Module 1

Overview of Finance & Analysis

of Financial Statements

Genevieve A. Cadornigara,
CPA, MMBM
Overview of Finance & Analysis of
Financial Statements

At the end of the module, students will be able

to:

1. Explain what finance entails and the basic

financial concepts.
2. Identify major goals that firms pursue
3. Explain the roles ethics and good
governance in successful businesses.
Overview of Finance & Analysis of
Financial Statements

4. Prepare the basic financial statements and

explain the information that each statement
provides
5. Explain how the firm's stakeholders use the
information in financial statements
6. Perform financial ratio analysis and explain
why the results of such an analysis are important
to both managers and investors
Overview of Finance & Analysis of
Financial Statements

7. Discuss potential problems associated with

financial statement analysis
8. Discuss and enumerate the advantages of
different types of organization
9. Explain the uses and approaches in
forecasting
10. Explain the dimensions and approaches in
financial planning
Overview of Finance & Analysis of
Financial Statements

Chapters Covered:

1 Introduction to Financial Management

2 Financial Statement Analysis
3 Financial Forecasting
4 Financial Planning and Budgeting
1. Overview of Finance & Analysis of
Financial Statements

1. Overview of Finance
2. Goals of the Business
3. Ethics and Governance in Business &
Social Responsibility
4. Types of Business Organizations
5. Financial Reports
1. Overview of Finance & Analysis of
Financial Statements

6. Financial Statements
7. Ratio Analysis
8. Uses and Limitations of Ratio Analysis
9. Financial Forecasting
10. Financial Planning and Budgeting
1. Overview of Finance

What is Finance?
According to Webster’s Dictionary, “It is
the system that includes the circulation
of money, the granting of credit, the
making of investments, and the provision
of banking facilities.
1. Overview of Finance

What is Financial Management?

Before: finance manager was only
involved in simple bookkeeping and
payments of the company’s bills

Present: evolved deeply into the major

parts of the firm’s activities, a role that
develops critically to what is now known
as financial management.
1. Overview of Finance
What is Financial Management?
..is the process of planning, organizing, controlling and
monitoring financial resources to achieve an organization’s
objectives. It involves making decisions about investment,
financing and dividend policies to maximize the value of the
organization or to ensure its long-term financial stability.

Key activities in financial management include budgeting,

forecasting, managing cash flows, analyzing financial
statements and making strategic financial decisions that align
with the organizations goals.
1. Overview of Finance

What is Financial
Management?
It is concerned with:
[Link]
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[Link] the firm’s funds.
1. Overview of Finance
1. Overview of Finance
Primary Objectives of Financial Management?

1. Profit Maximization: Ensuring the organization earns more

than it spends.
2. Wealth Maximization: Increasing the overall value of the
organization for its stockholders.
3. Efficient Resource Allocation: Ensuring that financial
resources are used effectively and efficiently.
4. Liquidity Management: Ensuring that the organization has
enough cash flow to meet its short-term obligations.
5. Risk Management: identifying and managing financial risks
to safeguard to organization’s assets.
2. Goals of the Business

FIRM’S GOAL

To maximize stockholder’s wealth

is through the value of their
ordinary share.
2. Goals of the Business

What is an Intrinsic Value?

… said to be the true value of the stock. Its
market value is estimated by a marginal
investor who conducted a security analysis.
2. Goals of the Business

Why not maximize profit?

• A change in profit is also a

change in risk.
2. Goals of the Business

Why not maximize profit?

It fails to determine the timing of

benefits.

In profit maximization, the timing of the

benefits is not considered. They do not
care if the cash flow is higher or lower in
the early years of the project.
2. Goals of the Business

Why not maximize profit?

Accounting profits cannot

be measured accurately.
2. Goals of the Business
PROFIT MAXIMIZATION STOCKHOLDERS’ WEALTH
MAXIMIZATION
OBJECTIVE Obtain large amount of profit Achieve the highest market
value of common stock

ADVANTAGES 1. Calculating profits is easy 1. The long-term wealth is

2. Determining the link between emphasized.
financial decisions and profits is 2. Risk or uncertainty is
simple recognized.
3. The timing of returns is
taken into account.
4. Stockholders’ return is
considered
DISADVANTAGES 1. The short-term wealth is more 1. There is no clear
emphasized. relationship between
2. Risk or uncertainty is ignored. financial decisions and
3. The timing of returns does not stock price.
matter. 2. Management anxiety
4. Immediate resources are and frustration may be
necessary experienced.
2. Goals of the Business

Roles of Financial Managers

1. Investment Decision

2. Financing Decision

3. Dividend Policy Decision

2. Goals of the Business

Roles of Financial Managers

1. Raising Funds - It is the responsibility of a financial

manager to decide the ratio between debt and equity. It is
important to maintain a good balance between equity and
debt.

2. Allocation of Funds -The funds should be allocated

in such a manner that they are optimally used.
2. Goals of the Business

Roles of Financial Managers

3. Profit Planning- Profit earning is important for survival

and sustenance of any organization. Profit planning refers to
proper usage of the profit generated by the firm.

4. Understanding Capital Markets - Shares of a

company are traded on stock exchange and there is a continuous
sale and purchase of securities. Hence a clear understanding of
capital market is an important function of a financial manager.
2. Goals of the Business

Financial Decisions and Risk-Return Trade Off

§ increase in return is coupled with increase in risk
§ finance managers role is to ascertain that the
risk is tolerable
§ company should remember that “the higher the
return, the higher the risk”
§ risk-return trade-off is also present in working
capital management
3. Ethics and Governance in Business & Social Responsibility
Concept

■ Ethics
ü An individual’s personal beliefs about
whether a behaviour, action, or decision is
right or wrong.

ü The domain of ethics does not have

specific laws.

ü The mistaken notion: “if it is not illegal, it

must be ethical”
G. Cadornigara
3. Ethics and Governance in Business & Social Responsibility
Managerial/Business Ethics
The three basic areas of concern for managerial
ethics are the relationships of the
■ Firm to the employee

■ Employee to the firm

■ Firm to the other economic agents

(Managers need to approach each set of

relationships from an ethical and moral
perspective) G. Cadornigara
3. Ethics and Governance in Business & Social Responsibility
Shift to ethics
■ Business create problems and should
therefore help solve them

■ Corporations are citizens in our society

■ Business often has the resources necessary to

solve problems

■ Business is a partner in our society, along with

the government and general population
G. Cadornigara
3. Ethics and Governance in Business & Social Responsibility

Social responsibility

The set of obligations an

organisation has to protect and
enhance the societal context in
which it functions.

G. Cadornigara
3. Ethics and Governance in Business & Social Responsibility

Areas of social responsibility

■ Stakeholders
■ Natural environment
■
General social welfare

(Some organizations Natural

Stakeholders
acknowledge their Environment
responsibilities in all three
areas and strive diligently to
meet each of them.
Few others emphasize only
one or two and few do not
acknowledge it at all) General
Social
Welfare

G. Cadornigara
3. Ethics and Governance in Business & Social Responsibility

G. Cadornigara
4. Types of Business Organizations

Types of Business Organizations

1. Sole Proprietorship – owned by a single person.

2. Partnership – composed of two or more persons

who agree to contribute money, property or services
for the purpose of dividing the profits between or
among themselves.
4. Types of Business Organizations

Types of Business Organizations

3. Corporation – Sec. 2, Revised Corporation Code of
the Philippines , is defined as an artificial being
created by operation of law that has the right of
succession and the powers, attributes and properties
expressly authorized by law or incidental to its
existence.
4. Types of Business Organizations
Sole Proprietorship
ADVANTAGES DISADVANTAGES
1. Ease of formation 1. Limited life
2. Control over operation 2. Unlimited liability
3. No sharing of profits 3. Difficulty in raising
capital
4. Simplicity 4. Limitation of skills
5, No taxation
4. Types of Business Organizations
Partnership
ADVANTAGES DISADVANTAGES
1. Convenient 1. Limited life
organization
2. Manageability 2. Unlimited liability
3. Good capitalization 3. Mutual agency
4. Difficulty in raising
capital
4. Types of Business Organizations

Corporation
ADVANTAGES DISADVANTAGES
1. Limited liability 1. Double taxation
2. Indefinite life 2. More government
control
3. No mutual agency 3. More costly to organize
4. Ease of obtaining 4. More involved in
additional capital decision-making process
5, Ease of transfer of 5. Dilution of earnings and
ownership interest control
6. Separate legal entity
4. Types of Business Organizations

Agency Theory
a. Stockholders and managers
TYPE OF ORGANIZATION POTENTIAL CONFLICTS

Sole Proprietorship Share of company to outsiders into

corporation
-- Shared ownership is relaxed,
knowing that wealth will accrue to
other stockholders
Sole proprietor is less frugal with money
knowing that some costs are carried
by others
Corporations Managers do not own even a small
percentage of company’s stocks.
Thinking of more of an employee rather
an owner
4. Types of Business Organizations

Agency Theory
a. Stockholders and managers
INCENTIVES PUNISHMENTS

Attractive-compensation No bonus
package
Bonus Threat of termination
Stock options No increase in salary

Threat of takeovers
4. Types of Business Organizations
Agency Theory
b. Stockholders and creditors
SITUATIONS POTENTIAL CONFLICTS

Take over Punishment to stockholders and not on

managers
Management undertake Increased Risk – creditor will increase
huge project that is too risky, interest and small amount of loan.
which is overlooked by Success – benefits to stockholders;
creditors disadvantage to creditors with small
interest rate on loans
Faiure –creditors will share the loss due
to non-payment of interest and
principal
Conclusion Creditors will protect themselves from
stockholders by restriction on loans
Misconceptions about Financial Management

1. Financial Management is n accounting provides financial

accounting information to arrive at a sound decision
n Financial accounting has accounting
standards; financial management
conform with traditional standards

2. Financial Management is a n Multiple formulas are used before

review of mathematics making a decision
n Mathematics is a tool in decision making

3. Financial Management is a n Statistics used to ascertain the risks

branch of statistics before making a decision
End of Chapter 1
5. Financial Reports

Importance of Financial Reports

The role of financial reporting is to give stakeholders,

from internal management teams to external
investors, the financial performance information
they need. It forms the backbone for financial
planning, analysis and benchmarking. Without it, it
can be difficult to make informed decisions about
the best ways to manage and grow a business or
whether to invest in it.
5. Financial Reports

Goals why the need to use Financial Reports

To provide information to investors – investors want

to know the return on their investment whilst
potential investors want to know how a company
has performed before they invest their funds.

To track business cash flow – financial reporting

shows different stakeholders where cash is coming
and going from.
5. Financial Reports

Goals why the need to use Financial Reports

To report on accounting policies – different

companies have different accounting policies,
financial reports allow investors and stakeholders to
compare these policies.

To enable the analysis of assets and more –

financial reporting highlights any changes in a
company's assets, liabilities and equity, allowing
these to be analyzed.
6. Financial Statements

Financial Statements

1. Information about the financial position,

result of operations and cash flow;

2. Tool to understand the performance;

3. Forecasting Device
6. Financial Statements

Financial Statement

4. Used for financing, investing and

formulating dividend policy;

5. Capability to produce cash

6. Financial Statements

Components of Financial Statement

1. Balance Sheet – financial position;

2. Income Statement – result of operations;

6. Financial Statements

Components of Financial Statement

3. Statement of Stockholder’s Equity –
movements of the components of equity:

a. Issuance of Stocks
b. Retained Earnings
c. Declaration of cash dividends
d. Distribution of stock dividend
e. Purchase and sale of treasury stock
f. Accumulated other comprehensive income
g. Correction of errors
6. Financial Statements

Components of Financial Statement

4. Statement of Cash Flow

– shows the company’s cash receipts and payments.

Ways to use:
a. cash flow from operating activities is compared with
company’s net income;
b. identifies the cash that is coming and out;
c. basis for financial decisions such as capital budgeting.
6. Financial Statements

Components of Financial Statement

5. Accounting policies and notes to Financial
Statements
– guidelines used in the preparation of financial
statements; detailed information does not
appear in the financial statements.
6. Financial Statements
Limitations of Financial Statements

1. There are variations in the Applications vary because

application of accounting companies use different methods
principles and procedures.
2. Financial statements are interim FS are prepared at every interval.
in nature Mere estimates
3. Financial statements do not Presented at historical cost.
reflect changes in the purchasing
power of the peso
4. Financial statements do not Non-quantitative Information about
contain all the significant facts the company is not presented in FS.
about the business
6. Financial Statements

Free Cash Flow (FCF)

FCF = [EBIT(1-T) + DA] – [CAPEX + ANOWC]

1. Cash produced from operating activities

after considering the capital expenditures and
the changes in working capital (CA - CL);
2. Positive FCF = increase in future earnings;
3. Negative FCF = improve earnings’ growth
6. Financial Statements

Market Value Added (MVA)

MVA = Outstanding Shares x (MV – BV)

1. Efficiency in using capital;

2. Determining wealth maximization (the
higher the MVA, the better);
3. May not show the true performance of a
company.
6. Financial Statements

Economic Value Added (EVA)

EVA = EBIT(1-T) – (Total Invested Cap x WACC)

1. Profitability of project;
2. Reflects the efficiency and profitability in
investments made;
3. Shows accounting profit and economic
profit
7. Ratio Analysis

Financial Statements Analysis

n evaluation of the past and current performance

n forecast of the future
n comparison of one company with another (same
size, industry average or norm)
n involves calculations
7. Ratio Analysis

Financial Statements Analysis

n Investor’s Standpoint: forecasting the future of the

company

n Management’s Point of view: determining future

conditions; starting point for actions to improve the
company’s future performance
7. Ratio Analysis
Role of a Financial Statement Analysts in Decision Making
n focus on company’s financial strength, liquidity, safety of
investments, effectiveness of management & profitability
growth rates to ascertain its value or credit worthiness

n must understand the industry practices to properly evaluate

the company’s financial performance

n understand the company’s business, objectives, products or

services, market and customers
7. Ratio Analysis

Role of a Financial Statement Analysts in Decision Making

n review the pages that discuss different operations and

business environment particularly on management’s
discussions and analysis of operations and financial
condition
n review of financial footnotes to understand accounting
practices
n examine financial information summary to get the overview
n evaluate company’s strength and performance
7. Ratio Analysis

Financial Statements Analysis

Horizontal Analysis - evaluate the trend over the years

1. Comparative Statements –financial data are

compared for two specific years to show increase or
decrease in the account balances

2. Trend Ratio – present financial ratio is compared

with its past and expected future ratios to determine
whether or not the company’s financial condition is
improving or deteriorating
7. Ratio Analysis
Financial Statements Analysis
Vertical Analysis - uses a significant item in the
financial statement as a base value, and all other
items in the financial statement are compared with it.

1. Common-size statement – each account in the

financial statement is expressed by dividing them to a
common base account (total assets, liabilities and
equity and sales or net sales)
7. Ratio Analysis

Financial Statements Analysis

2. Financial Ratios
a. Liquidity Ratio - determines the company’s ability to
meet maturing short-term obligations
b. Activity or asset management ratio – determines how
quickly various accounts are converted into sales or cash
c. Leverage ratio (solvency) – determines the company’s
ability to meet maturing long-term obligations
7. Ratio Analysis
Financial Statements Analysis

2. Financial Ratios
d. Profitability ratio – shows profitability of the
operations of a company
e. Market value ratio - relates the company’s stock price
to its earnings
7. Ratio Analysis

Financial Statements Analysis

Horizontal Analysis - evaluate the trend over the years

1. Comparative Statements

!"#$ &'"( )*"#' &'"(

= x 100%
*"#' &'"(
= percentage increase/decrease of an account
(see Illustration 3 and 4)
7. Ratio Analysis

Financial Statements Analysis

Horizontal Analysis - evaluate the trend over the years

2. Trend Ratio –
!"#$ &
= x 100% computation for the year after the base year
'#(" )"#$
!"#$ *
= x 100% computation for two years after the base year
'#(" )"#$
(see Illustration 3)
7. Ratio Analysis
Financial Statements Analysis
Vertical Analysis
1. Common-size statement – each account in the
financial statement is expressed by dividing them
to a common base account (total assets, liabilities
and equity and sales or net sales)
Common-size analysis is used to show the internal
structure of a company.
(see Illustration 6)
7. Ratio Analysis
Financial Statements Analysis
2. Financial Ratios
Two Types of Comparison:
a. Industry Comparison: a company may be able to
compare its performance against its competitors’ and
how it fares with them.

b. Trend Comparison: a company will know if its financial

performance is improving or not over the years.
7. Ratio Analysis

Liquidity Ratio: is a financial metric used to assess an

organization’s or individual’s ability to meet short-term
obligations with its most liquid assets. It measures
measure how easily and quickly a company can convert its
assets into cash to pay off its current liabilities.

These ratios are crucial indicators of financial health,

particularly in evaluating whether an organization has
enough resources to cover its immediate debts.
7. Ratio Analysis

Liquidity Ratio:
a. Working Capital
= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Having a positive working capital means a company is able

to meet its current measuring obligations with a safety
cushion to meet other unexpected or unrecorded current
liabilities.
7. Ratio Analysis

Liquidity Ratio:
b. Current Ratio
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

This ratio measures the ability to pay off short-term

liabilities with short-term assets. A current ratio above 1
indicates that the entity has more current assets than
current liabilities, which is generally seen as a good sign of
liquidity.
7. Ratio Analysis

Liquidity Ratio:
c. Quick Ratio (Acid-Test Ratio)
𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠 + 𝐴/𝑅
=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

This ratio is more stringent measure of liquidity than the

current ratio. It excludes inventory from current assets, as
inventory may not be as quickly converted to cash as other
assets. A quick ratio above 1 is generally considered good
indication of liquidity.
7. Ratio Analysis

Liquidity Ratio:
d. Cash Position Ratio
𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠
=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

This ratio measures the company’s ability to cover its

short-term liabilities using only its most liquid assets. It
provides the most conservative view of liquidity.
7. Ratio Analysis

Asset Ratio Management: often referred to as “asset

management ratios” or “efficiency ratios” involves
analyzing financial ratios that assess how effectively a
company is utilizing its assets to generate revenue and
maximize returns. These ratios help in understanding the
efficiency of asset use within a company, ensuring that
resources are not utilized or over-utilized.
7. Ratio Analysis

Asset Ratio Management :

a. Accounts Receivable Turnover Ratio
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

This ratio shows how efficiently a company collects

revenue from its credit customers. A high ratio indicates
that the company collects its receivable quickly, which is
positive for cash flow. A lower ratio may indicate
collection problems or overly lenient credit policies.
7. Ratio Analysis

Asset Ratio Management :

b. Average Collection Period
360
=
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

The average collection period measures the efficiency of

the company’s collection policy by computing the number
of days to collect the receivables.
7. Ratio Analysis

Asset Ratio Management :

b. Average Collection Period
Usage in Decision-Making:
1. Cash Flow Management: Understanding the average collection
period helps companies manage cash flow by anticipating when cash
will be available.
2. Credit Policy Evaluation: A longer than desired collection period
might prompt a company to tighten its credit policies or improve its
collection efforts.
3. Customer Relationships: The average collection period can also be
used to evaluate the creditworthiness of customers or to identify
potential risks in customer segments.
7. Ratio Analysis

Asset Ratio Management :

c. Inventory Turnover Ratio
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

This ratio measures how many times a company’s

inventory is sold and replaced over a period. A higher ratio
indicates efficient inventory management, meaning the
company is effectively converting its inventory into sales.
A lower ratio may suggest overstocking or sluggish sales.
7. Ratio Analysis

Asset Ratio Management :

d. Average Age of Inventory
360
=
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
..is a financial metric that indicates the average number of
days that inventory items are held by a company before
they are sold. It is a key indicator of inventory
management efficiency, reflecting how quickly a company
is able to convert its inventory into sales.
7. Ratio Analysis

Asset Ratio Management :

d. Average Age of Inventory
Usage in Decision-Making:
1. Inventory Management: The average age of inventory helps companies
assess the effectiveness of their inventory management strategies. A
lower age can lead to reduced storage costs and minimize the risk of
inventory becoming outdated.
2. Supply Chain Efficiency: It can provide insights into the efficiency of the
supply chain, including procurement, production and sales processes.
3. Product Lifecycle: For companies dealing with perishable goods or
products with short life cycles, monitoring the average age of inventory is
crucial to avoid losses due to spoilage or obsolescence.
7. Ratio Analysis

Asset Ratio Management :

e. Accounts Payable Turnover Ratio
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
..is a financial metric that measures how quickly a
company pays off its suppliers (or creditors) within a given
period. It shows the number of times a company pays its
average accounts payable during a specific period, usually
a year. This ratio is an indicator of a company’s
creditworthiness and financial stability.
7. Ratio Analysis

Asset Ratio Management :

f. Average Age of Payable (Average Payment Period)
360
=
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
..is a financial metric that measures the average number of
days it takes for a company to pay its suppliers after
receiving goods or services. This metric helps in assessing
the efficiency if a company’s payment practices and how
well it manages its short-term liabilities.
7. Ratio Analysis

Asset Ratio Management :

f. Average Age of Payable (Average Payment Period)
Usage in Decision-Making:
1. Cash Flow Optimization: Companies can use the average age of payables
to manage their cash flow effectively, ensuring they are not paying too
early or too late.
2. Supplier Negotiations: Understanding the average age of payable can help
in negotiating better credit terms with suppliers, balancing the need to
maintain good relationships with the need to optimize cash management.
3. Comparison with Industry Norms: Comparing the average age of payable
with industry averages can provide insights into whether the company is
more or less efficient in managing its payables compared to its peers.
7. Ratio Analysis

Asset Ratio Management :

g. Operating Cycle
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 𝑝𝑙𝑢𝑠 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

..is a financial metric that measures the time it takes for a

company to purchase inventory, sell the products and
collect cash from the sales. It is also referred to as the
“cash conversion cycle”, though the cash conversion cycle
includes the time it takes to pay suppliers, while operating
cycle focuses solely on inventory and receivables.
7. Ratio Analysis

Asset Ratio Management :

g. Operating Cycle
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 𝑝𝑙𝑢𝑠 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

The operating cycle is crucial for understanding how

efficiently a company manages its working capital. A
shorter operating cycle means the company can quickly
turn its investments in inventory back into cash, which is
generally favorable for liquidity and operational efficiency.
7. Ratio Analysis

Asset Ratio Management :

h. Fixed Asset Turnover Ratio
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
It measures how well the company uses every peso of
fixed asset invested to generate sales. It becomes a good
indicator of efficiency using fixed assets
7. Ratio Analysis

Asset Ratio Management :

i. Total Asset Turnover Ratio
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
It measures how efficiently a company uses its assets to
generate sales. A higher asset turnover ratio indicates that
the company is using its assets efficiently to produce
revenue. A lower ratio may suggest inefficiency or
underutilization of assets.
7. Ratio Analysis

Asset Ratio Management :

j. Capital Intensity Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
=
𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
… is a financial metric that measures the amount of capital
investment needed to generate a unit of revenue. It
indicates how much of a company’s assets are tied up in
generating sales, reflecting the efficiency of asset use. A
higher capital intensity ratio suggests that a company
requires more capital to generate revenue, while a lower
ratio indicates a more efficient use of assets.
7. Ratio Analysis
Asset Ratio Management :
j. Capital Intensity Ratio
Usage in Decision-Making:
1. Asset Management: Capital Intensity Ratio helps companies evaluate how
efficiently they are using their assets to generate revenue. A high ratio
might prompt a company to review its asset management strategies to
improve efficiency.
2. Industry Comparison: Comparing the capital intensity ratio across
companies within the same industry can provide insights into operational
efficiency and capital management. Companies with lower ratios may
have a competitive advantage due to more efficient use of resources.
3. Investment Decisions: Investors might use the capital intensity ratio to
assess the asset requirements of a business. Capital-intensive companies
may have a higher fixed costs, which could lead to a higher financial risks if
revenues fluctuate
7. Ratio Analysis
Risk and Return Trade-off Between Liquidity and Activity Ratios:

SITUATION LOW RISK HIGH RISK LOW RETURN HIGH RETURN

High Current Assets

High Current Assets

than Fixed Assets
Investment on Fixed
Assets
7. Ratio Analysis

Leverage Ratio:

..is a financial metric that evaluates the extent to which a

company uses debt (or leverage) to finance its operations
and growth. Leverage ratios are crucial in assessing the
financial risk and stability of a company, as higher leverage
typically indicates higher risk due to the obligation to meet
debt payments.
7. Ratio Analysis
Leverage Ratio:
Usage in Decision-Making:
1. Assessing Financial Risk: Leverage ratios help investors, creditors and
management assess the level of financial risk associated with a company.
High leverage can be risky, especially in periods of economic downturn,
but it can also increase returns during strong economic conditions.
2. Investment Analysis: Investors often use leverage ratios to determine
whether a company is a good investment. Companies with lower leverage
ratios may be more stable than less risky, while those with higher ratios
may offer higher returns but come with greater risk.
3. Creditworthiness: Creditors use leverage ratios to assess the
creditworthiness of a company before issuing loans. A high debt ratio,
might indicate that the company is already heavily leveraged and could
have difficulty taking on additional debt.
7. Ratio Analysis

Leverage Ratio:
a. Debt Ratio
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

This ratio measures the percentage of a company’s assets

that are financed by debt. A higher debt ratio indicates
that a larger portion of a company’s assets is financed by
debt, which could signal higher financial risk.
7. Ratio Analysis

Leverage Ratio:
b. Debt to Equity Ratio
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=
𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦

This ratio compares a company’s total debt to its

stockholders’ equity. It shows the proportion of debt
financing relative to equity financing. A higher ratio
indicates that a company is more leveraged, meaning it
relies more on borrowed funds than on equity.
7. Ratio Analysis

Leverage Ratio:
c. Times Interest Earned Ratio (Interest Coverage Ratio)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑇𝑎𝑥𝑒𝑠 (𝐸𝐵𝐼𝑇)
=
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒

This ratio measures a company’s ability to meet its interest

obligations from its operating earnings. A higher ratio
indicates that a company can easily cover its interest
payments, while a lower ratio suggests potential
difficulties in meeting these obligations.
7. Ratio Analysis

Leverage Ratio:
d. Fixed Payment Coverage Ratio
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑇𝑎𝑥𝑒𝑠 𝐸𝐵𝐼𝑇 + 𝑅𝑒𝑛𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
=
𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑅𝑒𝑛𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 + ( 1 −𝑇 )

It measures the coverage capability broader than the times

interest earned ratio by considering other fixed charges
such as rent and preferred stock dividend.
7. Ratio Analysis

Profitability Ratio:

..is a financial metric used to assess a company’s ability to

generate profit relative to its revenue, assets, equity, and
other financial aspects. These ratios are crucial for
evaluating a company’s financial health and its ability to
generate earnings. It is often used by investors, analysts
and management to compare a company’s performance
over time or against competitors.
7. Ratio Analysis

Profitability Ratio:

..is a vital tool for evaluating a company’s ability to

generate earnings relative to various financial metrics. It
offer insights into operational efficiency, financial health
and the potential for future growth, making it essential for
stakeholders in decision-making processes.
7. Ratio Analysis
Profitability Ratio:
Usage in Decision-Making:
1. Performance Evaluation: Profitability ratios help access a company’s
performance over time, highlighting trends in profitability that can inform
strategic decisions.
2. Investment Analysis: Investors use these ratios to to compare companies
and identify those that generate higher profits relative to sales, assets and
equity.
3. Operational Efficiency: Management can use profitability ratios to identify
areas where costs might be reduced or where operations might be
streamlined to improve margins.
7. Ratio Analysis

Profitability Ratio:
a. Gross Profit Margin
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
=
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Purpose: This ratio measures the percentage of revenue that

exceeds the cost of goods sold. It indicates how efficiently a
company produce and sells its goods.
Interpretation: A higher gross profit margin suggests that a
company is producing its goods at a lower cost relative to its sales,
which is generally favorable.
7. Ratio Analysis

Profitability Ratio:
b. Profit Margin
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑒𝑠
=
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Purpose: This ratio measures the percentage of revenue left after

covering operating [Link] reflects the company’s efficiency in
managing its operating costs.
Interpretation: A higher profit margin indicates better control over
operating costs relative to revenue.
7. Ratio Analysis

Profitability Ratio:
c. Return on Investment
Return on Total Assets (ROA)
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Purpose: ROA measures how effectively a company uses its assets
to generate profit. It shows the profitability relative to the
company’s total assets base.
Interpretation: A higher ROA indicates more efficient use of assets
to generate earnings.
7. Ratio Analysis

Profitability Ratio:
c. Return on Investment
DuPont Analysis Return on Total Assets (ROA)

,'$ -./01' ,'$ -./01' "7$'( $"8'# ,'$ 9"6'#

= x
23'.50$"6 2##'$# ,'$ 9"6'# 23'. 50$"6 2##'$#
7. Ratio Analysis

Profitability Ratio:
c. Return on Investment
Return on Equity (ROE)
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦
Purpose: ROE measures how effectively a company uses
stockholders’ equity to generate profit. It shows the return
generated on the stockholders’ investment.
Interpretation: A higher ROE indicates that the company is
generating more profit per peso of equity, which is favorable for
stockholders.
7. Ratio Analysis

Market Value Ratios:

..are financial metrics that assess a company’s current

stock price relative to its earnings, dividend, book value
and other financial data. These ratios are particularly
important for investors and analysts as they provide
insights into the market’s perception of a company’s value,
its growth potential and its financial health.
7. Ratio Analysis

Market Value Ratios:

Usage in Decision-Making:
1. Value Assessment: Market Value Ratios help investors assess
whether a stock is overvalued or undervalued based on various
financial metrics.
2. Comparative Analysis: These ratios are useful for comparing
companies within the same industry or sector, as they provide
insights into how the market values different companies relative
to their earnings, sales and book value.
3. Investment Decisions: Investors use these to make informed
decisions about buying, holding or selling stocks.
7. Ratio Analysis

Market Value Ratios:

a. Earnings per Share (EPS)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑒𝑠 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡
=
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

This measures the income generated per common stock held. EPS
is useful indicator of a company’s profitability.
7. Ratio Analysis

Market Value Ratios:

b. Price/Earnings (P/E) Ratio

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

=
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
Purpose: This measures the price the investors are willing to pay
for each peso of earnings. It indicates how expensive or cheap a
stock is relative to its earnings.
Interpretation: A high P/E ratio may indicate that the market
expects future growth in earnings, while a low P/E ratio could
suggest that the stock is undervalued or that the company is
experiencing difficulties.
7. Ratio Analysis

Market Value Ratios:

c. Book Value Per Share

𝑇𝑜𝑡𝑎𝑙 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘

=
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑟𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
This is the value of the company from the perspective of
accounting, whereas the market value signifies the market
valuation of the companys’ equity.
7. Ratio Analysis

Market Value Ratios:

d. Market-to-Book Value Ratio
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
Purpose: This ratio compares a companys’ market value to its book
value (net asset value). It shows how much investors are willing to
pay for each peso of net assets.
Interpretation: A ratio greater than 1 suggests that the market
values the company higher than its book value, often due to
expected future growth or intangible assets not reflected in the
balance sheet. A ratio less than 1 might indicate that the stock is
undervalued or that the company is in financial trouble.
7. Ratio Analysis

Dividend Ratios:
a. Dividend Yield
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
Purpose: This measures the annual dividend income relative to the
stock’s price. It shows how much cash flow investors receive for
every peso invested in the stock.
Interpretation: A higher dividend yield might attract income-
seeking investors, while a lower yield could suggest that company is
reinvesting earnings for growth rather than paying them out of
dividends.
7. Ratio Analysis

Dividend Ratios:
b. Dividend Payout Ratio
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
This measures how much of the earnings per share was declared as
dividend.
8. Uses and Limitations of Ratio Analysis

Uses of Ratio Analysis

1. Helps in decision-making
2. Helps in financial forecasting and
planning
3. Helps in communicating
4. Helps in coordination
5. Helps in control
8. Uses and Limitations of Ratio Analysis

Uses of Ratio Analysis

6. Other Uses:
a. Utility to Shareholders/Investors
b. Utility to Creditors
c. Utility to Employees
d. Utility to Government
e. Tax Audit Requirements
8. Uses and Limitations of Ratio Analysis

Limitations of Ratio Analysis

1. Limited use of a single ratio
2. Lack of adequate standards
3. Inherent Limitations of accounting
4. Change of accounting procedure
5. Window Dressing
8. Uses and Limitations of Ratio Analysis

Limitations of Ratio Analysis

6. Personal Bias
7. Un-comparable
8. Absolute Figures Distortive
9. Price Level Changes
10. Ratios no subsititutes
11. Clues not conclusions
Statement of Cash Flow

One of the primary financial statements used by companies to

report the cash inflows and outflows over a specific period,
typically a quarter of a year. It provides valuable insights into a
company’s cash-generating activities and its ability to manage its
cash flow, which is critical for maintaining liquidity and financing
operations.
Main Sections:
1. Operating Activities
2. Investing Activities
3. Financing Activities
Importance of Statement of Cash Flow
1. Liquidity Management: It helps assess a company’s ability to
generate cash to meet its short-term obligations and
operational needs.
2. Investment Decisions: Investors use this statement to evaluate
whether a company is generating enough cash to support its
operations, pay dividends and invest in growth.
3. Financial Health: it provides a clearer picture of a company’s
financial health than the income statement or balance sheet
alone, as it focuses solely on cash flow, which is less subject to
accounting estimates and non-cash items.
4. Creditworthiness: Creditors analyze cash flow statements to
determine a company’s ability to repay its debt and interest
obligations.
End of Chapter 2
Financial Forecasting

Projection of future sales, revenues, earnings, costs, and other

possible variables that are helpful in the company’s operations.

It is a starting point of business planning, making it one of the most

important functions to be applied to a business.

Primary objective of this is to reduce the risk or uncertainty that a

company will face in making a decision.
Importance of Financial Forecasting
1. Budgeting and Planning: It is the foundation for creating a
company’s budget. It helps businesses allocate resources
efficiently, plan for a future growth, and ensure that they have
enough cash on hand to meet obligations.
2. Managing Cash Flows: Accurate forecast of cash inflows and
outflows help businesses avoid cash shortages, manage liquidity
and ensure that they can meet expenses and obligations when
due.
3. Performance Monitoring: Forecasts provide benchmarks that
businesses can use to measure their actual performance
against. This allows them to identify variances and make
adjustments as needed,
Importance of Financial Forecasting

4. Investment and Financing Decisions: Financial forecasts are

crucial for securing funding from investors or lenders. A company
that can present reliable projections of future growth and
profitability is more likely to attract investment or secure loans.
5. Strategic Decision-Making: Businesses use financial forecasts to
make important strategic decisions, such as expanding into new
markets, launching new products or acquiring other companies.
Users of Financial Forecasts

USERS PURPOSES
1. Top Management Tool for long range planning
2. Production Manager Determining amount of raw
materials for production
3. Purchasing Manager Ascertain the bulk of materials
to be purchased
4. Marketing Manager Forecasting of sales and plan
for promotional and
advertising activities
5. Finance Manager Anticipation of funding
needed
6. Human Resource Manager Needed human resources
Forecasting Approaches
1. Qualitative (for judgmental) forecasts:
a. Expert Opinions: Relies on the insights of experienced
managers, industry experts and consultants to make
projections based on their knowledge and expertise.
b. Delphi Method: Same with expert opinions but the
difference is that members are asked individually about
their forecast of future events.
c. Sales Force Pulling: Sales professional estimates the
sales in their region.
Forecasting Approaches
1. Qualitative (for judgmental) forecasts:
d. Consumer Market Survey: This is done to improve
product design, planning for new products and
determining consumer behavior.
e. PERT-derived forecasts (Program Evaluation and Review
Technique): Estimating financial outcomes when future
events are uncertain.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting: Assumes that the future is a
function of the past. Historical data are used to predict
the future using sequences with equal periods.
b. Associative or Casual Model: Particularly linear
regression, incorporate the variables or factors that
might influence the data being forecasted.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
1. Naive Model (Benchmark Model): Assuming that the
demand in the next period will be equal to the demand in
the most recent period.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
1. Naive Model (Benchmark Model):
ADVANTAGES DISADVANTAGES
1. It is cheap to develop. 1. It does not attempt to explain
casual relationships with the
forecasted variables.
2. It does not require any software or 2. A drastic change in the variable for
machine. forecasting is not captured.
3. Storing data is simple because all
one has to do is keep the previous
records.
4, It is very easy to operate because
it does not require or use complex
mathematical applications.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
2. Moving Average: the number of period n, in which a
series of averages will be created and computed,
should be decided.
ADVANTAGES DISADVANTAGES
1. It is simple to use. 1. It requires numerous records and
data.
2. It is easy to understand. 2. Updating the records and data
needed to conduct a forecast is
convenient.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
3. Weighted Moving Average: the number of period n, in which a
series of averages will be created and computed, should be
decided.
Potential Problems:
1. They are less sensitive to real changes as the period under
observation increases.
2. They require extensive records of the past data.
3. They do not pick up trends as well.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
4. Exponential Smoothing: It is supported by the belief that the
future is more dependent on the recent past than on the distant
past. This method is known to be useful on random historical data
with no seasonal fluctuations.
Forecasting Approaches
2. Quantitative forecasts:
a. Time Series Forecasting:
5. Trend Projections: It fits a trend line to a series of historical data
points and projects the line into the future for medium to long
range forecasts.
Forecasting Approaches
2. Quantitative forecasts:
b. Associative or Casual Model:
Linear Regression: shows the relationship between two
variables: the dependent and the independent variables.
Forecasting Approaches
2. Quantitative forecasts:
b. Associative or Casual Model:
Standard Error of the Estimate: to measure the accuracy of
the regression estimates, Syx must be solved. It measures
the error from the dependent variable, y, to the regression
line, rather than to the mean.
End of Chapter 3
Financial Planning and Budgeting

Focuses on what the company intends to do in the future.

Covers the processes of setting the primary objective, identifying

the alternative courses of action and choosing the best alternative
to achieve the objective.

Involves the whole company.

Dimensions of Planning
1. Short Range:
a. Covers 12-months.
b. Provides many details and direct guidelines from time
to time to the different heads of a company.
c. Serves as guide to determine what to achieve.
d. At the end of the year, it serves as a control or
measuring device.
e. It helps a company analyze the differences in the action
plan and actual performance so that future
performances are improved.
Dimensions of Planning
2. Long Range:
a. Time frame from two years and up
b. More difficult and more prone to errors because of the
time frame involved
c. It helps the company see how far it has gone in terms of
what has been planned in the past
d. Subject to changes and is usually revised every year to
incorporate perceptions about the future
Financial Plan

Budget.

Formal statement prepared by a company with regard to the

expected sales, expenses, production and other financial
transactions for a certain period.

Variance between the financial plan and the actual performance is

analyzed and if needed corrective action is adopted.
Approaches to Financial Planning

APPROACHES
1. Zero-Based approach n Baseline is zero
n Previous budget is irrelevant
n Requires a lot of documentation
n Execution is long period of time
and cost is too expensive
2. Incremental-based n Traditional approach to budgeting
approach n Starts with the previous year’s
budget
n Incremental is always subject to
justification
Objectives of Financial Planning

1. Planning: It helps a company determine its objectives and

courses of action.
2. Coordination: It creates a harmonious relationship between the
different units of a company.
3. Control: It is an important tool in enhancing and measuring the
performance of a company.
Master Budget

n Combined budget of the different units in a company

1. Operating Budget: takes the form of a budgeted income

statements showing the operating results of a company in the
coming year

2. Financial Budget: shows the budgeted financial needs of a

company is prepared right after the operating budget
Operating Budget

1. Sales budget
2. Production budget
3. Ending inventory budget
4. Direct materials budget
5. Direct labor budget
6. Factory overhead budget
7. Selling and administrative budget
8. Pro forma income statement
Financial Budget

1. Cash budget: prepared to determine the financial needs of a

company

2. Pro form balance sheet: presents the forecasted components of

the balance sheet at a future date
Basic Steps in Preparing Budget

1. Company’s sales 7. Inventory level

2. Production volume 8. Cost of goods sold
3. Materials’ cost 9. Selling and administrative expenses
4. Materials’ purchased 10. Cash budget
5. Direct labor cost 11. Pro forma income statement
6. Factory overhead 12. Pro forma balance sheet