Unit of Competence: Perform Financial Calculations/

Administer Financial Accounts

Module Title: Perform Financial Calculations

INTRODUCTION

Welcome to the module “Perform Financial Calculations”. This learner’s

guide was prepared to help you achieve the required competence in “ Accounts
and Budget Support Level III”. This will be the source of information for you to
acquire knowledge attitude and skills in this particular occupation with
minimum supervision or help from your trainer.

Summary of Learning Outcomes

After completing this learning guide, you should be able to:

Lo1:- Obtain data and resources for financial calculations

Lo2:- Select appropriate methods and carry out financial calculations

Lo3:- Check calculations and record outcomes

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 Lo1:- Obtain data and resources for financial calculations
1.1 Business transactions and the accounting equation
1.1.1 Business transactions

Business transactions: it is an economic event or condition that directly

changes the entities financial position or directly affects its results of
operation. For instance: payment of utility bills of Br 50 affects financial
position to decline. Business transactions can be:

(a) Simple transaction: transaction occurs just only once in a time unless
it comes on another time.
(b) Complex transactions: transactions that cause another transaction to
occur. It is the case, in which a single transaction also brings other
several transactions.
(c) External transaction: a transaction between the organization and outsider party
(d) Internal transaction: a transaction within the organization itself.
.

1.1. Types of Business Organizations

There are three different types of businesses that are operated for profit:

1. Service business

2. Merchandising business

3. Manufacturing businesses.

Service businesses- provide services rather than products to customers.

 Nice entertainment services Selam Bus transportation service

Merchandising businesses- sell products they purchase from other businesses to customers.

Wal-Mart (general merchandise) and amazon.com (internet books, music, video)

Manufacturing businesses- change basic inputs into products that are sold to customers.

Ford Motor Co. (cars, trucks, vans) and Dell Inc. (personal computers)

Forms of Business Organizations

The common forms of business organization are the sole proprietorship, partnership,
corporation Sole proprietorship

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A Sole proprietorship is business owned by an individual and often managed by that
same individual. Many small service-type businesses and retail establishments are
single proprietorships. No legal formalities are necessary to organize such businesses,
and usually only a limited investment is required to begin operations. In a single
proprietorship, the owner is held solely responsible for all debts of the business.

a. Partnership
A partnership is an unincorporated business owned by two or more persons associated
as partners. The business is often managed by same persons. Partnerships are created
by a verbal or written agreement. A written agreement is preferred because it provides
a permanent record of the terms of the partnership. Each partner may be held liable
for all the debts of the partnership and for the actions of each partner with in the scope
of the business.

a. Corporation
A corporation is a business incorporated under the law of the country and owned by a large
number of persons. At most all large businesses are corporation. The corporation is unique in
that it is a legal business entity. The owners of the corporation are called stockholders or
shareholders.

The finance calculator can be used to calculate any one of the parameters of future value (FV),
number of compounding periods (N), interest rate (I/Y), annuity payment (PMT), and starting
investment if other parameters are known. The present value will always be given out. Each of
the following tabs represents the parameters to be calculated.

The finance section of The Calculator Site featuring useful financial calculator tools for loans,
car/auto loans, compound interest, savings, mortgages and more.

COMPOUND INTEREST CALCULATOR

Use these financial calculators to work out the compound interest on your savings. The first
calculator works out interest on a lump sum. The second calculator allows you to include
regular monthly deposits. Interest can be compounded on a monthly or yearly basis.

INTEREST RATE CALCULATOR

If you're want to work out what interest rate you're currently receiving on your loan, whether
it's a secured, unsecured or payday loan, use interest rate calculator to do the calculation for
you.

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How to Work a Financial Calculator

A financial calculator can be an indispensable tool in helping you coordinate your personal
finances. Most hand-held calculators can perform more than 100 common financial
computations. Online versions are abundant, easy to use, and cover a complete range of
calculations, including mortgage rates, deferred annuities, loan payments and retirement
planning. Follow these guidelines if you want to know how to work a financial calculator.

LO2. Select appropriate methods and carryout financial

calculations
Methods to carry out financial calculations Finance charges are applied to credit card balances
that aren't paid before the grace period. Different credit cards calculate finance charges in
different ways.

To find out how your creditor calculates your charge, look on the back of a recent billing
statement.

You should find an explanation there. Below are six ways finance charges can be calculated.

1) Adjusted Balance
The adjusted balance method uses the balance at the beginning of the billing cycle and
subtracts any payments you made. Purchases are not included in the balance. This is the
least expensive method of calculating finance charges.

2) Average Daily Balance The average daily balance method uses the average of your
balance during the billing cycle. Each day's balance is added together and divided by the
number of days in the billing cycle This is the most common way finance charges are
calculated.

How it's calculated: The Company averages your daily balance. For instance, if you
charged $100 on the first day of June and charged an additional $200 on the 16th, your
average daily balance would be $200. That number times roughly one-twelfth your annual
percentage rate, or APR, equals your monthly finance charge. Interest may be calculated
on a daily or monthly basis.

3) Daily Balance
The daily balance method uses the balance each day of your billing cycle. Each day's
balance is multiplied by the daily rate and added together. How it's calculated: The
Company calculates the actual balance you carried each day of your billing cycle and
multiplies it by roughly 1/365th of your APR and adds it together
4) Double Billing Cycle
The double billing cycle uses the average daily balance of the current and previous billing
cycles. This is the most expensive way finance charges are calculated. Fortunately for

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 credit cardholders, the double billing cycle method of calculating finance charges is now
against the law. How it's calculated: A credit card practice where the consumer is charged
interest on debt already paid. Here's how it works: A cardholder begins a billing cycle
with a zero blance and charges $500 on a credit card. They make an on-time payment of
$450. With double-cycle billing, they would be charged interest on the $500 -- instead of
the $50 still owed -- in the next billing cycle.

5) Ending Balance The ending balance method uses your beginning balance minus payments
plus charges made during the billing cycle. The number of days in the billing cycle doesn't
affect the amount of the finance charge.

6) Previous Balance The previous balance method uses the balance at the beginning of the
billing cycle which is also the ending balance of the last billing cycle. No payments or charges
are included. The number of days in the billing cycle doesn't affect the amount of the finance
charge.

How it's calculated: The bill will show beginning balance and ending balance for your
account. The finance charge is based on the outstanding balance at the beginning of the billing
cycle

How to Calculate Financial Ratios of Performance Financial ratios allow you to break down
your company's financial statements and see how it is performing from different angles.
Whether you are creating a proposal for new investors, seeking bank financing or want
compare your company to another, financial ratios provide a way to simplify a lot of financial
information quickly. There are many performance related ratios, but several are commonly
analyzed and discussed among business owners and potential investors.

Current Ratio

Use the current ratio to assess your company's ability to meet its financial obligations.
Calculate the ratio by dividing the current assets by the current liabilities; both these figures
are from the balance sheet. Assets and liabilities are "current" if they are receivable or payable
within one

Quick Ratio

The quick ratio excludes any shares your company may have issued from the current assets,
providing a more stringent view of your company's ability to meet short-term financial
obligations. Calculate the quick ratio by subtracting the value of outstanding shares from
current assets, and dividing the result by current liabilities. To get the value of outstanding
shares, multiply the number of shares outstanding by the share price. If you are unsure of the
share price, instead deduct inventories from the current assets to create an alternative measure
of the quick ratio. A ratio of one or higher is considered financially healthy.

Return on Assets

Use ROA to determine how much profit is being generated for each dollar your company has
in assets. Divide the net profit by net assets, and multiply by 100 to compute the ROA. Find

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net profit on the income statement, and use the balance sheet to compute net assets by taking
total assets minus total liabilities. The higher the ratio, the more efficiently your company is
generating profits from its resources. New businesses take time to produce profits and utilize
assets; therefore the trend in the figure year-over-year is often considered more important than
a single calculation.

Asset Turnover

Asset turnover, or sales-to-asset ratio, shows how efficiently your company is converting its
assets into sales. Find your company's sales on the income statement and divide it by total
assets from the balance sheet. The higher the ratio the better; a reading of one or higher
indicates the company is generating more than $1 in sales for each $1 in assets. New start-ups
may take time to generate significant sales, therefore track the quarterly or yearly trend of the
figure. A rising asset turnover ratio over time shows assets are being utilized more effectively

Lo3:- Check calculations and record outcomes

People generally earn money because they want to spend it. If they save it, rather than spend it
in the period in which it was earned, it is usually because they want it to spend in the future.
However, for most people present consumption is more desirable than future consumption if
only because the future is so uncertain. "Live and be merry, for tomorrow we may die," is a
rationale used over the ages to justify the urge to buy now rather than deferring gratification to
the future. For this reason, most of us would rather have a dollar today than a dollar a year
from today, and must be given something extra to get us to defer gratification.

Looking at the transaction from the borrower's perspective, there are consumers and
businesses (not to mention the deficit-ridden government) who really need that dollar today
and who are willing to promise to pay back more than that dollar in the future. Businesses can
invest borrowed funds in capital to create profits which are (hopefully) more than sufficient to
repay the borrowed funds (principal) plus INTEREST. Consumers and governments borrow
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for various reasons but are expected to have income in the future sufficient to repay principal
and interest. Simply put, the basic concept of mathematics of finance is that money has time
value. That is, a bird at hand worth two in the forest.

Interest is the price paid for the use of a sum of money over a period of time. It is the charge
for exchanging money now for money later.

Interest is usually computed as percentage of the principal over a given period of time. This is
called interest rate. Interest rate specifies the rate at which interest accumulates per year
through out the term of the loan. The original sum of money that is lent or invested/ borrowed
is called the principal.

A savings institution pays interest to a depositor on the money in the savings account since
the institution has use of those funds while they are on deposit. Or, a borrower pays interest
to a lending agent for use of that agent’s fund over the term of loan.

Interest can be:

1. Simple interest.
2. Compound interest.
Simple Interest
When we borrow money the money borrowed or the original sum of money lent (borrowed
or invested) is called the principal. (The principal remains fixed during the entire interest
period). Interest is usually expressed as a percentage of the principal for a specified period of
time which is generally a year. This percentage is termed the interest rate. If interest is paid
on the initial amount only and not on subsequently accrued interest, it is called simple
interest.

However, if the interest for each period is added to the principal in computing the interest
for the next period, the interest is called compound interest.

The sum of the original amount (principal) and the total interest is the future amount or
maturity value or Amount. A = P + I

Simple interest is generally used only on short term notes often of duration less than one
year.

Simple interest is given by the formula:

I = Prt

Where P= principal amount/ original amount borrowed or invested

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 r = Simple interest rate per year (expressed in decimal)

t= duration of the loan or investment in years

I = amount of interest in Birr.

If a sum of money, P is invested at a simple interest its value increases by the same amount
each year. Therefore, there is a linear relationship between amount and time.

1. I = Prt
2. A = P + I
A = P + Prt

A = P (1+rt)

A
3. P = or P = 1+rt

I
4. r = Pt
I
5. t = pr

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 Example:

1. Mr. X wanted to buy a leather sofa for his new family room. The cost of the sofa was Birr
10,000. He had short of cash and went to his local bank and borrowed Birr 10,000 for 6 months
at an annual interest rate of 12%. Find the total simple interest and the maturity value of the
loan.
Solution

I = Prt A = P+I

= 10,000 + 600

= Birr 600 = Birr 10,600 or

A = P (1+rt)

= 10,000 (1.06) = Birr 10,600

2. How long will it take if Birr 20,000 is invested at 5% simple interest to double in value?

Solution. I=A-p

= 40,000 - 20,000
pr¿
I¿ 20,000x0.05¿
P = 20,000 BIRR = 20,000 20,000¿
=20years¿
A = Birr 40,000 t= ¿
r = 5%

t =?

A =2p =20,000x2 = 40,000

3. At what interest rate will Birr 6,000 yield 900 Birr in 5 years time?

Solution

P = Birr 6,000 I
t = rP
r = Birr 900

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 t = 5 years 900
= 6000 x 5
r =?
= 3% annual rate

4. How much money must Mr. Z has to invest today at 6% simple interest if he is to receive Birr
3,100 as an amount in 4 years?

Solution. A
P=
1+rt
P = Birr?
3 ,100
A = 3,100
= 1+.06 x 4
t = 4 years
Birr 2,500
r = 6%

When time over which interest is paid is given in months, t is simply the number of month
divided by 12. If time is given as a number of days, then one of two methods of computing t
may be used:

¿ ofdays
t=
 Ordinary interest year - uses a 360 - day year - 360
When time is determined in this way, the interest is called ordinary simple interest.

¿ ofdays
t=
 Exact time- uses a 365-day year = t = 365 or a 366 for leap year. Interest computed
in this way (using exact time) is called exact simple interest.

5. Find the interest on Birr 1,000 at 5% for 45 days.

Solution

1. Using ordinary Interest year:

p = Birr 1,000 I = prt

r = 5%
= 1,000 x .05 x

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 t = 45 days Birr 6.25

I=

2. Using exact time:

I = Prt Always ordinary simple interest

is grater than exact simple
interest.
= 1,000 x .05 x

= Birr 6.16

Compound Interest
If the interest which is due is added to the principal at the end of each interest period, then this
interest as well as the principal will earn interest during the next period. In such a case the
interest is said to be compounded. The result of compounding interest is that starting with the
second compounding the account earning interest on principal in addition to earns interest on
interest.

The sum of the original principal and all the interest earned is the Compound Amount. The
difference between compound amount and the original principal is the Compound interest.

The compound interest method is generally used in long-term borrowing. There is usually more
than one period for computing interests during the borrowing time. The time interval between
successive conversions of interest in to principal is called the interest period or conversion
period or compounding period, and may be any convenient length of time. Hence, interest rate
must be converted in to or adjusted to the appropriate interest rate per conversion period (i)
for computational purposes; and we use the number of conversion periods as time.

The i is equal to the stated annual interest rate/nominal rate (r) divided by the number of

conversion periods in one year (m) = i =

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 Conversion # of conversions per year, m

Daily 365

Monthly 12

Quarterly 2

Semi annually 4

Annually 1

( mr )mt
A=P 1+

r
A= P (1 + i) n i=
m

n = mt

Where:

A = compound amount, after n conversion periods.

P = principal

r = stated annual rate of interest

m = number of conversion periods a year

t = total number of years

i = interest rate per conversion period

n =total number of conversion periods

Example:

1. What are the compound amount and compound interest at the end of one year if Birr 10,000 is
borrowed at 8% compound quarterly?

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 Solution

P = Birr 10,000 total number of conversions = 4

r = 8% t = one year

Total number of conversion periods (m) = 4 times = quarter

i= = = 2% n = mt = 1x4 = 4

A = P (1 + i) n

= 10,000 (1.02)4

= 10,824.3216 Birr

Compound interest = compound amount - original principal

= 10,824.3216 - 10,000

= Birr 824.3216

2. Find the compound amount compound interest resulting from the investment of Birr 1000 at 6%
for 10 years,

2.1. Compounded annually.

Solution

P = Birr 1,000 A = p(1+i)n

t = 10 years = 1,000 (1.06)10

m=1 = Birr 1,790.85

r = 6%

A =? Compound interest = Compound amount - principal

i = 6% = 1,790.85 - 1000

n = 10 = 790.85 Birr

2.2. Compounded semiannually.

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 Solution

P = Birr 1,000 A = p(1+i)n

r = 6% = 1,000 (1.03)20

m=2 = Birr 1,806.11

t = 10 years Compound interest = compound amount - principal

i = 3% = 1,806.11 - 1000

n = 20 = Birr 806.11

2.3 compounded quarterly.

Solution

P = Birr 1,000 A = 1,000 (1.015)40

r = 6% = Birr 1,814.02

m=4

t = 10 years Compound interest = compound amount - principal

i = .015 = 1814.02 - 1000

n = 40 = Birr 814.02

2.4 Compounded monthly.

Solution

P = Birr 1000 A = 1,000 (1.005) 120

r = 6% = 1,819.40 Birr

t = 10 years

m=12 Compound interest = compound amount - principal

i = .005 = 1,819.40 - 1000

n = 120 = 819.40 Birr

2.5. If compounded weekly

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Solution

P = Birr 1000 A = 1,000 (1.0012)520

r = 6% = 1,821.49 Birr

t = 10 years

m=52 Compound interest = compound amount - principal

i = .0012 = 1821.49 - 1000

n = 520 = Birr 821.49

Present Value

Frequently it is necessary to determine the principal P which must be invested now at a given
rate of interest per conversion period in order that the compound amount “A” to be
accumulated at the end of “n” conversion periods. This process is called discounting and the
principal is now a discounted value of a future income “A”.

A = P (1+i) n dividing both sides by (1+i) n leads to

P= = p = A (1+i)-n

Present values of a compound amount:

P = A (1+i)-n

Where:

p = principal / present value

A = compound amount (or future value)

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 i = interest rate per conversion period

n = total number of conversion periods

Example:

1. Find the present value of a loan that will amount to Birr 5,000 in four years if money is worth
10% compounded semi annually.

Solution.

A = 5,000 Birr P = A (1+i)-n

t = 4 years = 5,000 (1.05)-8

m=2 = Birr 3,384.20

r = 10%

P =?

Ordinary Annuity
An ordinary annuity is a series of equal periodic payments in which each payment is made at
the end of the period. In an ordinary annuity the first payment is not considered in interest
calculation for the first period (because it is paid at the end of the first period for which interest
is calculated) and the last payment doesn’t qualify for interest at all since the value of the
annuity’s computed immediately after this last payment is received.

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 The amount (future value) of an ordinary annuity is the sum of all payments plus all interests
earned.

A=
R [ (1+i)n −1
i ]
Example

1. What is the amount of an annuity if the size of each payment is Birr 100 payable at the end of
each quarter for one year at an interest rate of 4% compounded quarterly?

Solution

Periodic payment (R) = Birr 100

Payment interval = conversion period = quarter

Nominal (annual rate), r, = 4%

Interest rate per conversion period (i) = r/m = 4%/4 = 1%

Future value of (sum of an annuity) =?

Term one year

[(1 .01 )4 -1 ]
For the above example: A = 100 0 . 01 = Birr 406.04

Compound interest = Amount - R (n)

= 406.04 - 100(4) existence

= Birr 6.04

2. A newly married couple are both working and decide to have Birr 1000 at the end of a month for
a down payment on a home. The account earns 12% compound monthly. How large a down
payment will they have saved in three years?

Solution

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 R = Birr 1000 (1+i)n −1 ] Compound interest = A - R(n)
A = R[ ]
t = 3 years. i = 43,076.88 - 36,000
[(1 .01 )36−1 ]
=1000
m = 12 0 .01 = 7,076,88 Birr
=Birr 43 ,076 . 88
n = 36

r = 12%

i=1%

A =?

3. A person deposits Birr 200 a month for four years in to an account that pays 7% compounded
monthly. After the four years, the person leaves the account untouched for an additional six
years. What is the balance after the 10-year period?

Solution

R = Birr 200 A4 = 200 [(1 + 0.00583)48 – 1]

t = 4years 0.00583

m = 12 = 200 (55.209)

r = 7% + = 11,041.80 Birr

After the end of the fourth year, we calculate compound interest rate taking Birr 11,041.85 as
principal compounded monthly for 6 years.

P = 11,041.85 Birr A10 = P (1+i) n

=11,041.80 (1 + .00583) 72

t = 6years

m = 12 = 11,401.80 (1.5201)

r = 7% = Birr 16,780.70

A10 =?

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 Sinking Fund- Increasing Annuity

A Sinking fund is a fund in to which equal periodic payments are made in order to accumulate a
specified amount at some point in the future. Sinking funds are generally established in order to
satisfy some financial obligation or to reach some financial goal.

If the payments are to be made in the form of an ordinary annuity, then the required periodic
payment into the sinking fund can be determined by reference to the formula for the a mount
of an ordinary annuity. That is, if

A = R [(1+i) n –1]

Then A____

R = [(1+i) n - 1]

R=
A
[ i
( 1 + i )n −1 ]

Example:

1. What monthly deposit will produce a balance of Birr 100,000 after 10 years? Assume that the
annual percentage rate is 6% compounded monthly. What is the total amount deposited over
the 10-year period?

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 Solution

A = Birr 100,000 R=
A
[ i
( 1 + i )n −1 ]
t = 10years R=
100 ,000
[ 0.005
( 1.005 )120 −1 ]
m = 12

r = 6% = 100,000 (0.006102)

R =? = Birr 610.21

The total amount deposited over the 10-yr period is 120 (610.21) = Birr 73,225. The remaining
Birr 26,775 an interest.

2. XYZ Company purchased a tract of land under a purchase agreement which requires a payment
of Birr 500,000 plus 5% interest compounded annually at the end of 10 years. The company
plans to setup a sinking fund to accumulate the amount required to settle the land purchase
debt. What should the quarterly deposit into the fund be if the account pays 15% interest,
compounded quarterly?
Solution

First we have to find the total debt (future value) at the end of ten years as

A = P (1+i) n i = mt=1x5% = 5%

= 500, 000 (1+0.05)10

= Birr 814,447.31

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 The amount is taken as Future Value of an Ordinary annuity with r = 15% Compounded
quarterly for 10 years

A40 = Birr 814,447.31

[
.0375
40
R = 814,447.31 ( 1 . 0375 ) − 1
]
t = 10 years

m=4 = 9,088.80 Birr

r = 15%

i= 3.75%

R =?

Amortization- Decreasing Annuity

Amortization means retiring a debt in a given length of time by equal periodic payments that
include compound interest. After the last payment, the obligation ceases to exist-it is dead-and it
is said to have been amortized by the payments.

In amortization our interest is to determine the periodic payment, R, so as to amortize (retire) a

debt at the end of the last payment. Solving the PV of ordinary annuity formula for R in terms of
the other variables, we obtain the following amortization formula:

R=P
[ i
1 − ( 1 + i )− n ]
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 Where:

R = periodic payment

P = PV of loan

i= interest rate per period

n = number of payment periods

Example

1. Suppose you borrow Birr 500,000 from a bank and agree to repay the loan in five equal
installments including all interests due. The bank’s interest charges are 5% compounded
annually. How much should each annual payment be in order to retire the debt including the
interest in 5 years?
Solution

PV = Birr 500,000 R = 500,000 .05

t = 5years 1 – (1.05)-5

m=1

r = 5% = 500,000(.230975)

R =? = Birr 115,487.5 must be paid per year to amortize the

debt

Interest = (115,487.5 X 5) – 500,000

= Birr 77,4375

Exercise

1. Ato Kassahun wanted to buy TV which costs Br. 10, 000. He was short of cash and went
to Commercial Bank of Ethiopia (CBE) and borrowed the required sum of money for 9
months at an annual interest rate of 6%. Find the total simple interest and the maturity
value of the loan.

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2. How long will it take if Br. 10, 000 is invested at 5% simple interest to double in
value?
3. How much money you have to deposit in an account today at 3% simple interest
rate if you are to receive Br. 5, 000 as an amount in 10 years?

4. At what interest rate will Br. 5, 000 yield Br. 2, 000 in 8 years time.
5. Find the Interest on Br. 5, 000 at 10% for 45 days.
6. At what interest rate you should invest Br. 5000, if you want to receive an
amount of Br. 7,000 in 8 years time. Administer Financial Accounts

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