Development 11
Performance Assessment and Incentives 12
Valuation and Investor Communications 14
The Value Creating Company 15
Relevant Decision Information 15
Economic Incentives 17
Total Systems Management 18
Chapter 2
A Systems Context for Financial Management 21
A Dynamic Perspective of Business 22
Decision Context 22
The Business System 26
Investment Decisions 29
Operating Decisions 31
Financing Decisions 33
Interrelationship of Strategy and Value Creation 36
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Management’s Point of View 97
Operational Analysis 98
Resource Management 107
Profitability 112
Owners’ Point of View 115
Investment Return 116
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Contents xi
Disposition of Earnings 121
Market Indicators 123
Lenders’ Point of View 126
Liquidity 126
Financial Leverage 128
Debt Service 130
Ratios as a System 132
Elements of Return on Assets 133
Elements of Return on Equity 134
Integration of Financial Performance Analysis 137
Some Special Issues 139
Inventory Costing 140
Depreciation Methods 141
The Impact of Inflation 144
Key Issues 145
Analytical Support 147
Chapter 5
Projection of Financial Requirements 161
Pro Forma Financial Statements 163
Pro Forma Income Statement 164
Pro Forma Balance Sheet 167
Pro Forma Cash Flow Statement 171
Cash Budgets 174
Operating Budgets 178
Sales Budget 179

Simple Measures 234
Economic Investment Measures 237
Net Present Value 237
Present Value Payback 242
Profitability Index (BCR) 244
Internal Rate of Return (IRR, Yield) 245
Annualized Net Present Value 247
Applying Time-Adjusted Measures 250
Key Issues 250
Analytical Support 252
Chapter 8
Analysis of Investment Decisions 255
Strategic Perspective 256
Decisional Framework 259
Problem Definition 260
Nature of the Investment 261
Future Costs and Benefits 262
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Contents xiii
Incremental Cash Flows 263
Relevant Accounting Data 264
Sunk Costs 265
Refinements of Investment Analysis 266
A Machine Replacement 266
Net Investment Refined 267
Operating Cash Inflows Refined 268
Unequal Economic Lives 271
Capital Additions and Recoveries 272
Analytical Framework 272
A Business Expansion 275

Common Equity 306
Weighted Cost of Capital 312
Cost Choices 312
Weighting the Proportions 313
Calculating the Weighted Cost of Capital 315
Cost of Capital and Return Standards 317
Cost of Capital as a Cutoff Rate 318
Risk Categories 319
Cost of Capital in Multibusiness Companies 321
Multiple Rate Analysis 322
Key Issues 322
Analytical Support 324
Chapter 10
Analysis of Financing Choices 325
Framework for Analysis 326
Cost of Incremental Funds 326
Risk Exposure 327
Flexibility 328
Timing 328
Control 329
The Choice 330
Techniques of Calculation 330
Current Performance 331
Long-Term Debt in the Capital Structure 332
Preferred Stock in the Capital Structure 335
Common Stock in the Capital Structure 336
Range of Earnings Chart 339
The Optimal Capital Structure 345
Some Special Forms of Financing 347
Leasing 347

Valuing the Total Company 382
Using Shortcuts in Valuing an Ongoing Business 387
Key Issues 388
Analytical Support 389
Chapter 12
Managing for Shareholder Value 391
Shareholder Value Creation in Perspective 392
Evolution of Value-Based Methodologies 396
A Review of Key Measures 398
Economic Profit and CFROI 402
Creating Value in Restructuring and Combinations 411
Restructuring and Value 411
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xvi Contents
Combinations and Synergy 414
Combinations and Share Values 415
Integration of Value Analysis 417
Perspectives 418
Expectations 419
Time Period 419
Cash Flow Pattern 419
Ongoing Values 420
Comparables 420
Negotiations 421
Key Issues 421
Analytical Support 423
APPENDIX I
Financial Analysis Using Financial Genome 425
APPENDIX II
Glossary of Key Terms and Concepts 433

ested in the analysis and performance of a business: managers, owners, and cred-
itors. The book begins by providing a perspective on the recent speculative
excesses in the new economy’s “dotcom” revolution, with the argument that basic
economics and financial analysis have never changed, but only were ignored at
times. Next, the key concept of the business system and all of its relationships to
financial analysis and statements is presented in detail, from which the discussion
proceeds to explain the various techniques and concepts in a logical flow. Closure
is provided by returning to the systems concept in the final chapters on valuation
and managing for shareholder value. Within this structure, however, practicality
always remains paramount. Any issues and concepts going beyond what is essen-
tial are left to the more specialized textbooks and articles identified in the refer-
ences. The systems approach is also reflected in the commercially available
Financial Genome business analysis and planning software and its accompanying
interactive templates.
xvii
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xviii Preface
The Audience
Ever since the first edition appeared in 1963, the book has consistently maintained
a unique appeal both for students (graduate and undergraduate) and practitioners
because of its clarity and commonsense presentation. Straddling the educational
and professional markets, the book requires little if any background in finance and
accounting and provides an accessible, self-contained overview of the essential
financial management concepts and tools. Countless students have found the book
an understandable and useful guide for their studies and kept the book for ready
reference in their careers, while large numbers of professionals—whether finan-
cial practitioners or nonfinancial managers—recognized the practicality and ap-
plicability of the book’s approach to their needs and decision-making.
Originally an outgrowth of the compact technical briefing materials used in

Preface xix
Modernsoft, Inc. This professional application enables the user to develop finan-
cial statements, the whole range of key financial measures, and integrated finan-
cial projections and plans, as well as ad hoc financial analyses. The patented
knowledge-based technology enables the user to readily perform these tasks from
spreadsheet data or data bases with assured internal consistency, without having
to worry about cell locations and formulas. Knowledge of financial terms, rela-
tionships, and statement structures is built in, but can be accessed and displayed
at will for enhanced understanding. The software is also accompanied by a series
of interactive templates and displays relating to many of the key exhibits of this
book, especially the core diagram of the business system. The templates are de-
signed to enhance the learning experience by graphically illustrating the impact of
changes in assumptions and conditions. Many templates are also designed for
general use, such as break-even and present value analysis. Financial Genome is
described in detail in Appendix I. Interested readers can download the software
for trial, as well as the “TFA Templates,” from Modernsoft, Inc’s web site:
www.modernsoft.com.
As before, chapters 2 through 6 of the book form an integrated set, built
around the conceptual overview of the business system, its decisional context, and
its relationship to financial statements and analytical tools as presented in Chap-
ter 2. The coverage of analytical methods begins in Chapter 3 with funds flow
analysis, moves on to financial performance analysis, covers financial projections,
and culminates in a discussion of the financial dynamics useful in modeling fi-
nancial conditions and growth capabilities.
Chapters 7 through 11 deal with more specialized topics such as business
investment analysis, the cost of capital, financing choices, and valuation of secu-
rities and businesses, while the final Chapter 12 returns to the systems context in
an expanded discussion of the conceptual and analytical aspects of managing for
shareholder value. The informational Appendix III was updated to include key on-
line references.

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or wishes to understand the financial implications and economic trade-offs in-
volved in decisions about business investment, operations, or financing, a wide
variety of analytical techniques—and sometimes rules of thumb—is available to
generate quantitative answers. Selecting the appropriate tools from these choices
is clearly an important part of the analytical task. Yet, experience has shown again
and again that first developing a proper perspective for the problem or issue is just
as important as the choice of the tools themselves.
Therefore, this book not only presents the key financial tools generally
used, but also explains the broader context of how and where they’re applied to
obtain meaningful answers. To this end, the second chapter provides an integrated
conceptual backdrop both for the financial/economic dimensions of systematic
business management and for understanding the nature of financial statements,
data, and processes underlying financial analysis techniques. All subjects are
viewed in the context of creating shareholder value—a fundamental concept that
is revisited in the final chapter on managing for shareholder value.
While the tools and techniques covered in this book are discussed and
demonstrated in detail, the user must not be tempted to view them as ends in
themselves. It’s simply not enough to master the techniques alone! Financial/
economic analysis is both an analytical and a judgmental process which helps an-
swer questions that have been carefully framed in a managerial context. The
process is at its best when the analyst’s efforts are focused primarily on structur-
ing the issue and its context, and only secondarily on data manipulation. We can’t
stress enough that the basic purpose of financial analysis is to help those respon-
sible for results to make sound business decisions within a relevant cash flow
framework.
Apart from providing specific numerical answers, “solutions” to financial
problems and issues depend significantly on the points of view of the various par-
ties involved, on the relative importance of the issue, and on the nature and relia-
bility of the information available. In each situation, the objective of the analysis
must be clearly understood before pencil is put to paper or computer keys are

2. Which specific variables, relationships, and trends are likely to be
helpful in analyzing the issue? What’s the order of their importance,
and in what sequence should they be addressed?
3. Are there possible ways to obtain a quick “ballpark” estimate of the
likely result to help decide (a) what the critical data and steps might be,
and (b) how much effort should be spent on refining these?
4. How precise an answer is necessary in relation to the importance of the
issue itself? Would additional refinement be worth the effort?
5. How reliable are the available data, and how is this uncertainty likely to
affect the range of results? What confirmation might be possible, and at
what degree and cost of effort?
6. Are the input data to be used expressed in cash flow terms—essential
for economic analysis—or are they to be applied within an accounting
framework to test only the financial implications of a decision?
7. What limitations are inherent in the tools to be applied, and how will
these likely affect the range of results obtained? Are the tools chosen
truly appropriate to solving the issue?
8. How important are qualitative judgments in the context of the issue,
and what’s the ranking of their significance? Which analytical steps
might in fact be made unnecessary by such considerations?
Only after having thought through these questions should specific analyti-
cal work on any issue proceed. The amount of care and effort expended on taking
this critical first step at the beginning of the task will pay off in much more fo-
cused and meaningful work and results. In effect, we’re talking about using a
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Introduction xxiii
rational approach to problem solving in financial/economic analysis. In the end,
this is what effective support of decision making involving a company’s invest-
ments, operations, and financing is all about, because shareholder value creation
is the logical result of sound business decisions carefully analyzed and success-