FIN 081: P1 LESSON Sole Proprietorship - a business owned by one

individual.

DAY 1-2 - Ease of formation

- Subject to few regulations
Finance - is the system that includes the circulation of
- Difficult to raise capital
money, the granting of credit, the making of
- Unlimited liability
investments, and the provision of banking facilities. It
has three areas: Partnership - a business owned by two or more persons.

Financial Management - also called corporate - No corporate income taxes

finance, focuses on decisions relating to how much and - Limited life
what types of assets to buy, how to raise capital needed Corporation - a legal entity created by a state, separate
to buy assets, and how to run the firm so as to maximize and distinct from its owners and managers.
its value.
- Unlimited life
Capital Markets - relate to the markets where interest - Easy transfer of ownership
rates, along with stock and where-bond prices are - Limited liability
determined. Also studied are the financial institutions - Ease of raising capital
that supply capital to businesses. - Double taxation

Investments - relate to decisions concerning stocks and - Cost of setup and report filing

bonds and include a DAY 3

number of activities: (1) security analysis; (2) portfolio
1. STOCKHOLDER-MANAGER CONFLICTS
theory; (3) market analysis
Managers are naturally inclined to act in their own best
Based on the terms above, what do you think are the
interests, which are not always the same as the interest of
possible jobs related to finance?
stockholders. They might be more interested in
How can does finance help business organizations? maximizing their own wealth than their stockholders'
wealth; therefore, managers might pay themselves
Finance prepares students for jobs in banking,
excessive salaries.
investments, insurance, corporations, and government. It
is the managers' financial goal to promote stockholder However, good executive compensation plans can
value by maximizing their wealth. motivate managers to act in their stockholders' best
interest.
What are the different forms of business organizations?
How do they differ? These may include the following:

a. Reasonable compensation packages - compensation

packages should be sufficient to attract and retain able
Forms managers, but they should not go beyond what is

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needed; must also be structured so that managers are
rewarded on the basis of the stock's performance over
the long run, not the stock's price on an option exercise
date.
b. Firing of managers who don't perform well
c. The threat of hostile takeovers - happens when a
company is acquired by outside parties against the will
of its management.
o Managers should try to maximize their stock's
intrinsic value and then communicate effectively
with stockholders. That will cause the intrinsic
value to be high and the actual stock price to
remain close to the intrinsic value over time.
Consider the scenario:
Suppose a company has the chance to make an
investment that will result to a profit of P10 billion if it
becomes successful but the company will be worthless
and go bankrupt if the business is unsuccessful. The firm
has bonds that pay an 8% annual interest rate and have
a value of P1,000 per bond and stock that sells for P10
per share. If the new project is successful, the price of
the stock will jump to P2,000 per share, but the value of
the bonds will remain just P1,000 per bond. The
probability of success and failure is 50%-50%.
At whose point of view do you think this project looks
appealing? What made you come up with your
decision?
As a result of the situation above, the expected stock
price is Expected stock price
0.5(P2,000)+0.5(P0)=P1,000
versus a current price of P10. The expected percentage
gain on the stock is expected percentage gain on stock
= (P1,000-P10)/P10x 100%=9,900%
2. STOCKHOLDER-DEBTHOLDER
CONFLICTS
STOCKHOLDERS - more likely to prefer riskier
projects because they receive more of the upside if the
project succeeds.
DEBTHOLDERS - receive fixed payments and are
more interested in limiting risk.
- Particularly concerned about the firm's use of
additional debt.
- Attempt to protect themselves by including
covenants in bond agreements that limit the use
of additional debt and constrain managers'
actions.
Business Ethics can be thought of as a company's
attitude and conduct toward its employees, customers,
community, and stockholders. It is important to observe
and follow ethical behaviour in business so that frauds,
misleading accounting practices, etc. can be avoided and
punished appropriately.
DAY 4
Common-size analysis expresses line items or accounts
in the financial statements as percentages.
The two major forms of common-size analysis are
horizontal analysis and vertical analysis.
Horizontal analysis
- Also called trend analysis, expresses a line item
as a percentage of some prior-period amount.
= - This approach allows the trend over time to be
assessed.
- In horizontal analysis, line items are expressed
as a percentage of a base period amount.
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 - The base period can be the immediately
preceding period, or it can be a period further in
the past.
Vertical Analysis
- Expresses the line item as a percentage of some
other line item for the same period.
- With this approach, within-period relationships
can be assessed.
- Line items on income statements often are
expressed as percentages of net sales.
- Items on the balance sheet often are expressed as
a percentage of total assets.
How do Horizontal Analysis and Vertical Analysis
differ?,
- While horizontal analysis involves relationships
among items over time, vertical analysis, is
concerned with relationships among items
within a particular time period.,
What is Ratio Analysis?
Ratio analysis is the second major technique for
financial statement analysis.
- Ratios are fractions or percentages computed by
dividing one account or line-item amount by
another.
- For meaningful analysis, the ratios should be
compared with a standard. Only through
comparison can someone using a financial
statement assess the financial health of a
company.
- Two standards commonly used are the past
history of the company and industrial averages.
- Ratios are classified into three categories :
Liquidity ratios, Leverage ratios,
Profitability ratios.
Liquidity Ratios
- Used to assess the short-term debt-paying ability
of a company
Current ratio - a measure of the ability of. a company
to pay its short-term liabilities out of short-term assets.
Formula:
Current ratio = Current assets/Current liabilities
Quick or acid-test ratio - a measure of liquidity that
compares only the most liquid assets with current
liabilities.
- Excluded from the quick ratio are non-liquid current
assets such as inventories.
- The numerator of the quick ratio includes only the most
liquid assets (cash, marketable securities, and
accounts receivable).
Formula:
Quick ratio = (Cash 十 Marketable securities
+Accounts receivable)/Current liabilities
Accounts receivable turnover ratio - measures the
liquidity of receivables or how long it takes for the
entity to turn its receivables into cash.
- a low turnover ratio may suggest a need to modify
credit and collection policies to speed up the conversion
of receivables to cash.
Formula: ARTR = Net credit sales/Ave. accounts
receivable
Ave.AR = (Beginning AR +Ending AR)/2
Accounts receivable turnover in days = 365/Accounts
and receivable turnover ratio
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Inventory turnover ratio - Tells how many times the
average inventory turns over, or is sold, during the year.
-a low turnover ratio may signal the presence of too
much inventory or sluggish sales.
Formula: ITR = Cost of goods sold/Ave. inventory
Ave. Inventory
= (Beginning Inventory + Ending Inventory)/2
Inventory turnover in days
=365/Inventory turnover ratio
DAY 5
LEVERAGE RATIOS
- can help an individual to evaluate a company's
debt-carrying ability
- measure the ability of a company to meet its
long- and short-term obligations
- provide a measure of the degree of protection
provided to a company's creditors
Times-interest- earned ratio - uses the income
statement to assess a company's ability to service its debt
- Income before taxes must be recurring income; thus,
unusual or infrequent items appearing on the income
statement should be excluded in order to compute the
ratio
Formula: Times-interest earned ratio = (income
before taxes+ Interest expense)/Interest expense
Debt ratio - measures the degree of protection afforded
to creditors in case of insolvency
- If this percentage is exceeded, the company is in
default, and foreclosure can take place.
Formula: Debt ratio = total liabilities/total assets
Debt-to-equity ratio - compares the amount of debt that
is financed by stockholders
- Creditors would like this ratio to be relatively
low, indicating that stockholders have financed
most of the assets of the firm
- Stockholders, on the other hand, may wish this
ratio to be higher because that indicates that the
company is more highly leveraged and
stockholders can reap the return of the creditors'
financing.
Formula:
Debt-to-equity ratio = Total liabilities/Total
stockholders' equity
PROFITABILITY RATIOS -give an idea how
profitably the firm is operating and utilizing its assets
Return on Sales- is the profit margin on sales
- represents the percentage of each sales pesos
that is left over as net income after all expenses
have been subtracted
Formula: Return on sales =Net income/Sales
Return on Total Assets - measures how efficiently
assets, are used by calculating the return on total assets
used to generate profits
Formula:
Return on assets = {Net income + [Interest expense
(1- Tax rate)]}/Average total assets
Average total assets = (Beginning total assets +
ending total assets)/2
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Return on Common, stockholders equity - provides a reasonable approximation of the total return accruing to
measure that can be used to. compare against other an investor can be obtained.
return measures (e.g., preferred dividend rates and bond
- tells an investor the proportion of earnings that a
rates)
company pays in dividends.
- of special interest to common ¹stockholders is how they
Formula:
are being treated relative to other suppliers of capital
funds. Dividend yield = Dividends per common
share/Market price per common share
Formula:
Dividend payout ratio = Common
Return on common stockholders' equity = (Net
dividends/(Net income preferred dividends)
income - Preferred dividends) /Average common
Does ratio analysis have limitations?
stockholders' equity
 Ratio analysis is more useful for narrowly
Earnings per share - Investors also pay considerable
focused firms than for multidivisional ones.
attention to a company's profitability on a per-share
 Most firms want to be better than average, so
basis.
merely attaining average performance is not
- Average common shares outstanding is
necessarily good.
computed by taking a weighted average of the
 Inflation has distorted many forms' balance
common shares for the period under study.
sheets - book values are often different from
Formula: market values.
 Seasonal factors can also distort ratio analysis.
Earnings per share = (Net income - {referred
 Firms can employ “window dressing" techniques
dividends)/Average Common shares
to improve their financial statements.
Price earnings ratio-viewed by many investors as  Different accounting practices can distort
important indicators of stock values comparisons.
- should be interpreted with caution since it is  It is difficult to generalize about whether a
comprised of stock price, which is a number that particular ratio is “good” or “bad”.
can be manipulated to meet certain targets  Firms often have some ratios that look “good”
involving analyst expectations, managerial and others that look “bad”, making it difficult to
bonuses, and other organizational goals tell whether the company is, on balance, strong
or weak.
Formula: Price-earnings ratio = Market price per
share/Earnings per share

Dividend Yield and Payout Ratios - By adding the

dividend yield to the percentage change in stock price, a
DAY 6
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What is Forecasting? In general, there are two approaches to forecasting:
qualitative and quantitative (Shim et al.,2006).
- a projection of future sales, revenues, earnings,
costs and other possible variables that are Qualitative (or judgment) forecasts.
helpful in the firm's operations
Incorporate factors such as the decision maker's
- primary objective is to reduce the risk or
intuition, emotion, personal experiences, and value
uncertainty that the firm will face in making
system; useful in formulating short-term forecasts.
decisions
Qualitative Forecasting Methods
- the starting point of business planning (Brigham
and Houston,2011) Expert Opinions -The views of the managers or a group
with a high level of expertise, often in a combination
Who uses forecasting as a tool for decision-making?
with statistical models, are synthesized to generate a
Top Management - makes use of the forecast as a tool
consensual forecast.
for long-range planning, particularly in providing a basis
Delphi Method -Similar to the expert opinion except
for performance targets, implement, long-range strategic
that members of a group of experts are asked
objectives, and making capital budgeting, decisions
individually through a questionnaire about their forecast
Production Manager - Utilizes the forecasts to
of future events
determine the amount of raw materials that will be
- Useful for long-range forecasting and the results
needed in production, the budget, schedule of production
are not by the group or by strong leadership
activities, inventory levels to maintain so as not to
disrupt the production, labour hours, and the schedule of Sales Force Polling - Every sales person estimates the
shipments sales in his or her region; the responsibility of drawing
up the forecast lies with the people who will actually
Purchasing Manager - Uses the forecast to ascertain
work for the forecasted value; simple and practical
the volume or bulk of materials that should be purchased
for a particular period Consumer Market Surveys - Firms, at times, conduct
their own or potential customer surveys to accumulate
Marketing Manager - Makes use of the forecast to
information regarding future purchasing plans. Surveys
estimate how much sales should be made in a particular
can help not only in preparing a forecast but also in
period, and to plan promotional and advertising activities
improving product design, planning for new products.
for the products
and determining consumer behaviour.
Finance manager - Uses the forecast to anticipate the
PERT-derived Forecasts - Program Evaluation and
funding needed by the firm
Review Technique methodology requires that the expert
Human resource manager - Utilizes the forecast to
provide three estimates: pessimistic (a the most likely
supply the human resource needed in achieving the
(m), and optimistic (b). the theory suggests that these
firm's objectives
estimates combine to form an expected value, or
FORECASTING APPROACHES Forecast, as follows: EV=(a+4m+b)/6
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with a standard deviation of
o=(b-a)/6 where
EV = expected value (mean) of the forecast
O' = standard deviation of the forecast
- It is often easier and more realistic to ask the
expert to give optimistic, pessimistic, and most
likely estimates than a specific forecast value
- Includes measure of dispersion (the standard
deviation), which makes it possible to develop
probabilistic statements regarding the forecast
DAY 7
Quantitative Forecasts
Use a variety of mathematical models that rely on
historical data and/or causal variables to forecast demand
a. Time series forecasting- assumes the future is a
function of the past. Thus. historical data are used to
predict the future using sequences with equal periods.
Decomposition of a Time Series Forecast
Analyzing a time series means breaking down past data
into components and then projecting them forward.
Trend -the gradual upward or downward movement of
the data over time.
Seasonality -data pattern that repeats itself after a period
of days, weeks, months or quarters.
Cycle - a pattern of data that occurs every several years;
usually associated with the
business cycle and is very important in short-term
business analysis and planning
Random variations - “blips” in the data by chance and
unusual situations
b. Associative or causal models - such as linear
regression, incorporate the variables or factors that might
influence the quantity being forecasted
Time Series Forecasting
Naïve model -assumes that demand in the next period
will be equal to the demand in the most recent period
Moving average - the number of period, n, in which a
series of averages will be created and computed, should
be decided averages are immediately updated as new
information becomes available
- All data in the sample are weighted equally
Weighted moving average-more powerful and
economical compared with moving average
- widely used where repeated forecasts require the
application of methods like sum-of-the-digits
and trend adjustment methods
Exponential smoothing-uses the weighted moving
average method where more weight is given to the recent
data
- supported by the belief that the future is more
dependent on the recent past than the distant past
- Useful on random historical with no seasonal
fluctuations
Trend projections - fits a trend line to a series of
historical data points and then projects into the future
for medium-to-long range forecasts
Associative or Causal Models
Regression analysis -shows the relationship between
two variables: the dependent and independent; the
same mathematical model employed in the least
squares method of Trend projection can be used.
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CORRELATION COEFFICIENTS FOR REGRESSION LINES

 expresses the degree or strengths of the linear

relationship; usually identified as r, and can be
any number between +1 and-1

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