Financial Management i

ENT 109:
Financial Management
Prepared by: Kert John P.Baloca
Sharmine Faith A. Mahumas, MM
Financial Management ii
 Financial Management i

Financial Management

Course Overview
This course pack is designed to equip students or its readers on the importance
and significance of managing financial resources of the business. It aims to inculcate
awareness that financial literacy is an essential component in decision making.
Knowledge of basic financial management would help business stakeholders to make
viable decision related to proposed projects or investments. It also equip them with
necessary tools that will guide them in business management, proper utilization and
allocation of financial resources that will help improve the business overall
performance and profitability.
In order for learners to gain competency in this course, this course pack has been
structured into three (3) modules as follows:
Module 1: Financial Management and Financial Statement Analysis
Module 2: Financing Decision
Module 3: Investment Decision
At the completion of this course pack, learners should be able to:
 To discuss financial management in the organization;
 To analyse financial statement in the organization;
 To appreciate the role of financial management to accounting discipline; and
 To learn the scope and objectives of financial management.
Students in this course are encouraged to go through each lesson in every
module sequentially to maximize their learning. They should work on all exercise to
build on the concepts of each topic introduced in each lesson.
Hence, to make this learning experience rewarding for you, study this course
pack with your co-learners at your own pace. You can also ask the help and support of
your peers, tutor and friends.
Good luck!
 Financial Management ii

TABLE OF CONTENTS
Course Overview ………………………………………………………… i
Table of Contents ………………………………………………………… ii
Module 1: Financial Management and Financial Statement Analysis
Module Overview ………………………………………………… 1
Lesson 1: Introduction to Financial Management ………… 2
Lesson 2: Cash Flow Statements ………………………… 6
Lesson 3: Financial Statement and Analysis ………………… 10
Module Summary ………………………………………………… 22
References ………………………………………………………… 23
Module Assessment ………………………………………………… 25
Module 2: Financing Decision
Module Overview ………………………………………………… 28
Lesson 1: Time Value of Money ………………………… 29
Lesson 2: Bonds and Stocks Valuation ………………… 35
Module Summary ………………………………………………… 39
References ………………………………………………………… 40
Module Assessment ………………………………………………… 43
Module 3: Investing Decision
Module Overview ………………………………………………… 45
Lesson 1: Cost of Capital ………………………………… 46
Lesson 2: Capital Budgeting Techniques ………………… 54
Lesson 3: Working Capital Management ………………… 59
Lesson 4: Corporate Financial Planning ………………… 66
Module Summary ………………………………………………… 70
References ………………………………………………………… 71
Module Assessment ………………………………………………… 74
Appendices ………………………………………………………… 76
 Financial Management 1

Module Overview

Financial
Management and
Financial Statement
Analysis

In this Module
 Definition and Importance of Financial Management
 Fundamental Concepts in Financial Management
 Role of the Financial Manager
 Statement, Activities, Methods and Rules of Cash Flow
 Understanding the Basic Financial Statements
 Statement of Comprehensive Income
 Overview, Uses, Advantages, Limitations and Tools and Techniques of
Financial Statement Analysis

Financial Management is a system of policies and procedures in the

management of the Company's cash and assets to generate revenue at the least cost and
achieve the Company's business plan, and to protect the interest and share of
stockholders in the Company.

At the end of this module, you should be able to:

 Define and discuss what financial management is;
 Explain the importance of financial management;
 Know the role of financial manager in business entity;
 Recognize, explain and construct cash flow statement;
 Analyze the various information provided by the basic financial
statements;
 Compute and interpret Financial Statement Analysis.
 Financial Management 2

Introduction to Financial
Management

Objectives:
 Define what financial management is and explain the its
importance;
 Identify various fundamental concepts of financial
management; and
 Recognize the role of the financial manager in a business
entity.

Introduction:
Welcome to Lesson 1 of module 1! This lesson talks about Financial
Management, its nature, scope, and significance, along with financial decisions and
planning.

1. What are you going to do with the

monthly allowance you have?
__________________________________
__________________________________
__________________________________
2. Will your monthly allowance enough
with your monthly expenses?
__________________________________
__________________________________
__________________________________

1. Why do you think you have to plan your

monthly allowance?
Analysis __________________________________
2. How your monthly allowance does
affects your decision making?
__________________________________
3. Was planning allocates your monthly
allowance properly?
__________________________________
4. What could be the other way to sustain
your monthly needs?
__________________________________

Abstraction
Fiscal Management is
the process of
planning, directing and
controlling financial
resources.
Investment decision
such as capital
budgeting or financial
plan preparation.
Financing decision
such as creating the
best financing mix or
capital structure
Operating decision
such as cost control or
strategies to increase
revenue.
management. Since financial data require analysis and interpretation, an appropriate
cost is necessary to attract experts or knowledgeable professionals to do the job.
Financial Management 3
Financial Management, Defined
Financial management refers to the strategic
planning, organizing, directing, and controlling of
financial undertakings in an organization or an
institute. It also includes applying management
principles to the financial assets of an organization,
while also playing an important part in fiscal
management.
Importance of Financial Management
Financial management focuses on the areas of (a)
investment decision; (b) financing decision; and (c)
operating decision. These decisions add value and
set the directions of the company to accomplish its
business objectives.
Fundamental Concepts in Financial
Management
Financial management is in charge of efficient
planning and control of funds inflow and outflow.
Finances impact virtually everything in what the
company does, it is probably the most important
thing a manager must address. However, there are
both advantages and disadvantages to financial
management in business that managers must be
prepared to face.
Research, Time and Knowledge
Businesses would require a significant amount of
financial information. This information is a product
of past business transactions. The data collected
undergone a process of analysis and interpretation.
Cost
Cost is one of the considerations in financial
 Financial Management 4

Revision and Attention

Constant study and undivided attention are Internal Factors
refers to anything
needed to identify the factors that affect the financial within the company.
needs of a business.
External Factors or
Power external elements are
affecting factors
Not all financial decisions are popular with outside and under no
stakeholders and thus, financial managers are given control of the
company.
the power to make judgment calls especially when
the operations of the business will be affected.

Money Availability and Planning

Managing finances results in being able to identify the sources and uses of it. It
gives financial managers the edge of knowing when funds will be available and be able
to predict money availability or possible shortage.

Accountability
Financial management focuses on various control procedures related to the use
of financial resources. It places a heavy burden on accountability as it has procedures
and policies with regards to the management of the company’s financial resources.

Confidence
Financial management adds value and confidence in the sense that this aspect
of management puts a strong emphasis on efficient planning and control on its cash
flows.

Role of the Financial Manager

The financial activities of a firm are one of the most important and complex
activities of a firm. Therefore to take care of these activities a financial manager
performs all the requisite financial activities.
A financial manager is a person who takes care of all the important financial
functions of an organization. The person in charge should maintain farsightedness to
ensure that the funds are utilized most efficiently. His actions directly affect the
profitability, growth, and goodwill of the firm.

The following are the main functions of a Financial Manager:

1. Raise Needed Funds for the Business Operations
It is the role of the financial manager to ensure that the company meets
the obligation and required funds needed for the business.
2. Proper Allocation of Financial Resources
The moment funds are raised, the financial manager should be able to
make proper allocation on where to use the said funds.
 Financial Management 5

Factors affecting
business profit:
 Product pricing
 Competition
 Economic status
 Demand and
Supply
 Product Cost and
Output
3. Profit Planning
Profit is an inherent component to ensure
business sustainability and survival. As such, profit
planning requires a great amount of rational
forecasting of revenues and management of cost and
expenses.
4. Knowledge of Capital Markets
The financial manager should be able to have a
thorough knowledge and a clear understanding of
the capital market. Capital market is where
securities or company shares are traded.

Application Essay:
1. Make a self-reflection on why financial
management is significant and needed by any business
organization.
2. In the above information, how do these several
factors affect profit planning?

(Note: Please refer to the Appendix A of this module for the rubric.)

Congratulations! You have just finished

Lesson 1! You are now ready to go to the
next lesson which is the Cash Flow
Statement. Good luck!
 Financial Management 6

Cash Flow
Statement

Objectives:
 Recognize and explain the various activities in the cash flow
statement;
 Categorize the various business transactions related to
activities in the cash flow statement; and
 Construct a cash flow statement.

Introduction
Welcome to lesson 2 of module 1. This lesson is all about the cash flow
statement and its activities, significance in preparing financial statement, and how to
prepare it.

 Purchase of Equipment
 Increase (Decrease) in Accounts Receivable
 Increase (Decrease) in Merchandise
Inventory
 Payment of cash dividends
 Proceeds from sale of equipment
 Proceeds from note payable
 Increase (Decrease) in income tax payable
 Increase (Decrease) in Accounts Payable

Analysis 1. Cash flow from operating activities

_____________________________
_____________________________
_____________________________
_____________________________
2. Cash flows from investing activities
_____________________________
_____________________________
3. Cash flows from financing activities
_____________________________
_____________________________
4. What is your idea on Cash from operating, investing, and financing activities?
__________________________________________________________________
__________________________________________________________________
 Financial Management 7

Abstraction
Statement of Cash Flow
A cash flow statement, also known as statement
of cash flows or funds flow statement, is concerned
with the flow of cash in and cash out of the business.
A cash flow statement is a regular financial
statement telling you how much cash you have on
hand for a specific period.

KEY TAKEAWAYS
 A cash flow statement is a financial statement that summarizes the
amount of cash and cash equivalents entering and leaving a company.
 The cash flow statement measures how well a company manages its
cash position, meaning how well the company generates cash to pay
its debt obligations and fund its operating expenses.
 The cash flow statement complements the balance sheet and income
statement and is a mandatory part of a company's financial reports.

The Structure of the Cash Flow Statement

The main components of the cash flow statement are:
1. Cash from operating activities
2. Cash from investing activities
Generally Accepted
3. Cash from financing activities Accounting Principles
4. Disclosure of noncash activities is sometimes (GAAP) refer to a
common set of
included when prepared under the GAAP accounting principles,
standards, and
Operating activities procedures issued by
the Financial
The operating activities on the CFS include Accounting Standards
any sources and uses of cash from business activities. Board (FASB).
In other words, it reflects how much cash is generated
from a company’s product or services.

Important: Generally, changes made in cash, accounts receivable,

depreciation, inventory, and accounts payable are reflected in cash
from operations.

Investing activities
Investing activities include any sources and uses of cash from a company’s
investment. A purchase or sale of an asset, loans made to vendors or received from
customers or any payments related to a merger or acquisition is included in this
category. In short, changes in equipment, assets, or investments related to cash from
investing.
 Financial Management 8

Financing Activities
Cash from financing activities include the sources of cash from investors or
banks, as well as the uses of cash paid to shareholders. Payment of dividends, payments
for stock repurchases and the repayment of debt principal (loans) are included in this
category.

Disclosure of non-cash activities

Non-cash investing and financing activities are disclosed in footnotes or an
attachment to the financial statements. This activities are not included in the body of
the statement because no cash was involved.

Preparation methods
In order to figure out your company’s cash flow, you can take one of two routes:
The direct method, and the indirect method. While generally accepted accounting
principles (GAAP) approve both, the indirect method is typically preferred by small
businesses.

Direct method
The direct method
Using the direct method, you keep a record takes more legwork
of cash as it enters and leaves your business, then and organization than
the indirect method -
use that information at the end of the month to you need to produce
prepare a statement of cash flow. and track cash receipts
for every cash
transaction. For that
Indirect method reason, smaller
businesses typically
With the indirect method, you look at the prefer the indirect
transactions recorded on your income statement, method
then reverse some of them in order to see your
working capital

Sample cash flow statement using the direct method:

Operating activities
Cash received from customers 800
Cash paid to suppliers (150)
Employee compensations (200)
Other operating expenses paid (250)
Net cash from operating activities 200
Investing activities
Sale of land 200
Purchase of equipment (300)
Net cash from investing activities (100)
Financing activities
Common share dividends (200)
Payment on long-term debt (300)
Net cash from financing activities (500)
Cash and cash equivalents, beginning of year X
Cash and cash equivalents, end of year Y
 Financial Management 9

Sample cash flow statement using the indirect method:

Operating activities
Net income 50,000
Add: Depreciation expense 10,000
Decrease in Accounts Receivable 2,000
Increase in inventory 3,000
Decrease in prepaid expense 4,000
Increase in accounts payable 5,000
Net cash provided by operating activities xx,xxx
Investing activities
Sale of land 200
Purchase of equipment (300)
Net cash from investing activities (100)
Financing activities
Common share dividends (200)
Payment on long-term debt (300)
Net cash from financing activities (500)
Cash and cash equivalents, beginning of year X
Cash and cash equivalents, end of year Y

Application Cash Flow Statement Preparation

Friendster Company shows a beginning cash balance of
P395,000 and had the following transactions:
a. The company issued shares of stocks worth P550,000.
b. The company paid dividends of P365,000.
c. Applied and received a loan from Bank of the Philippines
Islands worth P600,000.
d. Payments for salaries P95,000; rent P60,000; supplies P215,000; other expenses
P105,000.
e. Total sales of P850,000 was recorded to which 55% was in cash and the balance
on account.
f. Interest payment of P85,000 while income tax paid was P90,000.
g. Old equipment was sold for P375,000.
h. New machineries were acquired at a cost of P425,000.
Based on the above data, compute for cash (a) from operating (b) from
investing (c) financing (d) ending cash balance

You have just finished Lesson 2 of this module.

The next lesson will discuss about Financial
Statement and Analysis. If you are ready then
begin the lesson now.
 Financial Management 10

Financial Statement
and Analysis
Objectives:
 Identify the various information provided by the basic financial
statements;
 Appreciate the relevance and importance of financial statement
analysis;
 Perform vertical and horizontal methods of financial statement
analysis.

Introduction
Welcome to lesson 3 of module 1. This lesson discusses the financial statement
and financial statement analysis. The informations contained in the statements, its
relevance and how to prepare both statements.

Account Payable 12,000

Furniture & Fixtures 7,000
Prepaid Rent 18,000
Account Receivable 5,000
CDF, Capital ??????
Cash 22,000
Accrued Salaries 8,000
Inventory 15,000

Analysis Arrange the data accordingly and

prepare a Statement of Financial
Position
Assets:

Liabilities:

Equity:
 Financial Management 11

Abstraction
The Statement of Financial Position
The statement of financial position, also called
“balance sheet,” is a financial “snapshot” of your
business at a given date in time. It provides
information about the financial condition, position
and structure of the company in terms of its assets,
liabilities, and difference between the two, which is
the equity or net worth.

What is the Accounting Equation?

The accounting equation is considered to be
Double-entry system,
the foundation of the double-entry accounting transactions are
system. The accounting equation shows on a recorded in terms of
debits and credits
company’s balance sheet whereby the total of all the
company’s assets equals the sum of the company’s
liabilities and shareholders’ equity.
Accounting Equation

Assets Liabilities Stockholders’

Equity

Cash Common + Retained

Accounts Payable
+ Stock Earnings
+
Supplies
Notes Payable
+
+ Revenues – Expenses – Dividends
Equipment

Two General formats for balance sheets

a. Report Form presents all the accounts vertically, with the Assets section above
the Liabilities and Equities sections that, together, balance it.

[Name of Company]
Balance Sheet
December 31, 2019
Assets
Cash 10.00
Accounts Receivable 20.00
Total Assets 30.00
 Financial Management 12

Liabilities
Accounts Payable 5.00
Total Liabilities 5.00

Owner’s Equity
Common Stock 25.00
Total Liabilities and Owner’s Equity 30.00

b. Account Form presents the asset accounts on the left side and the liabilities and
equity accounts on the right.

[Name of Company]
Balance Sheet
December 31, 2019
Assets Liabilities
Cash 10.00 Accounts Payable 5.00
Accounts Receivable 20.00 Total Liabilities 5.00

Owner’s Equity
Common Stock 25.00
Total Liabilities and
Total Assets 30.00 30.00
Owner’s Equity

Statement of Comprehensive Income

In the context of corporate financial reporting, the
income statement summarizes a company’s revenues
Fiscal Year is (sales) and expenses quarterly and annually for its
essentially a
customized 12-month fiscal year.
period used for
accounting purposes. Income statements come with various names. The
most commonly used are “statement of income,”
“statement of earnings,” “statement of operations,”
and “statement of operating results.”
Calendar Year is
simply the Forms and presentation of the Statement
conventional year that
begins on January 1 of Comprehensive Income
and ends on
December 31. a. Multi-Step Approach – the statement of
comprehensive income using the multi-step
approach shows the various profitability stages from
gross profit, operating profit up to the net profit
which is essential in terms of cost control and
management.
 Financial Management 13

[Name of Company]
Income Statement
December 31, 2019
( in thousand P )
Sales 785,000
Less: Sales Discount (16,500)
Sales Return & Allowances (53,200) 715,000
Less: Cost of Goods Manufactured & Sold 335,000
Gross Profit 380,300
Less: Selling and Administrative Expenses
Selling Expenses 133,000
Administrative Expenses 165,000 298,000
Net Operating Profit 82,300
Less: Interest Expenses 12,000
Net Profit Before Tax 70,300
Less: Income Taxes (30%) 21,090
Net Profit after Tax 49,210

Supporting Statement:
Cost of Goods Manufactured and Sold
Direct Materials
Raw materials 125,000
+ Raw Materials Purchases 225,000
Total Materials Available 350,000
- Raw Materials, ending 215,000 135,000
Direct Labor 95,000
Factory Overhead 115,000
Total Manufacturing Cost 345,000
Add: Work In Process, beginning 185,000
Total goods placed in process 530,000
Less: Work in process, end 225,000
Total Cost of Goods Manufactured 305,000
Add: Finished Goods, beginning 95,000
Total Goods Available for Sale 400,000
Less: Finished Goods, end 65,000
Cost of Goods Sold 335,000

b. Single Step Approach – The service type

of statement of comprehensive income
The single-step income
was shown using a single step approach as statement offers a
it simply identifies the income that comes straightforward
accounting of the
from professional fee and all expenses financial activity of
grouped together to arrive to a net profit. your business.
 Financial Management 14

[Name of Company]
Income Statement
December 31, 2019
( in thousand P )
Professional Fee 227,500
Less: Operating Expenses
Office Supplies 21,650
Depreciation 10,000
Rent 12,000
Salaries 48,000 91,650
Net Profit Before Taxes 135,850
Less: Income Taxes (30%) 40,755
Net Profit After Tax 95,095

Statement of Changes in Equity

The statement of changes in equity’s purpose is to provide readers with the
useful information on how the capital or fund of an entity is utilized and used and shows
all the changes in the owner’s equity for a period of time.

According to Philippine Accounting Standard #1 (PAS 1), this statement of

financial reporting is one of the five components of complete financial statements
(statement of financial position, income statement, statement of changes in
equity, statement of cash flow and notes to financial statements).

Illustrative Example of the Statement of Changes in Equity

[Name of Company]
Statement of Changes in Equity
December 31, 2019
( in thousand P )
Owner’s Equity
Beginning Balance 400,400
Less: Net Loss 27,190
Total 373,210
Less: Withdrawal 2,500
Total Owner’s Equity 370,710

Illustrative Example of the Statement of Retained Earnings

[Name of Company]
Statement of Retained Earnings
December 31, 2019
( in thousand P )
Retained Earnings, beginning (128,200)
Add: Net Income (Net loss) 670,733
Total 542,533
Less: Dividends -
Retained Earnings, ending 542,533
 Financial Management 15

Financial Statement Analysis

The financial statements of a company record
important financial data on every aspect of a business’s Horizontal, vertical
activities. As such they can be evaluated on the basis of past, and ratio analysis
are three techniques
current, and projected performance. Financial Statement analysts use when
analysis is the process of analysing a company’s financial analyzing financial
statements.
statements for decision-making purposes and identifying
financial strengths and weaknesses of the firm by properly
establishing relationship between the items of the balance
sheet and the income statement account.
What can you look for when reading financial statement
analysis report and how do you use it?
Trend – The results given in generally cover at least the previous three full
accounting years therefore any fluctuations in any area can be easily pinpointed.
Benchmarks – The average results for each ratio together with the industry
profile of the company is the sector can both be used as benchmarks to compare
individual company performance.
Size – All the major companies in the sector are ranked on the basis of sales,
profits, total assets and employee numbers.
Growth – The average annual growth of each company’s sales, profits, total
assets and number of employees over the three-year period being analysed is
calculated and ranked.

Advantages of Financial Statement Analysis

There are various advantages of financial statements analysis. The investors get
enough idea to decide about the investments of their funds in the specific company.
Moreover, company can analyse its own performance over the period of time through
financial statement analysis and the regulatory authorities like International Accounting
Standards Board can ensure whether the company is following accounting standards or
not.

Limitations of Financial Statement Analysis

Although financial statement analysis is highly useful tool, it has two
limitations.
a. Comparison of Financial Data
Comparison of one company to another can provide hints about
the financial health of an organization. However, differences in methods
used by the companies’ sometimes make it difficult to compare its
financial data.

b. The need to look Beyond Ratios

Decisions based on ratios analysis must be considered as
tentative. Ratios should be viewed as indicators of what to pursue in
greater depth.
 Financial Management 16

Tools and Techniques of Financial Statement Analysis

Horizontal Analysis Horizontal Analysis
is facilitated by
Comparison of two or more year’s financial showing changes
between years in
data in known as horizontal analysis, or trend both peso and
analysis. percentage form.

Illustrative Example 1 - Horizontal Analysis of the Balance Sheet

[Name of Company]
Comparative Statement of Financial Position
December 31, 2019 and 2018
( in thousand P )
Horizontal Analysis
2019 2018 Inc (Dec) %
Assets
Current Assets
Cash 90,500 64,700 25,800 39.9%
Marketable Securities 75,000 60,000 15,000 25.0%
Accounts Receivables, net 115,400 120,000 (5,000) -4.2%
Merchandise Inventory 264,000 283,000 (19,000) -6.7%
Prepaid Expenses 5,500 5,300 200 3.8%
Total Current Assets 550,000 533,000 17,000 3.2%

Non-current Assets
Long-term investments 95,000 177,500 (82,500) -46.5%
Property, Plant, and Equipment, net 444,500 470,000 (25,500) -5.4%
Intangible Assets 50,000 50,000 - -
Total Non-current Assets 589,500 697,500 (108,000) -15.5%
Total Assets 1,139,500 1,230,500 (91,000) -7.4%

Liabilities
Current Liabilities 210,000 243,000 (33,000) -13.6%
Long-term Liabilities 100,000 200,000 (100,000) -50.0%
Total Liabilities 310,000 443,000 (133,000) -30.0%

Stockholders’ Equity
Preferred 6% stock, P100 par 150,000 150,000 - -
Common Stock, P10 par 500,000 500,000 - -
Retained Earnings 179,500 137,500 42,000 30.5%
Total Stockholders’ Equity 829,500 787,500 42,000 5.3%
Total Liabilities and Stockholders’
1,139,500 1,230,500 (91,000) -7.4%
Equity

The above shows the changes in 2019 and 2018 by comparing both years.
Horizontal Analysis Formula:
Horizontal Analysis (%) = [(Amount in Comparison Year – Amount in
Base Year) / Amount in Base Year] x 100
For example, Cash in 2019
Horizontal Analysis (%) = [(90,500 – 64,700) / 64,700] x 100
 Financial Management 17

This is also the same formula to follow in doing the horizontal analysis for the
Income Statement as shown below:
Illustrative Example 2 – Horizontal Analysis of the Income Statement
[Name of Company]
Comparative Income Statement
December 31, 2019 and 2018
( in thousand P )
Horizontal Analysis
2019 2018 Inc (Dec) %
Sales 1,498,000 1,200,000 298,000 24.8%
Less: Cost of Goods Sold 1,043,000 820,000 223,000 27.2%
Gross Profit 455,000 380,000 75,000 19.7%
Less: Operating Expenses
Selling Expenses 191,000 147,000 44,000 29.9%
General Expenses 104,000 97,400 6,600 6.8%
Total Operating Expenses 295,000 244,400 50,600 20.7%
Operating Income 160,000 135,600 24,400 18.0%
Other Income 8,500 11,000 (2,500) -22.7%
Less: Other Expenses 6,000 12,000 (6,000) -50.0%
Income before Taxes 162,500 134,600 27,900 20.7%
Less: Income Tax 71,500 58,100 13,400 23.1%
Net Income 91,000 76,500 14,500 19.0%
Vertical Analysis
Vertical analysis is the procedure of preparing and presenting common size
statements. Common size statement is one that shows the items appearing on it in
percentage form as well as in peso form.
Illustrative Example 1 – Common Size Comparative Balance Sheet
[Name of Company]
Common Size Comparative Statement of Financial Position
December 31, 2019 and 2018
( in thousand P )
Common Size %
2019 2018 2019 2018
Assets
Current Assets
Cash 90,500 64,700 7.9% 5.3%
Marketable Securities 75,000 60,000 6.6% 4.9%
Accounts Receivables, net 115,400 120,000 10.1% 9.7%
Merchandise Inventory 264,000 283,000 23.2% 23.0%
Prepaid Expenses 5,500 5,300 0.5% 0.4%
Total Current Assets 550,000 533,000 48.3% 43.3%

Non-current Assets
Long-term investments 95,000 177,500 8.3% 14.4%
Property, Plant, and Equipment, net 444,500 470,000 39.0% 38.2%
Intangible Assets 50,000 50,000 4.4% 4.1%
 Financial Management 18

Total Non-current Assets 589,500 697,500 51.7% 56.7%

Total Assets 1,139,500 1,230,500 100% 100%

Liabilities
Current Liabilities 210,000 243,000 18.4% 19.7%
Long-term Liabilities 100,000 200,000 8.8% 16.2%
Total Liabilities 310,000 443,000 27.2% 36.0%

Stockholders’ Equity
Preferred 6% stock, P100 par 150,000 150,000 13.2% 12.2%
Common Stock, P10 par 500,000 500,000 43.9% 40.6%
Retained Earnings 179,500 137,500 15.7% 11.2%
Total Stockholders’ Equity 829,500 787,500 72.8% 64.0%
Total Liabilities and Stockholders’
1,139,500 1,230,500 100% 100%
Equity

Please note that the figures of each asset account expressed in percentages
is computed as:
Common Size % = each asset item / total assets x 100
Which for example Cash in 2019
Common Size % = 90,500 / 1,139,500 x 100

The same is true with the liabilities and stockholders’ equity account
expressed in percentage:
Common Size % = each liabilities & stockholders’ equity accounts / total
liabilities & Equity x 100
Which for example Current Liabilities in 2019
Common Size % = 210,000 / 1,139,500 x 100
Based on the example illustration above, you can observe significant changes
in current assets in 2019 compared to 2018.
Illustrative Example 2 – Common Size Comparative Income Statement
[Name of Company]
Common Size Comparative Income Statement
December 31, 2019 and 2018
( in thousand P )
Common Size %
2019 2018 2019 2018
Sales 1,498,000 1,200,000 100% 100%
Less: Cost of Goods Sold 1,043,000 820,000 69.6% 68.3%
Gross Profit 455,000 380,000 30.4% 31.7%
Less: Operating Expenses
Selling Expenses 191,000 147,000 12.8% 12.3%
General Expenses 104,000 97,400 6.9% 8.1%
Total Operating Expenses 295,000 244,400 19.7% 20.4%
Operating Income 160,000 135,600 10.7% 11.3%
Other Income 8,500 11,000 0.6% 0.9%
Less: Other Expenses 6,000 12,000 0.4% 1.0%
 Financial Management 19

Income before Taxes 162,500 134,600 10.9% 11.2%

Less: Income Tax 71,500 58,100 4.8% 4.8%
Net Income 91,000 76,500 6.1% 6.4%
In the income statement, the basis of the percentage figure is the net sales.

In the income statement, the basis of the percentage figure is the net sales.
For example, Cost of Goods Sold
Common Size % = Cost of Goods Sold / Net Sales x 100
Common Size % = 1,043,000 / 1,498,000 x 100

Ratio Analysis
The ratio analysis is the most powerful tool of financial statement analysis.
Ratio simply means one number expressed in terms of another. Ratios can be found out
by dividing one number by another number. Ratios show how one number is related to
another.
1. Profitability Ratios
Profitability ratios measure the results of business operations or overall
performance and effectiveness of the firm. Some of the most popular
profitability ratios are as under:
a. Gross profit ratio
Formula: Gross Profit Ratio = (Gross profit / Net sales) x 100
Example:
Total sales=P260,000;Sales returns = P10,000;Cost of goods sold P200,000
Calculation:
Gross profit = [(260,000 – 10,000) – 200,000] = 50,000
Gross Profit Ratio = (50,000 / 250,000) x 100 = 20%
Significance:
Gross profit ratio reflects efficiency with which a firm produces its
products. As the gross profit is found by deducting cost of goods sold from
net sales, the higher the gross profit, the better it is.
b. Net profit ratio
Formula: Net Profit Ratio = (Net Profit / Net sales) x 100
Example: using the same example above except that net profit is P20,000
Calculation:
Net sales = (260,000 – 10,000) = 250,000
Net Profit Ratio = [(20,000 / 250,000) x 100] = 8%
Significance:
This ratio measures the overall profitability and very useful to
proprietors or owners of the company. This ratio also indicates the firm’s
capacity to face adverse economic conditions such as price competition, low
demand and similar situations. The higher the ratio the better is the
profitability.
 Financial Management 20

c. Operating ratio
Formula: Operating Ratio = [(Cost of goods sold + Operating expenses) /
Net sales] x 100
Example:
Cost of goods sold is P90,000 and other operating expenses are P15,000 and
net sales is P150,000
Calculation:
Operating ratio = [(90,000 + 15,000) / 150,000] x 100 = (105,000 / 150,000)
x 100 = 70%
Significance:
Operating ratio shows the operational efficiency of the business. Lower
operating ratio shows higher operating profit and vice versa. It is generally
considered as standard for manufacturing concerns the operating ratio that
ranges between 75% and 80%.
d. Return on Shareholders’ investment or net worth
Formula: Return on shareholders’ investment = [Net profit (after interest
and tax) / Shareholders’ fund] x 100
Example:
Suppose net income in an organization is P30,000 whereas shareholders’
investments or funds are P200,000
Calculation:
Return on shareholders’ investment = (30,000 / 200,000) x 100 = 15%
This means that the return on shareholders’ funds is 15 centavos per peso.
Significance:
This ratio is one of the most important ratios used for measuring the
overall efficiency of a firm. This ratio is of great importance to the present
and prospective shareholders as well as the management of the company.

2. Liquidity Ratios
Liquidity ratios measure the short-term solvency of financial position of
a firm. These ratios are calculated to comment upon the short-term
paying capacity of a concern or the firm’s ability to meet its current
obligations. Following are the most important liquidity ratios.
a. Current ratio
Formula: Current Ratio = Current Assets / Current Liabilities
Example:
Current assets are P600,000 and total current liabilities are P 300,000
Calculation:
Current Ratio = P600,000 / 300,000 = 2 : 1
Significance:
This ratio is a general and quick measure of liquidity of a firm.it is an
index of the firm’s financial stability, technical solvency and strength of
working capital. A ratio equal to or near 2 : 1 is considered as a standard or
normal or satisfactory. The idea of having double the current assets as
compared to current liabilities is to provide for the delays and losses in the
realization of current assets.
 Financial Management 21

b. Liquid / Acid Test / Quick ratio

Formula: Liquid Ratio = Liquid Assets / Current Liabilities

Example:
Cash P90 Accounts Payable P350
Inventory P900 Notes Payable P500
Accounts Receivable P730 Accrued Expenses P75
Marketable Securities P800 Tax payable P550
Calculation:
Liquid Assets = P90 + 730 + 800 = P1,620
Current Liabilities = P350 + 500 + 75 + 550 = P1,475
Liquid Ratio = 1,620 / 1,475 = 1.10 : 1
Significance:
The quick ratio/ acid ratio measures the firm’s capacity to pay off
current obligations immediately and is more rigorous test of liquidity than
the current ratio. It is more rigorous test of liquidity than the current ratio
because it eliminates inventories and prepaid expenses as a part of current
assets. As a convention, generally, a quick ratio of “one to one” (1:1) is
considered to be satisfactory.

Application Financial Statement Preparation

Shinhwa Corporation had the following assets, liabilities,
revenues and expenses as of December 31, 2019 and the
accounts are listed below in alphabetical order.

Accounts receivable P28,000 Office equipment P59,500

Accounts payable 37,000 Office supplies 5,000
Building 45,000 Service revenue 130,000
Cash 80,000 Supplies expense 8,000
Commission expense 20,500 Utilities expense 8,500
Common stock 22,000 Wage expense 11,500
Interest payable 1,500 Land 40,000
Beginning retained earnings was P120,000 and dividends were P5,000 for the year.
Instructions: Prepare the income statement, statement of retained earnings, and
statement of financial position for Shinhwa Corporation for the current year.

You have just finished this module. You

are now ready for the next module. Good
luck!
 Financial Management 22

You have completed the first module of Financial Management. Key points
covered in the module include:
 Financial management is a functional unit of a business organization that sets
policies towards organizing, planning, controlling and directing the use of the
company’s financial resources.
 Functions of financial management in various areas that affecting the
management financial decisions.
 Concepts in Financial Management for efficient planning and control of funds
inflow and outflow.
 Analyse and understand the structure of the financial statements
 Accurate Financial Reporting
 A financial manager is a person who takes care of all the important financial
functions of an organization.
 A cash flow statement is a financial statement that summarizes the amount of
cash and cash equivalents entering and leaving a company.
 The financial statements are used by investors, market analysts, and creditors
to evaluate a company’s financial health and earnings potential.
 The primary financial statements are the statement of financial position (i.e.,
the balance sheet), the statement of comprehensive income (or two statements
consisting of an income statement and a statement of comprehensive income),
the statement of changes in equity, and the statement of cash flows.
 The statement of changes in equity provides information about increases or
decreases in the various components of owners’ equity.
 Uses, advantages, limitations, and tools and techniques of financial Statement
Analysis
 The financial statement analysis framework provides steps that can be
followed in any financial statement analysis project. These steps are:
o articulate the purpose and context of the analysis;
o collect input data;
o process data;
o analyse/interpret the processed data;
o develop and communicate conclusions and recommendations; and
o follow up.
 Financial Management 23

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Financial Statement Analysis. Retrieved from
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August 7, 2020
Introduction to Balance Sheet. Retrieved from
https://www.accountingcoach.com/balance-sheet/explanation; on August 5, 2020
Limitations of Financial Statement Analysis. Retrieved from
https://accountlearning.com/limitations-of-financial-statement-analysis/; on August 7,
2020
Pineda, A. (2019). Basic Financial Management. ISBN: 978-621-406-200-3.
Mindsahpers Co., Inc.
Single-Step vs Multi-Step Income Statement: Key Differences for Small Business
Accounting. Retrieved from
https://www.freshbooks.com/hub/accounting/single-step-vs-multi-step-income-
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https://www.investopedia.com/investing/what-is-a-cash-flow-statement/;
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August 4, 2020
What is Operating Cash Flow? Retrieved from
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flow/; on August 4, 2020
 Financial Management 24

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