SUPPLEMENTARY LEARNING

MATERIALS IN
BA 217- BUSINESS FINANCE
BSHM 2-A

VILMA E. LITAN, ED.D.

Subject Professor
 NOTES TO STUDENTS

Course No. and Title: BA 237 – BUSINESS FINANCE

Prerequisite: none

Course Description: This course deals with the fundamental principles, tools and techniques of
the financial operation involved in the management of business enterprises. It covers the basic
framework and tools for financial analysis and financial planning and control, and introduces
basic concepts and principles needed in making investment and financing decisions.
Introduction to investments and personal finance are also covered in the course. Using the
dual learning approach of theory and application, each chapter and module engages the
learners to explore all stages of the learning process from knowledge, analysis, evaluation and
application to preparation and development of financial plans and programs suited for a small
business.(CMO No. 62, s. 2017).

Course Credit/ Unit: 3 Units (54 Hours)

This lecture notes have been prepared by referring to many books and notes prepared by the
teacher. This does not claim any originality and cannot be used as a substitute for prescribed textbooks.
The information presented here is merely a collection of materials by the subject teacher. This is just an
additional tool for the teaching-learning process. These notes have been prepared to help the student in
Business Management in their preparation for examination. The ownership of the information lies with the
respective authors. Advantages of this lecture notes include: the potential of incorporating technology,
a broader base for evaluating student encouragement for independent learners, and the individualization of
instruction. It promotes students’ active involvement and responsibility for the exchange of ideas.
Students are informed in advance of unit objectives and are guided to complete various learning activities
to achieve the objectives. This approach enables the students to be more actively involved in learning
experiences.

There are eight (8) units in this module.

Unit I - Introduction to Business Finance
Unit II - Basic Financial Statements
Unit III - Financial Statement Analysis and Interpretation
Unit IV - Financial Planning and Management
Unit V - Debt and Equity Financing
Unit VI - Time Value of Money
Unit VII - Investment
Unit VIII- Money Management

The learning outcomes for BA 237, specified below are unpacked by the specific objectives of
each unit. Upon successful completion of this course you would have:

1. Describe the significance, relevance and functions of finance in a business organization;

2. Recognize the importance of finance in a business organization;
3. Identify and describe the various elements of financial statements;
4. Recognize ad explain the different information provided by each financial statements;
5. Describe the significance, importance and relevance of financial statement analysis;
6. Recognize ratio analysis measurement level in terms of liquidity, profitability, stability and
solvency;
7. Describe and explain steps in financial planning process;
8. Prepare projected financial statements
9. Discuss the significance and importance of financing in business;
10. Recognize and explain loan requirements of various banking institutions;
11. Describe the concept of the time value of money;
12. Compute and calculate the future and present value of money;
13. Compare and contrast different types of investments;
14. Classify and recognize various advantages and disadvantages of investments;
15. Recognize the importance of money management; and
16. Illustrate and describe the money management cycle.

Unit 1. Introduction to Business Finance

1.1 Definition of Business Finance

Business Finance involves the administration of the company’s resources and capital. In
business, financing is a way of obtaining capital to support business operations and a way
of obtaining capital to expand operations and acquire resources. Financing can be thru the
form of debt (liabilities from creditor or lender) or equity (investor’s capital). Debtors and
lenders support the normal operations of the business while equity are given by the
investors or proprietor in exchange of business ownership.

You need to be familiar with accounting method, investing strategies and debt
management.
 FINANCING

Financing: The act of bringing money into the organization

 Business Finance will help us in financing and investment decision.
Methods of financing are:
a. Taking on debt
b. Credit Arrangements
c. Investments on real assets and financial assets
 The success and failure of business rely on these discipline.

BUSINESS FINANCE AND ACCOUNTING

ACCOUNTANT – is concerned with financial record keeping, production or periodic report, statement and
analysis.

FINANCIAL MANAGER – only makes decision involving fiancé and not to provide financial information.
In a small business, an accountant and financial manager can be one person.

FINANCIAL MANAGEMENT

 It starts with a plan

 Having cash and resources is not enough
 Financial management in business is a must.
FINANCIAL MANAGEMENT
 Deals with decision that supposed to maximize the value of shareholders’ wealth (shares
of stocks)
 Planning, controlling, directing the financial activities such as procurement and utilizations
of funds.
Stocks – forms of ownership in a corporation.

1.2 Importance of Business Finance

We now know the meaning of Business Finance, let us learn its importance. Business finance is
an essential requirement for the establishment of any business. Money is actually the most important tool
to bridge the gap between production and sales. Let us take a look at some of the important functions of
business finances.

 We require business finances to meet certain contingencies and any unexpected problems
that may arise
 Necessary for the promotion of sales
 A requirement to avail any business opportunities that may present themselves
 1.3 Finance Function and the Organization
The Finance Function is a part
of financial management. Financial Management is the
activity concerned with the control and planning
of financial resources. In business, the finance
function involves the acquiring and utilization of funds
necessary for efficient operations.

ORGANIZATION OF FINANCE FUNCTION

The responsibilities for financial management are spread throughout the organization in the

sense that financial management is, to an extent, an integral part of the job for the .managers involved
in planning, allocation of resources and control. For instance, the production manager (engineer)  shapes
the investment policy (proposal of a new plant) the marketing manager/analyst provides  inputs in
forecasting and planning the purchase manager influences the level of investment in  inventories and the
sales manager has a say in the determination of receivables policy. Nevertheless, financial management is
highly specialized in nature and is handled by specialists. Financial decisions are of crucial importance. It
is, therefore, essential to set up an efficient organization for financial management functions.

Since finance is a major/critical functional area, the ultimate responsibility for carrying out  financial
management functions lies with the top management, that is, board of directors/managing director/chief
executive or the cornerstone of the board. However, the exact nature of the organization of the financial
management function differs from firm to firm depending upon factors such as size of the firm, nature of its
business type of financing operations, ability of financial officers and the financial philosophy, and so on.
Similarly, the designation of the chief executive of the finance department also differs widely in case of
different firms. In some cases, they are known as finance managers while in others as vice-president
(finance), director (finance), and financial controller and so on. He reports directly to the top management.
Various sections within the financial management area are headed by managers such as controller and
treasurer.
Depicts the organization of the financial management function in a large typical firm.

The job of the chief financial executive does not cover only routine aspects of finance and accounting. As a
member of top management, he is closely associated with the formulation of policies as well as decision
making. Under him are controllers and treasurers, although they may be known by different designations in
different firms. The tasks of financial management and allied areas like accounting are distributed between
these two key financial officers.  https://www.google.com/search?
q=finance+function+and+the+organization&oq=&aqs=chrome

Objectives of Finance Functions. Investment Decisions– This is where the finance manager

decides where to put the company funds. Investment decisions relating to the management of
working capital, capital budgeting decisions, management of mergers, buying or leasing of
assets.
https://www.google.com/search?q=objectives+of+finance+function&oq=objectives+of+finance+function&aq

A financial intermediary offers a service to help an individual/ firm to save or borrow money. A financial
intermediary helps to facilitate the different needs of lenders and borrowers. ... The bank raises funds from
people looking to deposit money, and so can afford to lend out to those individuals who need it.
Functions and Examples of Financial Intermediaries
26 November 2018 by Tejvan Pettinger
Definition of financial intermediaries
 A financial intermediary is a financial institution such as bank, building society, insurance company,
investment bank or pension fund.
 A financial intermediary offers a service to help an individual/ firm to save or borrow money. A
financial intermediary helps to facilitate the different needs of lenders and borrowers.
 For example, if you need to borrow £1,000 – you could try to find an individual who wants to lend
£1,000. But, this would be very time consuming and you would find it difficult to know how reliable
the lender was.
 Therefore, rather than look for individuals to borrow a sum, it is more efficient to go to a bank (a
financial intermediary) to borrow money. The bank raises funds from people looking to deposit
money, and so can afford to lend out to those individuals who need it.
Examples of Financial Intermediaries
1. Insurance Companies
If you have a risky investment. You might wish to insure, against the risk of default. Rather than trying to
find a particular individual to insure you, it is easier to go to an insurance company who can offer insurance
and help spread the risk of default.
2. Financial Advisers
A financial adviser doesn’t directly lend or borrow for you. They can offer specialist advice on your behalf. It
saves you understanding all the intricacies of the financial markets and spending time looking for the best
investment.
3. Credit Union
Credit unions are informal types of banks which provide facilities for lending and depositing within a
particular community.
4. Mutual funds/Investment trusts
These are mutual investment schemes. These pool the small savings of individual investors and enable a
bigger investment fund. Therefore, small investors can benefit from being part of a larger investment trust.
This enables small investors to benefit from smaller commission rates available to big purchases.
Benefits of Financial Intermediaries
1. Lower search costs. You don’t have to find the right lenders, you leave that to a specialist.
2. Spreading risk. Rather than lending to just one individual, you can deposit money with a financial
intermediary who lends to a variety of borrowers – if one fails, you won’t lose all your funds.
3. Economies of scale. A bank can become efficient in collecting deposits, and lending. This enables
economies of scale – lower average costs. If you had to sought out your own saving, you might
have to spend a lot of time and effort to investigate best ways to save and borrow.
4. The convenience of Amounts. If you want to borrow £10,000 – it would be difficult to find someone
who wanted to lend exactly £10,000. But, a bank may have 1,000 people depositing £10 each.
 Therefore, the bank can lend you the aggregate deposits from the bank and save you finding
someone with the exact right sum.
Potential Problems of Financial Intermediaries
 There is no guarantee they will spread the risk. Due to poor management, they may risk depositors
money on ill-judged investment schemes.
 Poor information. A financial intermediary may become complacent about spreading the risk and
invest in schemes which lose their depositors money (for example, banks buying US mortgage
debt bundles, which proved to be nearly worthless – precipitating the global credit crunch.)
 They rely on liquidity and confidence. To be profitable, they may only keep reserves of 1% of their
total deposits. If people lose confidence in the banking system, there may be a run on the bank as
depositors ask for their money bank. But the bank won’t have sufficient liquidity because they can’t
recall all their long-term loans. (This can be overcome to some extent by a lender of last resort,
such as the Central Bank and / or government)

4 Benefits of Financial Intermediaries to Lenders and Borrowers

The main advantages to ultimate lenders are summed up below:

(1) Low risk:

Other things being the same, lenders are interested in minimizing all kinds of risk of capital and interest loss
on leans or financial investments they make. These risks may arise in the form of risk of default or risk of
capital loss on stock-market assets, such risks on secondary securities are far less than on primary
securities for individual lenders. How Fls are able to reduce such risks even though they themselves hold
primary securities will be explained later. Besides, government regulation of the organization and working
of major FIs helps in reducing risks of their creditors. Any strengthening of the financial system that goes to
inspire public confidence in it reduces further any psychological risk suffered by lenders.
(2) Greater Liquidity:
Is offer much greater liquidity on their secondary securities to their lenders. Consider a few examples.
Demand deposits of banks are perfectly liquid. They can be drawn upon without notice. Banks allow even
time deposits to be drawn upon subject to certain conditions involving only some loss of interest. They, of
course, always stand ready to lend against them.
Units of the UTI can be sold back to it. Savings embodied in life insurance policies are not equally liquid,
but loans can always be arranged against them from banks or the LIC itself. Primary securities do not carry
any of these features, because primary borrowers need funds for agreed periods to finance their
expenditures. For reasons to be explained later, FIs can offer much greater liquidity to their creditors, and
yet lend on a much longer term to their debtors.
(3) Convenience:
Secondary securities sold by FIs are easy to buy hold, and sell. The information cost and transaction cost
involved are very low. Banks run branches in all urban areas and several semi-urban and rural areas. The
deposits they sell are standardized and information about them easily available.
So the choice about bank deposits, life insurance policies. UTI units are not as difficult as about (say)
corporate equities (primary securities). Much, however, depends on the quality of customer service
provided by the FIs which in the case of public-sector FIs in India is deplorably poor. This has hampered
greatly the growth of financial intermediation in the country.
(4) Other Services:
Each of the FIs specializes in selling special kinds of secondary securities and other services associated
with them. Thus, banks specialize in selling deposits with particular features. In addition, they transfer
funds, collect cheques for their clients, offer safe-deposit vaults, and. most important of all are the dominant
lender.
All these and several other services attract the public to banks and induce it to hold deposits with them. The
UTI sells units (shares) of a balanced asset portfolio of marketable corporate securities to the investing
public. The LIC collects long-term savings of the public by selling life insurance. These other services can
be had only when particular kinds of secondary securities carrying them are bought.

https://www.yourarticlelibrary.com/economics/4-benefits-of-financial-intermediaries-to-lenders-and-borrower

SUGGESTED CLASS ACTIVITIES:

1. You are ask to submit an Organizational Chart of the Finance Department of any
business entity. Write an essay depicting the importance of finance department
and must be submitted together with the organizational chart.

2. You are requested to collect news article or any published material on the various
financial institution in the Philippines.
 Unit 2. Basic Financial Statements
2.1 Statement of Financial Position

Statement of financial position (Balance Sheet)

The statement of financial position also known as a Balance Sheet represents the Assets, Liabilities and
Equity of a business at a point in time.

For example:

Assets include cash, stock, property, plant or equipment - anything the business owns. Liabilities are what
the business owes to outside parties, eg. suppliers, bank or business loans. Equity is the remaining
proportion of the owner's financial interest in the business after deducting any liabilities from the total assets
in the business.

Reading your Financial Position (Balance Sheet)

When reading your balance sheet, it represents what your business owns and controls (the Assets), what it
owes (the Liabilities) and the investment that the owner has contributed (the Equity) at a particular point in
time.

The accounting equation is:

Case Study

Paul has created his statement of financial position at startup. It shows that Paul has P9,438 in the bank,
he has various property, plant and equipment totaling P3,000 and furniture & fixtures of P400. He has no
liabilities and his investment in the business by way of capital is P12,838. You can see that Paul’s total
assets equals the total of the liabilities and equity for his business. It is displayed below.

THEO’S BUSINESS
Statement of Financial Position (Balance Sheet)
As of September 30, 2020
 P P P P
ASSETS LIABILITIES
Current Assets Current Liabilities 0
Cash in Bank 9,438
Total Current Assets 9,438 Total Current Liabilities 0

Non-Current Assets
Non-Current Liabilities 0
Property, Plant &
Equipment
Total Non Current 0
Computer, Printer, Mobile 3,000
Liabilities
Accumulated Depreciation-
Computer,Printer,Mobile
0 Total Liabilities
3,000 0
Furniture & Fixtures (at
Cost) 400 OWNERS EQUITY
Accumulated Depreciation- Capital 12,838
Furn & Fix 0 Plus: Profit or Less: Loss
400
Land & Building(at Cost) Less: Drawings
Acc Depr - Building Total
0 Owners Equity 12,838

Total Non-Current Assets TOTAL LIABILITIES &

OWNERS EQUITY 12,838
TOTAL ASSETS 12,838
2.2 Statement of Comprehensive Income

The statement of comprehensive income should be presented immediately after the income
statement. (However, it could be combined with the income statement.)

The term comprehensive income consists of 1) a corporation's net income (which is detailed on the

corporation's income statement), and 2) a few additional items which make up what is known
as other comprehensive income.
The items which make up other comprehensive income include:
 Unrealized gains or losses on derivatives used in hedging
 Unrealized gains or losses on pension and postretirement liabilities
 Foreign currency translation adjustments
The amounts of these other comprehensive income adjustments (positive or negative) are not
included in the corporation's net income, income statement, or retained earnings. Instead the
adjustments are reported as other comprehensive income on the statement of comprehensive income
and will be included in accumulated other comprehensive income (which is a separate item within
stockholders' equity).
The following shows the format of the statement of comprehensive income:
*Every financial statement should inform the reader that the notes are an integral part of the financial
statements and should be read for important information.
The adjustments for the items defined as other comprehensive income will be included in the amount
of accumulated other comprehensive income, which is reported in the stockholders' equity section of the
balance sheet:

https://www.accountingcoach.com/financial-statements/explanation/4

2.3 Statement of Changes in Equity

2.4 Statement of Cash Flow

 cash flow statement is a financial statement that provides aggregate data regarding all cash inflows a
company receives from its ongoing operations and external investment sources. It also includes all cash
outflows that pay for business activities and investments during a given period. 

A company's financial statements offer investors and analysts a portrait of all the transactions that go
through the business, where every transaction contributes to its success. The cash flow statement is
believed to be the most intuitive of all the financial statements because it follows the cash made by the
business in three main ways—through operations, investment, and financing. The sum of these three
segments is called net cash flow.

These three different sections of the cash flow statement can help investors determine the value of a
company's stock or the company as a whole.

KEY TAKEAWAYS

 A cash flow statement provides data regarding all cash inflows a company receives from its
ongoing operations and external investment sources.
  The cash flow statement includes cash made by the business through operations, investment, and
financing—the sum of which is called net cash flow.
 The first section of the cash flow statement is cash flow from operations, which
includes transactions from all operational business activities. 
 Cash flow from investment is the second section of the cash flow statement, and is the result of
investment gains and losses. 
 Cash flow from financing is the final section, which provides an overview of cash used from debt
and equity.

Understanding Cash Flow

How Cash Flow Statements Work

Every company that sells and offers its stock to the public must file financial reports and statements with
the Securities and Exchange Commission (SEC). 1 The three main financial statements are the balance
sheet and income statement. The cash flow statement is an important document that helps open a wind
interested parties insight into all the transactions that go through a company.

There are two different branches of accounting—accrual and cash. Most public companies use accrual
accounting, which means the income statement is not the same as the company's cash position. The cash
flow statement, though, is focused on cash accounting.

Profitable companies can fail to adequately manage cash flow, which is why the cash flow statement is a
critical tool for companies, analysts, and investors. The cash flow statement is broken down into
three different business activities: operations, investing, and financing.

Let's consider a company that sells a product and extends credit for the sale to its customer. Even though It
recognizes that sale as revenue, the company may not receive cash until a later date. The company earns
a profit on the income statement and pays income taxes on it, but the business may bring in more or less
cash than the sales or income figures. 

Investors and analysts should use good judgment when evaluating changes to working capital, as some
companies may try to boost up their cash flow before reporting periods.

Cash Flows From Operations

This is the first section of the cash flow statement covers cash flows from operating activities (CFO) and
includes transactions from all operational business activities. The cash flows from operations section
begins with net income, then reconciles all noncash items to cash items involving operational activities. So,
in other words, it is the company's net income, but in a cash version.

This section reports cash flows and outflows that stem directly from a company's main business activities.
These activities may include buying and selling inventory and supplies, along with paying its employees
their salaries. Any other forms of in and outflows such as investments, debts, and dividends are not
included.

Companies are able to generate sufficient positive cash flow for operational growth. If there is not enough
generated, they may need to secure financing for external growth in order to expand.
For example, accounts receivable is a noncash account. If accounts receivable go up during a period, it
means sales are up, but no cash was received at the time of sale. The cash flow statement deducts
receivables from net income because it is not cash. The cash flows from the operations section can also
include accounts payable, depreciation, amortization, and numerous prepaid items booked as revenue or
expenses, but with no associated cash flow.

Cash Flows From Investing

This is the second section of the cash flow statement looks at cash flows from investing (CFI) and is the
result of investment gains and losses. This section also includes cash spent on property, plant, and
equipment. This section is where analysts look to find changes in capital expenditures (capex).

When capex increases, it generally means there is a reduction in cash flow. But that's not always a bad
thing, as it may indicate that a company is making investment into its future operations. Companies with
high capex tend to be those that are growing.

While positive cash flows within this section can be considered good, investors would prefer companies
that generate cash flow from business operations—not through investing and financing activities.
Companies can generate cash flow within this section by selling equipment or property. 

Cash Flows From Financing

Cash flows from financing (CFF) is the last section of the cash flow statement. The section provides an
overview of cash used in business financing. It measures cash flow between a company and its owners
and its creditors, and its source is normally from debt or equity. These figures are generally reported
annually on a company's 10-K report to shareholders .

Analysts use the cash flows from financing section to determine how much money the company has paid
out via dividends or share buybacks. It is also useful to help determine how a company raises cash for
operational growth.

Cash obtained or paid back from capital fundraising efforts, such as equity or debt, is listed here, as
are loans taken out or paid back. 

When the cash flow from financing is a positive number, it means there is more money coming into the
company than flowing out. When the number is negative, it may mean the company is paying off debt, or is
making dividend payments and/or stock buybacks.
https://www.investopedia.com/terms/c/cashflowstatement.asp

Statement of Cash Flows Example

Here is a sample cash flow statement for Strauss Printing Services, a service type sole
proprietorship business.
All amounts are assumed and simplified for illustration purposes.

Strauss Printing Services

 Statement of Cash Flows
For the Year Ended December 31, 2019
      
Cash Flow from Operating Activities:    
  Cash received from customers P  146,000  
  Cash paid for expenses (81,000)  
  Cash paid to suppliers (47,500) P   17,500
Cash Flow from Investing Activities:    
  Cash paid to acquire additional equipment   (20,300)
Cash Flow from Financing Activities:    
  Cash received from investment of owner P   10,000  
  Cash received from bank loan 50,000  
  Cash paid for bank loan – partial payment (27,000)  
  Cash paid to owner – withdrawal (20,000) 13,000
Net Increase (Decrease) in Cash for the
  P   10,200
Year
Add: Cash – January 1, 2019 10,800
Cash – December 31, 2019 P   21,000
Explanation and Pointers
1. Statement of Cash Flows presents the inflows and outflows of cash in the different activities of the
business, the net increase or decrease in cash, and the resulting cash balance at the end of the
period. Cash inflows refer to receipts of cash while cash outflows to payments or disbursements.
2. A typical cash flow statement starts with a heading which consists of three lines. The first line
presents the name of the company; the second describes the title of the report; and the third states the
period covered in the report.
3. Notice that the third line is worded "For the Year Ended..." This means that the information
included in the report covers a span of time. In the illustration above, the report presents inflows and
outflows of cash for 1 year, i.e. from January 1 to December 31, 2019.
4. Cash inflows and outflows are classified in three activities: operating, investing, and financing.
5. Operating activities refer to the main operations of the company such as rendering of professional
services, acquisition of inventories and supplies, selling of inventories for merchandising and
manufacturing concerns, collection of accounts, payment of accounts to suppliers, and others.
Generally, operating activities refer to those that involve current assets and current liabilities.
6. Investing activities may be summed up as: "where the company puts its money for long-term
purposes", such as acquisition of property, plant and equipment; and investment in long-term securities.
Selling these properties are also considered investing activities. In general, investing activities include
transactions that involve non-current assets.
7. Financing activities refer to: "where the company gets its funds", such as investment of the
owner/s, and cash proceeds from bank loan and other long-term payables. The payment of such items
(i.e. withdrawal of owner/s and payment of loans) are also financing activities. Generally, financing
activities include those that affect non-current liabilities and capital.
8. All inflows are presented in positive figures while all outflows in negative (in parentheses).
9. After inflows and outflows are presented, the net increase or decrease in cash is computed. Then it
is added to the beginning balance of cash to get the balance at the end. Easy, right? In simple sense,
this report presents the cash balance at the beginning of the period, the changes during the period, and
the resulting balance at the end of the period.
10. Notice that the cash balance at the end, P 21,000, is the same as the cash balance presented in
the company's Balance Sheet.
11. Good accounting form suggests that a single line is drawn every time an amount is computed. It
signifies that a mathematical operation has been completed. The computed balance at the end of the
report is double-ruled. https://www.accountingverse.com/accounting-basics/cash-flow-
statement.html

Unit 3. Financial Statement Analysis and Interpretation

3.1 Significance and Importance of Financial Statement Analysis

Financial statement analysis is a significant business activity because a corporation's financial

statements provide useful information on its economic standing and profit levels. These statements also
help an investor, a regulator or a company's top management understand operating data, evaluate cash
receipts and payments during a period, and appraise owners' investments in the company.

Financial statement analysis allows a corporation to review operating data and evaluate periodic

business performance. There are also various methods of financial statement analysis where a company
may review financial statements for specific information to assess performance.

For instance, Company A may analyze levels of cash, inventories and accounts receivable to appraise
short-term assets. A corporation also may analyze financial statements to gauge levels of cash flows and
owner investments. Alternatively, a regulator, such as the Securities and Exchange Commission (SEC),
may review a company's retained earnings statement to appraise corporate shareholders' accounts.

Time Frame Covered

A company's accounting department may perform financial statement analysis throughout the year or at
a specific point in time. As an example, Mr. B., an accountant at a large retail store, may review the
company's financial position at the end of the year to gauge cash available and inventory quantities on
hand. Alternatively, Mr. B. may review levels of sales and expenses each month to understand whether
the company's expenses are appropriate based on sales.

Types of Financial Statement Analysis

Generally accepted accounting principles (GAAP) and regulatory guidelines, such as SEC rules, require
a company to prepare a full set of financial statements on a quarterly or annual basis. A full set of
financial statements includes a balance sheet (or statement of financial position), a statement of income
(also known as statement of profit and loss), a statement of cash flows and a statement of retained
earnings (also called statement of owners' equity). Even businesses that are not required to follow GAAP
should prepare these statements as a matter of good accounting practice.
Features of an Analysis

Financial statement analysis is a significant business practice because it helps top management review a
corporation's balance sheet and income statement to gauge levels of economic standing and profitability.
Let us say Mr. A., the chief financial officer (CFO) of a large distribution company, reviews the company's
balance sheet and compares short-term assets, such as cash and inventories, and short-term liabilities,
such as salaries, interest and taxes payable. Mr. A. may note that the $100 million difference between
short-term assets and liabilities (also called working capital) is a sign of economic health.

Benefits of Analyzing Financial Statements

The importance of financial statement analysis can be seen in how the practice may be pivotal for
management to understand levels of cash receipts and disbursements in corporate operations. A
statement of cash flows lists cash flows related to operating activities, investments and financing
transactions. A statement of owners' equity may help an investor identify a company's shareholders. For
example, Mr. A., the CFO of the sample company, may review cash payments for operating activities to
gauge trends in interest payments.

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By: Marquis Codjia

Reviewed by: Jayne Thompson, LLB, LLM
Updated July 19, 2019
3.2 Horizontal and Vertical Analysis

Village Shipping Inc.

Income Statement Horizontal Analysis %Change
For the year ending December 31, 2018 2019 from
and December 31, 2019 2018 2019 2018

Sales 500,000 475,000 -5.00%

Cost of goods sold 269,000 265,000 -1.49%
Gross profit 231,000 210,000 -9.09%
 Wages -5.52%
Repairs 163,000 154,000 39.76%
Rent 4,150 5,800 8.33%
Taxes 12,000 13,000 -5.52%
Office Expenses 17,930 16,940 14.14%
Total Expenses 587 1,023 -3.49%
Net Income 197,667 190,763 -42.29%
33,333 19,237

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Vertical analysis  restates each amount in the income statement as a percentage of sales. This analysis
gives the company a heads up if cost of goods sold or any other expense appears to be too high when
compared to sales. Reviewing these comparisons allows management and accounting staff at the company
to isolate the reasons and take action to fix the problem(s).
The following figure is an example of how to prepare a vertical analysis for two years. As with the horizontal
analysis, you need to use more years for any meaningful trend analysis. This figure compares the
difference in accounts from 2014 to 2015, showing each account as a percentage of sales for each year
listed

Village Shipping Inc.

Income Statement Vertical Analysis
For the year ending December 31, 2018
and December 31, 2019 2018 2019
Sales 500,000 100.00% 475,000 100.00%
Cost of Goods Sold 269,000 53.80% 265,000 55.79%
Gross Profit 231,000 46.20% 210,000 44.21%

Wages
Repairs 163,000 32.60% 154,000 32.42%
Rent 4,150 0.83% 5,800 1.22%
Taxes 12,000 2.40% 13,000 2.74%
Office Expenses 17,930 3.59% 16,940 3.57%
Total Expenses 587 0.12% 1,023 0.22%
Net Income 197,667 39.53% 190,763 40.16%
33,333 6.67% 19,237 4.05%
At the bottom of the analysis, note that net income, as a percentage of sales, declined by 2.62 percentage
points (6.67 percent to 4.05 percent). As a dollar amount, net income declined by P14,096 (P33,333 to
P19,237). Management should consider both the percentage change and the dollar amount change.
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3.3 Financial Statement Ratio Analysis

Introduction Earlier, we learned that the goal of the financial manager is to maximize shareholder wealth,
which occurs when the firm’s share price is maximized. In this chapter, we want to get more pragmatic.
How does the financial manager know that he or she is moving the company in the right direction, and how
do investors in the firm’s shares evaluate the performance of the managers? The stakeholders look at the
firm’s financial statements for answers to these and other questions. Firm managers use accounting
information to help them manage the fi rm. Investors and creditors use accounting information to evaluate
the fi rm. This chapter focuses on the interpretation and analysis of financial statements. To perform
financial analysis, you will need to know how to use common-sized financial statements, financial ratios,
and the Du Pont ratio method. In addition, you will learn market-based ratios that provide insight about what
the market for shares and bonds believes about future prospects of the firm. Financial analysis is the
process of using financial information to assist in investment and financial decision making. Financial
analysis helps managers with effi ciency analysis and identification of problem areas within the fi rm. Also, it
helps managers identify strengths on which the firm should build. Externally, financial analysis is useful for
credit managers evaluating loan requests and investors considering security purchases.

The Financial Statements Three financial statements are critical to financial statement analysis: the balance
sheet, the income statement, and the statement of cash flows. We provide a brief overview of each
statement and describe what information it contains.
1.1 The Balance Sheet The balance sheet provides the details of the accounting identity. Assets =
Liabilities + Owners> equity or Investments = Investments paid for with debt + Investments paid for with
equity

Unit 4. Financial Planning and Management

4.1 Financial Planning Process

4.2 Working Capital Management

4.3 Cash Management
4.4 Inventory Management

Unit 5. Debt and Equity Financing

5.1 Importance of Business Financing
5.2 Sources of Business Financing
5.3 Equity Financing

Unit 6. Time Value of Money

6.1 Overview of Time Value of Money
 6.2 Future Value of Money

Unit 7. Investment
7.1 Types of Investments
7.2. Types of Accounts
7.3 Types of Investment Risk

Unit 8. Money Management

8.1 Overview of Money Management
8.2 Essentials of Personal Finance

UNIT 1.