Title: Financial Management
1Financial Management
- Understanding Financial Statements
- Analysis of Financial Statements
- Introduction to Financial Management
2Understanding Financial Statements
- Objective of this section is
- To get an understanding about the Financial
Statements - Income Statement (Earnings Statement)
- Balance Sheet
- Statement of Changes in Equity
- Statement of Cash Flows
- Accounting Policies Notes
3Uses of financial statements?
- allow user to assess
- financial position of the company
- success of its operations
- policies and strategies of management
- insight into future performance
- Financial statements are history BUT they can
help project the future
4Accounting Period
- Although the firms life is continuous (going
concern), financial data is presented for
arbitrary time periods - year, quarter, etc. - Leads to make adjustments and estimates Ex.
Accruals, depreciations.
5Income Statement
- For a given Period
- (Ex. Year, semi annual etc.)
- Realization Principle
- Matching Concept
- Accrual Vs. Cash
6Income Statement cont) Ex.
- Revenue
- Cost of sales ()
- Gross profit
- Other income
- Distribution Cost ()
- Admin. Expenses ()
- Other ()
- Operating Costs ()
- Operating Profit
- Finance Cost ()
- Profit before tax
- Tax ()
- PAT
- Extraordinary Items ()
- NPAT
7Issues of the Income Statement
- Accrual basis
- Estimates, Ex. depreciation provision for bad
debts) - Cash flow Vs. Income statement.
- Opportunity cost is not considered.
8Balance Sheet
- A statement of financial condition
- On a particular date (a snapshot)
- Assets Liabilities Equities
9 Balance Sheet cont Ex.
- Assets Note Rs.
- Non Current Assets
- Property, Plant equipment ()
- Investments ()
- Intangible Assets ()
- Current Assets
- Inventories ()
- Debtors ()
- Cash Bank ()
- Total Assets
- Capital Liabilities
- Share Capital ()
- Reserves ()
- Accumulated Profits ()
- Non- current Liabilities
- Debentures ()
- Current Liabilities
10Issues of the Balance Sheet
- Historical cost
- Tangible (ex. Fixed assets)
- Intangible (ex. TM, Goodwill)
- Estimates (ex. depreciation)
- Non-Comparability (ex. Assets acquired at
different time periods)
11Statement of Equity
- Documents changes in balance sheet equity
accounts from one accounting period to the next - Provides an important link between the balance
sheet and the income statement
12Cash Flow Statement
- A positive net income on the income statement is
ultimately insignificant unless a company can
translate its earnings into cash - Only source in financial statement to learn about
the generation of cash from operations is the
statement of cash flows
13Components of Cash Flow Statement
- OPERATING ACTIVITIES
- INVESTING ACTIVITIES
- FINANCING ACTIVITIES
- Which do you think is most important in assessing
the firms prospects? Why? - Defining these activities may help answer the
question...
14The most important component of a cash flow
- All sources and uses of cash represent important
information - But, only cash flows from operating activities
represent cash generated internally - In order to SURVIVE, a firm needs to generate
positive cash flows internally, i.e. from what
it does for a living...
15Notes
- Are an INTEGRAL part of the statements
- Provide summary of accounting policies
- Present detail about particular accounts (e.g.
inventory, investments, etc.) - Include other information (e.g. leasing
arrangements, pending legal proceedings, income
taxes, etc.)
16Profitable, yet in Trouble?
- A firm is defined as profitable if it has a
positive net income - A positive net income results from accrual-based
revenues exceeding accrual-based expenses - A firm may have a positive net income, but this
does not guarantee that the firm has the CASH to
meet its obligations! - However, the idea is that, financial statements
will be much more of a map
17Analysis of Financial Statements
- The objective is to understand
- How financial statement analysis helps to assess
the firms health. - The basic tools of financial statement analysis
(e.g. trend, cross-sectional, and ratio analysis)
18Basic Tools
- Common size financial statements
- Financial ratio analysis
- Trend analysis
- Cross-sectional analysis
19Common Size Statements
- Common size income statement
- expresses each income statement category as a
percentage of net sales - Common size balance sheet
- expresses each item on balance sheet as a
percentage of total assets - Both statements facilitate structural analysis of
the firm
20Ratio Analysis
- A ratio measures the relationship between two or
more variables.
Motivation for use of ratios
- Gives a summary statistic
- Helps to identify benchmarks
- Standardizes financial statements
- Easy to measure relationships
- Easy to make comparisons
21Ratio Analysis cont
Five Categories of Ratios
- Profitability ratios
- Liquidity ratios
- Debt ratios
- Asset activity ratios
- Market value ratios
22Ratio Analysis cont
Profitability Ratios
- Profit Vs. Profitability
- Profitability ratios measure the overall
effectiveness of the firms management. - There are two profitability ratios
- Profit on Sales
- Profit on Investment
23Profitability Ratios
Gross Profit Margin Gross Profit Sales Measures a firm's ability to control its expenses relative to its sales.
Operating profit margin Operating Income Sales How effective is the firm in keeping costs of production low
Net Profit Margin Net Income Sales How much net profit is being generated from sales
Return On Assets Net Income Total Assets How effectively is the firm generating net income from its assets
Return On Equity Net Income Common Equity How well is the firm generating return to its equity providers
24Profitability Ratios cont
Profit Margin
Profit margin ratio measures a firm's ability to
control its expenses relative to its sales.
Gross Profit Sales
Gross Profit Margin
How effective is the firm in generating revenue
in excess of its cost of goods sold?
25Balance Sheet Beta Company Ltd.
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Bonds Rs.600 Plant
Equipment Rs.2,500 Owners Equity LessAcc.
Depr. (1,200) Common Stock Rs.300 Net Fixed
Assets Rs.1,300 Capital in Excess of Par 600
Total Assets Rs.2,530 Retained Earnings 800 Tota
l Owners Equity Rs.1,700 Total Liabilities
and Owners Equity Rs.2,530
Income Statement Beta Company Ltd.
Gross Profit Margin
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Net Operating Income Rs.330 Interest Expense
60 Income Before
Taxes Rs.270 Taxes (40) 108 Net
Income Rs.162 Dividends Paid 100 Addition to
Retained Earnings Rs.62
Gross Profit Sales
575 1,450
Gross Profit Margin
39.7
26Profitability Ratios cont
Operating profit margin
Operating Income Sales
Operating Profit Margin
How effective is the firm in keeping costs of
production low?
27Balance Sheet Beta Company Ltd.
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
Rs.115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Cap.l in
Excess of Par Rs.600 Total Assets Rs.2,530 Retai
ned Earnings Rs.800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd.
Operating Profit Margin
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Operating Income Sales
330 1,450
Oper. Profit Margin
22.8
28Profitability Ratios cont
Net Profit Margin
Net Income Sales
Net Profit Margin
How much net profit is being generated from sales?
29Balance Sheet Beta Company Ltd
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
Rs.115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Cap.l in
Excess of Par Rs.600 Total Assets Rs.2,530 Retai
ned Earnings Rs.800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Net Profit Margin
Net Income Sales
162 1,450
Net Profit Margin
11.2
30Profitability Ratios cont
Return On Assets
Net Income Total Assets
Return on Assets
- How effectively is the firm generating net income
from its assets ? - ROA does not consider leverage
31Balance Sheet Beta Company Ltd
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
Rs.115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Cap.l in
Excess of Par Rs.600 Retained
Earnings Rs.800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Total Assets Rs.2,530
Income Statement Beta Company Ltd
Net Income Total Assets
Return on Assets
Sales Rs.1,450 Cost of Goods Sold Rs.875 Gross
Profit Rs.575 Operating Expenses Rs.
45 Depreciation Rs. 200 Operating
Income Rs.330 Interest Expense Rs. 60 Income
Before Taxes Rs.270 Taxes (40) Rs.108 Net
Income Rs.162 Dividends Paid Rs.100 Addition to
Retained Earnings Rs.62
162 2,530
ROA
6.4
32Profitability Ratios cont
Return On Equity
Net Income Common Equity
Return on Equity
How well is the firm generating return to its
equity providers?
33Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
Rs.115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Cap.l in
Excess of Par Rs.600 Retained
Earnings Rs.800 Total Liabilities and
Owners Equity Rs.2,530
Total Assets Rs.2,530
Total Owners Equity Rs.1,700
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Net Income Common Equity
Return on Equity
162 1,700
ROE
9.53
34Liquidity Ratios
Measure the ability of the firm to meet its
short-term financial obligations.
Current Ratio Current Assets Current Liabilities Are there sufficient current assets to pay off current liabilities? What is the cushion of safety
Quick/Acid-test ratio Current Assets - Inventory Current Liabilities What happens to the firms ability to repay current liabilities after what is usually the least liquid of the current assets is subtracted
35Liquidity Ratios
- Measure the ability of the firm to meet its
short-term financial obligations.
Current Assets Current Liabilities
Current Ratio
Are there sufficient current assets to pay off
current liabilities? What is the cushion of
safety?
36Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs. 230
Current Assets Rs.1,230 Long-term DebtRs.
600 Plant Equipment Rs.2,500 Owners Equity
LessAcc. Depr (1,200) Common Stock Rs.300 Net
Fixed Assets Rs.1,300 Capital in Excess of Par
600 Total Assets Rs.2,530 Retained Earnings
800 Total Owners Equity Rs.1,700
Total Liabilities and Owners Equity Rs.2,530
Current Assets Current Liabilities
Current Ratio
1,230 230
Current Ratio
5.35
37Liquidity Ratios cont
Quick/Acid-test ratio
Current Assets - Inventory Current Liabilities
Acid-Test Ratio
What happens to the firms ability to repay
current liabilities after what is usually the
least liquid of the current assets is subtracted?
38Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories
625 Current Liabilities Rs. 230 Current
Assets Rs.1,230 Long-term Debt Rs. 600 Plant
Equipment Rs.2,500 Owners Equity LessAcc.
Depr. (1,200) Common Stock Rs.300 Net Fixed
Assets Rs.1,300 Capital in Excess of Par
600 Total Assets Rs.2,530 Retained Earnings
800 Total Owners Equity Rs.1,700
Total Liabilities and Owners Equity Rs.2,530
Current Assets - Inventory Current Liabilities
Acid-Test Ratio
1,230 -625 230
2.63
Acid-Test Ratio
39Debt Ratios
Measure the relative size of the firms debt and
the firms ability to pay off the debt.
Debt Ratio Total Debt Total Assets What proportion of firms assets are financed with debt
Debt To Equity Ratio Total Debt Common Equity What is the proportion of debt relative to equity financing for the firm
Times Interest Earned ratio Operating Income Interest Expense What is the firms ability to repay interest payments from their income
40Debt Ratios
- Measure the relative size of the firms debt and
the firms ability to pay off the debt.
Total Debt Total Assets
Debt Ratio
- What proportion of firms assets are financed
with debt?
41Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530
Retained Earnings 8 00 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses
45 Depreciation 200 Operating Income Rs.330 Intere
st Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Total Debt Total Assets
Debt Ratio
230 600 2,530
Debt Ratio
33
42Debt Ratios cont
Debt To Equity Ratio
Debt to Equity Ratio
Total Debt Common Equity
What is the proportion of debt relative to equity
financing for the firm?
43Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current
Liabilities Rs.230 Current Assets Rs.1,230 Long-
term Debt Rs.600 Plant Equipment Rs.2,500 Owner
s Equity LessAcc. Depr. (1,200)
Common Stock Rs.300 Net Fixed Assets Rs.1,300 Capi
tal in Excess of Par 600 Total
Assets Rs.2,530 Retained Earnings 800 Total
Owners Equity Rs.1,700 Total Liabilities
and Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Debt to Equity Ratio
Total Debt Common Equity
230 600 1,700
D/E
48.8
44Debt Ratios cont
Times Interest Earned ratio
Operating Income Interest Expense
Times Interest Earned Ratio
- What is the firms ability to repay interest
payments from their income?
45Times Interest Earned Ratio
Operating Income Interest Expense
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530Retain
ed Earnings 800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
330 60
5.5
TIE Ratio
46Asset Activity Ratios
Average Collection Period Accounts Receivable Avg. Daily Credit Sales How long does it take for the firm to collect its credit sales from customers
Inventory Turnover ratio Sales Inventory How many times the inventory is translated into sales
Fixed Asset Turnover Ratio Sales Net Fixed Assets How effective is the firm in using its fixed assets in generating sales
Total Asset Turnover Ratio Sales Total Assets How effective is the firm in using total assets to generate sales
47Asset Activity Ratios
- Help to assess how effectively the firm is using
assets to generate sales.
Accounts Receivable Avg. Daily Credit Sales
Average Collection Period
How long does it take for the firm to collect its
credit sales from customers?
48Average Collection Period
Accounts Receivable Avg. Daily Credit Sales
Balance Sheet Beta Company Ltd
Assets Liabilities
Additional Info We assume all sales are
credit sales.
Cash Rs.175 Accounts PayableRs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 BondsRs.600 Plant
Equipment Rs.2,500 Owners Equity LessAcc.
Depr. (1,200) Common Stock Rs.300 Net Fixed
Assets Rs.1,300 Capital in Excess of Par 600
Total Assets Rs.2,530 Retained Earnings800 Total
Owners Equity Rs.1,700 Total Liabilities
and Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold
875 Gross Profit Rs.575 Operating
Expenses 45 Depreciation 200 Operating
Income Rs.330 Interest Expense 60 Income Before
Taxes Rs.270 Taxes (40) 108 Net
Income Rs.162 Dividends Paid 100 Addition to
Retained Earnings Rs.62
430 1,450/365
ACP
108.24 days
Days in a year
49Asset Activity Ratios cont
Inventory Turnover ratio
Sales Inventory
Inventory Turnover Ratio
How many times the inventory is translated into
sales?
50Inventory Turnover Ratio
Sales Inventory
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530 Retain
ed Earnings 800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
1450 625
Inventory Turnover
2.3
51Asset Activity Ratios cont
Fixed Asset Turnover Ratio
Sales Net Fixed Assets
Fixed Asset Turnover Ratio
How effective is the firm in using its fixed
assets in generating sales?
52Fixed Asset Turnover Ratio
Sales Net Fixed Assets
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital
in Excess of Par 600 Total Assets Rs.2,530 Ret
ained Earnings 800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
1,450 1,300
Fixed Asset Turnover
1.12
53Asset Activity Ratios cont
Total Asset Turnover Ratio
Sales Total Assets
Total Asset Turnover Ratio
How effective is the firm in using total assets
to generate sales?
54Total Asset Turnover Ratio
Sales Total Assets
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530 Retain
ed Earnings 800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
55Market Value Ratios
Price to Earnings Ratio Market Price per Share Earnings per Share How much are investors willing to pay per rupee of earnings of the firm/(Indicator of investors attitudes toward future prospects of the firm.)
Market to Book Ratio Market Price per Share Book Value per Share How much are investors willing to pay per rupee of book value
56Market Value Ratios
Measure the relationships between financial
statement figures and market value of shares
Market Price per Share Earnings per Share
Price to Earnings Ratio
How much are investors willing to pay per rupee
of earnings of the firm? (Indicator of
investors attitudes toward future prospects of
the firm.)
57 P/E Ratio
Market Price/Share EPS
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530 Retain
ed Earnings 800 Total Owners
Equity Rs.1,700 Total Liabilities and
Owners Equity Rs.2,530
Additional Info 100 shares Rs.20.00 per share
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest Expense 60
Income Before Taxes Rs.270 Taxes (40) 108 Net
Income Rs.162 Dividends Paid 100 Addition to
Retained Earnings Rs.62
20 162/100
P/E ratio
12.35
58Market Value Ratios cont
Market to Book Ratio
Market Price per Share Book Value per Share
Market to Book Ratio
How much are investors willing to pay per rupee
of book value?
59Additional Info 100 shares Rs.20.00 per share
Balance Sheet Beta Company Ltd
Assets Liabilities
Cash Rs.175 Accounts Payable Rs.115 Accounts
Receivable 430 S-T Notes Payable
115 Inventories 625 Current Liabilities Rs.230
Current Assets Rs.1,230 Long-term
Debt Rs.600 Plant Equipment Rs.2,500 Owners
Equity LessAcc. Depr. (1,200) Common
Stock Rs.300 Net Fixed Assets Rs.1,300 Capital in
Excess of Par 600 Total Assets Rs.2,530 Retained
Earnings 800 Total Owners Equity Rs.1,700 To
tal Liabilities and Owners Equity Rs.2,530
Income Statement Beta Company Ltd
Sales Rs.1,450 Cost of Goods Sold 875 Gross
Profit Rs.575 Operating Expenses 45 Depreciation 2
00 Operating Income Rs.330 Interest
Expense 60 Income Before Taxes Rs.270 Taxes
(40) 108 Net Income Rs.162 Dividends
Paid 100 Addition to Retained Earnings Rs.62
Market to Book
Price/Share Common Equity/
shares
60Comparing the Beta Ltd with Industry Average
Ratio Industry Beta Ltd.
Profitability Gross Profit Margin
38 39.7 Operating Profit
Margin 20 22.8 Net Profit Margin 12 11.2 Retur
n on Assets 9.0 6.4 Return on Equity 13.4 9.5
- Beta Ltd
- May be Good at keeping operating costs down
- May not be good at controlling total costs
- ROA and ROE are low could be due to
productivity problems.
61Comparing the Beta Ltd with Industry Average
Cont..
Ratio Industry Beta Ltd.
Liquidity Current Ratio 5.00x 5.35x Acid-Test
Ratio 3.00x 2.63x
- Beta Ltd
- Current Ratio more liquid than the
industry - Acid Test Ratio -
- Not as liquid as the industry
- Could be due to high inventory levels
62Comparing the Beta Ltd with Industry Average
Cont..
Ratio Industry Beta Ltd.
Debt Debt Ratio 35 33 Times Interest
Earned 7.00 5.5 Debt to Equity
49 48
- Beta Ltd
- Interest cover is poor than the industry.
- Since the debt ratios are almost similar, this
could be due to higher interest rates. - Debt ratio Debt to equity ratio are almost
equal to the industry.
63Comparing the Beta Ltd with Industry average
Cont..
Ratio Industry Beta Ltd.
Asset Activity Avg. Collection Period 90
days 108 days Inventory Turnover 3.00 2.32 Fixed
Asset Turnover 1.00 1.12 Total Asset
Turnover 0.75 .57
- Beta Ltd
- Collection policies need examining
- Inventory turnover is low may be due to high
inventory levels - Efficient at converting Fixed Assets in to Sales
- It may be due to lower book value of fixed assets
64Comparing the Beta Ltd with Industry average
Cont..
Ratio Industry Beta Ltd.
Market Value Price Earnings 18.0
12.35 Market to Book
2.5 1.18
- Beta Ltd
- Investors are not willing to pay as much per
rupee of earnings or per rupee of book value for
shares of Beta - This signals that they consider the firms
prospects to be lower than the average.
65Relationships Among RatiosThe Du Pont Analysis
- Ratio Analysis generally involves an examination
of related ratios. - Ex. Du pont Analysis.
66Ex. The Du Pont Analysis
67Limitations of Ratio Analysis
- Ratios based on financial data share the same
limitations of financial data (ex. Accrual
basis). - 2. Changes in many ratios relate with other
ratios so a direct interpretation of a change in
a ratio is not always apparent. - 3. Comparing ratios over time is complicated due
to the fact that economic conditions may change. - 4. Comparing ratios between two firms is
complicated due to different - Economic environments
- Technologies even though they produce the same
product - Industries
- Strategies
68Trend / Time series analysis
- Compare present with past.
- Forecast the future.
69Trend / Time series analysis
70Cross-Sectional Analysis
- Compare with similar firms
- Compare with industry benchmarks.
Ratio Alfa Competitor Industry
ROS 20 22 20
ROI 16 18 16
ROE 15 19 15.5
71Time Series Cross-Sectional Analysis
ROE Analysis ROE Analysis ROE Analysis
Year Alfa Competitor
2001 15 16
2002 14 15.5
2003 15.5 15
2004 14.5 15
2005 16 18
2006 15.5 18
2007 10 16
72Introduction to Financial Management
- Financial management is concerned with the
financial aspect of the firm. - It is part of the decisions and control
sub-systems of the firm.
73Managers need to answer
- Will particular investment be profitable?
- Where will the funds come from to finance the
investment? - Does the firm have adequate cash?
- Which customer should be offered credit?
- How much inventories should be held?
- Is merger or acquisition advisable
- How should profits be used or distributed?
- What is the optimal dividend policy
- How risk and return are balanced?
74Organization of the Financial Management Function
75Organization of the Financial Management
DGM/VP of Finance
76Objective of the Firm
- Profit Maximization
- OR
- Wealth Maximization
77Objective of Shareholder
Objective of Financial Management ( FM )
Wealth Maximization (SWM) Profit maximization EPS
maximization
?
Social Responsibility
- Ethical issues will constantly confront with
financial managers as they try to achieve the
goal of the firm ( SWM ).
78Maximization of wealth?
- Wealth?
- How can it be determined?
- Market Value?
- Book Value?
- Liquidation value?
- Example
- You have purchased 1,000 of a listed company from
the open market. To purchase the shares you have
paid Rs. 23.50. The other information about the
share as follows. - par value Rs. 10.00each
- Book value is 17.50 each
- Current market price 22.75.
- Your wealth?
79Stockholders elect a board of directors
Board of directors then hire management (
officers )
80Agency Consideration in Financial Management
- Agents A persons who performs activities for
another person , called principle. Managers are
the agents of the form - Principal A individual who establishes a
compensation scheme to motivate an agent to
choose activities to the principal. Shareholders
are the principals of the firm
81Agency Consideration in Financial Management
- Principal - Agent problem
- The possibility that an agent will act in her or
his own self interest to the determent of the
principal for whom she or he is acting
82Financial Environment The Role of Financial
System
- provides the mechanism by which funds can be
transferred from those with surplus funds to
those who wish to borrow. - acts as an intermediary between surplus and
deficits
83The Flow of Funds
Indirect Finance
Financial Intermediaries
Funds
Funds
Borrowers (Spenders) 1. Households 2. Business
Firms 3. Government 4. Foreigners
- Lenders (Savers)
- Households
- Business Firms
- Government
- Foreigners
Funds
Funds
Financial Markets
Direct Finance
84Financial Intermediaries (FI)
- Individuals or institutions which bring borrowers
and lenders of funds together to trade. - The FI aid in arranging financial transactions
- between surplus units and deficit units
- banks as the main financial intermediary involve
in most of financing activities, (from the
underwriting of shares to the issuing of bonds).
85Types of Financial Intermediaries
- 1. Commercial Banks.
- Major suppliers of short-term and medium-term
loans to businesses for various purposes. - Accept time deposits and demand deposits.
- Provides these funds as loans to individuals,
businesses and governments. - 2. Investment companies
- Include mutual funds and real estate investment
trusts. - Pool funds from many savers and invest them in
various types of assets. - 3. Investment Bankers
86Types of Financial Intermediaries Cont
- 4. Pension funds.
- Pool pension contributions from employers and
their employees and invest them in a variety of
financial assets. - 5. Insurance companies
- The premiums collected on insurance policies are
invested in variety of assets. - The proceeds from these assets are used to pay
claims against insured events/losses such as
death, disability, accident, fire, etc. - 6. Finance companies.
- Raise funds by issuing their own debt or by
borrowing from commercial banks. - These funds are lended out to individuals and
businesses. - 7. Brokers
87Types of Markets Cont.
- Market
- Any organized system which facilitates for
meeting buyers and sellers. - Markets may exist in a specific physical location
or not -
- Money/Capital
-
- Money Market
- Market for the short term securities having
maturities less than one year. -
- Capital Market
- market for the Long-term securities having
maturities greater than one year.
88Types of Markets Cont
- Primary/Secondary
- Primary markets Primary markets are markets
that involve new issues of securities and hence,
provide a direct flow of cash to the issuing
entity. - Initial Public Offering (IPO) issuing equity to
the public for the first time by a company. - Seasoned Offering (SEO) is simply selling more
stocks by a firm is already publicly traded - Secondary Market
- A market for the securities issued already.
- Secondary market exists for the trading of common
and preferred stock, warrants, bonds, and put and
call options.
89Types of Markets Cont..
- Secondary Market for Equity Shares
- Common stocks, preferred stocks, and warrants
are traded. - Auction markets
- are involving an auction process in a specific
physical location. - Negotiated markets
- are involving a network of dealers who make a
market by standing ready to buy and sell
securities at specific prices. Negotiated market
involves the over-the-counter market.
90 Financial Instruments
-
- A financial instrument can be defined as a
claim to the payment of a sum of money at some
future dates.
91Characteristics of Financial Instruments
- Risk
- The future outcome of the instruments is not
known with certainty. Ex. uncertainty of the
price, default risk of the capital or income
stream. - Liquidity
- It refers to the ease and speed at which a
financial instrument can be turned into cash
without any loss. - Real Value certainty
- Effect of changes of the general price level
(Inflation or deflation)
92Characteristics of Financial Instruments Cont
- Terms of maturity
- FI vary widely according to their maturity. Sight
deposits at bank have zero term to maturity, as
they can be withdrawn on demand. - Currency denomination
- the return on non-domestic instruments are
affected on the appreciation or depreciation of
the relevant exchange rates. - Divisibility
- the degree to which the instruments can be
subdivided into small units for transaction
purposes.
93Corporate Securities
- Security
- "A legal contract representing the right to
receive future benefits under a stated set of
conditions." - The piece of paper defining the property
rights is the security.
94Financial Instruments Available in Sri Lanka
- CAPITAL MARKET
- Common stock
- Preferred stocks
- Corporate Bonds
- Treasury Bonds
- Sri Lanka Development Bonds
- Rupee Loans
- Mutual funds unit trust
- Deposits
- Whole-life insurance policy
- Nation Building Bonds
- MONEY MARKET
- Treasury Bills
- Repurchase (Repo)
- Reverse-repurchase agreement
- Commercial paper
- Banker Acceptances
- Eurodollar
95The Securities and Exchange Commission of Sri
Lanka
- regulates the disclosure of information in new
security offerings and sets disclosure
requirements for nearly all firms trading
publicly. - The SEC also regulates "insider" trading, which
includes trading done by directors, officers, and
major shareholders of a corporation. - All trading by insiders must be reported to the
SEC. - the SEC attempts to prevent insiders from
secretly trading securities on the basis of
private information that outside shareholders do
not possess.
96Colombo Stock Exchange
- The Colombo Stock Exchange (CSE)
- CSE is a company limited by guarantee, and
established under the Companies Act No. 17 of
1982. - The policy making body (Board of Directors)
- There are 9 Directors (the members elect five
Directors and the Minister of Finance appoints
four Directors). - CDS is used in the CSE for dealing shares.
97The Central Depository System
Colombo Stock Exchange cont
- The CDS provides depository facilities and
clearing services for securities traded on the
CSE. - The CDS is a 100 owned subsidiary of the CSE.
- A Board of Directors constitutes the CDS's
policy-making body. - The Board consists of nine Directors. Five
directors are elected to office by the members of
the CSE and four directors are nominated by the
Ministry of Finance.
98Colombo Stock Exchange Cont
- The Colombo Stock Exchange (CSE) currently has
235 listed companies representing 20 business
sectors. The market capitalization as at 03rd
September 2009 was 842.3 billion rupees. - 21 Member firms
- As at 03rd Sep. 2009 and 9th Dec. 2011
- ASPI 2,630.8, 6027.1
- MPI 2, 983.6, 5248.9
- TRI for all shares 3,110.1
- TRI for Milanka shares 3, 546.28
99Market Indices
- The four Indices are
- All Share Price Index (ASPI), which comprises all
listed companies on the market. - Milanka Price Index (MPI), which is based on 25
selected companies. - Total Return Index (TRI)
- Sector price indices
100Market Indices Cont
-
- All Share Price Index
- ASPI Market Capitalization of All Listed
Companies x 100 - Base Market Capitalization
- BMC Number of shares at Base year (1985) x Base
Market Price
101Market Indices Cont
- Milanka Price Index
- MPI Market Capitalization of 25 Selected
Companies x100 - Base Market Capitalization of those 25
Companies as at 31st December 1998 - The MPI is revised annually and the
- Total Return Index