BUSFIN (Business Finance)

LESSON 3
Working Capital and Cash Flow Management

Objectives
After studying this chapter, you will be able to:
1. Understand the importance of working capital.
2. Apply simple financial planning models.
3. Discuss cash flow and accounts receivable management.
4. Compute time value of money.

Customers can be provided with quality products and services if the company has
adequate fund to finance day-to-day operations. This funding requirement is covered by
the firm’s working capital.

Working Capital
Customers can be provided with quality products and services if the company has
adequate fund to finance day-to-day operations. This funding requirement is covered by
the firm’s working capital.

Working capital is a portion of the firm’s capital continuously converted into cash fund,
from its inventories, to accounts receivables to cash. It may include – firm’s safe cash,
checks for encashment, bank account balances, marketable securities, notes and
accounts receivables, supplies, inventories, prepaid expenses, and deferred items.

• Current Assets – Current Liabilities = Working Capital

Why does a firm need working capital?

1. For inventory replenishment. In order to have sufficient stock of inventory to attain
the sales goal, and to serve the customers demand.
2. As provision for operating expenses. For the day-to-day transactions. Intended to
back-up salaries and wages of employees, interest payments, insurance
premiums, taxes and licenses, or advertising budget.
3. Serves as a back-up for credit sales. Under cases where the firm needs to maintain
its operations until receivables are converted into cash.
4. As provision for a safety margin. Unexpected expenses, possible delays in cash
inflow, or decline in revenue.

Liquidity Management. Activities geared towards achieving the liquidity objectives of the
firm. It requires maintenance of sufficient amount of cash to cover the cash requirements
of the company, from various sources, including: cash sales, collection of accounts
receivables, loans, sale of assets, ownership contribution, or advances from customers.

Financial Planning. Refers to the process of determining the best uses of the financial
resources of an organization to attain its predetermined objectives and the procurement
of the required funds at the least cost. It formulates the way in which financial goals are
to be achieved. Financial planning requires preparation of a budget, or a plan in
quantitative terms or money form. It may include budgets for profit plan, capital
expenditures, or cash budgets. This will guide on what goals they need to achieve. This
will make the company aware of their limitations, to ensure operations are in accordance
with plans and directed toward predetermined objectives.

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Example:
• Suppose sales increase by 20%. Financial planning would then also forecast a
20% increase in costs. Therefore, Pro Forma Financial Statements, based on
financial planning, shall be:

Exercise:
1) Beta Corporation has predicted a sales increase of 22%. It has predicted that all
items in the balance sheet will also increase by 22% as well. Create the pro-forma
financial statements and reconcile them. Show computation.
• Pro-forma Income Statement
• Pro-forma Balance Sheet

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Cash budget. Shows estimated cash receipts and disbursement and the ending cash
balance. This will provide information, in advance, possible cash deficiency or excess
funds to serve as guide for appropriate decisions to make.

Cash Flow is the continual movement of money throughout the enterprise during any
period of time. The basic method of controlling cash is to forecast over the period ahead,
the cash which is expected to arrive, and to deduct from this cash the amount which is
anticipated to be spent.

Accounts Receivable are money owed to a business from the sale, on credit, of goods
or services in the normal course of business.
• Trade credit. Refers to credit sales made to other businesses.
• Consumer credit. Refers to a credit sale made to individuals.
• Inevitably, some accounts will prove difficult to collect and the company will need
to take steps to recover the amount – that is, the company will adopt a collection
policy.
• Collection policy may begin with:
• Standard reminder notice;
• Followed by personal letters, telephone calls, and eventually by personal
visits;
• The last resort is a legal action.

Benefits and Costs of granting credit:

1. Increased in sales and profit.
2. Opportunity cost of investment.
3. Cost of bad debts and delinquent accounts.
• Delinquent accounts – are those where payments have not been made on
due dates.
• Bad debts – are those accounts which have proven to be uncollectible and
are written off.
4. Cost of administration – the processing and collection.

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 5. Cost of additional investment – acquisition of plant and equipment to increase
sales.

Company’s Credit Term

Credit period is the period between the date that a buyer is invoiced and the date when
payment is due.
Discount period is the number of days during which a discount for prompt payment is
available to the buyer.
Discount rate is an expression of the price reduction a buyer will receive if payment is
made within the discount period.
• Example:
• n/30 - no discount, the credit period is 30 days.
• 2/10, n/30 - discount rate is 2%, discount period is 10 days, credit period is
30 days, no discount if paid after 10 days.
• On March 31, Company B purchased goods on credit worth P100 from
Company A.
• How much would Company B have to pay if account is paid by April
10?
• How much would Company B have to pay if account is paid after
April 10?

A discount is offered to accelerate business cash inflow and to improve its competitive
position. Earlier payments by customers will reduce the amount that a company has tied
up in receivables, and will also reduce the incidence of bad debts and delinquent
accounts.

Time Value of Money

Value of money, at present and in the future, can be influenced by some economic factors,
inflation, cost of goods, or buying power of peso. It may capture concepts such as: money
we have now, at the present, can be invested, which can yield higher amount in the future.
Finance managers are tasked with mentally moving money between the present and the
future. Money that the firm has today should not be left idle or it will lose real value. It

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should be put to work earning interest or creating income for the firm. Company should
plan for future investment and expenditure.

Future Value
Describes the amount of money one could expect to have in the future, with its known
present value. It includes the total amount of the principal and interest. Also known as
“maturity value of money.”

Interest
Is the fee that a borrower or debtor has to pay the lender or creditor, for assuming the risk
of the loan, for current use of a certain sum of money. Simple interest is expressed as an
annual percentage, even if the period of the loan is not exactly a year.
• Interest
• I = PRT
• Where:
• I – Interest earned
• P – Principal (amount borrowed/loaned)
• R – Rate of interest (expressed as an annual percentage rate)
• T – time of the loan (expressed as component of a year)

• Example:
If Ms. Santos borrowed P50,000 at 8% interest for 1 year, the simple interest would
be:
• I = PRT
• I = (P50,000) (8%) (1)
• I = P4,000
• Maturity Value = P + I
• MV = P50,000 + P4,000 = P54,000

Present Value
How much do we need today in order to purchase the item in the future?
• This is the question asked under the concept of money’s present value.
• PV = MV x TV (n,i)
• Where:
• PV – the present peso amount that needs to be invested or the
principal
• MV – the maturity value desired
• i – interest rate
• n – number of compounding periods (number of years)
• Example:
Supposing, Jenny Rose’s parents estimate that 5 years from now they will need
P50,000 to pay the first year of tuition at a university Jenny Rose is interested in
attending. How much must they invest today in a 5-year certificate of deposit that
offers 6% interest rate?
• PV = MV x TV (n,i)
• PV = P50,000 x 0.74726 (refer to the Table of Present Value to be received
after t periods)
• PV = P37,363 (the amount of money they need to invest today)
• The value of the interest earned during the 5-year period is P12,637
(P50,000 – P37,363)

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 Present Value of P1 to be received after t periods

Annuity
Annuity is a series of cash flows of equal amount, equally spaced in time.
• Example:
• P5,000 to be paid every month for a year.
• P6,000 to be paid per week for 12 weeks.
• P25,000 to be paid per year for 10 years.
• Annuity Due
• Annuity where the first cash flow or payment made at the beginning of the
period.
• Ordinary Annuity
• Payments that occur at the end of the first time period.
• Annuity tables are based on ordinary annuity.
• Present Value of an Ordinary Annuity (Discounted Cash Flow)
• PVA = R (IF)
• Where:
• R = value of each payment
• IF = present value annuity interest factor at i% n years
• Example:
• Find the present value of an ordinary annuity of P5,000 per year for
4 years if the interest rate is 8% per year.
• PVA = R (IF)
• PVA = P5,000 x 3.3121 (refer to Table of Present Value of Annuity
per period for t periods)
• PVA = 16,560.50

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Future Value of Annuity
It is also necessary to calculate the value of an annuity at the date of the final cash flow.
This calculation is known as the Future Value of Annuity, such as regular savings made
towards a target future sum, or periodic payments for amortization or installment
payments.
• Future Value of Annuity
• CVA = R x IF
• Where:
• R = value of each payment (?)
• IF = present value annuity interest factor at i% n years
• R = CVA / IF
• Example:
Find out how much should you set aside to your savings deposit at 8%
interest for 5 years to accumulate P100,000 at the end of 5 years.
• R = CVA / IF
• R = P100,000 / 5.8666 (refer to Table of Future Value of Annuity per
period for t periods)
• R = 17,045.65 (must be saved at the end of each year for 5 years to
accumulate P100,000 at 8%.)

Future Value of an Annuity of P1 per period for t periods

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 BUSFIN (Business Finance)
LESSON 4
Financial Analysis

Objectives
After studying this chapter, you will be able to:
1. Identify the steps in analysis of financial information.
2. Understand managerial and financial accounting.
3. Discuss basic financial statements.
4. Discuss financial ratios.

Analysis of financial information

One final step in understanding business finance is the analysis of
financial information. The prerequisite to this analysis is knowing and
understanding available information and drawing logical conclusions.
• Steps:
• The Information must be understood by the user.
• The information must be organized using some financial data
and statements.
• The information must be measured, then interpreted.

Managerial and Financial Accounting

Accounting is the process of collecting, reporting, and analyzing the costs
associated with operating a business. It is a system that communicates
important information about the company’s operations. There are internal
and external users of the accounting information.

Financial Accounting provides information to enable stockholders,

creditors, and other stakeholders to make informed decisions. This
information can be used to evaluate and make decisions for an individual
company or to compare two or more companies. (External use).
Managerial Accounting provides information to managers and other
users within the company in order to make more informed decisions. Its
main objective is to provide useful information to managers to assist them
in the planning, controlling, and evaluating roles. (Internal use).

Finance is the process of obtaining and employing assets that allow the
firm to continue and expand operations. Finance Manager is responsible
for maintaining the steady supply of cash needed to sustain operations
while minimizing the cost of keeping those funds.

The Basic Financial Statements

1. Balance sheet is a financial statement that presents all the assets
of, and claims against, or the liabilities and equity, of the firm at a
particular period of time. • Where: Assets = Liabilities + Owner’s
Equity
The balance sheet as summary of all the amounts and kinds of

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 assets that the firm possesses, as well as the claims made against
those assets by investors and creditors, include the following
accounts concepts:
• Current Asset. Is the one that can be converted into cash in
the normal operation of the firm within one year. Example:
Cash, Accounts Receivable
• Fixed Assets. Are permanent assets that will not normally be
converted into cash. A.k.a. Capital Assets, Non-current
Assets. On the balance sheet, fixed assets are shown at
historical cost, which is the amount actually paid for the asset.
Example: Property, Plant, and Equipment
• Market Value of the asset. Is the price the asset could
command in the market. It represents the price an asset
would get in the marketplace. Is the worth of a company
based on the total value of its market capitalization.
• Book Value of the asset. The value of the assets shown on
the financial reports and the books of the company.
• Current Liabilities. Are those that the firm reasonably expects
to pay within the next year. Company’s short-term financial
obligations. Example: accounts payable, notes payable.

2. Income Statement measures the profit or loss that an organization

has made over a set of period of time, quarterly or a year.
• Where: Income/Loss = Revenue - Expenses
Profit occurs when the revenues excess expenses. The bottom line
of the statement is either a net income or net loss. The income
statement, which presents the record of the firm’s sales and
expenses over a particular period, identifying the income derived
from its operations, and all of the charges incurred to generate the
income, include the following accounts concepts:
The income statement begins with a report of the peso volume of
sales. • Cost-of-goods sold. All costs of producing the product
for sale. • Earnings before tax. Is a calculation of a firm’s
earnings before taxes are
considered. It shows the company’s earnings with the cost
of goods sold and other operating expenses deducted from
gross sales.
• Earnings after tax. Subtracting taxes from EBT.
• Cash Flow. Refers to the actual payment of cash or cash
equivalents. Cash flow is very important because only cash
allows the firm to meet its own obligations.
3. Cash Flow Statement is the overview of the company’s financial
health. This gives data on the cash provided or used in operating
activities.

4. Statement of Changes in Financial Condition also known as the

statement of owners’ equity or statement of stockholders’ equity.
This describes the effect of operations on the cash position of the
company, the effect of operations and financing decisions to the
change in owners’ equity. This acts as the link between the income

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 statement and the equity portion of the balance sheet.

Financial Ratios
Financial ratios are indices used in expressing financial data in such a way
that it can be compared and trends identified and thus questions can be
raised. Ratios should be used to build up and summarize the evidence
available and to create a picture from which, not conclusions, but better
questions can be drawn.

1. Liquidity Ratios
Liquidity is the ability of the assets to be converted quickly into
cash. Ideally a company wants to be liquid to meet current debts.
Commonly used ratios to measure liquidity are:

2. Activity Ratios
are related to operations and operating efficiency because they
measure how quickly the firm is converting assets into cash. The more
quickly the firm is able to move through the cycle from inventory to
accounts receivable to cash, the more profit they are likely to receive
per peso.

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3. Leverage Ratios.
It is the responsibility of the financial manager to determine the level
of debt that is appropriate for the firm. If the firm can earn more than
the cost of loan interest, it may be worth securing additional loan or
leveraging the firm.

4. Profitability Ratios.
Since the goal of most companies is to earn profit, these ratios
are the most important to financial managers.

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