Lecture 11

Lecture 11
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Accounting & Finance.
Accounting is the process of
Collecting, measuring & recording raw financial
Organising this data using agreed upon
accounting rules and methods to create useful
information and communicating the results of
the analysis in financial reports and statements.
• Finance is the set of activities a company
engages in to decide how to
raise, use, and invest money so it generates
more cash, profit and capital in the future.
• Business finance is about increasing the rate of
return on a company's capital to maximize
the market value of stockholders equity.
• All of a company's stakeholders are vitally
interested in the financial statement that result
from the work of the accounting function
• The
and the manner in which accountants follow
agreed upon rules to prepare those statements.
information contained within these
statements allows both inside and outside
stakeholders to evaluate company performance.
• GAAP > Generally Agreed Accounting
• Used for ensuring accounting info is reported
honestly and accurately.
• GAAP is a set of rules & procedures developed over
time by accounting experts.
• Companies usually employ two different types of
– Internal and
– External.
• External accountants audit the work of the
internal accountant to ensure the company is
performing as claimed.
• There are three main kinds of financial
– A company's balance sheet (statement of financial
– Its income statement.
– Its statement of cash-flow.
• The balance sheet is a summary of the financial
position of a business at the end of a specific
reporting period.
• It reports the main types of assets owned by the
company, its liabilities or what it owes and its
stockholders equity or what its worth.
• The basic equation of accounting is :
Assets – Liabilities = Owners Equity
• The purpose of the income statement is to
summarize and report the results of a company's
profit making activities in a specific period.
• It is also called a profit and loss statement.
• The basic equation used to calculate a company's
bottom line profit, the amount of net income or
profit company reports on the bottom line of its
income statement, is
Revenues - Expenses = Profit (or loss)
• A company's cash-flow must be managed to
ensure the firms short and long term survival.
• It shows how much cash a company generates
during a specific financial period, where it came
from and how the company used it.
• In accounting cash refers to the value of a
company's asset that can be converted to cash
• Together the
– Balance sheet
– Income statement
– Cash flow statement
• Provide
the information necessary for
stakeholders to analyze the company's
performance and the way in which its assets,
liabilities, profit and loss are being made and
lost, i.e. how it is changing.
• Financial ratios are useful because they
benchmark the company's performance over
time and against the performance of others.
• The three main types of ratios utilised are
– Liquidity ratios
– Asset management ratios
– Profitability ratios
• Liquidity ratios measure a company's ability to
pay its bills when they are due.
• A vital short term measure of performance.
Current Ratio = Current Assets/Current Liabilities
Quick Ratio = Cash + Receivables/Current Liabilities
• Asset management ratios measure whether
managers have created a business model that
will give it the ability to efficiently generate
increasing profits over time.
Inventory Turnover Ratio = Cost of Good Sold/Inventory
Asset Turnover Ratios = Sales/Total Assets
• Profitability ratios compare the profit with some
other variable such as sales or equity to measure
how effectively managers using a company's
capital to create profit and cash.
Gross Margin Ratio = Gross Profit (Sale – COGS) / Sales
* 100
Profit Margin Ration = Net Income/ Sales * 100
• Return on Invested Capital (ROIC) is the ratio
most financial analysts use to get a good picture
of a company's present and future profitability.
ROIC = Net Income/Total Capital Invested
• All investments must be compared in terms of
their relative risks and returns. The higher the
risk the higher the payoff.
• Business finance is about increasing the rate of
return on a company's capital to maximize the
market value of stockholders equity.
• Capital investing and budgeting involve
developing a plan and budget to manage capital
so that it leads to a high ROIC.
• A break-even analysis forecasts the revenues and
costs associated with a project to locate the
point at which the project's sales just cover all of
its costs without a profit being earned.
• After the break-even point the revenues and
profits usually increase quickly.
• The goal of capital financing is to obtain the money
a company needs to fund its activities at the lowest
possible cost.
• Securities are investment documents that give
investors a legal claim against the assets of a
• Debt securities are investment documents that
provide evidence of a company's legal obligation to
repay within a certain amount of time the money it
has borrowed, as well as the interest upon it.
• Equity securities are the capital stock certificates
a company issues giving the owners of the
certificates the legal right to a company's assets
and the right to receive dividends from any
profits the company makes.
• An initial public offering (IPO) is the first time the
owners of a company offer their stock for sale to the
general public.
• Four main types of stock are
– Blue-chip stocks (prestigious company's stocks IBM, P&G,
– Income stocks (low risk and a tradition of high dividends
paid to investors)
– Growth stocks (potential to generate high dividends in the
near future)
– Speculative stocks (low sales with potential).
• And that’s a basic introduction to the world of

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