NETIQUETTE (INTERNET ETIQUETTE)

BASIC FINANCE /
FINANCE 1

Presented by: Prof. Mary Rose E. Patingo

HOMEWORK #
Reflection Paper on the Importance of Portfolio
Diversification
• Write a minimum of one pager (max of 2) reflection paper.
• 12 Font Size Single Space; Arial; 1 inch margin; Short Bond
DEADLINE: JANUARY 4, 2024 11:59PM
SOURCES OF FINANCING
ü Review Cost of Bonds
, Cost of Preferred Stocks,
Cost of Equity, WACC
ü Inventory Management
ü Receivables Management
ü Payables Management
COST OF DEBT - BONDS
• Cost of Debt Formula

• Rf = effective interest rate / Yield to Maturity

• T = Corporate Tax

Exercise: A company issued a P5 million bond with annualized yield of

9%. The company’s tax rate is 30%.

Source:
Cost of Debt (investopedia.com)
COST OF DEBT - BONDS
• Cost of Debt Formula

Example: A company issued a P5 million bond with annualized yield of 9%.

The company’s tax rate is 30%.
• Rf = Yield to Maturity = 9%
• T = Corporate Tax = 30%

Kd = 9% *(1 - 30%)
= 9% * 70%
Kd = 6.30%
Source:
Cost of Debt (investopedia.com)
COST OF DEBT – PREFERRED STOCKS
• Cost of Preferred Stocks Formula

Kp = D / P0

• D = Dividend Price
• P0 = Stock Price

Exercise: A company has preferred stock that has an annual dividend of

P40. If the current share price is P90, what is the cost of preferred
stock?
COST OF DEBT – PREFERRED STOCKS
• Cost of Preferred Stocks Formula
Kp = D / P0
Exercise: A company has preferred stock that has an annual dividend of
P40. If the current share price is P90, what is the cost of preferred stock?
D = Dividend Price = P40
P0 = Stock Price = P90

Kp = P40 / P90
Kp = 44.44%
COST OF EQUITY (STOCKS)
q CAPITAL ASSET PRICING MODEL (CAPM)
Ks = Rf + βi * [E(Rm) – Rf]
Exercise: ERP

Company A Company B
Risk Free Rate 3.5% 2.50%
Beta 2.0 2.5
E(Rm) 5% 4%
Cost of Equity
COST OF EQUITY (STOCKS)
q CAPITAL ASSET PRICING MODEL (CAPM)
Ks = Rf + βi * [E(Rm) – Rf]
Exercise: ERP

Company A Company B
Risk Free Rate 3.5% 2.50%
Beta 2.0 2.5
E(Rm) 5% 4%
Cost of Equity 6.50% 6.25%
COST OF EQUITY (STOCKS)
q DIVIDEND CAPITALIZATION MODEL
Dividend Growth = (Dt/Dt-1) – 1
where: Dt = Dividend payment of year t
Dt-1 = Dividend payment of year t-1 (one year before year t)
Example: Below are the dividend amounts paid every year by a company that has
been operating for four years. Compute for the Average Dividend Growth Rate.

Year 1 Year 2 Year 3 Year 4

Dividend 10.5 10.3 10.56 11.2
Dividend Growth Rate
COST OF EQUITY (STOCKS)
q DIVIDEND CAPITALIZATION MODEL
Dividend Growth = (Dt/Dt-1) – 1
where: Dt = Dividend payment of year t
Dt-1 = Dividend payment of year t-1 (one year before year t)
Example: Below are the dividend amounts paid every year by a company that has
been operating for four years. Compute for the Average Dividend Growth Rate.

Year 1 Year 2 Year 3 Year 4

Dividend 10.5 10.3 10.56 11.2
Dividend Growth Rate 0 -1.90% 2.52% 6.06%
Average DG = 6.68% / 3 = 2.23%
COST OF EQUITY (STOCKS)
q DIVIDEND CAPITALIZATION MODEL
Ks = (D1 / P0) + g

Example: XYZ Co. is currently being traded at P10 per share and just
announced a dividend of P1 per share, which will be paid out next year.
Using the computed average dividend growth rate of 2.23%, what is the
cost of equity?
• D1 = Dividends/share next year = P1
• P0 = Current share price = P10
• g = Dividend growth rate = 2.23%
Source:
Cost of Equity - Formula, Guide, How to Calculate Cost of Equity (corporatefinanceinstitute.com)
COST OF EQUITY (STOCKS)
q DIVIDEND CAPITALIZATION MODEL
Ks = (D1 / P0) + g

• D1 = Dividends/share next year = P1

• P0 = Current share price = P10
• g = Dividend growth rate = 2.23%

Ks = (1 / 10) + 2.23%
Ks = 12.23%

The cost of equity for XYZ Co. is 12.23%

Source:
Cost of Equity - Formula, Guide, How to Calculate Cost of Equity (corporatefinanceinstitute.com)
WEIGHTED AVERAGE COST OF CAPITAL
(WACC)
üWACC Formula and Calculation
where:
Re = Cost of equity
Rd = Cost of debt
E = Market value of the firm’s equity
D = Market value of the firm’s debt
V = E + D = Total market value of the firm’s financing
E/V = Percentage of financing that is equity
D/V = Percentage of financing that is debt
Tc = Corporate tax rate​

Example: BTS Company Market Value of Equity amounting to P15 Mn and Market
Value of Debt of P10 Mn. Assuming that Cost of Equity is 12% and Cost of Debt of
11%. BTS tax rate is 20%. Compute for WACC.
WEIGHTED AVERAGE COST OF CAPITAL
(WACC)
üWACC Formula and Calculation
Exercise: BTS Company Market Value of Equity amounting to P15 Mn and Market Value of Debt of P10 Mn. Assuming that Cost of Equity is 12%
and Cost of Debt of 11%. BTS tax rate is 20%. Compute for WACC.
Re = Cost of equity = 12%
Rd = Cost of debt = 11%
E = Market value of the firm’s equity = P15M
D = Market value of the firm’s debt = P10M
V = E + D = Total market value of the firm’s financing = P15M + P10M = P25M
E/V = Percentage of financing that is equity = 15 / 25 = 60%
D/V = Percentage of financing that is debt = 10 / 25 = 40%
Tc = Corporate tax rate​ = 20% (1-20% = 80%)
WACC = (60% x 12%) + [(40%) x (11% x 80%)]
= 7.2% + (40% x 8.8%)
= 7.2% + 3.52%
WACC = 10.72%
INVENTORY MANAGEMENT
Ørefers to the process of ordering,
storing and using a company's
inventory
Øincludes the management of raw
materials, components and finished
products, as well as warehousing
and processing such items
Ø a company's inventory is one of its
most valuable assets
Ø shortage of inventory when and
where it's needed can be extremely
detrimental while large inventory
carries the risk of spoilage, theft,
damage or shifts in demand
Source: Inventory Management Definition (investopedia.com)
INVENTORY MANAGEMENT
INVENTORY ACCOUNTING
Ørepresents a current asset since a company typically intends
to sell its finished goods within a short amount of time,
typically a year.
Øinventory has to be physically counted or measured before it
can be put on a balance sheet
Ø Three methods:
q First-in-first-out (FIFO) costing
q Last-in-first-out (LIFO) costing
q Weighted-average costing
INVENTORY MANAGEMENT
FIRST-IN, FIRST-OUT (FIFO)
COSTING
Øa method used for cost flow
assumption purposes in the cost of
goods sold calculation
Øthe FIFO method assumes that
the oldest products in a company’s
inventory have been sold first
Øthe costs paid for
those oldest products are the ones
used in the calculation
Source: What Is FIFO Method: Definition and Example (freshbooks.com)
INVENTORY MANAGEMENT
ADVANTAGES OF FIRST-IN, FIRST-OUT (FIFO) COSTING
ØThe method is easy to understand, universally accepted and trusted
ØFollows the natural flow of inventory (oldest products are sold first,
with accounting going by those costs first). This makes bookkeeping
easier with less chance of mistakes
ØLess waste (a company truly following the FIFO method will always be
moving out the oldest inventory first)
ØRemaining products in inventory will be a better reflection of market
value (this is because products not sold have been built more recently)
ØHigher profit
ØFinancial statements are harder to manipulate
INVENTORY MANAGEMENT
DISADVANTAGES OF FIRST-IN, FIRST-OUT (FIFO)
COSTING
Øcan result in higher income tax for a business to pay, because the gap
between costs and profit is wider (than with LIFO)
Øcompany also needs to be careful with the FIFO method in that it is
not overstating profit. This can happen when product costs rise and
those later numbers are used in the cost of goods calculation, instead
of the actual costs
HOW TO CALCULATE FIRST-IN, FIRST-
OUT (FIFO) COSTING
Øto calculate COGS (Cost of Goods Sold) using the FIFO method, determine the
cost of your oldest inventory. Multiply that cost by the amount of inventory sold.
Example:
If 200 items were purchased for P10 and 100 more items were purchased next for P15, FIFO would
assign the cost of the first item resold of P10. After 200 items were sold, the new cost of the item
would become P15, regardless of any additional inventory purchases made.
Month Items Price
January 200 x P10.00 = P2,000.00 P3,500.00
February 100 x P15.00 = P1,500.00

Sold 120 items (COGS) Remaining 180 items (INVENTORY)

120 items x P10.00 = P1,200.00 80 items x P10.00 = P 800.00
100 items x P15.00 = P1,500.00
HOW TO CALCULATE FIRST-IN, FIRST-
OUT (FIFO) COSTING
Example:
Sal’s Sunglasses is a sunglass retailer located in QC. Sal opened the store in September of last year.
Right now, it is just the one location but he may expand in the next couple of years depending on
whether he can make good money or not. January has come along and Sal needs to calculate his
cost of goods sold for the previous year, which he will do using the FIFO method.
Here is what his inventory costs are:
Month Product Price Paid
September 200 sunglasses P200.00 per 600
October 275 sunglasses P210.00 per Sunglasses
November 300 sunglasses P225.00 per
December 500 sunglasses P275.00 per

Sal sold 600 sunglasses during this time, out of his stock of 1275.
HOW TO CALCULATE FIRST-IN, FIRST-
OUT (FIFO) COSTING
Going by the FIFO method, Sal needs to go by the older costs (of acquiring his
inventory) first.
Sal’s COGS calculation is as follows:

200 x P200.00 = P40,000.

275 x P210.00 = P57,750.
125 x P225.00 = P28,125.
COGS Total: P125,875.

Sal’s cost of goods sold is P125,875.

The remaining unsold 675 sunglasses will be accounted for in “inventory”.

INVENTORY MANAGEMENT
LAST-IN, FIRST-OUT (LIFO) COSTING
Øa method used to account for inventory that records the most recently
produced items as sold first
Øunder LIFO, the cost of the most recent products purchased (or produced)
are the first to be expensed as cost of goods sold (COGS), which means the
lower cost of older products will be reported as inventory
ØAll three inventory-costing methods can be used under generally accepted
accounting principles (GAAP) while the International Financial Reporting
Standards (IFRS) forbids the use of the LIFO method
Øcompanies that use LIFO inventory valuations are typically those with
relatively large inventories, such as retailers or auto dealerships, that can
take advantage of lower taxes (when prices are rising) and higher cash flows
Source: Last In, First Out (LIFO) Definition (investopedia.com)
INVENTORY MANAGEMENT
LAST-IN, FIRST-OUT (LIFO) COSTING
Example:
Assume company A has 10 widgets. The first five widgets cost P100 each and arrived
two days ago. The last five widgets cost P200 each and arrived one day ago. Based
on the LIFO method of inventory management, the last widgets in are the first ones
to be sold. Seven widgets are sold, but how much can the accountant record as a
cost?
Product Price Paid Sold Cost of Goods Sold
5 widgets P100.00 per x 2 widgets P 200.00
5 widgets P200.00 per x 5 widgets P1,000.00
7 widgets P1,200.00
INVENTORY MANAGEMENT
WEIGHTED AVERAGE COST METHOD
Øthe Weighted Average Cost (WAC) method of inventory valuation uses a weighted
average to determine the amount that goes into COGS and inventory
Øthe weighted average cost method divides the cost of goods available for sale by
the number of units available for sale
Øthe WAC method is permitted under both GAAP and IFRS accounting

Where:
Costs of goods available for sale is calculated as beginning inventory value + purchases
Units available for sale are the number of units a company can sell or the total number of units in inventory and
is calculated as beginning inventory in units + purchases in units
Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)
INVENTORY MANAGEMENT
WAC Method under Periodic and Perpetual Inventory
Systems
ØPERIODIC INVENTORY SYSTEM
ü the company does an ending inventory count and applies product costs to determine
the ending inventory cost
üCOGS can then be determined by combining the ending inventory cost, beginning
inventory cost, and the purchases throughout the period
ØPERPETUAL INVENTORY SYSTEM
ükeeps continual tracking of inventories and COGS
üit provides more timely information for the management of inventory levels
ühowever, this method of inventory tracking can be costly for a company
üthe weighted average cost method is referred to as the “moving average cost method.”

Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)

INVENTORY MANAGEMENT
Example of WAC Method
At the beginning of its January 1 fiscal year, a company reported a beginning
inventory of 300 units at a cost of $100 per unit ($30,000). Over the first
quarter, the company made the following purchases:
• January 15 purchase of 100 units at a cost of $130 = $13,000
• February 9 purchase of 200 units at a cost of $150 = $30,000
• March 3 purchase of 150 units at a cost of $200 = $30,000

In addition, the company made the following sales:

• End of February sales of 100 units
• End of March sales of 70 units
Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)
INVENTORY MANAGEMENT
Example of WAC Method
ØPERIODIC INVENTORY SYSTEM
ü determine the cost of goods available for sale and the units available for sale at the
end of the first quarter

For the sale of 170 units over the January-March period, we would allocate $137.33 per unit sold. The
rest would go into ending inventory. Therefore:

170 x $137.33 = $23,346.10 in COGS

$103,000 – $23,346.10 = $79,653.90 in ending inventory

Note: The numbers may be slightly off due to rounding off.

Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)

INVENTORY MANAGEMENT
Example of WAC Method
ØPERPETUAL INVENTORY SYSTEM
üdetermine the average before the sale of units
Before the sale of 100 units in February, our average would be:

For the sale of 100 units in February, the costs would be allocated as follows:

100 x $121.67 = $12,167 in COGS

$73,000 – $12,167 = $60,833 remain in inventory

Note: The numbers may be slightly off due to rounding off.

Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)

INVENTORY MANAGEMENT
Example of WAC Method
ØPERPETUAL INVENTORY SYSTEM
Before the sale of 70 units in March, our average would be:

For the sale of 70 units in March, the costs would be allocated as follows:

70 x $139.74 = $9,781.80 in COGS

$90,833 – $9,781.0 = $81,051.20 in ending inventory

Note: The numbers may be slightly off due to rounding off.

Source: Weighted Average Cost - Accounting Inventory Valuation Method (corporatefinanceinstitute.com)
INVENTORY MANAGEMENT
vINFLATION AND NET INCOME
§ When there is zero inflation, all three inventory-costing methods
produce the same result.
§ But if inflation is high, the choice of accounting method can dramatically
affect valuation ratios.
§ FIFO, LIFO, and Average Cost have a different impact:
o FIFO provides a better indication of the value of ending inventory (on the balance
sheet), but it also increases net income because inventory that might be several
years old is used to value COGS. Increasing net income sounds good, but it can
increase the taxes that a company must pay.
o LIFO is not a good indicator of ending inventory value because it may understate
the value of inventory. LIFO results in lower net income (and taxes) because COGS
is higher. However, there are fewer inventory write-downs under LIFO during
inflation.
o Average Cost produces results that fall somewhere between FIFO and LIFO.
INVENTORY MANAGEMENT
RECEIVABLES MANAGEMENT
Øor Accounts Receivables
Management
Øis all about ensuring that customers
pay their invoices
Økeeping track of what customers buy
on credit from a company
Øgood receivables management helps
prevent overdue payment or non-
payment
Øit is therefore a quick and effective
way to strengthen the company’s
financial or liquidity position
Source: Accounts Receivable Management | Graydon
RECEIVABLES MANAGEMENT
IMPORTANCE OF RECEIVABLES MANAGEMENT
ØBetter Cash Flow - Predictable cash flow enables us to manage our
operations and expansion plans
ØLower Working Capital Requirements - Effective receivables
management ensures that our Working Capital requirements are kept
at minimum
ØLowered Interest costs - Working capital is also fixed capital, which
attracts interest. Lower Debtors will reduce our Interest burden
ØBetter Bargaining with Sellers - provides us with enough cash flow to
bargain effectively with our Suppliers
ØStop profit leakages - Non receipt or delayed receipt is the biggest
profit leakage any company can have
Source: Receivable Management - A definitive guide on Receivable Management (enjayworld.com)
RECEIVABLES MANAGEMENT
GOOD RECEIVABLES MANAGEMENT
ØDefining a clear Terms for Payment
ØWell Defined Credit Policies
ØSetting Responsibilities clearly
ØProper Credit Check Process in Place
ØVarious options for paying
ØUse Technology
ØRegular Ageing Analysis and Action
ØOutsource the Receivable Process

Source: Receivable Management - A definitive guide on Receivable Management (enjayworld.com)

RECEIVABLES MANAGEMENT
FEATURES OF GOOD RECEIVABLES MANAGEMENT
SOLUTIONS
üMobile App.
üReal time information.
üMessages templates for followup
üStore all contracts and related documents in one place.
üMonitoring Due and overdue Receivables.
üAutomated Reminders
üRule based Escalations
üProjected Day wise receivables.
üProjected Sales Person wise (or person responsible for collection) receivables
üArea wise or any other criteria for analysis
Source: Receivable Management - A definitive guide on Receivable Management (enjayworld.com)
PAYABLES MANAGEMENT
Ørefers to the set of policies,
procedures, and practices employed
by a company with respect to
managing its trade credit purchases
Øamount owed by an entity to its
vendors/suppliers for the goods and
services received
Øconsist of seeking trade credit lines,
acquiring favorable terms of
purchase, and managing the flow
and timing of purchases so as to
efficiently control the company’s
working capital
Source: Account Payables Management | HowTheMarketWorks
PAYABLES MANAGEMENT
IMPORTANCE OF PAYABLES MANAGEMENT
ØTakes charge of paying the entity’s bills on a timely basis. This is important so that
strong credit and long-term relationship with the vendors can be maintained.
ØOnly when invoices are paid on time, vendors will ensure an uninterrupted flow of
supplies and services; which in turn will help in the systematic flow of business.
ØA good accounts payable process ensures there are no overdue charges, penalty or
late fees to be paid for the dues.
ØThe organized accounts payable process ensures all that the invoices due are
tracked and paid properly. This will help avoid missing payments and making a
payment twice.
ØIt also enables business entities to manage better cash flows (i.e. making payments
only when due, using the credit facility provided by the vendor, etc.)
ØFrauds and thefts can be avoided to a greater extent by following a stringent
accounts payable process.
Source: Accounts Payable - Meaning, Process, Formula & Journal Entries (cleartax.in)
 ACCOUNTS PAYABLE PROCESS
ØRECEIVING THE BILL
§ In the case of goods, the bill/invoice helps in tracing the
number/quantity of goods received
ØSCRUTINIZING THE BILL FOR DETAILS
§ The vendor's name, authorizations, date, and
requirements raised with the vendor based on the
purchase order can be verified too
ØUPDATING THE RECORDS FOR THE BILLS
RECEIVED
§ Ledger accounts connected to the bills received need to
be updated
ØMAKING TIMELY PAYMENT
§ As and when the due dates arrive (based on a mutual
understanding with the vendor/supplier/creditor), the
payments need to be processed
Source: Accounts Payable - Meaning, Process, Formula & Journal Entries (cleartax.in)
 CASH CONVERSION CYCLE (CCC)
Øis a metric that expresses the length of
time (in days) that it takes for a
company to convert its investments in
inventory and other resources into cash
flows from sales
Øtakes into account the time needed to
sell its inventory, the time required to
collect receivables, and the time the
company is allowed to pay its bills
without incurring any penalties
ØCCC will differ by industry sector based
on the nature of business operations
Source: Cash Conversion Cycle (CCC) Definition (investopedia.com)
 CASH CONVERSION CYCLE (CCC)

To calculate CCC, you need several items from the financial statements:
Ø Revenue and cost of goods sold (COGS) from the income statement
Ø Inventory at the beginning and end of the time period
Ø Account receivable (AR) at the beginning and end of the time period
Ø Accounts payable (AP) at the beginning and end of the time period; and
Ø The number of days in the period (e.g. year = 365 days, quarter = 90)
 CASH CONVERSION CYCLE (CCC)
ØDAYS INVENTORY OUTSTANDING (DIO) or DSI
üA lower value of DIO is preferred, as it indicates that the company is making
sales rapidly, and implying better turnover for the business

ØDAYS SALES OUTSTANDING (DSO)

üA lower value is preferred for DSO, which indicates that the company is able to
collect capital in a short time, in turn enhancing its cash position

Source: Cash Conversion Cycle (CCC) Definition (investopedia.com)

 CASH CONVERSION CYCLE (CCC)
ØDAYS PAYABLES OUTSTANDING (DPO)
üA higher DPO value is preferred. By maximizing this number, the company
holds onto cash longer, increasing its investment potential.

Source: Cash Conversion Cycle (CCC) Definition (investopedia.com)

 CASH CONVERSION CYCLE (CCC)
IMPORTANCE OF CCC
ØCCC represents how fast a company can convert the invested cash from start
(investment) to end (returns). The lower the CCC, the better.
ØCCC value indicates how efficiently a company’s management is using the short-
term assets and liabilities to generate and redeploy the cash and gives a peek into
the company’s financial health with respect to the cash management.
ØThe figure also helps assess the liquidity risk linked to a company’s operations.
ØAnalysts use it to track a business over multiple time periods. Tracking a company’s
CCC over multiple quarters will show if it is improving, maintaining, or worsening
its operational efficiency.
ØAnalysts use it to compare the company to its competitors. Investors may look at a
combination of factors to select the best fit.
Source: Cash Conversion Cycle (CCC) Definition (investopedia.com)
 MS. MARY ROSE ESCALA PATINGO
PLM e-mail address: mrepatingo@plm.edu.ph
Personal e-mail address: mrose.patingo@gmail.com
Contact # (CP / Viber): 09151505609

Consultation Hour: Wednesday 4PM – 5PM

Thank You
and
Goodnight!
