Financial Statement & Cash flow

1. Total Assets:

Total Liabilities + Preferred Stock + Stockholder Equity

2. Net Cash Flow (NCF):

Net Income – None cash revenue + None cash expenses

It is a amount of cash generated by a firm for its shareholders during a year

3. Operating Working Capital:

It refers to all the current assets used in operation of the firm & the net operating working
capital is a part of operating working capital which is finance by interest bearing fund

NOWC = OWC – Noninterest bearing CL

Total Operating Capital ( TOC) = NOWC + Net Fixed Assets

4. Net Operating Profit After Tax: (NOPAT)

A better measurement for comparing manager’s performance is NOPAT, which is

defined as the amount of profit a company would generate if it had no debt & no
none operating assets.

NOPAT = EBIT(1-T)

5. Free Cash Flow:

It represents the cash actually available for distribution to investor

FCF = NOPAT – Net investment in operating capital

6. Market value Added (MVA)

Market value of stock – Equity capital supplied by shareholder

7. Economic Value Added

It represents the value added to shareholders by management during a given year

EVA = EBIT(1 – t) – (TOC) (after tax cost of capital)

*If the firm is all equity finance NCF = OCF

*If the firm is equity finance & also debt finance NCF < OCF

* Accounting profit & firms net cash flow are different due to depreciation

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 FINANCE ANALYSIS
The process of analyzing relative strengths and weakness of firm financial position is
financial analysis. Financial ratio is the quantitative relationship between two or more sets
of finance data derived from income statement and balance sheet.
A. Liquity Ratio :
The ratio used to ascertain the short terms solvency position of the firm by use of
current assets and current liabilities
1. Current Ratio (CR)

CR = Current Assets ∕ Current Liabilities

2. Quick Ratio (QR)

QR = Current Assets – Inventory ∕ Current Liabilities

B. Assets Management Ratio

These ratios looks at the amount of various types of assets and attempt to determine if
they are too high or too low at current operating levels. They provide the measure for how
effectively the firms’ assets are being managed.

1. Inventory Turnover Ratio (ITOR): It measures how a firm’s average in

inventory is capable of generating sales.

ITOR = Cost of goods sold ∕ Average Inventory

ITOR = Sales ∕ Inventory

Where, COGS = Sales – profit margin

Average Inventory = Inventory ∕ days in year

 A low ITOR indicates that the firm is holding excessive stock of inventory or is unable to
turn it over in terms of sale. The excessive investment in inventory is unproductive as idle
assets earn nothing.

 A high ITOR indicates that the firms is turning over its inventory at high rate.

2. Receivable Turnover Ratio (RTOR)

It indicates the number of times the firm collect its account receivables during the
year

RTOR = Annual credit sales ∕ Average account receivables

A low RTOR indicates that the firm is making excessive investment in receivables or it is
unable to make timely collection of credit sales. Higher RTOR shows better liquidity of debtors and
quick collection receivables.

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 3. Day Sales Outstanding (DSO):

It is a average length of time that a firm takes to realize in cash after credit sales has been
made. It measure how quick the account receivable are being converted into cash.

DSO = Account Receivables ∕ Average sales per day

DSO = AR 360 days ∕ Annual sales

DSO = 360days ∕ RTOR

4. Fixed Assets Turnover Ratio (FATOR):

It indicates the firm’s ability to generate sales based on its various fixed assets. It measures
the effectiveness of firm’s ability to make efficient utilization of fixed assets.

FATOR = Sales ∕ Net Fixed Assets

 A low FATOR indicates that the firm is using its fixed assets not as efficiently as other
firm in the industry.

5. Total Assets Turnover Ratio (TATOR): It measures the efficiency of assets

management in relation to all of the firm’s assets items.

TATOR = Sales ∕ Total Assets

A low TATOR indicates that the firm is unable to generate sufficient bushiness
volume in terms of general sales revenue.

C. Debt Management Ratio : It is the measuring of long term solvency of the firm.

1. Debt Assets Ratio (DA ratio) : It shows the proportion of total debt used in
financing total assets of firms.

DA ratio = Total debt ∕ Total assets

DA = DE ∕ (1 + DE)

Where, Total debt = CL + Long term debt

 Low DA ratio is consider to be beneficial from the debt holders viewpoint.

2. Debt Equity Ratio (DE ratio): It shows the relationship between debt capital and
equity capital. It is used as a tool for analyzing financial risk both by creditor as
well as by the firm.

DE ratio = Total debt ∕ Total equity

DE = DA ∕ (1 – DA)

 A high DE ratio indicates greater contribution at a firms finance by debt holders then
those of equity holders. From the creditors view point high DE ratio is riskier to them.

3. Long Term Debt to Total Assets Ratio : It shows the proportion of total assets that
is financed by long-term debt capital of the firm.

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 = Long term debt ∕ Total Assets

4. Equity Multiplier (EM) It refers to as the leverage factors simply states the
relationship of total assets to equity of a firms .It measures the extent to which the
total assets of a firms is greater than the firms equity capital.

EM = Total Assets ∕ Total equity

EM = 1 ∕ (1 – DA)

EM = 1 + DE

5. Interest Coverage Ratio : It indicates the extent to which the firms is able to
satisfy interest payment out of earnings before interest & taxes (EBIT). It also
refers to a time earnings ratio (TIE ratio ).

TIE ratio = EBIT ∕ Interest expenses

EBITDA Coverage Ratio = (EBITDA + Lease payment) ∕ (Interest + Lease payment

+ principal repayment )

D. Profitability Ratio :

1. Net profit margin: It is the ratio between net income and sales of a firm.

NPM = Net Income ∕ Sales

2. Gross Profit Margin (GPM)

GPM = Gross Profit ∕ Sales

3. Operating Profit Ratio

= Operating Profit ∕ Sales

4. Basic Earning Power Ratio This ratio is calculated to evaluate the firm’s ability to
generate profit before the payment of interest and taxes out of the assets used.

Earning Power = EBIT ∕ TA

E. Return:

1. Return on Assets (ROA): It is the percentage of net income on total assets. The
higher the firms ROA is better.

ROA = Net Income ∕ Total Assets

2. Return On Equity (ROE): It is the percentage of net income on total equity.

ROE = Net Income ∕ Total Equity

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 F. Market Value Ratio : They are used to assess firms stock price in relation to its earning and
book value of shares.

1. Price Earnings ratio (PE ratio) It is simply the ratio between market price per
share (MPS) and earning per shares (EPS). It represent the amount which
investors are willing to pay for each rupee of the firms earning

PE ratio = MPS ∕ EPS

2. Market-to-book ratio It is simply the ratio between market price per share (MPS)
to book value per share (BVPS).

= MPS ∕ BVPS

Where, BVPS =Total equity ∕ Number of outstanding shares

G. Du-point Identity: it is a method of classifying assessment of firms financial ratio that

shows the relationship of ROE to the Profit margin, ROA and Equity multiplier.

ROA = Profit Margin × Total Assets

Turnover

ROE = ROA × Equity Multiplier

NOTE: Turnover Ratio: Sales is always divided. (h] sf ]turnover lgsfNg] xf] t]:n] Sales nfO{ divide
ug]{.

Debt Ratio: Total debt nfO{ h] sf] debt ratio lgsfNg] xf] t]:n] divide ug]{.

Profit Margin: Sales n] h] sf] profit margin lgsfNg] xf] t]:nfO{ divide ug]{.

Return : Net income nfO{ h] sf] Return lgsfNg] xf] t]:n] divide ug]{.

RISK & RETURN THEORY

1. Absolute Return:
The total return of capital & cash receipts. It measures what percentage of
return an investor earns during the given period on an investment.
……….short period

…………Long period
Where,

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 2. Average return for single assets
It is used to know the rate of return from the investment.

Where,

n= Number of the year

3. Expected Return : E(r)

It is an estimated rate of return for the future period. An investor chooses the investment that
provides higher expected rate of return.

Where, n= Number of state

P= Probability of state

r= The return

4. Require Rate of return

It is the minimum return the investor wants to earn from a particular investment. They invest
in an assets only when the expected rate of return is higher or at least equal to the require
rate of return of a particular investment.

………………….(Under APM )

Where,

5. Variance of return : (
It measures how widely the returns are dispersed around the average returns or expected
return of the assets. The higher the variance of return the higher will be the dispersion of
returns which means higher risk.

Where,

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 p= the probability

6. Standard Deviation of return (SD)(σ)

It measure risk.

7. Coefficient of variation (CV)

It is the standard measure of risk per unit of return. Higher CV indicates higher risk.

Where, CV= Coefficient

σ = Standard deviation

8. Covariance:
It is a statistical measure of the relationship between two random variables.
A positive value for covariance indicates that the security returns tends to move in the same
direction & negative covariance indicates that the security returns tends to move offset one
another. A relative small or zero value for the covariance indicates that there is little or no
relation between the returns for two securities.

)
if probability is given

9. Correlation:
It is a statistical concept for measuring the extent to which two variables tends to move
together. It always falls between -1&1. A value of -1 represents perfect negative correlation
& a value 0f 1 represent perfect positive correlation. When the two variables have no relation
correlation is zero.

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 A perfect positive correlation between the returns of two stocks means there is one- on- one
increase or decrease between the stocks. A perfect negative correlation between the return of
two stocks means that unit (decrease) in the return of one stock is accomplished by the same
unit decrease.

10. Portfolio:
When s/he invests in more than one asset, the combination of assets is known as portfolio. In
other words, portfolio refers to the collection of securities.
A. Portfolio return: It refers to the return on total investment when an investor invest in more
than one assets.

where,
w=weight of total fund
r= return of securities

n= number of observation

B. Average return of portfolio : Average return of portfolio of two assets is equal to the
arithmetic mean of the holding period return of portfolio.

C. Portfolio Expected return E(

Where, n=number of assets

D. Portfolio risk:
Variance

Standard deviation

Variance of portfolio by using CV & correlation

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 11. Beta(β)
It is used to calculate the risk premium of particular assets. The beta of market itself is 1. If a
stocks beta is 1 the stock is as risky as market & such stock is known as neutral stock. If the
beta of stock is greater than 1it is riskier then market & such stock is known as aggressive
stock. A stock whose beta is less then 1 it is less risky than market and such stock is known as
defensive stock.

Where,

Where,

w=weight of assets

β=beta of assets

12. The Security market line (SML)

Beta version

Where,

CV version

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 where,

TIME VALUE OF MONEY

1. Future value (FV):

Where, FV= Future value

PV=Present value

i=the annual rate of return

n= the number of year

………….tabular Solution

2. Present value (PV):

…………….tabular solution

3. Interest rate or Discount rate (i):

Under tabular method

Step1: Calculate PVIF or FVIF

Step 2: Computing with FVIF or PVIF table

Step 3:
where, LR=low rate

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 =Factor of LR

=Factor of HR

4. Number of period (n):

Step1:

Step 2:

Step 3: Taking log on both side

n log (1+i)=log

Tabular solution
Step 1: Calculate PVIF or FVIVF
Step 2: Compare to the table
5. Annuity
A series of equal payment at equal interval of time for a given period.
A. Ordinary Annuity:
A series of equal payment at the end of equal period.
i. Future value

Where, FVA= Future value of ordinary annuity

PMT=Equal payment of annual amount
n =Number of compounding period
i = annual rate of interest

………Tabular solution

ii. Present value

B. Annuity Due:
Series of equal payment at the equal period at beginning of each period.
i. Future value

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 Where, FVA= Future value of annuity due
PMT=Equal payment of annual amount
n =Number of compounding period
i = annual rate of interest

………Tabular solution
(1+i)

ii. Present value

6. Perpetuity
An infinite stream of equal payment.

7. Uneven cash flow

In the stream of cash flow, the cash flow differ in each period

Note: Semiannually Compounding: Interest rate ÷2, number of cash flow×2

Quartile compounding: Interest rate ÷4, number of cash flow ×4

8. Effective annual rate

9. Continuous Compounding
If the interest is compound continuously there number of compounding period is
infinity.
where, e = exponential terms whose number numerical
value is approximates to 2.718282

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 10. Amortized loan (PMT)
A loan to be repaid in equal installment through the given period.

Amortization schedule

Year Beginning Payment Interest Re-payment of Ending

(1) Amount (2) PMT (3) 2×i=4 principal (5)=3-4 balance(6)=2-5

BOND VALUAION
1. Valuation of Assets

Where, =Expected cash flow

k= Investor require rate of return /discount

V= Value of assets at present

n= Time to maturity

There is a positive relationship between cash flow & value of assets. And inverse relation between
require rate of return.

2. Cash flow for the regular bond

Where,

, = Coupon interest in Rs (Face value × Coupon rate)

= the appropriate discount rate or market interest rate or investors

require rate of return
n = Maturity periods in year
M = Maturity value or par value
3. Valuation of Bond
I. Perpetual Bond:
A bond which is issued without a finite maturity period is called perpetual bond.

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 or

This is the amount at which an investor would be willing to purchase the bond.
II. Zero coupon bond
A bond without coupon interest & sold at substantial discount.
Here, I=0 so,

III. Coupon Bond with a finite maturity period

IV. Bond Valuation with Semi-annual interest

or

or

4. The return on bond can be measured as current yield, yield to maturity (YTM)
& YTC
A. Current Yield

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 It is coupon interest divide market price of bond.

Capital gain =YTM-Current Yield

B. Yield to Maturity (YTM)
It represent the rate of return investor earn if they buy the bond at specific price &
hold it until maturity.
Calculation Of YTM
1. Step: Compute approximate YTM

2nd. Step: Calculate bond value equation

3rd. Step: Now try at lower rate by putting the value in equation on step 2
4th. Step: Now try at higher rate by putting the value in equation on step 2
5th. Step: Interpolation

YTM=

C. Yield To Call ( YTC)

1. Step: Calculate approximate YTC

as YTM
Note: Effective YTM = (1+semiannual YTM - 1

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 STOCK VALUATION
1) Common Stock valuation

Po =

Where,
Po = intrinsic value of common stock
Dt = dividend per share at the end of the year t
Ks = investors require rate of return
a) At zero growth rate
If a firms future dividend are expected to remain constant forever zero growth rate
mode is used. Where, D1=D2=D3=Dn

b) Constant or Normal growth rate

Where, Expected dividend per share at the end of the year 1

= Price of the stock today

= Investor require rate of return

g = Growth rate
= b × ROE
=b×r
b= retention ratio 1- DPR

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 r = reinvestment rate
c) Non-constant Growth Rate
Step: 1 Compute the dividend for each year

Step:2 Find the value of the stock at the end of non constant growth period or horizon

value

Step: 3 Find the PV of the dividend during the non-constant growth period

Step: 4 Find the PV of the horizon\terminal value of stock.

Step:5 Add step 4 & step 5

d) Single period valuation

e) Multi-period Valuation

2) Expected rate of return on constant growth rate

Dividend yield: Expected dividend divided by the current price of stock.

Capital gain yield: The change in price during the period divided by beginning price

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 Now, Expected rate of return = Dividend yield + Capital gain yield

3) Valuation of the entire firm

Value of Total Equity =

Value of the entire firm = Value of total equity + Value of debt

4) Preferred Stock Valuation Models

Where, Vps = Current intrinsic value of preferred stock

Dps =Current annual cash dividend
Kps =Investor required rate of return

5) Value of Redeemable Preferred Stock

It has specific maturity period.

or

Where M = par value of stock

COST OF CAPITAL
1. Component Cost of capital
a. Cost of debt (Perpetual debt): The debt which do not have any specific
maturity period.

Where, Kd =
Before tax cost of debt
Kdt = After tax cost of debt
NP = Par value + Premium – Discount- Flotation cost
Selling Price – Discount – Flotation Cost

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 b. Cost of debt (Redeemable): Debt which have specific maturity period.
...............Approximate Formula Approach
Where, Kd= Before tax cost of debt
I = Coupon interest in Rs
M = Maturity Value
NP = Net Proceed
n = Maturity value
i. Under Bond Valuation method
 Calculation of NP

 Appropriate Kd
 In the same way as YTM is calculated
c. Cost of preferred stock ( Perpetual)

d. Cost of preferred stock ( redeemable)

e. Cost of Retain earning (Ks) Internal Equity

…….Discount Cash Flow Approach
…….CAPM Approach

f. Cost of External Equity

Where, NP = P0(New) – Flotation cost

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 g. Weight Average cost of capital (WACC)
i. Calculate the after tax component costs.
ii. Find the weight of each source of finance
iii. Multiply the after tax cost of each source by its weight in the capital
structure.
iv. Add the weighted component costs to get the firms WACC

Where,
WACC=Weight average cost of capital

h. Break Even Point (BEP)

i. Retain earning BEP

ii. Other BEP in MCC schedule

Where, Break point for finance source j

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 = maximum amount of fund available from finance
source at a give cost
W= weight of financing source

RECEIVABLE MANAGEMENT
 Cost of maintaining Receivables
1. Cost of Investment in receivable
: Investment in a\c receivable × Opportunity cost
Or,
: ( Average amount of receivables ×VCR) × Opportunity cost
Or,
: [(Annual credit sales/Days in year) ×DSO×VCR] ×Opportunity cost
Or,
:[( VC/Days in year) ×DSO] × Opportunity cost
Or,
:[( FC+VC)/Days in year] × DSO × Opportunity cost

2. Bad Debt losses

: Annual credit sales × % of default customer
Or,
: Annual credit sales × Bad debt %

3. Cash discount cost

: Annual net credit sales × % of customer taking discount × discount %
Or,
: Credit sales (1-BD) × %of customer taking discount × discount %

4. Day Sales Outstanding (DSO)

: % of customer taking discount × Discount period + % of customer paying
late × late payment day

BASIC OF CAPITAL BUDGETING

1. Traditional Technique
a. Pay Back Period (PBP): It is the expected number of year required to
recover the investment of the project.
In case of even cash flow

Where,
NCO = net Cash Outlay or initial cash outlay or initial investment

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 CF = Cash inflow

Where,
Minimum year = Year before final recovery of NCO
Amount to be recovered= Difference between NCO & cumulative cash flow
b. Accounting Rate of Return (ARR): It is book rate of return on investment.
It is based on the average accounting profit &average investment.

Or,

Where,

=Average Net Income

= Average investment

N= project life
EAT= Earnings After tax for a given year
I0 = Book value of the investment at the beginning of the year
In = book value of the investment at the beginning of the year
Note: If ARR is greater than the minimum required rate of return, accept the project
If ARR is less than the minimum require rate of return, reject the project

2. Discount Cash flow technique

a. Discount Payback Period: It is the time required to recover the original
investment of the project from the discount cash flow.

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 Note: Choose all projects which has DPP less than standard project which
have higher DPP.

b. Net Present Value (NPV): It is the amount difference between present value
of cash inflow &cash outflow of the project.

Where, k=cost of
capital

Table Method

Year Cash flow PV=PVIF × Cash flow

Total present value

Less: Initial investment
Net Present Value
Note: Independent
project: Project with higher NPV will be chosen & vice versa

Mutually exclusive project: Choose one with lowest NPV

c. Internal Rate of Return(IRR):

It is the rate of return which makes present value of cash inflow equal to the
present value of cash outflow.

IRR of eve cash flow

Step1: Calculate fake factor =

Step2: Search the calculated factor in PVIFA table at the given year.
Step3: If the factor lies exactly in the same rate that is IRR. If the factor lies
between tow rates then we use Interpolation method.

Where, LR%= Low rate %

HR% = High rate %

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 TR factor = True rate factor
LR factor = Low rate factor
HR factor = High rate factor

IRR of uneven cash flow

Step1: Calculate fake factor =

Step2: Search the calculated factor in PVIFA table at the given year.
Step3: Compute two PVIFA at same higher rate with one being negative &
one being positive
Step4: Use Interpolation method.

Note: Independent project: Choose project with IRR above cost of capital.
Mutually project: Choose one with high IRR.
If IRR is greater than the cost of capital, k, accept the project & vice
verse.
d. Modified Internal Rate of Return:

It is a discount rate at which the PV of project is equal to the PV of

terminal value. The terminal value is found as the future value as cash flow the
cost of capital. MIRR is better indicator then IRR because all cash flow are
invested at cost of capital, so it is also called the rate of return.

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 PROJECT CASH FLOW
Annual Depreciation =

1. Net Cash flow: It is the difference between cash inflow & cash outflow
2. Initial Cash outlay: It is the investment to be made at the beginning of the capital
project.

Rs

Cost of machine (………..)

Working capital (………..)
Market value of machine …………
Tax ………...

Total Initial Cash outlay ( ………)

3. Operating cash flow: It is a cash flow that result from the investment in the
project & continue until the firm dispose of such project.

Rs
Annual Sales ………..
Less: Cash operating expenses ………..
EBDT ……….
Less: Depreciation ..............
EBT ………..
Less: Tax …………
EAT ………..
Add: Depreciation ………..
Cash flow after tax

4. Terminal Cash flow: The cash flow that occur at the end of the life of the
project. It include the cash flow associated with the final disposal of the project
& returning to the operating level that existed prior to the acceptance of the
project.

Annual operating cash flow ……………

Release of working capital ……………
Sale proceeds received from the sale ……………
Tax on sale (……………)

Net cash flow …………….

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 5. Capital gain: It is the proceeds of an asset in excess to its original cost.
Capital gain = Market value – Original value
6. Depreciation recapture\Ordinary gain: It is the difference between original
cost & book value. Original cost – book value

Some Important Formulas

I. Annual Depreciation (AD)

Where,

OC = original cost

SV = Salvage value\scrap value

N = Life of machine

II. Increment of operating cash flow(∆CF)

Where
∆S = Change in revenue
∆OC= change in operating cost
∆Dep = Change in depreciation
T= Tax
III. Calculation of Depreciation

Under Straight line method

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 WORKING CAPITAL MANAGEMENT
1. Working Capital: The amount of fund that is needed to finance the current assets
of the firm.
2. Gross Working Capital: The capital invested in total current assets.
3. Net Working Capital: The excess of current assets over current liabilities.
Net working capital = Current assets – current liabilities
Net working capital = Long term fund – Fixed assets
4. Cash Conversion Cycle (CCC): It is the period between the payment to its
creditors &received from its suppliers.

CCC = ICP+RCP-PDP

Where, ICP = Inventory Conversion Period

RCP = Receivable Conversion Period
PDP = Payable Deferral Period
5. Inventory Conversion Period (ICP): The average length of time required
converting raw material into finished goods and then to sell those finished
goods.

Or,

6. Receivable conversion Period (RCP): The average length of time required to

convert the firm’s receivable into cash.

Or,

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 7. Payable Deferral Period (PDP): The average length of time received to pay for
the materials & labor after they are purchased.

Or,

Or,

8. Operating Cycle: The time period between the acquisition of inventory & when
cash is collected from receivable.

Operating Cycle = ICP + RCP

9. External Financing requirement working capital

= CCC × Daily working capital required

Or,

10. Working Capital Turnover

INVENTORY MANAGEMENT
1. Total Carrying Cost (TCC): It is the cost of holding inventory in stock.

TCC = C × A Where, C = carrying cost per

unit =C% × Price
A = Average inventory unit = Q/2

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 Q = Quantity of order size
2. Total Ordering Cost (TOC) : The cost of placing the order of inventory, which
include all the costs associated with administrative & processing of order.
TOC = O×N

Where, O = Ordering cost per unit

N = number of order to be placed = R/Q

R=Requirement for the period

Q = Quantity or order size

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