Dep,t of business mgnt , financial mgnt for 4th year students section M-X 29-01-2016/2023

Unit 1: anoveriew of financial management

1.1 INTRODUCTION
Financial Management IT Refers To The Strategic Planning, Organizing,Directing,And Controlling Of An
Organization”S Financial Resource, It Involves Making Decision About how To Obtain And Use Funds To
Achieve The Organization Objectives And Maximizing It’s The Value
Financial Management Encompasses Various Activity Including:
Budgeting, Financial Forecasting, Cash flow Management, Financial Analysis , Investment Decision And Risk
Management
1.2 MEANING OF FINANCE
Finance is the study of money. Finance means to arrange payment for. It is basically concerned with the nature,
creation, behavior, regulation and problems of money. It focuses on how the individuals, businessmen, investors,
government and financial institutions deal.
Finance It Refers To The Management Of Money And Other Financial Resources Are Acquired Allocate And
Utilized It Encompasses Various Activity Such As :Budgeting
:Budgeting Investment Borrowing Lending and Financial
Planning
1.3 FINANCE AND RELATED FIELDS
Though finance had ceded itself from economics, it is not totally an independent field of study. It is an integral part
of the firm’s overall management.
Finance heavily draws theories, concepts, and techniques from related disciplines such as economics, accounting,
marketing, operations, mathematics, statistics, and computer science. Among these disciplines, the field of finance
is closely related to economics and accounting.
1.3.1 Finance versus Economics
Finance and economics are closely related in many aspects. First, economics is the mother field of finance. Second,
the economic environment within which a firm operates influences the decisions of a financial manger. A financial
manger must understand the interrelationships between the various sectors of the economy. He must also
understand such economic variables as a gross domestic product, unemployment, inflation, interests, and taxes in
making financial decisions
Financial managers must also be able to use the structure of decision-making provided by economics. They must
use economic theories as guidelines for their efficient financial decision making. These theories include pricing
theory through the relationships between demand and supply, return analysis, profit maximization strategies, and
marginal analysis. The last one, particularly, is the primary economic principle used in financial management.
Basic Differences between Finance and Economics
i) Finance is less concerned with theory than is economics.
economics. Finance is basically concerned with the
application of theories and principles.
principles.
ii) Finance deals with an individual firm; but economics deals with the industry and the overall level of
the economic activity.
1.3.2 Finance Versus Accounting
Accounting provides financial information through financial statements. Therefore, these two fields are closely
linked as accounting is an important input for financial decision-making. Besides, the accounting and finance
functions generally overlap; and usually it is difficult to distinguish them. In many situations, the accounting and

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finance activities are within the control of the financial manager of a [Link] Differences Between Finance and
Accounting
i) Treatment of income: - in accounting income measurement is on accrual basis. Under this method
revenues are recognized as earned and expenses as incurred. In finance, however, the cash method is
employed to recognize the revenue and expenses.
ii) Decision-making: - the primary function of accounting is to gather and present financial data.
Finance, on the other hand, is primarily concerned with financial planning, controlling and decision-
making.
making. The financial manger evaluates the financial statements provided by the accountant by
applying additional data and then makes decisions accordingly.
iii) Accounting is highly governed by generally accepted accounting principles.

1.2 CLASSIFICATION OF FINANCE

The finance is classified into three categories
I. Personal finance b
II. Public finance
III. Business finance
I. Personal finance: - This deals with the mobilization of funds from own sources. Here funds may imply cash
and non-cash items also.
II. Public finance:
finance: - This kind of finance deals with the mobilization or administration of public funds. It includes
the aspects relating to the securing the funds by the government from public through various methods viz.
taxes, borrowings from public and foreign markets.
III. Business finance:
finance: - Financial management actually concerned with business finance. Business finance is
pertaining to the mobilization of funds by various business enterprises. Business finance is a broad term
includes both commerce and industry.
industry. It applies to all the financial activities of trade such as banking,
insurances, mercantile agencies, service organizations, and the manufacturing enterprises.
The following are the basic forms of organizations

a) Sole trading
b) Partnership
c) Corporation
d) Co-operative
In olden days the individual as a sole trader used to bring in his capital and manage with the help of family
members. Later, partnership form come into existences to overcome some of the defects of sole trading.
The partners used to contribute in the form of money,
money, assets expertise, management etc and profits will be shared
on agreed terms.
. In case of corporate form of organization the
the finances are raised through shares, bonds,
bonds, banks, financial
institutions, suppliers etc
The co-operatives raise funds through the members, government and financial institutions.
institutions. Thus business finances
can be classified into four categories
I. Proprietary finance

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II. Partnership finance

III. Corporate finance
IV. Industrial finance
I. Proprietary finance – This refers to the procurement of funds by the individuals, organizing themselves as sole
traders.
II. Partnership finance – It is concerned with the mobilization of finances by the partners of a business
organizations/partnership firms
III. Corporation finance – It deals with the raising of finances by corporate organizations. It includes the financial
aspects of the promotion of new enterprises and their administration during early period, the accounting,
administration problems arising out of growth and expansion
IV. Industrial finance – This deals with raising of finances from all sources. It is the study of principles relating to
securing the finances from the financial institutions and other institutional sources like banks and insurance
companies.
1.3 EVOLUTION OF FINANCE
The origin of finance can be traced to the start of civilization. The earliest historical evidence of finance is dated to
around 3000 BC banking originated in the Babylonia empire where temples and places where used as safe places
for the storage of valuables.
 The origin of evolution of finance
 Ancient and medieval civilizations in corporate basic function of finance such as banking, trading
and accounting in to their economies in the late 19thc the global financial system are formed
 In the middle 20thc finance is emerged as distinct academic discipline a separate form
economics.
 At the end of 19thc finance became a separate subject due to the spread of economic
activities ,money circulation ,control and monetary policies ,before this time finance was
accepted as a branch economics
1.3.1 SOURCES OF FINANCE
The finance required for any organization could be primarily divided into two one is long-
Internal sources of finance refer to the funds generated from within the organization, while
external sources of finance are the funds obtained from outside the organization.

Internal sources of finance include:

1. Retained earnings: This refers to the profits that are reinvested back into the business rather
than distributed to shareholders as dividends.

2. Sale of assets: Organizations can generate funds by selling their unused or non-essential
assets, such as property, equipment, or vehicles.

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3. Depreciation: The reduction in value of fixed assets over time can be considered as a source
of internal finance, as it frees up funds that would have been used for replacement or
maintenance.

4. Working capital: Efficient management of working capital, such as inventory, accounts

receivable, and accounts payable, can generate internal funds by optimizing cash flow.

External sources of finance include:

1. Bank loans: Organizations can borrow money from banks or financial institutions by agreeing
to repay the principal amount along with interest over a specified period.

2. Equity financing: Companies can raise funds by selling shares or ownership stakes to
investors, who become shareholders and may receive dividends or capital gains in return.

3. Bonds and debentures: Organizations can issue bonds or debentures to investors, who lend
money to the company for a fixed period at a predetermined interest rate.

4. Venture capital: Start-up companies or businesses with high growth potential can secure
funding from venture capitalists in exchange for equity ownership or a share of future
profits.

5. Crowdfunding: This involves raising funds from a large number of individuals through online
platforms, usually in exchange for rewards or equity in the business.

6. Trade credit: Suppliers may provide goods or services on credit, allowing the organization to
delay payment until a later date, thus providing short-term external finance.

7. Grants and subsidies: Governments, non-profit organizations, or other entities may provide
financial assistance in the form of grants or subsidies for specific projects or activities.

It is important for organizations to carefully consider the pros and cons of each s
1.4 THE NATURE AND SCOPE OF FINANCIAL MANAGEMENT
Are encompasses a wide range of activities aim at effectively managing an organizations financial resource to
achieve its goals and maximizing value.
Nature Of Financial Management May Include
1. Estimate capital requirement

2. Decide capital structure

3 .select sources of fund

4 .raise shareholders value

5. .management of cash

6. apply financial control

scopes Financial Management

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Scope Of Financial Mangement May Include

1. Investment decisions

2. Working capital decisions

3. Financing decision

4. dividend decision

5. ensure liquidity decision

6. profit management

Financial management approach measures the scope of the financial management in various fields, which include
the essential part of the finance. Financial management is not a revolutionary concept but an evolutionary. The
definition and scope of financial management has been changed from one period to another period and applied
various innovations. Theoretical points of view, financial management approach may be broadly divided into two
major parts.
Traditional Approach,, financial management was viewed as a filed of study limited to only raising of money.
Under the traditional approach, the scope and role of financial management was considered in a very narrow
sense of procurement of funds from external sources.
sources.
The subject of finance was limited to the discussion of only financial institutions,
institutions, financial instruments, and the
legal and accounting relationships between a firm and its external sources of funds.
Internal financial decision makings as cash and credit management,
management, inventory control,
control, capital budgeting
 were ignored.
ignored. Simply stating, the old approach treated financial management in a narrow sense and the
financial manager as a less important person in the overall corporate management.

Traditional approach is the initial stage of financial management, which are followed, in the early part of during
the year 1920 to 1950. This approach is based on the past experience and the traditionally accepted methods.
 Main part of the traditional approach is rising of funds for the business concern.
Traditional approach consists of the following important area.
 Arrangement of funds from lending body.
 Arrangement of funds through various financial instruments.
 Finding out the various sources of funds.
2. Modern Approach
The modern approach views the term financial management in abroad sense and provides a conceptual and
analytical framework for financial decision making. According to it, the finance function covers both acquiring of
funds as well as their allocations. Thus, apart from the issues involved in acquiring external funds, the main
concern of financial management is the efficient and wise allocation of funds to various uses. It is viewed as an
integral part of the overall management.
The main contents of this approach are:- The concept of finance includes capital, funds, money, and amount. But
each word is having unique meaning. Studying and understanding the concept of finance become an important part
of the business concern
 In general, the functions of financial management include three major decisions a firm must make. These
are:
Financing decisions: deal with the financing of the firm’s investments, i.e., decisions whether the
firm should use equity or debt funds in order to finance its assets. They are also concerned with
determining the most appropriate composition of short – term and long – term financing.
Dividend decisions how much of the cash a firm generates from operations should be distributed
to owners in the form of dividends and how much should be retained by the business for further
expansion
. Investment decisions

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i) Determining the asset mix or composition: - determining the total amount of the firm’s finance to be
invested in current and fixed assets.
ii) Determining the asset type: - determining which specific assets to maintain within the categories of
current and fixed assets.
iii, Managing the asset structure,
structure, i.e., maintaining the composition of current and fixed assets
and the type of specific assets under each category
1.4 GOAL OF A FIRM IN FINANCIAL MANAGEMENT
The goal of the firm in financial management is to maximize shareholder wealth or maximize the value of the
company.
✔️ This means that financial decisions and strategies should be aimed at increasing the long-term value of the
company and generating returns for its shareholders. This can be achieved through effective capital allocation,
efficient use of resources, and making sound financial decisions that optimize profitability and growth while
managing risks. Ultimately, the goal is to create sustainable and long-term value for the company and its
stakeholders.

UNIT 2: FINANCIAL ANALYSIS AND PLANNING

Financial analysis and planning involve the evaluation of a company's

financial performance, position, and future prospects. It helps organizations
make informed decisions, allocate resources effectively, and achieve their
financial goals.

2.1 .Meaning and objectives of financial analysis

A financial statement is an official document of the firm, which explores the entire financial information of the firm.
The main aim of the financial statement is to provide information and understand the financial aspects of the firm.
Financial analysis refers to analysis of financial statements and it is a process of evaluating the relationships
among component parts of financial statements. The focus of ✔️financial analysis is on key figure in the financial
statements and the significant relationships that exist between them. Analysis of financial statement refers to the art
of applying various tools to know the behavior of the accounting information.

✔️Financial analysis is used by several groups of users like managers, credit analysts, and investors. The analysis
of financial statements is designed to reveal the relative strengths and weakness of a firm. This could be achieved
by comparing the analysis with other companies in the same industry, and by showing whether the firm’s position
has been improving or deteriorating over time. Financial analysis helps users obtain a better understanding of the
firm’s financial conditions and performance. It also helps users understand the numbers presented in the financial
statements and serve as a basis for financial decisions.

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Management also employs financial analysis for purposes of internal control. In particular, it is concerned with
profitability on investment in the various assets of the company and in the efficiency of asset management.

2.3 Tools and techniques of financial analysis

✔️Financial analysis may be used internally to evaluate issues such as employee performance, the efficiency of
operations, and credit policies and externally to evaluate potential investments and the credit-worthiness of
borrowers, among other things. The analyst draws the financial data needed in financial analysis from many
sources.

We can use ratio analysis to try to tell us whether the business is profitable has enough money to pay its bills could
be paying its employees higher wages is paying its share of taxis using its assets efficiently has a gearing problems
a candidate for being bought by another company or investor. The type of analysis of financial statement maybe
broadly classified into categories

A .Based on Material Used/According to users of financial information

External Analysis: Outsiders of the business concern do normally external analyses but they are indirectly
involved in the business concern such as investors, creditors, government organizations and other credit agencies.
Internal Analysis: The Company itself does disclose some of the valuable information to the business concern in
this type of analysis. It is an analysis performed by corporate finance and accounting departments for the purpose
of planning, evaluating, and controlling of operating activities.
A. Based on Mode of Operation
Horizontal Analysis: the current year’s figures are compared with the base year and how the financial information
is changed from one year to another (several).
Vertical Analysis: Under the vertical analysis, financial statements measure the quantities relationship of the
various items in the financial statement on a particular period.

In general, a number of methods can be used in order to get a better understanding about a firm’s financial status
and operating results. The following are the common methods or tools/techniques, widely used by the business
concerning analyzing financial statements.
1. Comparative Statement Analysis
A. Comparative Income Statement Analysis
B. Comparative Position Statement Analysis
2. Trend Analysis
3. Common Size Analysis
4. Fund Flow Statement
5. Cash Flow Statement
6. Ratio Analysis
1. Comparative Financial Statement:

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Indicating the direction of movement with respect to financial position and operating results. It shows: Absolute
data (money values or birr amounts), increases or decreases in absolute data in terms of money values, increases
or decreases in absolute data in terms of percentages, comparisons expressed in ratios, percentage of totals.

2. Trend Analysis/ Time-series Analysis:

It is evaluation of the firm’s financial performance overtime to help determine or predict the improvement or
deterioration in its financial situation. Provide a horizontal analysis of comparative statements ratios with passage
of time.
3. Common Size Analysis
Comparative statements that give only the percentages for financial data Figures reported are converted into
percentage to some common base. It expresses individual financial statement accounts as a percentage of a base
amount. In the balance sheet the total assets figures is assumed to be 100 and all figures are expressed as a
percentage of this total. A common size status expresses each item in the balance sheet as a percentage of total
assets and each item of the income statement as a percentage of total sales. When items in financial statements
are expressed as percentages of total assets and total sales, these statements are called common size statements.
4. Funds flow statement:
It helps to understand the changes in the financial position of a business enterprise between the beginning and
ending financial statement dates. It is also called as statement of sources and uses of funds working capital.
5. Cash flow statement:
Shows the sources of cash inflow and uses of cash out-flow of the business concern during a particular period of
time. Provides a summary of operating, investment and financing cash flows and reconciles them with changes in
its cash and cash equivalents.
6. Ratio analysis:
Ratio is a mathematical relationship between one numbers to another number. It is a mathematical relationship
among money amounts in the financial-statements. They standardize financial data by converting money figures in
the financial statements. Ratios are usually stated in terms of times or percentages. Like any other financial
analysis, a ratio analysis helps us draw meaningful conclusions and interpretations about a firm’s financial
condition and performance. Ratio is used as an index for evaluating the financial performance of the business
concern.
3.4 Stages in financial analysis
Financial analysis consists of the following three major stages.
i) Preparation. The preparatory steps include establishing the objectives of the analysis and assembling the
financial statements and other pertinent financial data. Financial statement analysis focuses primarily on the

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balance sheet and the income statement. However, data from statements of retained earnings and cash flows
may also be used. So, preparation is simply objective setting and data collection.
ii) Computation. This involves the application of various tools and techniques to gain a better understanding of the
firm’s financial condition and performance. Computerized financial statement analysis programs can be
applied as part of this stage of financial analysis.
iii) Evaluation and Interpretation. Involves the determination for the meaningfulness of the analysis and to
develop conclusions, inferences, and recommendations about the firm’s performance and financial condition.
This is the most important of all the three stages of
2.5 Types of financial ratios
A financial ratio is a comparison between one bit of financial information and another. Ratio analysis of a firm’s
financial statements is of interest to shareholders, creditors, and the firm’s management. Management uses ratios
to monitor the firm’s performance from period to period. Ratios can be classified in to different groups using
different bases that reveal about the financial strengths and weaknesses of a firm. In general financial ratios can
be grouped into five (5) and each measuring about a particular aspect of the firm’s financial condition and
performance.
Liquidity ratio
Activity ratios
Leverage ratio
Profitability ratio
Market value ratio
2.5.1 Liquidity Ratios
Liquidity reflects a firm's ability to meet its short-term financial obligations on time using assets that are most
readily converted into cash. Current assets are used to satisfy short-term obligations, or current liabilities. .
Example: 1.42: 1 the following financial statements pertain to Zebra Share Company. We will perform the
necessary ratio analyses using them, and then evaluate and interpret each analysis. All of the ratios we perform in
this unit can be depend up on the following data’s and you are recommended to read and understand each of them
as much as you can.
Zebra Share Company
Comparative Balance Sheet
December 31, 2001 and 2002
(In thousands of Birrs)
Assets 2002 2001
Current assets:
Cash 9,000 7,000
Marketable securities 3,000 2,000
Accounts receivable (net) 20,700 18,300
Inventories 24,900 23,700
Total current assets 57,600 51,000
Fixed assets:
Land and buildings 33,000 27,000

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Plant and equipment 130,500 120,000

Total fixed assets 163,500 147,000
Less: accumulated depreciation 67,200 61,200
Net fixed assets 96,300 85,800
Total assets 153,900 136,800
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable 20,100 17,100
Notes payable 14,700 13,200
Taxes payable 3,300 3,000
Total current liabilities 38,100 33,300
Long-term debt:
Mortgage bonds –5% 60,000 60,000
Total liabilities 98,100 93,300
Stockholders’ equity:
Preferred stock –5% (Br. 100 par) 6,000 -
Common stock (Br. 10 par) 33,000 30,000
Capital in excess of par value 7,500 4,500
Retained earnings 9,300 9,000
Total stockholders’ equity 55,800 43,500
Total liabilities and stockholders’ equity 153,900 136,800

Zebra Share Company

Income Statement
For the Year Ended December 31, 2002
________________________________________________________________________
Net sales Br. 196,200,000
Cost of goods sold 159,600,000
Gross profit Br. 36,600,000
Operating expenses* 26,100,000
Earnings before interest and taxes (EBIT) Br. 10,500,000
Interest expense 3,000,000
Earnings before taxes (EBT) Br. 7,500,000
Income taxes 3, 600,00
Net income Br. 3,900,000
* Included in operating expenses are Br. 6,000,000 depreciation and Br. 2,700,000 lease payment.
Zebra Share Company
Statement of Retained Earnings
For the Year Ended December 31, 2002
Retained earnings at beginning of year Br. 9,000,000
Add: Net income 3,900,000
Sub-total Br. 12,900,000
Less: Cash dividends
Preferred Br. 300,000
Common 3,300,000
Sub-total Br. 3,600,000
Retained earnings at end of year Br. 9,300,000

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i) Current ratio – measures the ability of a firm to satisfy or cover the claims of short-term creditors by using only
current assets. To determine current ratio divide the current assets by the current liabilities. This ratio relates
current assets to current liabilities
Current ratio = Current assets
Current liabilities
Zebra’s current ratio (for 2002) = Br. 57,600 = 1.51 times
Br. 38,100.
ii) Quick ratio (Acid – test ratio)-Also known as the liquid or the quick ratio. It is a stricter indication of a
company's financial strength (or weakness). It measures the short-term liquidity by removing the least liquid
current assets such as inventories. Inventories are removed because they are not readily or easily convertible into
cash. Inventory/stocks are sometimes might be difficult to sell or use. Thus, the quick ratio measures a firm’s ability
to pay its current liabilities by using its most liquid assets into cash. It is calculated by taking current assets less
inventories, divided by current liabilities.
Quick ratio = Current assets – Inventory
Current liabilities
Zebra’s quick ratio (for 2002) = Br. 57,600 – Br. 24,900 = 0.86 times
Br. 38,100
Like the current ratio, the quick ratio reflects the firm’s ability to pay its short-term obligations, and the higher the
quick ratio the more liquid the firm’s position. But the quick ratio is more detailed and penetrating test of a firm’s
liquidity position as it considers only the quick asset. The current ratio, on the other hand, is a crude measure of
the firm’s liquidity position as it takes into account all current assets without distinction.

2.5.2 Activity Ratios

Activity ratios measure the degree of efficiency a firm displays in using its assets. These ratios include turnover
ratios because they show how rapidly assets are being converted (turned over) into sales or cost of goods sold.
Activity ratios are also called asset management ratios, or asset utilization ratios, or efficiency ratios. Generally,
high turnover ratios are associated with good asset management and low turnover ratios with poor asset
management.
Activity ratios include:
i) Accounts Receivable turnover – measures how efficiently a firm’s accounts receivable is being
managed. It indicates how many times or how rapidly accounts receivable are converted into cash
during a year.
Accounts receivable turnover = Net sales
Accounts receivable
Zebra’s accounts receivable turnover (for 2002) = Br. 196,200 = 9.48 times
Br. 20,700
ii) Days sales outstanding (DSO) – also called average collection period. It seeks to measure the average number
of days it takes for a firm to collect its accounts receivable. In other words, it indicates how many days a firm’s
sales are outstanding in accounts receivable.

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Days sales outstanding = 365 days

Accounts receivable turnover

Zebra’s days sales outstanding = 365 days = 39 days

9.48
iii) Inventory turnover – measures how many times per year the inventory level is sold (turned over).
Inventory turnover = Cost of goods sold
Inventory
For Zebra Company (2002) = Br. 159,600 = 6.41times
Br. 24,900
iv) Fixed assets turnover – measures how efficiently a firm uses it fixed assets. It shows how many birrs of sales
are generated from one birr of fixed assets
Fixed assets turnover = Net sales___
Net fixed assets
Zebra’s fixed assets turnover = Br. 196,200 = 2.04 times
Br. 96,300
v) Total assets turnover – indicates the amount of net sales generated from each birr of total tangible assets. It is a
measure of the firm’s management efficiency in managing its assets.
Total assets turnover = Net Sales
Total assets
Zebra’s total assets turnover = Br. 196,200 = 1.27 times
Br. 153, 900

2.5.3 Leverage Ratios

Leverage ratios are also called debt management or utilization ratios. They measure the extent to which a firm is
financed with debt, or the firm’s ability to generate sufficient income to meet its debt obligations. While there are
many leverage ratios, we will look at only the following three.
i) Debt to total assets (Debt) Ratio – measures the percentage of total funds provided by debt.
Debt ratio = Total liabilities
Total assets
Zebra’s debt ratio = Br. 98,100 = 64%
Br. 153,900.
ii) Times – interest earned – measures a firm’s ability to pay its interest obligations.
Times interest earned = Earnings before interest and taxes (EBIT)
Interest expense
Zebra’s times interest earned = Br. 10,500 = 3.50
Br. 3,000.
iii) Fixed charges coverage – measures the ability of firms to meet all fixed obligations rather than interest
payments alone. Fixed payment obligations include loan interest and principal, lease payments, and preferred
stock dividends.
Fixed charges coverage = Income before fixed charges and taxes
Fixed charges
For Zebra Company, the other fixed charge payment in addition to interest is lease payment. Therefore, Zebra’s
fixed charges coverage = Br. 10,500 + Br. 2,700 = 2.32

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Br. 3,000 + Br. 2,700

2.5.4 Profitability Ratios

i) Profit Margin– shows the percentage of each birr of net sales remaining after deducting all expenses.
Profit margin = Net income
Net Sales
Zebra’s profit margin = Br. 3,900 = 2%
Br. 196,200
ii) Return on investment (assets) – measures how profitably a firm has used its investment in total assets.
Return on investment = Net income
Total assets
Zebra’s return on investment = Br. 3,900 = 2.53 %
Br. 153,900
iii) Return on equity – indicates the rate of return earned by a firm’s stockholders on investments made by them-
selves.
Return on equity = Net income___
Stockholders’ equity
Zebra’s return on equity = Br. 3,900 = 6.99%
Br. 55,800
Return on equity = Return on investment
1 – Debt ratio
2.5.5 Marketability Ratios
Marketability ratios are used primarily for investment decisions and long range planning. They include:
i) Earnings per share (EPS) – expresses the profits earned on each share of a firm’s common stock outstanding. It
does not reflect how much is paid as dividends.
Earnings per share = Net income – Preferred stock dividend
Number of common shares outstanding
Zebra’s Eps for 2002 = Br. 3,900 – Br. 300 = Br. 1.09
Br. 33,000  Br. 10.
ii) Dividends Per Share (DPS) – represents the amount of cash dividends a firm paid on each share of its common
stock outstanding.
Dividends Per Share = Total cash dividends on common shares
Number of common shares outstanding
Zebra’s DPs for 2002 = Br. 3,300 _ = Br. 1.00
Br. 33,000  Br. 10
iii) Dividend pay-out (pay-out) ratio – shows the percentage of earnings paid to stockholders.
Dividends pay-out = Dividends per share
Earnings per share
= Total dividends to common stockholders
Total earnings to common stockholders
Zebra’s pay-out ratio = Br. 1.00 = Br. 3,300 = 92%
Br. 1.09 Br. 3,600
2.6 Comparing financial ratios
To address whether a given ratio is high or low, good or bad, a meaningful basis is needed for comparison. Two
types of ratio comparisons can be made.
i) Cross – sectional analysis – is the comparison of a firm’s ratios to those other firms in the same industry at the
same point in time. Here, the firm is interested in how well it has performed in relation to other firms. Generally,
cross – sectional analysis is preformed based on industry averages of different financial ratios.

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ii) Time – series analysis – is an evaluation of a firm’s financial ratios over time. Here, the current period ratios
are compared with those of the past years. The purpose is to determine whether the firm is progressing or
deteriorating.
To obtain the highest possible information about a firm, usually, a combination of both cross – sectional and time-
series analyses are applied.

Chapter -3: The Time Value Of Money And The

Concept Of Interest
The time value of money is very important
concept of financial management it has many
application in the financial decision like loan
settlement in vesting in the bond and stocks
The concept of time value of money the money
received now is generally better than the some
amount of money recieved some time at the
future.
The concept of time value of money is to
understand the meaning of interest
Interest-:means the cost of using money or
capital over specific period of time
They are two basic types of interest

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[Link] interest:-the interest that its

calculated only in the original amount or
principal
[Link] interest:-compounding interest is
it is the interest that is received on the original
NB:-MONEY: is time value
Time value of money is :
The sum of money received today is more than it is
the value of received after the period of times
The sum of money received in the future is less than
the value its todays
The present worth of the birr received after the
same times will be less than a birr received todays
The time value that abirr todays is worth more than
a birr received ayear from know because of the
value of one birr after a year will growth to one birr
& interest earned on it can be invested
Money received sooner rather than later allows one to use the funds for investment or
consumption purposes. This concept is referred to as the TIME VALUE OF MONEY
TIME allows one the opportunity to postpone consumption and earn INTEREST
THE time value of money referred as called time preference of money

Example of simple interest [Link] he deposited for birr 15000 at

the commercial bank of Ethiopia in nekemte branch the simple interest

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rate is 1O% for 5 years then what is the accumulated amount and
interest at the end of each five years
General formula: I=PRT 15000*0.1*5=7500
A=15OOO+7500=22500
Ato lami biyana he deposited for birr 25000 at cooperative bank of
oromia at boku branch at interest rate is 5% for 7years what is amount
and interest at the end of each 7 years
I=PRT =25000*5%*7 years =8750
A=25000+8750=33750

Future Value and Compounding

Future value refers to the amount of money an investment will grow to over some
length of time at some given interest rate
⚫ To determine the future value of a single cash flows, we need:
present value of the cash flow (PV)
interest rate (r), and
time period (n)
FVn = PV0 × (1 + r)n Future Value Interest Factor at ‘r’ rate of interest for
‘n’ time periods
Examples on computation of future value of a single cash flows
If you invested $2,000 today in an account that pays 6% interest, with
interest compounded annually, how much will be in the account at the
end of two years if there are no withdrawals
FUTURE VALUE FOMULA
FV1 = PV (1+r)n = $2,000 (1.06) 2 = $2,247.20
Future Value (Formula) FV =
future value, a value at some future point in time PV = present value, a
value today which is usually designated as time r = rate of interest per
compounding period n = number of compounding periods

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example [Link] wants to know how large his $5,000 deposit will become
at an annual compound interest rate of 8% at the end of 5 years.
Future Value Solution Calculation based on general formula:
FVn = PV (1+r)n FV5 = $5,000 (1+ 0.08) 5 = $7,346.64
Present Value and Discounting
The current value of future cash flows discounted at the appropriate
discount rate over some length of time period
Discounting is the process of translating a future value or a set of future
cash flows into a present value.
to compute present value of a single cash flow, we need:
future value of the cash flow (FV)
Interest rate (r) and
Time Period (n)
PV0 = FVn / (1 + r)n
PVIF (r,n)

Assume that you need to have exactly $4,000 saved 10 years from
now. How much must you deposit today in an account that pays 6%
interest, compounded annually,
Present Value (Formula)
PV0 = FV / (1+r)10 = $4,000 / (1.06) 10 = $2,233.58
Joann needs to know how large of a deposit to make today so that
the money will grow to $2,500 in 5 years. Assume today’s deposit
will grow at a compound rate of 4% annually
Calculation based on general formula:
PV0 = FVn / (1+r)n PV0 = $2,500/(1.04)5 = $2,054.81
Compounding frequency
General Formula:
FVn = PV0 (1 + [r/m])mn
n: Number of Years m: Compounding Periods per Year
r: Annual Interest Rate

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FVn,m: FV at the end of Year n PV0 : PV of the Cash Flow today

Examples Suppose you deposit $1,000 in an account that pays 12%
interest, compounded quarterly. How much will be in the account
after eight years if there are no withdrawals? PV = $1,000 r = 12%/4
= 3% per quarter n = 8 x 4 = 32 quarters

Solution based on formula: FV= PV (1 + r)n = 1,000(1.03)32 = 2,575.10

Multi period Compounding:
Compounding: Till now, we have seen the cash flows will occur once in a year.
But, the cash flows may occur monthly, bi-monthly, quarterly, half yearly and yearly. In such
instances we have to apply the following formulae.
nm
 1
Fn = P 1  
 m
You have deposited a birr of 1, 000 in Commercial Bank of Ethiopia at 12 percent interest per
annum. It compound annually, semi-annually, quarterly and monthly for two years. How much
does it grow?
Annual compounding
n=2 i = .12%

FV = P(CVFn .i)n*m
= 1, 000 (1+ 0 .12)2*1

= 1, 000 (1.254) = 1, 254

12
Half-yearly n=2x2=4 i= = 6%
2
FV = 1, 000 (CVF4 .06)
= 1, 000(1.262)
= 1, 225
12
Quarters n=4x2=8 i= = 3%= r/m
4
FV = 1, 000 (CVF8 .03)
= 1, 000 (1.267)
= 1, 267

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12
Monthly n = 12 x 2 = 24, i= = 1%
12
FV = 1, 000 (CVF24. .01)
= 1, 000 (1.270)
= 1, 270
To compute years (t)= (log(A/P))/Log(i+r)
To compute i=p*(1+r/n))t-p or i=p*(1+r)t-p

Present Value versus Future Value

Present value factors are reciprocals of future value factors
interest rates and future value are positively related
interest rates and present value are negatively related
Time period and future value are positively related
Time period and present value are negatively relate
Determining the Interest Rate (r)
what rate of interest should we invest our money today to get a desired
amount of money after a certain number of years?
essentially, we are trying to determine the interest rate given present
value (PV), future value (FV), and time period (n
Annuities
a series of level/even/equal sized cash flows that occur at the
end of each time period for a fixed time period

examples of Annuities:
car Loans

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House Mortgages
Insurance Policies
Some Lotteries
Retirement Money
The reason for time value of money
Invesment opportunity:-money has the potential to growth over period of
time because it can be invested
Inflation :fall into purchase power of money
Risk :money received know is certain ,whereas money tomorrow is less
certain
Personal consumption preference many peoplehas stong preference of
immediate rather than delayed consumptions

Set by teka ch (MBA)

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