BUSINESS FINANCE

What is Business Finance? Branches of Finance

Finance Personal Finance
- the art and science of managing money. - managing your own income.
- study of how people and businesses evaluate
investments and raise capital to fund them. Public Finance
- as the management of cash or funds. - role of the government in providing funds on the people.

- study of how and under what term savings(money) are
allocated between lenders and borrowers.
- distinct from economics in that it addresses not only how
resources are allocated but also under what terms and
through what channels(insurance.).
Corporate Finance
- capital structure of a business.
How to obtain funding for a business project?

Business Finance
- the art and science of managing financial resources of a
business.

History of Finance
- deals with management of resources. Exchange of
goods.

General Areas of Financial

Financial institutions and Markets
- focuses on banks, saving, loans

Investments
- options where they want to put.

Financial Management
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Advantages:
Careers in Finance - easy to start, no need to consult others while making
Commerce and Industry decisions, taxed at the personal tax rate
Government
Academe Disadvantages:
- Personally liable for the business debuts, ceases on the
FINANCE ACCOUNTING death of the proprietor

Focuses on the future Reports on the past Classifying Businesses

- each type of business can have different ways to finance
Personal finance, corporate Financial Accounting,
itself, so we need to look at types of business ownerships
finance, public finance Management Accounting,
 Sole trader – owned by 1 person
Tac Accounting, Audit
 Partnership – owned by 2 or more based on
Types of business organization agreement among them
Business forms: service, manufacturing, merchandising  Corporation – owned by 2 or more but separate I law
from people who own and control
Forms of business organization Partnership
Business forms: sole proprietorship, partnerships, - general partnership is an association of 2 or more
corporation persons who come together as co-owners for the purpose
________________________________ of operating a business for profit.
- there is no separation between the partnership and the
Sole Proprietorship owners with respect to debts or being sued.
- is a business owned by a single individual that is entitled
to all the firm’s profits and is responsible for all the firm’s Advantages:
subject. - relatively easy to start, taxed at the personal tax rate, and
- there is no separation between the business and the access to funds from multiple sources or partners
owner when it comes to debts or being sued.
- Sole proprietorships are generally being financed by Disadvantages:
personal loans from family and friends and business loans - partners jointly share unlimited liability
from banks.
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Corporation
- an artificial being, invisible, intangible, and existing only in
the contemplation of the law.
- can individually sue and be sued, purchase, sell or won
property, and its personnel are subject to criminal
punishment for crimes committed in the name of the
corporation.
- legally owned by its current stockholders.
- the board of directors are elected by the firm’s
shareholders. One responsibility of the board of directors is
to appoint the senior management of the firm

Advantages:
- liability of owners limited to invested funds, life of
corporations is not tied to the owner, easier to transfer
ownership, and easier to raise capital

Disadvantage:
- greater regulation and double taxation of dividends
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- involves making a sacrifice in the present with the hope of
CONTROLLER TREASURER deriving future benefits.
- postponed consumption
1. Planning for control which 1. Determination of - 2 important feature: current sacrifice, future benefits
includes budgeting. financial requirements and
2. Reporting and interpreting procurement of fund What is Investment?
results of operations and 2. Cash management, - Investment involves making a sacrifice of the present with
systems installation. banking, custody of fuds, the hope of deriving future benefits.
3. Evaluating of objectives, and foreign exchange - Postponed consumption
policies, and procedures problems. - The two important features are: Current Sacrifice and
and consulting with all 3. Investor relations Future Benefits
segments of management
regarding the same. 4. Credit and collections Types of Investments
4. Tax administration and Bonds, Stocks, Currency, Gold, Real Estate, Funds, and
government reporting 5. Insurance Deposits
5. Protection of assets
6. Economical appraisal 6. Employees’ benefits Financial Management
The Goal of Finance - The planning, directing, monitoring, organizing, and
- must be consistent with the mission of the corporation. controlling of the monetary resources of an organization.
• To maximize firm value shareholder’s wealth (as
measured by share prices). Financial Markets
While managers have to cater to all the stakeholders - In an economy there exist an interaction between
(such as consumers, employees, suppliers etc.), they need corporation, financial intermediaries and lenders and
to pay particular attention to the owners of the corporation, borrowers.
i.e., shareholders. - This occurs in the financial markets and is there for the
purpose of facilitating the rising of capital by corporation
If managers fail to pursue shareholder wealth and other businesses, which in turn lead to economic
maximization, they will lose the support of investors and growth.
lenders. The business may cease to exist and ultimately, - Unlike commodity markets where trading of physical
the managers will lose their jobs! goods is done, financial markets are markets where
Investments financial assets, instruments or securities are traded.
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Financial Market Types of Financial Markets
- these instruments facilitate the transfer of funds between - Financial markets can be categorized using several
units that need funds and those that supply funds. The important features of them:
financial markets that are found in any financial system - Debt and equity markets
consisting of a number of players. - Primary and Secondary Markets
- Exchanges and Over-the-counter Markets
- the markets bring together lenders, borrowers (investors, - Money and Capital Markets
and financial intermediaries (financial institutions).
-Financial intermediaries are firms such as commercial
banks, stock exchanges, investment companies, insurance
companies, and pension funds. Borrowers and lenders of
funds include both individuals and firms.

Function of Financial Market

- Financial markets channel funds from savers to firms,
government or other individuals through direct or indirect
finance.

Market
- a venue where goods and services exchanged.
- A financial market is a place where individuals and
organizations wanting to borrow funds are brought
together with those having a surplus of funds.
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Financial Intermediaries Mutual Funds
- are entities that facilitates financial transactions between - investment company that pool funds from different
2 parties. Such an intermediary could be firm/institution. investors and invests them in different securities depending
Example: on the objective of the fund
- Bank, mutual funds, Financial Advisors, and Credit Union
Function: - The Mutual Fund issues shares to investors which
- Convert savings into investments represent their ownership in the fund.
- Provides cash facilities
- Providing loans. - Types of mutual funds: Public Sector and Private Sector
- Assist clients to grow their investments

TYPES OF FINANCIAL INSTITUTIONS OR

INTERMEDIARIES

TYPES OF BANKS
Nonbank Financial Institutions (NBFIs)
- Investment houses, Financing Companies, Securities
dealers and brokers, Fund Managers, Lending Investors,
Pension Funds, Pawn Shops, and Nonstock Savings and
Loan Associations.
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Review of Financial Statement Preparation, Analysis,
and Interpretation
Importance of Financial Statements
- primary means of communicating important accounting
information to users.
- represents models of the business enterprise because
they show the business in financial terms.
Guidelines in the preparation of Financial Statements
- fair presentation
- going concern assumption
- accrual concept of accounting
- consistency of presentation
Basic Financial Statements: The Statement of Financial
Position / Balance Sheet
What are the important concepts we need to know
about the STATEMENT OF FINANCIAL POSITION?
- The Statement of Financial Position provides information
regarding the liquidity position and capital structure of a
company as of a given date.
- It must be noted that the pieces of information found in
this report are only true as of a given date.
- Liquidity is a company's ability to convert its assets to
cash in order to pay its liabilities when they are due.
- Capital structure provides information regarding the
amount of assets financed by debt or liabilities and equity.
Basic Financial Statements: The Statement of Profit or
Loss
What are the important concepts we need to know
about the STATEMENT OF PROFIT OR LOSS?
- The Statement of Profit or Loss provides information
regarding the revenues or sales, expenses, and net
income of a company over a given accounting period, a
period which may be for a month, a quarter, or a year.
- In analyzing earnings performance, a comparison with the
previous periods and with other companies, especially
those coming from the same industry, is a must. Such
comparison will not be made possible without knowing the
accounting periods covered in the statement of profit or
loss.
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- In analyzing Statement of Profit or Loss, it is important to
identify how much of the income comes from core business
(the main business of the company) and how
much comes from the non-core business.
There are two options in presenting the Statement of
Profit or Loss:
- The first option is to present it as a separate financial
statement; and
- The second option is to present it together with other
comprehensive income (OCI), which represents
transactions that are not reported in the profit or loss
statement but affects
the stockholders’ equity.
_____________________________
Basic Financial Statements: The Statement of Cash
Flows
What are the important concepts we need to know
about the STATEMENT OF CASH FLOWS?
- The Statement of Cash Flows provides an explanation
regarding the change in cash balance from one accounting
period to another.
The Cash Flows are classified into 3 Main Categories:
1. Operating
- In the cash flows from operating activities, the income
reported from the statement of profit or loss which is based
on accrual principle is converted to cash.
2. Investing
- The cash flows from investing activities provide
information regarding the future direction of the company; it
shows how much investment the company is making over
a given accounting period.
3. Financing
- The cash flows from financing activities provide
information whether there is a proper matching of investing
and financing activities.
Basic Financial Statements: The Statement of Changes
in Stockholder’s Equity
What are the important concepts we need to know
about the STATEMENT OF CHANGES IN
STOCKHOLERS’ EQUITY?
- The Statement of Changes in Stockholders’ Equity
provides information that explains the changes in the
stockholders’ equity account from one accounting period to
another.
The changes may be to the following:
1. Profit or loss for the accounting period:
2. Cash dividend declaration;
3. Issuance of new shares of stocks; and
4. Other transactions that affect the stockholders’ equity
such as other comprehensive income, treasury stocks, and
revaluation of assets.
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Notes to Financial Statements
What are the additional pieces of information that
NOTES TO FINANCIAL STATEMENTS provide?
1. Brief Description of the Company
- Information may include the nature of the business of the
company and the owners behind the company.
2. Summary of Significant Accounting Policies
- This is very important because the existing generally
accepted accounting principles provide alternative
accounting policies to companies. It is therefore important
to find out what specific accounting policies are used by the
company.
3. Breakdown of Amounts Found in the Financial
Statements
- The company’s property, plant, and equipment (PPE)
account may have too many components. Putting all the
details on the face of the balance sheet may make the
balance sheet too long. An alternative presentation is to
provide a single amount on the face of the balance sheet
for PPE but the breakdown of PPE can be presented in the
notes to financial statements.
Business Survival
There are two key factors for business survival:
Profitability
- is important if the business is to generate revenue
(income) in excess of the expenses incurred in operating
that business.
Solvency
- The solvency of a business is important because it looks
at the ability of the business in meeting its financial
obligations.
Financial Statement Analysis
- will help business owners and other interested people to
analyse the data in financial statements to provide them
with better information about such key actors for decision
making and ultimate business survival.
- The term ‘financial analysis’ also known as ‘analysis and
interpretation of financial statements’, refers to the process
of determining financial strengths and weaknesses of the
firm by establishing strategic relationship between the
items of the balance sheet, P & L A/c and other operative
data.
Goal
- Financial Statement Analysis is a tool for making complex
investment and credit decisions. Specifically, its basic goal
is to value a firm by establishing its future cash flows and
determining its financial health.
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Information For Analysis Financial Statement Analysis
1. Income Statement Purpose:
2. Balance Sheet To use financial statements to evaluate an organization’s
3. Statement of Stockholders’ Equity – Financial performance
4. Statement of Cash Flows – Financial position.
5. Notes to Financial Statements To have a means of comparative analysis across time in
terms of:
– Intracompany basis (within the company itself)
– Intercompany basis (between companies)
– Industry Averages (against that particular industry’s
averages)
To apply analytical tools and techniques to financial
statements to obtain useful information to aid decision
making.

Financial statement analysis involves analysing the

information provided in the financial statements to:
– Provide information about the organization’s:
• Past performance
Tools of Analysis • Present condition
Horizontal Analysis • Future performance
- Comparing company’s financial condition and – Assess the organization’s:
performance across time. • Earnings in terms of power, persistence, quality and
growth
Vertical Analysis • Solvency
- Comparing a company’s financial condition and
performance to a base amount. Effective Financial Statement Analysis
• To perform an effective financial statement analysis, you
Ratio Analysis need to be aware of the organization’s:
- Measurement of key relations between financial – business strategy
statement items. – objectives
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– annual report and other documents like articles about the • For example, a line item could look at increase in sales
organization in newspapers and business reviews. turnover over a period of
These are called individual organizational factors. 5 years to identify what the growth in sales is over this
period.
Effective Financial Statement Analysis
Requires that you: Vertical analysis/Common size analysis/
• Understand the nature of the industry in which the Component Percentages
organization works. This is an industry factor. • All items are expressed as a percentage of a common
• Understand that the overall state of the economy may base item within a financial statement
also have an impact on the performance of the • e.g. Financial Performance – sales is the base
organization. • e.g. Financial Position – total assets is the base
→ Financial statement analysis is more than just • Important analysis for comparative purposes
“crunching numbers”; it involves obtaining a broader picture – Over time and
of the organization in order to evaluate appropriately how – For different sized enterprises
that organization is performing What are Financial Statements?
- shows you where a company’s money came from, where
Tools of Financial Statement Analysis: it went and where it is now.
The commonly used tools for financial statement analysis
are: USERS OF FINANCIAL STATEMENTS
• Financial Ratio Analysis INTERNAL USERS EXTERNAL USERS
• Comparative financial statements analysis:
– Horizontal analysis/Trend analysis/Percentage analysis Managers Lenders
– Vertical analysis/Common size analysis/ Component
Percentages Officers Shareholders

Internal Auditors Governments

Horizontal analysis/Trend analysis
• Trend percentage Sales Manager Labor Unions
• Line-by-line item analysis
Budget Officers External Auditors
• Items are expressed as a percentage of a base year
• This is a time series analysis Controller Customers
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• Ratio analysis also expresses relationships between
Where to get Financial Statements? different financial statements.
Information is available from: • Financial Ratios can be classified into 5 main categories:
Published annual reports – Profitability Ratios
- Financial Statements – Liquidity or Short-Term Solvency ratios
- Notes to Financial Statements – Asset Management or Activity Ratios
- Letters to stockholders – Financial Structure or Capitalization Ratios
- Auditor’s report (independent Accountants) – Market Test Ratios
- Management’s discussion and analysis
Report filed with governments Profitability Ratios
Other sources 3 elements of the profitability analysis:
- Newspapers • Analyzing on sales and trading margin
- Periodicals – focus on gross profit
- Financial Information publications • Analyzing on the control of expenses
- Other business publications – focus on net profit
Online • Assessing the return on assets and return on equity
- Companies publish their Financial Statements online
Profitability Ratios
Financial Statement Analysis and Interpretation • Gross Profit % = Gross Profit * 100
What do internal users use it for? Net Sales
- Planning, evaluating, and controlling company operations. • Net Profit % = Net Profit after tax * 100
What do external users use it for? Net Sales
- Assessing past performance and current financial position Or in some cases, firms use the net profit before tax figure.
an making predictions about the future profitability and Firms have no control over tax expense as they would
solvency of the company as well as evaluating the have over other expenses.
effectiveness of management Net Profit before tax *100
Net Sales
Financial Ratio Analysis • Return on Assets = Net Profit * 100
• Financial ratio analysis involves calculating and analyzing Average Total Assets
ratios that use data from one, two or more financial • Return on Equity = Net Profit *100
statements. Average Total Equity
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Liquidity or Short-Term Solvency ratios
Short-term funds management
• Working capital management is important as it signals the
firm’s ability to meet short term debt obligations. For
example: Current ratio
• The ideal benchmark for the current ratio is 2:1 where
there are two dollars of current assets (CA) to cover 1 of
current liabilities (CL). The acceptable benchmark is 1: 1
but a ratio below 1CA:1CL represents liquidity riskiness as
there is insufficient current assets to cover 1 of current
liabilities.
Liquidity or Short-Term Solvency ratios
• Working Capital = Current assets – Current Liabilities
• Current Ratio = Current Assets
Current Liabilities
• Quick Ratio = Current Assets – Inventory – Prepayments
Current Liabilities – Bank Overdraft
Asset Management or Activity Ratios
• Efficiency of asset usage
– How well assets are used to generate revenues (income)
will impact on the overall profitability of the business.
For example: Asset Turnover
• This ratio represents the efficiency of asset usage to
generate sales revenuE
Asset Management or Activity Ratios
• Asset Turnover = Net Sales
Average Total Assets
• Inventory Turnover = Cost of Goods Sold
Average Ending Inventory
• Average Collection Period
= Average accounts Receivable
Average daily net credit sales*
* Average daily net credit sales = net credit sales / 365
Financial Structure or Capitalization Ratios
Long term funds management
• Measures the riskiness of business in terms of debt
gearing.
For example: Debt/Equity
• This ratio measures the relationship between debt and
equity. A ratio of 1 indicates that debt and equity funding
are equal (i.e. there is $1 of debt to $1 of equity) whereas a
ratio of 1.5 indicates that there is higher debt gearing in the
business (i.e. there is $1.5 of debt to $1 of equity). This
higher debt gearing is usually interpreted as bringing in
more financial risk for the business particularly if the
business has profitability or cash flow problems.
Financial Structure or Capitalization Ratios
• Debt/Equity ratio = Debt / Equity
• Debt/Total Assets ratio = Debt *100
Total Assets
• Equity ratio = Equity *100
Total Assets
• Times Interest Earned = Earnings before Interest and Tax
Interest
Market Test Ratios
• Based on the share market's perception of the company.
For example: Price/Earnings ratio
• The higher the ratio, the higher the perceived quality of
the earnings by the share market.
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Market Test Ratios
• Earnings per share = Net Profit after tax
Number of issued ordinary shares
• Dividends per share = Dividends
Number of issued ordinary shares
• Dividend payout ratio = Dividends per share *100
Earnings per share
• Price Earnings ratio = Market price per share
Earnings per share
Limitations of Financial Statement Analysis
• We must be careful with financial statement analysis.
– Strong financial statement analysis does not necessarily
mean that the organization has a strong financial future.
– Financial statement analysis might look good but there
may be other factors that can cause an organization to
collapse.
Income Statement
- summary of a company’s financial performance over a
specific period of time. It is one of the three important
financial statements used to analyze a company's
performance. Other two are Balance Sheet & Cash Flow
Statement.
Components of income statement:
- revenue / income
- expenses
- profit (or loss) i.e. (revenue-expenses)
The Income Statement is one of the major financial
statement used by accountants and business owners.
It shows the Profitability of a company during the time
interval specified in tis heading.
It helps in Identifying Risk and Opportunities and forecast
future performance for:
 Owners
 Creditors
 Competitors
 Investors
What is the use of Income Statement?
 Evaluate past performance
 Predicting future performance
 Help assess the risk or uncertainty of achieving
future cash flows.
How is Income Statement prepared?
 The revenues earned during the period.
 The expenses incurred in earning the revenue.
 Subtracting the expenses from the revenue to
determine if a net income was earned or a net loss
was incurred.
Net Profit (N/P)
- measure profitability of the company after taking into
consideration all costs incurred during an accounting
period.
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Elements on Income Statement Two Forms of Income Statement
Revenues Single-step
- Inflows or other enhancements of assets or settlements - All operating revenues and gains are reported first,
of its liabilities that constitute the entity’s ongoing major or followed by all operating expenses and other losses.
central operations. - No separate section is prepared for COGS and gross
Example of Revenue Accounts: profit.
- Sales, Fee revenue, Interest Revenue, Dividend
Revenue, Rent Revenue

Expenses
- Outflows or other using-up of assets or incurrences of
liabilities that constitute the entity’s ongoing major or
central operations.
Examples of Expense Accounts:
- Cost of goods sold, Depreciation Expense, Interest
Expense, Rent Expense, Salary Expense

Gains
- increases in equity (net assets) from peripheral or
incidental transactions.

Losses
- decreases in equity (net assets) from peripheral or
incidental transactions.

Gains and losses can result from:

- sale of investments or plant assets,
- settlement of liabilities,
- write-offs of assets
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Multiple-step
- Divided into separate sections, various subtotals are
reported.
- Involves separate sections for gross profit, operating
income, other income/losses, income before income taxes,
and net income.