THE FINANCIAL ENVIRONMENT

WEEK 1
 WHAT IS FINANCE?
The science and art of managing money
• At the personal level, finance is concerned with individuals’
decisions about how much of their earnings they spend, how
much they save, and how they invest their savings.

• In a business context, finance involves the same types of

decisions: how firms raise money from investors, how firms
invest money in an attempt to earn a profit, and how they decide
whether to reinvest profits in the business or distribute them
back to investors.
 THREE AREAS OF FINANCE WITHIN
THE FINANCIAL SYSTEM

✓ Financial Institutions

✓ Financial markets

✓ Financial Management
Areas of Finance within the Financial System
FINANCIAL INSTITUTIONS: Help the financial system
operate efficiently and transfer funds from savers to
investors.

FINANCIAL MARKETS: Forums in which suppliers of

funds and demanders of funds can transact business
directly. (ex. money market and capital market)

FINANCIAL MANAGEMENT: Involves financial planning,

asset management, and fund raising decisions to enhance
firm value

4
 FOUR PILLARS OF FINANCE
• Money has a time value
• Higher Returns are expected for taking on
more risk
• Financial markets are efficient in pricing
securities
• Reputation matters
 TIME VALUE OF MONEY
• Money in hand today is worth more than
the promise of receiving the same amount
of money in the future

• Time value of money exists because a

sum of money today could be invested
and “grow” over time
 RISK-RETURN TRADEOFF

• Risk is the uncertainty about the outcome

or payoff of an investment in the future

• Rational investors would choose a riskier

investment only if they feel the expected
return is high enough to justify the greater
risk
 EFFICIENT FINANCIAL MARKETS
• A financial market is “information efficient” if
at any point in time the prices of securities
reflect all information available to the public

• When new information becomes available,

prices quickly change to reflect that
information

• Information efficient markets provide liquidity

and fair prices
 REPUTATION MATTERS!
• Ethical Behavior:
How an individual or organization treats
others legally, fairly, and honestly.

• High reputation value reflects high

quality ethical behavior, so employing
high ethical standards is the “right” thing
to do
MANAGERIAL FINANCE FUNCTION:
RELATIONSHIP TO ACCOUNTING

• One major difference in perspective and

emphasis between finance and accounting is
that accountants generally use the accrual
method while in finance, the focus is on cash
flows.
Whether a firm earns a profit or
experiences a loss, it must have a sufficient
flow of cash to meet its obligations as they come due.
MANAGERIAL FINANCE FUNCTION:
RELATIONSHIP TO ACCOUNTING
Finance and accounting also differ with respect to
decision-making:

• Accountants devote most of their attention to the

collection and presentation of financial data.

• Financial managers evaluate the accounting

statements, develop additional data, and make
decisions on the basis of their assessment of the
associated returns and risks.
 The Goal of the Financial Manager
❖ The goal of the financial manager must be consistent with the mission of the
corporation, which is to maximize shareholder’s wealth.

❖ While shareholder wealth maximization is the goal of the company, it also

includes other broader goals (such as social responsibility) that will ultimately
benefit shareholders in the long-run.

❖ While managers have to cater to all the stakeholders (such as consumers,

employees, suppliers etc.), they need to pay particular attention to the
shareholders.

❖ If managers fail to pursue shareholder wealth maximization, they will lose the
support of investors and lenders. The business may cease to exist and ultimately,
the managers will lose their jobs!
Thank you

The end
ACC C204 – FINANCIAL
MANAGEMENT
Financial Analysis:
Sizing up Firm
Performance

Weeks 2-3

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 FINANCIAL STATEMENT ANALYSIS

➢ It yields important information about the

strengths and weaknesses of a firm’s
financial condition.

➢ It involves analyzing past performance to

predict future cash flows.

➢ Use to evaluate firm’s financial

performance in light of its competitors
and determine how the firm will improve
its operation.
 The Four Key Financial Statements:
The Income Statement

• The income statement provides a financial

summary of a company’s operating results during
a specified period.
• Although they are prepared annually for reporting
purposes, they are generally computed monthly by
management and quarterly for tax purposes.

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 The Four Key Financial Statements:
The Balance Sheet

• The balance sheet presents a summary of a

firm’s financial position at a given point in time.

• The statement balances the firm’s assets (what it

owns) against its financing, which can be either
debt (what it owes) or equity (what was provided
by owners).

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 The Four Key Financial Statements:
Statement of Retained Earnings

The Statement of Retained Earnings

reconciles the net income earned during a
given year, and any cash dividends paid, with
the change in retained earnings between the
start and the end of that year.

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 The Four Key Financial Statements:
Statement of Cash Flows

• The statement of cash flows provides a summary of

the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash and
marketable securities during the period.
• The statement also provides insight into a company’s
investment, financing and operating activities, but also
ties together the income statement and previous and
current balance sheets.

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 Basics of Financial Statement Analysis

Analyzing financial statements involves:

Characteristics Comparison Tools of

Bases Analysis

◆ Liquidity ◆ Intracompany ◆ Horizontal

◆ Profitability ◆ Industry ◆ Vertical

averages
◆ Solvency/leverag ◆ Ratio
e ◆ Intercompany

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 Basics of Financial Statement Analysis
Ratio analysis
Liquidity Profitability Solvency

Measures short- Measures the Measures the ability

term ability of the income or of the company to
company to pay its operating success pay its long and
maturing obligations of a company for a short-term
and to meet given period of obligations
unexpected needs time.
for cash.

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 Basics of Financial Statement Analysis
Ratio Comparison
Cross Sectional Time Series
Analysis Benchmarking
Analysis

Involves Type of cross Evaluation of the

comparison of the sectional analysis in firms’ current to past
firms’ financial which the firms’ ratio performance to
ratios to those of are compared to assess the firm’s
other firms in its those of key progress. Develop
industry at the competitor or group of trends by using
same point in time. competitors that it multiyear
wishes to emulate. comparisons.

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 Basics of Financial Statement Analysis
Tools of Analysis
Horizontal Analysis or Trend
✓Analysis
It is an analysis of the
percentage increase and
decrease of related
items in comparative
financial statements.
✓ Technique of evaluating
a series of financial
statement data over a
period
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 Basics of Financial Statement Analysis
Tools of Analysis
Vertical Analysis or Common-size Analysis
✓ A percentage analysis
to show the relationship
of each component to a
total within a single
statement.
✓ Technique that
expresses each
financial statement item
as a percent of a base
amount.

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 Basics of Financial Statement Analysis
Tools of Analysis
Ratios generally are classified into three categories: liquidity,
borrowing capacity or leverage, and profitability.
►Liquidity ratios measure the ability of a company to meet its
current obligations.
►Leverage ratios measure the ability of a company to meet its
long- and short-term obligations. These ratios provide a
measure of the degree of protection provided to a company’s
creditors.
►Profitability ratios measure the earning ability of a company.
These ratios allow investors, creditors, and managers to
evaluate the extent to which invested funds are being used
efficiently.
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 Ratio Analysis Liquidity Ratios

Liquidity Ratios are used to assess the short-

term debt-paying ability of a company.

The most common ones include:

✓ Current ratio
✓ Quick or acid test ratio
✓ Accounts receivable turnover ratio
✓ Inventory turnover ratio

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 Ratio Analysis Liquidity Ratios

The current ratio measures the ability of the firm to meet its short-
term obligations.

Current ratio = Current assets ÷ Current liabilities

The quick (acid-test) ratio excludes inventory, which is generally

the least liquid current asset.

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 Calculating the Current Ratio and
Quick or Acid Test Ratio
Problem
Concorde Industrial Inc. has current assets equal to Php120,000. Of these, Php15,000 is
cash, Php30,000 is accounts receivable, and the remainder is inventories. Current
liabilities total Php50,000.
Required:
1. Calculate the current ratio.
2. Calculate the quick ratio (acid-test ratio).
Solution:
1. Current ratio = Current assets/Current liabilities
= Php120,000/Php50,000
= 2.4
2. Quick ratio = (Cash + Marketable securities + Accounts Receivable) /
Current liabilities
= (Php15,000 + 0 + Php30,000)/ Php50,000
= 0.90

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 Account Receivable Turnover Liquidity Ratios

The liquidity of receivables is measured by the accounts

receivable turnover ratio, computed as follows:

Average accounts receivable is computed as

follows:

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 Account Receivable Turnover in Days
A variant of the receivable turnover ratio is to convert it to
an Average collection period in terms of days. The
objective is to assess the efficiency in collecting receivable
and in the management of credit.

A low turnover ratio may suggest a need to modify credit

and collection policies to speed up the conversion of
receivables to cash.

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 Calculating the Accounts receivable turnover and
Accounts receivable in days

Problem
Concorde Industrial Inc. had net sales of Php 750,000 and cost of goods
sold of
Php 400,000. Concorde had the following balances:
January 1 December 31
Accounts receivable Php 98,500 Php
101,500
Inventories 83,000
87,000

Required:
1. Calculate the accounts receivable turnover
2. Calculate the accounts receivable in days

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 Account Receivable Turnover and Turnover in Days

Solution:
1. Average accounts receivables
= (Php98,500 + Php101,500)/2
= Php 100,000

Accounts receivable turnover = Net sales/Ave. accounts

receivables = P 750,000 /
P100,000
= 7.5 times
2. Accounts receivables In days = 365 / Accounts receivable
turnover
= 365 / 7.5
= 48.7 days

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 Inventory Turnover Liquidity Ratios

Inventory turn over is a measure of the number of times the

average level of inventory is sold during a year. A low turnover
ratio may signal the presence of too much inventory or sluggish
sales
Inventory turnover = Cost of goods sold ÷ Average inventory

Average accounts receivable is computed as

follows:
Average inventory = (Beginning inventory + Ending inventory) /
2
The number of days inventory is held before being sold is
computed as follows:
Average Age of Inventory = 365 / Inventory turnover ratio

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 Calculating the Inventory turnover and
Inventory turnover In days

Problem
Last year, Concorde Industrial Inc. had net sales of Php 750,000 and cost of
goods sold of Php 400,000. Concorde had the following balances:
January 1 December 31
Accounts receivable Php 98,500 Php
101,500
Inventories 83,000
87,000

Required:
1. Calculate the inventory turnover ratio
2. Calculate the inventory turnover in days/Average Age of Inventory

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 Calculating the Inventory turnover ratio and
Inventory turnover In days
Solution:
1. Average inventory = (Beginning Inventory + Ending inventory) / 2
= (Php83,000 + Php87,000)/2
= Php 85,000

Inventory turnover = Cost of goods sold / Ave. inventory

= P 400,000 / P 85,000
= 4.7 times
2. Average Ave of Inventory = 365 / Inventory turnover
= 365 / 4.7
= 77.7 days

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 Solvency Ratios

Solvency ratios measure the ability of a company to survive

over a long period of time.
◆Debt ratio – indicates the proportion of assets financed
with debt.
=Total liabilities ÷ Total assets
◆Times-interest-earned ratio - measures the number of
times operating income can cover interest expense.

= Income from operations ÷ Interest

expense
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 Profitability Ratios

Measure the income or operating success of a company for a given period of

time.

◆Income, or the lack of it, affects the company’s ability to obtain debt
and equity financing, liquidity position, and the ability to grow.

◆Ratios include the profit margin, asset turnover, return on assets,

return on common stockholders’ equity, earnings per share, price-
earnings, and payout ratio.

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 Profitability Ratios

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 Economic Value Added (EVA)

Economic value added (EVA®) combines

accounting income and corporate finance to
measure whether the company’s operations have
increased stockholder wealth.

EVA® = Net income + Interest expense – Capital

charge

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 CASH FLOW – WEEK 4

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 Course Learning Objective

Identify the purposes of the statement

of cash flows and distinguish among
operating, investing, and financing cash
flows.

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 The Cash Flow Statement
The statement of cash flows reports cash flows by three
types of activities:
Cash receipts and disbursements
Operating related to revenue or expense
Activities activities. Includes cash flows
related to:
Investing Activities
• interest income and expense
Financing • dividend revenue
Activities • income tax expense
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 The Cash Flow Statement
The statement of cash flows reports cash flows by three
types of activities:
Operating Cash receipts and disbursements
Activities related to increases and decreases
in long-term assets, including:
Investing Activities • PP&E
• Notes Receivable
Financing Activities • Investments
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 The Cash Flow Statement
The statement of cash flows reports cash flows by three
types of activities: Cash receipts and disbursements
Operating related to increases and decreases
in long-term liabilities and equity.
Activities Includes:
• Borrowing
Investing Activities • Issuing stock
• Paying dividends
Financing Activities
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 Reporting Cash Flows
Increases in Cash Decreases in Cash

Operating Operating
(receipts from (payments for
revenues) expenses)

Investing
Investing
(receipts from sales of
(payments for acquiring
noncurrent assets)
noncurrent assets)

Financing Financing
(receipts from issuing
equity and debt securities) (payments for treasury stock,
dividends, and redemption of debt
2/4/2023 Hermie T. Bola 6
securities)
 Cash Flow Analysis Summary

Sources of Cash Uses of Cash

Decrease in an Asset account Increase in an Asset account

Increase in a Liability account Decrease in a Liability account

Increase in an Owner’s equity Decrease in an Owners’ equity

account account

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 Non-cash Investing and Financing Activities
➢Issuing bonds to acquire land

➢Issuing common stock for convertible

preferred stock
➢Issuing a long-term note to acquire
equipment
➢Issuing a stock dividend

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 Statement of Cash flows
Indirect and Direct Methods

Indirect method Direct method

Adjusts net income for Shows operating cash

items that do not affect receipts and payments,
cash. making it more consistent
with the objective of a
statement of cash flows
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 Step 1: Operating Activities
Summary of Conversion to Net Cash Indirect Method
Provided by Operating Activities

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 Step 2: Investing Activities

Cash Flows From Investing Activities:

Cash Payment for Purchase of Fixed Asset Deduct
Cash Receipt from Disposal of Fixed Asset Add
Equity Investment Deduct
Net Cash Used for Investing Activities

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 Step 3: Financing Activities

Cash Flows From Financing Activities:

Repayment of Debt Deduct
Sale of Stock Add
Repurchase of Stock Deduct
Payment of cash dividends Deduct

Net cash used for Financing Activities

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 Burch Company's net income last year was $119,000. Changes in the company's balance sheet accounts for
the year appear below:
Increases
(Decreases)
Debit balances:
Cash $29,000
Accounts receivable $(21,000)
Inventory $12,000
Prepaid expenses $(8,000)
Long-term investments $80,000
Plant and equipment $10,000

Credit balances:
Accumulated depreciation $26,000
Accounts payable $23,000
Accrued liabilities $14,000
Taxes payable $(9,000)
Bonds payable $(50,000)
Deferred taxes $4,000
Common stock $20,000
Retained earnings $74,000

The company declared and paid cash dividends of $45,000 last year.

Required:
a. Construct in good form the operating activities section of the company's statement of cash flows for the year. (Use the
indirect method.)
b. Construct in good form the investing activities section of the company's statement of cash flows for the year.
c. Construct in good form the financing activities section of the company's statement of cash flows for the year.
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a. Operating activities
Net income $119,000
Adjustments:
Depreciation charges $26,000
Decrease in accounts receivable 21,000
Increase in inventory (12,000)
Decrease in prepaid expenses 8,000
Increase in accounts payable 23,000
Increase in accrued liabilities 14,000
Decrease in taxes payable (9,000)
Increase in deferred taxes 4,000 75,000
Net cash provided by operating activities
$194,000

b. Investing activities: Increase in long-term investments $(80,000)

Increase in plant & equipment (10,000)
Net cash used for investing activities $(90,000)

c. Financing activities: Decrease in bonds payable $(50,000)

Increase in common stock 20,000
Cash dividends (45,000)

Net cash used in financing activities $(75,000)

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 A - Statement of Cash Flows - Direct Method

➢ Each item on the income statement will be converted

from the accrual basis to cash basis.

➢ Most of the amounts will be adjusted based on changes

in current asset amounts and current liability amounts.

➢ Non-cash expenses and gains and losses will be ignored.

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Statement of Cash Flows - Direct Method
 Cash Flows from Operating Activities

Cash Collections from Customers

Cash Receipts Beginning Ending
Sales
from = + Accounts - Accounts
Revenue
Customers Receivable Receivable

Cash Receipts of Interest

Beginning Ending
Interest Interest
= + Interest - Interest
Receipts Revenue
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Receivable
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 Cash Flows from Operating Activities

Cash Receipts of Dividends

Beginning Ending
Dividend Dividend
= + Dividends - Dividends
Receipts Revenue
Receivable Receivable
Cash Receipts of Interest
Beginning Ending
Interest Interest
= + Interest - Interest
Receipts Revenue
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Receivable
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 Cash Flows from Operating Activities

Payment to Employees
Salaries & Beginning Ending Salaries
Payments to
= Wages + Salaries & Wages - & Wages
Employees
Expense Payable Payable

Payment for Interest Expense and Tax Expense

Cash Paid for Beginning Ending Related
= Expense + -
the Expense Related Payable Payable

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 B - Statement of Cash Flows-Direct Method

1. Under the direct method, companies compute net cash

provided by operating activities by adjusting each item
in the income statement from the accrual basis to the
cash basis.
2. To simplify and condense the operating activities section,
companies report only major classes of operating
cash receipts and cash payments.
3. For these major classes, the difference between cash
receipts and cash payments is the net cash provided by
operating activities.
Statement of Cash Flows - Direct Method

Determining Cash Receipts from Customers

Statement of Cash Flows-Direct Method

Determining Cash Payments to Suppliers for

Inventory
 Statement of Cash Flows - Direct Method

Determining Cash Payments for Operating Expenses

 Operating Cash Flow (OCF)

•A firm’s operating Cash Flow (OCF) is the cash flow a firm

generates from normal operations—from the production and
sale of its goods and services.

•OCF may be calculated as follows:

NOPAT = EBIT  (1 – T)

OCF = NOPAT + Depreciation

OCF = [EBIT  (1 – T)] + Depreciation

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 Free Cash Flow (FCF)

• Free cash flow (FCF) is the amount of cash flow

available to investors (creditors and owners) after the
firm has met all operating needs and paid for investments
in net fixed assets (NFAI) and net current assets (NCAI).
FCF = OCF – NFAI – NCAI
•Where
NFAI = Change in net fixed assets + Depreciation

NCAI = Change in CA – Change in (A/P + Accruals)

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 Free Cash Flow (FCF)

Financial Analysis and Interpretation

Free Cash Flow is used to measure the

financial strength of a business. A company that
has positive free cash flow is able to fund internal
growth, retire debt, and enjoy financial flexibility.

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FINANCIAL
PLANNING

Week 5
 The Financial Planning Process
The financial planning process begins with long-term, or
strategic, financial plans that guide the formulation of short-term,
or operating, plans and budgets.
Two key aspects of financial planning
✓ Cash planning - involves the preparation of the firm’s cash
budget.

✓ Profit planning - involves preparation of pro forma

statements.
 The Financial Planning Process
Long-term (strategic) financial plans lay out a
company’s planned financial actions and the anticipated
impact of those actions over periods ranging from 2 to 10
years.

Short-term (operating) financial plans specify short-term

financial actions and the anticipated impact of those
actions. Key inputs includes sales forecast and other
operating and financial data.
 Steps in Financial Forecasting
Forecast sales
Project the assets needed to support sales
Project internally generated funds
Project outside funds needed
Decide how to raise funds
See effects of plan on ratios and stock price
 Short Term (Operating) Financial Plans
Sales forecast Assumptions Pro
+ + about cost forma
Assumptions about behavior income
levels of inventory, statement
collections of Budgets for
Balance purchases and
receivables, and
sheet at production
payments of
expenses and
+ beginning
of budget Budgets for
liabilities Pro
period cash and
+ requirements for forma
Plans for long-term short-term balance
financing and for financing sheet
capital spending
TYPES OF SALES FORECASSTING

✓ Annual forecasts
✓ Longer-term forecasts (three to
five years)
✓ Quarterly or monthly forecasts
 PROJECTING PRO FORMA STATEMENTS WITH THE PERCENT OF SALES
METHOD

Project sales based on forecasted growth rate

in sales
Forecast some items as a percent of the forecasted sales
 Cost of sales
 Cash
 Accounts receivable

(More...)
Items as percent of forecasted sales (Continued...)
 Inventories
 Net fixed assets
 Accounts payable and accruals

Choose other items

 Debt (which determines interest)
 Dividends (which determines retained earnings)
 Common stock
ASSUMPTIONS ABOUT HOW ADDITIONAL FUNDS NEEDED (AFN) BE
RAISED

Operate at full capacity

Each type of asset grows proportionally with sales.
Payables and accruals grow proportionally with sales.
Profit margin and payout will be increased or
maintained.
Sales are expected to increase by certain % .
ASSUMPTIONS ABOUT HOW ADDITIONAL FUNDS NEEDED (AFN) BE
RAISED

No new common stock will be issued.

Any external funds needed will be raised as debt, 50% notes payable, and 50% L-T
debt.