Finance definitions

1) Balance sheet- A balance sheet is a financial statement that reports a

company's assets, liabilities and shareholders' equity at a specific point
in time, and provides a basis for computing rates of return and
evaluating its capital structure.
2) Assets- Assets are economic resources which are owned by a business
and are expected to benefit future operations.
3) Liabilities are obligations of the entity to outside parties who have
furnished resources
4) Assets = Liabilities + Owners’ Equity
5) Owner’s equity- The amount the owner or shareholders would get if
assets are liquidated and liabilities are paid

Assets

Cash Funds that are readily available for distribution.

Marketable securities Investments that are both readily marketable and expected to be converted
into cash withinone year.

Accounts receivable Amounts owed to the entity by its customers Account

Current Inventories Aggregate of items either held for sale in the ordinary course of the business, in
process of production for such sale, or soon to be consumed in production
Prepaid expenses Assets, usually of an intangible nature, whose usefulness will expire in the near
future

Liabilities

Accounts payable Claims of suppliers arising from their furnishing goods or services to the entity for
which they have not been paid

Taxes payable Amount the entity owes governmental agencies

Accrued expenses Amounts earned by outside parties but have not been paid by the entity

Deferred revenues Liabilities that arise because the entity receives advanced payments for services
the entity has agreed to render in the future Current portion of long-term debt

Notes payable is a liability account where a borrower records a written promise to repay the
lender.

An organization has four types of accounting information:

1) Operating information, which has to do with the details of operations

2) Management accounting information, which is used internally for planning, implementation,
and control
3) Financial accounting information, which is used both by management and external parties
4) Tax accounting information, which is used to file tax returns with taxing authorities

Income statement
An income statement is a financial statement that shows you how profitable your business
was over a given reporting period. It shows your revenue, minus your expenses and losses.
Gross profit is defined as net sales minus the cost of goods sold
net income is an entity's income minus cost of goods sold, expenses, depreciation and
amortization, interest, and taxes for an accounting period
Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a
company. This amount includes the cost of the materials and labor directly used to create
the good. It excludes indirect expenses, such as distribution costs and sales force costs
Operating expenses
a profit from business operations (gross profit minus operating expenses) before deduction
of interest and taxes.
Operating expenses are expenses a business incurs in order to keep it running, such as
staff wages and office supplies. Operating expenses do not include cost of goods sold
(materials, direct labor, manufacturing overhead) or capital expenditures (larger expenses
such as buildings or machines).
 Book value is the total value of a business' assets found on its balance sheet, and
represents the value of all assets if liquidated. 
Market value is the worth of a company based on the total value of its outstanding shares
in the market, or its market capitalization

Important ratios

Liquidity ratios are an important class of financial metrics used to determine

a debtor's ability to pay off current debt obligations without raising external
capital. Liquidity ratios measure a company's ability to pay debt obligations
and its margin of safety through the calculation of metrics including the current
ratio, quick ratio, and operating cash flow ratio.

Current liabilities are analyzed in relation to liquid assets to evaluate the

coverage of short-term debts in an emergency.

The Current Ratio

The current ratio measures a company's ability to pay off its current liabilities
(payable within one year) with its current assets such as cash, accounts
receivable and inventories. The higher the ratio, the better the company's
liquidity position:

Current Ratio= Current Assets/ Current liabilities

The Quick Ratio

The quick ratio measures a company's ability to meet its short-term obligations
with its most liquid assets and therefore excludes inventories from its current
assets. It is also known as the "acid-test ratio":

Quick ratio=C+MS+AR/CL

where:C=cash & cash equivalents MS=marketable securities

AR=accounts rec CL=current liabilities
Another way to express this is:

Quick ratio= (Current assets - inventory - prepaid expenses)/ Current

liability

Days Sales Outstanding (DSO)

DSO refers to the average number of days it takes a company to collect
payment after it makes a sale. A higher DSO means that a company is taking
unduly long to collect payment and is tying up capital in receivables. DSOs are
generally calculated quarterly or annually:
DSO = Average accounts receivable/Revenue per day

Activity ratios

An activity ratio is a type of financial metric that indicates how efficiently a

company is leveraging the assets on its balance sheet, to generate revenues
and cash. Commonly referred to as efficiency ratios, activity ratios help
analysts gauge how a company handles inventory management, which is key
to its operational fluidity and overall fiscal health.

Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio determines an entity's ability to collect
money from its customers. Total credit sales are divided by the average
accounts receivable balance for a specific period. A low ratio suggests a
deficiency in the collection process.

Receivables Turnover Ratio – Net Credit Sales / Average account

receivable

Low - Bad credit Policies, Poor Collection Process or Liberal

High – Better than peers at collection or conservative

Inventory Turnover Ratio

The inventory turnover ratio measures how often the inventory balance is sold
during an accounting period. The cost of goods sold is divided by the average
inventory for a specific period. Higher calculations suggest that a company
can move its inventory with relative ease.

Inventory Turnover Ratio – COGS / Average Inventory

Low- Weak Sales, Excess Inventory or Liberal

High- Strong Sales, Insufficient Inventory

Total Assets Turnover Ratio

The total assets turnover ratio measures how efficiently an entity uses its
assets to tender a sale. Total sales are divided by total assets to decipher how
proficiently a business uses its assets. Smaller ratios may indicate that a
company is struggling to move its products.

= Sales/assets

Accounts payable ratio

Accounts payable turnover ratio is an accounting liquidity metric that evaluates

how fast a company pays off its creditors (suppliers). The ratio shows how
many times in a given period (typically 1 year) a company pays its average
accounts payable. An accounts payable turnover ratio measures the number
of times a company pays its suppliers during a specific accounting period.

Accounts payable turnover ratio = Total purchases / Average accounts

payable
Purchases = Cost of sales + Ending inventory – Starting inventory
Days Payable Outstanding (DPO) = 365 /Accounts payable turnover ratio

Low- Delayed Payment or Liberal

High- Prompt Payment or Conservative
Working Capital Turnover ratio
Working capital- The capital of a business which is used in its day-to-day trading
operations, calculated as the current assets minus the current liabilities.
Working Capital Turnover Ratio- Net Sales/ Net Working Capital
Very High – Very Problematic (Cannot Meet Sales Obligations) >0.7
(generally)
High- Suitable
Low – Can lead to Bad debt and Obsolete Inventory

Solvency ratios
Solvency refers to an enterprise's capacity to meet its long-term financial
commitments.
A solvent company is one that owns more than it owes; in other words, it has
a positive net worth and a manageable debt load. Here are some of the most
popular solvency ratios.

Debt-to-Equity (D/E)
Debt to equity = Total debt / Total equity

This ratio indicates the degree of financial leverage being used by the
business and includes both short-term and long-term debt. A rising debt-to-
equity ratio implies higher interest expenses, and beyond a certain point,
it may affect a company's credit rating, making it more expensive to raise
more debt.

Debt-to-Assets
Debt to assets = Total debt / Total assets

Another leverage measure, this ratio quantifies the percentage of a company's

assets that have been financed with debt (short-term and long-term). A higher
ratio indicates a greater degree of leverage, and consequently, financial risk.

Interest Coverage Ratio

Interest coverage ratio = Operating income (or EBIT) / Interest expense
This ratio measures the company's ability to meet the interest expense on its
debt, which is equivalent to its earnings before interest and taxes (EBIT). The
higher the ratio, the better the company's ability to cover its interest expense.

Proprietary Ratio - Shareholder’s Equity/Total Assets (or Total Tangible

Assets generally)
High- Sufficient Liquidity to support business, take more debt or Conservative
Low- Not enough liquidity to support business, reduce debt or Liberal
Interest Coverage Ratio (used by creditors to assess risk) – EBIT/ Fixed
Interest Charges
High- Can Cover Interest, more loans or Conservative
Low- Cannot Cover Interest, reduce loans or Liberal

Profitability ratios
 Gross Profit Ratio - Gross Profit/Net Sales * 100

 Net Profit Ratio – Net Profit after Tax/Net Sales * 100

 Operating Profit Ratio – Operating Net Profit/Net Sales * 100

 Return in Investment – Net Profit after Tax/ Shareholder’s

equity * 100

• Return of equity: ROE = Net Income /Average Shareholder

Equity

Return on equity (ROE) is a ratio that provides investors with

insight into how efficiently a company (or more specifically, its
management team) is handling the money
that shareholders have contributed to it. In other words, it
measures the profitability of a corporation in relation to
stockholders’ equity. The higher the ROE, the more efficient a
company's management is at generating income and growth
from its equity financing. 

• Return of assets:
 ROA= Earnings before interest / Average total assets
= Net income + [Interest expense * (1 - Tax rate)] /Average total
assets
= ROA = Earnings before interest / Sales revenue (Profit margin)
* Sales revenue/ Total assets (Asset turnover)
ROA gives a manager, investor, or analyst an idea as to how
efficient a company's management is at using its assets to
generate earnings
Profit margin can be improved by getting better prices or by
reducing the various expenses incurred. A responsive supply chain
can allow a firm to provide high value to a customer, thus
potentially getting higher prices. Good supply chain management
can also allow a firm to decrease the expenses incurred to serve
customer demand

• cash-to-cash (C2C) cycle, which roughly measures the average

amount of time from when cash enters the process as cost to
when it returns as collected revenue.
C2C = - weeks payable (1/APT) + weeks in inventory (1/INVT) +
weeks receivable (1/ART)

-ve means company is using supplier’s money to finance sales

Session 2
Discounted cash flow- Discounted cash flow (DCF) is a valuation method used
to estimate the value of an investment based on its future cash flows. DCF
analysis attempts to figure out the value of an investment today, based on
projections of how much money it will generate in the future. This applies to
both financial investments for investors and for business owners looking to
make changes to their businesses, such as purchasing new equipment.
Discounted cash flow analysis is a method of valuing a security, project,
company, or asset using the concepts of the time value of money.

NPV=TVECF−TVIC
where:

TVECF=Today’s value of the expected cash flows

TVIC=Today’s value of invested cash
A positive net present value indicates that the projected earnings generated
by a project or investment - in present dollars - exceeds the anticipated costs,
also in present dollars. It is assumed that an investment with a positive NPV
will be profitable, and an investment with a negative NPV will result in a net
loss. This concept is the basis for the Net Present Value Rule, which dictates
that only investments with positive NPV values should be considered.

Determining NPV
To do this, the firm estimates the future cash flows of the project and
discounts them into present value amounts using a discount rate that
represents the project's cost of capital and its risk. Next, all of the investment's
future positive cash flows are reduced into one present value number.
Subtracting this number from the initial cash outlay required for the investment
provides the net present value of the investment.

Let's illustrate with an example: suppose JKL Media Company wants to buy a
small publishing company. JKL determines that the future cash flows
generated by the publisher, when discounted at a 12 percent annual rate,
yields a present value of $23.5 million. If the publishing company's owner is
willing to sell for $20 million, then the NPV of the project would be $3.5 million
($23.5 - $20 = $3.5). The NPV of $3.5 million represents the intrinsic
value that will be added to JKL Media if it undertakes this acquisition.

Determining IRR

The internal rate of return is a metric used in financial analysis to estimate the
profitability of potential investments. The internal rate of return is a discount
rate that makes the net present value (NPV) of all cash flows equal to zero in
a discounted cash flow analysis.
So, JKL Media's project has a positive NPV, but from a business perspective,
the firm should also know what rate of return will be generated by this
investment. To do this, the firm would simply recalculate the NPV equation,
this time setting the NPV factor to zero, and solve for the now
unknown discount rate. The rate that is produced by the solution is the
project's internal rate of return (IRR).

For this example, the project's IRR could—depending on the timing and
proportions of cash flow distributions—be equal to 17.15%. Thus, JKL Media,
given its projected cash flows, has a project with a 17.15% return. If there
were a project that JKL could undertake with a higher IRR, it would probably
pursue the higher-yielding project instead.

Thus, you can see that the usefulness of the IRR measurement lies in its
ability to represent any investment opportunity's possible return and compare
it with other alternative investments.

Cost of capital- Cost of capital is the required return necessary to make

a capital budgeting project, such as building a new factory, worthwhile.
Cost of capital is the rate of return that a firm must earn on its project
investments to maintain its market value and attract funds.
 K = rj + b + f
 K = Cost of capital.
 rj = The riskless cost of the finance.
 b = The business risk premium.
f = The financial risk premium (not present in cost of equity).

 Cost of equity- Cost of equity is the return a company requires for an

investment or project, or the return an individual requires for an equity
investment.
 Cost of equity = Risk Free Rate + Beta * (Market Premium)
 Market Premium = Market Return – Risk Free Rate
The cost of debt is the rate a company pays on its debt, such as bonds and loans.
The key difference between the cost of debt and the after-tax cost of debt is the
fact that interest expense is tax-deductible. Cost of debt is one part of a
company's capitalstructure, with the other being the cost of equity.
Debt requires company to make payments on loans, interest expense is tax
free, is safe for investors. Eg- bonds, debentures( bonds without collateral)
Equity requires giving ownership of company, requires no payment is risky for
investors
Types of equity trading
Intraday- When a trader buys an equity share and sells it on the same day, it is
called Equity Intraday Trading. The intention is to earn profits from the
fluctuation of prices in a single day. In the case of Equity Intraday Trading,
there is no delivery of shares and therefore ownership is not transferred.
Delivery-When a trader buys an equity share and sells it on the same day, it is
called Equity Intraday Trading. The intention is to earn profits from the
fluctuation of prices in a single day. In the case of Equity Intraday Trading,
there is no delivery of shares and therefore ownership is not transferred.
Futures - When a trader expects the price of a share to move up or move
down in the near future, they can enter into a Futures Contract. Therefore,
a Futures contract is an agreement to buy or sell an underlying asset
on a future date at a pre-agreed price. 
Options- Options is a contract with the right to buy or right to sell an
underlying asset at an agreed-upon price today (strike price) on a
specified future date. Hence, the buyer of an Option receives the ‘Right to
Buy’ or ‘Right to Sell’ the underlying asset at a specified future date.
Therefore, the seller of an Option has the ‘Obligation to Buy’ or ‘Obligation
to Sell’ the underlying asset at a specified future date. The buyer may or
may not exercise the option and thus pays a premium to the seller to
attain this right. This is called ‘Option Premium’.

 Buyer of Call Option – Right to Buy the underlying asset at the

strike price on a future date
 Buyer of Put Option – Right to Sell the underlying asset at the
strike price on a future date
 Seller of Call Option – Obligation to Buy the underlying asset at
the strike price on a future date
 Seller of Put Option – Obligation to Sell the underlying asset at the
strike price on a future date

Buyer of an Option has a limited loss (premium paid) and unlimited profit
while the Seller of an Option has an unlimited loss and limited profit
(premium received)

Example of Call Option

Akshay buys a Call Option on Nifty Index from Raj at a price of Rs. 1000
and expiry of one month from today. Akshay pays a premium of Rs.10 to
Raj.

 Buyer of Call Option – Akshay

 Seller of Call Option – Raj
 Option Premium – Rs.10
 Expiry of Contract – 1 month
 Strike Price or Exercise Price – Rs. 1000

If the price of Nifty on expiry is Rs. 1200

 Akshay’s Call Option is ‘in the money’. He will exercise the Call
Option
 So, Akshay has the ‘Right to Buy’ Nifty at Rs.1000 from Raj
 Therefore, Akshay’s Total Profit = 1200 – 1000 – 10 = Rs. 190
 And since Raj has the ‘Obligation to Sell’ Nifty at Rs.1000 to Akshay
 Raj’s Total Loss = 1000 – 1200 + 10 = Rs. -190

If the price of Nifty on expiry is Rs. 800

 Akshay’s Call Option is ‘out of the money’. Therefore, he will not

exercise the Call Option
 And hence, The Call Option lapses
 Therefore, Akshay’s Total Loss = Rs. -10
 And Raj’s Total Profit = Rs. 10

Types of equity investments

Promoter- A corporate promoter is a firm or person who does the preliminary work
incidental to the formation of a company, including its promotion, incorporation, and
flotation, and solicits people to invest money in the company, usually when it is
being formed.
Mutual funds- A mutual fund is a company that pools money from many investors
and invests the money in securities such as stocks, bonds, and short-term debt. 
Foreign institutional investors (FII) or foreign portfolio investors (FPI) refers to
investors from other countries putting money in Indian stock markets. These are in
the form of sovereign wealth funds, investment trusts, mutual funds, pension funds
apart from banks. Domestic institutional investors (DII) comprise local mutual
funds, insurance companies, local pension funds, and banking and financial
institutions. 
A retail investor is an individual who purchases securities for his or her own personal
account rather than for an organization. Retail investors typically trade in much smaller
amounts than institutional investors such as mutual funds, pensions, or university
endowments.

Economic terms
1) Gross domestic product (GDP) is a monetary measure of the market value
of all the final goods and services produced in a specific time period
2) Purchasing power parity is a measurement of prices in different countries that
uses the prices of specific goods to compare the absolute purchasing power of
the countries' currencies. 
3) PMI or a Purchasing Managers' Index (PMI) is an indicator of business activity
-- both in the manufacturing and services sectors. It is a survey-based measures
that asks the respondents about changes in their perception of some key
business variables from the month before.
 Net Domestic Product (NDP)
 NDP is calculated by deducting the depreciation of plant and
Machinery from GDP.
 NDP = Gross Domestic Product - Depreciation
 Gross National Product (GNP)
  GNP is the value of all final goods and services produced by the
residents of a country in a financial year (i.e., 1st April to 31st March
of the next year in India).
 While Calculating GNP, income of foreigners in a country is excluded
but income of people who are living outside of that country is included.
The value of GNP is calculated on the basis of GDP.
 GNP = GDP + X - M
 Where,
 X = income of the people of a country who are living outside of
the Country
M = income of the foreigners in a country
 Net National Product (NNP)
 Net National Product (NNP) in an economy is the GNP after deducting
the loss due to depreciation.
 NNP = GNP - Depreciation
NI- National Income

PCI- Per capita income

GNH- Gross national happiness

 CPI- The Consumer Price Index (CPI) is a measure that examines

the weighted average of prices of a basket of consumer goods and
services, such as transportation, food, and medical care. It is calculated
by taking price changes for each item in the predetermined basket of
goods and averaging them. Changes in the CPI are used to assess price
changes associated with the cost of living. The CPI is one of the most
frequently used statistics for identifying periods of inflation or
deflation.
Session 2