What is Finance? * Finance can be defined as the science and art of managi money. + At the personal level, finance is concerned with individuals’ decisions about how much of their earnings they spend, how much they save, and how they invest their savings. ° In a business context, finance involves the same types of decisions: how firms raise money from investors, how ] firms invest money in an attempt to earn a profit, and hoy they decide whether to reinvest profits in the business or distribute them back to investors. ll.Seen What is Accounting? e® Accounting is the process of recording, classifying, analysing & interpreting the business transactions which can be measured in terms of money. @ Thus, accounting keeps a permanent record of all business transactions. F Ty ..... re.Sei eee Accounting | Basic Terms |Asset fa-set] A resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will. provide a future benefit.Liability ff-a- bi-la-té} | Something a person or company owes, usually sum of money.Liabilities Something a business owns: + Cash Something a business owes: + Employee wages + Inventory + Employee benefits Accounts receivable + Vendor payments Real estate + Long-term loans + Equipment VehiclesASSETS VS. LIABILITIES Assets Y Items of value Y Business owns the items Generates revenue for the business Provide long-term _ benefits to the business Liabilities Hi, Debts the business owes to another entity ES, Can be used to purchas‘ NX f } assets &&, May help finance busine X operations Are an expense for the businessAND INTANGIBLE AS NGIBLE AND INT: ASSETS Cee ad eee eee ae Pov n iti inatitlncedeeeTST Current Assets Current assets are the resources that:a company owns that are expected to be converted into cash within a short period, typically within one year. These assets include: o Fm 6@ Cash and cash equivalents Accounts Receivable Inventory Short-term investments}{f | iFIXED vs CURRENT ASSETS > Current Assets 1) Heid for a short period of time iaCurrent Liabilities Pker-ant [i-a~bi-la-téz] The short term oh that are expected to beLong-Term Liabilities [169 term I¥-e-bi-le-tés] A company’s financial obligations that are due more than one year in the future.ee The Fundamental Accounting Equation (a) fe eS | ka, Assets Liabilities Equity any Financial obligations Whats lett after bot octin fgtigSsSeeucnas: = Such as: Kabitues from assetas 9 in + Agcounts payable = Sommon stock 2 Sie 2 Sages 2 Somer Grawss + ReSoumts receivante > Ren + Retained Somning: ee 2 Unites 7 + Prope + Bank debt = Equipment = Deferred tax lability 2 OSag term debeFinancial Statements [fa-‘nan(t)-shal ‘stat-mants] Written records that convey the business activities and the financial performance of a company.Balance Sheet Cba-lan(t)s ‘shét] A financial statement thai reports a company’s assets, liabilities, and shareholder equity at a specific point in time.A Simple Balance Sheet Total Assets Greys Nom- Current Assets a ilsg Skeeree - 4 [ # | (ia Kine Benes pttAsm —— SSDS Tn arene 2 2200 a LL ees enero a ca ee eet ne womens ——— ee a _ieoses ae ene eee aS om as2o am SS eeges Comereeen a ee tener Rect Coenen and heneten ° STORM PEOL DMI KQUEY _ Common sens foes sonore RENT rere incoerm ° Tonge saaeney & wees toEna corporation ‘Guiance Shoot Decommer 34, 3022 SII an cquwanents s 2200 ROSSoa wecowane et 39850 Saar enene sess SuSchee ese Ponond expenses Bisco Rent Lene ese, SBISSS investmenss, 29,009 Proserth slant & equipement - set oo 3.300 LEAS enorowemenss eee Chermeent etisee CSae Doce ceprectiation (S21909) Posoarty Dime & equIDrment MOE Sar se0 creangione aeneee Sosa 308.000 Stier ineanaiinie mamene —2R2.980 ‘Tonat Wenge area 3en.cco Other semen 2.209 Yona wamere, sz79.cce Current pocion of lonenterrn dost Adgrued compensation and Senetts: incoers taxes payanin Sener accrued nacthtis Soterres revenues, ‘Foca! currone maitre Long-term llabuition Notes paysoee Gonce payanto Sotorect more tes: Toten tanger Henin, Fotar natin Commitments and contingenctrs tm mw! rourryMeare A SF | | >INVESTMENT DECISIONS total amount of assets to be held in the firm >composition of these assets Ans ones avathabte are limited and need to be zLong term investment decision or capital budgeting eShort term investment decision or working capital managementINVESTMENT DECISIONS >rotal amount of assets to be held fn the firm >composition of these assets SLong term investment decision or capital budgeting Short term investment decision or working capital managementNon-Diseounted ’ Gr traditional teehriauesPayback Period {p&-.bak ‘pir-é-ad] The amount of time it takes to recover the cost of an investment. | Meaning of Payback Period it mPaybac® Sétiad_ formula — even cash flow: * When net annual cash inflow is even (i.e., same cash flow every period), the payback period of the project can be computed by applying the simple formula given below: Payback period = Initial Investment/ Annual Cash inflow ‘oe oy #7 Year? Year2 “Year3. + 32,000 + 32,000 + 32,000 +32,000 Payback period = 4.69 years year ° 1 iz 3 4 s 6 lemeestenert s 7200 $ - $s - S$ -S$ 8S - SS Cash Ficwr 3 -_$ 2000 $ 2000 $2000 $ 2000 $ 2000 $ 2000 Cummutative Cast Flow on ¢ 3 s ‘$ 2800 $Payback Period with Even Cash Flows FasTrac is considering buying a new machine that will be used in its manufacturing operations. The machine costs $16,000 and is expected to produce annual net cash flows of $4,100. The machine is expected to have an 8-year useful life with no salvage value. Calculate the payback period. Payback _ Cost of Investment period Annual Net Cash Flow Payback _ = 216,000 period $4,100 = 3.9 yearsYear 4: $24 Year 5: $15 $139ae ee Discounted _ Years Until | _ Unrecovered Amount Payback Period ~ Break-Even — Recovery Year Cash Flow Example: You investt$ in a business The Free Cash Flow (FCF or OCF) is as follows: Collected Payback What if... FCF not “exactly” 630 and so Collected Year 1: $40 Payback not exactly $100? year esa This means your exact $100 45 $115 ): payback happened sometime Year 4: $24 in between Year 2 and Year 3! When exactly? Year 5: $15 &«mp Payback Péfiod with ] | Uneven Cash Flows Cumulative Annual Net Net CashPayback Period CalculationSSS Accounting rate of return (“ARR”) The accounting rate of return (“ARR”) method looks at the total accounting return fora project to see if it meets the target returnCalculating ARR Total net profit / No years ARR (%) = ————__—_——-"_—x100 Initial cost eae Total net profit (5 years) = £1,350,000 Divided by project life = £1,350,000/5 = £270,000 Divided by the initial cost (€2,000,000) = £270,000 / £2,000,000 = 13.5%woe WN ee Particulars Average Revenue ‘Average Expenses “Average Annual Profit initial InvestmentTime Value of Money (TVM) (tim ‘val-(Jyd av ‘ma-né] The concept that a sum of money is worth more now than the same sum will be at a future date due to its earnings potential in the interim.Future Value (FV) = Present Value (PV) x (1+i)" i is the annual interest rate or required return. a: is the number of years before you receive the money. Money 5 This formula can help you determine how much money you will have affer a given period. TimeSe Time Value of Calculating Present Value What i is the present value of $100, 000 to be 5 percent?Time Value of Money, Calculating Present Value What is the present value of $100,000 to be | received 12 years from today if the discount rate isi] 5 percent? Present value = Future Value / (1+r)" Present value = $100,000 / (1 + 0.05)'? = $55,684 nail-Present Value (PV) Problems » PV problems involve caloulating the value today of future cash flow(s), » For example: < Intereat rates are 7%, If need to have $100,000 aaved (10 years, how much money muat | pul axide today to create that cash flow? < Intereat rates are 12%. Fl need te ereate an income af $6,000 per year for 10 years, how much money must! put aside today to create that aah flow’?DCF [dé 'sé ef} A valuation method used to estimate the value of 2 investment based on its expected future cash floy DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future.Formula for Discounted Cash Flow Valuation (DCF) CF, cr, CF, DcF = (———G] *(——a]* - oS (1+r)4 (141) (14r)9 eee eee te DCF = Discounted Cash Flow. CF = total free cash flow for the year. CF, means total free cash flow for year 1, CF, means total free cash flow for year 2. n= the period of time. You can use as many as you want. r= the rate of return. It is the targeted rate of return. For small businesses, this should be a reflection of the expected rate of return bearing in mind that it should normally be higher than what an investor/buyer would get if they invested their money in “safe” investments.Cc Net Present Value = —C,+ de re of (NPV) (1+r) (1+r)? -C,= Initial Investment —_r = Discount Rate C= Cash Flow T= Time