BUSINESS FINANCE
FINANCIAL LITERACY
-Financial literacy means different things
to different people.
-it is the set of skills and knowledge on
finance that allows individuals to make
informed and effective decisions given all
their financial resources regarding the
use and management of money.
-It influences how people save, borrow,
invest, and manage them financial
affairs. It is important for individuals, the
financial system, and the economy.
-Some have the misconception that
money is wealth, but it is not the case.
Money may come and go. What I
sustainable is financial education,
experience and training translated into
financial literacy.
IMPORTANCE OF FINANCIAL LITERACY
-Concerns about financial preparedness
are documented in recent
studies demonstrating that both young
and older adults lack the basic
knowledge needed to make good
financial choices.
-Business Finance comes in to equip you
to make healthy financial decisions.
-Financial literacy can help you as an
individual consumer of financial
services or any business whether it be
yours in the future or that of your
employers.
1. PERSONAL FINANCE
-Some people say managing finance is
common sense. But why is it
that many adults are still struggling
financially?
-It is a common desire to be wealthy. But
to achieve that, one must be prepared to
make financial decisions. The outcomes
of financial decisions have significant
implications for an individual’s financial
security and standard of living.
-A person with a good level of financial
literacy is likely to be better placed than
someone without those skills and
knowledge to manage their financial
affairs prudently; all else being equal,
they are more likely to budget effectively,
invest wisely and manage their debt level
in a sustainable manner.
-By contrast, poor financial choices,
possibly based on a lack of
understanding of financial matters, can
result in several negative outcomes,
including a lower level of financial wealth
and imprudent debt levels.
2. HEART OF BUSINESS
-If you will own a business in the future,
chances are you will be making
economic decisions to decide the
direction of your company. Even when
you are an employee of an institution, you
will not be saved from regular financial
decision-making either.
-Well-informed investment decisions,
based on a high level of financial literacy,
could be expected to result in a more
productive allocation of resources
through time, reflecting a more
discerning approach to the balancing of
risk and return. In turn, this should
contribute to a higher potential growth
rate and financial stability.
-Not everyone is privileged enough to
become financially literate. Take
advantage of this chance. Remember
that effective financial decisions lead
to financial wellness which results from
sound financial education.
THE BASICS OF FINANCE
-Topics in finance — such as money,
investments, lending, savings — have
been around since the dawn of human
history in many forms but it is only in the
1940s and 1950s that it was recognized as
a specific study and theory.
-Investopedia defines finance as
activities associated the management,
creation, and study of money and
investments. It can be broadly
segmented into three categories —
personal finance, corporate finance, and
public finance.
-Recall that the reason you are studying
this subject is to equip yourself with
financial literacy to be able to help you
make healthier financial decisions. As
public finance deals with the
government’s financial management of a
country’s wealth which is a specialized
study, we will only be focusing on
personal and corporate finance as we go
through this subject.
-Observe that the common denominator
of the two is how finance deals with the
management of money. It has three
functions — planning, administration, and
control.
-Even if you do not see yourself pursuing
a career in finance, you’ll find that an
understanding of the basic ideas of
finance will help make you a smarter
consumer and a wiser investor with your
own money. It will also help you
understand the financial consequences
of the important business decisions you
will face no matter your career choice.
GOAL OF FINANCE
-The primary goal of the finance is to
maximize the wealth of the owners for
whom the firm is being operated.
(Brigham & Houston, 2004)
-But what is wealth? How is it measured?
Meriam Webster Dictionary defines
wealth as an abundance of valuable
material possessions or resources that
have economic utility. Does that mean
sales? Income? Assets? Savings? Net
worth?
-Wealth is a combination of all those
things and more. Here are some
indicators of wealth:
There is an increased net worth or
value of the business
Employees are well-paid and
motivated to work
 Shareholders are happy because their
dividends are enough and
paid on time
Customers’ satisfaction is high
Market status is stable
Liabilities are utilized and managed
effectively
-In fact, being wealthy may also involve
deeper relationships with suppliers,
customers, or even competitors. This can
be achieved by taking care of these
stakeholders and their interests.
-Finance and accounting are different
studies but both work hand in hand to
achieve the common goal of maximizing
wealth.
FINANCIAL MANAGERS
-Financial managers act on behalf of the
firm’s owners. They make operating and
investment decisions whose benefits
exceed their costs to maximize the value
of the firm and thereby maximize the
wealth of its owners. (Gitman & Zutter,
2012)
-As financial managers, you will be
practicing financial management.
This involves decisions that will
supposedly maximize the value of
shareholders’ wealth. Whether you are
the manager of a small store or a
managing officer in a large company, the
objective of your financial decision is the
same: to make the enterprise and
yourself better off.
-I must stress that this does not mean
maximize shareholder value “at all costs.”
Financial managers, like you, should
behave ethically and follow laws as
well as other society-imposed constraints
FINANCIAL SYSTEM
-A Financial System is a process that
explains the flow of funds from the savers
to the users.
-Saver’s act as the creditors because the
money they have deposited in the bank
serves as one of the bank’s assets which
will then be available for credit to users
who seek funding. What acts as conduits
between savers and users of funds are
the financial institutions serving as
intermediaries.
FINANCIAL INSTITUTIONS
-Financial institutions are companies
engaged in the business of dealing with
monetary transactions, such as deposits,
loans, investments, and currency
exchange. This encompasses a broad
range of business operations within the
financial services sector, including banks,
insurance companies, and brokerage
firms, mutual funds and others pension
funds.
-Absent these institutions, the investment
and financial sector would suffer.
Individuals would be inconvenienced with
transacting everyday exchanges and
large companies would discover it
difficult to secure funding. Thus, it is
critical to recognize how relevant the role
of financial intermediaries is.
BANKS
-Banks provide a means where savers
can place their extra funds in deposits.
Banks give the depositor interest on the
money deposited to them. To cover for
the interest given to the depositors; banks
lend the money to borrowers in the form
of loans after performing credit
investigation. Banks can also serve
as conduits of investors in buying and
selling both government securities and
bonds.
-Added security is the maximum amount
of ₱500,000.00 that the Philippine
Depositary Insurance Company (PDIC)
guarantees every depositor in the event
of bank bankruptcy. How does that work?
If your deposit is ₱15,000.00, you are
insured to receive back ₱15,000.00
because that’s what you deposited. But if
your deposit is ₱800,000.00, you can only
get ₱500,000.00 which is the maximum
insurance.
MUTUAL FUNDS
-Mutual funds are organizations that
accept money from savers and then
utilize these funds by buying financial
instruments that can provide return on
investment. From these financial
instruments, a portfolio is created for the
savers. A portfolio is a collection or group
of financial instruments like stocks, bonds,
and cash investments. It is managed by
professional managers for a fee which is
a small percentage of the funds invested.
-Mutual funds afford opportunities to
investors, whether they be big or small, to
invest in financial instruments which they
would not have considered on their own,
or they may have thought of investing but
do not have the time or the expertise to
do it.
-As a saver, you will pay the mutual fund
corporation money to create a portfolio
for you which can include investments in
the stock market, bonds, treasury notes,
and other money market instruments. The
company will manage your investment
for you, and you will only wait on that
investment to grow so you can reap the
benefits, if any. As a financial manager,
you may be the professional managing
the portfolio of another person.
INSURANCE
-Insurance companies offer different
insurance products that serve as security
for an individual, business, property, life,
which can be broadly categorized into life
insurance and non-life insurance
products. It provides a means of
protection from financial loss.
-The company providing insurance is
called the insurer while the person who is
protected is called the insured. In
exchange for the protection, the insured
pays the insurance companies cash
which is referred to as premiums. These
premiums are used to fund claims.
-Usually, the cash from the premiums is
more than enough to cover the claims for
most periods. Hence, the surplus from
premiums can be invested by insurance
companies.
STOCK EXCHANGE
-The Philippine Stock Exchange (PSE)
provides a system for the trading of
equity securities called stocks of publicly
listed companies. It acts as a large
platform where people can buy and sell
corporation stocks by facilitating every
transaction and the entire process. As
with other similar institutions, it earns
revenues through transaction fees and
interest rates.
-An individual cannot directly trade in the
stock market. If a person wants to invest
and trade in the stock market, he must
open an account with an accredited
stock brokerage firm. After doing that, he
must pay the stock exchange money to
acquire the actual stocks. This way, the
individual becomes an investor who gets
his desired assets while the corporation
gets funding.
OTHERS:
Social Security System
Government Service Insurance System
Credit unions
Philippine Health Insurance
FINANCIAL INSTRUMENTS
-Financial instruments are assets that
can be traded. Most types of these
instruments afford flow and transfer of
capital throughout financial system.
When companies need funding, they
either sell debt securities or issue equity
instruments. The proceeds from the sale
will be used to finance the company’s
operations or expansion plans. On the
other hand, investors buy debt or equity
instruments in hopes of receiving returns
through interest, dividend income or
appreciation in the asset’s price.
DEBT FINANCING
-Debt financing can be in the form of
borrowings from banks or other lending
institutions. It can also be in the form of
advances from stockholders or loans.
These generally have fixed returns due to
fixed interest rates. Examples of debt
instruments are as follows:
• Treasury Bonds and Treasury Bills are
issued by the Philippine government.
These bonds and bills have usually low
interest-rates and have a very low risk of
default since the government assures
that these will be paid.
• Corporate Bonds are issued by publicly
listed companies. These bonds usually
have higher interest rates than debt
securities offered by the government.
However, these bonds are not risk-free. If
the company which issued the bonds
goes bankrupt, it can no longer provide
the holder of the bonds return from their
investment. Worse, even their principal
investment can be wiped out.
EQUITY FINANCING
-Equity financing refers to the issuance of
new shares of stocks and the internal
generation of funds. This form of
financing generally has varied returns
based on the performance of the issuing
company.
-Just to refresh your memory,
corporations offer two main types of
stock — common stock and preferred
stock. Both represent some degree of
ownership of the company and a piece of
the company profit. However, both are
different and have their advantages and
disadvantages. Either of these two stocks
can be issued as equity financing.
-There are benefits to being a common
stockholder. Common stockholders are
the true owners of the company. Being
residual owners, the growth potential of
their investment is unlimited.
-As its name suggests, preferred stock
has priority over common stock in terms
of claims over the assets of a company.
This means that when a corporation was
to be liquidated, no asset will be
distributed to common stockholders
unless all the claims of the preferred
stockholders have been satisfied. At the
same time, no cash dividends will be
given to common stockholders unless all
the dividends due to preferred
stockholders are settled first.
CORPORATE ORGANIZATION STRUCTURE
You now understand that the goal of
corporate finance is to maximize
wealth. It is important to understand the
hierarchy of the administration that
will work together to achieve that goal.
Below is the basic corporate
organizational chart of a company.
-In the diagram presented, each line is
working for the interest of the person on
the line above them. As discussed in the
previous, common stockholders have
voting rights. These voting rights are used
to elect the Board of Directors. Since the
Board of Directors is elected by the
shareholders, their responsibility is to
carry out the objectives of the
stockholders.
-The board of directors is the highest
policy-making body in a corporation.
Their primary responsibility is to ensure
that the corporation is operating to serve
the best interest of the stockholders. They
set policies on investments, capital
structure, and dividend policies; approve
the company’s strategies, goals, and
budgets; appoint and remove members
of the top management including the
president; determine top management’s
compensation: and approve the
information and other disclosures
reported in the financial statements.
-The roles of a president in a corporation
may vary from one company to another.
The word “president” is the keyword for
this module. Among the responsibilities of
a president are overseeing the operations
of a company and ensuring that the
strategies as approved by the board are
implemented as planned; performing all
areas of management including
planning, organizing, staffing, directing,
and controlling; and representing the
company in professional, social, and civic
activities.
-Although the president carries out the
decision making for all functions, it would
be difficult for him to do all this alone
especially when the corporation has
become too big. To assist him are the
vice presidents (VP) of different functional
areas: finance, marketing, production and
administration.
THE FINANCE MANAGER
-As a finance manager, you would be
interested in the job description of the
Vice President for Finance. This person
has a lot of responsibilities but for the
purposes of our discussion, let’s simplify it
into four– financing decisions, investing
decisions, operating decisions, and
dividend policies.
FINANCING DECISIONS
-This function includes making decisions
as to how to finance long-term
investments and working capital which
deals with the day-to-day operations of
the company. Basically, his role is to
determine the appropriate capital
structure of the company.
-Capital structure refers to how much of
your total assets is financed by debt and
how much is financed by equity. Refer to
the graph below: Recall that in
accounting, Assets = Liabilities + Owner’s
Equity.
-To be able to acquire assets, our funds
must have come somewhere. If it was
bought using cash from the owner’s
pockets, it is financed by equity. On the
other hand, if money comes from
borrowings, the asset bought is financed
by debt. This was also discussed in detail
in the previous module.
-In the illustration above, the total assets
are financed by 60% debt and 40% equity.
Accordingly, the capital structure is 60%
debt and 40% equity.
INVESTING DECISIONS
-Investing decisions include determining
the financial viability of an investment. It
is deciding where to put your excess cash
to make it more profitable. Investments
may either be short term or long term.
OPERATING DECISIONS
-Operating decisions deal with the daily
operations of the company. The role of
the VP for Finance is determining how to
finance working capital needs by either
long term or short-term sources.
-Therefore, the choice between short-
and long-term sources depends on the
risk the management is willing to take.
DIVIDEND POLICIES
-Dividend decisions involve
recommending to the president and the
board of directors the amount of cash
dividends the company can declare.
Recall that dividends are paid by
corporations to existing shareholders a
return on their investment. Some
investors buy stocks because of the
dividends they expect to receive from the
company. Non-declaration of dividends
may disappoint these investors. Hence, it
is the role of a financial manager to
determine when the company should
declare cash dividends.
-As we progress with the subject, you will
be experiencing how to make these
decisions and act like a financial
manager. We will tackle each decision in
more detail in the succeeding modules.
FINANCIAL STATEMENT ANALYSIS
FINANCIAL STATEMENT
-is basically a summary of all
transactions that are carefully recorded
and transformed into meaningful
information.
-facts and figures shown on the financial
statements give the people and
businesses using them a bird’s-eye view
of how well the business is performing.
5 BASIC FINANCIAL STATEMENTS
STATEMENT OF FINANCIAL POSITION
-This provides information regarding the
liquidity position and capital
structure of a company as of a given
date.
STATEMENT OF COMPREHENSIVE INCOME
-This provides information regarding the
revenues or sales, expenses, and net
income of a company over a given
accounting period.
-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 a comparison will not be
made possible without knowing the
accounting periods covered in the
statement of profit or loss.
STATEMENT OF CASH FLOWS
-This provides an explanation regarding
the change in the cash balance from one
accounting period to another.
-The Cash Flows are classified into three
main categories:
Operating - In the cash flows from
operating activities, the income is
reported from the statement of
profit or loss.
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.
Financing - The cash flows from
financing activities provide
information on whether there is a
proper matching of investing and
financing activities.
STATEMENT OF CHANGES IN EQUITY
-This provides information that explains
the changes in the stockholders’ equity
account from one accounting period to
another.
-The changes may be due to the
following:
Profit or loss for the accounting
period.
Cash dividend declaration.
Issuance of new shares of stocks;
and
Other transactions
NOTES TO FINANCIAL STATEMENT
-This is an integral part of the financial
statements because provides additional
pieces of information on the following:
Brief Description of the Company
Information may include the nature of the
business of the company and the owners
behind the company.
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.
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.
FINANCIAL STATEMENT ANALYSIS
-Financial statements convey a lot of
useful information that helps corporate
managers assess the company’s
strengths and weaknesses and gauge
the expected impact of various
proposals.
-If a firm’s managers do not understand
the fundamentals of accounting or the
preparation of Financial Statements, they
won’t be able to judge the effects of them
actions or decisions properly, which will
make it hard for the firm to survive or to
have a maximum value.
-The financial health of a company can
be measured through financial
statements. They provide information on
how the company is doing. Also, by
comparing the firm’s performance to that
of other firms in the same industry and
evaluating trends in the firm’s financial
position, we could identify the company’s
deficiencies and take corrective actions.
-Financial Statement Analysis is made of
the following parts:
RATIO ANALYSIS
-Ratio analysis is one of the most
important techniques of financial analysis
in which quantities are converted into
ratios for meaningful comparisons, with
past ratios and ratios of other firms in the
same or different industries. It determines
trends and exposes the strengths or
weaknesses of a firm.
-You may assume that all investors care
about is how profitable a company is, but
that’s not necessarily true. Liquidity, which
indicates how well, a company can cover
its short-term debt, and activity, which
shows how well a company uses its
assets to generate sales, must be
considered along with profitability to form
a complete picture of how well the
business is performing.
-The different ratios handling the
measurement categories are:
PROFITABILITY RATIOS
The following ratios are used to measure
the profitability of a company:
1. Return on common equity (ROE)
-It indicates the firm’s efficiency in
applying the common stockholders’
money or capital to generate profit.
2. Return on total assets (ROA)
-It indicates a firm’s ability to efficiently
allocate and manage its resources.
3. Gross profit margin (GPM)
-It is a financial metric used to assess the
company’s financial health and business
model by revealing the proportion of
money left over from revenues after
accounting for the cost of goods sold.
4. Operating profit margin (OPM)
-It gives analysts an idea of how much
the company makes on each dollar of
sales after paying for fixed and variable
costs.
5. Net profit margin (NPM)
-It is the percentage of revenue
remaining after all the operating
expenses, interest, taxes, and preferred
stock dividends have been deducted
from a company’s total revenue.
LIQUIDITY RATIOS
The following ratios are used to measure
the liquidity of a company:
1. Current Ratio
-It indicates a company’s ability to pay
off its current obligations using its current
assets.
2. Quick Asset Ratio
-It measures the ability of a company to
pay off its current liabilities using its most
liquid assets. It does not include the
inventories which are typically the least
liquid current asset of a firm.
-Most financial analysts prefer the quick
ratio for it is more conservative. In other
words, it does not include the inventories
that may turn obsolete or unsold.
LEVERAGE RATIOS
-The following ratios are used to measure
the leverage of a company:
1. Debt Ratio
-It indicates how much of the total assets
are financed by liabilities.
2. Debt to Equity Ratio
-It indicates a firm’s leverage or gearing
and its capacity for debt repayment, it
indicates the proportion of a firm’s total
capital contributed by trade creditors
and lenders.
3. Interest Coverage Ratio
-It provides information regarding a
company’s ability to cover interest
expense using its income.
EFFICIENCY RATIOS
-The following ratios are used to measure
the leverage of a company:
1. Total Asset Turnover Ratio
-It indicates the ability of a company to
generate sales for every peso of asset
invested.
2. Fixed Asset Turnover Ratio
-It measures the ability of a firm to
generate sales for every peso of fixed
asset invested in.
3. Accounts Receivable Turnover Ratio
-It measures the efficiency by which
accounts receivable are managed. A high
ratio means efficient management of
receivables.
What does the Average Collection Period imply?
-It measures how long the receivables
are collected or converted into cash.
A low ACP means that the company is
very efficient in collecting its
receivables. Otherwise, the company has
a problem regarding the collection of its
receivables and might not be able to pay
its suppliers and creditors on time. It is
also known as Day Sales Outstanding
(DSO).
4. Inventory Turnover Ratio
-It shows how many times a company’s
inventories are sold or replaced over a
period. The higher this ratio, the more
capable or efficient the company is in
selling its inventories.
What does the Days’ Inventory Outstanding
measure?
-It measures how long the inventories
were sold to the customers from the time
they were bought or purchased from the
suppliers. Generally, a low DSO ratio
means that the company is efficient in
generating sales.
5. Accounts Payable Turnover Ratio
-It provides information regarding the
rate by which trade payables are paid.
What does the Days’ Payable measure?
-It measures the average payment
period of the company. Generally, a
higher ratio means that the company is
utilizing its allowable credit period.
RESULT ANALYSIS
-The financial ratios that have computed
for are relationships determined from a
company's financial information and
used for comparison purposes. The use of
financial ratios is a time-tested method
of analyzing a business.
-Financial ratio analysis can be used in
two different but equally useful ways. You
can use them to examine the current
performance of your company in
comparison to past periods of time. It can
help you identify problems that need
fixing and can direct your attention to
potential problems that can be avoided.
In addition, you can use these ratios to
compare the performance of your
company against that of your
competitors or other members of your
industry.
INTERPRETATION OF FINANCIAL RATIOS
-Though calculation of ratios is important,
it is only a clerical task whereas
interpretation requires skill, intelligence,
and foresightedness. The ratios are only
the tools of analysis, and their
interpretation will depend upon the
caliber and competence of the reader. A
financial manager should be familiar with
various financial statements and the
significance of changes. A wrong
interpretation may create a problem
since wrong conclusions may lead to
wrong decisions.
PROFITABILITY RATIOS
1. RETURN ON COMMON EQUITY
-A higher ROE is usually better. ROEs of 15-
20% are generally considered good.
-A rising ROE suggests that a company is
increasing its profit generation without
needing as much capital. It also indicates
how well a company's management
deploys shareholder capital while a
falling ROE may indicate a less efficient
usage of equity capital.
-Generally, when a company has low ROE
for a long period, it simply means that the
business is not very efficient in generating
profit. In other words, it also tells you that
the business is not worth investing in
since the management simply can't
make very good use of investors' money.
-For example, if your ROE is 23.87%, it
means that for every ₱1 of stockholder’s
equity, ₱0.2131 was earned.
2. RETURN ON TOTAL ASSETS
-A high return on assets (ROA) is
generally better than a low ratio. An
improving ROA is considered a good sign.
ROAs over 5% are generally considered
good.
-A higher return on assets value indicates
that a business is more profitable and
efficient because the assets produce high
income through utilization of its assets.
-For example, if your ROA is 14.92%, it
means that the company generated
₱0.1492 for every ₱1 of asset in the
company.
3. GROSS PROFIT MARGIN
-A good GPM will vary considerably by
industry, but a higher margin is preferred
to a lower one.
-A high gross profit margin means that
the company did well in managing its
cost of sales. It also shows that the
company has more to cover for
operating, financing, and other costs. A
negative margin can be an indication of
a company's inability to control costs.
-For example, if your GPM is 26.63%, it
means that for every ₱1 of sale the
company generates, it earns ₱0.2663 in
gross profit.
4. OPERATING PROFIT MARGIN
-A high operating margin is a good
indicator that a company is being well
managed and is potentially less of a risk
than a company with a lower operating
margin which could indicate a company
is underpricing.
-For example, if your OPM is 7.71%, it
means that for every ₱1 of sale of the
company, it earns ₱0.771 after deducting
operating expenses.
5. NET PROFIT MARGIN
-A good margin will vary considerably by
industry, but as a rule of thumb, a 5%
margin is low, a 10% net profit margin is
considered average while anything
above a 20% margin is considered high or
good.
-A higher net profit margin means that a
company is more efficient at converting
sales into actual profit.
-For example, if your GPM is 5.02%, it
means that the company earned ₱0.502
for every ₱1 of revenue generated.
LIQUIDITY RATIOS
1. CURRENT RATIO
-A good current ratio is between 1.1 to 2,
which means that the business has 2
times more current assets than liabilities
to covers its debts. A current ratio below 1
means that the company doesn't have
enough liquid assets to cover or settle its
short-term liabilities.
-A very high current ratio does not
necessarily indicate that a company is in
a state of financial well-being. It might
suggest that the company is not using its
current assets efficiently. It may also
indicate that the company has too many
old inventories, a huge amount of idle
cash and too many accounts receivable
that may turn into bad debts.
-For example, if your current ratio is 1.18, it
means that the company earned ₱1 of
current liabilities that the company has, it
has ₱1.18 current assets.
2. QUICK ASSET RATIO
-The higher the ratio, the better. A quick
ratio of 1 or above is considered good.
-When the ratio is at least 1, it means a
company's quick assets are equal to its
current liabilities. This means the
company should not have trouble paying
short-term debts. A company that has a
quick ratio of less than 1 may not be able
to fully pay off its current liabilities in the
short term.
-For example, if your current ratio is 0.48,
it means that for every ₱1 of current
liabilities, it has ₱0.43 quick assets to
settle it.
LEVERAGE RATIOS
1. DEBT RATIO
-Ideally, the lower the number, the better
because a high-risk level, with a high
debt ratio, means that the business has
taken on a large amount of risk. But it still
is relative depending on industry of the
company.
-A debt ratio of less than 0.50 means that
the company has less liabilities as
compared to stockholder’s equity.
Meaning, it is highly financed by
investment of owners. Otherwise, a debt
ratio is 0.50 or more, this means that a
company is highly leveraged and
financed by debt.
-A very high debt ratio means that the
company has a large amount of liabilities
to settle. Over time, if not paid, the
company might experience insolvency or
even bankruptcy.
2. DEBT TO EQUITY RATIO
-A good debt to equity ratio is around 1 to
1.5. However, the ideal debt to equity ratio
will vary depending on the industry
because some industries use more debt
financing than others.
-A low debt-to-equity ratio indicates a
lower amount of financing by debt via
lenders, versus funding through equity via
shareholders. Higher ratio indicates that
the company is getting more of its
financing by borrowing money than
through investment of owners, which
subjects the company to potential risk if
debt levels are too high.
3. INTEREST COVERAGE RATIO
-The higher the rate, the more capable
the company is in paying interest to
lenders, creditors, preferred stockholders,
and bondholders.
-Generally, an interest coverage ratio of
at least 2 is considered the minimum
acceptable amount for a company that
has solid, consistent revenues. In contrast,
a coverage ratio below 1 indicates a
company cannot meet its current interest
payment obligations and, therefore, is not
in good financial health
EFFICIENCY RATIOS
-In general, the higher the efficiency
ratios – the more "turns" – the better. A
higher number indicates that the
company is using its assets efficiently.
1. TOTAL ASSET TURNOVER RATIO
-For example, if your total asset turnover
ratio 2.35, it means that for every ₱1 of
asset of the company, it can generate
sales has ₱2.35.
2. FIXED ASSET TURNOVER RATIO
-For example, if your fixed asset turnover
ratio is 4.30, it means that the company
was able to generate ₱4.30 for every ₱1 of
property, plant, and equipment it has.
3. ACCOUNTS RECEIVABLE TURNOVER RATIO
-For A high ratio is desirable, as it
indicates that the company's collection of
accounts receivable is efficient.
-It becomes more meaningful when
converted to Average Collection Period or
Days’ Receivables. Using the equation
provided, an Accounts Receivable
Turnover Ratio of 22.82 will produce an
average collection period of 15.78 or 16
days. This means that the company had
an average of 16 days, from the day the
sale was made, to collect its accounts
receivables.
4. INVENTORY TURNOVER RATIO
-In general, the higher the inventory
turnover ratio of a company each year,
the better it is for the company's future.
Low inventory turnover means low
sales, too much inventory or overstocking
and poor liquidity of its inventory.
-It becomes more meaningful when
converted to Days’ Inventories. Using the
equation provided, an Inventory Turnover
Ratio of 8.65 will produce a Days’
Inventories result of 41.62 or 42 days. This
means that it took the company 42 days,
on average, to sell its inventories from the
time they were bought.
5. ACCOUNTS PAYABLE TURNOVER RATIO
-A high ratio indicates prompt payment is
being made to suppliers for purchases on
credit. A low ratio indicates slow payment
to suppliers for purchases on credit.
-It becomes more meaningful when
converted to Days’ Payable. Using the
equation provided, an Accounts Payable
Turnover Ratio of 8.31 will produce a Days’
Payable result of 43.32 or 43 days. This
number suggests that the average
payment period of the company for its
trade accounts payable was 43 days.
BENCHMARKING
-To guide different users of financial
statements, i.e., creditors, investors,
regulators, and managers, in their
decisions, financial statement analysis
tools can be used. You have learned how
to perform ratio analysis by computing
for the four major categories of financial
ratios. Each of the financial ratios provide
important information relevant to the
financial aspect that each represents;
however, without applying context and
comparison, all these numbers mean
very little. Therefore, it is also beneficial to
practice benchmarking.
-Benchmarking is a method of
establishing a standard for comparison
to add context to the financial
information provided in financial
statements and ratios to derive meaning
from these valuable data. (Schaefer,
2013) It is a standard practice that is
effective in establishing standards for
comparison. This can be accomplished
by comparing the company’s
performance to industry benchmarks,
viewing the company’s performance
over time or identifying the relationship
between company’s major accounts.
INDUSTRY AVERAGE ANALYSIS
-Industry average analysis is the process
of comparing a particular company’s
results to another company in the same
industry. It evaluates the various aspects
of a company’s financial ratios and
compares them to those of the “best
practice” companies within the same
industry. This setup makes it easy for
managers to see exactly where the
company stands relative to its
competition. The information gained from
such a comparison allows firms to
develop new and better plans for how to
make improvements or adopt certain
best practices.
-For example, let’s say a company earns
₱100,000. Is that too high? Is that too low?
Well, if they had ₱1,000,000 in revenue
then you can say “Oh, they have a 10%
profit margin”. Now we can start to
analyze is 10% good enough. You may
look at their competition. Let’s say them
competitors had a 15% profit margin. You
can now assess why and how your
company is performing beneath the
industry’s average performance.
HORIZONTAL ANALYSIS
-Another tool used in benchmarking is
horizontal analysis. It is commonly known
as trend analysis. This is the analysis of a
firm’s financial ratios over time. It is
illustrated in both the two major financial
statements of the company – the
Statement of Financial Position and the
Statement of Comprehensive Income.
It is important to analyze trends in ratios
because these trends give clues as to
whether a firm’s financial condition is
likely to improve or to deteriorate. The
focus of this discussion will be on vertical
analysis and horizontal analysis. To
establish the trend, percentage changes
of accounts from one period to another
must be made.
FORMULA FOR THE ANALYSIS:

EXAMPLE OF A HORIZONTAL ANALYSIS OF

A STATEMENT OF FINANCIAL POSITION: EXAMPLE OF A HORIZONTAL ANALYSIS OF
A STATEMENT OF COMPREHENSIVE
INCOME:

VERTICAL ANALYSIS
-This is a technique for evaluating the
data of financial statements that express
each item within a financial statement in
terms of a percent of a base amount. This
is also called common size analysis. In EXAMPLE OF A VERTICAL ANALYSIS OF A
using this type of analysis, attention must STATEMENT OF COMPREHENSIVE
be focused on items with significant INCOME:
changes from one period to another.
Depending on the nature of the business,
it is possible that even a slight change in
the numbers that you can see can have
huge possible implications in the
business.
FORMULA FOR THE ANALYSIS:
1. For the Statement of Financial Position,
all accounts are presented as a
percentage of total assets.
2. For the Statement of Comprehensive
Income, all accounts are presented as a
percentage of net sales.
EXAMPLE OF A VERTICAL ANALYSIS OF A
STATEMENT OF FINANCIAL POSITION:

FINANCING NEEDS
FINANCING
- Financing is the process of providing
funding for a particular need. In the
context of businesses, you have already
learned that it can come in two major
categories: debt financing and equity
financing. Recall that debt financing is the
act of borrowing money from lenders and
not giving up ownership while equity
financing is the method of raising capital
by selling a part of the company in the
form of stocks to investors in exchange of
ownership interests in the company.
FINANCIAL NEEDS
-The need for financing may be for long-
term, medium-term or for short-term
because financial requirements vary from
one organization to other. To meet out
these needs, funds need to be raised
from various sources.
TYPES OF FINANCIAL NEEDS
➢ SHORT-TERM REQUIREMENTS
-Such type of financial needs arises to
finance current assets. Investment in
these assets is known as meeting of
working capital requirements of the
concern. The main characteristic of
short-term financial needs is that they
arise for a short period of time not
exceeding the accounting period or one
year.
-After establishment of a business, funds
are required to meet its day-to-day
expenses, right? For example, raw
materials must be purchased at regular
intervals, workers must be paid wages
regularly, water and power charges must
be paid regularly. Thus, there is a
continuous necessity of liquid cash to be
available for meeting these expenses. For
financing such requirements, short-term
funds are needed. The inadequacy of
short-term funds may even lead to
default on obligations and unfortunate
closure of business.
➢ MEDIUM-TERM REQUIREMENTS
-Such requirements refer to those funds
which are required for a period exceeding
one year but not exceeding 5 years. For
the purposes of this module, we will only
focus on short-term and long-term
sources. This type of finance is attained
for expansion and transformation of
existing organization.
➢ LONG-TERM REQUIREMENTS
-Long-term needs generally refer to
requirements of funds which are for a
period exceeding 5-10 years. It tends to
be used for financing the setting up of
businesses and for expansion of existing
businesses. All investments in plant,
machinery, land, buildings, are
considered as long-term financial needs.
Take for example a company considering
setting up new offices or acquiring
additional land and building for
expansion. The methods of financing this
type of project will generally be quite
complex and can involve millions of
pesos.
SOURCES OF FUNDS ON THE BASIS OF PERIOD
-Businesses, class, is concerned with the
production and distribution of goods and
services for the satisfaction of needs. For
carrying out various activities, business
requires money. That is why Finance is
called the life blood of any business. A
business cannot function unless
adequate funds are made available to it.
The initial capital contributed by the
entrepreneur is not always sufficient to
take care of all financial requirements of
the business. A business, therefore, must
look for other sources from where the
need for funds can be met.
-On the basis of period, the different
sources of funds can be categorized into
three parts. These are long-term sources,
medium-term sources, and short-term
sources. Again, although we have
skimmed through all three in the previous
module, for the purposes of our receivable and inventories. These funds
discussion, we will only be focusing on can also be used when a company has
funds that can be generated from short- some maturing obligations and does not
term and long-term financing. have enough cash to pay such maturing
-A business can raise funds from various obligations.
sources. Each of the source has unique
characteristics, which must be properly
understood so that the best available
source of raising funds can be identified.
Sources or funds must be matched with
the needs of the company because this
saves the business from encountering
defaults on obligations and incurring
losses, and at the same time, use the
funds at hand to earn profits.
-However, there is not a single best
source of funds for all organizations.
Depending on the situation, purpose, cost
and associated risk, a choice may be
made about the source to be used.
SOURCES OF SHORT-TERM FUNDS
-Let us recall your lesson in liquidity.
Remember that there should be a
balance between liquid funds and
investments because too high liquidity
will have opportunity costs since these
funds could have been invested to yield
revenue while too low liquidity may cause The following factors are considered in
the institution to default on payments selecting the source of short-term
should emergency situations arise. It is financing:
important that enough liquid assets ❖ Cost or Interest
should be available to meet short term -Interest is the cost of borrowing money.
obligations. Of course, borrowing money from lenders
-Short-term funds are normally used to is not for free so funds must be utilized to
finance the day-to-day operations of the compensate for the high costs. Take for
company which represent working example informal lending sources like 5/6
capital requirements such as accounts which may be the most expensive.
❖ Availability of short-term funds -Note class that long-term investments
-Informal lending sources like 5/6 is most must be financed by long-term sources
available because there are no formal of funds to minimize the risk that a
requirements to avail of the facility. Other company may not be able to pay
lenders have higher restrictions and maturing obligations. The returns on
requirements before a loan is approved long-term investments may not be
and issued. realized immediately, and therefore
❖ Risk require more patient sources of financing.
-Whatever the source of fund is, if the
company defaults, the lenders may
foreclose some of the company’s
properties or even the entire business
itself to settle the loan.
❖ Flexibility
-This pertains to the ability of the
company to access funds. For example, a
bank loan may be cheaper, but the bank
may reject the loan application of the
borrower because he/she did not pass
the credit evaluation process of the bank.
❖ Restrictions
-Some lenders like banks may require a
minimum deposit balance with their
branch for as long as the loans remain
outstanding. The bank’s approval may
also be secured before cash dividends
can be declared.
SOURCES OF LONG-TERM FUNDS
-Long-term funds are used for long-term
investments or sometimes called capital
investments including expansion,
buying new equipment, or buying a piece -The company’s capital structure is a
of land which will be the site of future major consideration for deciding which
expansion. Long-term funds can also be long-term sources of funds to utilize. The
used to finance permanent working target would be to balance debt and
capital requirements. equity and come up with the minimum
cost of capital.