INTRODUCTION TO FINANCIAL ● In income statements, all items are usually

MANAGEMENT expressed as a percentage of sales.

● In balance sheets, all items are usually
expressed as a percentage of total assets.
FINANCIAL STATEMENT ANALYSIS
● We use Lifo Method to value inventory
Gross Margin Percentage
● We use the Average Cost Method to value
● the measure indicates how much of each
inventory.
sales dollar is left after deducting the cost of
goods sold to cover expenses and provide a
Limitations of Financial Statement Analysis
profit.
Analysts should look beyond ratios
Gross Margin Percentage =
● Technological changes
Gross Margin / Sales
● Industry trends
Vertical Analysis
● Changes within the company
● Focuses on the relationship among financial
● Consumer tastes
statement items at a given point in time.
● Economic factors
Individual item / Base amount * 100%

Statement in Comparative and Common-Size

3. RATIOS
Form
The common stockholder
1. DOLLAR AND PERCENTAGE CHANGES ON
● The ratios that are of most interests to
STATEMENTS
stockholders include those ratios that focus
on net income, dividends, and stockholders'
Horizontal Analysis (Trend Analysis)
equity.
● Shows the changes between years in the
● Whenever the ratio divides an income
financial data in both dollar and percentage
statement balance by a balance sheet
form.
balance, the average for the year is used in
● Side-by-side comparison of two or more
the denominator.
years' financial statements.
● Earnings from the basis for dividend
payments and future increases in the value
Calculating Change in Dollar Amounts
of shares of stocks.
Dollar Change =
Current Year Figure - Base Year Figure
Earnings Per Share
● This measure indicates how much income
Calculating Change as a Percentage
was earned for each share of common
Percentage Change =
stock outstanding.
Dollar Change / Base Year Figure * 100%
Earnings per Share =
Net Income – Preferred Dividends /
Trend Percentage
Average Number of Common Shares
● State several years of financial data in
Outstanding
terms of a base year, which equals 100
Price-Earnings Ratio
percent.
● A higher price-earnings ratio means that
Trend Percentage =
investors are willing to pay a premium for a
Current Year Amount / Base Year
company’s stock because of optimistic
Amount * 100%
future growth prospects.

2. COMMON-SIZE STATEMENTS
Price-Earnings Ratio =
● The financial statement is a vertical analysis
Market Price Per Share / Earnings Per
in which each financial statement item is
Share
expressed as a percentage.
Dividend Payout Ratio
● This ratio gauges the portion of current
earnings being paid out in dividends.
Investors seeking dividends (market price
growth) would like this ratio to be large
(small).
Dividend Payout Ratio =
Dividends Per Share / Earnings Per
Share
Dividend Yield Ratio
● This ratio identifies the return, in terms of
cash dividends, on the current market price
of the stock.
Dividend Yield Ratio =
Dividends Per Share / Market Price Per
Share
Return on Total Assets
● Adding interest expense back to net income
enables the return on assets to be
compared for companies with different
amounts of debt or over time for a single
company that has changed its mix of debt
and equity.
Return on Total Assets =
Net Income + [Interest Expense × (1 –Tax
Rate)] Average / Total Assets
Return on Common Stockholders’ Equity
● This measure indicates how well the
company used the owners’ investments to
earn income.
Return on Common Stockholders’ Equity =
Net Income – Preferred Dividends /
Average Stockholders’ Equity
Financial Leverage
● Results from the difference between the
rate of return the company earns on
investments in its own assets and the rate
of return that the company must pay its
creditors.
● Negative financial leverage is when the
fixed return to a company’s creditors and
preferred stockholders is greater than the
return on total assets.
Book Value Per Share
● Market price reflects expectations about
future earnings and dividends, whereas the
book value per share is based on historical
cost.
Book Value per Share =
Common Stockholders’ Equity /
Number of Common Shares Outstanding
The short-term creditor
● Short-term creditors such as suppliers, want
to be paid on time. Therefore, they focus on
the company’s cash flows and working
capital.
Working Capital
● Excess of current assets over current
liabilities
● Working capital is not free. It must be
financed with long-term debt and equity.
Current Ratio
● A declining ratio may be a sign of
deteriorating financial condition, or it might
result from eliminating obsolete inventories
Current Ratio =
Current Assets / Current Liabilities
Acid-Test (Quick) Ratio
● Quick assets Include cash, marketable
securities, accounts receivable, and current
notes receivable.
● Measures a company’s ability to meet
obligations without having to liquidate
inventory.
Acid-Test Ratio =
Quick Assets / Current Liabilities
Accounts Receivable Turnover
● Measures how many times a company
converts its receivable into cash each year.
Accounts Receivable Turnover =
Sales on Account / Average Accounts
Receivable
Average Collection Period
● measures on average how many days it
takes to collect an accounts receivable.
Average Collection Period =
365 Days / Accounts Receivable
Turnover
Inventory Turnover Investments
● Measures how many times a company’s • Work with financial assets such as stocks and
inventory has been sold and replaced bonds
during the year. • Value of financial support, the risk versus
● If a company’s inventory turnover is less return, and asset allocation
than its industry average, it either has • Job opportunities
excessive inventory or the wrong sorts of – A stockbroker or financial advisor
inventory. – Portfolio manager
Inventory Turnover = – Security analyst
Cost of Goods Sold / Average Inventory
Financial Institutions
Average Sale Period • Companies that specialize in financial
● measures how many days, on average, it matters
takes to sell the inventory. - Banks – commercial and investment, credit
Average Sale Period = unions, savings, and loans
365 Days / Inventory Turnover - Insurance companies
- Brokerage firms
The Long–Term Creditor
● concerned with a company’s ability to repay International Finance
its loans over the long run. • An area of specialization within each of the
areas discussed so far
Times Interest Earned Ratio • It may allow you to work in other countries or
● most common measure of a company’s at least travel on a regular basis
ability to provide protection for its long-term • Need to be familiar with exchange rates and
creditors. A ratio of less than 1.0 is political risk
inadequate. • Need to understand the customs of other
Times Interest Earned = countries; speaking a foreign language
Earnings before Interest Expense and fluently is also helpful
Income Taxes / Interest Expense
Why Study Finance?
Debt-to-Equity Ratio • Marketing
● indicates the relative proportions of debt to - Budgets, marketing research, marketing
equity on a company’s balance sheet. financial products
● Stockholders like a lot of debt if the • Accounting
company can take advantage of positive - Dual accounting and finance function,
financial leverage. preparation of financial statements
● Creditors prefer less debt and more equity • Management
because equity represents a buffer of - Strategic thinking, job performance,
protection. profitability
Debt–to–Equity Ratio = • Personal Finance
Total Liabilities / Stockholders’ Equity - Budgeting, retirement planning, college
planning, day-to-day cash flow issues
Basic Areas Of Finance
1. Corporate finance = Business Finance Business Finance
2. Investments • Some essential questions that are answered
3. Financial institutions using finance
4. International Finance - What long-term investments should the firm
take on?
 - Where will we get the long-term financing to
pay for the investments?
- How will we manage the everyday financial
activities of the firm?
Financial Manager
Financial managers try to answer some, or all, of
these questions.
The top financial manager within a firm is
usually the Chief Financial Officer (CFO).
- Treasurer – oversees cash management,
credit management, capital expenditures,
and financial planning
- Controller – oversees taxes, cost
accounting, financial accounting, and data
processing
Financial Management Decisions
Capital budgeting
- What long-term investments or projects
should the business take on?
Capital structure
- How should we pay for our assets?
- Should we use debt or equity?
Working capital management Managerial compensation
- How do we manage the day-to-day finances
of the firm?
Forms of Business Organizations
Three major forms in the United States Corporate control
1. Sole proprietorship
2. Partnership
- General Other stakeholders
- Limited
3. Corporation
- S-Corp
- Limited liability company
International Corporate Forms
• Joint stock companies
• Public limited companies
• Limited liability companies
• All share:
– Public ownership
– Limited liability
Goals of Financial Management
● What should be the goal of a corporation?
- Maximize profit?
- Minimize costs?
- Maximize market share?
- Maximize the current value per share of the
company’s existing stock
- Maximize the market value of the existing
owners’ equity
Agency Problem
• Agency relationship
- Principal hires an agent to represent its
interests
- Stockholders (principals) hire managers
(agents) to run the company
• Agency problem
- Conflict of interest between principal and
agent
• Management goals and agency costs
Do Managers Act in the Shareholder’s
Interests?
– Incentives can be used to align
management and stockholder interests
– Incentives need to be carefully
structured to ensure that they achieve
their goal
– The threat of a takeover may result in
better management
Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ
CASH FLOW STATEMENT
• Most important cash flows of a business
• 2 methods:
- Direct method
• Reports operating cash flows as
sources use of cash
 - Indirect method
• Reports operating cash by
adjusting accrual net income to
cash flows
INVESTING ACTIVITIES
• Cash inflows from investing activities arise
from
– Selling fixed assets, investments,
intangible assets
• Cash outflows from investing activities arise
from
– Buying fixed assets, investments,
intangible assets
FINANCING ACTIVITIES
• Cash inflows from financing activities arise
from
– Issuing debt, equity securities
• Cash outflows from financing activities arise
from
– (Re)Paying dividends, debt, purchasing
treasury stock
NON-CASH ACTIVITIES
• Arise from investing, financing activities
– Examples
• Issue stock to retire long-term
debt
• Issue stock, and debt in
exchange for fixed asset
– Has no direct effect on cash flows
– Disclosed in a separate schedule
Direct method
– Reports operating cash flows as
sources use of cash
– Adjusts certain income statement items
for changes in current assets, liabilities
FINANCIAL MARKET
• A market is a venue where goods and services
are exchanged.
• A financial market is a place where individuals
and organizations who want to borrow funds are
brought together with those having a surplus of
funds.
THE IMPORTANCE OF THE FINANCIALS
MARKET
• Well-functioning financial markets facilitate the
flow of capital from providers of funds (e.g
inventors) to the users of capital.
• Well-functioning markets promote economic
growth. The users can make use of the funds for
expansion and the providers of funds obtained
additional income.
• Economies with well-developed markets perform
better than economies with poorly-functioning
markets.
PROVIDERS AND USERS OF FUNDS
1. Providers of funds – savers; suppliers of
capital; individuals and institutions with excess
funds; they look for the rate of return on their funds
to be provided or invested
2. Users of funds – can be borrowers or
corporations needing funds; demanders or users of
capital; individuals and institutions who need funds
to finance their investment activities; they are
willing to pay a rate of return on the amount they
borrow/receive
HOW IS CAPITAL TRANSFERRED BETWEEN
PROVIDERS OF FUNDS AND USERS OF
FUNDS?
Direct Transfer
- Providers of funds transfer money to Users
of funds (Shares and dividends, Bonds and
interest)
Problems that can be encountered:
1. Costly on the part of the users of funds (e.g.
borrower)
2. Risky on the part of the providers of funds (e.g.
creditor)
3. It is difficult to match the need of the users of
funds
Indirect Transfer
- Investment Bank issued money to users
and providers of funds.
WHY DO COMPANIES GO TO TO FINANCIAL
INTERMEDIARIES?
• Financial intermediaries hire highly qualified
people to assess risky investments.
• These know how to diversify (scatter)
money/funds to different investments instead of
only to a single investment.
• These have cost advantages or economies of
scale (especially in the case of mutual funds).
• this help reconcile the conflicting interests of users
and providers of funds.
• These give providers of funds (particularly savers)
liquidity (as in the case of commercial banks on
deposits).
Financial markets are generally separated into
two and they are
1. Short-term (money market)
The short-term market is primarily dealing with
securities whose life is less than one year like
treasury bills, commercial papers, and negotiable
certificates of deposits.
2. Long-term market (capital market)
The capital market is further divided into two.
1. Primary markets, deal with the issue of new
securities by business firms, governmental bodies,
or other organizations to raise new funds.
2. Secondary markets, which are involved in
trading securities already outstanding among
investors.
An initial public offering (IPO) occurs when a
company issues stock in the public market for the
first time.
• “Going public” enables a company’s owners to
raise capital from a wide variety of outside
investors. Once issued, the stock trades in the
secondary market.
• Public companies are subject to additional
regulations and reporting requirements.
• This market provides liquidity to the investor since
he can trade his securities at any time.
• The secondary market is the financial market for
the trading of securities that have already been
issued in an initial private or public offering.
• The secondary market sets the level of a stock’s
price and therefore influences how much can be
raised in future issues.
• This is the market where previously issued
securities are traded (e.g. PSEi – Phils. Dow Jones
- USA; S&P 500 – USA; DAX – Germany; CAC 40
– France; FTSE 100 - Great Britain). In this market,
the money goes to the previous stockholder who
sold the stocks.
Financial intermediaries are as follows:
1. Banking Institutions
a. Private Banking Institutions
i. Commercial Banks
a) Universal Bank
b) Commercial Banks
ii. Thrift Banks
a) Savings and Mortgage Banks
b) Private Development Banks
iii. Rural Banks
b. Government Banks
i. Development Bank of the Philippines
ii. Land Bank of Philippines
2. Non-Bank Financial Institutions
a. Private Non-bank Financial Institutions
i. Investment Bank
ii. Securities Dealers/Brokers
iii. Insurance Companies
iv. Credit Unions
v. Pawnshops
b. Government Non-Bank Financial Institution
i. Government Service Insurance System
ii. Social Security System
FUNCTIONS OF INVESTMENT BANKER
1. To originate securities issues – negotiation
between the officers of the issuing firm and officers
of the investment bank.
2. To underwrite the issues by guaranteeing their
sale in the primary capital markets
3. To manage the distribution of these securities to
the ultimate investors. Members of the underwriting
syndicate will form a selling group comprising
dealers that will reach the ultimate investors.
4. To advise their corporate clients on long-term
financial Matters
MONEY MARKETS
This is a market intended for short-term
placements. The placement usually takes one year
or less to mature.
1. Treasury bills (T-Bills)
2. Repurchase agreements
3. Commercial paper
4. Negotiable certificates of deposit
5. Banker’s acceptance
Treasury Bills (T-bills).
It is an obligation by the national
government. The interest is normally higher than
the savings and time deposit. T-bills are regarded
as a risk-free investment because the payment is
guaranteed by the government.
Repurchase Agreement (repo).
It is a financial instrument wherein one party
sells a financial instrument to another party at a
specified price with a commitment to repurchase
the financial instrument at a fixed amount agreed
upon at a specific date. Many repos have a maturity
date of 1 to two weeks.
Commercial paper.
It is an unsecured promissory note with a
fixed maturity of 1 to 270 days. Commercial paper
is a money-market security issued by high-credit
rating companies to raise money to meet short-term
obligations.
Negotiable Certificate of Deposit.
It is a time deposit where the investor and
the bank agree on the term of placement. The
investor may invest in the span of at least 14 days
to less than a year and is entitled to receive the
agreed interest payment.
Banker’s Acceptance
It is a bank draft where the bank is required
to pay the holder at a specified amount on a
specified date. It has a maturity of 90 days from the
date of issue, but can be extended up to 180 days.
At the time of purchase, these bank drafts are sold
at a discount, and their value increases as it
approaches their maturity date. The bank draft
normally transpires from export and import
transactions. It is less risky compared to other
instruments because the payment is guaranteed by
the importer’s bank.
CAPITAL MARKET
It is a market that trades equity and debt
instruments with maturities of more than one year.
There are two important elements of the capital
market. They are:
1. Organized security exchanges. A securities
exchange operates under the rules and regulations
formulated by an exchange.
2. Over-the-counter-markets (OTC). It is involved
in the buying and selling of financial instruments but
not in organized securities exchanges.
CAPITAL MARKET INVESTMENTS
Stocks
issued by corporations who would like to
raise money in the financial market. The investors
may invest in the primary market and/or in the
secondary market.
Returns that are expected in investing in stocks are
dividends and capital appreciation.
Below is a simple formula for the valuation of
stocks:
P0 = D1/rs or P0 = D1/rs + g
Where:
P0 = price of the stock at year 1
D1 = expected dividend at year 1
rs = required return on the stocks
g = growth and computed as ROE(1 – DPO)
Bonds
It is a long-term debt where the issuer is
obliged to repay the principal at its face value on
the maturity date and to make periodic interest
payments until such time the principal value has
been paid. Return from bonds is interest income
and capital appreciation.
VB = FV(1+i) -n + CP [1-(1+i)-n / i]
Where:
VB = Value of the bond at the time of issuance.
FV = the Face value of the bond.
CP = Coupon or interest payment
i = required rate of return or discount rate
n = total no. of conversion periods for the whole
term
FOREIGN EXCHANGE MARKET
It is a venue for the exchange of currencies. Banks
normally have this as one of their functions.
Direct quotation
P1 = US $0.0192308
Indirect quotation
1US$ = P52
DERIVATIVES MARKET
financial securities whose payoffs are linked to
other, previously issued (or underlying) primary
securities or indexes.
It generally involves an agreement between two
parties to exchange a standard quantity of an asset
or cash flow at a predetermined price and at a
specified date in the future.
• Forward contract
• Futures contract
• Option: Long and Put
• Swap
FINANCIAL MARKET REGULATION
Financial Instruments are subject to rules and
regulations imposed by regulatory agencies.
Securities and Exchange Commission. The main
concern is to give full and fair disclosure of
information on securities issues to actual and
potential investors.
Efficient Market Hypothesis (EMH)
It states that the stock prices already reflect all
available information in the market and this
information is immediately available to the investing
public.
It directly implies that nobody can beat the market
consistently on a risk-adjusted basis because the
market prices only react to new information.
This hypothesis also describes that the market is
perfect and nobody should benefit from the
fluctuation of the prices.
According to Eugene Francis Fama, there
are three types of market efficiency. They are
1. Strong form. It is concerned with all information
sets, including private information, incorporated in
price trends; it states no monopolistic information
can entail profits, in other words, insider trading
cannot make a profit in the strong-form market
efficiency world.
2. Semi-strong form. It requires that all public
information is reflected in prices already, such as
companies' announcements or annual earnings
figures.
3. Weak efficiency. It is saying that the information
set is just historical prices, which can be predicted
from historical price trends; thus, it is impossible to
profit from it.
The Time Value of Money
• The principles and computations used to
revalue cash payoffs from different times so
they are stated in dollars of the same time
period.
Cash Flow Time Lines
PV = Present Value – the beginning amount
that can be invested. PV also represents the current
value of some future amount.
FV = Future Value – the value to which an
amount invested today will grow at the end of n
periods.
Types of Cash Flow Patterns
• Lump Sum Amount – a single payment
(received or made) that occurs either today or
at some date in the future.
• Annuity – Multiple payments of the same
amount over equal time periods.
• Uneven Cash Flows – Multiple payments of
different amounts over a period of time.
Future Value
• Compounding – To compute the future
value of an amount we push forward the
current amount by adding interest for each
period in which the money can earn interest in
the future.
Future Value of a Lump-Sum Amount
FVn = PV (1+r)^n
Four Ways to Solve Time Value of Money Problems
• Use Cash Flow Time Line
• Use Equations
• Use Financial Calculator
• Use Electronic Spreadsheet
Future Value of an Annuity
● Annuity - A series of payments of equal
amounts at fixed intervals for a specified
number of periods.
● Ordinary (deferred) Annuity - An annuity
whose payments occur at the end of each
period.
● Annuity Due - An annuity whose payments
occur at the beginning of each period
Present Value
• Present value is the value today of a future
cash flow or series of cash flows.
• Discounting is the process of finding the
present value of a future cash flow or series of
future cash flows; it is the reverse of
compounding.
Present Value of a Lump-Sum Amount
PV = FV / (1 + i)^n
Present Value of an Annuity (Ordinary)
• PVAn = the present value of an annuity with n
payments.
• Each payment is discounted, and the sum of
the discounted payments is the present value
of the annuity.
Uneven Cash Flow Streams
• A series of cash flows in which the amount
varies from one period to the next:
• Payment (PMT) designates constant cash
flows—that is, an annuity stream.
• Cash flow (CF) designates cash flows in
general, both constant cash flows and uneven
cash flows.
Semi-annual and Other Compounding Periods
• Annual compounding is the process of
determining the future value of a cash flow or
 series of cash flows when interest is added
once a year.
• Semiannual compounding is the process of
determining the future value of a cash flow or
series of cash flows when interest is added
twice a year.
Effective Annual Rate
The annual rate that causes PV to grow to the
same FV as under multi-period compounding.
Amortized Loans

Distinguishing Between Different Interest Rates
rSIMPLE = Simple (Quoted) Rate
used to compute the interest paid per period
rEAR = Effective Annual Rate
the annual rate of interest actually being earned
APR = Annual Percentage Rate = rSIMPLE
periodic rate X the number of periods per year
• Amortized Loan - A loan that is repaid in
equal payments over its life
• Amortization tables are widely used for home
mortgages, auto loans, business loans,
retirement plans, and so forth to determine
how much of each payment represents
principal repayment and how much
represents interest

Comparison of Different Types of Interest Rate

• rSIMPLE: Written into contracts, quoted by

banks and brokers. Not used in calculations
or shown on timelines.
• rPER: Used in calculations, shown on
timelines.
• rEAR: Used to compare returns on investments
with different payments per year.

Simple (Quoted) Rate

• rSIMPLE is stated in contracts
Periods per year (m) must also be given

Examples:
• 8%, compounded quarterly
• 8%, compounded daily (365 days)

Periodic Rate
• Periodic rate = rPER = rSIMPLE/m, where m is the
number of compounding periods per year. m
= 4 for quarterly, 12 for monthly, and 360 or
365 for daily compounding.

Examples:
• 8% quarterly: rPER = 8/4 = 2%
• 8% daily (365): rPER = 8/365 = 0.021918%