FINANCIAL MANAGEMENT (1st Day, p.m.

1. What is the formula for profit maximization? Explain the meaning.

Profit maximization is the central assumption in price theory. This emphasis on profits is however
easily justifiable. Marginal revenue (MR) is equal or greater than its Marginal Cost (MC)

2. What are the two ratios often used in analyzing balance sheets? Define each.

Current ratio determines the amount of coverage that current assets provide to current liabilities.
Debt/equity ratio is used to gauge (1) the business use of external funds to support its operations,
and (2) degree of financial sophistication or weakness of a company.

3. Business expenditures are generally distinguished in two categories. What are these
categories? Explain each briefly.

(a) Capital expenditures – the object of the expenditure is to acquire some assets that are expected
to have an economic life of more than one year. This will result in the ownership of goods of a
semi-permanent type (buildings, factories, machineries, vehicles, and office furnishings). They
are expected to contribute to the operation of the business over several profit-making periods.
They are included under Balance Sheets under the heading Fixed Assets.

(b) Revenue expenditures – they involve the acquisition of goods and services that are consumed
quickly. The items involved have no permanent character. They are fully consumed within one
year (wages, salaries, rent, insurance, and maintenance. They are included under Income
Statement.

4. What are the sources of a long-term capital?

(a) Lower cost compared to equity shares

(b) No dilution in the claims of existing shareholders
(c) Broader base of possible sources
(d) Successful use of debt generates return

5. How can a businessman ensure that he has a good and profitable financial management?

(a) Financing priorities are established in accordance with organizational objectives;

(b) Spending is planned & controlled in line with established priorities;
(c) Adequate funding is available when needed, now and I the future;
(d) Funds are obtained and used efficiently

6. Explain the meaning of Inventory Management and give the two methods of Inventory
Management.

It is the determination of economic order sizes for various items. It includes the level of monthly
sales, ordering cost, and the carrying costs (the interest cost on the amount invested in goods in
storage as well as the foregone use of space occupied by these goods.

Two methods on Inventory Management

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 1) LIFO – Last in, first out
2) FIFO – First in, first out

7. Excess idle cash can earn some interest if placed in a money market business. What is
the procedure to be followed and how much will be the interest if for example your idle
cash is P 1 million?

Excess idle cash can earn some interest in a money market placement, a time deposit account, or in
some forms of redeemable instrument. Just how much must be invested, in what form and what
expected earning levels must be determined.

8. What is probability?

It is an important unit in decision-making process. It is always expressed in fraction and percentage.

It measures the likelihood of the occurrence of the events.

9. Identify and discuss your alternative when a business firm is unable to show a profit
and is experiencing a gradual depletion of its resources in order to enable it to stay in
operation.

10. The basic financial statement of an organization consists of the balance sheet, income
statement and the cash flow. Describe the nature of each and explain how their
functions differ.

Balance sheet is the financial position of an accounting entity as of a specified moment in time (also
known as the statement of financial position or status report). Income statement summarizes the
results of operations for a period of time (flow report). Cash flow analysis is an economic method of
analysis that employs the positive (inflow) and negative (outflow) movements of cash caused by an
activity.

11. Discuss the reasons why net income for a particular period does not necessarily reflect
a firm’s cash flow during the period.

12. Can you make a statement regarding the relationship between a gross profit margin and
inventory turnover? Discuss in detail. Give specific examples.

Gross profit margin = Gross margin

Net sales/Revenue

It is the total margin available to cover other expenses beyond cost of goods sold, and still yields a
profit.

Inventory turnover = Cost of Sales

Inventory

It is the number of times that average inventory of finished goods was turned over or sold during a
period of time, usually a year.

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13. Differentiate Gross Profit Margin from Net Profit Margin. Define each and give the
formula of each one.

Gross profit margin reflects the company’s ability to cover its manufactured or purchased cost of
merchandise. It also reflects the management’s policies related to pricing and production efficiency in
technology. Gross profit margin = sales – cost of sales
sales

Net profit margin is “bottom-line” ratio indicating the company’s ability to generate surplus for its
stockholders. Net profit margin = net income
Sales

14. Define the following and give their formula: a. Current Ratio b. Quick Ratio

Current Ratio determines the amount of coverage that current assets provide to current liabilities.

Current ratio = Current assets

Current liabilities

Quick Ratio measures the firm’s capacity to cover its short-term obligation using only its more liquid
assets. Inventories are included from current assets in calculating this ratio. It is also known as acid-
test ratio, which measures a firm’s ability to pay its bills quickly from available cash and near-cash
assets (Test of immediate solvency).

Quick ratio = current assets – inventory

Current liabilities

15. What is the role of Working Capital Policy?

Under perfect markets, these “Policy” questions are irrelevant in the sense that they are answered by
individual asset and financing choices. WCP will depend on how management resolves the trade-off
between potential return and the risk of bankruptcy.

16. Explain the meaning of a Positive Net Present Value. Give an example.

Positive NPV discounts all future cash flows to the present, using the required rate of return. It is a
“net” value because all cash flows are matched against cash outflows.

All cash flows are discounted to present value, using a required rate of return. If the sum of this
discounted cash flow is zero or more, the proposal is accepted, if not it is rejected. Other way to
screen the acceptance criterion and say that the project will be accepted if the present value of cash
flow exceeds present value of outflows.

17. Define payback period and give its formula.

Payback period is a measure of the expected number of years needed to receive the total cash
investments on the project. This is the number of years required to recover the initial cash
investment. It is the ratio of the initial fixed investment over the annual cash inflows for the recovery
period.

Payback period = initial cost of investment *

Annual cash inflow **
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 * - net of proceeds from sale of old investment

** - if NI add non-cash expenses

The major shortcoming of the payback method is that it fails to consider cash flows after the payback
period. Consequently, it can’t be regarded as a measure of profitability. It does not take account of
the magnitude or timing of cash flows during the payback period. It considers only the recovery
period as a whole. The shorter the payback period, supposedly the less risky the project and the
greater its liquidity.

18. What are the effects of deregulation of banks in a public sector, banking institutions,
government, and loan sharks?

19. Which is more important stability or liquidity? Explain.

Liquidity is the company's ability to meet its current obligations. Liquidity tests focus on the size of,
and relationships between current liabilities and current assets.

Stability is the ________________________ .

20. Is it advantageous for a company to be highly leverage? Why? Discuss.

Leverage (or Trading on Equity) is the buying of assets with money raised by borrowing or issuing
preferred stock. It is achieved through debt financing (current and long-term firm liabilities. Effects:

a. Favorable if the return on total assets is above the average cost of borrowed capital.
b. Unfavorable if the return on total assets fall below the average cost of borrowed capital.

21. An increase in income does not necessarily mean increase in cash. Explain.

22. Price earnings. Explain the significance if a company has a high price earnings ratio.

Price/Earning ratio = Market Price per share

Net Income per share
It involves an amount not directly controlled by the company: the market price of its common stock. It
is the best indicator of how investors judge the firm's future performance. Management is interested
in this market appraisal and a decline in the company's P/E ratio not explainable by a general decline
in stock market prices is cause for concern. Management compares its P/E ratio with those of similar
companies to determine the marketplace's relative rankings of the firms.

23. Explain EOQ, JIT. Can they be used simultaneously in a company? Explain. Can they
be always be used?

24. Financial tools/ratios used in the evaluation of company’s performance. Cite all
applicable ratios used in FM, the formulae and its significance. Among the tools or
techniques in assessing firm’s performance are financial ratios or indices. Discuss the
issues and limitations of these tools and indices in performance analysis of firms.
25. Role of financial intermediaries in Financial Management.

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26. Role stock market. What happens if there is no active stock market? How will this
affect the realization of corporate goals?

27. Requirements of working capital revolved around factors of perfect and imperfect
markets, where under the former working capital is not a need but the latter is
critical. Discuss fully the reasons why under imperfect market, working capital is
very critical and under perfect market it is not.

28. The theories and practices of financial management consist of acquisition, allocation
and financing of resources needed by the firm. Name and discuss the theories and
practices that underlie financial management from the point of view of stakeholders.

29. Nelson Drug has 50,000 shares of stock outstanding, total earnings of $600,000 and a
market price per share of $90. It pays a cash dividend of $4 per share.
Requirements:
a) Determine the market total market value
b) Earnings per share (EPS)
c) Price earnings Ratio (P/E)
d) Dividend Payout ratio

30. When a firm first goes public with its common stocks, the offering is referred to as an
initial public offering (IPO). Some of the issues raised in the IPO are underpricing or
overpricing. Discuss the situations under which these issues may occur.

31. What are the basic factors to be considered in making decisions on financing? Discuss
in full any two from each of the following financial schemes:
a. Short-term financing
1) Trade credit
2) Accounts Receivable financing
3) Pledging inventories
4) Factoring
5) Short term borrowing
b. Long-term financing
1) Mortgage bonds
2) Registered and coupon bonds
3) Convertible bonds
4) Miscellaneous bonds
5) Financing with Preferred stocks

32. The J Company and S Company, engaged in the same kind of mercantile business, and
owned by the same person, report for a year substantially the same amounts for

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 sales, cost of sales, and gross profit, respectively. The J Company reports a
merchandise turnover of 4.5 while the S Company one of 10.
(a) Explain, illustrating with an example how such difference might occur.
(b) Comment on the significance of the merchandise turnover in the administration and
control of merchandising operations.

33. Discuss thoroughly how the following techniques are used in analyzing capital
investment proposals:
a) Net present value method
b) Internal rate of return method
c) Payback method
d) Unadjusted return on investment method

34. You would like to venture in a new business in a situation similar to the present where
there is an economic crisis brought about principally by currency exchange crisis.
What kind of business (type of industry) would you prefer to go into? Why? Explain
fully.

35. Yours is a medium-sized corporation, which is doing relatively well in the industry.
Another smaller corporation is doing relatively well also but for some reason the
principal owners would like to put it up for sale or takeover or merger. Would you be
interested? Why? What would your considerations be?

36. You are engaged in a business with significant import activities and therefore with
significant foreign exchange exposure. Enumerate possible ways to either protect
yourself from foreign exposure or minimize said foreign exchange exposure.

37. What would a wide discrepancy between a gross profit margin and net profit margin
normally indicate? (e.g. a gross profit margin of 35% and net profit margin of only
3%) What steps are you going to take?

38. One of the most controversial issues under the present administration is the de-facto
devaluation of the Philippine pesos, which resulted to volatile interest rate. Discuss
the implication of the scenario on the firms goals and objectives as regards:
a) Profit maximization
b) Maximization of the value of the firm
c) Achievement of a leading market position
d) Become an exemplary proponent of government thrust of being a financial center in
Asia.

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39. ABC Company is one of the top five companies in terms of earnings. In a recent board
meeting, the company approved the manager’s compensation scheme. A member of
the board asked the chair the relevant merits of the scheme. If your are the chair
of the board, how will you explain the merits paying managers in terms of:
a. Salary
b. Salary plus lump sum bonus once profit target is met
c. Salary plus proportionate bonus on the level of profit achievement.
d. No salary instead profit sharing
e. No salary or profit but shares of stock value at current market price.

40. Paltok company has two alternative proposals submitted to management for approval as
follows:

Project Alpha Project Beta

Year Cash Flow (000) Probability Cash Flow (000) Probability
1 2,000 .20 2,000 .05
2 4,000 .30 4,000 .45
3 6,000 .30 6,000 .45
4 8,000 .20 8,000 .05

Required:
1. Select the best proposal
2. Support your answers by calculating mean, standard deviation and coefficient of
variation.

41. You are planning to form a new corporation. You can avail of several capital structures.
Investment bankers indicated that debt and equity capital will cost the following
under different debt ratio (D/TA)

Debt ratio < 20% 21-40% 41-50% 51-65%

Before tax cost-debt 8% 9% 11% 14%
Cost of equity capital 12% 17% 18% 25%

Required:
a) Assuming a 35% tax rate, what is the after tax weighted cost of capital for the
following structure.

1 2 3 4 5 6 7 8
Debt 0% 20% 21% 40% 41% 50% 51% 65%
Equity 100% 80% 79% 60% 59% 51% 49% 35%

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b) Which capital structure minimizes weighted average cost of capital.

Net present value is the difference between the present value of the cash inflows and the amount of
investment. If the NPV is positive, the proposal is acceptable.

Payback period is the number of years over which the investment outlay will be recovered (paid back)
from the cash inflows if the estimate turn out to be correct.

Ex. Payback period = Cost of machine

Generated cash flow/year

= $1,200 = 3 years
$400/yr

Asset = Liabilities + Capital

Entity – any organization or activity for which accounting reports are prepared.

Assets – the economic resources of an entity.

Goodwill – the amount by which the purchase prices exceeds the value of the assets.

Current Assets – cash and other assets that are expected to be realized within one year.

Cash – consists of fund readily available for disbursements.

Marketable securities – investments that are both readily marketable and expected to be converted to
cash within one year.

Accounts receivable – amounts owed by the entity by customers.

Inventories – aggregate of items either 1) held for sale in the ordinary course of bus, 2) in process of
production 3) soon to be consumed by the production of goods and services.

Prepaid expenses – intangible assets (insurance).

Liabilities – are obligations to outside parties.

Current liabilities – obligations expected to be satisfied within one year.

Accounts payable – claims of suppliers

Taxes payable – the amount that the entity owes the government agencies for taxes.

Accrued expenses – amounts that have been earned by outside parties but have not yet been paid.

Deferred revenues – represent the liability because of advance payments.

Bond – a certificate promising to pay its holder 1) specified sum of money at a stated time (maturity date)
and 2) interest at a stated rate until the maturity date.

Convertible bond – may be exchanged for a specified number of shares of the issuing corporation’s
common stock.

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Preferred stock – pays a stated dividend

Common stock – shareholders have residual interest in profits and assets.

Financial Aspect Components

 Sources of Financing
 Assumptions to financial projections
 Projected financial statements
 Financial analysis

Objectives of Financial Statements

 To present fairly in conformity with generally accepted accounting principles a) financial position, b)
results of operations, and c) other changes in financial position.
 Financial position and changes in financial position of an enterprise are defined in terms of its
economic resources and obligations and changes in them that are identified and measured in
conformity with accounting principles that are generally accepted at the time the statements are
prepared.

Principles of Financial Statement Presentation

Basic Financial Statements - A balance sheet, a statement of income, a statement of changes in retained
earnings, a statement of changes in financial position, disclosure of changes in other categories of
stockholder’s equity, descriptions of accounting policies, and related notes is the minimum presentation
required to present fairly the financial position and results of operations of an enterprise.

Complete Balance Sheet - The balance sheet or statement of financial position should include and
properly describe all assets, liabilities, and classes of owner’s equity as defined by GAAP.

Complete Income Statement - The income statement should include and properly describe all revenue
and expenses as defined by GAAP.

Complete Statement of Changes in Financial Position - The statement of changes in financial position of a
period should include and properly describe all-important aspects of the company’s financing and
investing activities.

Accounting Period - The basic time period for which financial statements are presented is one year;
interim financial statements are commonly presented for period of less than one year.

Translation of foreign balances - Financial information about the foreign operations of enterprises should
be translated into Philippine pesos by the use of conventional translation procedures that involve foreign
exchange rates.

Classification and segregation - Separate disclosure of the important components of the financial
statements is presumed to make the information more useful. Examples in the income statement are
sales or other sources of revenue, cost of sales, depreciation, selling and administrative expenses,
interest expense, and income taxes. Examples in the balance sheet are cash, receivables, inventories,
property, plant and equipment, payables and categories of owner’s equity.

Working Capital - Disclosure of components of working capital (current assets less current liabilities) is
presumed to be useful in manufacturing, trading and some service enterprises. Current assets and
current liabilities are distinguished from other assets and liabilities.

Offsetting - Assets and liabilities in the balance sheet should not be offset unless a legal right of offset
exists.

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Gains and Losses - Revenue and expenses from other that sales of products, merchandise, or services
may be separated from other revenue and expenses and the net effects disclosed as gains or losses.

Extraordinary Items - Extraordinary gains and losses should be presented separately from other revenue
and expenses in the income statement.

Net Income - The net income of an enterprise for a period should be separately disclosed and clearly
identified in the income statement.

Other Disclosures - In addition to informative classifications and segregation of data, financial statements
should disclose all additional information that is necessary for presentation in conformity with generally
accepted accounting principles. Descriptions of accounting policies and notes that are necessary for
adequate disclosure are an integral part of the financial statements.

Customary or Routine Disclosure - Information about measurement bases of important assets, restrictions
on assets and of owners equity, contingent liabilities, contingent assets, important long-term commitments
not recognized in the body of the statements, information on terms of owner’s equity and long-term debt,
and certain other disclosures required by pronouncements of PICPA, ASC, and regulatory bodies that
have jurisdiction are necessary for full disclosure.

Disclosure of changes in accounting principles - Changes in accounting principles, practices, or the

methods of applying them, together with the financial effect, and the justification for the change should be
disclosed in the financial statements or in a note thereto.

Depreciation Methods

1. Straight-line method – service provided (benefit received) by/from a fixed asset is equal in each year
of its life.

Ex. If net cost = $1,000

Estimated service life = 10 years
Depreciation expense for 1st year = 1/10 ($1000) = $100
This is similar for 2nd, 3rd, 4th… 1o years

2. Accelerated Method – benefits provided by the asset maybe greater in the 1 st year and least in the
last year. The asset’s mechanical efficiency tends to decline with age, maintenance costs tend to
increase with age, increasing likelihood that better equipment will become available and make it
obsolete.

a. Declining balance method – each year’s depreciation is found by applying a rate to the net book value
of the asset as of the beginning of that year.

Net book value of an asset at a point in time is the original acquisition cost less depreciation.

Financial Statements - A set of reports which is the end product of the financial accounting process.

a) Balance sheet – financial position of an accounting entity as of a specified moment in time (also
known as statement of financial position or status report).

b) Income Statement – summarizes the results of operations for a period of time (flow report).

Financial reporting should provide the information:

1. Useful to present and potential investors and creditors in making rational investment and credit
decisions.
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2. Comprehensible to those who have a reasonable understanding of business and economic activities
and are willing to study the information with reasonable diligence.

3. About the economic resources of an enterprise, the claims to those resources, and the effects of
transactions and events that change resources and claims to those resources.

4. About an enterprise’s financial performance during a period.

5. To help users assess the amounts, timing, and uncertainty of prospective cash receipts from
dividends or interest and the proceeds from the sale or redemption of securities or loans.

BASIC ACCOUNTING CONCEPTS

Balance Sheet

1. Money Measurement
2. Entity
3. Going Concern
4. Cost
5. Dual Aspect

Income Statement

6. Accounting Period
7. Conservatism
8. Realization
9. Matching
10. Consistency
11. Materiality

1. Money Measurement – money is the common denominator, its value at the time an event is recorded
in the accounts.

2. Entity – accounts are kept for entities not for the persons who are associated with these entities.

3. Going Concern- assumes the entity will continue to operate for an indefinitely long period in the
future.

4. Cost – It is the basis for all accounting of the assets.

5. Dual Aspect – Assets = Equities Assets = Liabilities + Owner’s Equity

6. Accounting Period – accounting measures activities for a specified interval of time (accounting period)
= one year).

7. Conservatism – prudent reporting based on healthy information. Preferences for using the smaller
number when measuring assets or revenues and the larger for liabilities or expenses (anticipate net
profits but anticipate all losses).

8. Realization – the amount of revenue that should be recognized from a given sale. Realization refers
to inflows of cash or claims to cash (accounts receivable) arising from the sale of goods or services.

9. Matching – determining the items of revenue to recognize for the period and their amounts and then
matching items of cost to these revenues.
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10. Consistency – once an entity has decided on one method it should use the same method for all
subsequent events of the same character unless it has a sound reason to change methods.

11. Materiality – insignificant events may be downgraded but there must be full disclosure of all-important
information.

FUNDS FLOW ANALYSIS – the technique employed to determine the major uses and sources of funds
within one year in a project’s life.

1. Cash Flow Analysis – an economic method of analysis that employs the positive (inflow) and negative
(outflow) movements of cash caused by an activity.

a. Sources of funds:
 Net decrease in any asset other than cash
 Net increase in any liability
 Proceeds from the sale of stocks
 Funds provided by operations

b. Use of funds:
 Net increase in any asset other than cash and fixed assets
 Gross increase in fixed assets (ending net fixed assets plus period depreciation less beginning net
fixed assets)
 Net decrease in any liability
 Retirement of stock
 Cash dividends

2. Working Capital Flow Analysis – an economic method of analysis that employs the positive (inflow)
and negative (outflow) movements of working capital caused by an activity.

a. Sources of funds:
 Net decrease in any asset other than current assets
 Net increase in long-term liabilities
 Proceeds from the sale of stocks
 Funds provided by operations

b. Use of funds:
 Net increase in other assets
 Gross increase in fixed assets
 Net decrease in long-term liabilities
 Retirement of stock
 Cash dividends

CLASSES OF FINANCIAL RATIOS

1. Profitability ratios – margin of sales and overall efficiency of asset or capital employed.

2. Turnover Ratios – efficiency in the use of specific asset categories.

3. Liquidity Ratios – company’s capacity to meet short-term obligations.

4. Leverage Ratios – company’s degree of dependence on external debt funds sources and its ability to
meet the corresponding debt-service requirements.

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