Financial Management|1

Financial Management
Introduction
Financial Statement Analysis
for primary purpose of forecasting the financial health of
the company, for decision making
Steps in Financial Statement Analysis
1. Establish objectives of the analysis
2. Study the industry in which the industry
operates and relate industry climate to current
and projected economic development
3. Develop knowledge of the firm and the quality
of management
4. Evaluate financial statements
5. Summarize findings based on analysis and reach
conclusions about firm relevant to the
established objectives
that arise; the higher the ratio, the easier is the ability to
clear the debts and avoid defaulting on payments
Liquidity Measures
Current Ratio = Current Assets
Current Liabilities
*in every peso liability, there is an amount of assets (times) that the company
can pay
Quick Ratio = Current Assets - Inventory
Current Liabilities
*in every peso liability, there is an amount of assets (times) that the company
can pay; however, inventory is excluded
Cash Ratio = Cash
Current Liabilities
*in every peso liability, there is an amount of assets (times) that the company
can pay; however, cash only is analyzed

Techniques in Evaluating Financial Statements

Horizontal Analysis – study of percentage changes in Solvency, long-term solvency
comparative statements; compute peso amount of the intended to address the firm’s long-run ability to meet
change from base period to later period its obligations, or, more generally, its financial leverage;
*when base year is negative or zero, it is impossible to compute used to measure an enterprise's ability to meet its long-
Trend Percentages – index number showing relative term debt obligations.
changes in financial data resulting with the passage of
Solvency Measures
time; compute the percentage relationship that each item
Total Debt Ratio = Total Assets – Total Equity
bears to the same item in the base year by dividing each
Total Assets
value by the base year
*in every peso asset, there is an amount of debt (times) that company have;
Common Size Financial Statements – translate peso percent on how much a company is financed by debt i.e. P1 = P.25 + P75 (debt;
25, equity; 75)
amounts to percentages, which indicate the relative size
Debt-Equity Ratio = Total Debt
of an item in proportion to the whole; vertical analysis
Total Equity
Equity Multiplier = Total Assets
Financial Ratio Analysis
Total Equity
Times interest earned ratio = EBIT
Financial Ratio – a comparison of two significant figures Interest
taken from financial statements; it expresses direct *how well (times) has its interest obligations covered
relationship between two or more quantities in the Cash Coverage Ratio = EBIT + Depreciation
statement of financial position and income statement of Interest
a business firm
purpose; to provide insight into the profitability of
Asset Management, turnover
operations, the soundness of the firm’s short-term and
asset utilization ratios, intended to describe is how
long-term financial condition and the efficiency with which
efficiently, or intensively, a firm uses its assets to
management has utilized the resources entrusted to it.
generate sales.
Liquidity, short-term solvency Asset Management Measures
a measure of the ability of a company to pay off its Inventory
short-term liabilities; determine how quickly a company Turnover = Cost of Goods Sold
can convert the assets and use them for meeting the dues Inventory
*how many times your inventory has restocked
Days’ Sales in Inventory = 365 days
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Inventory Turnover Total Equity

*how many days for it to take to be restocked *a measure of how the stockholders fared during the year; for every peso in
equity, how much cents you generated in profit
Receivables Turnover = Sales
Accounts Receivable
*how fast can we sell products and collect the sales
Market Value Measures
Days’ Sales in Receivables = 365 days used to evaluate the current share price of a publicly
Receivables held company's stock
Turnover
*how many days for it to take to be collected

Total Asset Turnover = Sales Cash Flows

Total Assets
*in every peso asset, we have generated amount (times) in sales
Purposes
1. To predict future cash flows
Profitability Measures
2. To evaluate management decisions
class of financial metrics that are used to assess a
3. To determine the ability to pay dividends to
business's ability to generate earnings relative to its
shareholders and interest and principal to
revenue, operating costs, balance sheet assets, or
creditors
shareholders' equity over time, using data from a specific
4. To show relationship of net income to changes
point in time.
in the business’ cash
Profitability Measures, in percent
Profit Margin = Net Income
Statement of Cash Flows
Sales
*in every peso in sales, how much (percent) can you generate profit
component of financial statements summarizing the
Return on Assets = Net Income operating, investing, and financing activities of an entity
Total Assets it is designed to provide information about the change
*a measure of profit per peso of assets in an entity’s cash and cash equivalents.
Return on Equity = Net Income for cash flow computation, bank overdrafts that are
Market Value Measures repayable on demand are included as part of cash and
Price earnings Ratio = Price per share cash equivalents.
Earnings per share
*how much investors are willing to pay per peso of current earnings; the Classifications of Cash Flows
shares sell for about number of times earnings Operating activities – cash flows arising from the
Price-sales Ratio = Price per share purchase and sale of dealing or trading securities
Sales per share Investing Activities – acquisition and disposal of long-
*used when there is negative earnings
term assets and other investments
Market-to-book Market Value per
Financing Activities – equity capital and borrowings of
Ratio = share
an entity
Book value per share
*value less than 1 could mean that firm has not been successful overall in
Noncash activities – excluded in cash flow preparation
creating value for its stockholders
Total Market Value of Alternative Treatments
Enterprise Value = Stock + Book Value of Interest – primarily classified as operating cash inflows.
all Liabilities - Cash Interest paid is classified as financing cash flows since
EBITDA Ratio = Enterprise Value it is related to loans obtained; while, interest received is
EBITDA classified as investing activities since it pertains to
*both are an estimate of the market value of company’s operating assets investments
Dividends – dividends received are operating cash
inflows; alternatively, it is an investing cash inflow.
Income Taxes – separately disclosed as cash flow from
operating activities, unless they can be specifically
identified with investing and financing activities

Gross Profit Variation Analysis

Factors causing Gross Profit Variation
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1. Change in volume or quantity of product sold Working Capital Management

2. Change in selling prices Short Term Finance – is primarily concerned with the
3. Change in purchasing prices or product sold analysis of decisions that affect current assets and
4. Change in Sales Mix current liabilities.
5. Other factors
Working Capital = Current Assets
a. Purchasing and merchandising policies Net Working Capital = Current Assets – Current
b. Markups and markdowns Liabilities
c. Credit extension policies Working Capital Management – Short-Term Financial
Dupont Formula Management

Working Capital Management

 Cash
 Accounts Receivable
 Inventories
 Short Term Payable
OPERATING ASSET USE EQUITY
EFFICIENC EFFICIENC MULTIPLIE
Y Y R Working Capital

Working capital is a financial metric that is the

difference between a company's current assets and
current liabilities. As a financial metric, working capital
helps plan for future needs and ensure the company has
enough cash and cash equivalents meet short-term
obligations, such as unpaid taxes and short-term debt.
NET INCOME / SALES/ ASSETS/
SALES ASSETS TOTAL
EQUITY Working Capital Financing Approaches

Hedging Approach/Matching Approach

 According to this approach, the maturity of
the sources of the funds should match the
nature of the assets to be financed. For the
purpose of analysis, the current assets can be
broadly classified into two classes- 
 Those which are required in a certain amount
for a given level of operation and, hence, do
not vary over time. 
 Those which fluctuate over time. 
 The Hedging approach suggests that long
term funds should be used to finance the
fixed portion of current assets requirements
in a manner similar to the financing of fixed
assets. 
 The purely temporary requirements, that is,
the seasonal variations over and above the
permanent financing needs should be
appropriately financed with short term
funds. 
 This approach, therefore, divides the
requirements of total funds into permanent
and seasonal components, each being
financed by a different source. 

Conservative Approach
 This approach suggests that the estimated
requirement of total funds should be met
from long term sources; the use of short-
term funds should be restricted to only
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emergency situations or when there is an

unexpected outflow of funds. 
 Long-Term Financing Benefits 
 Less worry in re financing short-term
obligations. 
 Less uncertainty regarding future interest
costs  Price Factor
 Long-Term Financing Risks 
 Borrowing more than what is necessary. 
 Borrowing at a higher overall cost
(usually) 

Aggressive Approach Cost Factor

 A working capital policy is called an aggressive
policy if the firm decides to finance a part of
the permanent working capital by short term
sources. The aggressive policy seeks to
minimize excess liquidity while meeting the
short-term requirements. The firm may accept GPV Analysis
even greater risk of insolvency in order to save
cost of long-term financing and thus in order to
earn greater return. 
 Short-Term Financing Benefits
 Financing long-term needs with a
lower interest cost than short-term
debt 
 Borrowing only what is necessary. 
 Short-Term Financing Risks
 Refinancing short-term obligations in
the future 
 Uncertain future interest costs 

Gross Profit Variation Analysis

A change in gross profit can be traced directly to one or
combination of the following factors:
 Change in Volume or Quantity of Product Sold
 Change in Selling Price
 Change in Purchasing Prices or Product Sold
 Change in Sales Mix

The following are the information of Lablab Company for

the year 2022 and 2021:

2022 2021
SALES 165,000.00 100,000.00
COST OF SALES 90,000.00 50,000.00
GROSS PROFIT 75,000.00 50,000.00

UNITS SOLD 1,500.00 1,000.00

UNIT SELLING PRICE 100.00 100.00
UNIT COST 60.00 50.00

Quantity Factor

Working Capital Management
Introduction
Working Capital Management
deals with a firm's current assets and liabilities.
 Cash
 Accounts Receivable
 Inventory
Float and Cash Management
The basic objective in cash management is to keep the
investment in cash as low as possible while still operating
the firm's activities efficiently and effectively. This goal
usually reduces to the dictum,” Collect early and pay late.”
Reasons for Holding Cash
 Speculative and Precautionary Motives – the
need to hold cash to take advantage of
additional investment, such as bargain
purchases. It is also the need hold cash as a
safety margin to act as a financial reserve.
 Transaction Motive – the need to hold cash to
satisfy normal disbursement and collection
activities associated with a firm’s ongoing
operations.
Benefit and Opportunity Cost of Holding Cash
When the firm holds cash in excess of some
necessary minimum, it incurs an opportunity cost. The
opportunity cost of excess cash (held in currency or bank
deposits) is the interest income that could be earned in
the next best use, such as investing in marketable
securities.
Understanding Float
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Float – the difference between book cash and bank
cash, representing the net effect of checks in the
process of clearing.
 Disbursement Float – checks written by a firm
generate disbursement float, causing a decrease in
the firm’s book balance but no change in its
available balance.
A paid the supplier 20,000 by issuing a cheque which is
yet to be cleared. A's bank balance is 70,000. After the
issuance of check, the book balance of A is reduced to
50,000.
Disbursement Float = Firm's available balance – Firm's
book balance
Disbursement Float = 70,000 – 50,000
Disbursement Float = 20,000
 Collection Float – checks received by firm create
collection float. Collection float increases book
balances but does not immediately change
available balances.
A received a cheque worth 10,000 from customer. This
cheque is not yet deposited in the bank. The current
bank balance of A is 60,000. But as per book, the cash
balance is 70,000.
Collection Float = Firm's available balance – Firm's book
balance
Collection Float = 60,000 – 70,000
Collection Float = -10,000
 Net Float – the sum of the total collection and
disbursement floats. The net float at any point in
time is the overall difference between the firm’s
available balance and its book balance.
Positive Net Float - means disbursement float
exceeds its collection float and its available balance
exceed its book balance.
Negative Net Float – means available balance is
less than book balance.
A received a cheque worth 10,000 from customer. This
cheque is not yet deposited in the bank. A paid the
supplier 20,000 by a cheque which is yet to be cleared.
The cash balance per book is 100,000. But bank
statement shows a balance of 110,000.
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The firm may develop strategies to increase mail

Net Float = Firm's available balance – Firm's book balance float, processing float, and availability float on the
Net Float = 110,000 – 100,000 checks it writes.
Net Float = -10,000
Increasing Disbursement Float
Disbursement float can be increased by writing a
check on a geographically distant bank.

Controlling Disbursement
Zero-Balance Account – a disbursement account in
which the firm maintains a zero balance, transferring
Float Management funds in from a master account only as needed to cover
checks presented for payment.
Float management involves controlling the collection and
disbursement of cash. 
    The objective in cash collection is to speed up
collections and reduce the lag between the time customer
pay their bills and the time cash becomes available. 
    The objective in cash disbursement is to control
payments and minimize the firm's costs associated with
making payments.

Components of Collection Time

Controlled Disbursement Account – a disbursement
1. Mailing Time – is the part of collection and
practice under which the firm transfers an amount to a
disbursement process during which checks are
disbursing account that is sufficient to cover demands
trapped in the postal system.
for payment.
2. Processing Delay – is the time it takes the
receiver of check to process the payment and
deposit it in a bank for collection.
Credits and Receivables
3. Availability Delay – refers to the time required to
clear a check through the banking system.
Speeding up collections involves reducing one or more of
these components.

Components of Credit Policy

A credit policy defines how your company will extend
credit to customers and collect delinquent payments. A
good credit policy protects you from late payments and
helps you maintain a healthy working capital position.
Cash Management
1. Terms of Sales – conditions under which a firm sells
Lockboxes – special post office boxes set up to intercept its goods and services for cash or credit.
and speed up accounts receivable collections.
Cash Concentration – the practice of and procedures for
moving cash from multiple banks into the firm’s main
accounts.

Managing Cash Disbursement

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Credit Period – the length of time for which credit is Collection Effort
granted. A firm usually goes through the following sequence of
Cash Discount – a discount given to induce prompt procedures for customers whose payment are overdue:
payment. Also, sales discount. 1. It sends out a delinquency letter informing the
customer of the past-due status of the
account.
Term of Sales
2. It makes a telephone call to the customer.
Terms: 3/30, n/60
3. It employs a collection agency.
Credit Days = 60 – 30
4. It takes legal action against the customer.
= 30
Rate per 30 = .03/ (1-.03)
days = 3.093% Inventories
EAR = ((1+.03093) ^12.17)-1
= 44.9% Inventory Types
P = 365/30 For manufacturers, inventory normally is classified
= 12.17 into one of three categories.
APR = .03093 x12.17  Raw Materials
= 37.6%  Work-In-Process
 Finished Goods
Credit Instrument
The credit instrument is the basic evidence of Inventory Costs
indebtedness. Most trade credit is offered on open
 Carrying Cost – represents all of the direct
account. This means that the only formal instrument of
and opportunity cost of keeping inventory
credit is the invoice, which is sent with the shipment of
goods and which the customer signs as evidence that the on hand. The include:
goods have been received. 1. Storage and Tracing Costs
2. Insurance and Taxes
Optimal Credit Policy 3. Losses due to obsolescence,
In principle, the optimal amount of credit is determined by deterioration, and theft
the point at which the incremental cash flows from 4. The opportunity cost of capital
increased sales are exactly equal to the incremental cost for the invested amount.
of carrying the increased investment in accounts
 Cost of Restocking
receivable.
1. Any cost associated with
2. Credit Analysis – the process of determining the ordering.
probability that customers will or will not pay. It
usually involves two steps: gathering relevant Inventory Management Techniques
information and determining creditworthiness.
3. Collection Policy – procedures followed by a firm in  ABC Approach – is a simple approach to
collecting accounts receivable. It involves monitoring inventory management where the basic
receivables to spot trouble and obtaining payment on idea is to divide inventory into three (or
past-due accounts.
more) groups. The ABC approach to
inventory should not be confused with
Aging Schedule – a compilation of accounts receivable by
the age of each account. Activity Based Costing, a common topic in
managerial accounting.
 Just In Time Model (JIT) – a system for
managing demand-dependent inventories
that minimizes inventory holdings.
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 Economic Order Quantity Model (EOQ) – Safety Stock (SS) = Average Sales x nb Safety Days
the restocking quantity that minimizes the Safety Stock (SS) = 100 qty/day x 5 days
total inventory costs. Safety Stock (SS) = 500 qty

Reorder Point = Safety Stock + Average Sales x

Lead Time
A orders 3,600 units each time and the carrying Reorder Point = 500 + 100 x 10
cost were .75 per unit per year. Reorder Point = 1,500 qty

Carrying Cost = Average Inventory x Carrying

Costs per Unit
Carrying Cost = (3,600/2) x .75
Carrying Cost = 1,350

The Annual sales of A is 46,800 and the order

size is 3,600. The company spends 50 per order.

Cost of Restocking = Fixed Cost per Order x No.

of Orders
Cost of Restocking = (46,800/3600) x 50
Cost of Restocking = 650
Total Cost = Carrying Cost + Cost of Restocking
Total Cost = 1,350 + 650
Total Cost = 2,000

Carrying Cost = Cost of Restocking 

EOQ=
√ 2( Annual Demand x Cost per Order )
Annual Holding Cost per Unit

EOQ=
√
2(46,800 x 50)
.75
EOQ=2 , 498units

Extensions to the EOQ Model

Safety Stock - is a term used by logisticians to
describe a level of extra stock that is maintained to
mitigate risk of stockouts caused by uncertainties in
supply and demand. It is the minimum level of
inventory that a firm keeps on hand.

Reorder Points - are the times at which the firm will

actually place its inventory orders.

Given: AS = 100 qty/day | Lead Time = 10 days |

Safety = 5 days
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 Discounted Payback Period

Capital Budgeting
Introduction
Capital Budgeting
Involves identifying the cash inflows and cash out flows
rather than accounting revenues and expenses flowing
from the investment. For example, non - expense items
like debt principal payments are included in capital
budgeting because they are cash flow transactions.
Is a capital budgeting procedure used to
determine the profitability of a project. A
discounted payback period gives the number
of years it takes to break even from
undertaking the initial expenditure, by
discounting future cash flows and recognizing
the time value of money.
 Net Present Value
Is the difference between the present value of
cash inflows and the present value of cash
outflows over a period.

Theories and Concepts  Internal Rate of Return

 Short-Term Cash Budgets Internal rate of return is a capital budgeting
Aim to solve or control cash requirements on a calculation for deciding which projects or
weekly or monthly basis. These budgets help investments under consideration are
forecast the payments that need immediate investment-worthy and ranking them. IRR is
fund allocation and identify sources that can the discount rate for which the net present
help offset this requirement. value (NPV) equals zero (when time adjusted
future cash flows equal the initial investment).
IRR is an annual rate of return metric also used
 Long-Term Cash Budgets
to evaluate actual investment performance.
Focus on quarterly and annual tax payments,
capital expenditure projects, and long-term
 Depreciation Tax Shield
investments. Long-term cash budgets usually
Is a tax reduction technique under which
require more strategic planning and detailed
depreciation expense is subtracted from
analysis as they require cash to be tied up for a
taxable income. The amount by which
longer period.
depreciation shields the taxpayer from income
taxes is the applicable tax rate, multiplied by
 Relevant Cash Flows
the amount of depreciation.
Often used for relevant cash flows states that
they must be cash flows that occur in the future
and are incremental. While on the face of it
obvious, only costs or revenues that give rise to
a cash flow should be included.

 Initial Cash Outlay

Refers to the initial investments needed to begin
a given project. For instance, if opening a new
factory, a company would need to purchase new
land and machinery to get the project going.

 Payback Period
Is defined as the number of years required to
recover the original cash investment. In other
words, it is the period of time at the end of
which a machine, facility, or other investment
has produced sufficient net revenue to recover
its investment costs.