financial management module 2
TRANSCRIPT
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TIME
V A L U E
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Time Value of Money Time value of money acts as a base for financial management. The value of
money decrease day by day and year after year. To take decision for future and
present time value of money become important.
The time value of money is the value of money figuring a given amount of
interest earned over a given amount of time.
Two important tools of time, value of money are
Time Value of Money
For calculation: - 2 important situations are arisen
Single cash flow :- when there is one investment in a single year
Multiple cash flow: - when there is inflow or outflow in each
period. Multiple cash flow further divided into two category
1. Even cash flow:- Same amount of money is deposited
every year.
2. Uneven cash flow: - Different amount of money is
deposited every year.
The time value of money is calculated using 4 tables.
1) Present value of lump sum
2) Present value of annuity
3) Future value of lump sum
4) Future value of annuity
Present value of “Future inflows”
(Discounting)
‘
Future value of “Present outflows”
(Compounding)
Example: - need Rs. 50000
after 3 year what is its value
as of today?
Example: investing Rs. 50000
after 3 year how much it will
grow?
Formula, PV = FV
(1+r)n
Formula, FV = PV (1 + r)n
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Present Value: The current worth of a future sum of money or stream of cash
flows given a specified rate of return.
Future Value: It is the value of an asset or cash at a specified date in the future
that is equivalent in value to a specified sum today.
Formula
Present value of a future sum
The present value (PV) formula has four variables, each of which can be solved
for:
PV = FV
(1+r)n
1. PV is the value at time=0
2. FV is the value at time=n
3. „I‟ is the rate at which the amount will be compounded each period
4. „n‟ is the number of periods (not necessarily an integer)
The problem can also be solved without using the table. The formula for the
same is:
PV = 1/ (1+r) n
Future value of a present sum
The future value (FV) formula is similar and uses the same variables.
FV = PV (1 + r)n
Numerical questions:-
Q1. An investor wants to invest Rs. 28000 in FD OF PUNJAB BANK at
10.5 % p.a. for the period of 5 year. Find the value at the end of 5 year
Solution: - FV = PV (1 + r)n
=28000 (1 + 0.105)5
= 28000(1.105)5
= 28000 X 1.648
FV = 46128
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Q2. A cash certificate scheme of SBI has a maturity value of 15000 after 6
year at 9% p.a. find the price of the certificate.
Solution:- PV = FV
(1+r)n
= 15000
(1 + 0.09)6
=15000 = 15000
(1.09)6 1.689
=8929
Problem based on using table
Q3. A business man considering a project value will generate a cash
inflows of 15000, 25000, 30000 45000 for 4 year. Rate of interest 10% .find
PV
Solution:-
Year cash inflow interest@ 10% PV
1 15000 X 0.909 13635
2 25000 X 0.826 20650
3 30000 X 0.751 22530
4 45000 X 0.683 30735
If we do not have a table then w use formula 1/ (1 + r)n
Q4. Businessman investing Rs. 100000 and generate 20000, 35000, 25000,
45000 rate of interest 11%. Advise the business to go for the project or not.
Solution:-
Year FV interest PV
1 20000 X 0.901 =18020
2 35000 X 0.812 =28420
3 25000 X 0.731 =18275
4 45000 X 0.659 =29655
= 94370
It should not invest in this project at present value of inflow is less then
initial investment.
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Q4. Person invests 3000,2500,4500,6000 for 4 year, rate of interest 10%.
How much it grows.
Solution:-
Year PV interest FV
4 3000 X 1.464 4392
3 2500 X 1.331 3327.5
2 4500 X 1.210 5445
1 6000 X 1.100 6600
19764.5 or 19765
Q5. Investor capacity inflow of Rs. 10000 each year foe 5 year @ 9% p.a.
what is the PV (annuity for PV).
Solution: - 10000 X 3.890 = 38900
Financial Statement Analysis
Financial analysis involves analyzing financial statements prepared in
accordance with generally accepted accounting principles to ascertain
information concerning the magnitude, timing, and riskness of future cash
flows. The objective of the financial analysis imbedded in the quarter project is
to evaluate a company as an investment opportunity
I. Past performance record and future expectations
II. How much risk is inherent in the current capital structure
III. What is the performance of the firm compared to the industry and/or
specific competitors
Following are the method of financial statement analysis:-
1. Ratio Analysis
2. Trend Analysis
3. Cash flow Analysis
4. Fund flow Analysis
5. Common size Analysis
6. Comparative Analysis
7. DuPont Analysis
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Ratio Analysis
Ratio analysis is the process of computing, determining and presenting the
relationship of items or group of items of financial statement .it also involve the
comparison and interpretation of those ratios and the use of them for future
projections. A ratio is a mathematical relationship between two relative item
expressed in quantitative from. This quantitative relationship may be expressed
in either of the following way:-
1. In proportion
2. In rate or time or coefficient
3. In percentage
Classification of Ratios
Ratios can be classified into four broad groups:-
i. Liquidity ratios
ii. Profitability ratios
iii. Turnover ratios
iv. Solvency ratios
Liquidity ratios: - it is the ability of a firm to satisfy its short term
obligations as they become due. Liquidity is inversely proportional to
profitability. If liquidity is “0” then profitably is 100%.
Current Ratio = Current Assets
Current Liabilities
If the CR is between 2:1 to 1.33:1 then liquidity is good and satisfactory.
If the CR is below 1.33:1 then the liquidity is bad. Business have no
sufficient fund
If the CR is above 2:1 then the liquidity is not under control. Too much
ideal fund lying in the business. The ideal fund must be reduced & should
be invested in long term investment/fixed assets.
Acid Test Ratio (Quick Assets Ratio) = Liquid Assets
Current Liabilities
Liquid Asset = Current Assets – (Closing Stock +Pre paid expenses)
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Liquid Liability = Current Liability – (bank overdraft)
Liquid assets are assets that can be converted into cash in no time (10-15 days)
List of current assets and current liability are
Current Assets Current Liability
Cash in hand bank overdraft
Cash at bank short term loans
Marketable security creditor
Short term investment bills payable
Debtor outstanding expenses
Bills receivable
Stock/inventory
Prepaid expenses
Q1:- from the following detail compute liquid ratio and give your inference:-
Cash in hand....................................45000
Bank overdraft.................................15000
Cash at bank.....................................50000
Furniture & fixture.........................100000
Marketable security..........................25000
Creditor............................................50000
Plant and machine..........................250000
Bills payable.....................................35000
Debtor...............................................50000
Bills receivable.................................40000
Stock/inventory.................................65000
Prepaid expenses...............................10000
Solution:-
Current Assets Current Liability
Cash in hand 45000 bank overdraft 15000
Cash at bank 50000 bills payable 35000
Marketable security 25000 creditor 50000
Prepaid expenses 10000 100000
Debtor 50000
Bills receivable 40000
Stock/inventory 65000
285000
Current Ratio = Current Assets = 285000 = 2.85 : 1
Current Liabilities 100000
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Inference: - so, the liquidity is not under control.
Acid Test Ratio= Current Assets – (Closing Stock +Pre paid expenses)
Current Liabilities
= 285000 – 65000- 10000
100000
= 2:1
Profitability ratios:-
Gross Profit Ratio= Gross Profit X 100
Sales
Higher the ratio is better the position of the firm which means that the firm
earns greater profits out of the sales and vice versa.
Net Profit Ratio= Net Profit X 100
Sales
Higher the ratio is better the operating efficiency of the firm which means
that the firms earns greater volume of both operating as well as non
operating profit out of sales and Vice versa
Operating ratio = operating cost X 100
Net sales
Operating cost = Cost of goods sold + Operating expenses X 100
Net sales
Expenses ratio = particular expenses X 100
Net sales
Operating expenses ratio = operating expense X 100
Net sales
Turnover ratio: inventory and stock both are same
Stock turnover ratio= Cost of Goods Sold or Sales
Average stock closing stock
Higher the ratio is better the firm in converting the stock into sales and vice
Versa
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Cost of goods sold = sales – gross profit
Cost of goods sold = opening stock +purchases+ wages+ direct exp – cl. stock
If Cost of goods sold is not given in problem the used below formula:-
Stock turnover ratio = net sales
Average stock
Average stock = opening stock + closing stock
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Inventory conversion period = 365 days /52 weeks /12 months
Stock turnover ratio
Lower the duration is better the position of the firm in converting the stock
Into sales and vice versa
Debtors turnover ratio = Net Credit Sales OR Net Credit Sales
Average Debtors Debtor + Bills Receivable
Higher the ratio is better the position of the firm in collecting the overdue
Means the effectiveness of the collection department and vice versa
Net credit sales = total sales – cash sales
Average trade debtor = op Dr + cl Dr
op B/R + cl B/R
op a/c rec + cl a/c rec
2
Creditors Turnover ratio = net Credit Purchase or Credit Purchase
Average creditors payable + Sundry Cr
Lesser the ratio is better the position of the firm in liquidity management
Means enjoying more credit period from the creditors and vice versa
Average trade debtor = op Cr + cl Cr
op B/P + cl B/P
op a/c payable + cl a/c payable
2
Net credit sales = total sales – credit sales
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Solvency ratio
Debt –Equity Ratio = Debt or outsides fund or external equity
Equity Share holder‟s fund internal equity
The ideal norm is that 1:2 which means that every one rupee of debt
finance is covered by the 2 rupees of shareholders’ fund
List of Debt list of Equity
Debenture Equity Share Capital
Mortgage Preference Share Capital
Loans Capital Reserve
Bonds Reserve Capital
Bills Other Kind Of Reserve
Other Liability Contingency Reserve
Sinking Fund Reserve
Proprietary Ratio = Owner‟s Funds or Equity or Share Holder‟s Funds
Total Assets
Fixed Assets Ratio= Share Holders‟ Funds + Outsiders‟ Funds
Net Fixed Assets
Earnings per share (EPS) = net income
No. Of equity share
Interest Coverage Ratio = Earnings before Interest & Tax
Total interest expenses
Return on equity = net income X 100
Share holder fund
Dividend per share = dividend / share
P/E Ratio = Marketing Price of the Share
EPS
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Trend analysis
Trend analysis is a form of comparative analysis that is often employed to
identify current and future movements of an investment or group of
investments. The process may involve comparing past and current financial
ratios as they related to various institutions in order to project how long the
current trend will continue. This type of information is extremely helpful to
investors who wish to make the most from their investments.
Sales:-
2001 Jan 100000
2002 Feb 120000
2003 Mar 110000
2004 Apr 90000
2005 May 130000
Funds Flow Statement
Fund flow statement takes cash + near cash assets.
The term „flow‟ means movement and includes both „inflow‟ and „outflow‟.
The term „flow of funds‟ means transfer of economic values from one asset
of equity to another
Flow of funds is said to have taken place when any transaction makes
changes in the amount of funds available before happening of the transaction
0
20000
40000
60000
80000
100000
120000
140000
Jan Feb Mar Apr May
Trend Analysis
Revenve
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Cash Flow Statement
Inflow and outflow of cash are found.
Analyses are in three different categories:-
Investing activity:- purchase and sale of fixed assets
Operating activity:- regular activity of the business, like raw material &
sales. Generally short term periods
Financing activity: - issue and repayment of share, debenture and loans.
Generally long term periods
Common Size Financial Statements
Common size financial statement is also known as percentage analysis. Profit
and loss account and balance sheet is considered. Common size ratios are used
to compare financial statements of different-size companies or of the same
company over different periods. By expressing the items in proportion to some
size-related measure, standardized financial statements can be created, revealing
trends and providing insight into how the different companies compare. A sale
is always 100% taken.
The common size ratio for each line on the financial statement is calculated as
follows:
Common Size Ratio = Item of Interest
Reference Item
For example, if the item of interest is inventory and it is referenced to total
assets (as it normally would be), the common size ratio would be:
Common Size Ratio for Inventory = Inventory
Total Assets
The ratios often are expressed as percentages of the reference amount. Common
size statements usually are prepared for the income statement and balance sheet,
expressing information as follows:
Income statement items - expressed as a percentage of total revenue
Balance sheet items - expressed as a percentage of total assets
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The following example income statement shows both the dollar amounts and
the common size ratios:
Common Size Income Statement
Income Statement Common-Size
Income Statement
Revenue 70,134 100%
Cost of Goods Sold 44,221 63.1%
Gross Profit 25,913 36.9%
SG&A Expense 13,531 19.3%
Operating Income 12,382 17.7%
Interest Expense 2,862 4.1%
Provision for Taxes 3,766 5.4%
Net Income 5,754 8.2%
Risk & Return
Nobody knows what the future holds. So, whenever we talk about future
returns, we should be humble. Always there is an element of uncertainty or risk.
Perhaps the returns won't materialize; perhaps they will exceed our
expectations. We can't be sure.
Risk
Risk is the variability of actual return from the expected return associated with a
given asset. The greater variability, the riskier the security is said to be. The
more certain the return from an assets, the less the variability and, therefore the
less the risk. Risk is often understood as the possibility of loss. But risk, in
financial terms, is really a way to talk about a range of possibilities -- the
variability of returns. In short, risk is a way to describe degrees of uncertainty.
Returns
The return of assets and investment for a given period say a year, is the annual
income received plus any change in market price, usually expressed as a per
cent of the opening market price .symbolically the one period actual (expected)
return „R‟
R =Dt + (Pt-Pt-1)
Pt-1
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Where, Dt = annual income/cash dividend at the end of the period, t
Pt = security price at time period, t (closing/ending security price)
Pt-1 = security price at time period, t-1 (opening/beginning security price)
Portfolio
In finance, a portfolio is an appropriate mix or collection of investments or
security. Holding a portfolio is part of an investment and risk-limiting strategy
called diversification. By owning several assets, certain types of risk (in
particular specific risk) can be reduced. The assets in the portfolio could include
stocks, bonds, options, warrants, gold certificates, real estate, futures contracts,
production facilities, or any other item that is expected to retain its value. In
building up an investment portfolio a financial institution will typically conduct
its own investment analysis, whilst a private individual may make use of the
services of a financial advisor or a financial institution which offers portfolio
management services.