WEEK 2

Introduction to Financial Statements

Financial statements are formal records that provide a snapshot of a company's financial performance and
position. They are essential tools for stakeholders to make informed decisions about the company. There are
three main types of financial statements:
A. Income Statement
Definition: The income statement, also known as the profit and loss statement, summarizes a company’s
revenues and expenses over a specific period to determine its net profit or loss.
Components:
 Revenue: The total income generated from sales of goods or services. It’s also referred to as sales or
turnover.
 Expenses: The costs incurred to generate revenue. This includes operating expenses (e.g., salaries, rent),
interest, and taxes.
 Net Income: The final result after subtracting total expenses from total revenue. It represents the
company’s profitability during the period.
Purpose: The income statement helps assess the company’s performance by showing how well it can generate
profit from its operations. It provides insights into operational efficiency and cost management.
Example:
Revenue: $500,000
Expenses: $350,000
Net Income: $150,000
B. Balance Sheet Statement
Definition: The balance sheet provides a snapshot of a company’s financial position at a specific point in
time. It details the company’s assets, liabilities, and shareholders’ equity.
Components:
 Assets: Resources owned by the company that are expected to provide future economic benefits. They
are categorized into current assets (e.g., cash, accounts receivable) and non-current assets (e.g., property,
equipment).
 Liabilities: Obligations or debts that the company must settle in the future. Liabilities are divided into
current liabilities (e.g., accounts payable, short-term debt) and long-term liabilities (e.g., bonds payable,
long-term loans).
 Shareholders’ Equity: The residual interest in the assets of the company after deducting liabilities. It
includes common stock, retained earnings, and additional paid-in capital.
Purpose: The balance sheet helps evaluate the company’s financial stability and liquidity by showing
what the company owns versus what it owes. It provides insights into the company’s ability to meet its
short-term and long-term obligations.
Example:
Assets: $1,000,000
Liabilities: $600,000
Shareholders’ Equity: $400,000
C. Cash Flow Statement
Definition: The cash flow statement tracks the flow of cash into and out of the company over a specific
period. It categorizes cash flows into three main activities: operating, investing, and financing.
Components:
 Operating Activities: Cash flows from primary business operations, including receipts from sales and
payments to suppliers and employees. It shows how much cash is generated or used by the company's
core business operations.
 Investing Activities: Cash flows related to the acquisition and disposal of long-term assets and
investments. This includes purchases of property, equipment, or investments in other companies.
 Financing Activities: Cash flows from transactions with the company’s owners and creditors, including
issuing stock, borrowing, and repaying debt.
Purpose: The cash flow statement provides insights into the company’s liquidity and financial flexibility
by showing how cash is generated and used. It helps assess the company's ability to maintain and expand
operations.
Example:
Operating Cash Flow: $200,000
Investing Cash Flow: -$100,000
Financing Cash Flow: $50,000
Net Increase in Cash: $150,000

WEEK 3 -Analyzing Financial Statements

Vertical, Horizontal, and Ratio Analysis

a. Vertical Analysis
Definition: Vertical analysis involves expressing each line item in a financial statement as a percentage of a
base amount. This technique helps in understanding the relative size of each item.
Application:
 Income Statement: Each line item is expressed as a percentage of total sales. For example, if total sales
are $100,000 and cost of goods sold (COGS) is $40,000, then the COGS as a percentage of sales is 40%.
  Balance Sheet: Each line item is expressed as a percentage of total assets. For instance, if total assets
are $200,000 and current liabilities are $50,000, the current liabilities as a percentage of total assets are
25%.
Purpose: Helps in comparing financial statements of companies of different sizes and in understanding the
proportion of each line item relative to the base amount.
b. Horizontal Analysis
Definition: Horizontal analysis, also known as trend analysis, involves comparing financial data over multiple
periods to identify growth patterns or trends.
Application:
 Compare financial statements from different periods (e.g., year-over-year) to analyze changes in line
items such as revenue, expenses, and net income.

 For example, if revenue in Year 1 is $80,000 and in Year 2 is $100,000, the percentage increase in revenue is 25%.

Purpose: Helps in understanding how key financial metrics are evolving over time and identifying trends in
financial performance.
c. Ratio Analysis
Definition: Ratio analysis involves calculating and interpreting financial ratios to assess various aspects of a
company’s performance, such as liquidity, profitability, and solvency.
Types of Ratios:
 Liquidity Ratios: Measure a company’s ability to meet short-term obligations.

Example: If current assets are $60,000 and current liabilities are $30,000, the current ratio is 2.0.
 Profitability Ratios: Assess the company’s ability to generate profit relative to sales, assets, or equity.

Example: If net income is $10,000 and total revenue is $100,000, the net profit margin is 10%.
 Solvency Ratios: Evaluate the company’s ability to meet long-term obligations and manage debt.
 Example: If total liabilities are $80,000 and total equity is $40,000, the debt-to-equity ratio is 2.0.

 Efficiency Ratios: Measure how effectively a company manages its assets.

Example: If COGS is $120,000 and average inventory is $30,000, the inventory turnover ratio is 4.0.
Purpose: Helps in analyzing specific aspects of financial performance and making comparisons with industry
benchmarks or past performance.

WEEK 4

Definition of Time Value of Money (TVM)

 Concept: TVM is a financial principle that money available today is worth more than the same amount
in the future due to its potential earning capacity.
 Core Idea: Money today can be invested to earn returns, making it more valuable than the same amount
received in the future.
To understand TVM, we need to explore a few key concepts:
 Opportunity Cost: This is the potential gain lost when choosing one investment over another. If you
choose to hold onto your P50,000 instead of investing it, you miss out on potential earnings.
 Discounting: This is the process of determining the present value of future cash flows. It answers the
question: How much is a future amount worth in today’s terms?
 Compounding: This refers to the process of calculating the future value of money invested today,
considering the interest earned on previously accrued interest. Compounding allows your investment to
grow at an accelerated rate over time.
A. Simple Interest
Definition
 Simple Interest: Interest calculated only on the principal amount of a loan or investment. It does not
account for interest earned on previously accumulated interest.
Formula: I =P × r × t
where:
 I = Interest
 P = Principal amount (initial sum of money)
 r = Annual interest rate (decimal)
  t = Time period (in years)

Example Calculation
 Scenario: Invest P50 000 at 5% annual simple interest for 3 years.
o Calculation: I = 50 000 × 0.05 × 3 = P 7 500
o Interest earned: P 7 500
o Total amount after 3 years: A = P + I = 50 000 + 7 500 = 57 500
 Linear Growth: Interest grows linearly over time.
 Simplicity: Easy to calculate and understand.
 No Compounding: Does not account for interest on interest.
Applications
 Short-term Loans: Often used in short-term financial products where compounding is less of a factor.

B. Compound Interest
Definition
 Compound Interest: Interest calculated on the initial principal, which also includes all accumulated
interest from previous periods.
Formula: A=P (1 + r/n) nt
where:
 A = Amount after interest
 P = Principal amount
 r = Annual interest rate (decimal)
 n = Number of times interest is compounded per year
 t = Time period (in years)
Example Calculation
 Scenario: Invest 50,000 at 5% annual interest, compounded quarterly for 3 years.
 Calculation:
o Quarterly interest rate: r/n=0.05/4=0.0125
o Total number of compounding periods: nt=4 × 3=12
o Future Value: A=50 000(1+0.0125)12 ≈ 58,037.73
o Interest earned: I = A−P = 58,037.73 – 50,000 = 8,037.73
Characteristics
 Exponential Growth: Interest grows exponentially due to compounding.
 Accuracy: Reflects real-world scenarios more accurately than simple interest.
 Compounding Frequency: The more frequently interest is compounded, the higher the total interest
earned.
Applications
 Long-term Investments: Used in savings accounts, bonds, and other financial instruments where interest
is compounded over time.

WEEK 5

Definitions
Risk: Risk in finance refers to the possibility of an investment's value fluctuating, leading to potential
loss or gain. It represents the uncertainty about the future performance of an investment. This uncertainty stems
from various factors, including market volatility, economic changes, and company-specific events.
Return: Return is the profit or income earned from an investment. It can be expressed as:
 Income Return: Regular income received from investments such as dividends from stocks or interest
from bonds.
 Capital Appreciation: Increase in the value of the investment itself, such as the rising price of a stock.

Types of Risks
Systematic Risk: Also known as market risk, systematic risk affects the entire market or a large portion of
it. It is inherent to the entire market and cannot be mitigated through diversification.
Examples include:
 Economic Downturns: Recessions or economic slowdowns that affect all sectors.
 Political Instability: Events like elections, wars, or geopolitical tensions.
 Natural Disasters: Catastrophic events such as earthquakes, hurricanes, or floods that impact the broader
economy.
Unsystematic Risk: Also known as specific or idiosyncratic risk, this type affects individual companies or
industries. Unlike systematic risk, it can be reduced or eliminated through diversification. Examples include:
 Product Failures: A company’s specific product might fail, impacting its stock price.
 Management Changes: Changes in a company’s leadership can influence its performance.
 Legal Issues: Legal troubles or regulatory changes affecting a particular industry.

Determining the Inflation Rate

Inflation is the general rise in the price of goods and services over time. It can erode the purchasing power of
your money, meaning that the same amount of money can buy less over time.

How is Inflation Measured?

The most common measure of inflation is the Consumer Price Index (CPI). This index tracks the average
price of a basket of goods and services that a typical household buys. By comparing the price of this basket over
time, economists can calculate the inflation rate.
Calculating Inflation Rate
Here's a simplified formula to calculate the inflation rate:

Inflation Rate = ((Price in Year 2 - Price in Year 1) / Price in Year 1) * 100

For example, if the price of a loaf of bread was $2 in 2023 and $2.20 in 2024:
 Inflation Rate = (($2.20 - $2) / $2) * 100 = 10%
This means that the price of bread increased by 10% from 2023 to 2024.

Factors Affecting Inflation

Several factors can influence inflation, including:
 Demand-pull inflation: When demand for goods and services exceeds supply, prices tend to rise.
 Cost-push inflation: When the cost of production increases, businesses may pass these costs on to
consumers in the form of higher prices.
 Money supply: An increase in the money supply can lead to inflation if it outpaces economic growth.

WEEK 7

BONDS AND THEIR VALUATION

• Is a technique for determining the theoretical fair value of particular bond.

TYPES OF BOND
A. Government bond is a type of debt security issued by a government to raise funds for various purposes, such as
infrastructure projects, public services, or paying off existing debt. When investors purchase government bonds,
they are essentially lending money to the government in exchange for a promise to be repaid with interest over a
specified period of time.
B. Corporate bond is a debt security issued by a corporation to raise capital for various purposes, such as funding
expansion, refinancing existing debt, or financing operations. When an investor buys a corporate bond, they are
lending money to the company in exchange for regular interest payments (called coupons) and the promise to be
repaid the principal (the bond’s face value) at the maturity date.
C. Municipal bond (often referred to as a muni bond) is a debt security issued by a state, city, county, or other local
government entity to raise funds for public projects such as building infrastructure (e.g., schools, highways,
bridges, or hospitals), funding services, or refinancing existing debt.

CHARACTERISTICS OF A REGULAR BOND

• COUPONRATE
- is the fixed return that an investor earns periodically until it matures.
• MATURITYDATE
- refers to the moment in time where the principal of a fixed income instrument must be repaid to an
investor.
• CURRENTPRICE
- is the most recent price at which a security was sold on an exchange.

KEY FEATURES OF A BOND

 • PARVALUE
- face amount of the bond, which is paid at maturity
• COUPONINTERESTRATE
- stated interest rate paid by the issuer
• MATURITYDATE
- years until the bond must be repaid
• YIELDTOMATURITY
-rate of return earned on a bond held until maturity

EXAMPLE:
• Let’s find the value of a corporate bond with an annual interest rate of 5%, making semi-annual
interest payment for 2 years , after which of the bond matures and principal must be repaid.
Assume a YTM of 3% and principal of 1,000
WEEK 8

CAPITAL BUDGETING- is the process of evaluating long-term investment decisions that involve significant
expenditures.

DISCOUNTED CASH FLOW

• is a valuation method used to estimate the attractiveness of an investment opportunity.

CFt
PV=
( 1+ r )t
• PV –present value
• CF – cash flow at time
• r – discount rate
• t- time/period

• Calculate Discounted Cash Flow and Profitability Index

Example Scenario: Imagine a project that requires an initial investment of $100,000 and is expected to generate the
following cash flows over 5 years:
Year 1: $30,000
Year 2: $35,000
Year 3: $40,000
Year 4: $45,000
Year 5: $50,000
• Assuming a discount rate of 10%, let's calculate the DCF and the Profitability Index.

CFt 30,000 30,000 30,000

PV= t =
= = =27,273
( 1+ r ) ( 1+ 0.10 ) 1
1.10
1
1.10
CFt 35,000 35,000 35,000
PV= t=
= = =¿ 28,926
( 1+ r ) ( 1+ 0.10 ) ( 1.10 )2
2
1.21

WEEK 9

Profitability Index is a ratio that calculates the value created per unit of investment. It is calculated using the formula:

• Calculate Discounted Cash Flow and Profitability Index

Example Scenario: Imagine a project that requires an initial investment of $100,000 and is expected to generate the
following cash flows over 5 years:
Year 1: $30,000
Year 2: $35,000
Year 3: $40,000
Year 4: $45,000
Year 5: $50,000
• Assuming a discount rate of 10%, let's calculate the DCF and the Profitability Index.

CFt 30,000 30,000 30,000

PV= t =
= = =27,273
( 1+ r ) ( 1+ 0.10 ) 1
1.10
1
1.10
CFt 35,000 35,000 35,000
PV= t=
= = =¿ 28,926
( 1+ r ) ( 1+ 0.10 ) ( 1.10 )2
2
1.21

TO SOLVE PROFITABILITY INDEX: