SOUTH PHILIPPINE ADVENTIST COLLEGE
AE 424 STRATEGIC BUSINESS ANALYSIS
LESSON 5
FINANCIAL MANAGEMENT BASICS
Lesson Objectives:
❖​ Explain the role of financial management in strategic business analysis
❖​ Apply the fundamental tools and concepts of financial management in business
operations
❖​ Appraise the risk profile of sample companies
❖​ Discuss how financial management operations work in the overall functioning of
an organization
❖​ Evaluate the governance structure of a company for the purpose of leading it to
sustainable growth.
Financial management involves the planning, organizing, directing, and controlling of
financial activities such as procurement and utilization of funds of the enterprise.
Financial management covers decision-making in the areas of:
➢​ Investment decision
➢​ Financial operations
➢​ Shareholder dividends
Objective of FM: maximization of shareholder wealth which is achieved with the
optimal decision on procurement and allocation and control of financial resources so
that organizations can ensure regular and adequate supply of funds.
It functions to estimate capital requirements, determine capital composition, assess
sources of funds, dispose of surplus funds, manage cash, invest funds, and establish
financial controls.
Financial Management functions on the following areas:
➢​ Cost control
➢​ Pricing
➢​ Profit forecasting
➢​ Measuring of Required Return
➢​ Measuring Assets
SOUTH PHILIPPINE ADVENTIST COLLEGE
AE 424 STRATEGIC BUSINESS ANALYSIS
➢​ Measuring Funds
Roles of financial manager:
➢​ Performs financing decisions
➢​ Performs investment decision
➢​ Forecasts and plans the firm's financial needs
➢​ Deals with financial markets
➢​ Managing risks
Financial planning is the process of estimating the capital required and determining its
competition.
Financial management system varies based on the organization:
➢​ Proprietorship
➢​ Partnership
➢​ Corporations
There must be proper management of finances in business organizations. Major
causes of business failure is financial illiquidity(lack of funds), including improper
financial planning, and the lack of proper financial control.
The amount of total debt that is needed by a business should be limited to the funds
that can be provided by its equity owners in the form of investments and retained
earnings.
Income Statement:
Sales
(COGS)
Gross Profit
(Operating expenses)
Operating income (EBIT)
(Interest Expense)
Earnings before taxes (EBT)
(Income taxes)
Net Income
SOUTH PHILIPPINE ADVENTIST COLLEGE
AE 424 STRATEGIC BUSINESS ANALYSIS
FREE CASH FLOW - Cash that a company generates after accounting for cash
outflows to support operations and maintain capital assets.
Computation:
(1)​Starting point is Net Income
Net Income
+ Interest Expense
(Tax Shield on Interest Expense)
+Non-cash Expenses (Depreciation, Amort.)
(Change in (CA-CL)
(CAPEX)
Free Cash Flow​
Example:
Accountancy Company generated revenues and cash expenses before tax as follows:
Sales Revenue
750,000
Cost of Sales
400,000
Salaries, shipping, etc. 270,000
Annual Depreciation exp. 30,000
Tax rate is 30%
Budgeted CAPEX for the year is 40,000.
How much is the FCF?
Components of Cash Flow Statements:
➢​ Cash from Operating activities - Refers to the net cash inflows.
➢​ Cash from Investing activities - refers to cash flows from acquisition and
disposal of long-term assets and disposal.
➢​ Cash from Financing activities - Cashflow in funding operations and capital
structure.
RATIO ANALYSIS
➢​ A fundamental component of fundamental equity analysis by gaining insight into
a company's liquidity, operational efficiency, and profitability by examining the
financial statement
●​ LIQUIDITY RATIO reflects the ability of the business to pay its debts when they
come due by converting its assets to cash.
SOUTH PHILIPPINE ADVENTIST COLLEGE
AE 424 STRATEGIC BUSINESS ANALYSIS
Current ratio = CA / CL
Quick ratio = (CA- Inventories) / CL
●​ SOLVENCY RATIO(Debt management ratio) measures the long-term viability
of a business and determines the long-term risks in the interest of investors and
stockholders. It measures the level of debts of a company as compared to its
assets, annual earnings, or equity.
Debt ratio = TL/TA
Equity Ratio = TE / TA
Debt-to-equity ratio = TL / TE
Book Value per Share = Total Common Equity / Number of common
shares outstanding
Times Interest Earned (Interest Coverage Ratio) = EBIT / Interest
Payments
Cash Coverage = EBIT + Non-cash expense / Interest Expense
Equity Multiplier = 1 / Equity Ratio
●​ PROFITABILITY RATIO reflects the company's profitability in relation to its
assets and measures the ability of a business to earn profit in relation to its
expenses. Ratios are used to measure if the company is profitable when
compared to the previous periods or compared against its competitors
Gross Profit Margin = GP/Sales
Operating Profit Margin = EBIT/ Sales
ROS = Net Income / Sales
ROA = Income / Average Asset
ROE = Income / Average Equity OR RoA / Equity Ratio
●​ ACTIVITY/EFFICIENCY RATIOS(Asset Utilization Ratio) - determines the
right mix between assets vs. sales, and debt against equity. It measures the
performance of the business in terms of utilizing its assets and liabilities in order
to generate sales and earn profits.
Asset Turnover = Sales / Average Total Sales
Accounts Receivable Turnover = Net Credit Sales/Ave. Accounts
Receivable
Inventory Turnover = COGS/ Ave. Inventory
SOUTH PHILIPPINE ADVENTIST COLLEGE
AE 424 STRATEGIC BUSINESS ANALYSIS
Working Capital Turnover = Net Sales / Ave. Working Capital
Fixed Asset Turnover = Sales/Net FA
Accounts Payable Turnover = Credit Purchase / Average AP
AGES:
Age of Receivable = 360/ARTo
Age of Inventory = 360/ITo
Age of Payable = 360/APTo
●​ MARKET VALUE RATIO (Market Prospect Ratio). Such ratios help predict the
possible amount of earnings in the investment.
EPS = (Net Income - PS Dividends) / Weighted Ave. Number of OS
Outstanding
Market Value per share = Total Market value of the shares / Total # of
Outstanding share
Price-Earnings Ratio = Market Price per Share / EPS
Dividend Yield = Dividend Per Share / Market Price per Share
Dividend Payout = Dividend Per Share / EPS
Market to BV ratio = Price/sh / BV/sh
Limitations of financial ratios:
Comparisons with competitors
Comparison in industry average
Difference in accounting methods of companies
Difference in operating methods of companies
Distortion in comparing ratio impact
Seasonal accounting periods
Accuracy level of ratio estimates