WHAT IS FINANCE?

Finance Terms

 Finance : The proper management of money

 Money : The current medium of exchange or means of payment
 Credit or Loan : A sum of money to be return normally with interest

The main goal of finance is to maximize profit

 Finance
 is the study of how investors allocate their assets over time under
conditions of certainty and uncertainty. A key point in finance, which
affects the decisions, it the time value of money, which states that a
dollar today is worth more than a dollar tomorrow. Finance measures
the risks vs. profits and gives an indication of whether the investment is
good or not.
 It is the study of how individuals or businesses evaluate investment
opportunities, business proposals, and business projects, and raise
capital to fund them.
 Evaluating an investment means ensuring that the fund to be invested
will create value to business or an individual in the form of profit.
WHY DO BUSINESSES NEED FINANCE?
 Everyday bill payment
For starting up

BUSINESSES
Expansion NEED MONEY Take over bid
FOR …

Replacement
Internal Growth
machinery/equipment
 Why Do Businesses Need Finance?

 Starting Up – Buildings, machinery, raw materials and office equipment

 Working Capital – Short term finance require for day-to-day running a business
 Unforeseen Events – Sudden decline in sales, large customers fails to pay on
time or pay expense quickly
THE ROLE OF FINANCIAL INSTITUTIONS IN THE MONEY
FLOW

FINANCIAL INSTITUTION
Evaluation of Investment
FINANCIAL INSTITUTION
Lends funds

2
1 BUSINESS
PROJECT
DEPOSITOR BORROWER

4 3

FINANCIAL INSTITUTION FINANCIAL INSTITUTION

Pays Interest Return of Investment
 THE KEY INDIVIDUAL ROLES

 The Depositors Who Has the Funds

The depositor is the person who has the money and deposits it in a savings
account with a bank that pools this together with the savings from the depositors.
 The Borrower Who Needs the Funds
The borrower is the party at the other end. He is the small business owner. He
is the one who needs the funds and borrows the funds through a bank. He needs
the funds to start a project or a business venture, or expand his ongoing business.
He knows where the funds can be placed or invested in so that the funds will grow.

The main role of financial institution is to act as financial intermediary. Acting as

financial intermediary means to be in the middle, to be the go-between, or link
between the depositors who have the money and the borrowers who need the
money.
 Financial Market and Financial Institution
 Financial Institution include banks and non banks . These are your commercial
banks, universal banks, investment banks , investment companies, finance
companies, life and non life insurance companies, mutual fund companies, and
private equity firms.
 Financial Instruments are tools that help a business’ daily operations, and eventually
make it grow. These tools help the finance manager handle his cash, his short-term
operating requirements, and long-term business requirements.
 Money Market instruments are an inexpensive way to government and financial
institution to raise funds. These funds are usually available for short periods of time.
Their rates are generally lower than funds which are available for use longer period
of time.

The money market is a mechanism that deals with the lending and borrowing of short
term funds (less than one year)

 It doesn’t deal in cash or money but deals with substitute of cash like trade bills,
promissory notes, and government papers which can converted into cash without
any loss at low transaction cost
 FINANCIAL INSTITUTION VS NON-BANKING FINANCIAL INSTITUTION

Financial Institution Non Banking Financial

 A financial institution is an
institution which collects funds from
the public and places them in
financial assets, such as deposits,
loans, and bonds rather than
tangible property.
FINANCIAL
INSTITUTION
Institution
A
 non-bank financial institution is a financial
institution that does not have a full
banking license or is not supervised by a
national or international banking
regulatory agency

 Non-banking institutions, are financial

NON institutions that provide banking services,
BANKING BANKING but do not hold a banking license. These
INSTITUTION INSTITUTION institutions are not allowed to take
deposits from the public.
 Financial Institution Support Nation Building

 Financial institutions help in funding important government projects and extend

advisory services to help in nation building.

 A financial institution can be a bank and non bank.

 The Different Money Market Instruments and Their Characteristics

Financial Instruments Basic Characteristics

Money market debt:
Treasury bills
Commercial papers
Money market funds
Consumer credit, credit card
debt
 Issued by the treasury/government
 Matures within one year
 Is generally default-free as government will exert all effort to pay
 Issued by financially-sound businesses to fund investments in inventories
and receivables
 Maturity is about nine months
 Generally low default risk as businesses have good credit standing
 Issued by banks or mutual fund companies
 No specific maturity date
 The degree of default risk is low
 These funds are usually invested in money market instruments, treasuries,
and commercial papers
 Issued by banks, credit unions, finance companies
 Maturity date varies
 Default risk varies
 Financial Instrument and Their Basic Characteristics
Financial Instruments Basic Characteristics

Long – term debt:

 Issued by the government
 Notes matures in two, five, or ten years
 Bonds mature longer ( ten years or more )
Treasury notes and bonds
 No default risk as governments exert all efforts to pay
 The price of bonds usually fall, becoming less attractive as interest
rates in the market rise.
 This is United States type of long-term debt and not applicable in
the Philippine setting
Federal agency debt
 Issued by federal agencies and is similar to treasuries
 Has a long-term maturity (i.e., up to thirty years)
 Issued by local governments
Municipal Bonds, local
 Matures longer (i.e., up to thirty years)
government bonds
 More risky than government securities
 Issued by the corporation
 Matures in forty years, (some bonds like Walt Disney and Coca-Cola
have issued 100-year bonds)
Corporate bonds
 More risky than government securities and rely on the financial
soundness of the company
 HERE ARE THE DIFFERENT KINDS OF BANKS

1. THRIFT BANKS are deposit-taking financial institutions that also extend credit to the consumer market.
Thrift banks usually caters to the countryside or rural areas as compared to commercial banks which focus
mainly on top companies located in the major cities.
2. COMMERCIAL BANKS are mainly deposit-taking financial institutions that extend credit to the retail and
consumer market. They deal with the “mom and pop stores” and their transaction are usually many but
small, denominated in the local currency.
 Commercial Bank – clients are mostly retail customers. They are the moms and dads in the neighborhood
who are employed, self-employed, or who are have small businesses to operate. Its main purpose is
lending. Example are BDO, Union Bank, Metrobank, and BPI.
 Commercial bank collect and safe keep the funds of savers/depositors. Accounts such as savings and checking
accounts provide a fast and efficient way for bank clients to access their money and use their money to pay
bills and other short-term requirements such as electricity bills, grocery bills, medical bills, educational bills,
transportation expenses, and rest and recreational expenses.
 Commercial banks also lend money of savers/depositors to small to medium enterprises that will pay them
an interest regularly in exchange for the use of their funds. The spread between the rates paid to depositors
and the rate received by the bank from the borrower will pay banking costs which will include employee
salaries, office rent, electricity, and other business costs.
3. UNIVERSAL BANKS lend to multi national companies or companies with global presence. Their
transactions are larger than commercial banking transactions and denominated in multi currencies and not
just limited to the local currency.
 Universal banks are like commercial bank except that their clientele are mostly the larger corporation.
They are usually multinationals, unlike the retail clientele of the commercial banks.

4. INVESTMENT BANKS are known to successful raise funds for big corporations and governments. They
deal with the “big ticket items” and are able to raise from the “investing public” through bond issuances
and initial public offerings.
 Investment banks also lend or provide funding to businesses but in a somewhat more creative manner and
more specialized than the commercial bank. They will raise funds from what is called the investing public or
the man on the street – you and me.
 Investment Banks are similar to universal banks in terms of sophisticated banking services. Unlike,
commercial banks, they do not have branches all around the country. They are more specialized and deal
with top corporation, global businesses, and government. They perform market making activities such as
trading, fund management, and portfolio management.
 THE NON-BANKS THAT LEND OR RAISE FUNDS FOR BUSINESSES ARE THE FOLLOWING:

1. LEASING COMPANIES are not banks and are not governed by the central banks. Yet leasing companies
also extend credit or financing to companies that need it for projects
Leasing Companies
A lease or tenancy is the right to use or occupy personal property or real property given by the lessor to
another person (usually called the lessee or tenant) for a fixed or indefinite period of time, whereby the
lessee obtains exclusive possession of the property in return for paying the lessor a fixed or determinable
consideration (payment).
2. INVESTMENT COMPANIES are regulated by Securities and Exchange Commission (SEC) and perform
similar functions as banks in the sense that they can provide funding to companies or raise funds through bond
issuances or initial public offerings.
 Investment Companies pool your money together with the money of other investors and invest these in
financial instruments – stocks, bonds, currencies, commodities, financial derivatives.
3. MUTUAL FUNDS are collective investments or funds of small investors pooled together and managed to
be able to reach maximum returns. Mutual funds, through small individually, are big collectively.
4. INSURANCE COMPANIES sells insurance coverage to provide guarantee of compensation for specified
death, illness, accident, loss, or damage to property in return for payment of a premium. Purchasing
insurance protects the owner from these unforeseen events that may happen anytime. The insurance
premiums paid annually for protection is managed by the insurance company so that in due time when there
is an insurance claim, the owner can count on the service he paid for and will be able to go about his life
despite the damage or loss.
 INSURANCE COMPANIES sell life and non-life insurance products. This non-bank financial institution’s
role is to offer security and stability during times of death of loved ones, loss of property, other business risks,
or uncertainty.

5. PRIVATE EQUITY FUNDS are not regulated by government or any regulatory body. They are funds
managed by private fund manager and private investors and hence, the owners are able to invest
aggressively in the financial markets. Private equity funds finance business and projects.
 Private Equity Funds – are funds of private investors used to finance lucrative projects (producing money
or wealth) that are projected to give good returns.
 Long – term are also available to the borrower for his business needs. The interest rate that these debts
charge is higher than money market instruments and is usually locked in over the entire life of the debt.
 An example of a long – term debt is bond. It is a security that represents debt of a government or
business promising to pay a fixed interest to the holder of the bond for a definite period of time.
 Another example of long – term is a note. A note is a security that has long term than a money
market instrument, but shorter term than a bond.
 Notes are similar to bonds in the sense that they make regular interest payments and have specified term
in maturity.

 A BOND is a certificate of indebtedness. It is a formal unconditional promise, made under seal, to pay a
specified sum of money at a determinable future date and to make periodic interest payment at stated
rate until the principal amount is paid.

 Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the
coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments,
or, in the cause of government bonds, to finance the current expenditure.
 FINANCIAL INSTRUMENTS

1. COMMERCIAL PAPERS are mainly borrowing of corporations usually with good credit standing. Funds
raised through commercial paper borrowing are used to finance inventories and receivables. This means
that while inventories are not yet sold or are not converted into cash, corporations resort to financing by
issuing commercial papers. Also, while not yet receiving payment in cash, companies survive through
commercial paper financing.
 A Commercial Paper is a unsecured money market instrument issued by corporation or bank in the form
of a promissory note
2. TREASURY NOTES. Notes are borrowings of government. When government embark on long-term
infrastructure projects, they borrow by issuing notes. Notes have along-term maturity, which means that
governments have more time before they pay back the financial institution.
3. GOVERNMENT OR CORPORATE BONDS. Bonds are borrowings of governments or corporations. Like
notes, bonds are issued to finance very long-term projects of government or corporations. For corporations,
these projects may be capital-intensive projects like building a new factory or financing a new product
plant.
4. STOCKS are shares issued by businesses. They raised funds by selling part of their companies to potential
stock investors. Stock investors become part owners of corporations.
 Why invest in stocks?
 Stocks investors are part-owners
 Stocks investors benefit from growth potential
 Stocks investors receives cash
5. MUTUAL FUNDS/INVESTMENT FUNDS
 Financial markets are the platform where financial instruments are offered, bought, and sold. In simple
terms, it is where you can find the financial instruments like money market instruments, notes, and bonds
that you need to manage your business daily, and the financial instruments you need to grow your business
exponentially.
 Financial markets like stock exchange have a physical structure and more organized. A good example is the
Philippine Stock Exchange (PSE)
 Over-the-counter (OTC) markets platform only needs a telephone, and some electronic gadgets like
computer and/or a mobile phone, to enable the trading of financial instruments. A good example of this is
National Association of Securities and Dealer Automated Quotation (NASDAQ). IT ALSO PROVIDE AN
ALTERNATIVE PLATFORM FOR FINANCIAL INSTRUMENTS.
 Mutual funds/Investment Funds

 Are pooled investments. They are investments of small investors pooled together and managed
collectively to afford investment outlets in the bigger global landscape. Mutual funds are invested
in money market instruments, notes, bonds, and stocks. They finance important projects of large
corporations and governments. They move global financial markets and though are small
individually, they are very important collectively.
 A stock is a type of security that signifies ownership in a corporation and
represents a claim on part of the corporation’s assets and earnings

 There are two main types of stocks: preferred and common

 Preferred and common stocks are financial instruments businesses can use to
raise funds for their long – term requirements
 Preferred and Common Stocks with Their Basic Characteristics

Financial Instruments Basic Characteristics

 Issued by corporations in exchange for units of ownership
 Has no maturity date
 Pays dividends when declared
Preferred stock  More risky than corporate bonds
 Has no voting rights
 Has preference over common stocks in asset liquidation,
hence the term preferred.
 Units of ownership in a public corporation
 Pays dividends when declared
 Ownership are entitled to vote on the selection of
directors and other important matters
Common stocks  In the event of a corporate liquidation, claims of
preferred stockholders take precedence over common
stockholders
 For the most part, common stockholders enjoy potentials
profits from capital appreciation of their stock
 FINANCIAL MANAGER
 A financial manager is responsible for providing financial
advice and support to colleagues and clients to enable them
to make sound business decisions. The role of the financial
manager is more than simply accounting; it is functional .
Financial mangers must understand all aspects of the business
so that they are able to adequately advise and support the
chief officer in decision-making and ensuring company growth
and profitability.
 Is a person who manages the finances of a business entity
both efficiently and effectively.
 PRIMARY ACTIVITIES OF FINANCIAL MANAGER

 CAPITAL BUDGETING
 What long – term investments or projects should the business take on?
 CAPITAL STRUCTURE
 How should we pay for our assets?
 Should we use debt or equity?
 WORKING CAPITAL MANAGEMENT
 How do we manage the day–to–day finances of the firm?
 WHAT IS FINANCIAL MANAGEMENT?

 Financial management is the efficient and effective management of

(funds) in such a manner as to accomplish the objectives of the
organization. It is the planning, organizing, controlling and monitoring
of the financial resources of an organization.
 Financial Management ( or Business Finance ) is concerned with
managing a corporate’s money
 WHERE DOES THE FINANCIAL MANAGER PUT THIS BORROWED
MONEY?

 Remember that the goal of finance is to maximize profit. Therefore, it is expected that the financial
manager invests this money in projects that are worthwhile. He invests it in new business venture,
or a new manufacturing plant. Also, he can invest it to expand his already thriving business he has a
dream of a bigger enterprises. Sometimes, he invests this money to train his people to continue
servicing his customers and to continue doing a good job.

 WORTHWHILE BUSINESS is a business worth giving your time and attention to because it
achieves the goal of financial soundness, liquidity, profitability, and nation building. The role of the
financial manager is to ensure that the entire flow of money happens and is completed up to
payments of interest on the borrowed loan after money is invested in a worthwhile business.
 TYPES OF BUSINESS ORGANIZATION

TYPES OF BUSINESS ACCORDING TO OWNERSHIP

SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION

 TYPES OF BUSINESS ORGANIZATION

TYPES OF BUSINESS ACCORDING TO OPERATIONS

SERVICE MERCHANDISING MANUFACTURING

 Vertical Analysis – (common-size) is the process of comparing
accounts in the financial statements within the
same accounting period. It involves converting
amounts as a percentage of a common base
 Good Food Snack House
Income Statement
December 31, 2013 and December 31, 2014
2014 2013
Amount % Amount %
Net Sales 7,457,736 100% 6,396,040 100%
Less: Cost of Goods Sold 6,228,532 84% 5,859,680 92%
Gross Profit 1,229,184 16% 536,360 8%
Less: Other Expense 886,177 12% 561,974 9%
Operating Income 343,008 5% -25,614 0%
Less: Interest Expense 74,208 1% 144,173 2%
Net Income 268,799 4% -169,787 -3%
 Good Food Snack House
Balance Sheet
December 31, 2013 and December 31, 2014
2014 2013
Amount % Amount %
Cash 91,626 2.3% 7,792 0.2%
Account Receivable, net 939,460 24.0% 676,411 19.7%
Inventories 1,836,634 46.8% 1,377,475 40.2%
Prepaid Rent 180,000 4.6% 360,000 10.5%
Total Current Assets 3,047,720 77.7% 2, 421,678 70.7%
Equipment and Fixtures 1,280,961 32.7% 1,287,157 37.6%
Less: Accumulated Depreciation 406,728 10.4% 281,581 8.2%
Total Fixed Assets 874,233 22.3% 1,005,575 29.3%
Total Assets 3,921,953 100.0% 3,427,253 100.0%
Accounts Payable 467,376 11.9% 560,851 16.4%
Notes Payable 321,000 8.2% 681,385 19.9%
Accruals 436,560 11.1% 523,872 15.3%
Total Current Liabilities 1,224,936 31.2% 1,766,108 51.5%
Long-term Debt 608,000 15.5% 1,134,072 33.1%
Owner’s Capital 2,089,017 53.3% 527,073 15.4%
Total Liabilities & Capital 3, 921,953 100.0% 3,427,253 100.0%
 Horizontal Analysis – or trend analysis, on the other hand involves
comparing amounts in the financial statements of
two or more consecutive periods.
 Good Food Snack House
Income Statement
December 31, 2013 and December 31, 2014

2014 2013 Change in Amount %

Net Sales 7,457,736 6,396,040 1,061,696 17%
Less: Cost of Goods Sold 6,228,532 5,859,680 368,872 6%
Gross Profit 1,229,184 536,360 692,824 129%
Less: Other Expense 886,177 561,974 324,203 58%
Operating Income 343,008 -25,614 368,621 1,439%
Less: Interest Expense 74,208 144,173 -69,964 -49%
Net Income 268,799 -169,787 438,586 258%
 Good Food Snack House
Balance Sheet
December 31,2013 to December 31, 2014

2014 2013 Change in Amount Percent ( % )

Cash 91,626 7,792
Account Receivable, net 939,460 676,411
Inventories 1,836,634 1,377,475
Prepaid Rent 180,000 360,000
Total Current Assets 3,047,720 2,421,678

Equipment and Fixtures 1,280,961 1,287,157

Less: Accumulated Depreciation 406,728 281,581
Total Fixed Assets 874,233 1,005,575
Total Assets 3,921,953 3,427,253

Accounts Payable 467,376 560,851

Notes Payable 321,000 681,385
Accruals 436,560 523,872
Total Current Liabilities 1,224,936 1,766,108

Long-term Debt 608,000 1,134,072

Owner’s Capital 2,089,017 527,073
Total Liabilities & Capital 3,921,953 3,427,253
 Financial Statement Analysis

 Financial Ratios – are relationships established from a company’s financial statements and are
used for comparison and decision-making.
 Ratio are the tools used for financial statement analysis. A ratio is a mathematical relationship
between two numbers, and expressed in percentage or decimal. Since ratios are number
relationships, they should provide meaningful information to the users.
 For example short term creditors are interested in ratios about liquidity, while long term creditors
are more interested in ratios about solvency and stability. The owners and managers, are
interested primarily on the ratios about profitability, but would consider all ratios for decision
making and management purposes.
 Performance Measurements

 Liquidity – is the ability of the business to pay its current maturing liabilities as they fall on its due
date. Comparing current assets and current liabilities assesses liquidity. While liquidity is most
important to short-term creditors, it is also important to long-term creditors. This is because it is
impossible for a business to pay long-term debts if it cannot even pay its short-term debts.
 Solvency – is the ability to pay long-term liabilities. Long–term creditors are interested in the
solvency of a business because they are concerned about receiving interest payments and more so
of the principal payment for the loan granted to the company.
 Profitability – addresses a very basic goal of any business: to earn the highest possible profit or
return on its investment. This is assessed by the effective costs control and the efficient utilization
of assets.
 PROFITABILITY RATIOS
 THE FOLLOWING RATIOS ARE USED TO MEASURE PROFITABILITY OF A COMPANY:
 Return on Equity (ROE) – it measures the amount of the net income earned in relation to
stockholder’s equity
 ROE = Net income ÷ Stockholder’s Equity
= 2,659,087 ÷ 12,478,559
= 0.21309
= 21.31%
 Return on Assets (ROA) – measures the ability of a company to generate income out of its
resources.
 ROA = Operating income ÷ Total Assets
= 4,048,698 ÷ 22,298,020
= 0.18157
= 18.16%
 Gross Profit Margin – is a profitability ratio that measures the ability of a company to cover its cost
of good sold from its sales
 Gross Profit Margin = Gross Profit ÷ Sales
= 10,546,355 ÷ 52,501,085
= 0.20087
= 20.09%
 Operating Profit Margin – measures the amount of income generated from the core business
company
 Operating Profit Margin = Operating Income ÷ Sales
= 4,048,696 ÷ 52,501,085
= 0.077116
= 7.71%
 Net Profit Margin – measures how much net profit a company generates for every peso of sales or
revenue that it generates.
 Net Profit Margin = Net Income ÷ Sales
= 2,659,087 ÷ 52,501,085
= 0.05064
= 5.06%
  Liquidity Ratios

 Current Ratio = Current Assets ÷ Current Liabilities

= 9,262,331 ÷ 7,819,461
= 1.1845
= 1.18

 Acid – Test or Quick Asset Ratio = Cash + Accounts Receivable + Marketable Securities
Current Liabilities

= 3,363,027
7,819,461
= 0.4300
= 0.43
Leverage Ratios – show the capital structure of a company, that is, how much of the total
assets of a company is financed by debt and how much is financed by stockholders’ equity.

 Debt Ratio = measures how much of the total assets are financed by liabilities.
 Debt Ratio = Total Liabilities ÷ Total Asset
= 9,819,461 ÷ 22,298,020
= 0.4403
= 0.44
 Debt to Equity Ratio – is a variation of the debt ratio. A debt to equity ratio of more than one
means that a company has more liabilities as compared to stockholder’s equity.
 Debt to Equity Ratio = Total Liabilities ÷ Total Stockholders’ Equity
= 9,819,461 ÷ 12,478,559
= 0.7869
= 0.79
 Interest Coverage Ratio – provides information if a company has enough operating income to
cover interest expense.
 Interest Coverage Ratio = EBIT ÷ Interest Expense
= 4,048,696 ÷ 250,000
= 16.194
= 16.19
 EBIT stands for earnings before interest and taxes

Efficiency Ratios and Turnover Ratios

 They measure the managements efficiency in utilizing the assets of the company
 Total Asset Turnover Ratio – measures the company’s ability to generate revenues for every peso
of asset invested
 Asset Turnover Ratio = Sales ÷ Total Assets
= 52,501,085 ÷ 22,298,020
= 2.354
= 2.35
 Fixed Asset Turnover Ratio – if a company is heavily invested in property, plant, and
equipment of fixed assets, it pays to know how efficient the management of these assets is.
 Fixed Assets Turnover Ratio = Sales ÷ PPE
= 52,501,085 ÷ 12,200,000
= 43.303
= 43.30
 Accounts Receivable Turnover Ratio – measures the efficiency by which accounts receivable
is managed. A high receivable turnover ratio means efficient management of receivables.
 Accounts Receivable Turnover Ratio = Sales ÷ Accounts Receivable
= 52,501,085 ÷ 2,300,500
= 22.821
= 22.82
 Average Collection Period = 360 ÷ 22.82
= 15.78 or 16 days
 Inventory Turnover Ratio – measures the company’s efficiency in managing its inventories.
 Inventory Turnover Ratio = Cost of Sale ÷ Inventories
= 41,954,730 ÷ 4,849,304
= 8.651
= 8.65
 Days’ Inventories = 360 ÷ Inventory Turnover Ratio
= 360 ÷ 8.65
= 41.62 or 43 days
 Accounts Payable Turnover Ratio – provides information regarding the rate by which trade
payable are paid.
 Accounts Payable Turnover Ratio = Cost of Sales ÷ Trade Accounts Payable
= 41,954,730 ÷ 5,050,810
= 8.306
= 8.31
 Days’ Payable = 360 ÷ Accounts Payable Turnover Ratio
= 43.32 or 43 days
 Operating Cycle and Cash Conversion Cycle – this operating cycle covers the period from the
time the merchandise is bought to the time the proceeds from the sale are collected.
 Operating Cycle = Days’ Inventories + Days’ Receivable
= 42 + 16
= 58 days
 Cash Conversion Cycle – is inversely related to the operating cash flows. If the cash conversion
cycle is low, expect more operating cash flow and reserve is true.
 Cash Conversion Cycle = Operating Cycle – Days’ Payable
= 58 days – 43 days
= 15 days
 4th QUARTER
FINANCIAL PLANNING
 STEPS IN THE FINANCIAL PLANNING PROCESS

 The financial Planning Process is articulated in a document called the financial plan. The financial
plan is divided into:
1. The long – term financial plan, also known as strategic plan financial plan involves forecasting
the financing requirements of a business three – to – five years down the road.
2. The short – term financial plan, also kwon as the operating financial plan involves forecasting
the financing requirements of a business within a year or less, and as is expected is more
detailed than the former.
 Financial Planning is often defined as the forecasting of a business’ future financing
requirements.
DEVELOPING THE LONG – TERM PLAN COMES DOWN TO A FEW SIMPLE STEPS

1. FORECAST YOUR SALES.

2. COMPUTE THE DIVIDEND PAYOUT RATIO AND THE PLOWBACK RATIO.
3. IDENTIFY YOUR SPONTANEOUSLY – GENERATED FUNDS.
4. USE THE PERCENT OF SALES APPROACH TO PREPARE THE PRO FORMA FINANCIAL
STATEMENTS.
5. CALCULATE YOUR EXTERNAL FINANCING NEED (EFN).
Let us say sales are forecasted to grow 20% next year. Obviously this translate to a 20%
growth in assets. Then, use the percent of sale approach to calculate the weights
needed in preparing the pro forma income statement . As you can see, costs and net
income were 55% and 31.50% of sales , respectively. Furthermore, the dividend pay out
ratio is 0%.

Income Statement % of Sales

Sales 9,268,315.00
Costs 5,097,573.00 55.00%
Taxable Income 4,170,741.75
Taxes ( 30% ) 1,251,222.53
Net Income 2,919,519.23 31.50%
Dividend ( 0% ) 0.00
Addition to 2,919,519.23
Earnings
 Pro Forma Income Statement % of Sales
Projected Sales 11,121,978.00
Costs ( 50% ) 6,117,078.90 55.00%
Taxable Income 5,004,890.10
Taxes ( 30% ) 1,501,467.03
Net Income 3,503,423.07 31.50%
Dividends ( 0% ) 0.00
Addition to 3,503423.07
Retained Earnings
 Balance Sheet % of Sales
Cash and Cash Equivalent ( 20% ) 1,482,930.40 16.00%
Accounts Receivable ( 44% ) 4,078,058.60 44.00%
Inventory ( 60% ) 5,560,989.10 60.00%
Current Assets 11,121,978.00 120.00%

PPE – net 16,682,967.00 180.00%

Total Assets 27,804,945.00

Accounts Payable ( 30% ) 2,780,494.50 30.00%

Accrued Expenses 926,831.50 10.00%
Notes Payable 88,150.00 n/a
Current Liabilities 3,795,476.00 n/a
Non – current Liabilities 500,597.00 n/a
Liabilities 4,296,073.00 n/a

Common Stock 16,456,210.40 n/a

Retained Earnings 7,052,661.60 n/a
Owner’s Equity 23,508,872.00 n/a
Total Liabilities and Owner’s Equity 27,804,945.00 n/a
 Pro Forma Balance Sheet % of Sales % increase
Cash and Cash Equivalents 1,779,516,48 16.00% 20.00%
Accounts Receivable 4,893,670.32 44.00% 20.00%
Inventory 6,673,186.80 60.00% 20.00%
Current Assets 13,346,373.00 120.00% 20.00%

PPE – net 20,019,560.40 180.00% 20.00%

Total Assets 33,365,943.00 20.00%

Account Payables 3,336,593.40 30.00% 20.00%

Accrued Expenses 1,112,197.80 10.00% 20.00%
Notes Payable 88,150.00 n/a
Current Liabilities 4,536,941.20 n/a
Non – current Liabilities 500,597.00 n/a
Liabilities 5,053,538.20 n/a

Common Stock 16,456,210.40 n/a

Retained Earnings 10,556,084.57 n/a
Owner’s Equity 27,012,295.00 n/a
Total Liabilities + Owner’s Equity 32,049,833.00 n/a
External Financing Needed 1,316,101.00
 The Budget Preparation
 The primary tool in short-term financial planning is the cash budget, also known as cash
forecast. It plots the business’ projected cash inflow and outflow and is typically done
monthly and is used to cover a year’s time. An example of a cash budget is shown below.

Cash Budget
January February March
Cash Receipts
Less: Cash Disbursement
Net Cash Flow
Add: Beginning Cash
Ending Cash
Less: Minimum Cash Balance
Required Total Financing
Excess Cash Balance

 It is divided into three parts, which are follows:

1. Cash Receipts
2. Cash Disbursement
3. Excess cash balance/required total financing
PREPARING CASH BUDGET COMES DOWN TO A FEW SIMPLE STEPS:

1. Forecast the business’ monthly sales

2. Forecast the cash sales and the credit sales from the projected monthly sales
3. Take into account other cash receipts
4. Sum up the total cash receipts
5. Forecast the business’ monthly sales
6. Forecast the cash purchases and credit purchases from the projected monthly purchase
7. Take into account other cash disbursements
8. Sum up the total cash disbursements
9. Subtract the total cash disbursements from the total cash receipts to get the net cash flow.
10. Add the beginning cash balance to the net cash flow to get the ending cash balance.
11. Subtract the minimum cash balance from the ending cash balance.
Sales in January and February were 150,000 and 220,000 respectively. Sales of 380,000, 340,000, and 295,000
have been forecasted for March, April, and May, respectively. Thus, we are trying to develop a cash budget for
March and May. Based on historical data, 15% of the business sales are in cash form, 55% have generated
account receivables collected after one month, and the remaining 30% have generated accounts receivables
collected after two months. It also receives a monthly interest payment of 150,000 from a bank certificate of
deposit.

Sales Forecast January February March April May

150,000.00 220,000.00 380,000.00 340,000.00 295,000.00

Cash sales ( 15% ) 22,500.00 33,000.00 57,000.00 51,000.00 44,250.00

Accounts Receivables
Collection
Lagged 1
month
82,500.00 121,000.00 209,000.00 187,000.00

Lagged 2
months
45,000.00 66,000.00 114,000.00

Other cash receipts 150,000.00 150,000.00 150,000.00 150,000.00 150,000.00

Total cash receipts 172,500.00 265,000.00 373,000.00 476,000.00 495,250.00

 Purchases represent 80% of sales. Of this amount, 5% is paid in cash, 80% and 15% are paid after one months,
respectively. After the purchases, the business also pays a rent of 15,000 every month.
Wages are 5% of monthly sales. On the other hand, fixed salary cost of the year is 144,000 or 10,000 per month.
Taxes of 40,000 will be paid in April while capital expenditure in the form of new machinery costing 200,000 will
be purchased and paid in full in March.
Furthermore, an interest payment of 110,000 is due every month. A 150,000 principal payment is also due in May

January February March April May

Purchases 120,000.00 176,000.00 304,000.00 272,000.00 235,000.00
Cash Purchases 6,000.00 8,800.00 15,200.00 13,600.00 11,800.00
Accounts Payable payments
Lagged 1 Month 96,000.00 140,800.00 243,000.00 217,600.00
Lagged 2 Months 18,000.00 26,400.00 45,600.00
Rent Payments 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00
Wages and Salaries 19,500.00 23,000.00 31,000.00 29,000.00 26,750.00
Tax Payments 40,000.00
Fixed Assets Outlay
Interest Payment 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00
Principal Payment 150,000.00
Total Cash Disbursement 150,500.00 252,800.00 530,000.00 472,000.00 576,750.00
 At the end of February, the cash balance was 70,000. It wants to have a target cash balance of
90,000.

January February March April May

Cash receipts 172,500.00 265,500.00 373,000.00 476,000.00 495,250.00

Less: Cash Disbursements 150,500.00 252,800.00 530,000.00 477,200.00 576,750.00

Net cash flow 22,000.00 12,700.00 -157,000.00 -1,200.00 -81,500.00

Add: Beginning cash 70,000.00 -87,000.00 -88,200.00

Ending cash 70,000.00 -87,000.00 -88,200.00 -169,700.00

Less: Minimum cash balance 90,000.00 90,000.00 90,000.00

Required total financing -177,000.00 -178,200.00 -259,700.00

Excess Cash Balance