Introduction to Finance

1. Introduction to Finance Dr. Panos Dantis

2. Definition of Finance • Money management • Allocation of assets and liabilities • Pricing of assets UNDER RISK and UNCERTAINTY

3. Areas of Finance • Personal Finance (individuals) • Corporate Finance (businesses) • Social Finance ( Social enterprises) • Financial Markets • Public Finance (Governments) • International Finance • Behavioral Finance

4. Personal Finance • Deals with the financial position , net worth and cash flows of the household • protection against the risks • Tax management • Investments and accumulation of wealth • Retirement planning • Estate planning ( after death assets disposition)

5. Corporate Finance • Deals with corporations • Sources of funding • Capital structure • Investment management • Risk management • Allocation of resources => To increase shareholders value

6. Social Finance Equity and Debt financing of • Social enterprises • Cooperatives • Charitable organizations • Microfinance ( funding to SB owners and entrepreneurs in less developed countries) investors seek a profit and a social gain : earn a return, improve living standards and benefit local society and economy

7. Financial Markets • Capital markets • Debt (Bond) markets • Money markets • Derivatives markets • Commodity markets • Crypto markets • Market Intermediaries (banks,brokers etc)

8. Public Finance • Required expenditure • Sources of revenues • Budgeting • Debt issuance • Central Banks : lenders of last resort that make /lead Monetary policy

9. International Finance Or International Macroeconomics : • Monetary interactions between countries • Foreign direct Investments • Exchange rates • Political risk • Exchange rate risk • Country risk / default risk / credit risk • Theories : Purchasing Power Parity Optimun currency area Interest rate parity International Fisher Effect

10. Behavioral Finance • The study of the influence of psychology on the behavior of investors, households, businesses and financial markets. • Investors are Not always rational, have limits to their self control and are influenced by their own biases. • 6 Nobel prizes have been awarded for behavioral research ( i.e.Shiller 2013 – Thaler 2017)

11. Financial Analysis Tools • Investment Decisions criteria • EMH • Financial Statements analysis • Ratio Analysis

12. Financial and Investment Decisions • Methods used • NPV • IRR • Payback • Accounting rate of Return

13. Efficient Market Hypothesis • In an efficient market, the prices fully reflect all the relevant information as it becomes available. • Importance of information • One of the basic building blocks of the theory of finance

14. EMH : 3 forms • Weak form All the information contained in market trading data, such as the history of past prices, is reflected. • Semi-strong form The prices reflect all the publiclyavailableinformation • Strong form The prices reflect all relevant information, both public and private.

15. Financial Statements • Are central in financial analysis • Assessment of the firm’s past, present and future financial conditions • Done to find firm’s financial strengths and weaknesses • Primary Tools: • Financial Statements • Comparison of financial ratios to past, industry, sector and all firms

16. Financial Statement analysis /Ratio analysis

17. Main Purpose : • To identify aspects of a business’s performance to aid decision making • Quantitative process – may need to be supplemented by qualitative factors to get a complete picture • 5 main areas:

18. Financial Statements are: • Balance Sheet • Income Statement • Cash flow Statement • Statement of Retained Earnings

19. Sources of Data • Annual reports • Via mail, SEC or company websites • Published collections of data • e.g., Dun and Bradstreet or Robert Morris • Investment sites on the web • Examples • http://moneycentral.msn.com/investor • http://www.marketguide.com

20. Assets Current assets: Cash & securities Receivables Inventories Fixed assets: Tangible assets Intangible assets Liabilities and Equity Current liabilities: Payables Short-term debt Long-term liabilities Shareholders Major Balance Sheet

21. Major Income Statement (P&L) • Gross Profit = Sales - Costs of Goods Sold • EBITDA = Gross Profit - Cash Operating Expenses • NI or EAT = EBT- Taxes • Net Income is a primary determinant of the firm’s cashflows and, thus, the value of the firm’s shares

22. Ratio Analysis • To identify aspects of a business’s performance to aid decision making • Quantitative process – may need to be supplemented by qualitative factors to get a complete picture

23. Types of ratios • Liquidity – the ability of the firm to pay its way • Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment • Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital • Profitability – how effective the firm is at generating profits given sales and or its capital assets • Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets

24. 1. Liquidity Check how solvent is the company : • Acid Test = (Current assets – stock) / liabilities • Current ratio = Current Assets / Current Liabilities • Cash ratio = Cash / Current Liabilities

25. 2. Investment Ratios • P/E • P/Book Value • P/Cash Flow (operating ) • PEG : (P/E) / EPS Growth • P / Sales • Dividend yield

26. 3. Gearing Ratios • Gearing ratio LT loans / Capital employed x100 • Debt / Equity ratio Total Debt / Total Equity • Equity ratio Equity / Assets • Debt ratio Total Debt / Total Assets

27. 4. Profitability Ratios • Gross Profit Sales – cost of sales • Net Profit Sales – Variable costs + Fixed costs • ROCE (return on capital employed) Profit / capital employed x 100 • ROA Net Income / Total Assets

28. 5. Financial Ratios • Asset Turnover Sales turnover / assets employed • Stock Turnover Cost of Goods Sold / stock expressed as times per year

29. Summary of Ratios • Ratios help to: • Evaluate performance • Structure analysis • Show the connection between activities and performance • Benchmark with • Past for the company • Industry • Ratios adjust for size differences

30. Limitations of Ratio Analysis • A firm’s industry category is often difficult to identify • Published industry averages are only guidelines • Accounting practices differ across firms • Sometimes difficult to interpret deviations in ratios • Industry ratios may not be desirable targets • Seasonality affects ratios

31. Ratios and Forecasting • Common stock valuation based on • Expected cashflows to stockholders • ROE and r are major determinants of cashflows to stockholders • Ratios influence expectations by: • Showing where firm is now • Providing context for current performance • Current information influences expectations by: • Showing developments that will alter future performance

32. How ratios can help Analysis • Analysis of a company, and comparisons to other competitor companies can help to: • Assess the (absolute and relative) financial state of the company • Show each company’s strengths and weaknesses • Predict sustainable growth rate • Combined with current information, this can help to: • Assess likely future performance • Predict future valuation and earnings growth • Predict returns