1. CDA COLLEGE BUS235: PRINCIPLES OF FINANCIAL ANALYSIS Lecture 1 Lecture 1 Lecturer: Kleanthis Zisimos

2. Lecture Topic List What is managerial finance What is managerial finance Career opportunities in finance Career opportunities in finance The financial manager’s responsibility The financial manager’s responsibility Goals of corporation Goals of corporation Balance sheet and Profit and Loss account Balance sheet and Profit and Loss account Cash flow statement and ratio analysis Cash flow statement and ratio analysis

3. What is Finance? Finance consists of three interrelated areas: Finance consists of three interrelated areas: Money and Capital Markets. Money and Capital Markets. Investments. Investments. Managerial Finance or Business finance which involves the actual management of the business Managerial Finance or Business finance which involves the actual management of the business

4. Career opportunities in finance Financial controller Financial controller Bank officer Bank officer Security analyst Security analyst Stock broker Stock broker Insurance analyst Insurance analyst Real estate analyst Real estate analyst Pension analyst Pension analyst Credit controller Credit controller

5. The financial manager’s responsibility 1. Forecasting and planning. The financial manager must interact with other executives as they look ahead and lay the plans which will shape the firm’s future position. 2. Major Investment and financing decisions. The financial manager must help determine the optimal sales growth rate and decide on the specific assets to acquire and the best way to finance those assets.

6. The financial manager’s responsibility 3. Coordination and control. The financial manager must interact with other executives to insure that the firm is operated as efficiently as possible. 4. Dealing with the financial markets. The financial manager must deal with the money and capital markets.

7. Forms of business organizations 1. Sole proprietorship. The Business is owned by one person which has unlimited liability, that means he is responsible to pay the debts of the company by his personal belongings. 2. Partnership. The Business is owned by two or more persons. The business is not legally separated from its owners which means they have unlimited liability. One type of partnership though limits liability and that is LLC. 3. Corporation (ltd). The business is legally separated from its owners (shareholders). The difference between Corporation and LLC is in the tax treatment of profit. LLC is not subject to business income tax.

8. The goals of the corporation Primary goal is to maximize stockholder wealth. That means to make profits and maximize the price of the firm’s common stock Primary goal is to maximize stockholder wealth. That means to make profits and maximize the price of the firm’s common stock Social responsibility. Responsible for the welfare of their employees, customers and community. Social responsibility. Responsible for the welfare of their employees, customers and community.

9. Main Financial Statements The main financial statements which are presented to the stockholders are 1) the Balance Sheet 2) income statement,3) statement of retained earnings and 4) cash flow. The main financial statements which are presented to the stockholders are 1) the Balance Sheet 2) income statement,3) statement of retained earnings and 4) cash flow. 1. The balance sheet is a list of all the assets owned by a business and all the liabilities owed by a business as at a particular date Assets are the business resources which a company owns like a building, machinery and furniture. Additionally it may have bank balances, cash and amounts of money owed to it. Liabilities are the debts of the company like a bank loan, creditors and the capital. Capital is money invested from the proprietor

10. Main Financial Statements (continued) 2. An income statement is a record of income generated and expenditure incurred over a given period. 3. A cash flow statement shows the cash received and the cash payments of a company at a particular date. It is very important to a company because it exposes information that the income statement and Balance Sheet do no show. 4. The statement of retained earnings shows the net retained earnings at the end of the year. It includes the net profit of the year minus the dividends to the stockholders

11. Note on Cash flows In accounting generally emphasis is given on determining the net profit but in finance we focus on cash flows. The value of a company is determined by the cash flow it generates. In accounting generally emphasis is given on determining the net profit but in finance we focus on cash flows. The value of a company is determined by the cash flow it generates. The next example demonstrates the difference between net income and net cash flow The next example demonstrates the difference between net income and net cash flow

12. Differences between Net Profit and Net cash flows Prepare a cash flow statement and a Profit & Loss account for 3 months starting from January based on the following data Projected sales in 2011. 40% cash and 60% received after 3 months Projected sales in 2011. 40% cash and 60% received after 3 months January 40000 € January 40000 € February 50000 € February 50000 € March 30000 € March 30000 € Pizza Hot Ltd plans to buy a computer for 1000 € in Febr. Pizza Hot Ltd plans to buy a computer for 1000 € in Febr. Depreciation is 300 per month Depreciation is 300 per month Rent is 500 € per month Rent is 500 € per month Insurance 200 € per month Insurance 200 € per month Salaries 4000 € per month Salaries 4000 € per month Cost of sales paid each month is 70% on sales Cost of sales paid each month is 70% on sales

13. Ratio analysis Ratio analysis transforms accounting data to useful information. It provides managers and shareholders an effective and systematic basis for making business decisions. Ratio analysis transforms accounting data to useful information. It provides managers and shareholders an effective and systematic basis for making business decisions. The analysis focuses on four elements of a company’s financial condition of performance, which are the following: The analysis focuses on four elements of a company’s financial condition of performance, which are the following: 1. Liquidity and efficiency 2. Solvency 3. Profitability 4. Market prospects

14. Analysis of financial statements (continued) Liquidity and efficiency ratios. Liquidity refers to the availability of recourses to meet short term cash requirements and the efficiency refers to how productive a company is in using its assets. Liquidity and efficiency ratios. Liquidity refers to the availability of recourses to meet short term cash requirements and the efficiency refers to how productive a company is in using its assets. Current ratio= current assets current liabilities current liabilities It measures short term debt paying ability. A 2:1 current ratio is thought to be good Acid test ratio = Current assets-inventories current liabilities current liabilities It measures immediate short term debt paying ability A 1:1 acid test ratio is thought to be good

15. Analysis of financial statements (continued) Liquidity and efficiency ratios Inventory Turnover= Sales average inventory average inventory It measures the efficiency of inventory management Day sales outstanding= Accounts receivables Annual sales/ 360 Annual sales/ 360 It measures the liquidity of receivables

16. Analysis of financial statements (continued) Liquidity and efficiency ratios Fixed asset Turnover= Net Sales Net Fixed assets Net Fixed assets It measures how effectively the firm uses its plant and equipment Total asset Turnover= Net Sales average total assets average total assets It measures the efficiency of assets in producing sales

17. Analysis of financial statements (continued) Solvency ratios. Solvency refers to a company’s long-run financial viability and its ability to cover long-term obligations Debt ratio= Total Liabilities It measures creditor financing Total Assets Total Assets Equity ratio= Total Equity It measures Owner financing Total Assets Total Assets It is desirable equity ratio to be higher than debt ratio Times interest earned= Income before interest and taxes interest expense interest expense It measures the protection in meeting interest payments. The larger the ratio the less risky is the company for lenders

18. Analysis of financial statements (continued) Profitability ratios. Profitability refers to a company’s ability to generate an adequate return on invested capital Profit Margin ratio= Net income x 100 Net Sales Net Sales Gross Margin ratio= Net sales-cost of goods sold x 100 Net Sales Net Sales Return on total assets= net income average total assets average total assets It measures the overall profitability of assets

19. Analysis of financial statements (continued) Profitability ratios. Return on equity (ROE)= Net income – preferred dividends Average common stock equity Average common stock equity It measures the profitability of owners equity Basic earnings power= EBIT Total assets Total assets This ratio shows the raw earnings power of the firms assets Return on assets (ROA)= Net income – preferred dividends Total assets Total assets

20. Analysis of financial statements (continued) Market prospects ratios. They are useful for public Companies ( register in stock exchange market) Price earnings ratio (P/E) = Market price per share Earning per share Earning per share It measures the market value relative to earnings Market/book ratio= Market price per share Book Value per share Book Value per share