Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
WEEK 2 INTRODUCTION TO FINANCIAL MANAGEMENT

OBJECTIVES:
At the end of this lesson, the students are expected to:
Describe Financial Management in terms of the three major decision areas that confront the financial
manager

Identify the goal of the firm and extrapolate why shareholders’ wealth maximization is preferred Explain

the basic responsibilities of financial managers

TO DO LIST:
In order to successfully complete Module 1 Week 2 lesson, students are required to do the
following:
1. Join: the discussion on the topics about Financial Management
2. Follow: Online Netiquette
3. Submit: the required output for this module on or before the given deadline.

LECTURE:

Financial management is mainly concerned with the proper management of funds. The finance manager
must see that funds are procured in such a manner that risk, cost and control considerations are properly
balanced and there is optimum utilization of funds.

According to Soloman, “Financial management is concerned with the efficient use of economic
resources”. According to Phillippatus, “Financial management is concerned with management decision
that result in acquisition and financing of long-term and short-term credits for the firm”.

Financial management is an integrated decision making process, concerned with acquiring, managing and
financing assets to accomplish overall goals within a business entity. Speaking differently, it is concerned
with making decisions relating to investments in long term assets, working capital, financing of assets and
soon.

What is Financial Management?

Financial management capacity is a cornerstone of organizational excellence. Financial management

pervades the whole organization as management decisions almost always have financial implications.

Meaning of Financial Management

Financial management entails planning for the future of a person or a business enterprise to ensure a
positive cash flow, including the administration and maintenance of financial assets. The primary concern
of financial management is the assessment rather than the techniques of financial quantification. Some
experts refer to financial management as the science of money management.

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

Components of Financial Management

The five basic components of the Financial Management Framework are: Planning and

Analysis

Asset and Liability Management

Reporting

Transaction Processing

Control

Importance of Financial Management

Financial management is concerned with procurement and utilization of funds in a proper way. It is
important because of the following advantages:

1. Helps in obtaining sufficient funds at a minimum cost.

2. Ensures effective utilization of funds.

3. Tries to generate sufficient profits to finance expansion and modernization of the enterprise and secure
stable growth.

4. Ensures safety of funds through creation of reserves, re-investment of profits, etc.

The finance function relates to three major decisions which the finance manager has to take: Investment

decisions

Finance decisions

Dividend decisions

Investment decision: This decision relates to the careful selection of assets in which funds will be
invested by the firm. It Involves buying, holding, reducing, replacing, selling & managing assets.
Common questions involving Investments include:

In what lines of business should the firm engage? Should

the firm acquire other companies?

What sort of property, plant, equipment should the firm hold? Should

the firm modernize or sell an old production facility?

Financing decisions involve the acquisition of funds needed to support long-term investments. While
taking this decision, financial management weighs the advantages and disadvantages of the different
sources of finance. The business can either finance from its shareholder funds which

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

can be subdivided into equity share capital, preference share capital and the accumulated profits.
Borrowings from outsiders include borrowed funds like debentures and loans from financial institutions.

This decision relates to the appropriation of profits earned. The two major alternatives are to retain the
profits earned or to distribute these profits to shareholders. While declaring dividend, a large number of
considerations are kept in mind such as:

 Trend of earnings Stability in dividends

 The trend of share market prices

 The requirement of funds for future growth

 The cash flow situation Restrictions under the Companies Act

 The tax impact on shareholders etc.

Investment decision Three Legged Tool Analogy: Broad Classification of Decision Activities

Objectives of Financial Management

The objectives or goals of financial management are-(a) Profit maximization,(b) Return maximization,
and(c) Wealth maximization.

Objectives of Financial Management

(1) Profit maximization: Maximization of profits is generally regarded as the main objective of a business
enterprise.

(2) Return Maximization: Another goal of financial management is to safeguard the economic interest of
the persons who are directly or indirectly connected with the company, i.e., shareholders, creditors and
employees.

(3) Wealth Maximization: Maximization of profits is regarded as the proper objective of the firm but it is
not as inclusive a goal as that of maximizing its value to its shareholders.

Financial Management levels Broadly speaking, the process of financial management takes place at two
levels:

At the individual level, financial management involves tailoring expenses according to the financial
resources of an individual. From an organizational point of view, the process of financial management is
associated with financial planning and financial control.

At the corporate level, the main aim of the process of managing finances is to achieve the various goals a
company sets at a given point of time.

Financial planning means deciding in advance how much to spend, on what to spend, according to the
funds at your disposal. Thus, there are two aspects of financial planning:

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

 How much funds are required to finance current and fixed assets and future expansion project?

 From where will these funds come? Financial planning takes into consideration the growth,
performance, investments and requirement of funds for the business for a given period of time.

Capitalization Capital Management structure of capital

Capitalization Capital is the basis of all financial decisions and the term capitalization has been derived
from it .Capital means the total funds invested in the business and includes owners’ funds, long term
loans and other reserves which are represented by assets. Capitalization is the valuation of this capital and
will include owner’s funds, borrowed funds, long term loans, reserves and any surplus earnings.

Three possible situations of Capitalization Fair capitalization Over Under capitalization Business employs
correct amount of Business employs Business employs capital more capital than less capital than
warranted

Over Capitalization There are three main indicators of over capitalization:

i. When the amount of capital invested in the business exceeds the real value of its assets.
ii. When the earnings are not justified by the amount of capitalization i.e. a fair return is not
realized on capital employed.
iii. When a business has more net assets than it requires

Under Capitalization Under capitalization is the reverse of over capitalization. A company becomes
undercapitalized when: The future earnings are under estimated at the time of promotion. Unforeseen
increase in earnings

Functions of Financial Management Functions of financial management can be divided into two groups:

Executive (or managerial)functions

Incidental or routine functions

Executive functions: These functions involve financial, investment and dividend decision making.
Executive functions involve the following decisions:

Financial Forecasting

Investment decisions

Managing corporate asset structure The

management of income Management of

cash

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

Deciding about new sources of finance

To contact and carry negotiations for new financing

Analysis and appraisal of financial performance

Advising the top management

Incidental functions: They are performed by low level assistants like accountants, account assistants
etc. They include:

Record keeping and reporting

Preparation of various financial statements Cash

planning and its supervision

Credit management

Custody and safeguarding different financial securities etc.

Providing top management with information on current and prospective financial conditions of the
business.

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

WEEK 3 – FINANCIAL MARKETS, INSTITUTIIONS AND INTEREST RATES

OBJECTIVES:
At the end of this lesson, the students are expected to:
Discuss the term structure of interest rates and its relationship to yield curve

TO DO LIST:
In order to successfully complete Module 2 Week 3 lesson, students are required to do the
following:
1. Join: the discussion on the topics about Financial Markets, Institutions and Interest Rates
2. Follow: Online Netiquette
3. Submit: the required output for this module on or before the given deadline.

LECTURE:

WEEK 3

Cost of money

Fundamental factors affecting the cost of money:

1. Production opportunities – returns from investments in cash-generating assets

2. Time preferences for consumption – preference of consumers for current vs. future
consumption (savings)

3. Risk of low or negative return

4. Inflation – the amount prices increase over time

Cost of money  Risk-free rate of interest, k RF

The real risk-free rate, k*, plus an inflation premium, IP  k RF = k* + IP

The nominal (quoted) interest rate also includes default risk (DRP), liquidity (LP), & maturity risk (MRP)

k RF = k* + IP + DRP + LP + MRP

Effecting the cost of money:

The real rate and inflation change over time Central

bank money supply management International

currency flows

Cost of money  Effecting the cost of money:

 The real rate and inflation change over time

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

 Central bank money supply management & International currency flows also lead to interest rate
changes

 Because interest rate levels are difficult to predict, sound financial policy calls for using a mix of
short- and long-term debt

What is a Financial market?

A market is a venue where goods and services are exchanged.A financial market is a place where
individuals and organizations wanting to borrow funds are brought together with those having a surplus of
funds.

Flow of Funds:

Funds flow indirectly from ultimate lenders [households] through financial intermediaries [banks or
insurance companies] or directly through financial markets [stock exchange/bond markets] to ultimate
borrowers [business firms, government, or other households].In order for financial system to function
smoothly, must be adequate information about the markets and their operation.

Flow of Funds: Financial system provides a transmission mechanism between saver-lenders and
borrower-spenders. Savers benefit—earn interest Investors benefit—access to money otherwise not
available Economy benefits—efficient means of bringing savers and borrowers together

Flow of funds from lenders to borrowers:

The Financial Markets:

Physical VS. Financial asset markets Spot

VS. future markets

Money VS. capital markets

Primary VS. secondary markets

Public VS. private markets

The Financial Markets:

Physical Asset Markets: It is a market for such products as wheat, autos, real estate, and machinery.
Financial Asset Markets: It deals with stocks, bonds, notes, mortgages, and derivatives.

The Financial Markets:

Spot Markets: It is a market in which assets are bought and sold for on the spot delivery. Futures
Markets: It is a market in which participants agree today to buy or sell an asset at some future date.

The Financial Markets:

The Money Market: Exchange of short-term instruments—less than one year Highly liquid, minimal risk
Commercial paper—short-term liabilities of prime business firms and finance companies

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

Bank Certificates of Deposits—liabilities of issuing bank, interest bearing to corporations that hold them

U.S. Treasury bills—short-term debts of US government

The Financial Markets:

The Capital Market: Exchange of long-term securities—in excess of one year Generally used to secure
long-term financing for capital investment.

Stock market—Largest part of capital market and held by private and institutional investors

Residential and commercial mortgages—Held by commercial banks and life insurance companies

Corporate bond market—Held by insurance companies, pension and retirement funds

The Financial Markets:

Primary Markets: Market for issuing a new security and distributing to saver-lenders. Initial Public
Offering Market (IPO).Investment Banks—Information and marketing specialists for newly issued
securities.

The Financial Markets:

Secondary Markets: Market where existing securities can be exchanged New York Stock Exchange
American Stock Exchange Over-the-counter (OTC) markets (NASDAQ).

Financial Institutions:
Funds are transferred between those who have funds and those who need funds by three processes: Direct
transfers, Investment banking houses, or Financial intermediaries.

Financial Intermediaries:
Commercial banks Savings and loan associations Credit unions Pension funds Life insurance companies
Mutual funds

Role of Financial Intermediaries:

Act as agents in transferring funds from savers-lenders to borrowers-spenders. Acquire funds by issuing
their liabilities to public and use money to purchase financial assets

Earn profits on difference between interest paid and earned Diversify

portfolios and minimize risk

Lower transaction costs

Commercial Banks: Most prominent Range in size from huge to small

Major source of funds used to be demand deposits of public, but now rely more on “other liabilities” Also
accept savings and time deposits—interest earning

Savings and Loan Associations [S&L’s]:

Traditionally acquired funds through savings deposits Used funds to make home mortgage loans Now
perform same functions as commercial banks issue checking accounts make consumer and business
loans

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

Credit Unions: Organized as cooperatives for people with common interest Members buy shares
[deposits] and can borrow Changes in the law in early 1980’s broadened their powers checking [share]
accounts make long-term mortgage loans

Pension and Retirement Funds:

Concerned with long run

Receive funds from working individuals building “nest-egg” Accurate

prediction of future use of funds

Invest mainly in long-term corporate bonds and high-grade stock Invest

in wide variety of securities—minimize risk

Life Insurance Companies:

Insure against death

Receive funds in form of premiums

Use of funds is based on mortality statistics—predict when funds will be needed Invest

in long-term securities—high yield

Long-term corporate bonds

Long-term commercial mortgages

Mutual Funds: Stock or bond market related institutions

Pool funds from many people Invest in wide variety of securities—minimize risk

Physical location stock exchanges vs. Electronic dealer-based markets

Auction market vs. Dealer market (Exchanges vs. OTC)NYSE vs. Nasdaq

The Stock Market: Organized Security Exchanges:

NYSE, AMEX, and regional Actual physical locations Over-the-Counter Markets: Network of brokers
and dealers Auction market Organized Investment Network Electronic Communications Networks

The Cost of Money: Four factors that affect the cost of money:
Production opportunities

Time preferences for consumption Risk

Expected inflation

“Real” versus “Nominal” Rates:

= real risk-free rate. T-Bond rate if no inflation;2% to 4%.k*= any nominal rate. k= Rate on T-
securities—risk-free.kRF

The Determinants of Market Interest Rates:

Quoted Interest Rate = k = k* + IP + DRP + LP + MRPk = Quoted or nominal ratek* = Real risk-

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
free rate (“k-star”)IP = Inflation premium DRP = Default risk premium LP = Liquidity
premium MRP = Maturity risk premium

Hypothetical yield curve:

Years toMaturity Real risk-free rate 5 10

15 InterestRate (%)Maturity risk premium

Inflation premium

Other Factors that Influence Interest Rate Levels:

Federal Reserve Policy Controls money supply Federal Deficits Larger federal deficits
mean higher interest rates Foreign Trade Balance Larger trade deficits mean higher
interest rates Business Activity

Interest Rate Levels and Stock Prices:

The higher the rate of interest, the lower a firm’s profits Interest rates affect the level
of economic activity, and economic activity affects corporate profits

Risks associated with investing overseas:

Exchange rate risk – If an investment is denominated in a currency other than U.S.
dollars, the investment’s value will depend on what happens to exchange rates. Country
risk – Arises from investing or doing business in a particular country and depends on
the country’s economic, political, and social environment.

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

TIME VALUE OF MONEY

Time value of money (TVM) is the idea that money that is available at the present time is worth more
than the same amount in the future, due to its potential earning capacity. This core principle of finance
holds that provided money can earn interest, any amount of money is worth more the sooner it is
received. In simpler terms, it would be safe to say that a peso was worth more yesterday than today and a
peso today is worth more than a peso tomorrow.

The time value of money is also related to the concepts of inflation and purchasing power. Both factors
need to be taken into consideration along with whatever rate of return may be realized by investing the
money. Inflation and purchasing power must be factored in when you invest money because to calculate
your real return on an investment, you must subtract the rate of inflation from whatever percentage return
you earn on your money. If the rate of inflation is actually higher than the rate of your investment return,
then even though your investment shows a nominal positive return, you are actually losing money in
terms of purchasing power. For example, if you earn a 10% on investments, but the rate of inflation is
15%, you’re actually losing 5% in purchasing power each year (10% – 15% = -5%).

Present value (PV)

 This is your current starting amount. It is the money you have in your hand at the
present time, your initial investment for your future.
 Present value, also called "discounted value," is the current worth of a future sum
of money or stream of cash flow given a specified rate of return. Future cash
flows are discounted at the discount rate; the higher the discount rate, the lower
the present value of the future cash flows. Determining the appropriate discount
rate is the key to properly valuing future cash flows, whether they are earnings or
obligations.

Future value (FV)

 This is your ending amount at a point in time in the future. It should be worth
more than the present value, provided it is earning interest and growing over
time.

The number of periods (N)

 This is the timeline for your investment (or debts). It is usually measured in years,
but it could be any scale of time such as quarterly, monthly, or even daily.

Interest rate (I)

 This is the growth rate of your money over the lifetime of the investment. It is
stated in a percentage value, such as 8% or .08.

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

Payment amount (PMT)

 These are a series of equal, evenly-spaced cash flows.

TIME VALUE OF MONEY FORMULA

Present Value of a Lump Sum

PV = FV / (1+i)n
PV = Present Value
FV = Future Value
PMT= Payment
i = Interest rate
n = Number of years

Future Value of a Lump Sum

FV = PMT (1+i)n
FV = Future Value
PMT = Payment
i = Rate of return you expect to earn
n = Number of years

Present Value of an Ordinary Annuity

An ordinary annuity is a series of equal payments, with all payments being made at the
end of each successive period)

PV = PMT [(1 – (1 / (1 +i)n)) / i]

PV = The present value of the annuity stream to be paid in the future
PMT= The amount of each annuity payment
i = The interest rate
n = The number of periods over which payments are to be made

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
Future Value of an Ordinary Annuity
FV = FV = (PMT [((1 + i)n - 1) / r])(1 + i)
FV = The future value of the annuity stream to be paid in the future
PMT = The amount of each annuity payment
i= The interest rate
n = The number of periods over which payments are to be made

Examples:

Present Value of a Lump Sum

Problem
Suppose you are depositing an amount today in an account that earns 5% interest,
compounded annually. If your goal is to have P5,000 in the account at the end of six
years, how much must you deposit in the account today?
Solution
The following information is given:
 Future value = P5,000
 interest rate = 5%
 number of periods = 6
We want to solve for the present value.
Present value = future value / (1 + interest rate)number of periods or, using notation
PV = FV/ (1 + i)n
Inserting the known information,
PV = P5,000 / (1 + 0.05)6
PV = P5,000 / (1.3401)
PV = P3,731
We can use the present value table (or table of discount factors) to solve for the present
value.
PV = FV (discount factor for i and n)
The discount factor, from the table, is 0.7462. Therefore,
PV = P5,000 (0.7462)
PV = P3,731

Present Value of an Ordinary Annuity

Problem
A company has made an investment in government bonds. The bonds will generate an
interest income of P25,000 each year for 5 years. The interest rate is 10% compounded
annually.
Solution
The following information is given:
 the amount of each annuity payment = P25,000
 interest rate = 10% compounded annually
 number of periods = 5
PV = 25,000 [(1 – (1 / (1 +0.1)5)) / i]
= P25,000 [1 – (1 / 1.61051) / 0.10]
= P25,000 [1 – 0.62092 / 0.10]
= P25,000 × [3.791]
PV = P94,775
We can compute present value of an annuity using present value of an annuity of 1
table: 10% interest rate; 5 periods
PV = P25,000 x 3.791

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
= P94,775

Future Value of a Lump-Sum

Problem
Suppose you are depositing P5,000 today in an account that earns 5% interest,
compounded annually. What will be the balance in the account at the end of six years if
you make no withdrawals?
Solution
The following information is given:
 present value = P5,000
 interest rate = 5%
 number of periods = 6
We want to solve for the future value.
FV = PV (1 + i)n
Inserting the known information,
FV = P5,000 (1 + 0.05)6
FV = P5,000 (1.3401)
FV = P6,701
We can use the future value table (also known as the table of compound factors) to
solve for the future value.
FV = PV (compound factor for 5% and 6)
The compound factor, from the table, is 1.3401
FV = P5,000 (1.3401)
FV = P6,701

Future Value of an Ordinary Annuity

Problem
The treasurer of ABC International expects to invest P100,000 of the firm's funds in
a long-term investment vehicle at the end of each year for the next five years. He
expects that the company will earn 7% interest that will compound annually
Solution
The following information is given:
 present value = P100,000
 interest rate = 7%
 number of periods = 5
We want to solve for the future value of an ordinary annuity
FV = (PMT [((1 + i)n - 1) / r])(1 + i)
Inserting the known information
FV = P100,000 [((1 + .07)5 - 1) / .07](1 + .07)
FV = P575,074
We can compute future value of an annuity using future value of an annuity of 1 table:
7% interest rate; 5 periods

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
FINANCIAL STATEMENT ANALYSIS
Financial statement analysis is the process of analyzing a company's financial
statements for decision-making purposes and to understand the overall health of an
organization. Financial statements record financial data, which must be evaluated
through financial statement analysis to become more useful to investors, shareholders,
managers, and other interested parties.

IMPORTANCE OF FINANCIAL STATEMENT ANALYSIS

The financial statement analysis is important for different reasons:

Holding of Share
Shareholders are the owners of the company. Time and again, they may have to
take decisions whether they have to continue with the holdings of the company's share
or sell them out. The financial statement analysis is important as it provides meaningful
information to the shareholders in taking such decisions.

Decisions and Plans

The management of the company is responsible for taking decisions and
formulating plans and policies for the future. They, therefore, always need to evaluate its
performance and effectiveness of their action to realize the company's goal in the past.
For that purpose, financial statement analysis is important to the company's
management.

Extension of Credit
The creditors are the providers of loan capital to the company. Therefore they may
have to take decisions as to whether they have to extend their loans to the company and
demand for higher interest rates. The financial statement analysis provides important
information to them for their purpose.

Investment Decision
The prospective investors are those who have surplus capital to invest in some
profitable opportunities. Therefore, they often have to decide whether to invest their
capital in the company's share. The financial statement analysis is important to them
because they can obtain useful information for their investment decision making
purpose.

MODELS OF FINANCIAL STATEMENT ANALYSIS

There are at least four traditional techniques of interpreting financial statements, namely:
 Horizontal or Comparative Analysis
 Trend Analysis
 Vertical or Common-size Analysis
 Financial Ratio Analysis

Horizontal (Comparative) Analysis

Horizontal analysis presents the difference in absolute amount and in percentage
between two compared variables such as years, two companies, actual and budgeted
data and other bases of analyses. The difference could either be an increase or a
decrease both in amount and in percentage. A percentage change is computed as
follows:
Percentage of Change = Amount of Change/Base

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 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
 The base may be the last year’s data, budgeted data, average industry data or
chief competitor’s data
 The percentage of change is not computed if the denominator or the base is zero
or negative
 Getting the changes in amount and percentage is not the end-in-view of financial
statement analysis. The interpretation about those changes is more relevant

Trend Analysis
 Trend analysis extends beyond two years.
 It uses indexes and ratios to simplify the visible complications of numbers
contained in the financial reports.
 Financial data expressed in indexes and ratios are easily readable than those
presented in terms of millions of pesos
 Indexes are expressed in hundreds while ratios are expressed in normal decimal
places. In computing the trend index or ratio, the base year (100%) is normally
the earliest year. The choice of the base year is, however, purely judgmental.

Vertical (Common-Size) Analysis

The vertical (common-size) analysis gets the proportional component of each of
the variables in the financial statements in relation to a chosen base (i.e., 100%). As in
horizontal analysis, the financial statements are treated individually and each is analyzed
independent of the others.
 The base in the income statement is the net sales; the base in the balance sheet
is the total assets. In the statement of cash flows, the base may be the total cash
available for use. By expressing the financial data in percentage using a
particular base, the size of different companies is brought to a common
expression.
 Size alone does not reflect the true merits of managerial performance. To
compare the financial data, they should be put in equal standing by expressing
financial figures into percentage and defining a common base (100%)

Financial Ratios
 Since the financial statements are fundamentally-related, we also have to relate
an information contained in one statement with the related information found in
another. This is called inter-financial statements analysis or simply financial mix
ratio analysis.
 In the financial ratio analysis, the income statement data is totaled while the
balance sheet data is averaged.
 There are at least four (4) basic classification of financial mix ratio analysis, as
follows:
- Profitability ratios
- Growth ratios
- Liquidity ratios
- Leverage ratios
 A little bit of caution…
- Ratios have greater disparities from one industry to another
- The economic and business environment keep on changing
- Prices and inflation rates sometimes significantly change from one period to
another
- The availability of many generally accepted accounting principles contribute

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management
to inconsistencies in methods used from one company to another, an industry
to another
- Conservatism has a bias towards diminishing the value of the firm
- Historical cost principle may significantly contribute to a distorted financial
statement analysis

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Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

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Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

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Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
/rcd
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

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