BUSINESS FINANCE CONCEPTS - MIDTERM REVIEWER

UNIT 1: Investment

2 Commonly used rates of return in

Risk and Return
financial management
- Relationship between investment
1. Nominal rates of return that
risk and return is a fundamental
include inflation
investment principle
2. Real rates of return that exclude
- If investor desire for higher
inflation
investment returns, they must be
willing to accept greater
- Investment returns are usually
investment risk
presented as a percentage
- Higher investment return =
greater risk

In its simplest form, nominal investment

Risk
returns can be calculated using 3
- Probability of losing an amount of
variables:
an investment over a given time
period or as the return volatility of
1. Initial investment
an investment over a given time
2. Ending value of investment
period
3. Investment time period
- Return volatility is typically defined
as standard deviation
The Risk-Return Relationship
- Statistical figure measures the
dispersion of a dataset relative to its
Returns
mean, calculated as the square root
- Higher risks = higher returns
of the variance
- Sd is usually applied to an
Diversify
investment’s annual return to
- Diversification is a risk mitigation
gauge return volatility
technique that attempts to
- Greater sd = Greater investment
reduce losses by allocation
volatility = Greater risk
investments among various
financial instruments
Return
- Financial return / investment
What is the Right Investment?
return
- Higher Returns = Higher Risk of
- Presented as a percentage increase
Loss
relative to the original investment
- Small Returns = Lower Risk of Loss
over a given time period
- Both?

It all depends on you

- Different risk appetites of various
investor groups determine the
investments
Time Value of Money
Worth
- Time value is a basic financial
concept
- Money in the present is worth
more than the same sum of
money to be receive
Opportunity Cost
- Money that you have right now
can be invested and earn a return,
thus creating a larger amount of
money in the future
- Inflation is a factor to consider
- The amount of goods that can be
bought today will not be equal to
the goods in the future.
Time Value and Purchasing Power
- The time value of money is also
related to the concepts of
inflation and purchasing power
- Both factors need to be taken into
consideration along with whatever
rate of return may be realized by
investing the money
- Inflation constantly erodes the
value, and therefore the
purchasing power of money
- If rate of inflation is higher than
investment return rate, there is a
loss in terms of purchasing power
despite it showing a nominal
positive return
Time Value of Money Formula
- Companies consider the time value
of money in making decisions
about:
- Investing in new product
development
- Acquiring new business equipment
or facilities
- Establishing credit terms for the
sale of their products or services
Future Value
- The amount that your original
funds will be worth in the coming
time
Present Value
- Today’s worth of future money
Effective Annual Interest Rate
- The Effective Annual Interest Rate (
EAR ) is the interest rate that is
adjusted for compounding over a
given period
- The effective annual interest rate is
the rate of interest that an
investor can earn ( or pay ) in a
year after taking into consideration
compounding
- The amount that your original
funds will be worth in the coming
time
Investment Payment Options
Annuities
- A series of equal payments that
are made at the end or at the
beginning of time
Types
- Ordinary Annuity
- Annuity Due
Characteristic Amortized Loans
- A series of payment - A type of loan with scheduled
- Fixed intervals of time periodic payments that are
- Limited life time applied to both the loan’s principal
amount and the interest accrued
E.g: - First pay off relevant interest
- Regular savings deposit expense for the period, after which
- Monthly mortgage payments the remainder of the payment is
- Pension payments put toward reducing the principal
amount.
FV Annuity - Common amortized loans include
- The future value is the total that will auto loans, home loans, and
be achieved over time personal loans from a bank for
small projects or debt
PV Annuity consolidation.
- The present value of an annuity is
the sum that must be invested
now to guarantee a desired
payment in the future

Ordinary Annuity
- Requires payments at the end of
each period
- E.g: bonds generally pay interest at
the end of every 6 months, regular
quarterly stock dividends

Annuity Due
- Payments come at the beginning
of each period
- May arise due to any same /
recurrent obligation or saving for
retirement or putting money
aside for specific purpose
- E.g: Rent, which landlords typically
require at the beginning of the
month, mortgages, car and
cellphone payments
UNIT 2: Budgeting

Why Do We Need To Budget? Operating Helps plan and manage

- Budgeting’s primary function is to Budget day-to-day business
ensure an organization has
enough resources to meet its A detailed projection of
goals what a company expects
its revenue and expense
- Help mitigate unwanted surprises
will be over a period of
and prevent you from spending time
more than you wanted
Financial Depicts the expectations
Preparation of Budgets Budget of cash inflows and
outflows, including:

All companies, - How these - cash payments for

small, medium or resources are planned operations
big have limits on utilized to - The purchase or sale
the amount of reach their of assets
money or objectives - The payment or
resources must be set financing of loans
and planned - Changes in equity

Offers a strategic overview

Budgeting
of how a business
- The act of estimating when and
manages cash flows,
how much cash or other
assets, expenses and
resources will be allocated and
income
used
- Quantitative plans set for future use
will be made based on the needs of
the organization.
- Some budgets take months / years
to develop, depending on its kind
and its complexity

Management
- Begins with an objective or vision of
the future

Long-term vision
- sets the direction of the
company

Most organizations, regardless of size or

type of company will have a master
budget

Master Budget
- Has 2 components ( operational
and financial )
- Having their own sub-budgets (
operating and financing budget )
 Types of Operating Budget
- Includes several individual budgets
- Essential in planning and monitoring for the organization’s day-to-day operations
- Provides details on how many units need to be produced, how much material should
be ordered, the number of labor hours to schedule and expected overhead costs

Type Description Components ( in order )

Sales Budget Details the expected sales in units and Expected Sales ( Units )
sales price for the budget period
Sales Price Per Unit
Leads into the production budget to
determine how many units must be Total Sales Revenue
produced each week, month, quarter or
year

Production After estimating sales, identify the Expected Sales

Budget desired quantity of inventory to meet
the demand Desired Ending Inventory

Used to determine the quantity of direct Total Required Units

or raw material to purchase, to schedule
enough direct labor to manufacture the -Beginning Inventory
units, and to approximate the overhead
required for production Required Production

Direct Materials To ensure the correct quantity of Units to be produced

Budget materials is ordered and the correct
amount is budgeted for those Direct Material per Unit
materials
Total Pounds Needed for Production
Management knows how much the
materials will cost and integrates this +Desired Ending Inventory
information into the schedule of
expected cash disbursements Total Material Required

- Beginning Inventory

Pounds of Direct Material Required

Cost per Pound

Total Cost of Direct Material Purchase

Direct Labor Ensure that the proper amount of staff Units to be Produced
Budget is available for production and that
there is money available to pay for the Direct Labor Hours per Unit
labor, including potential overtime
Total Required Direct Labor Hours
Total number of hours is next multiplied
by the direct labor rate per hour, and the Labor Cost Per Hour
labor cost can be budgeted and used in
the cash disbursement budget and Total Direct Labor Cost
operating budget
Manufacturing Includes the remainder of the Variable Costs
Overhead production costs not covered by the
Budget direct materials and direct budgets - Indirect Material
- Indirect Labor
E.g: - Maintenance
- Electricity - Utilities
- Utilities
- Repairs and Maintenance Total Variable Manufacturing Costs
- Employees who performed
maintenance Fixed Costs
- Supervisory Salaries
- Maintenance Salaries
- Insurance
- Depreciation

Total Fixed Manufacturing Costs

Total Manufacturing Overhead

Sales and - The direct materials budget, the
Administrative direct labor budget, and the
Expenses manufacturing overhead budget
Budget plan for al costs related to
production
- contains a listing of variable
and fixed expenses estimated
to be incurred in all areas other
than production costs
- While this one budget contains
all nonmanufacturing expenses
Budgeted Sales In Units
Variable Expenses
- Sales Commissions
- Transportation
Total Variable Expenses
Fixed Expenses
- Sales Salaries
- Administrative Salaries
- Marketing Expense
- Insurance Expense
- Depreciation Expenses

- Only manufacturing costs are Total Fixed Expenses

treated as a product cost and Total Selling and Administrative
included in ending inventory, so Expenses
all of the expenses in the sales
and administrative budget are
period expenses and included in
the budgeted income statement
 Types of Financial Budget
- Help with planning and monitoring the financing requirements of the
organization

Type Description Components ( in order )

Capital - Shows company’s plans to invest Discount Rate Tax Rate

Expenditure in long-term assets
Budget Beginning Cash Flows
- Budgeting for these types of - Real estate
expenditures requires long-range - Equipment
planning because the purchases - Working capital
affect cash flows in current and
future periods and affect the Operating Cash Flows
income statement due to - Volume of sales
depreciation and interest expenses - Sale price
- Cash Revenue
- Variable Cash Costs
- Fixed Cash Costs
Cash Flow ( before taxes )
- Building Depreciation
- Equipment Depreciation
- Depreciation Recapture
- Taxes
Cash Flow ( after taxes )

Ending Cash Flows

- Cadh value of buildings
- Cash value of equipment
- Return of working capital

Total

Net Cash Flow

Net Present Value

Cash Budget - Combined budget of all inflows For Sales

and outflows of cash Collections from
Prior year Quarter #
- Anticipate the timing of cash inflows
and outflows, which allows a Quarter 1
company to try to avoid a decrease Quarter 2
in the cash balance due to paying Quarter 3
out more cash than it receives Quarter 4
Total Collections
Accounts Receivable

For Purchases
Collections from
Prior year Quarter #
 Quarter 1
Quarter 2
Quarter 3
Quarter 4
Total Collections
Accounts Payable

Year End
Beginning Cash Balance
Collections from Customers
( Cash Collections Schedule )
Issuing of Stock
Total Cash Collected during the Period
Total Available Cash
- Disbursements
Direct Materials ( Cash Payments
Schedule )
Direct Labor ( Direct Labor Budget )
Manufacturing Overhead Less
Depreciation
( MFG OH Budget )
Selling and Administrative Expenses
Less
Depreciation ( Sales and Administrative
Expense Budget )
Income Tax Expense
Purchase of Copier ( Capital Asset
Budget )
Total Disbursements
Excess ( deficiency ) of Available Cash
Financing
+ Borrowings
- Repayments Including Interest
Ending Cash Balance

Budgeted - Formatted similarly to a traditional Sales

Income income statement except that it COGS
Statement contains budgeted data Gross Profit
Sales and Administrative Expenses
- Once all operating budgets have Uncollectible Expense
been created, these costs are used Income before Interest
to prepare a budgeted income Interest Expense
statement and budgeted balance Income Tax
sheet Net Income

Budgeted - The estimated assets, liabilities Cash

Balance and equities that the company
Sheet would have at the end of the year
if their performance were to meet
its expectations
Accounts Receivable
- Allowance of Doubtful Accounts
Inventory
Machinery and Equipment
Accumulated Depreciation
 Total Assets
Accounts Payable
Line of Credit
Common Stock
Retained Earnings
Total Liability and Owner’s Equity

Budget vs Forecast vs Projection vs Pro

Forma
Projected Financial Statements
- the estimation of the statements
like Income statement,
Budget Where you want
Comprehensive Income, Financial
the business to go
Position and Cash Flow.
- looks at the current trends and
Plan
then develops expectations to
arrive at the financial picture that
Forecast Where the
management desires to attain in
business is going
the future
Projection Hypothetical - Shows the approximation or
“What would summary of the statement of
happen if we did financial statement
this…” - assists the managers and other
internal users to take future
Pro Forma Historical decisions accordingly.
statements - also known as "pro forma financial
adjusted for the statements” which means "as a
effects of a future matter of form” .
transaction - It is a significant part while
drafting a business plan for a new
A prediction business or making strategic
plans.
A. Projected income statement
*Your budget may be based on the B. Projected of financial
financial information of your pro forma position
statements C. Projected cash flow
statement

FINANCE
- The management, creation and
study of money and investments.
- Involves the use of debit and credit,
securities and investment to
finance projects
- Finance is closely linked to the time
value of money, interest rates and
other related topics
 position and
prepare and
implement
financial plans

Financial engages in the

The key activities of a financial manager
Institution business of
financial and
monetary Financial involving the firm’s
transactions such Planning revenues,
as deposits, loans, expenditures, and
investments, and finances
currency exchange
and more. They Investment ( Using the firm’s funds
include a broad spending money ) in projects and
variety of business instruments that
operations within provide high returns in
the financial relation to their risks.
services sector,
including banks, Financing ( raising Obtaining funds for
insurance money ) the firm’s operations
companies, while seeking the
brokerage firms, effective balance
and investment between borrowed
dealers funds (debt) and funds
raised through the
Financial Market primarily refers to sale of ownership in
the marketplace the business (equity)
where buyers and
sellers participate Financial Statement Analysis
in the trade,

It is the platform Horizontal - Time series analysis

that facilitates the - Used to identify trends
trade of financial and patterns in the
instruments and financial statement
securities. items over a period of
time
Financial can be shares, - The period covered
Instrument stocks, bonds, could range between
commercial one-month, a quarter,
papers, bills, or a full fiscal year
debentures, - Tracking of a
cheques, etc. company’s financial
performance in
Financial Manager Analyze financial current time and
data prepared by comparing those
accountants, figures to its past
monitor the performance
company’s
financial
performance,
 - Comparing financial
Financial Ratios
data from a base
- Offers a way to evaluate their
period to a different
company’s performance and
selected period in
compete it with other similar
order to identify
businesses in their industry
trends is known as
- Ratio measure the relationship
horizontal analysis.
between 2 or more components of
Consequently, it is still
financial statements
possible to compare
businesses that differ in
terms of their overall
Liquidity Ratios
revenue and where
- Used to pay off short-term
they are in their
liabilities
lifecycle to gain
- Pay off current debt obligations
insightful information.
with its current resources without
raising external capital

Current Ratio or Higher = Right

Working Capital amount of liquid
Ratio assets to cover is
short-term debts as
Vertical - Each line item on the they come due
financial statement is
expressed as a Low = company may
percentage of a base not have enough
amount in vertical liquid resources to
analysis, which is often cover the liabilities
revenue from the come due
income statement (or
sales). The identical 1:1 = healthy
procedure is carried out
on the balance sheet, Acid Test ( Quick ) - Utilize more
except the starting Ratio liquid assets
amount is often total
assets. Greater = enough
liquid assets
Financial - Use numerical values
Ratios taken from financial Lower = possibility of
statements to gain being unable to meet
meaningful insight these responsibilities
about a company;s
finances
 Cash Ratio - Assesses
company’s
capacity to
settle its
short-term
entirely with
cash / cash
equivalents
- Strictest of the
liquidity ratios
Greater = No need to
sell additional assets
to pay short-term debt
Net Working Greater ratio = No
Capital Ratio need to sell additional
assets to pay
short-term debt
Main Advantages of Liquidity Ratios
Identifying The liquidity ratios can
Financial assist in the identification
Problems of any potential financial
problems before they
become too big.
Analyzing Liquidity
Ratios regularly will
allow us to identify
issues early, giving a
business time to take
corrective actions.
Assessing Creditors often use
Creditworthiness Liquidity Ratios to assess
a business’s
creditworthiness before
deciding whether or not
to extend credit.
Measuring Liquidity ratios are a
Efficiency useful tool for assessing a
company's efficiency in
managing its current
assets and obligations.
A company with a high
liquidity ratio can pay off
its debts and quickly turn
its assets into cash.
Comparing Liquidity ratios are a
Companies useful tool for comparing
businesses within the
same sector or industry
in order to understand
how they are
performing in
comparison to their
peers.
Predicting Liquidity Ratios are
Bankruptcy another tool for
predicting the probability
of bankruptcy. The
business is probably in
danger of going into
default on its financial
obligations if the
liquidity ratios are
continuously low.
Solvency Ratios
- Compute the business’s ability to
fulfill long-term debt
requirements
- Shows if company’s cash flow is
good enough to meet its long-term
liabilities
Debt-to-equity Compare a company’s total
Ratio debt to the amount of
equity that its owners have
placed in it
Low Ratio = Less debt on
balance sheet to its
outstanding shares ( often
want to maintain these ratios
low )
Debt-to-asset Shows how much debt is
Ratio there relative to all of its
assets
Debt-to-Asset Ratio > 1.0
- Highly reliant on debt
funding and may find
it difficult to make its
debt payments
Proprietary Shows how much of a
Ratio ( Equity company’s funding comes
Ratio ) from equity rather than
debt
High equity ratio = less debt
utilized to finance the
business, most opt for 1
Low equity ratio = not
indicative of a solvent
business
Interest Utilized to determine the
Coverage Ratio company’s ability to pay
interest on the outstanding
debt obligations
Smaller Coverage Ratio =
Heavily indebted
Greater Coverage ratio =
Beneficial for the solvency of
company
Profitability Ratios
- Class of financial metrics that are
used to assess a business’s ability
to generate earnings relative to its
revenue, operating costs, balance
sheet assets or shareholders’ equity
over time, using data from a
specific point in time
Profitability Compares a company’s
Ratio profit metric to its
revenue
Analyze the efficiency
at which the company
can convert revenue
into earnings over a
stated period
Standardized against
revenue ( expressed as a
percentage of revenue )
Gross Profit Shows how much profit
Margin a company retains as
gross profit after paying
off its Cost of Goods
Sold (COGS).
Operating Calculates a company's
Profit profit on each dollar of
Margin sales, indicating how
well the business
converts sales into
profits. ( not interest or
taxes )
Higher ratios = well-run
and adapt at converting
sales into profits
EBITDA Focuses on operating
profitability and cash
flow by eliminating
interest, taxes,
amortization, and
depreciation.
Net Profit Determines the
Margin proportion of profit an
organization makes
relative to its total
revenue.
ROA ( return Shows how lucrative a
of assets ) business is in
comparison to is total
assets
Useful metric for
investors, analysts and
corporate management
to assess how well a
business uses its
resources to turn a profit
ROIC ( Measures how
return on effectively a business
invested turns a profit on its
capital ) capital, indicating if
capital is being used
efficiently.
ROE ( return A measure of a Payables Low turnover of
of equity / company’s profitability Turnover and payables could indicate
return of net and profit-generating No. of Days credit or payment
assets ) efficiency from equity Payable issues, while high
financing turnover may suggest
efficient payment
Higher = company’s practices.
management is more
effective at producing Days of Payables
revenue and growth Outstanding (DPO)
from its equity financing measures the number
the higher the ROE of days it takes to pay off
creditors.

Activity Ratios
Working Shows how efficiently
- Measure the efficiency of a
Capital a company generates
business in using and managing
Turnover sales from its working
its resources to generate
capital.
maximum possible revenue
Fixed Asset Reveals how
Turnover effectively a company
Inventory Low inventory turnover generates sales from
Turnover and suggests slow-moving its fixed assets.
DOH inventory, tying up
capital. Total Asset Measures how
Turnover efficiently a company
High turnover can uses its assets to
indicate efficient stock produce sales.
movement but could
lead to shortages and
lost revenue.

Days of Inventory on
Hand (DOH) measures
the number of days it
takes to sell inventory.

Receivables High turnover of

Turnover and accounts receivable
DSO indicates quick
conversion to cash,
while low turnover
suggests delays.

Days of Sales
Outstanding (DSO)
measures how long it
takes to convert credit
sales into cash.