Republic of the Philippines

Region VII, Central Visayas

Commission on Higher Education
MADRIDEJOS COMMUNITY COLLEGE
Crossing Bunakan, Madridejos, Cebu

COLLEGE OF BUSINESS ADMINISTRATION

Course Code: FM 211

Course Title: FINANCIAL MANAGEMENT

FINANCIAL MANAGEMENT
A Student-Curated Compilation

Compiled For:
Financial Management Class
Academic Year 2024–2025

Instructor: MS. CARMELA CENA

 LESSON 1: Financial Management
 All about preparing, directing, controlling, and managing the money activities of a company such as buying and selling.
 One of the most significant responsible in business entity.
 Requires considerable amounts of decision making.
 Application of finance principles to management.

SCOPE
5 A’s
1. Anticipation - how much is required by the company.
2. Acquisition - collects finance for the company from different resources.
3. Allocation - what to produce by the company.
4. Appropriation - distribution for the company profits among the debenture holders.
5. Assessment - controlling the financial activities.

3 Key Elements
1. Financial Planning - the company must secure enough funds, whether for short or long term.
2. Financial Control - the business must have to know if they have superficial fund to meet the objective goals.
3. Financial Decision-Making - the management must decide whether to keep the money or distribute.

Dividends
 The distribution of profits in a corporation.

IMPORTANT FUNCTIONS OF FINANCIAL MANAGEMENT IN BUSINESS ORGANIZATION

 Guarantee rational and attractive return on investment made in the business.
 Examine business financial performance for growth and expansion.
 Plan, direct, and control the use of financial resources.
 Ensure maximum and efficient flow of operation.
 Create pleasant and amiable relations with company stakeholders.
 Harmonize operation of different facets of the business.
 Build up appropriate controls to secure proper use of financial resources.

ROLE
Strategic Activities
 High level of planning
 Vision, Mission, and Objectives
Financing Activities
 Raise capital
Investing Activities
 Invest the capital to earn highest possible returns
Operating Activities
 Day to day transactions
 Financial control

SWOT Analysis
 Strengths
 Weaknesses
 Opportunities
 Threats

LEGAL FORMS
Sole Proprietorship
 Business owned by one person for his or her own profit.
Advantages:
 East of formation
 Control over operation
 Simplicity
 No sharing profit
Disadvantages:
 Unlimited legal liability
 Limit to available capital
 Limited life
 Limitations of skills and experience

Partnership
 A business owned by two or more people and operator for profit.
Advantages:
 Convenient organization
 Manageability
 Good capitalization
 Risk sharing
Disadvantages:
 Limited life
 Potential for conflict
 Shared profit
 Unlimited liability

Corporation
 Artificial being created by operation of law is organized by one or more incorporators.
Advantages:
 Indefinite life
 Ability to raise funds
 Attractive to investors
 Transferable ownership
Disadvantages:
 More government control
 More costly to organize
 Double taxation
 More involved in decision making process

CAREER OPPORTUNITIES
Career Options
 Financial Analysts
 Portfolio Manager
 Budget Analysts
 Treasury Analysts
 Financial Planners
 Corporate Treasurer
 Commercial Bankers
 Controllers
 Financial Managers
 Chief Financial Officer (CFO)

LESSON 2: Cash Flow Statement

 Crucial form of a finances and the understanding of the health of the business.
 One of the most important components of a financial statement.
 Focuses on the financial report that the company can monitor the health of the business.

3 Components of a Financial Statement

1. Income Statement - most common financial statement that shows the revenues and the total expenses of the company.
2. Balance Sheet - shows the own of the asset of the company in asset form or liabilities form. It also manages the money of the
stakeholders under the lists of the stakeholders equity.
3. Cash Flow Statement - shows the exact amount of cash in flows and cash out flows of the company over a period of time.
3 MAIN CATEGORIES
3 Main Categories of Cash Flow Statement
Operating Activities
 Include the production, sales, and delivery of the company’s product as well as collecting payments from its customers.
 More on the income statement of the company.
Example:
 Receipts from the sale of goods and services.
 Receipts for the sale of loans, debt or equity that instrument in trading portfolio.
 Interest received on equity securities.
 Payments to supplies for goods and services.
 Payments to employees or on behalf of employees.
Cash In Flow:
 From sale of goods and services.
 From interests received and dividends receiver.
Cash Out Flow:
 To suppliers for inventory.
 To employees for wages.
 To government for taxes.
 To lenders for interests.
 To others for expenses.

Investing Activities
 Cash earned or spent from investments your company makes, such as purchasing equipment or investing in other companies.
 More on dealing with long-term asset.
Examples:
 Purchase or sale of an asset.
 Loans made to suppliers or received from customers.
 Payments related to merges and acquisitions.
Cash In Flow:
 From sale o property, plant, and equipment.
 From sale of investments in doubt or equity securities of other entities.
 From collection of principal on loans to other entities.
Cash Out Flow:
 To purchase property, plant, and equipment.
 To purchase investments in debt or equity securities of other entities.
 To make loans to other entities.

Financing Activities
 Include the in flow of cash from investors.
 Deals with long-term liabilities and shareholders equity.
Examples:
 Proceeds from issuing short-term or long-term debt.
 Payments of dividends.
 Payments for repurchase of company shares.
 For non-profit organizations, receipts of donor-restricted cash that is limited to long-term purposes.
Cash In Flow:
 From sale of common stock.
 From issuance of debt (bonds and notes).
Cash Out Flow:
 To stakeholders as dividends.
 To redeem long-term debt or reacquire capital stock (treasury stock).

4 Simple Rules to Remember as You Create Your Cash Flow Statement

1. Increase in assets, decrease in cash flow.
2. Decrease in assets, increase in cash flow.
3. Increase in liabilities, increase in cash flow.
4. Decrease in liabilities, decrease in cash flow.
DIRECT AND INDIRECT METHOD
2 Methods in Calculating Cash Flow Statement
Direct Method
 Uses real time figures and considers only cash flow to show actual payments and receipts.
Benefits of Direct Method:
 Increased Accuracy
 Clearer Understanding
Drawback of Indirect Method:
 Hard to Expand
 Time Consuming and Ineffective

Indirect Method
 A way to calculate each cash flow using transactions to determine payments and expenses rather than cash on hand.
Benefits of Indirect Method:
 Widely Used
 Simpler Preparation
Drawback of Indirect Method:
 Limited Insight
 Possible Error

Additional
Merge and Acquisitions - two business merge together for a new business that merge to the investing business.
GAAP - General Accepted Accounting Principle
IFRS - International Financial Reporting Standard
CFO - Chief Financial Officer
Cash Out Flow - pagawas
Cash In Flow - pasyud

LESSON 3: Financial Statement Analysis

 Provides the basic source of information by managers and other interested parties outside the organization regarding its financial
conditions and results of operations.
 Based on the historical accounting information of the company.
 Also to communicate the financial strength and weaknesses of the company/organization.
 Is prepared by the external users.
External Users:
 Shareholders
 Investors
 Other Government Agencies
 The external users must have to prepare the financial statement because the manager find it equally useful in decision-making in the
performance evaluation of the company together with the other operating activities of the company.

Uses of Financial Statement Analysis

Trend
 The result given in generally cover at least the previous three full accounting years therefore, any fluctuations in any area can be easily
pinpointed.
 Identify if your business is going to upward or downward trend.

Benchmarks
 The average results for each ratio together with the industry profile of the average company in the sector can both be used as
benchmarks to compare.
 Comparing your business through other companies.

Size
 All the major companies in the sectors are ranked on the basis of sales, profit, total assets, and employee members.
 Rank for the all major companies.
Growth
 The average annual growth of each company’s sales, profits, total assets and number of employees over the 3 year period being analyzed,
calculated and ranked.
 Identify where did you loss or where did you gain.

STATEMENT OF FINANCIAL POSITION

 Other term is “Balance Sheet”.
 Snapchat of your business at a given period of time.

2 Forms
Report Form
 The statement of financial position can be presented in vertical form with the assets sections above the liabilities and equities section.

Account Form
 Normally presented in horizontal layout. With an asset page on the left and a page for liabilities and equities form on the right side.

2 Approaches
Multi-Step Approach
 Shows the various profitability stages from gross profit, operating profit up to the net profit which is essential in the terms of cost control
and management.

Single-Step Approach
 Simply identifies the income that comes professional fee and all expenses grouped together to arrive to a net profit.

3 TOOLS AND TECHNIQUES IN FINANCIAL STATEMENT

Horizontal Analysis
 A technique for evaluating a series of date over a period of time to determine the increase or decrease that has taken place, expressed as
either an amount or a percentage.
Formula:
Amount in Comparison Year − Amount in Base Year
Horizontal Analysis (%) = Amount in Base Year
× 100

Example:
Year 2 Year 1 Peso Amount Percentage Ratio
Cash 2,400 2,100 300 14.29% 1.14
Solutions:
Peso Amount
 Subtract the comparison year to base year.
 2,400 － 2,100 = 300
Percentage
 Divide the peso amount to the base year then multiply to 100.
 300 ÷ 2,100 = 0.1429 × 100 = 14.29%
Ratio
 Divide the comparison year to base year.
 2,400 ÷ 2,100 = 1.14

Comparative Analysis
 Under horizontal analysis.
 Has little meaning itself.
 Meaning of the numbers can be enhanced by drawing comparisons.
Vertical Analysis
 Another term is “Common Size Sheet”.
 A technique that express each item within a financial statement of a percentage of a relevant total of a base amount.
 It focuses on the relationship between various financial items in a given statements in a single period.
 Has 2 kinds the Income Statement and the Balance Sheet.
Formula:
Income Statement Item
Vertical Analysis (%) (Income Statement) = Total Sales
× 100
Item Value
Vertical Analysis (% ) (Balance Sheet) = Total Assets × 100

Example 1:
Vertical Analysis (Income Statement)
Year 1 Year 2 Year 2 Year 1
Net Sales 261,000 246,000 100.0% 100.0%
Less Cost of Sales 182,790 169,050 70.0% 68.7%
Gross Profit 78,210 76,950 30.0% 31.3%
Less, Operating Expenses 21,000 20,100 8.0% 8.2%
Net Operating Expenses 57,210 56,850 21.9% 23.1%
Less, Interest Expenses 12,090 11,670 4.6% 4.7%
Net Income 45,120 45,180 17.13% 18.4%
Less, Tax Expense 11,280 11,400 4.3% 4.6%
Net Income 33,840 33,780 13.0% 13.7%
Solutions:
 Divide the Income Statement Item to the Net Sales
 Income Statement Item and Value is blue
 Total Sales is orange
 Answers is green
 The answer for Year 1 will be derived from Year 2, while the answer for Year 2 will be derived from Year 1.
 Example: To calculate the percentage, take the value of "Less Cost of Sales" in Year 1, which is 182,790, and divide it by the "Net Sales" in
Year 1, which is 261,000. Then multiply the result by 100.
 182,790 ÷ 261,000 = 0.70034… 0.70034 × 100 = 70.03…
 We will round to one decimal place. Since the digit next to 0 is 3, we do not round up. Therefore, the final answer is 70.0%.
 The values we use are from Year 1, but once we calculate the answers, we will record them in the Year 2 table, as shown in the table
format. For example, the final answer of 70.0% will be written in the Year 2 table.
 Now, use the same process with the Income Statement and Net Sales values from Year 2.
 PS: Don’t forget to include the "%" sign; otherwise, your answer will be marked as incorrect.
Example 2:
Vertical Analysis (Balance Sheet)
Common Size %
Assets 2018 2017 2009 2010
Current Assets
Cash 600 1,175 3.81% 8.11%
Accounts Receivable, net 3,000 2,000 19.05% 13.81%
Inventory 4,000 5,000 25.40% 34.52%
Prepaid Expenses 150 60 0.95% 0.41%
Total Current Assets 7,750 8,235 49.21% 56.85%

Non Current Assets

Land 2,000 2,000 12.70% 13.81%
Buildings, net 3,000 2,500 19.05% 17.26%
Equipment, net 2,000 1,000 12.70% 6.90%
Furniture and Fixtures, net 1,000 750 6.35% 5.18%
Total Non Current Assets 8,000 6,250 50.79% 43.15%

Total Assets 15,750 14,485 100.00% 100.00%

Liabilities and Stockholders Equity

Current Liabilities
Accounts Payable 2,900 2,000 18.41% 13.81%
Accrued Payable 450 200 2.86% 1.38%
Notes Payable, short term 150 300 0.95% 2.07%
Total Current Liabilities 3,500 2,500 22.22% 17.26%

Non Current Liabilities

Mortgage Payable 2,750 2,000 17.46% 13.81%
Bonds Payable, 5% 1,000 2,000 6.35% 13.81%
Total Non Current Liabilities 3,750 4,000 23.81% 27.61%

Total Liabilities and Equity 7,250 6,500 46.03% 44.87%

Solutions:
 The process here is almost the same as the previous one, but the difference is that you divide the Value of the Item by the Total Assets.
 To calculate the Total Assets, you need to add the Total Current Assets and the Total Non-Current Assets.
 Value and Name of the Item is blue
 Total Assets is orange
 Answers is green
 In this table, Year 1 refers to 2018 and 2010, also called the “Base Year,” while Year 2 refers to 2017 and 2009, also called the
“Comparison Year.”
 As in the previous process, the answer for 2018 (Base Year) will be placed in 2009 (Comparison Year), and the answer for 2017
(Comparison Year) will be placed in 2010 (Base Year).
 Example: To calculate the percentage, take the value of "Cash" in 2018, which is 600, and divide it by the "Total Assets" in 2018, which is
15,750. Then multiply the result by 100.
 600 ÷ 15,750 = 0.03809… 0.03809 × 100 = 3.809…
 In this calculation, we round to two decimal places. Since the digit after 0 is 9, we round up, making the final answer 3.81%.
 Now, use the same process with the Value of each Item and Total Assets from 2017.
 PS: Don’t forget to include the "%" sign; otherwise, your answer will be marked as incorrect.
Trend Analysis
 The item being analyzed is compared against itself in previous periods.
 It is a several years financial data in terms of a base year, which equals 100%.
Formula:
Current Year
Trend Analysis (%) = Base Year
× 100

Example:
2023 2022 2021 2020 2019 2018
Sales 261,000 246,000 234,000 224,400 219,000 216,000
Net Income 33,840 33,780 33,000 31,500 30,600 29,700
Answers:
2023 2022 2021 2020 2019 2018
Sales 121% 114% 108% 224,400 104% 100%
Net Income 114% 114% 111% 106% 103% 100%
Solutions:
 Divide the Current Year by Base Year the multiply to 100.
 The Base Year here is only the 2018 the rest are Current Year.
 Example: To calculate the percentage, take the value of "Sales" in 2023, which is 261,000, and divide it by the "Base Year" in 2018, which
is 216,000. Then multiply the result by 100.
 261,000 ÷ 216,000 = 1.20833… 1.20833 × 100 = 120.8…
 In this calculation, we round to the nearest whole number. Since the digit after 0 is 8, we round up, making the final answer 121%.
 Now, use the same process with the Value of each Item and Base Year from 2018.
 PS: Don’t forget to include the "%" sign; otherwise, your answer will be marked as incorrect.

LESSON 4: Ratio Analysis

 A tool for calculating and understanding a company’s financial standing, performance, liquidity, efficiency, and profitability.

Uses of Ratio Analysis

1. Comparisons
 Ratio analysis is to compare a company’s financial performance to similar firms in the industry to understand the company’s position
in the market.
2. Trend line
 Companies can also use ratios to see if there is a trend in financial performance.
 The trend obtained can be used to predict the direction of future financial performance.
3. Operational Efficiency
 The management of a company can also use financial ratio analysis to determine the degree of efficiency in the management of assets
and liabilities.

Types of Ratio Analysis

1. Liquidity Ratios
 Liquidity ratios measure a company’s ability to meet its debt obligations using its current assets.
 When a company is experiencing financial difficulties and is unable to pay its debts, it can convert its assets into cash and use the
money to settle any pending debts with more ease.
2. Debt Management Ratios or Financial Leverage/Solvency Ratios
 Solvency ratios measure a company’s long-term financial viability.
 These ratios compare the debt levels of a company to its assets, equity, or annual earnings.
3. Profitability Ratios
 Profitability ratios measure a business’ ability to earn profits, relative to their associated expenses.
 Recording a higher profitability ratio than in the previous financial reporting period shows that the business is improving financially.
 A profitability ratio can also be compared to a similar firm’s ratio to determine how profitable the business is relative to its competitors.
4. Asset Management Ratios or Efficiency Ratios
 Efficiency ratios measure how well the business is using its assets and liabilities to generate sales and earn profits.
 They calculate the use of inventory, machinery utilization, turnover of liabilities, as well as the usage of equity.
 These ratios are important because, when there is an improvement in the efficiency ratios, the business stands to generate more
revenues and profits.
LIQUIDITY RATIO
Working Capital
 To cover all of a company's short-term expenses.
 Working capital is the difference between a company's current assets and current liabilities.
 Working capital is used to purchase inventory, pay short-term debt, and day-to-day operating expenses.
Interpretation:
 Positive working capital generally means a company has enough resources to pay its short-term debts and invest in growth and
expansion.
 Negative working capital indicates potential cash flow problems, which might require creative financial solutions to meet obligations.
Formula:
Working Capital = Current Asset － Current Liability
Example:
100,500 － 40,000 = 60,500

Current Asset Ratio

 Current assets are the resources that a business owns and expects to use or sell within a year.
 Current assets are important to a business because by converting them to cash they allow it to pay its day-to-day operating expenses,
bills and loan payments - its current liabilities.
Interpretation:
 A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities
 More than 1 it could more easily pay of short-term debts.
Formula:
Current Assets
Current Asset Ratio = Current Liabilities

Example:
100,500
40,000
= 2.5 : 1

Quick (Acid) Test Ratio

 Measures how sufficient a company's short-term assets are to cover its current liabilities.
 Compares a company's most short-term assets to its most short-term liabilities to see if it has enough cash to pay its immediate liabilities.
Interpretation:
 Companies should have a ratio of 1.0 or greater, meaning the firm has enough liquid assets to cover all short-term debt obligations or
bills.
Formula:
���ℎ ��� ����������� + ���������� ���������� + �����������
Quick (Acid) Test Ratio = ������� �����������

Example:
2,400 + 1,350 + 36,000
40,000
= .99 : 1

Cash Ratio
 A measurement of a company's liquidity.
 It calculates the ratio of a company's total cash and cash equivalents to its current liabilities.
Interpretation:
 A ratio above 1 means that a company will be able to pay off its current liabilities with cash and cash equivalents, and have funds left
over.
 A higher cash ratio is generally better but it may also reflect that the company is inefficiently utilizing cash or not maximizing the
potential benefit of low-cost loans instead of investing in profitable projects or company growth.
Formula:
���ℎ ��� ���ℎ �����������
Cash Ratio = ������� �����������

Example:
2,400
40,000
= 0.6 : 1
DEBT MANAGEMENT RATIOS OR FINANCIAL LEVERAGE/SOLVENCY RATIOS
Debt to Total Asset Ratio
 Defines how much debt a company carries compared to the value of the assets it owns.
 Compares the total amount of liabilities of a company to all of its assets.
 The ratio is used to measure how leveraged the company is.
Interpretation:
 Investors usually look for a company to have a debt ratio between 0.3 (30%) and 0.6 (60%).
 From a pure risk perspective, debt ratios of 0.4 (40%) or lower are considered better, while a debt ratio of 0.6 (60%) or higher makes
it more difficult to borrow money.
Formula:
Total Debt/Liabilities
Debt to Total Asset Ratio = Total Asset
× 100

Example:
7,250
15,750
× 100 = 0.5 or 50%

Debt to Equity Ratio

 Shows how much of a company is owned by creditors (people it has borrowed money from) compared with how much shareholder
equity is held by the company.
Interpretation:
 A high Debt-to-Equity Ratio indicates that a company is borrowing more capital from the market to fund its operations.
 Low Debt-to-Equity Ratio means that the company is utilizing its assets and borrowing less money from the market.
Formula:
����� ����������
Debt to Equity Ratio = ����� �����ℎ������ ������

Example:
150,000
210,000
= 0.71

PROFITABILITY RATIOS
Profit Margin
 The percentage of revenue left after paying business expenses.
Interpretation:
 A net profit of 10% is generally regarded as a good margin for most businesses.
 A net profit of 20% and above is regarded as very healthy.
 A net profit of less than 5% is relatively low in most industries and can indicate financial risk and unsustainability.
Formula:
Net Income Available to Common Stock
Profit Margin = Sales
× 100

Example:
33,840
261,000
× 100 = 12.97%

Return on Sales
 A percentage measure, used to indicate how efficiently a business transforms sales into profits.
Interpretation:
 An increasing ROS indicates that a company is improving efficiency.
 A decreasing ROS could signal impending financial troubles.
Formula:
Operating Income
Return on Sales = Net Sales
× 100

Example:
57,210
261,000
× 100 = 21.92%
Return on Total Assets
 A ratio that measures a company's earnings before interest and taxes (EBIT).
Interpretation:
 A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits.
 A lower ROA indicates there's room for improvement.
Formula:
Net Income Available to Common Stock
Return on Total Assets = Average Total Assets
× 100

 Solve first the Average Total Assets before the ROA.

Formula: (Average Total Assets)
Beginning Total Assets ＋ Ending Total Assets
Average Total Assets = 2

Example: (Average Total Assets)

14,485 ＋ 15,750
2
= 15,117.5

Example: (ROA)
33,840
15,117.5
× 100 = 22.39%

Return on Equity
 How much net income a company generates per peso of invested capital.
Interpretation:
 A higher ROE indicates that a company is generating more profits from the money invested by shareholders.
 A lower ROE may indicate that a company is not using its shareholders' equity effectively to generate profits.
Formula:
Net Income
Return on Equity = Average Shareholders Equity
× 100

 Solve first the Average Shareholders Equity

Formula: (Average Shareholders Equity)
Beginning Shareholders Equity ＋ Ending Shareholders Equity
Average Shareholders Equity = 2

Example: (Average Shareholders Equity)

188,800＋ 210,000
2
= 199,400

Example: (ROE)
33,840
199,400
× 100 = 16.97%
ASSET MANAGEMENT RATIOS OR EFFICIENCY RATIOS
Accounts Receivable Turnover
 Indicates how many times the accounts receivables have been collected during an accounting period.
 It can be used to determine if a company is having difficulties collecting sales made on credit.
 The higher the turnover, the faster the business is collecting its receivables.
Purpose:
 To measure how effective a business is at collecting debt and extending credit.
 To quantify how efficiently a company is in collecting receivables from its clients.
 The ratio measures the number of times that receivables are converted to cash during a certain time period.
Interpretation:
 A good accounts receivable turnover ratio is 7.8.
 This means that, on average, a company will collect its accounts receivable 7.8 times per year.
 A higher number is better, since it means the company is collecting its receivables more quickly.
Formula:
Net Sales
Accounts Receivable Turnover = Average Accounts Receivable

 Solve first the Average Accounts Receivable

Formula: (Average Accounts Receivable)
Beginning Accounts Receivable ＋ Ending Accounts Receivable
Average Accounts Receivable = 2

Example: (Average Accounts Receivable)

33,000＋ 36,000
2
= 34,500

Example: (ART)
261,000
34,500
× 100 = 7.56 times

Average Collecting Period

 Amount of time that passes before a company collects its accounts receivable.
 In other words, it refers to the time it takes, on average, for the company to receive payments it is owed from clients or customers.
 The average collection period must be monitored to ensure a company has enough cash available to take care of its near-term financial
responsibilities.
Interpretation:
 A lower average collection period is generally more favorable than a higher one, means the company collects payment faster.
 A high collection period indicates companies are collecting payments at a slower rate.
 A high collection period could mean customers are taking their time to pay their bills.
Formula:
365 Days (in a year) Average Account Receivable
Average Collecting Period = Accounts Receivable Turnover
or Average Collecting Period = Average Daily Sales

Example: (Formula 1)
365 Days (in a year)
7.56
= 48.28 days

2nd Formula:
 Solve first the Average Daily Sales
Formula: (Average Daily Sales)
Net Sales
Average Daily Sales = 365 Days (in a year)

Example: (Average Daily Sales)

261,000
365 Days (in a year)
= 715.07 per day

Example: (Formula 2)
34,500
715.07
= 48.25 days
No. Of Days Account Receivable or Inventory Turnover
 Is the measurement of the number of times a business's inventory is sold throughout a month, a quarter, or (most commonly) a year of
trading and help businesses make better decisions on pricing, manufacturing, marketing, and purchasing.
Interpretation:
 A higher inventory turnover ratio is considered better because it signifies a business is efficiently managing its inventory.
 Low inventory turnover means you're not selling your products quickly enough.
Formula:
Cost of Sales Cost of Goods Sold
Inventory Turnover = Average Inventory or Inventory Turnover = Average Inventory

 Solve first the Average Inventory

Formula: (Average Inventory)
Beginning Inventory ＋ Ending Inventory
Average Inventory = 2

Example: (Average Inventory)

51,000 ＋ 60,000
2
= 55,500

Example: (Formula 1)
182,790
55,500
= 3.30 times

No. Of Days in Inventory or Average Selling Period

 Is the average number of days it takes for a firm to sell off inventory.
Interpretation:
 A high DSI can indicate that a firm is not properly managing its inventory or that it has inventory that is difficult to sell.
 Low DSI reflects fast sales of inventory stocks and thus would minimize handling costs, as well as increase cash flow.
Formula:
365 Days (in a year)
Average Selling Period = Inventory Turnover

Example:
365 Days (in a year)
= 110.61 days
3.30

Total Asset Turnover

 Measures how effectively a company uses its assets to generate revenues or sales.
Interpretation:
 A higher ratio is favourable because it indicates that the company is using its assets efficiently.
 A lower ratio can indicate inefficiency, which could be due to a poor use of assets, ineffective collection methods.
Formula:
��� �����
Total Asset Turnover = ������� ����� ������

 Solve first the Average Total Assets

Formula: (Average Total Assets)
Beginning Total Assets ＋ Ending Total Assets
Average Accounts Receivable = 2

Example: (Average Total Assets)

14,485 ＋ 15,750
2
= 15,117.5

Example: (TAT)
261,000
15,117.5
= 17.26

LESSON 5: Bonds and Stock Valuation

CONCEPTS OF BONDS
 Bonds are source of financing in the form of debt or borrowing.
 Bonds are commonly issued by the government and corporations commonly in order to raise needed funds or capital.

Maturity Dates
 Refers to the time the issuer must pay the amount borrowed.
Interest Rate
 Is known as the bond's yield or coupon.

Advantages of Bonds
1. Investor will receive regular income through the interest earned from the bonds over the period of time.
2. Full amount of investment will be received by the investor on the maturity date of bond.
3. Profit can be generated from the bonds if it can be sold on a higher price.

Disadvantages of Bonds
4. Since bond investment normally cover's along period of time of gaining profit it might even result to a loss.
5. The risk of companies not being able to return the money to investors.

EFFECT OF BONDS IN THE ECONOMY

 A bonds investment during this period might be attractive as the government may offer better interest rates to attract the general public
or individual investor to buy the bonds.
 Bonds affect the economy thru the determination of the interest rate.
 Bonds also affect stocks attractiveness when the interest rates rise.

CONCEPTS OF STOCKS
 Stocks represent ownership in a corporation and are a way for companies to raise funds for operations or expansion.
 Two main types of stocks: common and preferred.

Common Stockholders
 Have voting rights in corporate decisions.

Preferred Stockholders
 Do not but are prioritized for dividend payments.

Disadvantages in Investing in Stocks

1. Contribution to Economic Growth
When company performance results to profit, it affects the growth of the economy.
2. Beats Inflation
Dividends received from stocks range from 10%-12% which are normally higher to an average inflation rate that ranges between 3%-5%.
3. Accessibility
Stocks can be brought in capital markets through a broker, a financial planner, or online.
4. Return on Investment
Investors would normally buy stocks when the prices are low and later sell them when the prices are high.
5. Liquidity and Conversion to Cash
Stocks maybe sold at any given time as it does not carry a maturity date.

Disadvantages of Owning Stocks

1. Investment Risk
Stock prices can decrease if a company performs poorly, risking investor losses.
2. Priority for Payment
Stockholders receive payment after third-party creditors in case of company bankruptcy.
3. Time Requirement
Research, financial analysis, and monitoring are essential for informed stock investments.
4. Stock Price Volatility
Emotional highs and lows can result from fluctuating stock prices.
5. Competition with Professionals
Individual investors may face challenges competing with institutional investors and traders.

VALUATION OF BONDS AND STOCK

 A process to calculate the theoretical fair value of a particular bond.
 Bond valuation is needed to determined the rate of return and make a decision if bond investment would be advisable.
 Bond valuation would involve calculation of the present value of the bond’s future interest payments and the bond value.
 Bond’s price equals the present value of its expected future cash flows.
PRICING COUPON BONDS
 Refers to determining the current market value of the bond, which is the amount an investor should be willing to pay for it today.

Periodic Coupon Payments (interest payments)

 The bondholder will receive until the bond matures.

Face Value (or par value)

 The bondholder will receive when the bond matures.

Formula to determine the price of a coupon bearing bond is as follows:

T C F
P= t = 1 (1 + y)t + (1 + y)T

The components of the formula are:

C = the periodic coupon payment
y = the yield to maturity (YTM)
F = the bond’s par or face value
t = time
T = the number of periods until the bond’s maturity date

The above formula calculates that the price of the bond is the present value of its future cash flows.

Illustration:
To illustrate, let us take a bond with a face value of P1,000, an interest rate of 4% and will mature in 4 years and will have an annual coupon
payments. Determine the bond price on;
4% yield to maturity
5% yield to maturity
3% yield to maturity

C = P1,000 × 4% = P40
Solution:
1. 4% yield to maturity
40 40 40 1040
P = (1.04)1 ＋ (1.04)2
＋ (1.04)3
＋ (1.04)4

P = 38.46 ＋ 36.98 ＋ 35.56 ＋ 889 = P1,000

The result show an important relationship that if y (yield to maturity rate) equals the coupon rate, then the bond price will be equal to the
face value.

2. 5% yield to maturity
40 40 40 1040
P = (1.05)1 ＋ (1.05)
＋ (1.05)3
＋ (1.05)4

P = 38.10 ＋ 36.28 ＋ 34.55 ＋ 855.61 = P964.54

The result show an important relationship that if y (yield to maturity) is greater than the coupon rate, then the bond price will be less than
the face value.

3. 3% yield to maturity
40 40 40 1040
P = (1.03)1 ＋ (1.03)2 ＋ (1.03)3 ＋ (1.03)4

P = 38.83 ＋ 37.70 ＋ 36.61 ＋ 924.03 = P1,037.17

The result show an important relationship that if y (yield to maturity) is less than the coupon rate, then the bond price will be greater than
the face value.
SEMI-ANNUAL COUPON BOND PRICING
 For a bond that makes semi-annual coupon payments, the following adjustments must be made to the pricing formula:
a. The coupon payment is cut in half.
b. The yield is cut in half.
c. The number of periods is doubled.
Illustration:
Suppose that a bond has a face value of P1,000, a coupon rate of 8% and a maturity of two years. The bond makes semi - annual coupon
payments, and the yield to maturity is 6%. The semi - annual coupon is P40, the semi - annual yield is 3%, and the number of semi - annual
periods is four.
Solution:
C = P1000 × 8% = 80
80
Semi - annual: 2
= P40:
40 40 40 1040
P = (1.03)1 ＋ (1.03)2 ＋ (1.03)3 ＋ (1.03)4

P = 38.83 ＋ 37.70 ＋ 36.61 ＋ 924.03 = P1,037.17

PRICING ZERO COUPON BONDS

 Does not make any coupon payments; instead, it is sold to investors at a discount from face value. The difference between the price pain
for the bond and the face value, known as a capital gain, is the return to the investor.
Formula for pricing for a zero coupon bond is:
�
P = ( � + � )�

Illustration:
Suppose that a one - year zero - coupon bond is issued with a face value of P1,000. The discount rate for this bond is 8%.
What is the market price for this bond?
Solution:
In order to be consistent with coupon - bearing bonds, where coupons are typically made on a semi - annual basis, the yield will be divided
by 2, and the number of periods will be multiplied by 2.
1000
P = ( 1.04 )2 = P924.56

LESSON 6: Capital Budgeting

 A long-term plan that forecast a receipts and a payments related to a propose budget.
 Budgeting of funds/capital.
 Capital budgeting is a process of evaluating, the best way to invest your money in a long-term project that increase the value of your
business.

3 Important Purposes for the Companies in Capital Budgeting

1. Accountability - helps to provide just to measure the risk factor.
2. Measurability - it allows the company to measure the effectiveness.
3. Resource Allocation - identify what would be the important decision-making process that will not affect your money invested in that
company.

TYPES OF A CAPITAL PROJECT

1. Cost Reduction - it is a process where your expenses should not exceed your revenues.
2. Business Expansion - means growing a business or starting another business while keeping the same ownership.
3. Equipment Replacement - when should a company decide to replace or buy new equipment.
4. Lease or Buy - refers to the decision-making process where a business evaluates whether to lease equipment or property (rent for a
specific period) or purchase it outright.
5. Equipment Selection - refers to the process of choosing the appropriate tools, machines, or technology for a business or organization.
BASIC PRINCIPLES IN CAPITAL BUDGETING
1. Incremental Cash Flows - the additional cash flow you expect to gain or lose in a new investment or project.
2. After-Tax Basis - it’s essential to factor in taxes to see the actual amount you’ll keep.
3. Ignore Sunk Costs - expenses that have already been spent and cannot be recovered.
4. Include Opportunity Costs - the potential benefits you miss out on when choosing one option over another.
5. Exclude Financing Costs - cash flow should be operational in nature. Since the goal is to determine whether the project should be
implemented or not.

STEP BY STEP IN CAPITAL BUDGETING

1. Identify
2. Gathers Information
3. Establish Criteria
4. Evaluate
5. Implemented

3 Important Types of Decisions Encountered in Capital Budgeting

1. Screening Decisions
2. Preference Decisions
3. Optimization

PAYBACK PERIOD (PBP)

 It measures how long it takes for a capital project to break-even or “payback”.
 The unit of time depends on the periodicity of the cash flows used in the analysis.
Formula:
Net Investment
Payback Period = Periodic Cash Flow

Example:
Problem:
What is the payback period of a project that costs P1,000,000 to implement, and will generate P300,000 in after-tax cash flows for the next
five years?
Given:
Net Investment: 1,000,000
Periodic Cash Flow: 300,000
Solution:
1,000,000
300,000
= 3.33 years
ACCOUNTING RATE OF RETURN (ARR)
 A variation of “return on investment”.
Formula:
Average After−Tax Operating Income
Accounting Rate of Return = Investment

Example:
Problem:
TelCo is evaluating a project with an investment costs of P1,250. The project is expected to last for 4 years. The initial investment consists of
a piece of machinery that is expected to have a salvage value and will be depreciated over 4 years straight-line depreciation.
Table 1:
Cash In Flows Year 1 Year 2 Year 3 Year 4
Project X 600 500 400 300
Solution:
 1st calculate the annual Depreciation Expense.
Formula: (Depreciation)
���� �������
Depreciation = ������ ����

Given:
Cost Salvage: 1,250
Useful Life: 4 years
Solution:
1,250
4
= 312.50

Table 2:
Project X Year 1 Year 2 Year 3 Year 4
Cash In Flows 600 500 400 300
Less: Depreciation 312.50 312.50 312.50 312.50
Operating Income (loss) 287.50 187.50 87.50 -12.50

 2nd calculate the Average After-Tax Operating Income.

Solution:
287.50 ＋ 187.50 ＋ 87.50 ＋ −12.50
OIx = 4
550.50
OIx = 4
= 137.50

 3rd calculate the Average Investment

Formula: (Average Investment)
Beginning Investment ＋ Ending Investment
Average Investment = 2

Solution:
1,250 ＋ 0
2
= 625

 Lastly, calculate the Accounting Rate of Return (ARR).

Formula: (ARR)
Average After−Tax Operating Income
Accounting Rate of Return = Investment

Given:
Average After-Tax Operating Income: 137.50
Investment: 625
Solution:
137.50
625
= 22.0%
DISCOUNTED PAYBACK PERIOD (DPBP)
 It measures the number of periods it takes for a project to payback the initial investment. It is interpreted in the same ways as the
regular payback period.
Formula:
No. of Periods Before Breaking Even ＋ Unrecovered Discounted Amount in the Period of Recovery
Discounted Payback Period = Discounted Cash Flow in the Period of Recovery

Example:
Problem:
Continuing with the previous example, calculate the discounted payback period of TelCo. Assume that TelCo uses discount rate of 10% and
accepts a project, if its discounted payback period does not exceeds 85% of the projects life.
Table 1:
Cash In Flows Year 0 Year 1 Year 2 Year 3 Year 4
Project X 1,250 600 500 400 300
Solution:
 1st calculate the Discount Factor for each year based on the discount rate.
 It will be accomplished using the future value equation for a lump sum, and a present value of 1.
Formula: (Future Value)
Future Value = Present Value (1 ＋ r)n
 The discount rates of all periods, using a discount rate of 10%.
Table 2:
Year 1 Year 2 Year 3 Year 4
1 2 3
DF1 = (1 ＋ 10%) DF2 = (1 ＋ 10%) DF3 = (1 ＋ 10%) DF4 = (1 ＋ 10%)4
= 1.1000 = 1.2100 = 1.3310 = 1.4641
Note:
 Decimal digits should consist of 4 digits. If the answer has only 1 decimal digit, add '0' to the end until it reaches 4 decimal places.

 2nd calculate the Discounted Cash Flows by dividing the nominal (undiscounted cash flow) by the discount factor.
 Note that cash flows in year 0 have a discount factor of 1.
Formula: (Discounted Cash Flows)
CFx3
DCFx3 = DF3

Solution:
 Simply divide the table 1 and table 2.
Example:
400
1.3310
= 300.53

Table 3:
Discounted Cash Flows Year 0 Year 1 Year 2 Year 3 Year 4
Project X 1,250 545.45 413.22 300.53 204.90

 3rd calculate the Cumulative Cash Flows, except this should now be based on the discounted cash flows.
 There is no rate to calculate for project X past year 3 because, it has already broken even in year 3.
Table 4:
Cumulative Discounted Cash Flow Year 0 Year 1 Year 2 Year 3
Project X 1,250 704.55 291.33 9.20
Solution:
 Simply subtract 1,250 (Year 0) from the years in Table 3, then subtract the result from the next year in Table 3.
Example:
1,250 (Year 0/Table 4) － 545.45 (Year 1/ Table 3) = 704.55
704.55 (Year 1/Table 4) － 413.22 (Year 2/Table 3) = 291.33
291.33 (Year 2/Table 4) － 300.53 (Year 3/Table 3) = 9.20
Note:
 The answer in Year 3, Table 4 is 9.20, even though the calculated value is -9.20, because the absolute value (positive only) is used.
  Lastly, calculate the Discounted Payback Period.
Project X turned cash flow positive in Year 3. Which means there were two years before breaking even. The unrecovered discounted amount
if the last unrecovered year (Year 2) is 291.33 and the discounted cash flow in the year of the recovery (Year 3) is 300.53.
Formula:
No. of Periods Before Breaking Even ＋ Unrecovered Discounted Amount in the Period of Recovery
Discounted Payback Period = Discounted Cash Flow in the Period of Recovery

Given:
��. �� ������� ������ �������� ����: 2
����������� ���������� ������ �� ��� ������ �� ��������: 291.33
���������� ���� ���� �� ��� ������ �� ��������: 300.53
Solution:
2 ＋ 291.33
300.53
= 2 ＋ 0.97 = 2.97 years

 Calculate 1st the 291.33 ÷ 300.53 before adding the 2.

NET PRESENT VALUE (NPV)

 It measures the total lifetime value of a project or an investment of today’s money.
Formula:
�� 1
Net Present Value = CF0 ＋ [ 1－( )]
� (1 ＋ r)N

Example:
Problem:
A project that costs P1,000,000 to implement will generate after-tax cash flows of P300,000 per year for the next 5 years. What is the NPV if
the costs of capital is 12%?
Given:
CF0: 1,000,000
CF: 300,000
r/rate: 12% or 0.12 (must use the decimal form)
N: 5 years
Solution:
300,000 1
NPV = 1,000,000 ＋ 0.12
[1－(
(1 ＋ 0.12)5
)]

1
NPV = 1,000,000 ＋ 2,500,000 [ 1 － (1.7623)]

NPV = 1,000,000 ＋ 2,500,000 [ 1 － 0.5674]

NPV = 1,000,000 ＋ 2,500,000 [0.4326]
NPV = 1,000,000 ＋ 1,081,500
NPV = 2,081,500

LESSON 7: Cost of Capital

 Is the cost incurred in order to raise needed fund for business operations.
 Also refers to the expense incurred by a company to fund its operations and investments.

COST OF DEBT
 Is the annualized cost of financing associated with taking at a loan or issuing debt instrument like a note or bond.
Formula:
⎾d after-tax = ⎾d × (1 － Tax Rate)
Example:
Problem:
If a company’s cost of debt amounts to 8% and it has a tax rate of 25%.
Given:
d: 8%
Tax Rate: 25% or 0.25 (convert it to decimal form)
Solution:
⎾d after-tax = 8 × (1 － 0.25)
= 8 × 0.75
= 6%
COST OF COMMON STOCK
 The cost of common stock is the rare of return required by the company’s common stockholders and is almost higher than the cost of
debt or preferred.
 Compensation demanded by inventors for buying and holding the company’s stock.
 Synonymous with the term Cost of Retained Earning.
Formula:
d₁
⎾s =
P₀ (1 － F)＋g

Where:
⎾s = required return on common stock
D₁ = per share dividend expected at the end of year 1
P₀ = value of common stock
f = flotation (%)
g = constant rate growth
Example:
Problem:
Bus Rapid Transit Co. Plans to issue common stock for P8 per share. The stock is expected to pay a dividend of 37.6 C. It targets a dividend
payout ratio of 25% and the company’s return on equity amounted to 8%, if the flotation cost is 6% what is the cost of new common stock?
Solution:
 Solve first the Constant Rate Growth (g)
Formula: (Constant Rate Growth)
g = b × ROE
b = (1 － target dividend rate) × 100
Solution: (Constant Rate Growth)
(1 - 25%) = 75%
75% × 8% = 6%
 Solve for the Cost of Common Stock
Solution: (Cost of Common Stock)
Given:
D₁ = 37.6 or 0.376 (37.6 ÷ 100 = 0.376)
P₀ = 8
f = 6%
g = 6%
Substitute:
0.376
⎾s = ＋ 6%
8 (1 － 6%)

0.376
⎾s = 8 (94%) ＋ 6%
0.376
⎾s = 7.52
＋ 6%

⎾s = 5% ＋ 6%
⎾s = 11%

Yield To Maturity Approach

 Or preferred approach that calculates the securities effective rate of interest.

Debt Rating Approach

 Is used when the market price of debt is not available.
COST OF PREFERRED STOCK
 Flotation cost increase the cost of preferred stock by effectively reducing the proceeds that the issuer receives.
Formula:
d₁
⎾ps =
P₀ (1 － F)

Where:
⎾ps = the required rate return or cost of preferred stock
d₁ = the dividend expected from the preferred stock
P₀ = the current market price of the preferred stock
F = flotation cost
Example:
Problem:
TrainCo plans to issue preferred stock at P88 per share. The stock pays a semi-annual dividend of P2.09. If the flotation cost are 5%, what is
the cost of preferred stock to be issued?
Solution:
2.09 × 2
⎾ps =
88 (1 － 5%)
4.18
⎾ps = 88 (95%)
4.18
⎾ps =
83.6

⎾ps = 5.00%
WEIGHTED AVERAGE COST OF CAPITAL
 It combines the cost of each source of capital.
 It is one of the most important figure in assessing a company’s financial health, both for internal use (in capital budgeting) and external
use (valuing companies on investment markets).
Formula 1: (Based on YouTube)
E D
(V × Re) ＋ (V × Rd (1 － Tax Rate))

Where:
E = Market Value of Equity
V = Total Market Value of Equity and Debt
Re = Cost of Equity
D = Market Value of Debt
Rd = Cost of Debt
Tax Rate = Corporate Tax Rate
Example:
Problem:
Suppose XYZ Inc. has:
Equity
Market Value of Equity (E): 500 million
Cost of Equity (Re): 12% (required return by shareholders)
Debt
Market Value of Debt (D): 200 million
Cost of Debt (Rd): 6% (interest rate of debt)
Tax Rate (T): 25%
Solution:
 Calculate first the Total Market Value.
Formula: (Total Market Value)
V=E＋D
Solution: (Total Market Value)
V = 500,000,000 ＋ 200,000,000
V = 700,000,000
 Calculate the Weighted Average Cost of Capital
Solution: (WACC)
500,000,000 200,000,000
= (700,000,000 × 12%) ＋ (700,000,000 × 6%) (1 － 25%)

= (0.086) ＋ (0.017) (0.75)

= 0.0988 or 9.88% (convert into percentage)
Formula 2: (Based on Book 1/Ms. Cena)
WACC = (Proportion of Total Funding that is Equity Funding) × (Cost of Equity) ＋
(Proportion of Total Funding that is Debt Funding) × (Cost of Debt) × (1 － Corporate Tax Rate)
Example:
Problem:
ABC Corporation has the following information:
Equity
Market Value of Equity: 800 million
Cost of Equity: 10%
Debt
Market Value of Debt: 400 million
Cost of Debt: 7%
Tax Rate
Tax Rate: 30%
Solution:
 Solve for the Total Market Value
Formula: (Total Market Value)
Total Market Value = Market Value of Equity ＋ Market Value of Debt
Solution: (Total Market Value)
800,000,000 ＋ 400,000,000 = 1,200 million
 Solve for the Proportion of Equity
Formula: (Proportion of Equity)
Market Value of Equity
Proportion of Equity = Total Market Value

Solution: (Proportion of Equity)

800 million
1,200 million
= 0.6667 or 66.67% (convert into percentage)

 Solve for the Proportion of Debt

Formula: (Proportion of Debt)
Market Value of Debt
Proportion of Debt = Total Market Value

Solution: (Proportion of Debt)

400 million
1,200 million
= 0.3333 or 33.33% (convert into percentage)

 Solve for the WACC

Solution: (WACC)
Given:
Proportion of Equity: 66.67% or 0.6667 (convert into decimal)
Cost of Equity: 10% or 0.10 (convert into decimal)
Proportion of Debt: 33.33% or 0.3333 (convert into decimal)
Cost of Debt: 7% or 0.07 (convert into decimal)
Corporate Tax Rate: 30% or 0.30 (convert into decimal)
Substitute:
WACC = (0.6667 × 0.10) ＋ (0.3333 × 0.07) (1 － 0.30)
WACC = (0.06667) ＋ (0.023331) (0.7)
WACC = 0.0830 or 8.30% (convert into percentage)
Formula 3: (Book 2)
WACC = (Wd × ⎾d ) (1 － T) ＋ (Wps ×⎾ps ) ＋ (Ws ×⎾s)
Where:
Wd = Weight of Debt
⎾d = Cost of Debt
T = Tax Rate
Wps = Weight of Preferred Stock
⎾ps = Cost of Preferred Stock
Ws = Weight of Equity
⎾s = Cost of Equity
Example:
Problem:
ABC Corporation has the following information:
Equity
Market Value of Equity (E): 800 million
Cost of Equity (⎾s): 10%
Debt
Market Value of Debt (D): 400 million
Cost of Debt (⎾d): 7%
Preferred Stock
Market Value of Preferred Stock (PS): 100 million
Cost of Preferred Stock (⎾ps): 8%
Tax Rate
Tax Rate: 30%
Solution:
 Calculate first the Total Market Value
Formula: (Total Market Value)
Total Market Value = E ＋ D ＋ PS
Solution: (Total Market Value)
= 800 million ＋ 400 million ＋ 100 million
= 1,300 million
 Calculate the Weights of Equity, Debt and Preferred Stock
Weight of Equity (Ws):
E 800 million
Ws = Total Market Value 1,300 million
= 0.6154 or 61.54%

Weight of Debt (Wd):

D 400 million
Wd = Total Market Value 1,300 million
= 0.3077 or 30.77%

Weight of Preferred Stock (Wps):

PS 100 million
Wps = Total Market Value 1,300 million
= 0.0769 or 7.69%

 Solve for the WACC

Solution:
Given:
Wd = 0.3077
⎾d = 0.07 (7%)
T = 0.30 (30%)
Wps = 0.0769
⎾ps = 0.08 (8%)
Ws = 0.6154
⎾s = 0.10 (10%)
Substitute:
WACC = (0.3077 × 0.07 ) (1 － 0.30) ＋ (0.0769 × 0.08) ＋ (0.6154 × 0.10)
WACC = (0.021539) (0.7) ＋ (0.006152) ＋ (0.06154)
WACC = (0.021539) (0.7) ＋ (0.067692)
WACC = 0.0828 or 8.28%
 LESSON 8: Working Capital Management
 All about company’s managerial accounting strategy that aims to monitor and utilize the two components of working capital current
assets and current liabilities, to ensure the most financially efficient operation of the company.

ELEMENTS OF WORKING CAPITAL MANAGEMENT

Working Capital Ratio
 Calculated as current assets divided by current liabilities, is a key indicator of a company’s fundamental financial health since it indicates
the company ability to successfully meet all of its short-term financial obligations.
Formula:
Current Asset
Working Capital Ratio = Current Liabilities

Example:
Let’s say a company has:
Current Assets: 100,000
Current Liabilities: 50,000
Solution:
100,000
50,000
= 2

Collection Ratio/Average Collection Ratio

 Is a principal measure of how efficiently a company manage it’s account receivables.
Formula:
Average Accounts Receivables × No. of Days in Accounting Period
Collection Ratio = Net Credit Sales

Example:
Missy Co has an average accounts receivable of 50,000 and a total of 200,000 in net credit sales during a month (30 days).
Given:
Average Accounts Receivables: 50,000
No. Of Days in Accounting Period: 1 month or 30 Days
Net Credit Sales: 200,000
Solution:
50,000 × 30 1,500,000
200,000
= 200,000
= 7.5 days

Inventory Management
 To operate with maximum efficiency and maintain a comfortable higher level of working capital.
Formula:
Revenue
Inventory Turnover Ratio = Inventory Cost

Example:
Dines Company has a revenue of 500,000 and an average inventory cost of 100,000.
Solution:
500,000
100,000
=5

TYPES OF WORKING CAPITAL

1. Gross and Net Working Capital - the total of current is known as gross working capital whereas the difference between current assets
and current liabilities is known as the net working capital.
2. Permanent Working Capital - the minimum amount of working capital that must always remain invested.
3. Variable Working Capital - working capital requirements of a business form might increase or decrease from time to time due to various
factors.

OBJECTIVES OF WORKING CAPITAL MANAGEMENT

 Maintaining the working capital operating cycle and to ensure the smooth operation.
 Mitigating the cost of capital.
 Maximizing the return on current assets investment.
THE WORKING CAPITAL CYCLE
 The minimum amount of time which is required to convert net current assets and net current liabilities into cash.
 Cash: Is the funds available for the purchase of goods.
a. There is a shortage of cash inflow for some reason. In the absence of reserved cash, day to day business will get hampered.
b. Some new opportunities spring up. In such a case, the absence of reserve cash will pose a hindrance.
c. In case of any contingency, absence of a reserved fund can cripple the company and poses a threat the solvency of the firm.
Creditors And Debtors
 Creditors - refers to the account payable.
 Debtors - refers to the account receivable.
 Inventory - refers to the stock in hand.

PROPERTIES OF A HEALTHY WORKING CAPITAL CYCLE

1. Sourcing of Raw Material – beginning point for most business.
2. Production Planning – are necessary for the production to start are met, and production of goods or services.
3. Selling – once the goods are produced and are moved into the inventory.
4. Payouts and Collections - the account receivables need to be collected on time to the creditors.
5. Liquidity - for the smooth functioning of the working capital cycle.

APPROACHES TO WORKING CAPITAL MANAGEMENT

1. The Conservative Approach - involves low risk and low profitability.
2. The Aggressive Approach - to minimize profits while taking higher risks.
3. The Moderate or the Hedging Approach – involves moderate risks along with moderate profitability.

SIGNIFICANCE OF ADEQUATE WORKING CAPITAL

 Adequate working capital ensures sufficient liquidity that ensures the solvency of the organizations.
 Sufficient liquidity
 On-time payments
 Good credit history
 Ensures that dividends are regularly paid
 Uninterrupted flow of production

FACTORS FOR DETERMINING THE AMOUNT OF WORKING CAPITAL NEEDED

 Factors that determine the liquid cash and assets required for any firm to operate smoothly:
 Nature of business
 Size of the business Unit
 Terms of purchase and terms of sale
 Turnover of Inventories
 Process of manufacture
 Importance of labor

IMPORTANCE OF WORKING CAPITAL

 Working Capital is a vital part of a business and can provide the following advantages to a business:
 Higher Return On Capital
 Improved Credit Profile And Solvency
 Higher Profitability
 Higher Liquidity
 Increased Business Value
 Favorable Financing Condition
 Uninterrupted Production
 Ability To Face Shocks And Peak Demand
 Competitive Advantage

CASH FLOW MANAGEMENT

 Describe the practice of balancing income to expenses.
a. Positive Cash Flow - the cash coming into your business sales and accounts receivable.
b. Negative Cash Flow - the cash going out of your business is greater than incoming cash.
PROJECTING CASH FLOW
 To successfully project cash flow, organization look at their prior years checkbook as a basis of cash flow for the following year.
 As the year unfolds, a company then updates cash flow projections to adequately reflect recent developments in expenses and profits.

ADDRESSING CASH SHORTAGES

 The following practices are quite common among businesses of all sizes
 Apply for a loan from a banking institution or individual
 Apply for a line of credit from a banking institution
 Speed up the collection process
 Finance the purchasing of equipment through leasing or loans
 Liquidate assets
 Delay payments to vendors

MAXIMIZING USE OF PROJECTED CASH SURPLUSES

 An organization won’t always find itself encountering debts before revenue is generated.
 An organization may expect a revenue surplus in a cash flow projection. What the company does with that money can affect future
opportunities.
 The money shouldn’t be spent or left sitting around. Instead, accountants recommend that companies make the money work for them.

ACCOUNT RECEIVABLE MANAGEMENT

 3 key areas:
1. Assess creditworthiness before granting credit.
2. Set suitable credit terms and monitor receivables efficiently.
3. Collect cash from customers effectively.

ASSESSING CREDIT WORTHINESS

 6 methods:
1. Bank Reference - verify facts, but limited scope.
2. Trade Reference - insights from other companies.
3. Credit Rating/Reference Agency - professional credit assessments.
4. Financial Statements - publicly available data.
5. Financial Media - news and updates from press, trade journals, and online.
6. Visit - personal meeting to discuss needs and build rapport.

SETTING CREDIT TERMS & MONITORING ACCOUNTS RECEIVABLE

1. Define Credit Terms Clearly - outline payment periods, early payment discounts, and interest charges for late payments.
2. Offer Flexibility - standard terms apply, but adjust based on customer reliability and relationship history.
3. Set Credit Limits - begin with a set limit for each customer; increase gradually while monitoring for any violations.
4. Identify Unethical Patterns - watch for customers who initially pay on time for small orders but delay on larger ones.

MONITORING TOOLS
 Accounts Receivable Aging Report – shows the amounts outstanding from each customer and for how long they have been outstanding.
 Credit Utilization Report – shows the proportion of each customer’s credit limit that is currently being utilized.

RISK MANAGEMENT APPROACH

 Group customers by risk level, establish credit ratings.
 Regularly reassess terms to balance sales opportunities with credit risk.

COLLECTING CASH
 It is essential that the invoice is sent out quickly and accurately. The receipt of your invoice is the first indication a company gets of the
efficiency of your debt collection system.
1. Monthly statements - produced quickly and easily by any computerized sales ledger system and sent to customers.
2. Chasing Letters – should be directed to a specific person preferably at a reasonably senior level.
3. Chasing Phone Calls – have a great impact as all businesses have to answer the telephone and, hence, they have a nuisance value which
can generate results.
4. Personal Approach - a quite common in trades where the personal relationship with clients is important.
5. Stopping Supplies – a cash collection tool that must be used with care.
6. Legal Action – a costly and is likely to lead to the customer being lost.
7. External Debt Collection Agency – as with legal action this is costly and is likely to lead to the loss of the customer.
METHODS OF SPENDING UP CASH COLLECTION FROM ACCOUNTS RECEIVABLE
 There are two key methods of spending up cash collection from accounts receivable:
1. Using factoring.
2. Using early settlement discounts.
 The customer’s cost of refusing the discount = the supplier’s cost of offering the discount.
Formula:
365
D
Cost = (1 ＋ 100 − D ) t －1

Where:
D = discount
t = the period by which the payment is advanced if the discount is taken
Example:
A company offers its customers 30 days credit but, at present, customers are taking an average of 41 days credit. In order to speed up cash
collection, the company is considering introducing a 1% discount for payment within 10 days. The company finances its working capital
requirement using an overdraft at an annual cost of 9%.
Given:
D: 1%
t: 31 days ( 41 － 10 = 31 days)
Solution:
365
1
Cost = (1 ＋ 100 − 1 ) 31 － 1
365
= (1.0101) 31 － 1
= (1.0101)11.774 － 1
= 1.126 － 1
= 0.126 or 12.6%

INVOICE DISCOUNTING
 Use to speed up the receipt of cash from its receivables.
 Use to SMEs who are starting to win contracts with large customers.

Confidential Invoice Discounting - the customer is not aware of the discounting arrangement and, as long as they pay their debt, they will
never aware of it.

INVENTORY MANAGEMENT
 A collection of interdisciplinary processes that include a full circle from chain management to demand forecasting, through inventory
control and including reverse logistics.
 Effective inventory management depends on understanding all the details of what is inventory management.

LESSON 9: Financial Planning Process

 The process of controlling and managing the use of money to achieve personal economic satisfaction and independence.
 Can enhance quality of life and reduce certain uncertainties about future needs.
 Also increases effectiveness in securing, using and protecting financial resources of an individual or business. As such, the risk of
indebtedness, lack of money or financial insufficiency would be reduced.

1. Assess Your Present or Current Financial Situation

 Start listing down the resources of all your income, any obligation or debts and what are the expenses you or your business incurred. In
knowing these items you will be able to identify if there are enough money left to save or there are just enough money coming in to
satisfy your standard or way of living.

2. Develop Financial Goals and Objectives

 Developing financial goals and objectives is a crucial step in financial planning. It involves identifying needs and wants, setting priorities,
and allocating resources strategically to achieve financial security.
 Financial planning involves a systematic approach to managing money, including setting financial goals, budgeting, saving, and investing.
Tips:
 Needs vs. Wants: A clear understanding of needs and wants is essential for effective financial planning.
 Prioritization: Prioritizing needs over wants ensures that essential expenses are covered, leading to financial stability.
 Financial Goals: Setting specific, measurable, achievable, relevant, and time-bound (SMART) financial goals provides direction and
motivation.
3. Develop Alternative Courses of Action
 Developing alternatives is critical in making good decision.
 Many factors will influence the available alternatives, possible courses of action usually fall into these categories:
 Continue the same course of action.
 Expand the current situation.
 Change the current situation
 Take a new course of action

4. Evaluate Possible Alternatives

 Evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions.
 Opportunity cost is what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision.
 Uncertainty is a part of every decision.
 Selecting a college major and choosing a career field involve risk.
 The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial
planning information sources.

5. Create and Follow Financial Plan

 You need to develop an action plan which will require selecting ways to achieve your goals.

6. Re-Evaluate and Re-Example the Plan

 An ongoing process that needs to continue even if a particular action had been taken.
 Monitoring and regular assessment of your financial decision is needed.
 Financial planning will alter and affect your life as this will serve a tool for achieving you financial goals that will lead to financial security
and independence thus improving the quality of your life or business.

THE FINANCIAL PLANNING PROCESS, ILLUSTRATED

1. Determine Current Financial Situation - by determining your current financial situation, you'll gain clarity on your financial health and
make informed decisions to achieve your goals.
2. Develop Your Financial Goals - developing financial goals involves identifying, prioritizing, and quantifying specific, achievable, and
measurable financial objectives.
3. Identify Alternatives Courses - identifying courses of action involves determining specific steps or strategies to achieve your financial
goals.
4. Evaluate Alternatives - evaluating alternatives involves assessing and comparing different options or solutions to achieve your financial
goals. This process helps you;
 Identify pros and cons
 Weigh risks and benefits
 Consider trade-offs
 Select the best option
 Create and implement your financial action plan

CREATING AND IMPLEMENTING A FINANCIAL ACTION PLAN MEANS:

Creating:
 Identifying financial goals and objectives
 Assessing current financial situation
 Developing strategies to achieve goals
 Outlining specific steps and tasks
 Establishing timelines and deadlines
Implementing:
 Executing tasks and strategies
 Monitoring progress and tracking results
 Adjusting plan as needed
 Staying accountable and motivated
 Reviewing and revising plan regularly
 Review and revise the financial plan
REVIEWING AND REVISING A FINANCIAL PLAN INVOLVES:
Review:
 Assessing progress toward financial goals
 Evaluating effectiveness of current strategies
 Identifying areas for improvement
 Considering changes in financial situation or goals
Revise:
 Updating financial objectives
 Adjusting investment strategies
 Re-balancing portfolios
 Refining budget and expense management
 Updating insurance coverage