Managerial Finance
Dr. Rabab Khamis
Midterm: 30 degree @ lec 5
Project: 20-degree group of 5 and chose company listed in the stock market in Egypt
Attendance and participation: 10 degree
Final exam: 40 degree
Study from BOOK and notes
Difference between accounting and finance
Accounting: it is the process of identifying, summarizing and recording and
communicating information to end users.
There are two types of accounting:
1. Financial accounting main output is the financial statements
2. Managerial accounting
AREA 0F
ACCOUNTING
Financial accounting
‫محاسبة مالية‬
1.
2.
3.
4.
Managerial accounting
‫محاسبة ادارية‬
Financial statements
Custom performance analysis and
‫القوائم المالية‬
reports
‫وهي الهدف الرئيسي من المحاسبة المالية‬
‫تقارير التكلفة واالداء‬
‫ قوائم وهي‬4 ‫والقوائم المالية تتكون من‬
‫وهي تعتبر الهدف الرئيسي من المحاسبة‬
‫االدارية‬
Income statement
‫ومن امثلتها‬
‫وهدف قايمة الدخل تحديد المكسب او الخسارة ولذلك تحتوي‬
• breakeven analysis
‫علي االيرادات والمصروفا ت‬
Income statement will show profit or loss as it • Profit planning or budgeting:
will compare between expenses and revenues • Differential analysis
Statement of cash flow
‫والهدف النهائي هو اتخاذ قرار مستقبلي‬
Will show cash inflows and cash outflows
Statement of owners’ equity ‫قايمة حقوق ملكية‬
Will show the owners equity change from one
year to another
Balance sheet (statement of finical positions)
this will show the below
Assets -Liabilities -Owner equity
Notes: The statement of owner’s equity is a financial statement that reports changes in equity
from net income (loss), from owner investment and withdrawals over a period of time.
Statement of cash flow:
Identifies cash inflows and cash outflows over a period of time
Why we make statement for cash only: cash is the king as In finance we
always care about cash not the net income
Cash flow from three main activities:
• Operations activities the most important source is operations activities
• investing activities
• financing activities (from liabilities and equity)
Assets ‫ االصول‬: Any economic resources owned or controlled by a company or a
business and These resources are expected to Provide future benefits.
‫االصول هي اي مصادر اقتصادية تمتلكها الشركة ويتوقع ان تحقق عائد مستقبلي‬
‫ ليس اصال‬HR ‫الحظ انه هنا ذكر ان االصول هي مصادر اقتصادية فقط فمثال ال‬
There Are Two Types of Assets classified by maturity ‫تم تصنيف االصول طبقا لعمر االصل‬
Assets
Current assets = short term assets
Fixed assets = long term assets ‫االصول‬
‫االصول المتداولة او االصول قصيرة االجل‬
‫الثابتة او االصول طويلة االجل‬
Assets with a maturity less than one year Assets with a maturity more than one
‫هي االصول التي عمرها سنة او قل‬
year
‫هي االصول التي عمرها اكثر سنة‬
Most of current assets should be
Expected to be held for more than one
liquidated (converted to cash) with in
year
one year
utilization ‫والهدف منها هو ال‬
‫تسيل خالل سنة فالهدف االساسي منها هو السيولة‬
Examples:
Examples:
Cash
Land
Inventory
Building
Office supplies
Equipment
Receivables
Machines
receivable is used to refer to an asset that promises a future inflow of resources.
A company that provides a service or product on credit is said to have an account receivable
from that customer.
Note: liabilities and owners equity are sources of financing assets
Liabilities :‫ الديون‬Depts ‫الديون‬And Obligations ‫وااللتزامات‬Against
Business and Expected to Provide Negative Cash Flow in The Future
The term payable refers to a liability that promises a future outflow of resources.
Examples are wages payable to workers, accounts payable to suppliers, notes payable to
banks, and taxes payable to the government.
There Are Two Types of Liabilities classified by maturity ‫تم تصنيف الديون طبقا لفترة االستحقاق‬
Liabilities ‫الديون‬
Current Liabilities = short term
Liabilities ‫الديون المتداولة او الديون قصيرة‬
‫االجل‬
Liabilities with a maturity less than one
year
‫هي الديون التي عمرها سنة او قل‬
Most of current liabilities should be paid
within one year
Payment is due with in one year
Examples:
Payables
Short term loans
long term Liabilities ‫الديون طويلة االجل‬
Liabilities with a maturity more than one
year
‫هي الديون التي عمرها اكثر سنة‬
Examples:
Long term loans
Bonds ‫السندات‬
Equity ‫ الملكية‬is the owner’s claim on total assets.
owner’s share in the business
Equity is equal to assets minus liabilities. This is the reason equity is also
called net assets or residual equity.
Equity for a noncorporate entity—commonly called owner’s equity
Equity increases and decreases as follows: owner investments and revenues
increase equity, whereas owner withdrawals and expenses decrease equity.
ASSETS = LIBILITIES + OWENER EQUITY
Why assets should be equal to liabilities and owners’ equity:
As we can finance (purchase) assets from liabilities or owner equity
As the total value of the business's Assets will ALL have been funded through
Liabilities and Equity.
Means liabilities and owners’ equity are the sources of company assets
owner’s equity:
• Owner investments (capital) are assets an owner puts into the company and
are included
under the generic account Owner, Capital. (capital affected by the below 3 )
• Revenues are sales of products or services to customers.
Revenues increase equity (via net income) and result from a company’s
earnings activities.
Examples are consulting services provided, sales of products, facilities rented
to others, and commissions from services.
• Owner withdrawals are assets an owner takes from the company for personal
use.
• Expenses are the costs necessary to earn revenues. Expenses decrease equity. \
Examples are costs of employee time, use of supplies, and advertising, utilities,
and insurance services from others.
‫‪Finance: Managing of funds. Investments and Savings (investment should offer‬‬
‫‪returns that are higher than interest rates in banks as high risk should be compensated‬‬
‫‪with high returns, borrowing decisions.‬‬
‫هو علم ادارة الفلوس‬
‫‪If income more than expenses: surplus of funds‬‬
‫اذا كان الدخل اعلي من المصروفات يحدث ما يسمي فائض في االموال وهنا البد من استثمار‬
‫هذا الفائض للمحافظة علي ‪ Purchasing power of money‬القدرة الشرائية لالموال‬
‫وتقل القيمة الشرائية للمال نتيجة حدوث التضخم ‪ inflation‬حيث ان التضخم يقلل القيمة‬
‫الشرائية لالموال‬
‫‪Inflation: consistent increase of prices over time‬‬
‫لذلك تقوم الدول برفع معدل الفائدة لكي يقوم بسحب الفلوس من الالقتصاد اي يقوم بتقليل‬
‫السيولة من السوق لكي تكون الفلوس والبضائع متقاربين فيقل التضخم‬
‫‪If we have surplus of funds we have two options:‬‬
‫‪1- Savings: Keeping money in banks and gets interest rate‬‬
‫يتم االحتفاظ باالموال في البنوك والبنك يعطي فايدة ولكن هذا ليس الحل االمثل‬
‫الفايدة هنا تسمي ال ‪ nominal interest rate‬اي هي فايدة تزود القيمة االسمية لالموال اي‬
‫تزيد كمية االموال وال تزيد ‪ purchasing power of money‬فكثير من االحيان تكون قيمة‬
‫التضخم اعلي من قيمة الفايدة فتقل القيمة الشرائية لالموال‬
‫لذلك يفضل ان يتم حساب ال ‪real interest rate‬‬
‫‪Real interest rate = nominal interest rate – inflation effect‬‬
‫‪https://www.investopedia.com/ask/answers/032515/what-difference‬‬‫‪between-real-and-nominal-interest-rates.asp‬‬
‫اذا كان ال ‪ real interest rate‬بالسالب يعني ان فلوسنا خسرت حتي مع الفايدة فلذلك يفضل‬
‫فقط وضع الفلوس في البنك اذا كان ‪ real interest rate‬يكون موجب‬
‫االستثمار ‪2- Investment‬‬
‫المالذ االمن ( ‪Ex: real estate – stocks – gold‬‬
‫هل الدهب ال يخسر ابدا الدهب يرتفع سعره في االزمات دائما لذلك يسمي بالمالذ‬
‫االمن‬
Note: people will make investment if return more than banks interest rate
And the higher the risk, the higher return an investor should expect
High risk must be compensation by high return
No risk, no fun
investment should offer returns that are higher than interest rates in banks as high
risk should be compensated with high returns,
So in case banks increase interest rate, most of investors will go to saving in banks
‫فاي مشروع البد ان يكون العائد منه اعلي من الفايدة في البنك ونتيجة رفع الفايدة يتجة الناس لحفظ‬
stagflation ‫اموالهم في البنوك النها تعطيهم فايدة اعلي فيحدث ما يسمي بالركود التضخمي‬
In case of shortage of fund so we have to make borrowing ‫االقتراض‬decisions.
• When we make borrowing
• Terms of borrowing (long or short)
CONCLUSION:
Finance: Managing of funds.
• In case of surplus of funds:
We have two options: Investments and Savings (investment should offer
returns that are higher than interest rates in banks as high risk should be
compensated with high returns,
• In case of shortage of funds: borrowing decisions. (when – terms)
Finance related to decision making
Areas of Finance:
1) Investment
2) Corporate Finance will be studied here
3) Financial Markets and Institutions
4) International Finance
Investment: It deals mainly with investing in financial assets such as stocks and
bonds.
Types of assets:
1- Real assets: assets with physical existence: as land, buildings, cars …etc
2- Financial assets: as stocks and bonds
➢ Stocks: claim of ownership. ‫االسهم هي سند ملكية‬
Rewards for owing stocks: ‫العائد علي امتالك االسهم‬
There are two gains from stocks
a) Dividends: ‫التوزيعات‬distribution of the company’s profit over the owners.
• Companies can decide to pay no dividends and they may decide to retain
all the profits as retained earnings (source of internal finance) for
future investments. (not sure gain) ‫هنا الربح غير مضمون‬
• Retained Earnings ‫االرباح المحتجزة‬is considered as source of internal
finance as company financed from its profit
b) Capital Gain: This occurs when the stock price increases (not sure gain)
‫عند زيادة سعر السهم يزيد قيمة المحفظة هنا الربح غير مضمون‬
capital loss ‫واذا قل سعر السهم يسمي ب‬
➢ Stocks are risky investment as the two gains from stocks (dividends – capital
gain) are not sure gain ‫االسهم هو استثمار عالي المخاطر الن المكسب منه سواء بالتوزيعات‬
‫او ارتفاع سعر السهم هو مكسب غير مضمون‬
➢ Stocks is considered as long-term investment
Bonds :‫ السندات‬I O U instrument. I OWE YOU.
I OWE YOU. ‫انا مدين لك‬
Rewards expected from bonds: the coupon rate is determined based on the credit
ratings ‫التصنيف االئتماني‬of the company and the governments.
a) Coupon Payment: It is the interest paid. ‫دي قيمة الفوائد‬
b) Face Value: ‫القيمة االسمية‬This is the amount borrowed and it is paid at maturity.
‫قيمة اصل الدين‬
• Bonds are sure gain (safe investment with no risk)
• Bonds will be issued by
a- Governments ‫حكومات الدول‬
b- Companies ‫الشركات‬
the coupon rate is determined based on the credit ratings ‫التصنيف االئتماني‬of the
company and the governments.
If the credit rating decreased the coupon rate will increase ‫كلما قل التصنيف االئتماني‬
‫زاد معدل الفايدة علي السندات‬
‫كلما زادت الديون يقل التصنيف االئتماني للدول وبالتالي تقوم الدول بزيادة الفايدة الكوبونات لجذب‬
‫المتستئمرين‬
How Bond Coupon Rates Work
A bond's coupon rate denotes the amount of annual interest paid by the bond's issuer
to the bondholder. Set when a bond is issued, coupon interest rates are determined
as a percentage of the bond's par value, also known as the "face value." A $1,000
bond has a face value of $1,000. If its coupon rate is 1%, that means it pays $10 (1%
of $1,000) a year.
Treasury Bills ‫سندات الخزينة‬vs. Bonds
The key difference between the two is the amount of time it takes for each to
mature.
• While bonds are considered long-term debt securities, maturing 30 years after
they are sold,
• Treasury bills are short-term securities that mature within a year and pay less
interest than bonds. In fact, the maturity period of T-bills can be as short as
four weeks.
Questions in Investments:
1) What determines the price of an assets?
• Intrinsic Value ‫ القيمة الجوهرية‬or the fair value: it is the discounted value of
all the future benefits that will be generated from the stock or the asset.
Therefore, the fair value of the asset is determined by the future benefits, risk,
time.
When we purchase any asset, we focus on the future benefit of the asset
Note : as time increase , risk increase due to less prediction
So, the fair value of an asset is equal to the future benefits that will be
generated from this asset over its life
• Market Price: it is determined by the demand and supply forces.
It can be affected by fundamental information and rumors.
‫سعر السوق يتاثر بالمعلومات االساسية واالشاعات‬
Market price is not usually represent the actual value, may be over evaluation
or under evaluation because it is effected by rumors
The more in efficient market, the more effect of rumors on market price
• Note: we trust the fair value more than market price
• In market we see usually the market price
2) What are the risks and rewards associated with an investment?
Risk: Is the probability that realized returns will differ from expected returns.
‫ هو احتمال اختالف العوائد المحققة عن العوائد المتوقعة‬:‫المخاطرة‬
There are two types of risk:
a) Systematic Risk: is the market risk that cannot be avoided such as inflation,
political instability, COVID….. it cannot be avoided
• We have to measure the systematic risk of each company which measures
how sensitive the company is to the fluctuations in the economy. This
measure is called BETA.
‫البيتا بتقيس مدي حساسية الشركة للتردد في االقتصاد فاذا كانت الشركة تحقق ربح عند حدوث خسارة‬
‫ مثل الدهب اما اذا كانت الشركة تتارجح مع االقتصاد‬safe ‫او انكماش في االقتصاد فتكون الشركة‬
risky company ‫بمعني حدث انخفاض فتنخفض الشركة تكون الشركة‬
• if the company moves positively with the economy it is a risky company,
• if the company moves negatively with the economy this is a safe company.
• Measure of systematic risk is Beta
b) Non-Systematic Risk: company-specific risk or sector-specific risk and it can
be avoided through diversification. It can be avoided
‫المخاطر الخاصة بالشركة أو المخاطر الخاصة بقطاع معين ويمكن تجنبها من خالل التنويع‬.
Unsystematic risk is essentially eliminated by diversification, so a relatively
large portfolio has almost no unsystematic risk.
Only systematic risk is rewarded in the market. High risk should be
compensated by high return.
3) What is the best combination of assets to hold?
Investors should try to diversify their investments through holding different
investments from different sectors and different companies and different countries.
‫يجب أن يحاول المستثمرون تنويع استثماراتهم من خالل القيام باستثمارات مختلفة من قطاعات مختلفة‬
‫وشركات مختلفة ودول مختلفة‬
We must hold stocks with negative relation or week relation through
diversification process to decrease nonsystematic risk
Financial Markets and Institutions
They are institutions that deal with financial securities such as banks, Insurance
companies and Stock market.
‫هي مؤسسات تتعامل مع األوراق المالية مثل البنوك وشركات التأمين و سوق األوراق المالية‬
Banks are intermediary ‫ وسيط‬between those who have shortage of funds and those
who have surplus of funds.
‫البنوك هي وسيط بين أولئك الذين لديهم نقص في األموال وأولئك الذين لديهم فائض في األموال‬
‫ وبالتالي تحدد قيمة الفايدة‬risk assessment for each customer . ‫تقوم البنوك بعمل‬
‫الحظ شركات التامين تعتبر من الموسسات المالية حيث انها تقوم باستثمارات الموال المومنين حتي تتمكن‬
‫من سداد اي التزامات عليها‬
Stock Market: it is a place where stocks and bonds are sold and bought.
Types of Markets:
Primary Market: it is the market where the stocks and bonds are initially sold by
corporations or governments.
‫ السوق التي يتم فيها بيع األسهم والسندات في البداية من قبل الشركات أو الحكومات‬:‫السوق األولية‬.
Who have the right to issue bond and stocks?
• Corporations have the right to issue stocks and bonds
• while Governments have the right to issue bonds only
governments not allowed to issue stocks as stocks is claim of ownership
‫والحكومات ال يحق لها بيع اصول الدوله‬
There two types of primary market. ‫هناك نوعان من السوق األولية‬.
• Initial Public Offering (IPO): in which the corporations sell stocks to the
general public. • ‫( الطرح العام األولي‬IPO): ‫حيث تقوم الشركات ببيع األسهم لعامة الناس‬
• Private Placement: in which the corporations sell the stocks to a specific
buyer such as an insurance company or a bank and the price is determined
based on negotiations.
‫ حيث تقوم الشركات ببيع األسهم إلى مشتر معين مثل شركة التأمين أو البنك ويتم‬:‫الطرح الخاص‬
‫تحديد السعر على أساس المفاوضات‬
.
Secondary Market: in which stocks and bonds are sold and bought between
individuals. The prices of the stocks are determined by demand and supply forces.
‫ يتم تحديد أسعار األسهم من خالل قوى‬.‫ حيث يتم بيع وشراء األسهم والسندات بين األفراد‬:‫السوق الثانوية‬
‫العرض والطلب وليس للشركة هنا دخل في تداول االسهم بين االفراد‬
International Finance:
It deals with all areas of finance but from a global perspective. It deals with areas
such as Exchange rate risk and it is highly affected by globalization.
Lecture 2:
Corporate Finance: is the financial issues related to corporations.
ASSETS = Liabilities + owner equity
Assets: are resources owned or controlled by the company and they must have
future benefits.
Assets are listed in the Balance sheet based on their liquidity which means the
ease of conversion into cash but without a significant loss in value.
Types of Assets:
Current Asset –
Non-Current Asset:
1) Current Asset: can be converted into cash in less than 1 Year without a
significant loss in value
Examples:
• Cash and Cash Equivalents.
Cash equivalent as )Marketable Securities( as cheques ‫شيك قابل الدفع‬,
current bank account ‫الحسابات البنكية الجارية‬
• Account Receivable: A promise to receive cash from a client in less
than a year.
If there is part that is doubted ‫مشكوك فيه‬to be collected, we record
Allowance for Doubtful Accounts (AFDA)
‫اذا كان هناك ديون مشكوك في تحصيلها من العمالء يتم تسجيلها في حساب خاص‬
• Inventory: there are 3 types of inventory:
• Raw material,
• Work-in-Process (WIP)
• Finished Goods
(inventory remains in the balance sheet until it is sold it is
transferred to the COGS account in the Income statement this is to
follow the matching principle).
Inventory is considered as the least liquid current asset. As if it is
not sold it can be expired
‫ وهذا يتبع‬، ‫ في بيان الدخل‬COGS ‫يبقى المخزون في الميزانية العمومية حتى يتم بيعه ويتم تحويله إلى حساب‬
‫ يعتبر المخزون على أنه أقل األصول الحالية سيولة‬.)‫مبدأ المطابقة‬
2) Non-Current Assets:
a) Plant, Property and Equipment (PPE): Fixed Assets are listed in the
balance at their cost rather than their market value.
As market value is very subjected from one to another and cannot be
verified so fixed asset recorded by their cost price at time of purchase
‫يتم تسجيل األصول الثابتة في الرصيد على اساس تكلفتها وقت شرائها بدالً من قيمتها السوقية‬
‫الحالية‬.
‫ لذلك يتم تسجيل‬، ‫نظرا ألن القيمة السوقية تختلف تقييمها من واحد إلى آخر وال يمكن التحقق منها‬
ً
‫األصول الثابتة من خالل سعر التكلفة في وقت الشراء‬
• All Fixed asset except land are subject to depreciation ‫(االهالك‬non-cash
expense ‫)اي اليتم دفع مبالغ تحت مسمي االهالك‬.
• The purchase of fixed assets is called CAPEX (capital expenditures)
and by nature CAPEX has a lumpy nature. Fixed can decrease due to
depreciation and disposal of fixed assets.
‫ (النفقات الرأسمالية) وبطبيعة الحال فإن النفقات الرأسمالية لها طبيعة‬CAPEX ‫• يسمى شراء األصول الثابتة‬
.‫ يمكن أن تنخفض قيمة االصول الثابتة بسبب االهالك او التخلص او بيع األصول الثابتة‬.‫متكتلة‬
• Disposal is related to CAPEX as companies sells or disposal its fixed
assets usually before purchasing new fixed assets
• The main purpose for purchase fixed assets (PPE) is to generate
revenues
b) Long-term Investments: such as CDs certificate of deposit (CD) or
investment in another company.
c) Intangible Assets: assets that don’t have physical existence such goodwill
and copyrights and patents.‫براءات االختراع‬
Liabilities: are obligations on the company. It is the creditor’s claims over the
company assets. They are listed in the BS (balance sheet) based on their
maturity ‫تاريخ االستحقاق‬.
Types of Liabilities:
1) Current Liabilities: Liabilities that should be settled ‫ تسوي‬in less than 1
year (low cost, high risk) such as:
• Account Payable: A promise to pay in less than 1 year.
Receivables collection period should be shorter than payment period
‫البد ان تكون فترة تحصل المستحقات اقل من المدفوعات‬
• Current Portion of Long-Term Loans (CPLTD): installment on the LTL.
‫ تسدد سنويا‬100000 ‫هو قيمة القسط المستحق من القرض طويل االجل مثال شركة واخدة قرض ب‬
CPLTD=10,000 ‫ كقسط سنوي فيكون‬10000
• Short-term loans
• Overdrafts ‫السحب علي المكشوف مثل الكريدت كارد‬
Note: Current Liabilities: (low cost, high risk)
High risk as the time period is less than one year so company must pay within
a year so it makes high risk
Low cost: for short term loans interest rate is less than long term loans as
banks must protect themselves from inflation
2) Non-Current Liabilities: liabilities that should be settled in more than 1
year (high cost, low risk)
• Such as LTL long term loan
The finance rule is:
Short for Short and Long for Long
(Current Assets CA should be financed from Current Liabilities CL , and NonCA should be financed from Non-CL).
Means if we want to purchase inventory we will use short term loan
And if we want to purchase machines PPE we will use long term loan
Note: if company cash increased over years this is bad investment as companies
must invest this case to purchase assets
Owner’s Equity: Residual claims of owners on the company assets.
• Common Stock and Paid Up Capital
• Retained Earnings: is the part of the net income NI that is kept in the
company for future investments rather than being paid as dividends
and it is considered as source of internal finance.
Why the assets should be equal to liabilities and O/E:
As The liabilities and O/E are sources to finance the company assets.
The CFO answers three main questions in dealing with the financial issues of
the company:
1) What are the types of long-term LT investments should the company
undertake? “Capital Budgeting Decision”
The decision taken by the financial manager is called the Capital Budgeting
Decision. It is the process of planning and managing the firm LT
investments. Related to non-current asset
Projects should be accepted if the benefits generated from them exceeds
their costs.
‫بيتم اختيار المشاريع التي يكون الدخل منها اعلي من المصروفات خالل فترة تقريبا خمس سنوات‬
: ‫تعريف مهم‬
Capital Budgeting Decision: It is the process of planning and managing the
firm Long Term investments
Example: To be able to compare the costs with the future benefits we have to
compare between the cost of the project and the future benefits generated from the
project. However, to compare the cost with the future benefits, we need to get the
present value of these future benefits to have a fair comparison.
Example 01: Assume you deposited $1000 in the bank at 10% IR, how much
will you have after 1 year?
PV =present value = 1000
Interest rate : IR = 10%
Time : T = 1 YEAR
Future value FV = ?
Interest = 10%*1000 = 100
Future Value = 1000 + 100 = 1100
FV = Present Value + Interest Earned =PV + IR = 1000 + (1000 *10%) = $1100
Example 02 : Assume you deposited $1000 in the bank at 10% IR, how much
will you have after 2 years?
PV = 1000
IR = 10%
T = 2 YEARs
FV = ?
st
1 Year
Interest = 1000*10% = 100
FV = 1000 + 100 = 1100
ND
2 Year
Interest = 1100 *10% = 110
FV = 1000 + 100 + 110 = 1210
In second year we got interest of interest
FV = PV*(1+R)^T
‫القانون المستخدم لحساب القيمة المستقبلية‬
FV = PV*(1+R)^T = 1000*(1+10%)^2 = $1210
The most important equation in finance:
Therefore, the rule is: FV = PV*(1+R) ^T
AS
FV = future value
R : interest rate %
, PV = present value
, T : time in years
If we need to get present value PV = FV/(1+R)^T…..
And this equation named as Discounted Cash Flow Valuation Rule.
PV = FV/(1+R)^T….DISCOUNTING APPROACH AS IF YOU ARE
REMOVING THE INTEREST YOU EARNED
Example3: Assume that you are offered a project that will generate the following
CFs ( cash flow ) over its life:
Year 1: 10,000 cash flow we get in first year FV1
Year 2: 13,000
cash flow we get in year 2 FV2
Year 3: 15,000
cash flow we get in year3 FV3
If the initial cost of this project is 30,000, and the rate of return = 15%, would you
accept or reject this project and why?
PV = FV/(1+R)^T
= 10000/(1+15%)^1 = $8,695
= 13,000/(1+15%)^2 = $9,829
= 15,000/(1+15%)^3 = $9,862
Total PV = $28,386 ‫مجموع قيم المبالغ عند حساب قيمتها الحالية‬
This project should be rejected as the future benefits are lower than the initial cost
of the project.
‫ وفي‬30000 ‫هنا تم استخدام المعادلة لحساب القيمة الحالية لالموال من قيمها المستقبلية فهنا تم استثمار‬
‫بعد حساب المجموع للمبالغ التي تم الحصول عليها وارجاعها لقيمها الحالية تبين انها اقل من ما تم‬
‫استثماره في البداية‬
To answer this question, the CFO needs three pieces of information:
PV = FV/(1+R) ^T so the present value if function of FV , R and T
1) The size of the Cash Flows that will be generated from the project over its life
It is the FV that will be generated from the project over its life
2) The risk of the project that will be used to estimate the rate of return
R is related to Risk as if risk increased R must be increased
Means rate of return is function of Risk
From equation: if R increased PV decreased so in case of bank interest
increased present value decreased so most of projects will be rejected
‫عندما يتم رفع سعر الفائدة فإن ذلك يؤدي إلى الركود التضخمي الن عند رفع الفايدة‬:
.‫• تراجع فوري للطلب على االقتراض‬
.‫ زيادة الطلب على إيداع األموال‬،‫• بالمقابل‬
.‫• هذه األمور قد تؤدي إلى إبطاء معدالت النمو االقتصادي‬
.‫• تراجع وتيرة االستثمار‬
‫• الن معدل الفايدة المرتفع يكون اعلي من العائد االستثماري من المشاريع‬
‫للمشاريع تقل فيتم رفض‬PV ‫• اي كلما زادت الفايدة يقل معدل االستثمار الن ال‬
‫معظم المشاريع‬
3) The time of the CFs as the time period affects the time value of money.
as time increased forecasting accuracy for future benefits will be decreased
value of money decreased with time
2) How can the company finance its Long-Term Investments? “Capital
Structure”
This question is related to Capital Structure Decision of the Financial Manager.
Capital Structure ‫الهيكل التمويلي‬is the Mixture of debt and Equity used by the
company.
Any asset will be financed by liabilities (debt)and owner equity
‫حيث يتم التمويل الي مشروع اما من خالل الديون او الملكية‬
‫او من خالل مزيج من الثنين معا وهذا يسمي ب الهيكل التمويلي‬
: ‫فايهما افضل في التمويل القروض ام الملكية‬
https://www.investopedia.com/ask/answers/042215/what-are-benefitscompany-using-equity-financing-vs-debt-financing.asp
•
•
•
•
CL current liabilities has low cost but high risk,
LTL long term liabilities has high cost but lower risk,
Equity has very high cost but low risk.
The main benefit of taking debts is the tax benefit as taking debts helps the
company reduce its tax bill.
‫الحظ ان عند التمويل باستخدام الملكية يحرمنا من فرص استثمارية اكبر الن الملكية تكون محدودة‬
‫فلذك يفضل بعض المديرين الماليين االعتماد علي الديون لتمويل المشاريع لسببين‬
‫ القروض تزيد التمويل فالبتالي يتم استخدمها لزيادة االستثمار وتحقيق ربح اعلي‬-1
‫ نتيجة استخدام القروض انها تقلل من الضرائب التي تدفها المشاريع النها تزيد التكلفة مما يقلل‬-2
‫الضرائب‬
risk ‫ لذلك فهو يعتمد علي قرار المدير الماليين ومدي تقبله لل‬-3
Theories of Capital Structure:
1) Modigliani and Miller Theory: This theory argues that the capital structure
has no effect on the value of the company.
‫هذه النظرية تفترض بأن هيكل رأس المال ليس له أي تأثير على قيمة الشركة‬.
‫هنا يفترض انه ال يوجد فرق بين تمويل من خالل القروض او الملكية وكانت تبني علي فرضيات‬
‫غير حقيقة كثيرة ولكنها نظرية غير صحيحة فتم رفضها‬
2) Trade-off Theory: it compares between the benefits and costs of taking debts
to determine the optimal capital structure.
• Here we will study on the depts ‫هنا يتم النظر للقروض فقط من حيث المزايا‬
‫والعيوب‬
• Depts highest disadvantage: very high risk ‫اكبر عيب‬
• Depts highest advantage: Tax advantage as the more we take depts, the
tax will decrease
• And we will compare between the benefits and costs of taking debts to
determine the optimal capital structure.
trade off ‫وهنا يتم المقارنة بين المزايا والعيوب حتي نصل لنقطة التعادل التي عنها تتساوي وهي تكون‬
the benefits and costs of taking debts‫نقطة التعادل التي عنها تتساوي الم‬
‫ولكن كانت تحتاج لمعادالت كثيرة تصعب من عملية استخدام هذه النظرية‬
3) Pecking-Order Theory:
‫وضعت ترتيب لتمويل المشروعات وهي كالتالي‬
• Retained Earnings (Internal Finance)
• Debts
• Issue New Stocks ( new owners =financing from equity )
Notes:
• the most costly source for financing is the equity
• The most risky source of financing is depts
3) How to Manage the Firm’s Day to Day Operations? “Working Capital
Management” (short term)
This is related to Working-Capital Management Decision. This is related to
managing the firm’s current assets CA and current liabilities CL.
For safe combines CA must be higher than CL as we use CA to pay for CL
CA ( inventory , cash , AR ( account receivables ) )
In this decision, the financial manager can deal with decisions such as:
1) The amount of cash to hold
If we kept more cash lead to poor investment plan
If we kept less cash will affect their operations
So companies must keep minimum cash balance to finanace Day to Day
Operations
2) Which customers to sell on credit to? AR
TO sell credit we have to make evaluation for any credit customers to avoid
bad depts
3) The amount of inventory to hold
• If we kept high levels of inventory will lead to some of it will be expired and
increasing holding cost
• If we kept low levels of inventory will lead to shortage will lead to risk of
out of stock
4) The payment Policy of the company and its relation to the collection
policy.
So finance manager must make sure that collection period is faster than
payment period
5) What are the sources of short term ST finance?
So finance manager take decision for : capital budgeting . capital structure,
working capital management
Organization Chart:
BOD (Board of directors) ….. head of BOD is the CEO…..
Under CEO There are three assistants:
1) CFO chief financial officer
2) COO chief operations officer
3)CMO chief marketing officer
Under the CFO:
• Treasurer (Finance):
For finance functions as: financial planning (capital structure) , Capital Expenditures
(CapEx), cash management ,
• Controller (Accounting):
For finance functions as : tax calculation , data processing ( account cycle)
Agency Problem: arises in corporations due to the separation between ownership
and management. This may lead to conflict of interest between owners and
managers.
‫ قد يؤدي هذا إلى تضارب المصالح‬.‫ تنشأ في الشركات نتيجة الفصل بين الملكية واإلدارة‬:‫مشكلة الوكالة‬
‫بين المالكين والمديرين‬.
Managers Goals: main goal of managers is Job Security: this might lead
managers to reject risky projects that might achieve high returns for owners.
The managers’ need to be managers of big companies might lead managers to over
purchase assets and this might lead the stock price to fall if these assets aren’t
efficiently used in the business.
‫ قد يؤدي ذلك إلى رفض المديرين للمشاريع الخطرة التي قد تحقق عوائد‬:‫ األمن الوظيفي‬:‫أهداف المديرين‬
‫عالية للمالكين‬.
‫قد تدفع حاجة المديرين ألن يكونوا مديرين لشركات كبيرة المديرين إلى اإلفراط في شراء األصول وقد‬
‫يؤدي ذلك إلى انخفاض سعر السهم إذا لم يتم استخدام هذه األصول بكفاءة في األعمال التجارية‬.
Owners Goals: main goal of owners is to Maximize the Current Market Price
of the Stock. This is a goal that is affected by all the future benefits that will be
generated from the company and all the decisions taken by the company such as
expansion plans, increasing profits, R&D,
In this regard, Maximizing Profit is not an appropriate Goal for managers and
Owners as it may lead to maximum the profit but will lead to future loss (Check
The recordings and the Book for Details ‫)الزم مراجعة الكتاب هنا‬.
• General Goal for Sole and Partnership is to Max the current Market Value
of Equity.
Ways to Solve the Agency Problem:
1) Managerial Compensation‫ تعويض‬:
➢ Stock Options: Giving managers stocks in the company at a fixed price and as
the stock price increases, the managers will benefit from this.
➢ Successful Managers always have high salaries in the market.
2) Control of the Firm‫ السيطرة على الشركة‬:
➢ Proxy Fight: Shareholders might vote to fire the managers if they are not satisfied
of their performance
➢ Mergers and Acquisitions‫ عمليات االندماج واالستحواذ‬: managers are afraid of M&A as
this threatens his job security.
Relationship between Corporations and Financial Markets:
1) The Company issues Short-term Loans, Long-term Loans, Bonds, Stocks
to raise money
2) This money raised will be invested in CA and LT Assets
3) These assets will be used in the business to generate CFs
4) These CFs will be used to:
➢ Pay taxes
➢ Pay interest
➢ Pay part of the loans
➢ Pay dividends
➢ Kept in the company as RE Retained Earnings
Sarbens Oxley Act (Sarbox) ‫هو قانون امريكي لحماية المتثمرين في سوق االسهم‬
This act was initiated after Enron Scandal, its goal is to protect investors from
accounting fraud, after this act managers became legally responsible for all the
numbers listed in the financial statements and they have to approve that the numbers
fairly represent the actual position of the company, how due to the high cost of
compliance the act backfired and many companies decided to go dark.
‫ وهدفه حماية المستثمرين من االحتيال‬، Enron Scandal ‫بدأ هذا القانون بعد‬
‫ بعد أن أصبح المدراء مسؤولين قانونًا عن جميع األرقام المدرجة في‬، ‫المحاسبي‬
‫البيانات المالية وعليهم الموافقة على أن األرقام تمثل الوضع الفعلي للشركة بشكل‬
‫ كيف أنه بسبب التكلفة العالية لالمتثال نتيجة الزام الشركات باستخدام واحدة‬، .‫عادل‬
‫ جاء هذا القانون بنتائج عكسية وقررت العديد من‬،auditing ‫في ال‬big 5 ‫من ال‬
. ‫الشركات أن تخرج من البورصة نتيجة التكلفة العالية‬
Lec 03: Chapter 3: Financial Statement Analysis
First : Income statement: the main goal of this statement is to show either the
company achieving income or loss
Income statement: it shows the financial performance of the company over a
period of time , it mainly shows the revenues and expenses of the company
So, we have to compare between revenues and expenses
Revenues: are generated from selling a product or providing a service
Revenues are recorded when service is provided or produced sold regardless
when cash is received
So revenues is not cash earned as may be cash collected or still
Revenue recognition principle ‫مبدا استحقاق االيراد‬
Revenues are recognized and should be recorded when earned
‫االيراد يستحق مع تقديم الخدمة سواء تم تحصيل المبلغ ام ال‬
Types of revenues:
1) Operating revenue ‫'هو االيراد الذي نحصل عليه من النشاط الرئيسي للشركة‬
2) Non-operating revenue (investing income -financing income)
‫هو االيراد الذي نحصل عليه من انشطة اخري للشركة االستثمارات‬
investing income ‫ايرادات الشركة مناستثماراتها مثل شراء اراضي او حصتها في شركة اخري‬
-financing income ‫ايرادات الشركة من ودائع البنوك‬
• Operating revenue is more important and must be the main focus of the
company
• Revenues can be cash or credit
Expenses: any expenses incurred to generate the revenue
There are two types of expenses
1- Operating expense:
Examples: COGS cost of goods sales (direct materials DM , direct labor cost DL ,
manufacturing overhead MOH which include all indirect manufacturing costs
as depreciation of machines )
Operating expenses, or OPEX for short, are the costs involved in running the
day-to-day operations of a company; they typically make up the majority of a
company's expenses.
OPEX are not included in cost of goods sold (COGS) but consist of the direct
costs involved in the production of a company's goods and services. COGS
include direct labor, direct materials or raw materials, and overhead costs for the
production facility. Cost of goods sold is typically listed as a separate line item
on the income statement
selling general and administering expenses SG&A known as operating
expenses
•
General and administrative expenses are the necessary costs required to
maintain a company's daily operations and administer its business
• General and administrative costs are not directly attributable to the
production of goods and services.
• While there is a strong motivation for management to reduce these costs,
because they are fixed costs, reducing general and administrative costs is a
difficult thing to do.
general and administrative expenses include:
•
•
•
•
•
•
•
.
Rent
Utilities
Insurance
Executives wages and benefits
The depreciation on office fixtures and equipment
Legal counsel and accounting staff salaries
Office supplies
2- non-operating expenses
• A non-operating expense is a cost from activities that aren’t directly
related to core, day-to-day company operations.
• Examples of non-operating expenses include interest payments and onetime expenses related to the disposal of assets or inventory write-downs.
• Non-operating expenses generally appear near the bottom of a company's
income statement after operating expenses.
We should work to make operating revenues greater than operating expenses
Expenses recognition principle ‫مبدا استحقاق المصروفات‬
expenses are recognized and should be recorded when incurred
‫المصروفات يستحق وتسجل فور حدوثة سواء تم دفع المبلغ ام ال‬
Also named as matching principle
Income Statement:
Net Sales/service revenues: Sales after excluding sales returns and allowances and
sales discounts.
Net Sales/service revenues =total Sales -sales returns and allowances -sales discounts.
• We have to record sales returns in sperate lines to check if we have problem in quality
• and sales discounts on sperate lines as discount should be reflected in higher sales
Less ‫ اول بند يتم خصمه من ال‬net sales
COGS ‫(تكلفة البضاعة المباعة‬excluding depreciation): Manufacturing costs incurred to
produce the product that include Direct Material DM, Direct Labour DL and
Manufacturing Overhead (MOH).
• COGS as percentage of sales is almost same from time to time
• The percent of COGS is almost within the same range from one year to another to
keep the margin constant.
‫بيتم رفع سعر البيع وبالتالي يظل ال‬COGS ‫ تقريبا يكون ثابت فاذا ارتفعت تكلفة ال‬margin ‫• الن ال‬
‫ بالنسبة للمبيعات ثابته من سنة الخري‬COGS ‫ثابت وبالتالي تظل نسبة بين ال‬margin
• However, some events might lead to major changes in the COGS and this requires
corrective actions by the company to apply cost reduction strategies and try to cut
non-value adding activities (Check recording for details)
‫ مثال في مصر رفع دعم الطاقة وتعويم الجنية مما‬COGS ‫قد تؤدي بعض األحداث إلى تغييرات كبيرة في‬
‫ فهنا ال تستطيع‬COGS ‫وايقاف االستيراد وغيرها مما ادي الي رفع ال‬, ‫ادي الي رفع اسعار المواد الخام‬
‫وهذا يتطلب إجراءات تصحيحية من قبل‬MARGIN ‫الشركات رفع سعر البيع مرة واحدة مما يقلل ال‬
‫ وتقليل العمالة وغيرها ولكن‬BACKGING ‫الشركة لتطبيق استراتيجيات خفض التكلفة مثل تقليل ال‬
‫بدون خفض جودة المنتج لتجنب خسارة العمالء ومحاولة خفض األنشطة غير ذات القيمة المضافة‬
Controlling COGS as percentage of sales must keep it fixed and if the percentage
changed we have
When we make cutting COGS for must be through process called value
engineering process as we have to divide all activities to two types:
• value adding activities
• non-value adding activities we have to decrease it as it is not reflected to
product or service quality
Less
Depreciation:‫ االهالك‬Non-Cash Expense
Gross Profit: it is the profit generated from manufacturing the product and selling
it,
Gross profit is the profit a business makes after subtracting all the costs that are
related to manufacturing and selling its products or services. You can calculate
gross profit by deducting the cost of goods sold (COGS) from your total sales.
and it is also almost within the same range from one year to another.
gross profit ‫ من سنة الخري اما اذا قلت نسبة ال‬sales ‫ثابتة من ال‬gross profit ‫وايضا نسبة ال‬
gross profit ‫البد من عمل خطوات تصحيحة لزيادة ال‬
‫ زيادة المبيعات عن طريق عمل خصومات والبد من دراسة الخصم قبل تطبيقة حتي ال يؤثر بطريقة‬-1
profit ‫ علي ال‬negatively
‫ مع مراعاة عدم المساس بجودة المنتج كما سبق ذكرة‬Sales ‫ كنسبة من ال‬COGS ‫ تقليل نسبة ال‬-2
Less
Operating Expenses (SG&A): selling, general and admin expenses.
EBIT ‫ وبعد خصمها نحصل علي‬Operating Expenses (SG&A): ‫بعد ذلك يتم خصم‬
Earnings Before Interest and Taxes (EBIT) operating profit: This is the
operating profit of the company; it is the profit generated from the main operation
of the company. ‫وهذا الرقم ليس كاش‬
• This is not a cash figure due to:
• revenue recognition principle which states that revenues are recorded once the
product is sold or the service is delivered regardless of when cash is received
• In addition, the matching principle states that expenses should be matched with
revenues they helped to generate regardless of when cash is paid
• Furthermore, depreciation is a non-cash expenses that is recoded in the income
statement IS to match the part consumed from the asset to generate revenues
SG&A ‫ وكذلك ال‬COGS ‫ مخصوم منها ال‬sales ‫ ليس كاش النه يحتوي علي‬EBIT ‫الخالصة ان‬
‫وهو اصال ليس كاش وكذلك‬depreciation ‫و كذلك‬credit sales ‫فمثال ال هناك‬credit ‫وجميعهم بيهم‬
‫ليس كاش‬SG&A ‫جزء من ال‬
Less
Interest (Finance Cost): ‫بعدها بيتم خصم الفوايد من ال‬EBIT
‫هنا بيتم خصم الفوائد من المبلغ الذي يتم عليه احتساب الضرائب لذلك يفضل التمويل من خالل القروض الن‬
‫الفوائد تخصم من المبلغ الذي يتم عليه احتساب الضرائب‬
Earnings Before Taxes (EBT): Taxable Income ‫وهو المبلغ الذي يتم عليه حساب الضرائب‬
Less
Taxes (Percent of the EBT)
In Egypt taxes = 22.5%
Earnings Before Taxes (EBT): Taxable Income
‫في قيمة ال‬taxes ‫بيتم هنا ضرب نسبة ال‬
‫وهي تكون قيمة الضرائب المستحقة‬
NET income ‫وبعد خصم الضرائب نحصل علي ال‬
One of the main advantages of taking lone that company will reduce tax
Final: NET INCOME
WE have to compare net income as percentage from sales to average of
industry if it within or above the average of industry it will be accepted but if
it less than the average of industry we have to take corrective actions as below
• Some companies will decrease SG&A as first step
• Then they decrease the COGS
Example on income statement:
Ddff
For finance this income statement is not sufficient as he cares about cash flow not
the net income
Earning management ‫علم ادارة االرباح‬
Earnings management is the use of accounting techniques to produce financial statements
that present an overly positive view of a company's business activities and financial
position. ‫بيتم اللعب فقي االرقام حتي يتم تحقيق االرباح‬
Most of companies use earning management so we for finance net income cannot trust
SO for finance we have to remove any non-cash expenses to transfer net income to cash
The first measure of cash flow is EBITDA
EBITDA: earnings before interest, taxes, depreciation, and amortization
• EBITDA: is a measure of cash flow from the main operations of the company .To
measure the cash flow from the company operations
• This is calculated by adding back Depreciation and Amortization to the EBIT as
they are non-cash expenses.
• The factor which prevent the EBIT to be cash is the depreciation as it is based on
estimation and differ from company to another so depreciation is not cash and it
never be converted to be cash
‫‪• Depreciation is based on estimation and Amortization to the EBIT as they are non‬‬‫‪cash expenses.‬‬
‫‪• Depreciation is part of COGS‬‬
‫‪Amortization same as depreciation but for intangible assets‬‬
‫ال ‪Depreciation‬هو االهالك ود بيتحسب لل ‪ Fixed Assets‬و بنوزع تكلفة األصل على ال ‪Useful life‬بطرق االهالك المختلفة‬
‫عشان نثبت االنحدار اللى حصل فى قيمة ال ‪ Asset .‬وال ‪Amortization‬اللى هو االستهالك وده بيتحسب لل ‪Intangible‬‬
‫‪Assets‬زى ال ‪Patent‬وال ‪ Copyright,‬وبرده بنستهلك تكلفة األصل على ال ‪Economic life‬أو ال‪Legal life .‬‬
‫‪ EBIT : EBIT‬ليس كاش النه ‪ sales‬مخصوم منها ال ‪ COGS‬وكذلك ال ‪SG&A‬‬
‫وجميعهم بيهم ‪credit‬فمثال ال هناك ‪credit sales‬و كذلك ‪depreciation‬وهو اصال ليس كاش وكذلك‬
‫جزء من ال ‪SG&A‬ليس كاش فلكي نحوله لكاش نخصم منه ال ‪DEPRECIATION & Amortization‬‬
‫النهم ليسوا كاش ولن يصبحوا كاش بينما ‪credit sales‬سوف يتم تحصيلها وكذلك المدفوعات الكرديت سوف‬
‫يتم دفعها ولكن االهالك ال يمكن ان يتحول الي كاش فعند يتم ارجاعه الي ‪ EBIT‬نحصل علي ال ‪EBITDA‬‬
Common-Size Financial Statement:
Balance Sheet: it shows the financial position of the company at a specific date
It mainly shows the assets, liabilities and owner equity (O/E) of the company
Note: income statement over a period of time
Balance sheet: is a snapshot of the company at a specific point of time date
All numbers in balance sheet may be different after this date
A- Assets:
Assets: are resources owned or controlled by the company and they must have
future benefits. (assets must have future benefits)
Assets are listed in the Balance sheet based on their liquidity which means the
ease of conversion into cash but without a significant loss in value.
Types of Assets:
Current Asset –
Non-Current Asset:
• Current Asset: can be converted into cash in less than 1 Year without a
significant loss in value Examples:
• Cash and Cash Equivalents.
• Account Receivable: (AR must be less than one year)
• Inventory: there are 3 types of inventory:
• Raw material, ‫المواد الخام‬
• Work-in-Process (WIP) ‫منتج غير تام الصنع‬
• Finished Goods ‫منتج تام الصنع‬
Inventory is considered as the least liquid current asset. as if it is not sold, it
might be obsolete. In this case, the company has cash tied-up in slow moving
inventory.As if it is not sold it can be expired
• Non-Current Assets:
2- Plant, Property and Equipment (PPE): Fixed Assets are listed in the balance at
their cost rather than their market value.
As market value is very subjected from one to another and cannot be verified so
fixed asset recorded by their cost price at time of purchase
• All Fixed asset except land are subject to depreciation ‫( االهالك‬non-cash expense ‫اي‬
‫)اليتم دفع مبالغ تحت مسمي االهالك‬.
• The main purpose for purchase fixed assets (PPE) is to generate revenues
• Accumulated depreciation: is the sum of all recorded depreciation on an asset to a
specific date.
• Ex: IF we bout car with 100,000 sar and we used for 5 years each year will be
depreciation of 10,000 sar so
Accumulated depreciation =5*10,000 =50,000 sar ,
future benefit = 100,000 -accumulated depreciation = 100,000-50,000 sar
• net PPE will be decreased from year to year due to depreciation or disposal of assets
• and it will increase if we purchased new assets and we will purchase new assets
when we need it to generate assets
• healthy company any company purchasing new asserts from time to time to renew
its assets (and assets must purchase only to be used to generate revenues)
• non-healthy company trend when company selling its assets and not purchasing
new assets
3- Long-term Investments: such as CDs certificate of deposit (CD) or investment in
another company.
4- Intangible Assets: assets that don’t have physical existence such goodwill and
copyrights and patents.‫براءات االختراع‬
Impairment: ‫هو اعادة تقييم لالصل بحيث اذا قلت قيمته عن القيمة السوقية‬
Assets reevaluation: ‫هو اعادة تقييم لالصل بحيث اذا زادت قيمته عن القيمة السوقية‬
B- Liabilities:
Liabilities: are obligations on the company. It is the creditor’s claims over the
company assets. They are listed in the BS (balance sheet) based on their
maturity ‫تاريخ االستحقاق‬.
Types of Liabilities:
•
•
•
•
Current Liabilities: Liabilities that should be settled ‫ تسوي‬in less than 1
year (low cost, high risk) such as:
Account Payable:
Current Portion of Long-Term Loans (CPLTD): installment on the LTL.
Short-term loans
Overdrafts and bank credit facilities
Non-Current Liabilities: liabilities that should be settled in more than 1
year (high cost, low risk)
• Such as LTL long term loan
C- Owners equity: O/E Residual claims of owners on the company assets.
• Common Stock and Paid Up Capital
Common stocks=Bar values ‫ *القيمة االسمية للسهم‬number of outstanding
shares
• Retained Earnings: ‫ االرباح المحتجزة‬the part of the Net Income that isn’t
distrusted to Owners as Dividends but kept in the company for future
investments. Source of Internal Finance.
Note: for balance sheet the equation must be as below:
Assets = Liabilities + O/E
Why the assets should be equal to liabilities and O/E:
As The liabilities and O/E are sources to finance the company assets.
Financial statement analysis:
1) Common-Size Financial Statements
2) Ratio Analysis (financial ratios)
Example:
The following are students grades in exams: 30%
50%
90%
• The financial statements in their original format cannot be used to compare
between companies and thus we should use either common-size statements or
ratio analysis as the size of the companies and the currencies differ.
‫نتيجة اختالف حجم الشركات وحتي لنفس الشركة من سنة الخري يختلف حجمها‬
Net Income
In income statement: we depend on total revenues (sales) to indicate the size of
the company
Common-Size income statement IS: represents all numbers as a % of Total
Sales as sales is one of the proxies (indication ) of the size of the company.
Example: Common-Size COGS = (COGS/Sales) *100 = 58.2%
This means that 58.2% of the company sales is spent on COGS
• To get the indication whether this ratio is high or low, we have to compare to the
industry average
• If this ratio is high the company should apply cost reduction strategies through
applying value-engineering differentiating between value adding and non-value
adding activities
• Also, gross profit represents =1-58.2 = 57.2% of company sales
• Common-Size net income NI =(net income/sales) *100=
• Common-Size net income NI =(363/2311)*100 = 15.7%
• This means for every 1 $ in sales, the company generates 0.156 $ in NI
The higher this % , the better
• This means that the NI of the company is 15.7% of its sales the remaining amount
represent the costs of the company,
• if this ratio is low compared to the industry, then the company should apply cost
reduction strategies.
Common-Size Balance Sheet: represent all numbers in the balance sheet BS as a
percentage % of the total assets as the assets give indication about the size of the
company.
• Common-Size Cash 2015 = (Cash/TA)*100 = 84/3373 *100 = 2.5%
Means that cash represent 2.5 % from the total assets
• Common-Size A/P 2016 = (344/3588)* 100 = 9.6%
Common-Size A/P 2016 = (344/3588)* 100 = 9.6%
Account payable AP is part of liabilities and it is source of financing assets Means
9.6% of assets are financed by account payable
• Note common size analysis will give parliamentary analysis about the
company and we will get more details when using ratio analysis
‫هذه الطريقة تعطي فكرة مبدئية عن الشركة‬
In Common-Size BS we focus on 5 main figures:
1) Total Current Assets: increased from 19% to 19.7%. This reflects an increase in
the liquidity of the company.
Further investigation is required on the components of the current assets which
are cash, AR and inventory to ensure that the company isn’t holding idle cash
or that it has a problem in collecting it’s A/R or selling its inventory
As Current assets represent liquidity,
• If liquidity increased means we are safe as we can pay any loans
• If liquidity decreased means this company has Poor investment strategy
Here in this example total assets as percent from total assets increased from
19% to 19.7% and this good sign as this increment is small if the increment is
large further investigation is required
To analyze whether this increase is favorable or not we have to compare to the
Current Liability to determine whether this increase is within the acceptable range.
As current asset must be larger than current liabilities to ensure paying
company loans and to avoid liquidity problems
Overall, the company should maintain CA that are enough to cover its Current
liabilities and day to day needs
A bulk amount held in CA, means that the company has poor investment strategies
2) Total Non-Current Assets: decreased from 81% to 80.3%, this decrease might be
due to depreciation and this reflects that the company this year didn’t have a major
investment in its non-CA.
• non-CA can increase by CAPEX (capital expenditures) this is not a regular action
in companies but it always has a lumpy nature.
• Non-CA can decrease due to depreciation and it can also decrease due to disposal
or selling assets
• As long as there is no major decrease in NON-CA that may reflect liquidation,
there is no worries. however, further investigation is required to ensure that the
company is using it assets efficiently to generate sales
3) Current Liabilities: it decreased from 16.1% to 15.1% which means that the
company is paying its CL and this compared to the CA reflects that the company
has a safe liquidity position.
• As the percentage between CA is greater than CL by a small value means no poor
investment strategies
• This also reflects that the company is decreasing its dependence on short term loans
as a source of finance
4) Non-Current Liabilities: decreased from 15.7% to 12.7%
SO decreasing NON- CL with the decrease in CL reflects that the company is
decreasing its dependence on debt ‫تقلل اعتمادها علي الدين‬as a source of finance and it
is increasing its dependence on Equity. And company paying off its depts
If uncertainty is high in market so it is not recommended to take loans during
uncertainty as it is too risky
This company following conservative strategy not aggressive strategy as it is
Decreasing the risk due to decreasing its dependence on debt
Overall, choosing debts as a source of finance is a risky option
5) Total Equity: increased from 68.2% to 72.2%. this means that the company is
increasing its dependence on Equity as a source of finance and decreasing its
dependence on debt as
Here company financed from retained earnings and common stocks and
mainly form retained earning (source of internal fianace ) low risky but more
costly
Ratio Analysis:
Ratio: Relationship between two numbers or figures
For every ratio there are 5 questions to answer:
1- How it can be calculated?
2- What is the Unit of measurement?
3- What is Meant by this ratio?
4- Is this ratio value good or bad or what does a high or low value imply?
5- How it can be improved?
Ratio Analysis: ‫المالءة الماليه‬solvency
1) Liquidity Ratios or short-term solvency ratios
2) Long-term Solvency Ratios = dept ratio
3) Asset Management Ratios =Activity ratios = asset utilization ratios
4) Profitability Ratios
5) Market Value Measures
Liquidity Ratios: focused on short term
• As this focus on short term so it focuses on current assets and current liabilities
• CA should be higher than CL to grantee company pay for its liabilities not should
be not higher by high value to prevent poor investment strategies
• Liquidity Ratios (This category) is important for short-term creditors and
suppliers and investors
• Assets recorded by its purchased value (book values)
• But finance it is important to knew market value of the assets but accountant
gives us book value only
• The main focus of this ratio is on CA and CL. These ratios focus on whether the
company has enough CA to cover its CL or not.
• Since these ratios focus on short-term assets the GAP between Book values BV
and Market values MV isn’t very big and thus the data is more too date.
MV and BV ‫• خالل السنة ال يحدث تغيير كبير في ال‬
• As the MV and BV of this category are so close to each other so one of the The
main advantage of this ratios is Somehow giving us real indication about market
value of the company
1) Net Working Capital (NWC) = CA – CL = 708 – 540 = $168 amount not
percenatge
This means that the CA of this company exceeds its CL by $168. Since the NWC is
positive, an overall indication is that the company has no liquidity issues. this
indicates that the company has a safe liquidity position.
Cases of NWC:
1) Positive: if CA> CL….Safe Position as the company has enough CA to cover
its CL
2) ZERO: if CA = CL…This is a border-line position, as some of the CA might
not be converted into cash such as if the A/R is not collected or the inventory
isn’t sold the company may not be able to cover its CL
3) Negative: if CA<CL…. This is a risky position. This means that the company
doesn’t have enough CA to cover its CL. This is an aggressive strategy
When loan date came so company must take loans or sell its assets which lead
to loss and this is very aggressive strategy
Why CL higher than CA means company use CL to finance non-current
asset which is very risky but company use it to decrease of cost of finance as
CL more risky but less in cost as CL has low interest rate
2) Current Ratio = CA/CL = 708/540 = 1.31 TIMES unit of measurement
Rule if we want to describe any ratio we divide it by 1
for every $1 in CL, this company has $1.31 in CA available to cover it. This
means that the CA are almost 1.31 times the CL. Therefore, the company has
enough CA to cover its CL.
Overall, for a healthy company this ratio should fall between 1 and 3,
a current ratio CR higher than 3 Indicates that the company has a large amount
of CA that are not utilized means that the company has very high CA which
indicates poor investment plans,
a ratio lower than 1 means that the company doesn’t have enough CA to cover
its CL.
Cases of CR:
1) Equal to 1: if CA = CL , Net Working Capital (NWC) =0 …This is a
border-line position, if the A/R is not collected or the inventory isn’t sold the
company may not be able to cover its CL.
2) Greater than 1: if CA> CL , NWC is positive …. Safe Position
3) Less than 1: if CA<CL….NWC is negative This means that the company
doesn’t have enough CA to cover its CL. This is a risky position.
Case 01 Example:
If the company sold inventory at a price (100) higher than its cost (50), what
will happen to the CR? Will it increase, decrease or remain the same?
Solve:
Cash or A/R will increase by 100….CA will increase by 100
Inventory will decrease by 50………CA will decrease by 50
CL will not be affected
Net Effect on CA increased by 50
Current Ratio = CA/CL so CR will increase.
Case 02 : If the company sold inventory at cost (50), what will happen to the
CR?
Cash increase by 50…..CA will increase by 50
Inventory decrease by 50…..CA will decrease by 50
Net Effect on CA = ZERO
CL will not be affected
CR will stay the same.
Case 03: the company took a long-term loan of 100,000 $ what will happen to
CR?
Solve: as it is long term so CL will not be affected
Cash will increase by 100,000 $ so CA will increase by $100,000
So, CR will increase
3) Quick Ratio (Acid-Test) Ratio = (CA – Inventory)/CL or (Cash + A/R)/CL =
708-422/540 =0.53 times
• Current Assets: Cash + A/R + inventory
• As inventory is the least liquid current assets so it may take time to be liquid or
may be expired so we will neglect it for the quick ratio
• Quick ratio focuses on quick assets which can be quickly transferred to cash (cash
+ A/R)
• for every $1 in CL, this company has $0.53 in QUICK ASSETS (Cash and A/R)
available to cover it.
• This ratio excludes inventory as it is the least liquid CA. by comparing the QR
with the CR we can get that almost 50% of this company CA is tied up in
inventory, so if the company cannot sell its inventory quickly it might have a
liquidity problem as more than half of its CA is held in slow moving inventory
• If CR current ratio = QR quick ratio, this indicates that the company has zero
inventory.
• Some companies use JIT system just in time system (from factory to customer)
As Toyota
4) Cash Ratio = Cash/CL = 98/540 = 0.18 TIMES
•
•
•
•
Cash is the most liquid current asset
for every $1 in CL, this company has $0.18 in cash available to cover it.
If this ratio is 1 means company has poor investment strategies
This ratio is important for very short-term creditors who are expecting
payment in less than 2 weeks.
• We have to compare this ratio with industry
LEC 04
Long-term Solvency: solvent ‫القابلية للدفع‬
It deals mainly with the capital structure of the company (mixture of debt and equity
held by the company). Furthermore, it focuses on the ability of the company to pay
its interest.
This ratio focuses on two main parts:
1- What is the capital structure of the company?
Capital structure: How can the company finance its Long-Term
Investments? Whither the company finance its assets from liabilities or
equity
This question is related to Capital Structure Decision of the Financial Manager.
2- The ability of the company to pay its interest
Assets = Liab + O/E
100
= ? + 70 here
liab=CL+nonCL=assets -O/E
1) Total Debt Ratio = Total Liabilities/Total Assets or (Total Assets- Total
Equity)/Total Assets or (CL + Non-CL)/ Total Assets = (540 + 457)/3588
= 27.7%
FROM BELOW EX: CL =540, NON-CL = 457
• This means that 27.7% of this company total assets are financed using
debts,
• therefore, the remaining 72.3% of this company assets are financed using
equity.
• This means that this company depends more on equity as a source of
finance. Thus, this company has low financial leverage,‫رفع مالي‬
• as leverage increases, risk increases. Financial Leverage Maximize gains
as well as losses.
• Maximize gains through depts as company will increase investment
• Maximize losses: if the company misuse the depts ‫النه عند سوء استخدام الدين‬
‫قد يؤدي الي الحجز علي ممتلكات الشركة‬
• financial leverage ‫ يبين مدي اعتماد الشركة علي القروض‬,‫رفع مالي‬
2) Total Equity Ratio = Total Equity/Total Assets or (Total Assets- Total
Liab)/Total Assets or 100% - Total Debt Ratio = 2591/3588 = 72.3%
This means that 72.3% of this company assets are financed using equity which
means that 27.7% of this company total assets are financed using debts.
Total Debt Ratio + Total Equity Ratio = 100%
3) Debt-to-Equity Ratio = Total Liab. /Total Equity or Debt Ratio/Equity
Ratio = 27.7%/72.3% = 0.38 times
This means that for every $1 in equity, this company takes loans of $0.38,
therefore, this company depends more on equity as a source of finance.
4) Equity Multiplier (EM) (financial leverage ratio) = Total Assets/Total
Equity or 1 + Debt-to-Equity Ratio = 1 + 0.38 = 1.38 times
This means that for every $1 in equity, this company obtains assets that worth
$1.38 due to taking debts, this shows the benefit of financial leverage. Leverage
can maximize your gains as well as losses and thus it is very risky.
‫سؤال امتحان‬
Assume that a company has an equity ratio of 40%, calculate debt ratio,
debt-to-equity ratio and equity multiplier.
Debt Ratio = 100% - 40% = 60%
Debt-to-equity ratio = 60%/40% = 1.5 times
EM = 1 + 1.5 = 2.5 TIMES
equity ratio =100- debt ratio
percentage
debt ratio =100- equity ratio
percentage
debt-to-equity ratio =debt ratio / equity ratio
equity multiplier =EM = 1 + debt-to-equity ratio
times
times
5) Times-Interest Earned (TIE) Ratio = EBIT/Interest = 691/ 141 = 4.9
times
We get EBIT and interest from income statement
This means that for every $1 in interest, this company has $4.9 in EBIT available to
cover it, this means that the interest is covered almost 5 times. The higher this ratio,
the better.
However, this ratio has a drawback, since EBIT is not a cash figure due to:
➢ Not all sales are cash sales
➢ Not all expenses are cash expenses
➢ Depreciation which is a non-cash expense will never be converted into cash.
6) Cash Coverage Ratio = EBIT + Depreciation (EBITDA)/Interest =
= (691 +276)/141 = 6.9 times
This means that for every $1 in interest, this company has $6.9 in EBITDA
available to cover it
EBITDA: is a measure of the ability of the company to generate cash from its
operations. This is calculated by adding back Depreciation and Amortization to
the EBIT as they are non-cash expenses.
Note: cash coverage ratio is more Accurate than Times-Interest Earned (TIE)
Ratio as EBIT is non-cash but EBIDA is take into consideration depreciation
which is non-cash but EBITDA is a measure of cash flow
EBIDA is a cash flow measure but it is not the most accurate cash flow measure
the most accurate cash flow measure is free cash flow to the firm
Free cash flow to the firm (FCFF) represents the amount of cash flow from
operations available for distribution after accounting for depreciation expenses,
taxes, working capital, and investments.
Asset Management Ratios:
The main goal of purchasing assets is to generate sales
To analyze the ability of the company to generate assets sales from its assets (i.e.
manage its asset efficiently).
Asset Management Ratios: shows how efficiently the company is managing its
assets
Efficiency means to utilize the assets to the max. and decrease losses
‫معناها ان الشركة تستخدم وتستغل اصولها للحصول علي اعلي ربح وعندما نصل العلي كفاءة بعدها يمكن‬
‫شراء اصول جديدة‬
1) Inventory Turnover Ratio = COGS/Inventory = 1344/422 = 3.2 times
COGS ‫بمجرد بيع المخزون يتحول الي‬
• Inventory is Current assets in balance sheet when we sold it turn into
expense which is COGS
•
Inventory Turnover Ratio = COGS (sold inventory) /Inventory remaining
• This means that this company produces and sells inventory 3.2 times a year.
Overall, the higher this ratio, the better.
• But if this ratio is high because the company is holding low inventory and
has lost sales this is not a favorable situation
• If the ratio is high We have to investigate may be company keeps low
inventory which cause lost sales
• Note: COGS from income statement (over one-year period)
But inventory from balance sheet (at the end of the period) so we have
to make more investigation
Some companies use average inventory to calculate this ratio
•
•
Example on average inventory =(inventory of 2021+ inventory of 2022)/2
Most of companies use ending inventory only ex inv of 2022
2) Days sales in inventory or Average Selling Period = 365/Inventory
Turnover Ratio = 365/3.2 = 114 days.
This means that the inventory remains on shelf 114 days before being sold, overall
the lower this ratio, the better. To determine whether the number is good or bad, you
have to refer back to the industry average.
Since the numbers used in this ratio covers different periods sometimes this ratio is
calculated using the average inventory ((Beg + End)/2))
3) A/R Turnover Ratio = Credit Sales/Account receivables = 2311/188 = 12.3
times
This means that this company sells on credit and collects it’s A/R 12.3 times a year.
Overall, the higher this ratio, the better.
4) Days sales in Receivables or Average Collection Period
= 365/A/R Turnover = 365/12.3 = 30 days
This means that this company collects its receivables every 30 days. The lower, the
better.
have to be compare with industry average
Notes: this ratio less than the industry average means this may affect our sales as
competitors give more facilities to customers so customers will go for the companies
with more facility in payment
5) A/P account payable Turnover = COGS/ (A/P) = 1344/344 = 3.9 times a
year
This means this company paid its payment every 3.9 times a year
6) Average Payment Period = 365/ account payable Turnover = 365/3.9= 93
Days
This means that company pays its payable every 93 days. The higher is better for
the company but however the company should respect its suppliers’ policy.
Note: we have to compare Average Collection Period with the Average
Payment Period
Average Collection Period =30 days
Average Payment Period = 93 Days
To ensure company will pay in time Average Collection Period must be
shorter than Average Payment Period
7) Cash Conversion Cycle (CCC) = Average Selling Period + Average
Collection Period – Average Payment Period = 114+30-93=48 days
It shows the number of days the company waits with no cash, the lower the better.
the number of days the company waits cash from its operation = 48 days
8) Total Asset Turnover Ratio (TATO) = Sales/Total Assets = 2311/3588 =
0.64 times
For every $1 invested in TA, this company generates $0.64 in sales. Overall, the
higher this ratio, the better.
This ratio measures the asset management efficiency.
Note: we have to make more investigation in this ratio as per may happen
• some companies did not renew its assets to keep this ratio high which will be
bad effect in the future
• If company renewed or added new assets this ratio will be low but this is good
indications as the new assets will generate more sales in the future
9) Capital Intensity Ratio = Total Assets/Sales or 1/TATO = 1/0.65 = 1.55
Times
This means that to generate $1 in sales, this company should invest $1.55 in TA and
thus this company is capital intensive rather than labor intensive.
We have to types of companies: capital intensive companies depend on assets and
labor-intensive companies depend on labor as service companies
Profitability Ratios:
Profitability is a primary measure of the overall success of a company.
Focus on the ability of the company to generate profit so it the base of this ratios is
net income
Debt and Equity as sources of Finance…..Invest in Assets……Generate
Sales…….Generate NI by Reducing Expenses.
‫الشركة تحتاج شراء اصول لتحقيق ربحية ويتم تمويل االصول من الملكية او الديون ويتم استخدام االصول‬
‫ بعد خصم المصاريف‬NI ‫لتحقيق مبيعات ومن المبيعات يحدث ال‬
The main aim of profitability ratios is to determine whether the company is able to
generate profits or not. Through maximizing the benefits of the above chart.
1) Profit Margin = NI/Sales = 363/2311 = 15.7%
•
•
•
•
•
This means that for every $1 in sales, this company generates $0.157 in NI.
The higher this ratio the better.
Also means for every $1 in sales, will cost $.843 in NI.
This ratio measures OPERATING EFFICIENCY OF THE COMPANY.
If this ratio is low, companies may apply cost reduction strategies through
applying value engineering and analyzing value-adding vs non-value-adding
activities.
Gross Profit Margin = (Gross Profit / Net Sales) * 100
This ratio tells us the percentage of each sales dollar that is gross margin.
Gross Profit = Net Sales - Cost of Goods Sold
A gross profit margin of 3.2% means that for every dollar of revenue
generated by the company, it retains 3.2 cents as gross profit after deducting
the direct costs associated with producing or acquiring the goods or services
• Operating Profit Margin = (Operating Margin / net sales ) * 100
This ratio tells us the percentage of each sales dollar that is operating
margin
Operating Profit = Gross Profit - Operating Expenses
A 5% Operating Profit Margin means that for every dollar of revenue generated by
the company, it retains 5 cents as operating profit after deducting both the direct
costs of goods sold and the indirect operating expenses
2) Return on Assets (ROA) = (Net Income / Average Total Assets) * 100
Average Total Assets = (Total Assets for year 01 + Total Assets for year
01) /2 ‫لو عندنا بيانات اكتر من سنة‬
Return on Equity (ROE) = net income / total assets= NI/TA ‫لو عندنا بيانات‬
‫سنة واحدة‬
Return on Assets (ROA) = net income / total assets= NI/TA = 363/3588 =
10.1%
This means that for every $1 invested in TA, this company generates $0.101 in NI.
The higher this ratio, the better.
Since this ratio is very important for investors, companies always try to improve this
ratio through: ‫لتحسين هذه النسبة فتقوم الشركات بالتالي‬
1) TATO: Asset Management Efficiency. This means that companies should try
to manage its assets well to generate high sales. ‫ادارة االصول بطريقة صحيحة وتحقيق‬
‫اقصي مبيعات‬
‫عن طريق اما بيع االصول الغير مستغله او استغالل االصول لالقصي درجة لتحقيق اعلي مبيعات‬
2) PM: profit margin Operating Efficiency: This means that the company should
try to manage its expenses well to generate the highest possible NI from its
sales. ‫ادارة النفقات لتحقيق اعلي ربح‬
‫بتقليل النفقات الغير ضرورية‬
ROA = PM * TATO
‫مهم جدا‬
3) Return on Equity (ROE( = (Net Income / Average Shareholders'
Equity) * 100
‫معدل العائد علي حقوق الملكية او حقوق المساهمين‬
Average Stockholders’ Equity = (total equity for year 01 + total equity
for year 01) /2 ‫لو عندنا بيانات اكتر من سنة‬
Return on Equity (ROE) = NI/Total Equity
‫لو عندنا بيانات سنة واحدة‬
Return on Equity (ROE) = NI/Total Equity = 363/2591 = 14%
This means for every $1 invested by shareholders in this company, the company
generates $0.14 in NI. The higher the better
TO knew if this ROE is good or no we have to :
1- Industry comparison: ROE should be compared to the average or median
ROE of companies within the same industry.
2- Historical trend: It is useful to analyze a company's ROE over time and
assess its trend. A consistently high or improving ROE may indicate a wellperforming company, while a declining or volatile ROE may raise concerns
about its profitability and efficiency
3- Compare it with the index if exists for the market (no index for Egyptian
market
Using average shareholders' equity instead of total equity in the ROE calculation
provides a more accurate representation of a company's performance over a
specific period. Here's why:
• A company's equity can change throughout the year due to various factors
such as additional investments, stock buybacks, dividends, and retained
earnings. Using the total equity at a single point in time may not reflect the
fluctuations in equity that occurred during the period under consideration.
By using the average shareholders' equity, which considers the beginning
and ending equity values, the ROE calculation accounts for the changes in
equity over time.
ROE cannot be compared by interest rate, as these two items are totally
different
ROE is an accounting return that cannot be compared to market return such as
interest rates in banks. This is the bottom-line measure of performance.
ROA = NI/TA
<
As Assets = liabilities + equity
ROE = NI/TE
so Assets <equity
The gap between ROA and ROE depends on the amount of liabilities.
If ROA = ROE, this means that liabilities = zero.
As liabilities increase ROE will increase and this is the one of the benefits of
taking debts
So, to increase ROE, companies take more debts
‫ان في حالة الديون العالقة بين البنك والشركة تنتهي بمجرد سداد الديون وال يشارك الشركة في ربحها‬
‫بينما عند بيع ملكية فالمالك الجدد يشاركون في الربح وتستمر العالقة معهم‬
Financial Leverage Percentage ‫نسبة الرفع المالي‬
Financial Leverage = Return on Equity – Return on Assets
Financial leverage is the advantage or disadvantage that occurs as the result
of earning a return on equity that is different from the return on assets.
Earnings per Share (EPS) is a financial metric that measures the profitability
of a company on a per-share basis. It represents the portion of a company's
earnings that is allocated to each outstanding share of common stock.
EPS = (Net Income - Preferred Dividends) / Weighted Average Number of
Outstanding Shares
• Average number of shares based on the number of shares at the
beginning and end of the year
• Earnings per share is probably the single most widely watched financial
ratio.
EX:
The EPS value of $1.82 per share means that for every common share of ABC
Corporation, the company generated earnings of $1.82 during the given
period. This metric provides a measure of profitability on a per-share basis.
Test of Profitability ─ Quality of Income
Quality of Income = Cash Flow from Operating Activities / net income
A ratio higher than 1 indicates high-quality earnings.
The Cash Flow Coverage Ratio compares the cash flow generated from a
company's core operations (Cash Flow from Operating Activities) to its
reported net income. It indicates the extent to which the reported net income
is supported by actual cash flows from the company's operations. A ratio
greater than 1 suggests that the company's reported net income is adequately
supported by cash flows, indicating a higher quality of income.
Another method to calculate ROE:
ROE = ROA * EM (Measure of Financial Leverage)
The DuPont Identity: ‫مهم جدا جدا‬
ROE = EM* PM * TATO
Components of ROE:
1) Financial Leverage as measured by EM: This means that companies can
take debts to increase its ROE as debts max gains but it also max losses
so companies should be aware of this risk
‫يعني أنه يمكن للشركات أن تأخذ ديونًا لزيادة عائد حقوق الملكية الخاص بها حيث أن الديون تصل‬
‫ضا خسائر قصوى لذلك يجب أن تكون الشركات على دراية‬
ً ‫إلى أقصى قدر من المكاسب ولكنها أي‬
‫بهذه المخاطر‬
2) Asset Management Efficiency as measured by TATO : This means that
companies should try to manage its assets well to generate high sales.
3) Operating Efficiency as measured by PM : This means that the company
should try to manage its expenses well to generate the highest possible NI
from its sales.
Revision
SDJ, Inc., has net working capital of $1,965, current liabilities of $5,460, and
inventory of $2,170. What is the current ratio? What is the quick ratio?
CR = CA/CL = 7425/5460 = 1.36 TIMES
CA = ?
CL = 5,460
NWC = CA – CL
1965 = CA – 5460
CA = 1965 + 5460 = 7,425
QR = (CA – Inv)/CL = 7425 – 2170/5460 = 0.96 TIMES
Aguilera, Inc., has sales of $13.5 million, total assets of $8.7 million, and total
debt of $4.1 million. If the profit margin is 7 percent, what is net income? What
is ROA? What is ROE?
PM = NI/Sales
7%
= NI/13.5
NI = 7%*13.5 = 0.945 M
ROA = NI/TA OR PM * TATO = 0.945/8.7 = 10.8%
TATO = SALES/TA
ROE = NI/TE OR ROA * EM OR PM *TATO*EM = 0.945/4.6 = 20.5%
TE = TA – TD = 4.6 M
EM = TA/TE OR 1 + Debt-Equity Ratio
Jiminy Cricket Removal has a profit margin of 7.6 percent, total asset turnover
of 1.73, and ROE of 17.2 percent. What is this firm’s debt–equity ratio?
Debt-Equity Ratio = Debt/Equity or Debt Ratio/Equity Ratio
EM = 1 + Debt-Equity Ratio
1.31 = 1 + Debt-Equity Ratio
Debt-Equity Ratio = 1.31 – 1 = 0.31 TIMES
ROE = PM * TATO * EM
17.2% = 7.6% * 1.73*EM
EM = 17.2%/(7.6%*1.73) = 1.31
Delectable Parsnip, Inc.’s, net income for the most recent year was $8,417. The
tax rate was 34 percent. The firm paid $4,632 in total interest expense and
deducted $5,105 in depreciation expense. What was the company’s cash
coverage ratio for the year?
Cash Coverage = (EBIT + DEP)/Interest Expense
Cash Coverage = EBIT + DEP/ INt = 17385 + 5105/4632 = 4.86 times
Sales
Less
COGS
Less
SG&A
Less
Dep
EBIT
? 17,385
Less
Interest
4632
EBT
12,753
Less
Taxes (34%)
NI
8417
EBT – Taxes = NI
EBT – (34%*EBT)
= 8417
0.66EBT = 8417
EBT = 8417/0.66 = 12,753
Which one of the following functions should be assigned to the controller
rather than the treasurer?
A) Capital expenditure
B) Credit management
C) Cash management
D) Data processing
2) In general, the more debt a firm uses in relation to its total assets
A) the less risk there is to the equity holders of the firm.
B) the greater the financial leverage it uses.
C) the greater extent to which it uses equity.
D) the less financial leverage it uses.
3) What ratio measures the ability of the firm to satisfy its short term
obligations as they come
due?
A) Current ratio
B) Inventory turnover ratio
C) Debt ratio
D) Times interest earned ratio
4) Working capital management includes which one of the following?
A) Determining which customers will be granted credit
B) Deciding which new projects to accept
C) Deciding whether to purchase a new machine or fix a current machine
D) Determining how many new shares of stock should be issued
Long-term Solvency:
It deals mainly with the capital structure of the company (mixture of debt and equity
held by the company). Furthermore, it focuses on the ability of the company to pay
its interest.
Assets = Liab + O/E
100
= 30 + ? (70)
7) Total Debt Ratio = Total Liabilities/Total Assets or (Total Assets- Total
Equity)/Total Assets or (CL + Non-CL)/ Total Assets = (540 + 457)/3588 =
27.7%
This means that 27.7% of this company total assets are financed using debts,
therefore the remaining 72.3% of this company assets are financed using equity.
This means that this company depends more on equity as a source of finance.
8) Total Equity Ratio = Total Equity/Total Assets or (Total Assets- Total
Liab)/Total Assets or 100% - Total Debt Ratio = 2591/3588 = 72.3%
This means that 72.3% of this company assets are financed using equity which
means that 27.7% of this company total assets are financed using debts.
Total Debt Ratio + Total Equity Ratio = 100%
9) Debt-to-Equity Ratio = Total Liab. /Total Equity or Debt Ratio/Equity Ratio
= 27.7%/72.3% = 0.38 times
This means that for every $1 in equity, this company takes loans of $0.38,
therefore, this company depends more on equity as a source of finance.
10)
Equity Multiplier (EM) = Total Assets/Total Equity or 1 + Debt-toEquity Ratio = 1 + 0.38 = 1.38 times
This means that for every $1 in equity, this company obtains assets that worth
$1.38 due to taking debts, this shows the benefit of financial leverage. Leverage
can maximize your gains as well as losses and thus it is very risky.
Assume that a company has an equity ratio of 40%, calculate debt ratio,
debt-to-equity ratio and equity multiplier.
Debt Ratio = 100% - 40% = 60%
Debt-to-equity ratio = 60%/40% = 1.5 times
EM = 1 + 1.5 = 2.5 TIMES
11)
Times-Interest Earned (TIE) Ratio = EBIT/Interest = 691/
4.9 times
141 =
This means that for every $1 in interest, this company has $4.9 in EBIT available to
cover it, this means that the interest is covered almost 5 times. The higher this ratio,
the better. However, this ratio has a drawback, since EBIT is not a cash figure due
to:
➢ Not all sales are cash sales
➢ Not all expenses are cash expenses
➢ Depreciation which is a non-cash expense will never be converted into cash.
12)
Cash Coverage Ratio = EBIT + Depreciation (EBITDA)/Interest = 691
+276/141 = 6.9 times
This means that for every $1 in interest, this company has $6.9 in EBITDA
available to cover it
EBITDA: is a measure of the ability of the company to generate cash from its
operations. This is calculated by adding back Depreciation and Amortization to
the EBIT as they are non-cash expenses.