Introduction

Financial Analysis: Making Money Moves

Financial analysis:

 like taking a business's financial health to the doctor

 involves examining a company's financial statements, trends, and data to understand its
financial performance and position.

Why is this important? Because businesses use this analysis to make informed decisions about
their money. Here's how:

 Planning for the future: set realistic budgets, allocate resources wisely, and plan for
growth or expansion.
 Investment decisions: can assess the risks and potential rewards before committing their
money, to invest or not, when or where to invest
 Improving profitability: Identifying areas where the business can save money or
generate more revenue can lead to increased profitability.
 Understanding risk: helps businesses identify and manage financial risks, such as debt
or economic downturns.

In short, financial analysis is a powerful tool that helps businesses make smart decisions about
their money, ultimately leading to greater success.

Why Time Value of Money Matters in Financial

Calculations
Imagine you have a choice: receive $100 today or $100 a year from now. Most people would
choose the $100 today. Why? Because of the time value of money.

Here's the core principle: a dollar today is worth more than a dollar tomorrow. There are two
main reasons for this:

1. Earning Potential: Money in hand can be invested and earn interest. That $100 today
could potentially grow to $105 or more in a year, making it more valuable than waiting
for a flat $100 later.
2. Purchasing Power: Inflation erodes the buying power of money over time. The $100
you get a year from now might not buy as much as $100 today due to rising prices.
Ignoring time value of money in financial calculations can lead to misleading results. For
example:

 Comparing a one-time cost today to a series of smaller payments in the future without
considering the interest you could earn on the lump sum today.
 Deciding between two investments solely based on their total payout without
considering when the money will be received.

Considering the time value of money allows for a more accurate comparison of options.
Financial calculations that take time value into account, like Present Value (PV) and Future
Value (FV), help us make informed financial decisions.

Here are some real-world examples:

 Saving for retirement: Knowing the time value of money helps you determine how
much you need to save today to reach your desired retirement income in the future.
 Taking out a loan: Understanding the time value of money helps you compare the true
cost of loans with different interest rates and repayment periods.
 Investing your money: Time value of money helps you choose investments based on
their potential future growth, not just their initial payout.

1.1. Time Value of Money

The time value of money gives rise to two key concepts: future value (FV) and present value
(PV) of cash flows. These concepts help us understand how money grows over time (future
value) and how to compare future cash flows to their current worth (present value).

1. Future Value (FV): Imagine you invest $100 today at a specific interest rate for a certain
period. The future value (FV) represents the total amount of money you will have at the
end of that period, including your original investment and the interest earned.
2. Present Value (PV): Let's say you are offered $100 a year from now. The present value
(PV) represents the current worth of that $100, considering the time value of money and a
specific interest rate. In other words, it's the amount of money you would need to invest
today to have $100 in one year, taking into account the potential interest you could earn
on that investment.

Here's an analogy: Think of future value like a snowball rolling down a hill, growing bigger
(more money) as time goes by (interest is added). Present value is like melting that snowball
back down to its original size (considering interest lost) to understand its current worth.
1.2 Money Discounting at Normal and Inflationary Conditions

Discounting is a financial concept that takes the future value of money and adjusts it to its
present worth. It's like looking through a special lens that shrinks future cash flows back to their
current value, considering the time value of money.

Remember, a dollar today is worth more than a dollar tomorrow. Discounting helps us account
for this difference.

Here's how it works in the context of present value (PV) calculations:

Present Value (PV) = Future Value (FV) / (1 + Discount Rate)^t

 Discount Rate: This is the key player in discounting. It represents the rate of return we
could expect to earn on an investment over a specific period. The higher the discount
rate, the greater the "discount" applied to the future value, resulting in a lower present
value.

Why Discounting Matters:

 Compares Apples to Apples: Imagine comparing an apple you have today to one you'll
get next year. Discounting future cash flows (the apple next year) allows us to compare
them to current options (the apple today) on a fair basis.
 Makes Investment Decisions: Businesses and individuals use discounting to evaluate
potential investments. By calculating the present value of future cash flows an investment
might generate, they can see if the upfront cost is justified by the discounted future
returns.
 Loan Payments: Lenders use discounting to determine the present value of all your
future loan payments, essentially what the loan is truly worth upfront.

Discounting vs. Interest Rates:

Interest rates - how much your money will grow over time (future value)

Discount rate - how much you need to decrease a future value to get its present value.

Inflation: The Time Value of Money's Kryptonite

Inflation is the gradual increase in prices of goods and services over time. This rising cost of
living erodes the purchasing power of money.
1. Shrinking Future Value: Imagine you invest $1,000 today and earn a 5% interest rate in a
year. With no inflation, your future value would be $1,050. However, if inflation is 3%, the
$1,050 won't buy as much as it would today.

2. Discounted Future Cash Flows: A higher discount rate will be used to account for
inflation, resulting in a lower present value for future cash flows.

3. Investment Strategies: Understanding inflation's impact helps you choose appropriate

investment strategies.

Examples:

 Savings Account: If your savings account offers a 2% interest rate and inflation is 3%,
your money is actually losing value in real terms.
 Retirement Planning: When planning for retirement, you need to factor in inflation and
choose investments that can grow faster than inflation to ensure your retirement savings
maintain their purchasing power in the future.

Mitigating the Impact:

 Invest in Assets that Grow: Investing in stocks, real estate, or certain commodities that
historically tend to appreciate in value can help offset inflation.
 Choose Inflation-Adjusted Investments: Some investments, like Treasury Inflation-
Protected Securities (TIPS), adjust their principal amount based on inflation, helping to
preserve purchasing power.
 Increase Savings Rate: If inflation is high, you might need to save a larger portion of
your income to maintain your desired future financial goals.

1.3. Conditions (15 minutes)

Economic Conditions:

 Economic Growth: A strong and growing economy typically leads to higher corporate
profits, increased consumer spending, and potentially rising asset prices. This can
positively impact financial analysis of companies and investments. Conversely, a
recession or economic slowdown can lead to lower profits, decreased spending, and
falling asset prices, negatively affecting financial analysis outcomes.
 Interest Rates: Changes in interest rates can significantly impact investment returns,
loan payments, and the overall cost of capital. Rising interest rates can make borrowing
more expensive and decrease the attractiveness of some investments. Conversely, falling
interest rates can stimulate borrowing and potentially increase asset prices.

Industry Factors:

 Industry Trends: The overall health and growth prospects of a specific industry can
significantly impact the financial performance of companies within that sector.
 Understanding industry trends and their potential impact is critical for accurate financial
analysis.
 Regulation: Government regulations can affect various aspects of a business, from
product safety standards to environmental regulations. These regulations can impact a
company's costs, profitability, and overall financial performance.

Company-Specific Factors:

 Management: The quality and experience of a company's management team can

significantly influence its financial performance. Strong leadership can make strategic
decisions that lead to growth and profitability, while poor management can lead to
financial difficulties.
 Financial Health: A company's financial health, as reflected in its financial statements,
is vital for financial analysis. Factors like profitability, debt levels, and cash flow all need
to be considered when analyzing a company's financial performance and future prospects.
 Risk Factors: Every investment and business decision carries inherent risks. Financial
analysis should consider these risks, such as market fluctuations, competition,
technological advancements, or potential legal issues.

1.4 & 1.5. International Accounting Standards (IAS) & International Financial Reporting
Standards (IFRS) (45 minutes)

In the vast world of international finance, clear communication and a common language are
essential. This is where International Accounting Standards (IAS) come into play. They are a
set of globally recognized accounting principles that aim to create consistency and transparency
in how companies prepare their financial statements.

Imagine a scenario where a US investor wants to invest in a Chinese company. How can they be
sure the financial information presented by the Chinese company is reliable and comparable to
what they're used to seeing from US companies? This is where IAS become crucial.

Importance of International Accounting Standards:

 Transparency and Trust: By using a common set of accounting rules, investors gain a
clearer picture of a company's financial health regardless of its location. This fosters trust
and confidence in the global financial markets.
 Comparability: IAS allow investors to easily compare financial statements of companies
from different countries. This makes it easier to identify investment opportunities and
make informed decisions on a global scale.
 Reduced Costs: With a single set of accounting standards, companies can avoid the extra
burden and cost of complying with different national accounting rules when operating
internationally.
 Improved Efficiency: Standardized accounting practices create a more efficient global
financial system by simplifying reporting and analysis processes.
Here are some key IAS/IFRS standards relevant to financial analysis:

 IAS 1: Presentation of Financial Statements: This sets the overall framework for how
financial statements are presented, ensuring consistency and allowing users to compare
different companies' financial performance.

 IAS 7: Statement of Cash Flows: This standard defines the format and content of the
cash flow statement, which is crucial for understanding a company's liquidity and cash
generation capabilities.

 IAS 8: Accounting Policies, Changes in Estimates and Errors: This standard requires
companies to disclose their accounting policies, allowing analysts to understand the
specific accounting methods used, which can impact the reported financial results.

 IAS 12: Income Taxes: This standard defines how companies account for income taxes,
which is a significant expense for most businesses. Understanding how taxes are
recognized is crucial for analyzing a company's true profitability.

 IAS 18: Revenue Recognition: This standard defines the criteria for recognizing
revenue, which is the core element of a company's top line. Understanding how revenue
is recognized is essential for assessing a company's growth and profitability.

 IAS 2: Inventories: This standard outline different methods for valuing inventory (e.g.,
FIFO, LIFO, weighted average), which can impact a company's reported cost of goods
sold and profitability. Analysts need to consider the chosen inventory valuation method
for proper analysis.

 IAS 36: Impairment of Assets: This standard defines how companies assess and
account for potential losses in the value of their assets. Understanding impairment
charges helps analysts evaluate the health and value of a company's assets.
 IFRS 3: Business Combinations: This standard defines the accounting treatment for
mergers and acquisitions, which can significantly impact a company's financial
statements. Analysts need to understand how these transactions are accounted for to
assess their impact on the company's financial position.