Financial Management Reviewer

FINANCE Financing Decisions

- The system that includes the circulation - Financing decisions assert that the mix
of money, the granting of credit, the of debt and equity chosen to finance
making of investments, and the investments should maximize the value
provision of banking facilities. of investments made.

FINANCIAL MANAGEMENT Dividend Decisions

1. Also called as Corporate Finance, Managerial - The dividend decision is concerned with
Finance or Business Finance. the determination of quantum of profits
to be distributed to the owners, the
2. It focuses on the decisions relating to how
frequency of such payments and the
much and what types of assets to acquire, how
amounts to be retained by the firm.
to raise the capital needed to purchase assets,
and how to run the firm so as to maximize its Significance of Financial Management
value.
1. Broad Applicability
Scope of Financial Management
2. Reduction of Chances of Failure
1. Procurement of short-term as well as long-
3. Measurement of Return of Investment
term funds from financial institutions.
RELATIONSHIP
2. Mobilization of funds through financial
instruments. 1. Financial Management and Accounting
3. Compliance with legal and regulatory 2. Financial Management and Economics
provisions relating to finance.

TYPES OF FINANCIAL DECISIONS

1. Investment Decisions

2. Financing Decisions

3. Dividend Decisions

Asset = Liability + Equity

Investment Decisions

- The investment decisions are those

which determine how scarce or limited
resources in terms of funds of the
business firms are committed to
projects.
Wealth Maximization Goal professionals commonly manage other
people's money
1. Profitability
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2. Sustainability

The wealth maximization goal is advocated on Financial Markets, Financial Institutions, and
the following grounds: Interest Rates

1. It considers the risk and the time value of Three Ways of Capital Transfer
money.
1. Direct Transfer – this occurs when a business
2. It considers all future cash flow, dividends and sells its stocks or bonds directly to savers,
earnings per share. without going through any type of financial
institution.
3. It suggests the regular and consistent
dividend payments to the shareholders. 2. Transfer Through an Investment Bank – the
company sells its stocks or bonds to the
4. The financial decisions are taken with a view investment bank, which then sells these same
to improve the capital appreciation of the share securities to savers.
price.
3. Transfer Through a Financial Intermediary –
5. Maximization of firm's value is reflected in the financial intermediary such as bank,
the market price of share. insurance company, or a mutual fund obtains
funds from savers in exchange for its securities.
The intermediary uses this money to buy and
hold businesses’ securities, and the savers hold
the intermediary’s securities.

Jobs in Finance

1. Banking

2. Investments

3. Insurance Types of Markets

4. Corporations 1. Physical Asset Markets vs Financial Assets

Markets
5. Government
2. Spot Markets vs Futures Markets
Ethical Behavior
3. Money Markets vs Capital Markets
- Ethics are of primary importance in any
practice of finance. Finance 4. Primary Markets vs Secondary Markets

5. Private Markets vs Public Markets

Physical Asset Markets – also called as Interest Rates
“tangible” or “real” asset markets; these are for
1. The interest rate is the amount a lender
products such as bread, autos, real estate,
charges a borrower and is a percentage of the
computers, and machinery.
principal—the amount loaned.
Financial Asset Markets – deals with stocks,
2. An interest rate also applies to the amount
bonds, notes, and mortgages and derivative
earned at a bank or credit union from a deposit
securities.
account.
Spot Markets – markets in which assets are
Theories in Interest Rates
brought or sold for “on-the-spot" delivery
(literally, within a few days). In general terms, the following observations of
interest rates over time are made in reality.
Futures Markets – markets in which participants
agree today to buy or sell an asset at some 1. Interest rates for different terms move
future date. together.
Money Markets – markets for short-term highly 2. Interest rates on short-term debts fluctuate
liquid debt securities. more than those on long-term debts. (vice
versa)
Capital Markets – markets for intermediate-
term or long-term debt and corporate bond. 3. The term structure of interest rates usually
slopes upward in most cases.
Primary markets – markets in which
corporations raise new capital. The corporation Term Structure of Interest Rate
selling the newly created stock receives the
proceeds from the sale in a primary market The term structure of interest rates refers to the
transaction. relationship between the yields and maturities
of a set of bonds with the same credit rating.
Secondary markets – markets in which existing, Typically, the term structure refers to treasury
already outstanding securities are traded among securities, but it can also refer to riskier
investors. securities. A graph of the term structure of
interest rates is known as a yield curve.
Private Markets – where transactions are
negotiated directly between two parties;
because these transactions are private, they
may be structured in any manner to which the
two parties agree.

Public Markets – where securities that are

traded are held by many individuals. These
securities must have fairly standardized
contractual features because public investors do
not generally have the time and expertise to
negotiate unique and non-standardized Financial Institutions
contracts.
A company engaged in the business of dealing
with financial and monetary transactions such
as deposits, loans, investments, and currency The income statement is a report summarizing a
exchange. firm’s revenues, expenses, and profits during a
reporting period, generally a quarter or a year.
1. Banks
3. The Statement of Cash Flows
2. Insurance Companies
A report that shows how items that affect the
3. Investment House and Securities
balance sheet and income statement affect the
Dealers/Brokers
firm’s cash flows.
4. Financing Companies
4. Statement of Stockholders’ Equity
5. Pawnshops
A statement that shows by how much a firm’s
6. Cooperatives equity changed during the year and why this
change occurred.
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Financial ratio is a comparison in fraction,
Financial Reporting and Analysis proportion, decimal or percentage of two
Financial Statements and Reports significant figures taken from financial
statements. It expresses the direct relationship
The annual report is the most important report between two or more quantities in the
that corporation’s issue to stockholders and statement of financial position and statement of
other key users, and it contains two (2) types of comprehensive income of a business firm.
information:

1. There is a verbal section, often presented as

a letter from the chairperson, which describes
the firm’s operating results during the past year
and discusses new developments that will affect
future operations.

2. The report provides the four (4) basic

financial statements – the balance sheet, the
Liquidity Ratios
income statement, the statement of cash flows
and the statement of shareholders’ equity These ratios are also known as Solvency Ratios.
These ratios give us an idea of the firm's ability
1. Balance Sheet
to pay off debts that are maturing within a year
This financial statement shows what assets the or within the next operating cycle.
company owns and who has claims on those
1. Current Ratio
assets as of a given date – for example, as of
December 31, 20X3. The balance sheet is a 2. Acid-Test or Quick Ratio
“snapshot” of a firm’s position at a specific point
1. Current Ratio
in time.
Primary test of solvency to meet current
• Assets = Liabilities + Equity
obligations from current assets as a going
2. Income Statement concern; measure of adequacy of working
capital.
Formula: Current Ratio = Total Current 2. Average Collection Period
Assets/Total Current Liabilities
3. Accounts Payable Turnover
Solution: 20x4 = 32,923/13,730.50 = 2.397 or
4. Average Payment Period
2.40 20x3 = 28,132/10,216 = 2.75
5. Inventory Turnover
Interpretation: In 20x4, the company has 2.40
times capability to pay its current liabilities 6. Average Age of Inventory
using its current assets. Likewise, in 20x3, the
company has 2.75 times capability to pay its 7. Total Assets Turnover
current liabilities using its current assets. 1. Accounts Receivable Turnover
Rule of Thumb: The higher the current ratio It roughly measures how many times a
result, the capable the company is in paying company's accounts receivables have been
their current liabilities using its current assets. turned into cash during the year.
2. Acid-Test or Quick Ratio Formula: Net Sales (Most recent year) Average /
A more severe test of immediate solvency; test Accounts Receivable balance (Ave. of 2 most
of ability to meet demands from current assets. recent years)

Formula: Total Current Assets- (Inventories + Solution: 107, 800 = 107,800 = 24.91 4,480 +
Prepaid Expense) Total Current Liabilities 4,175 4,327.50 2
Solution: 20x4: 32,923 - (23,520.50 + 256) = Interpretation: The company converted
9,146.50 = 0.666 or 0.67 13, 730.50 13, 730.50 accounts receivable into cash 24.91 times in a
Solution: 20x3: 28,132 - (18,384.50 + 379.50) = year.
9,368 = 0.917 or 0.92 10,216 10,216 Rule of Thumb: Generally, a high turnover is
Interpretation: In 20x4, the company has 0.67 good because it could indicate efficiency in the
times capability to pay its current liabilities collection of receivables.
using its quick assets. Likewise, in 20x3, the 2. Average Collection Period
company has 0.92 times capability to pay its
current liabilities using its quick assets. The average collection period of accounts
receivable is the average number of days
Rule of Thumb: The higher the quick ratio result, required to convert receivables into cash.
the capable the company is in paying their
current liabilities using its quick assets. Formula: 365 days / Accounts Receivable
Turnover
Activity Ratios/Asset Management Efficiency
Ratios Solution: 365 = 14.65 days or 15 days 24.91
Interpretation: It takes 15 days for the company
These ratios give us an idea of how efficiently to collect receivables and turn/covert them into
the firm is using its assets. These ratios measure cash.
the management of assets such as accounts
receivable, accounts payable, inventory and Rule of Thumb: If the average collection period
fixed assets. is within the credit terms of the company, then
the company is doing a good job in collecting
1. Accounts Receivable Turnover their receivables from the clients. Otherwise,
the company handles poorly in receivables It measures the efficiency of the firm in
collection. managing and selling inventory.

Formula: Cost of Goods Sold (Most recent

year) / Average Inventory balance (Ave. of 2
3. Accounts Payable Turnover
most recent years)
It measures the efficiency of the company in
Solution: 64,682 = 64,682 = 3.087 or 3.09
meeting trade payable.
23,520.50 + 18, 384.50 20,952.50 2
Formula: Net purchases (Most recent year) /
Interpretation: The company replenishes its
Average Accounts Payable balance (Ave. of 2
inventories 3.09 times a year.
most recent years)
Rule of thumb: Generally, a high turnover is
Net purchases are defined as the gross amount
preferred because it is a sign of efficient
of purchases made, less deductions for
inventory management and profit for the firm.
purchase discounts, returns, and allowances.
Generally, it is a portion of Cost of Goods Sold. 6. Average Age of Inventory

Solution: 64,682 = 64,682 = 11.82 7,147 + The number of days being taken to sell the
3,795.50 5,471.25 2 entire inventory.

Interpretation: The company has made Formula: 365 days / Inventory Turnover
payments 11.82 times in a year to its creditors.
Solution: 365 = 118.12 days 3.09
Rule of Thumb: Generally, a high turnover is
Interpretation: It takes 119 days for the
good because it could indicate efficiency in the
company to sell its entire inventory for the
meeting the payments/payables of the
whole year.
company.
Rule of Thumb: Generally, the faster inventory
4. Average Payment Period
sells, the fewer funds are tied up in inventory
The average payment period is the number of and more profits are generated.
days a company pay its obligations.
7. Total Assets Turnover
Formula: 365 days / Accounts Payable Turnover
It is a measure of the efficiency of management
Solution: 365 = 30.88 days or 31 days 11.82 to generate sales and thus earn more profit for
the firm using its entire assets.
Interpretation: It takes 31 days for the company
to pay its obligations to its creditors. Formula: Net Sales (Most recent year) / Average
Total Assets (Ave. of 2 most recent years)
Rule of Thumb: If the average payment period is
within the credit terms of the creditors, then Solution: 107,800 = 107,800 = 2.519 or 2.52
the company is doing a good job in paying their 47,649 + 37,954.50 42,801.75 2
payables to its creditors. Otherwise, the
Interpretation: It indicates that the company
company has a bad record in paying its
uses its entire assets 2.52 times a year to
obligations when due.
generate sales.
5. Inventory Turnover
Rule of thumb: Generally, high turnover could Rule of thumb: If debt to equity ratio is greater
mean that the assets are efficient enough to than 1, debt financing has more weight. If debt
generate sales. to equity ratios is less than 1, equity financing
has more weight. If debt to equity ratio is equal
Stability Ratios
to 1, debt and equity financing has equal
These ratios are also known as Leverage Ratios weight.
or Debt Management Ratios. These ratios
3. Times Interest Earned Ratio
measure the extent of a firm's financing, with
debt relative to equity and its ability to cover It measures how many times interest expense is
interest and other fixed charges. covered by operating profit.

1. Debt Ratio Formula: Operating profit / Interest Expense

2. Debt to Equity Ratio Solution: 20X4: 9,621.50 = 7.44 1,292.50

3. Times Interest Earned Ratio Interpretation: Interest expense can be paid by

the company 7.44 times.
1. Debt Ratio
Rule of thumb: The higher the ratio, the more
It shows proportion of all assets that are
times a company can cover its annual interest
financed with debt.
expense from operating earnings.
Formula: Total Liabilities / Total Assets
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= Answer x 100
Financial Reporting and Analysis (Part 2)
Solution: 20x4: 24,681.50 = 0.518 x 100 =
Financial ratio is a comparison in fraction,
51.80% 47,649
proportion, decimal or percentage of two
Interpretation: More than half or 51.80% of the significant figures taken from financial
total assets are financed by debts. statements. It expresses the direct relationship
between two or more quantities in the
Rule of thumb: Generally, the higher the portion statement of financial position and statement of
of debt, the greater the risk because the comprehensive income of a business firm.
creditors must be satisfied first before the
owners in the event of bankruptcy. Profitability Ratios

2. Debt to Equity Ratio Profitability ratios are financial metrics used by

analysts and investors to measure and evaluate
It measures debt relative to amounts of the ability of a company to generate income
resources provided by the owners and other (profit) relative to revenue, balance sheet
stockholders. assets, operating costs, and shareholders’ equity
Formula: Total Liabilities / Total Equity during a specific period of time.

Solution: 20X4: 24,681.50 = 1.07 22,967.50 Margin Ratios

Interpretation: Debt financing has more weight Margin ratios represent the company’s ability to
than equity financing. convert sales into profits at various degrees of
measurement.

1. Gross Profit Margin

2. Earnings Per Share It is a measure of overall operating efficiency
and incorporates all of the expenses associated
3. Operating Profit Margin
with ordinary or normal business activities.

Formula: Operating Profit / Net Sales = Answer x

100

Solution:20x4: 9,621.50 = 0.0893 x 100 = 8.93%

107,800 Solution:20x3: 5,903 = 0.0772 x 100 =
7.72% 76,500
Return Ratios Interpretation: In 20x4, the company has 8.93%
Return ratios represent the company’s ability to operating profit margin. Likewise, in 20x3, the
generate returns to its shareholders. company has 7.72% operating profit margin.

1. Return on Assets Rule of Thumb: Companies with high operating

profit margins are generally more well-equipped
2. Net Profit Margin to pay for fixed costs and interest on obligations.
3. Return on Equity 3. Net Profit Margin
1. Gross Profit Margin It measures profitability after considering all
This shows how much a business is earning, revenue and expenses, including interest, taxes
taking into account the needed cost of goods or non-operating items.
sold to produce its goods and services. Formula: Net Income / Net Sales = Answer x 100
Formula: Gross Profit / Net Sales = Answer x 100 Solution: 20x4: 4,697 = 0.0436 x 100 = 4.36%
Solution: 20x4: 43,118 = 0.4000 x 100 = 40% 107,800 Solution: 20x3: 2,955 = 0.0386 x 100 =
107,800 Solution: 20x3: 30,560.50 = 0.3995 x 3.86% 76,500
100 = 39.95% 76,500 Interpretation: In 20x4, the company has 4.36%
Interpretation: In 20x4, the company has 40% net profit margin. Likewise, in 20x3, the
gross profit margin. Likewise, in 20x3, the company has 3.86% net profit margin.
company has 39.95% gross profit margin. Rule of Thumb: Companies with high net profit
Rule of Thumb: A high gross profit margin ratio margins are generally have better chances to
reflects a higher efficiency of core operations, survive an economic slowdown, and are more
meaning it can still cover operating expenses, capable of offering lower prices than their
fixed costs, dividends, and depreciation, while competitors that have a lower net profit margin.
also providing net earnings to the business. On 4. Earnings Per Share (EPS)
the other hand, a low profit margin indicates a
high cost of goods sold, which can be attributed It indicates a company’s ability to produce net
to adverse purchasing policies, low selling profits for common shareholders.
prices, low sales, stiff market competition, or Formula: Net Income (Most Recent Year) /
wrong sales promotion policies. Weighted Average Number of Ordinary or
2. Operating Profit Margin Common Shares Outstanding (2 Most Recent
Year)
Solution:20x4: 4,697,000 = 4,697,000 = P2.00 Interpretation: It indicates that the amount of
2,297,000 + 2,401,500 2,349,250 2 profit earned relative to the level of investment
in total equity is 22.42%.
Interpretation: The company earns P2 for every
common share outstanding of the company. Rule of Thumb: A favorably high ROE ratio is
often cited as a reason to purchase a company’s
Rule of Thumb: The higher the earnings per
stock. Companies with a high return on equity
share, the better for the investors. Hence, many
are usually more capable of generating cash
investors will be attracted to put their
internally, and therefore less dependent on debt
money/fund to the company
financing.
5. Return on Assets/Return on Investment on
Market Ratios
Assets (ROA)
These ratios check the financials of the public
It shows the percentage of net earnings relative
companies which are traded in the secondary
to the company’s total assets. The ROA ratio
market to understand their financial position,
specifically reveals how much after-tax profit a
whether the stocks are rightly valued or not and
company generates for every one peso of assets
at what price shares should be bought or sold.
it holds.
1. Price/Earnings Ratio
Formula: Net Income (Most Recent Year) /
Average Total Assets (2 Most Recent Years) = 2. Price/Earnings Growth Ratio
Answer x 100
3. Book Value Per Share
Solution:20x4: 4,697 = 4,697 = 0.1097 x 100 =
4. Market/Book Ratio
10.97% 47,649 + 37,954.50 42,801.75 2
5. Dividend Payout Ratio
Interpretation: It indicates that the amount of
profit earned relative to the level of investment 1. Price/Earnings Ratio
in total assets is 10.97%.
These ratios check the financials of the public
Rule of Thumb: The lower the profit per peso of companies which are traded in the secondary
assets, the more asset-intensive a company is market to understand their financial position,
considered to be. Likewise, the higher the profit whether the stocks are rightly valued or not and
per peso of assets, the less asset-intensive a at what price shares should be bought or sold.
company is considered to be.
Formula: Market Price of Ordinary Shares /
6. Return on Equity (ROE) Earnings Per Share
It expresses the percentage of net income Solution: 20x4: 30 = 15 2
relative to stockholders’ equity, or the rate of
return on the money that equity investors have Interpretation: It indicates that the investors are
put into the business. willing to pay Php15 per share of stock for every
P1 of earning per share of stock.
Formula: Net Income (Most Recent Year) /
Average Total Stockholder's Equity (2 Most Rule of Thumb: In general, a high P/E suggests
Recent Years) = Answer x 100 that investors are expecting higher earnings
growth in the future compared to companies
Solution:20x4: 4,697 = 4,697 = 0.2242 x 100 = with a lower P/E.
22.42% 22,967.50+ 18,933.50 20,950.50 2
2. Price/Earnings Growth (PEG) Ratio Rule of Thumb: If the value of BVPS exceeds the
market value per share, the company’s stock is
The PEG ratio is used to determine a stock's
deemed undervalued. Otherwise, overvalued.
value while also factoring in the company's
expected earnings growth, and it is thought to 4. Market/Book Ratio
provide a more complete picture than the more
It measures the market's perception of price per
standard P/E ratio.
share of the stock to its book value.
Formula PEG Ratio: P/E Ratio (Most Recent Year)
Formula: Market Price Per Share (Most Recent
/ EPS Growth
Year) / Book Value Per Share
Formula for EPS Growth: (EPS Recent Year/EPS
Solution: 30 = 3.07 9.78
Last Year) - 1 = Answer x 100
Interpretation: This means that investors are
Solution: EPS Growth = (2/1.29) - 1 = 0.5504 x
willing to pay more for every peso book value of
100 = 55.04
per share of stock of the company. The investors
PEG Ratio: 15 = 0.27 55.04 are willing to pay P3.07 per every P1 book value
of per share of stock of the company.
Interpretation: The market price per share of
the company is not expensive in relation to the Rule of Thumb: A low ratio (less than 1) could
earnings growth of per share of stock of the indicate that the stock is undervalued (i.e., a
company. bad investment), and a higher ratio (greater
than 1) could mean the stock is overvalued (i.e.,
Rule of Thumb: If the PEG Ratio is greater than
it has performed well).
1, the market price per share of the company is
too expensive considering the growth rate of 5. Dividend Payout Ratio (DPR)
earnings per share of the company. If the PEG
It measures the percentage of earnings given
Ratio is less than 1, the market price is not
out as dividends.
expensive in relation to the growth of earnings
per share of the company Formula: Dividends per share (Most Recent
Year) / Earnings per share = Answer x 100
3. Book Value Per Share (BVPS)
Solution: 0.33 = 0.165 x 100 = 16.50% 2
It represents the minimum value of a company's
equity and measures the book value of a firm on Interpretation: The company declared 16.50%
a per-share basis. Book Value is the share capital dividends to be given out to the investors.
of the investors plus the retained earnings.
Rule of thumb: A high DPR means that the
Formula: Total Stockholder's Equity (Most company is reinvesting less money back into its
Recent Year) / Average Common Shares business, while paying out relatively more of its
Outstanding earnings in the form of dividends. A low DPR
means that the company is reinvesting more
Solution: 22,967,500 = 22,967,500 = 9.78
money back into expanding its business.
2,297,000 + 2,401,500 2,349,250 2

Interpretation: The investors will pay P30

market value per share of stock of a company
for P9.78 book value per share of the company.