Finance

MGST 672: Introduction to Business

 LEARNING OBJECTIVES – Finance

1 What is the time value of money?

2 What are some key financial ratios?

3 What is Capital Structure?

 LEARNING OBJECTIVES – Finance

1 What is the time value of money?

 1900 Price $1 Ten Movie Tickets

$1 One Pound of Coffee

$1 70 lbs of potatoes
https://www.ranker.com/list/things-yo
u-could-buy-for-a-dollar-in-1900/erin-
mccann?page=5
Price today $130 Ten Movie Tickets

$12 One Pound of Coffee

$35 70 lbs of potatoes

 Why $0.10 Movie Ticket: 1900

$13 Movie ticket: 2021

What factors contributed to the increase in price for movie tickets?

 Factors of
Time Value Time
of Money
Interest Rate

Compounding Period

Risk (+ Interest = Discount Rate)

 • Present Value: The value of money today
PV vs. FV • Future Value: The value of money in the future

“What will I be able to purchase with my money when I receive it?”

What if there is: no inflation

no risk?
 The time value of money principle states that a
PV vs. FV dollar you receive five years from now is worth
less than a dollar you receive today.

The reason:
Even assuming no inflation or risk, the dollar you get today can be
invested somewhere. Assuming a positive return on that
investment, you would be able to accumulate more than a dollar
by the fifth year. (original dollar + return on your investment)
 Perpetuity Yahoo!!! I WON!!!!

Options for lottery payout:

• one payment of $125,000
• Lifetime of payments of $7,000
per year

Note: The annual interest rate is 5%. Image Source: Pixabay.com

What is the
Formula

PV = present value
C = cashflow
r = rate
What is the
Formula
1. PV of $125,000 payment =

2. =
 LEARNING OBJECTIVES – Finance

2 What are some key financial ratios?

 Key
Financial Key Accounting Equations:
Ratios
Assets = Liabilities + SH Equity

Profit = Revenue - Expenses

 Key
Financial Assets
Ratios
Short Term Long Term

Cash Property
Accounts Receivable Plant
Inventory Equipment
 Key
Financial
Ratios Liabilities

Short Term Long Term

• Line of Credit • Loans

• Accounts Payable • Other commitments
• Other commitments due >1 year
due <1 year
 Key Simple Income Statement
Financial
Ratios Revenue $xxx
Cost of Good Sold < xx>
Gross Margin $xxx
Operating Expenses < xx>
Earnings Before Interest & Taxes (EBIT) $ xx
Interest Expense < xx>
Income Tax < xx>
Net Income $ xx
 Key What ratios might help me make wise finance
Financial decisions?
E.g. If I am considering selling valuable products or
Ratios
services to a potential customer on credit, what
would I look at? (assuming access to financial statements)

1. Are they profitable? Gross Margin %

EBIT %
Net Income %
…compared to industry averages!!
 Key What ratios might help me make wise finance
Financial decisions?
E.g. If I am considering selling valuable products or
Ratios
services to a potential customer on credit, what
would I look at? (assuming access to financial statements)

2. Can they pay their bills? Current Ratio

Quick Ratio
Debt/Equity
…compared to industry averages!!
 Key Current Assets
Current Ratio =
Financial Current Liabilities
Ratios
Liquid Current Assets
Acid Test =
(Quick Ratio) Current Liabilities
1. Current ratio: Can you convert existing assets to cash within twelve months
to pay existing debts that are due within the coming 12 months
2. Acid test: Let’s be real. Inventory is not always so easy to convert to cash
quickly… so let’s exclude it from the ratio.
 Key Debt
Financial Debt to Equity =
Equity
Ratios

1. Tells us how we are financing our assets.

2. Too much debt can be risky
a. You have to pay interest whether you are profitable or not.
b. If you default, the bank may take control of your firm
c. It may limit your ability to raise more capital
 LEARNING OBJECTIVES – Finance

3 What is Capital Structure?

 Key
Financial
Ratios

What is Capital?

What is Capital Structure?

 Capital
Structure
1. Financial Capital: (Examples- Cash and Securities)
• “Anything can be a form of financial capital as long as it has
a monetary value and is used in the pursuit of future
revenue.”
• “Most investors encounter financial capital with respect to
debt and equity.”

Source: https://www.investopedia.com/ask/answers/031715/what-difference-between-financial-capital-and-economic-capital.asp
 Capital
Structure
2. Capital Assets:
Essentially, any asset that is not for sale (inventory), used to
generate revenue for more than a year. (e.g. PPE)

3. Working Capital:
Current Assets – Current Liabilities
(remember the Current Ratio)
 Capital
Structure
4. Economic Capital answers the question:
“How much financial capital does the business need to cover
potential future loss based on current risk exposure?”

Source: https://www.investopedia.com/ask/answers/031715/what-difference-between-financial-capital-and-economic-capital.asp
 Capital
Structure

Assets = Liabilities + SH Equity

 Capital
Structure
Assets

Liabilities SH Equity
 Capital
Structure
Assets

Debt Equity
 Capital
Structure
Assets

Debt Equity

1. Bank Loans 1. Common Shares

2. Bonds 2. Preferred shares
3. Accounts Payable 3. Retained earnings
 Capital
Structure

Debt
Measurement:
Equity

https://www.investopedia.com/terms/c/capitalstructure.asp
 Capital Why might some firms have higher
Structure D/E ratios than others?
Riskier
Recent acquisitions
Belong to a capital intensive industry
Very stable predictable earnings
Group Activity: Come up with 1 - 2 examples of firms in each category.
 LEARNING OBJECTIVES – Finance

1 What is the time value of money?

2 What are some key financial ratios?

3 What is Capital Structure?