Finance for Non-

Finance People
Ayman M. El-Najjar

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 Out-Line
• Overview of Financial Management
• Nature of Costs
• Break-Even Analysis
• Financial Statements ( e.g. Balance Sheet,
Cash Flows, Profit loss statement)
• Ratio analysis & Performance Measures
• Capital Budgeting
• Investment Appraisal
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Overview of Financial
Management

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• Financial Manager has the
primary responsibility for
acquiring funds (cash) needed by
the firm and for directing those
funds into projects that will
maximize the value of the firm

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• Financial Management
responsibilities are divided between
– Controller, who has all responsibilities
related to accounting, &
– Treasurer, who is concerned with the
acquisition, custody, and expenditure of
funds.

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 Financial Analysis & Ratios
• Financial ratio is a relationship that
indicates something about a firm’s
activities.
• Financial Ratios enable an analyst
to make a comparison of a firm’s
financial condition over time or in
relation to other firms.
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 Keep in Mind

• Financial Ratios are only “Flags”

indicating potential areas of strength or
weakness.
• A Financial Ratio is meaningful only
when it is compared with some
standard, such as industry ratio trend, a
ratio trend for the specific firm being
analyzed, or a stated management
objective.

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6-Groups of Financial Ratios
1. Liquidity Ratios
2. Asset Management Ratios
3. Financial Leverage Ratios
4. Profitability Ratios
5. Market-Based Ratios
6. Dividend Policy Ratios
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Liquidity Ratios

Financial Ratios that indicate a

firms ability to meet a short-term
financial obligations

Current Assets
1.Current Ratio =
Current Liabilities

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Liquidity Ratios

2. Quick Ratio =

Current Assets - Inventories

Current Liabilities

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Asset Management Ratios
• Average Collection Period
(average number of days an account
receivable remains outstanding) =
Account Receivables
Annual Credit Sales/365

Ex. ACP=32,000,000/(65,000,000/365)= 180 days!

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Asset Management Ratios
• Inventory Turnover Ratio

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Nature of Costs

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• Fixed Costs:
– Definition: Don’t change by
changing production volumes
– Examples: Rents, insurance,
depreciation, salaries, fees, fixed
bank loans charges, …

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• Semi-Fixed Costs:
– Def.: don’t change as a result of
changes in production volume except
when a specific ceiling is reached
– Ex.: new salaried staff required,
penalty charges,…

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• Variable Costs:
– Definition: directly proportionately
related to production volumes
– Examples: light, heat, energy bills,
labor, direct materials,
transportations, …

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• Semi-Variables Costs:
– Def.:A step change variation once a
specific ceiling is reached
– Ex.: overtime payments, electricity
charges, …

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• Sunk Cost:
– Def.: costs that have been paid out before
a specific project under review was ever
considered
• Marginal Costs:
– Def.: the additional cost of one extra unit

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Break Even Analysis

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Definition: A technique used to
examine the relationship
between a firm’s sales, costs,
and profits at various levels of
output. It is sometimes termed
“cost-volume-profit analysis”

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 TR
Break Even Point
TC

Revenue, + EBIT
Cost (Operation profits)
($)

- EBIT
FC
(operating loss)

Output, Q 21
Break Even Point =

Fixed Cost + Target Profit

__________________________
Price – Variable Cost

= (Targeted Volume) 22
• Contribution Margin: the
difference between price and
variable cost per unit.
A B
Selling Price = 24 25
variable Cost = 12 14
Contribution = 12 11

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exercise
Firm A manufactures one
product, which sells at $250.
Total sales is $5 million. Fixed
cost is $1 million & the total
variable costs are $3 million.
Find the breakeven output.
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 Limitations of Breakeven analysis

1. Constant selling price & variable cost

per unit.
2. Composition of costs.
(all costs are variables on the long run. some
costs increase in a stepwise manner as output
changes)
• Single product or constant mix
• Short-term Planning Horizon (1 year)
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Capital Budgeting

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• Capital Budgeting: the process of
planning for purchases of assets
whose returns are expected to
continue beyond one year.
• Capital expenditure: is a cash
outlay that is expected to generate
a flow of future cash benefits
lasting longer than one year.
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• Cost of capital: Cost of Fund;
– “the required rate of return”
• Depreciation: a systematic allocation
of the cost of an asset over more than
one year.
– non-cash expense
– reduce reported earning
– reduces also taxes
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Decision Models for
Evaluating
Alternatives

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4 - Criteria are Commonly used:

1. Net Present Value (NPV)

2. Internal Rate of Return (IRR)
3. Profitability Index (PI)
4. Payback (PB) Period

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 Net Present Value (NPV)
• Def.: the present value of the
stream of net operating cash flows
from the project minus the
project’s net investment
– NPV = PVNCF – NINV
• PVNC: present value of net operating cash flow
• NINV: net investment
– “Discounted Cash Flow (DCF)” method
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 NPV Formula

NPV =
Σ (NCF)t/(1+k) - NINV
t

t=1 to n,
k=cost of capital, required rate of return

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 Decision Rule

A Project should be
accepted if its NPV is
greater than or equal to
zero.

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Internal Rate of Return (IRR)
• Def.: the discount rate that
equates the present value of the
NCF’s with the ININV

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 Decision Rule

The IRR method indicate

that a project whose IRR
is greater than or equal t
the firm’s cost of capital
should be accepted.
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 Profitability Index (PI)
• It is benefit-cost ratio
• It is the ratio of the PVNCF to
NINV
• It is the present value return for
each dollar of initial investment
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 Decision Rule

A Project whose PI is
greater than or equal to 1
is considered acceptable

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 Payback (PB) Period
• De.: is the period of time
required for the cumulative cash
inflows (i.e. NCF) to equal the
initial cash outlay (i.e. NINV)
PB = (NINV)/(Annual NCF)

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 Decision Rule

• Because the PB method has a

number of serious shortcomings, it
should not be used in deciding
whether to accept or reject an
investment project.
• It can be useful as a supplementary
decision-making tool

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 Con’s on PB

• Ignores the time value of money

• Ignores cash flows occurring after
the payback period
• Provides no Objective criterion for
decision making. Different people
using same data may make
different accept-reject decisions.

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 Pro’s on PB

• Easy & Inexpensive to use

• Provides a crude measure of
project risk
• Provides a measure of project
liquidity.

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