Service Provided: Audit Services, Tax Services, Consulting Equity ratio = Total shareholder (BS) / Total Assets (BS)

Services. Company Assets by contribution of owners

Assets = Liabilities Equity Classify/record transaction, prepare financial statements, develop Pledged Asset to secured liabilities = Book value of pledged
Cash Land Notes Common Retained budgets, assess performance and measure costs assets / Book value of secured liabilities
Payable Stock Earnings Mainly used by banks and creditors. Measures the protection to
120 120 Common Features of Ethical Misconduct secured creditors
400 400 Existence of a non sharable problem Times interest earned = Net income before interest expense and
(500) 500 • A problem that must be kept secret income tax / interest expense
85 85 • Person inclined to secrecy more likely to accept Protection to long term creditors, Higher the better (>10)
unethical/illegal solution
(50) (50)
Presence of an opportunity Profitability –
(4) (4)
• Internal controls designed to decrease opportunity for fraud Profit Margin = Net income (IS) / Net sales (IS)
51 500 400 120 31 Capacity for rationalization Net sales ---> revenue
• Justify misconduct Company‟s ability to earn a net income from sales
Income Statement Gross Margin = (Net sales (IS) – Cost of sales (IS)) / Net sales
Cash Flow
Balance Sheet Lecture – 02 – Analyzing Financial Statements (IS)
Amount remaining from Rs.1 sales that is left to cover operating
Classify Business Events Basics of Analysis: Reduces uncertainty, Application of exp and a profit after cost of sales
Classify events into one of three categories: analytical, involves transforming data Return on total assets=Net income (IS)/Avg. total assets (BS)
Asset source transactions increase the total amount of assets and Purposes of Analysis: Financial statement analysis helps Best measure of overall profitability
increase the total amount of claims internal (managers, officers, internal auditors) and external Return on common shareholders’ Equity = (Net income (IS) –
Asset exchange transactions decrease one asset and increase (shareholders, lenders, customers) users make better decisions. Preferred dividends) / Avg. Shareholder equity
another asset Building block of analysis How well the company employed the owners‟ investments to
Asset use transactions decrease the total amount of assets and • Liquidity & efficiency (cash position) – ability to meet earn income
the total amount of claims. short term obligations (liabilities) and efficiently generate Preferred dividend method is not used in SL
revenues. Book value per common share = Shareholders equity
Sample Financial Statements • Profitability – ability to provide financial rewards sufficient applicable to common share (or total equity) (BS) / No of
to attract and retain financing common shares outstanding (Notes)
Balance Sheet • Solvency – ability to generate future revenues and meet long Liquidation at reported amounts
Assets term obligations Basic earnings per share = (Net income (IS) – Preferred
Current Assets • Market – ability to generate positive market expectations dividends) / weighted avg. common shares outstanding
Cash and Equivalents Weighted avg. common shares outstanding = Number of
Accounts Receivables Assets common shares outstanding.
Inventory • Current assets – can be converted quickly into cash How much income was earned for each share of common stock
Prepaid Expenses • Non - current assets – hardly converted to cash outstanding?
Total Current Assets • Intangible assets – patents, brand name reputation, licenses If this is high share price is also high
Fixed Assets
Land and Property Tools of analysis – Market -
Machinery/Equipments • Horizontal – comparing the fin performance across time Price earnings ratio = Market price per share / Earning per
Total Fixed Assets • Vertical – comparing to a base amount share
Total Assets • Ratio – using key relation among financial statement items Used by investors to gauge stock value. Generally higher the PE
Liabilities ratio the more opportunity a company has for growth.
Current Liabilities Horizontal analysis Dividend yield = Annual dividend per share / Market price per
Accounts Payable • Dollar Change = analysis period amount – base period share
Notes Payable amount Identifies the return in terms of cash dividends on the current
Total Current Liabilities • Percentage change = Dollar change / base period amount % market price of the stock
Long Term Liabilities • Trend percent = analysis period amount / base period
Bonds Payable amount % Lecture – 03 – Cost Volume Analysis
Shareholders’ Equity
Preferred Stock Vertical analysis Costs
Common Stock Common size percent = analysis amount / base amount % Fixed cost
Additional Paid in Capital * Base amount is total assets (or total liabilities + shareholders • Total fixed cost remains unchanged
Total Paid in Capital equity) for balance sheet and total revenue for income statement. • Fixed cost per unit decline as activity increases
Retained Earning Variable cost
Total Shareholder’s Equity Working capital • Total variable cost change when activity changes
Total Liabilities and Shareholder’s Equity (Cash for day-to-day activities) = current assets – current • Variable costs per unit do not change as activity increases
liabilities. ---> If negative it‟s called deficit. Mixed costs – Contains fixed portion that is incurred even when
Income Statement Avoiding Working Capital problem facility is unused and a variable portion that increase with usage.
• Giving discounts to clients and collect debt E.g. Electricity service charge and usage bill
Revenue • Giving discounts to stocks and collect cash Stepwise costs – total cost remains constant within a narrow
Cost of Sales Solving Working Capital problem range of activity.
Gross Margin • Sales of non operating assets E.g. Depreciation or insurance of machines with no of machines
Operating Expenses • Differ the creditors payments Curvilinear costs – cost increase when activity increases, but in
Net Operating Income • Mortgage the non - current assets and get loan a nonlinear manner
Interest Expense • Rent out the assets and collect money
Net Income before taxes • Get help from other org – leveraging Identifying and Measuring Cost Behavior: Objective is to
Taxes • Govt. fund – for govt. org classify all costs as either fixed or variable.
Net Income • Giving part of ownership to the debtors (convert liability to
ownership) Methods used
Scatter Diagram
Statement of Cash Flows Ratio analysis Unit variable cost = change in cost / change in units
Cash Flow from operating activities High Low Method
Cash receipts from revenue Liquidity and Efficiency – Difference in Cost/Difference in Sales = Unit Variable Cost
Cash Payments from expenses Current ratio = Current assets (BS)/ current liabilities (BS) Fixed Cost = Total Cost – (Sales * Unit Variable Cost)
Net Cash flow from operating activities (This ratio measures the short term debt paying ability of the Fixed cost = total cost – total variable cost
Cash Flow from investing activities company >1 better Least squares regression – used for same purpose but no
Cash payments to purchase land Acid –test ratio = Quick assets (BS)/Current Liabilities (BS) manual calculation. SW based calculations are used.
Cash flow from financing activities Quick asset = Current asset – closing stock
Cash receipts from burrowing funds Accounts receivable turnover = sales on account (IC) / Avg. Break Even Point – the BEP is the unique sales level at which a
Cash receipts from issuing common stock accounts receivable company earns neither profit not incurs a loss.
Cash payment for dividends Sales on account = revenue Sales revenue – variable cost = contribution margin (amount by
Net cash flow from financing activities Avg. AR (avg. of 2 year values)= trade & other receivables / which revenue exceeds the variable costs of producing the
Net increase in cash debtors revenue)
Plus beginning cash balance How many times the receivables are converted into cash each Contribution margin – fixed cost = Net income
Ending cash balance year Formulas:
Merchandise turnover = cost of goods sold (GS) / Avg. 1. BEP in units = Fixed cost / contribution margin per unit
Statement of Stockholders Equity Inventory (BS) 2. BEP in dollars = fixed cost / contribution margin ratio
Beginning Common Stock For service sector – cost of GS = direct cost Contribution margin ratio = unit contribution / unit sales
Plus: Common Stock Issued Higher the better, How many times merchandise sold & replaced price
Ending Common Stock Days sales uncollected = Acct receivable * 365 (BS) / Net sales 3. Income = sales – fixed cost – variable cost
(IS) 4. Unit sales =(fixed cost + Target income) / contribution
Beginning Retained Earnings Liquidity of receivables, Lower the better. margin per unit
Plus: Net Income Days sales inventory = Ending inventory * 365 (BS)/Cost of Dollar sales = (fixed cost + target income) /contribution
Less: Dividends sales (IS) margin ratio
Ending Retained Earnings Liquidity of inventory, Lower the better. 5. Dollar sales = (FC + Target net income + Income tax) /
Total Stockholder’s Equity Total asset turnover = Revenue (IS)/ Avg. Total assets (BS) CMR
Efficiency of assets in producing sales, Higher the better 6. Before-tax income = target net income / (1 – tax rate)
What do accounts do? 7. Margin of safety percentage = (expected sales – Break
Identify, record, analyze and communicate information about the Solvency – even sales) / Expected sales
economic events that affect organizations Debt ratio = Total liabilities (BS)/ Total assets (BS) MOS-the amount by which sales may decline before
Company Assets by contribution of creditors reaching BE sales.

Assumptions of CVP (cost-volume-profit) analysis
A limited range of activity called the relevant range, where CVP
relationships are linear
1. Unit selling price remains constant
2. Unit variable costs remain constant
3. Total fixed cost remain constant
Production = sales (no inventory changes)
Multiproduct BEP
BEP in composite units = FC / CM per composite unit
Operating Leverage
Measure of the extent to which fixed costs are being used in an
organization
Measure of how a percentage change in sales will affect profits
Degree of Operating leverage = Contribution margin / net income
% increase in income = % increase in sales * degree of operating
leverage
FINANCIAL MANAGEMENT
Lesson 1- Introduction
1. Goal to increase share holder value
2 .Sourcing of funds / Investment of funds
3 Agency principal- cost for managers not working to SH value
4 Money (fd, treasury bills ) and capital market (equity)
5 Private limited – family and friends own
5 Public limited – issue shares to public
6. Capital market related concepts -IPO ,Stock exchanges ,
SEC,primary (ipo) V secondary market
7 .share price indices – Milanka (Listed) , All share (All)
Lesson 2- Sources of financing & Cost of Capital
Sources of Corporate Funding Equity, Debt
Equity Capital: Equity (Share Capital, Reserves (Capital &
Revenue))
- Initial Public Offering (IPO)
- Rights issue: SH buy at the second issue in decent rate
- Bonus Issue: Capitalisation of profits, Reduce ordinary
dividends and provide ordinary shares –keep happy
Debt Capital: Term Loans, Equipment Loans & Leases,
Debentures, Mortgages, Sell & Lease Back, Preference Shares
Institutional Investors: Pension funds, Insurance companies,
Unit trusts
Venture Capital: Long term equity capital provided by a
financial institution or venture capital company to a „promising‟
business
Cost of Capital: The minimum acceptable return on an
investment, generally computed as a „hurdle rate‟ for use in
investment appraisal exercises.
Cost of Capital - two aspects ( - Cost of funds that a company
raise, - Minimum return that a company should make)
Cost of Equity - Listed Companies
Gordon’s Dividend Growth Model
ke = (d1/ p0)*g
ke = Cost (k) of equity (e), d1 = Dividends in Y1, p0 = Price of
Share in Y0, g = Growth rate in dividends
Capital Asset Pricing Model (CAPM)
ke = Rf + (Rm – Rf)b
Rf = Risk Free Return, Rm = Market Return, b = Beeta factor
(risk factor)
Cost of Equity - Unlisted Companies
Estimate the ke of similar listed companies and then add a further
risk premium for business and financial risk
To the Risk free rate (Rf) rate add estimated risk premiums for
both the Business risk and the Financial risk of the entity
Bank Loan / Overdraft
kd = I (1 - t)
Debentures - Irredeemable
kd = [ I (1 - t) ] / MP
Debentures - Redeemable
kd = IRR of Debenture
kd = Cost (k) of debt (d), I = Interest rate , t = tax rate, MP =
Market Price of Debenture, IRR = Internal Rate of Return
Cost of Debt Capital
Preference Shares - Irredeemable
kp = DPS / MPS
Preference Shares - Redeemable
kp = IRR of Preference Share
kp = Cost (k) of Preference (p) share, DPS = Dividends per
Share, MPS = Market Price of Share
Cost of Capital - Overall (WACC)
ko = keVe + kdVd + kpVp /Ve + Vd + Vp
k = Cost, V = Value
Types of Cost of Capital
Cost of Equity (COE): Cost of Ordinary Shares (Ordinary
Shares and Reserves
Weighted Average Cost of Capital (WACC): the average cost
of the total mix of Capital
Marginal Cost of Capital (MCC): the incremental cost of the
new capital or the difference between the new capital structure
and the old capital structure
Opportunity Cost of Capital (OCC): the higher of the yield
forgone on the most profitable investment opportunity rejected
because of the budget constraint or the company‟s normal cost of
capital
Lesson 3 Investment Appraisal & Capital Budgeting
Capital Budgeting: What is Capital Budgeting, Why is it
important Time Value of Money, Methods used (Non-
discounting Methods: Accounting Rate of Return (ARR),
Payback method, Discounting Methods: Net Present Value
(NPV), NPV Index, Internal Rate of Return (IRR)
Investment Appraisal – Non Discounting
Accounting Rate of Return – add all , balance/years , %
Advantages - Simple to understand, Relatively simple to
calculate, Uses the yields in all the years
Disadvantages- The timing of the cash flows (return) is ignored,
The returns are expected to occur evenly throughout the life of
the project
Payback Period – CCF, get the years by reducing and cal
months
Advantages - Simplicity of calculation, Can be used as a quick
screening method, Places a higher emphasis on the earlier
returns, which are likely to be more accurate than the later
returns, An early return is more important since „liquidity‟ is
more critical than „profitability‟
Disadvantages - It ignores the timing of the return prior to
payback, It ignores the earnings after payback, It discriminates
against projects that have a longer payback period, May
encourage a more short-term attitude
Discounting methods & Time Value of Money
“Money today is better than money tomorrow”
- Inflation - money losing its purchasing power
- Earning potential of money (Time Value of Money)
- Risk associated with Future
Future cash flows converted into today‟s (Y0) values by :
PV = Future Cash Flow = FV
(1 + r)^n (1 + r) ^n
PV=Present Value, r = discounting rate, n = number of years
Net Present Value (NPV)
- Aggregate all future discounted cash flows to arrive at the
„Net Present Value‟ (NPV) of the project.
- A positive NPV would mean that the project is worthwhile
at the current „cost of capital‟.
- If there is more than one project and there are capital
restrictions the project with the highest NPV will be chosen
NPV Index
- Calculate the „Net Present Value‟ (NPV) of the project.
- Express the NPV as a percentage (%) of the initial
Investment
Internal Rate of Return (IRR)
- The rate (r) at which the NPV of the project becomes zero
(0) is the „Internal Rate of Return‟ (IRR) of the project.
- The IRR can be compared with the Cost of Capital to see if
the project is worthwhile
- If there are multiple projects the project with the highest
IRR would be chosen
- Higher the Discounting factor lower the DCF and resulting
NPV
- Lower the Discounting factor higher the DCF and the
resulting NPV
- IF COC < IRR it is a worth project
NPV NPV + IRR
Discounting Rate (%)_
NPV -
Advantages - All cash flows are included, Takes timing of cash
flows into account, Can consider different scenarios , Takes into
account the „opportunity cost‟ of the investment funds
Disadvantages - More complicated than other methods, The cost
of capital is often difficult to ascertain, The meaning of the
results may be often misunderstood, Projects can be compared
with each other only if the initial investment cost is the same
Limitations of Investment Appraisal Techniques - The
accuracy of the expected cash flows and the rate used for
discounting have a tremendous impact on the final outcome. -
The cost of capital may not remain constant throughout the
project and may vary with time. This makes project evaluation
difficult. - In addition one should remember that apart from the
financial consideration there are so many other factors which one
needs to considered too (The objectives of the organisation,
External costs and benefits, Competencies and capabilities, Level
of risk, Economic state, Alternative investments etc)
1. Working Capital Management
Useful Working Capital ratios Current Ratio, Acid test ratio,
Cash ratio, Stock Turnover, Debtors Turnover (debtors payment
period), Creditors Turnover (creditors payment period)
Importance of Stock Control – because idle funds
Stock Control & Management
Re-order Level, Supplier Lead Time, Avg. Sales / Consumption,
Re-Order Quantity (Economic Order Quantity)
EOQ = Sqrt ( 2DCo/Ch)
D = Avg. Demand, Co = Cost of Ordering, Ch = Cost of Holding
1 Unit of stock
Total
Holding
Cost
Cost
Cost
Order Cost
EOQ Order Size
Optimum Stock Control
Importance of Debtors Control: - idle fund...
Credit Risk Management: -Good Credit Evaluation will make
Credit Control much easier,
Customer Account Profitability – CAP: -Customer Account
Profitability - Measuring the profitability of separate customer
accounts based on separately identifiable costs being matched
against the revenues generated from those specific customer, -
Robert Pareto‟s 80:20 rule be applied to Customers &
Profitability as well, -William Sherden modified it as 80:20:30
rule, based on his research
2. Shareholder Value Analysis
Factors affecting Business Value: Nature and type of business -
level of „risk‟ involved, The Industry life cycle stage the market
is in, Earning potential (including past track record), Competency
and ability level of the Management, General market perception
about the company, Any special circumstances eg.) Proposed
merger, Financial strength and soundness of the organisation,
Rights or ownership to some specific assets (tangible or
intangible)
Value Creation Strategies: Diversification: spread of business
risk , Mergers & Acquisitions / De-mergers & spin-offs, Market
Development & Product Development, Improving the returns to
investment of existing investments, Extending the useful life of
projects / assets, Extending the scope of the business
upstream/downstream the supply chain, Reducing the Cost of
Capital (WACC)
Drivers of Shareholder Value
Cornelius and Davies (1997) identifies five ways of improving
shareholder value
- Increase the return on the existing capital of that the
shareholder has invested in
- Invest additional capital only if the return exceeds the rate of P
return required by the shareholder
- Divest assets generating a return below the required rate
- Extend the period over which returns over and above the (S
required rate are enjoyed
- Reduce the cost of capital
Rappaport states that shareholder value can be arrived at by:
- Business Value = PV of Free Cash Flows + Value of
marketable securities
In other words :
- the amount of cash that is generated which can become
dividend and will be the basis of the market capitalisation of
the business
- the securities or investments held by the company which
could be disposed of for cash without affecting its
operations
The company‟s overall value is arrived at by:
Shareholder Value = Business Value – Debt Value
Rappaport outlines seven value drivers: Sales Growth rate ,
Operating Profit Margin, Cash income tax rate, Incremental fixed
capital investment rate , Investment in working capital,
Planning period - a longer stream of cash flows and Cost of
Capital
Monitoring Value Creation
Market Value Added (MVA)
Rise in market capitalization – Increase in invested capital
Economic Value Added (EVA)
Adjusted profits after tax1 – (Adjusted invested capital X
WACC2)
1
Net Operating Profit After Tax (NOPAT), 2 Weighted
Average Cost of Capital
MVA Vs EVA: - The two measures are intended to correspond
with MVA being the external measure monitored by investors
and EVA being the internal performance measure which leads to
a satisfactory MVA, - Stern & Stewart, the proponents of the
EVA measure suggest that by ensuring that all projects/divisions
demonstrate a positive EVA that in effect increase the
shareholder wealth as measured by the MVA
From EVA to MVA: -The market capitalisation of the business
is roughly equivalent to the expected present value (PV) of free
cash flows of the organisation (Free cash flows are the cash profit
less the cost of financing the capital needed to generate that
profit) , -MVA is thus equivalent to the increase in the PV of free
cash flows over the period minus any increase in the capital
invested, -Therefore to maintain the PV of the organisation‟s free
cash flows management must ensure that each division yields a
free cash flow, -To yield free cash flows, the division or new
project must have cash profits in excess of the WACC on
investment, -Therefore by ensuring all divisions/projects show a
positive EVA the organisation can ensure that MVA remains
steady & growing
Critique of EVA / MVA: -The conceptual basis of the
adjustments seems quite arbitrary. Certain expenses such as
Advertising and Training costs can be seen as both investments
as well as current year expenses, -The need to effect an elaborate
set of adjustments. Room for „window-dressing‟ as a result, -
Limits measures of earnings to the current period and does not
consider forecast profits, -Affected by the absolute size of the
firm and causes difficulties in comparing firms of different sizes,
-MVA does not necessarily track EVA in the way suggested.
General market sentiment is more important, -It is criticised as a
self-fulfilling prophecy, -Ignores „dividends‟ in the analysis. Two
organisations having the same MVA over a period would be still
different if the dividends paid out are brought into the analysis