What is Finance?

- is a broad term that describes two related activities:

(1) the study of how money is managed and
(2) the actual process of acquiring needed funds.
 It encompasses the oversight, creation and study of money,
banking, credit, investments, assets and liabilities that make
up financial systems.
 What is Budgeting?
- the act of estimating revenue (in
the form of their allowance) and
expenses over a period of time (in
this case, on a daily basis).
 What is Investment?
- is a monetary asset purchased with the idea that
the asset will provide income in the future or will
later be sold at a higher price for a profit.
 Finance
-is concerned with decisions about:
 How much of your earnings you spend
 How much you save or how much you need
 How you invest your savings
 How you raise additional funds you need
ROLE OF FINANCIAL MANAGEMENT
Liquidity Profitability Management
•Forecasting cash flows • • flow of internal funds
•Forecasting cash flows •Raising funds •Managing the flow of internal funds
•Cost control • • Future Profits • of Capital •Cost control •Pricing •Forecasting Future Profits •Measuring
Cost of Capital
• management of long • management of short

• The management of long-term funds •The management of short-term funds

FINANCIAL INSTITUTIONS
- is an establishment that conduct financial transactions suh as
investments, loans and deposits
FINANCIAL MARKET

- is a market where people trade financial securities occurs.

FINANCIAL INSTRUMENTS
- are assets that can be traded ( stocks, bonds and
options)
 FINANCIAL
INSTITUTIONS

1. BROKERAGES – act as intermediaries between buyers and sellers to

facilitate securities transactions. They are compensated via commission
after the transaction has been successfully completed. (can be a full
service or discount)
 FINANCIAL
INSTITUTIONS
2. COMMERCIAL BANKS – accept deposits and provide security and
convenience to their customers. They also grants loans to individuals and
businesses to start a business operation or to expand the business which
in turn leads to more deposits.
3. INVESTMENT BANKS– is a private company that provide finance and
other related services to individuals, corporations and governments (
raising financial capital by underwriting or acting as the client/s agent in
the issuance of securities).
4. INSURANCE COMPANIES – they collect premiums from a large group of
people who want to protect themselves or their love ones against a
particular loss and in order to preserve wealth.
 FINANCIAL MARKET
(Financial Securities)

1. Equities – are shares in a company that are owned by people who have a
right to vote at the company’s meetings and to receive part of the
company’s profits after the holders of preference shares have been paid
2. Bonds – are certificate of indebtedness under which the issuer owes the
holders a debt and is obliged to pay them interest or to repay the principal
at a later date.
4. Currencies – are generally accepted form of money (coins & paper notes)
which are issued by the government (BSP).
5. Derivatives - are contracts that derive its value from the performance of
an underlying entity (asset, index or interest rate)
What is Single Proprietorship?
 It is a form of
business in which there
is only one person who
owns and manages the
operations. It is very effective in
improving the social and economic condition of the poor

 The proprietor is the general

manager.
What is Partnership?
 It is a type of business organization in which
there are two or more owners.
 Is established when two or more
persons agree to combine their
resources
(money, materials, management
and time) in a business enterprise
for profit.
What is a Corporation?
 Is a legal entity that is distinct and separate from its
owner.
 It has legal rights and obligations similar to an
individual.
 It can enter into contracts, loan,
hire employees, pays taxes.
 It can sue and be sued.
 It is formed by at least 5 persons.

A corporation's life begins when a

document called the "Articles of
Incorporation“
 SINGLE PROPRIETORSHIP

Easy and least costly Unlimited personal

to create liability

Total decision-making Limited access to

authority capital

Easy to discontinue Slim chance for

expansion
Profits belong to the Lack of continuity for
owner the business
 PARTNERSHIP

Quite easy to Unlimited personal

establish liability

Greater credit facilities  Disagreement

between partners is
possible
Combined ability and
skills
Lack of continuity
 CORPORATION

Transferable Most difficult &

ownership costly to establish
has the best  Lack of secrecy
immediate means to
raise funds  Less direct control
Limited Liability

Perpetual life  Double taxation

 Corporations may either be privately owned or publicly owned. Privately owned
corporations are often owned by family members whose stocks may not be offered
to outsiders unless consent by the family members is secured.

Companies which are publicly listed are owned by unrelated investors and are
traded in organized exchanges like the Philippine Stock Exchange. While there are
many stockholders, there is generally a group of investors or a family which
controls each listed company. For example, in the case of BPI, the biggest
stockholder is Ayala Corporation and in the case of Banco De Oro, it is SM
Investment Corporation. Prices of stocks of listed corporations are driven by several
factors such as the earnings of the companies, the prospects of the industry where
these companies operate, the general market sentiment, and the economic
prospects of the country, among others.
1. The Accounting Equation The basic accounting equation is:
ASSETS = LIABILITIES + OWNER’S EQUITY
• This means that the whole assets of the company comes from the liability, or debt of the company, and from the
capital of the owner of the business, and the income it generated from the business operations. This reflects the
double-entry bookkeeping, and shown in the balance sheet.
• Double entry bookkeeping tells us that if we add something from the one side, which is asset, we must add the
same amount to the other side to keep them in balance.
• If we were to increase cash (an asset) we might have to increase note payable (a liability account) so that the
basic accounting equation remains in balance.
• In double-entry bookkeeping, there is the concept of debit (dr) and credit (cr). Debit is the left, and credit is the
right.
• There is also a concept of normal balances. A normal balance, either a debit normal balance or a credit normal
balance, is the side where a specific account increases.
• In the accounting equation, asset is on the left side, while liabilities and equity is on the right side. Therefore,
asset has a debit normal balance, meaning that cash as an asset is debited to increase, while credited to decrease.
• On the other hand, liabilities and owners’ equity have a credit normal balance. This means that a liability account
is credited to increase, while debited to decrease. The accounting equation provides the foundation for what
eventually becomes the balance sheet.
2. T-Account Analysis In double-entry bookkeeping, the terms debit and credit are used to identify which side of the
ledger account an entry is to be made. Debits are on the left side of the ledger and Credits are on the right side of the
ledger. It does not matter what type of account is involved
3. Nominal Accounts
There are two major categories of nominal accounts: Expense and Revenue accounts.
• Expense Accounts - A resource, when not yet used up for the current period, is considered an Asset and will provide
benefits at a future time. - On the other hand, a resource that has been used for the current period is called an
Expense. At the end of each accounting period, expenses are closed out to the Retained Earnings Account which
decreases the Owners’ Equity. Since expenses decrease the owners’ equity, those expense accounts carry a normal
debit balance.
• Revenue Accounts - Revenue Accounts reflect the accumulation of potential additions to retained earnings during the
current accounting period. - At the end of the accounting period accumulation of revenues during the period are closed
to the Retained Earnings Account which increases Owners’ Equity. - Therefore revenue accounts carry a normal credit
balance meaning the same balance as the Retained Earnings Account.
4. The Accounting Cycle
An accounting cycle is the collective process of identifying, analyzing, and recording the accounting
events of a company. The series of steps begins when a transaction occurs and end with its inclusion in
the financial statements.
Additional accounting records used during the accounting cycle include the general ledger and trial
balance.
• It is all about getting data and putting them into the accounting equation, the end products are financial
statements such as a balance sheet and income statements, the process of accounting follows a cycle called the
Accounting Cycle.
• It starts with the identification of whether a transaction is accountable or can be quantified, and ends with a
post-closing trial balance.
The Process:
Step 1: Analyze Business Transactions.
• In this step, a transaction is analyzed to find out if it affects the company and if it needs to be recorded.
• Personal transactions of the owners and managers that do not affect the company should not be recorded.
• In this step, a decision may have to be made to identify if a transaction needs to be recorded in special journals
such as a sales or purchases journal.

Step 2: Record This in the Journal.

• Using the rules of debit and credit, transactions are initially entered in a record called a Journal and the entry
made is called a Journal Entry.
• The journal serves as a record of when transactions occurred and were recorded.
• For repetitive transactions or high volume transactions (e.g. one thousand sales transactions in one day), Special
Journals are made. These special journals include sales journal, purchases journal, cash receipts journal, and cash
disbursements journal.
Step 3: Post the Transactions on a Ledger.
• A transaction is first recorded in a journal. Periodically, the journal entries are transferred to the accounts in the
ledger.
• The process of transferring the debits and credits from the journal entries to the accounts is called Posting.
•Ledgers provide chronological details as to how transactions affect individual accounts. There are two types of
ledgers: the General Ledger and Subsidiary Ledger. The general ledger is a summary of the different Subsidiary
Ledgers and can serve as a control account.
• For example, a general ledger for accounts receivable summarizes the balances found in the different subsidiary
ledgers for different customers.
Step 4: Prepare an Unadjusted Trial Balance.
• Errors may occur in posting debits and credits from the journal to the ledger. One way to detect such errors is by
preparing a trial balance.
• Double-entry accounting requires that debits must always equal credits. The trial balance verifies this equality.
• The steps in preparing a trial balance are as follows:
1. List the name of the company, the title of the trial balance, and the date the trial balance is prepared.
2. List the accounts from the ledger and enter their debit or credit balance in the Debit or Credit column of the
trial balance.
3. Total the Debit and Credit columns of the trial balance.
4. Verify that the total of the Debit column equals the total of the Credit column
Step 5: Make adjustments. Journalize adjusting entries.
• At the end of the accounting period, many of the account balances in the ledger can be reported in the
financial statements without change.
• For example, the balances of the cash and land accounts are normally the amount reported on the balance
sheet. However, some accounts in the ledger require updating.
• This updating is required for the following reasons:
1. Some expenses are not recorded daily. For example, the daily use of supplies would require many entries with
small amounts. Also, managers usually do not need to know the amount of supplies on hand on a day-to-day
basis.
2. Some revenues and expenses are earned as time passes rather than as separate transactions. For example,
rent received in advance (unearned rent) expires and becomes revenue with the passage of time. Likewise,
prepaid insurance expires and becomes an expense with the passage of time.
3. Some revenues and expenses may be unrecorded. For example, a company may have provided services to customers
that are has not billed or recorded at the end of the accounting period. Likewise, a company may not pay its employees
until the next accounting period even though the employees have earned their wages in the current period.
• The analysis and updating of accounts at the end of the period before the financial statements are prepared is called
the Adjusting Process. The journal entries that bring the accounts up to date at the end of the accounting period are
called Adjusting Entries.
• The following are normally adjusted at the end of a period:
- Accruals. These include unpaid salaries for the accounting period, unpaid interest expense, or unpaid utility
expenses.
- Prepayments. If a company has prepaid expenses such as prepaid rent or prepaid insurance then the correct
balances for these accounts have to be established at the end of each accounting period to reflect their correct
balances.
- Depreciation and amortization expenses. Depreciation expenses are recognized at the end of each accounting
period through adjusting entries. If there are intangible assets such as franchise, the allocation of their costs which is
called amortization expense, is also recognized at the end of each accounting period through adjusting entries.
- Allowance for uncollectible accounts. Bad debt expense from accounts receivable is also recognized through
adjusting entries.
Step 6: Prepare an Adjusted Trial Balance. An adjusted trial balance is prepared after taking into consideration the
effects of the adjusting entries. Again, this is to ensure that the total debit balances equal the credit balances after
posting and journalizing adjusting entries made.

Step 7: Prepare the financial statements. From the adjusted trial balance, the financial statements can then be
prepared. These are the statement of financial position, statement of profit or loss, and the statement of cash flows.

Step 8: Make the closing entries. In the discussion about accounts, it was discussed that nominal accounts (revenue
and expense accounts) are closed to retained earnings, or an owner’s capital account because these accounts refer
only to a specific accounting period. Actually, these accounts to be closed are accounts that can be seen in the
income statement.

Upon closing: - If the revenues exceed expenses during an accounting period, retained earnings will increase. - The
reverse is true which means that if the expenses exceed revenues, the retained earnings will decrease.

In closing temporary accounts: - Revenue account balances are transferred to an account called Income Summary
Account (sometimes profit or loss summary). - Expense account balances are also transferred to the Income
Summary Account. - The balance of the Income Summary (net income or net loss) is transferred to the owner’s
capital account. - The balance of the owner’s drawing account is transferred to the owner’s capital account.
Step 9: Make a Post-Closing Trial Balance. A Post-Closing Trial Balance shows the accounts that are permanent or real.
These are the accounts that can be seen in your balance sheet. The post-closing trial balance is prepared to test if the
debit balances equal the credit balances after closing entries are considered.

5. Basic Financial Statements. A financial statement is basically a summary of all transactions that are carefully recorded
and transformed into meaningful information. It also shows the company’s permanent and temporary accounts.
The general purpose of the financial statements is to provide information about the results of
operations, financial position, and cash flows of an organization. This information is used by the readers
of financial statements to make decisions regarding the allocation of resources
Basically, financial statements are comprised of the following:

a. Income Statement • These are also known as the Profit/Loss Statement, Statement of
Comprehensive Income, or Statement of Income. • This is a summary of the revenue and
expenses of a business entity for a specific period of time, such as a month or a year.
b. Statement of Owner’s Equity • These are also known as the
Statement of Changes in Equity. • This reports the changes in the
owner’s equity over a period of time.
• It is prepared after the income statement because the net income or
net loss for the period must be reported in this statement.
• Similarly, it is prepared before the balance sheet since the amount of
owner’s equity at the end of the period must be reported on the
balance sheet.
• Because of this, the statement of owner’s equity is often viewed as
the connecting link between the income statement and balance sheet,
c. Balance Sheet
• Formerly known as the Statement of Financial Position.
• This provides information regarding the liquidity position and capital structure of a company as of a given
date.
• It must be noted that the information found in this report are only true as of a given date.
• It shows a list of the assets, liabilities, and owner’s equity of a business entity as of a specific date, usually at
the close of the last day of a month or a year.

The balance sheet consists of three major elements:

assets, liabilities and owners' equity.

The object of the statement is to prove true the accounting equation, "Asset = Liabilities + Owner's Equity."
d. Statement of Cash Flows
• The statement of cash flows reports a company’s cash inflows and outflows for a period.
• This is used by managers in evaluating past operations and in planning future investing and financing activities.
• It is also used by external users such as investors and creditors to assess a company’s profit potential and ability to pay
its debt and pay dividends.

Cash Flow Activities:

1) operating activities - include cash activities related to net income. For example, cash generated
from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because
revenues and expenses are included in net income.
2) investing activities - include cash activities related to noncurrent assets. Noncurrent assets include
(1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to
other entities. For example, cash generated from the sale of land and cash paid for an investment in another
company are included in this category. (Note that interest received from loans is included in operating activities.)
3) financing activities - include cash activities related to noncurrent liabilities and owners’ equity.
Noncurrent liabilities and owners’ equity items include (1) the principal amount of long-term debt, (2) stock sales
and repurchases, and (3) dividend payments. (Note that interest paid on long-term debt is included in operating
activities.)
Four (4) components of Financial Statement

•Income statement. Presents the revenues, expenses, and profits/losses generated during the reporting
period. This is usually considered the most important of the financial statements, since it presents the operating results of
an entity.
•Balance sheet. Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the
information presented is as of a specific point in time. The report format is structured so that the total of all assets equals
the total of all liabilities and equity (known as the accounting equation). This is typically considered the second most
important financial statement, since it provides information about the liquidity and capitalization of an organization.
•Statement of cash flows. resents the cash inflows and outflows that occurred during the reporting
period. This can provide a useful comparison to the income statement, especially when the amount of profit or loss
reported does not reflect the cash flows experienced by the business. This statement may be presented when issuing
financial statements to outside parties.
•Statement of retained earnings. Presents changes in equity during the reporting period. The
report format varies, but can include the sale or repurchase of stock, dividend payments, and changes caused by reported
profits or losses. This is the least used of the financial statements, and is commonly only included in the audited financial
statement package.
1. Using the following (scrambled) accounts, prepare a balance sheet for ABC, a retail company, for the
year ending in December 31, 2014. Assume that these are the only Balance Sheet Accounts.

Accounts Payable 39,000

Accrued Expenses 8,000
Accumulated Depreciation 51,000
Additional Paid-In Capital 86,000
Allowance for Doubtful Accounts 2,000
Cash 23,000
Common Stock (PHP0.20 par) 45,000
Current Portion of L.T. Debt 6,000
Gross Accounts Receivable 40,000
Gross Fixed Assets 486,000
Inventories 54,000
Long-Term Debt 210,000
Net Accounts Receivable 38,000
Net Fixed Assets 435,000
Retained Earnings 138,000
Short-Term Bank Loan (Notes Payable) 18,000
2. Prepare a multi-step income statement for the retail company, ABC, for the year ending December 31, 2014
given the information below:

Advertising expenditures 68,000

Beginning inventory 256,000
Depreciation 78,000
Ending inventory 248,000
Gross Sales 3,210,000
Interest expense 64,000
Lease payments 52,000
Management salaries 240,000
Materials purchases 2,425,000
R&D expenditures 35,000
Repairs and maintenance costs 22,000
Returns and allowances 48,000
Taxes 51,000
At the end of this lesson, the learners will be able to:

• Apply their knowledge on liquidity and efficiency

ratios in tackling real life business problems.

• Pinpoint business problems and formulate relevant

recommendations and strategies.
Four (4) main categories of financial ratios:

• Liquidity
• Profitability
• Efficiency
• Solvency
1. Liquidity refers to the company’s ability to
satisfy its short-term obligations as they come
due. Refer back to the household example to
emphasize the meaning of liquidity.
 2. Profitability refers to the company’s ability
to generate earnings. It is one of the most
important goals of businesses
Profitability ratios and formulas:

1. Return on equity measures the amount of net income

earned in relation to stockholders’ equity.
Formula:
ROE (return on equity) = Net income ÷ Stockholders’ equity
2. Return on assets measures the ability of a company
to generate income out of its resources/assets.
Formula:
ROA (return on asset) = Operating income ÷ Total assets
3. Gross profit margin shows how many pesos of gross
profit is earned for every peso of sale. It provides
information regarding the ability of a company to
cover its manufacturing cost from its sales. Remember
that gross profit is just sales less cost of goods or cost
of services.
Formula:
Gross profit margin = Gross profit ÷ Sales
4. Operating profit margin shows how many pesos
of operating profit is earned for every peso of sale.
It measures the amount of income generated from
the core business of a company.
Formula:
Operating profit margin =Operating income ÷ Sales
5. Net profit margin measures how much net profit
a company generates for every peso of sales or
revenues that it generates.
Formula:
Net profit margin = Net income ÷ Sales
3. Efficiency refers to a company’s ability to be efficient in
its operations. Specifically, it refers to the speed with which
various current accounts are converted into sales, and
ultimately, cash.
• Accounts receivable turnover
• Average collection period, otherwise known as average
age of AR, days’ receivable or days sales outstanding
• Inventory turnover
• Average age of inventory or days’ inventory
• Accounts payable turnover
• Average age of payables, average payment period, or days’
payable
• Total asset turnover
• Operating cycle
• Cash conversion cycle
Compute for the ratios: