Finance management deals with the management of financial resources of a company. The common areas of finance are business finance, personal finance andpublic finance. Lending money and investing money are basic tools of Finance. The finance management deals with the concepts of money, time, risk and their relation between them. Finance also related to spending and budgeting of money.
The financial resources management is very important for any company to maintain a balance between its spending and earnings.it helps the financial team to set their financial goals and achieve these targets by applying the tools of financial management. Financial management is also helpful to identify the position of a company, its profit and loss analysis. Companies largely depend on the report of the financial directors, Infact financial management is the main tool to identify financial and market position of any company. Financial management has various different tools for the measurement of financial resources and their relationship between each other. The most common tools which helps to identify the relationship between assets and liabilities or earning and spending. There is another very effective tool which can really help a company to identify its assets and liabilities or in simple words its help companies to identify relationship between their total net debts and their net retain earning. If the debts of companies are more than their total net retains earnings, it represents that company's financial position is not going good and the management has really need to think about it.
The management analyse the financial reports of the company also compare these reports to the previous years, so they can find what they have achieved and what they need to do more to achieve maximum of their financial targets. If the company has more retained earnings than the previous year it indicates that company is utilizing its financial resources in a well-planned way. But on the other hand side if debt of the company increasing and its retained earnings are decreasing. It indicates that company is not utilizing its financial resources in a well-planned way. We have chosen two different companies doing different business. We will apply the theory of financial resource management on these two companies and will check the performances of these companies. It will be also a test of our theory that whether our theory of financial management will be feasible or not. I try to explain and support the theory of financial management by implementing this theory to the financial statements of the company.
Major tools for Financial Analysis
The most important tools of financial analysis are as follows:
Comparative Financial Statements
Common Size Statements
Trend Ratios or percentages
Ratio Analysis
Funds Flow Analysis
Cash Flow Analysis
The Tree of Ratios
Chapter Two: Analysis of the Financial Performance of ABC Ltd
2.2 RATIO ANALYSIS
One number expressed in terms of another is termed "Ratio"
Ratio analysis describes in mathematical terms the relationship that exist between two numbers or items in the financial statement
Ratio analysis is therefore defined to refer to the analysis and interpretation of financial statements through ratios.
Nature of Ratio Analysis
Ratios are designed to show how one number is expressed in terms of another.
Ratios can be presented either in the form of a percentage, coefficient or as proportion.
Ratios are invaluable aids in the analysis and interpretation of financial statements because absolute figures may be misleading unless compared with one another to show the relationship that exists between the figures.
However, ratios by themselves are meaningless unless they are appropriately compiled and interpreted.
Uses or Advantages of Ratio Analysis
Simplification of mass of accounting data
An invaluable aid to management
Facilitates better coordination and control
A tool to assess important characteristics of business
An effective tool of analysis for intra-firm and inter-firm comparisons
Limitations of Ratio analysis
Limitations of financial statements: The limitations associated with financial statements may affect the quality of ratio analysis
No fixed standards or ideal ratios for comparisons resulting in confusions
Qualitative factors are ignored: Ratios are tools of quantitative analysis only and normal qualitative factors that may generally influence conclusions derived are ignored.
Lack of standard formulae: The number of ratios is large , and there are no standard formulae for working them out thereby making comparisons difficult
It is no substitute for personal judgement: It is just an aid cannot replace thinking and personal judgement employed in complex decision-making processes
Problems of price level changes: Ratios fail to reflect price level changes as they are based on historical data thereby making comparisons between periods difficult because of inflationary conditions
Ratios alone are not adequate: ratios computed on past data my provide only a glimpse of a firm's past performance thereby rendering resultant future forecasts incorrect due to management policies, economic and market conditions etc.
2.3 Profitability Analysis
Net Profit Margin
The ratio of profitability is calculated as the total net income divided by the revenues. In another way the net profits divided by total sales. It enables the company to find that how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage
= Profit before interest and tax
Sales
Calculations for ABC LTD:
2002
= 9100/35000 = 0.26
2001
= 29635/7705 = 3.84
2.4 Liquidity Analysis
Liquidity ratios play a key role in assessing the short-term financial position of a business
These ratios normally indicates the ability of the business to meet the maturing or current debts, the efficiency of management in utilising the working capital, and the progress attained in the current financial position
Shareholders and debenture holders and other long-term creditors can use these ratios to assess the prospects of dividend and interest payments
Current Ratio:
Balance-sheet financial performance is measured by current ratio of company liquidity.
Current Ratio may be defined as the ratio of current assets to current liabilities.
It is also known as 'working capital ratio'
Ratio of more than 1.0 means that a company's short term assets exceed its short term liabilities.
High ratio than a normal figure can be; a sign of poor working capital control.
It measures the firm's financial stability, solvency, and the strength of working capital
The ratio less than 1 indicates that company would be unable to pay off its debts if they came due at that point.
While this shows the company is not in good financial health, The Company has to maintain a balance among its own liabilities and current assets to hold a good well in the market.
Current Assets: means cash or those assets easily convertible or expected to be converted into cash within the accounting.
Current Liabilities: refers to those liabilities to be paid within the same year
Calculations for ABC Ltd:
ABC Ltd.
2002
= 22500/26000 =0.86
2001
= 15000/14000 = 1.07
Acid Test Ratio:
It measures the relationship between liquid assets and current liabilities or liquid liabilities
It is also known as 'Quick Ratio' and 'Acid Test Ratio'
Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution.
Furthermore, if the Quick ratio is much lower than the working capital ratio, it means current assets are dependent on inventory
Liquid Assets: Normally include cash, bank, sundry debtors, bills receivable, and short-term investments or marketable securities.
Liquid/Current Liabilities: Refers to all current liabilities minus bank overdraft and income received in advance.
Calculations for ABC Ltd:
2002
7000+9500/2600 = 0.63
2001 3000+6000/14000 =0.64
Creditors Ratio:
It signifies the credit period by the firm in paying creditors.
Same as debtors' turnover ratio, creditors' turnover ratio can be calculated in two forms, creditors' turnover ratio and average payment period.
The average payment period ratio represents the number of days by the firm to pay its creditors. A high creditor's turnover ratio or a lower credit period ratio signifies that the creditors are being paid promptly. However a very favourable ratio to this effect also shows that the business is not taking the full advantage of credit facilities allowed by the creditors.
A company which is short of cash will be forced to get as much as credit it can despite losing discount for prompt payment.
Any indication of charge of supplier or refusal of credit by suppliers may be an early warning sign of trouble.
= Average Creditors x 365(days)
Credit Purchases
Calculations for ABC Ltd.:
2002
= 26000/25900 * 365 = 366 days
2001
= 14000/22559 * 365 = 226 days
2.5 Management Efficiency Analysis
Stock Turnover Ratio
Stock turnover ratio indicates the number of time the stock has been turned over during the period.
It evaluates the efficiency with which a firm is able to manage its inventory.
This ratio indicates whether investment in stock is within proper limit or not.
Also known as inventory turn over
Every firm has to maintain a level of inventory of finished goods so that they may be able to meet the requirements of the business.
But the level of inventory should neither be too high nor too low.
A too high inventory means higher carrying costs and higher risk of stocks becoming obsolete.
Low inventory may mean the loss of business opportunities.
It is essential to keep sufficient stock in business.
Interpretation:
This ratio should be compared against industry averages.
A low turnover implies poor sales and, therefore, excess inventory.
A high ratio implies either strong sales or ineffective buying.
It should be compared with those of similar businesses.
= Cost of Sales
Stocks
Calculations for ABC Ltd:
2002
= 25900/6000 =4.31
2001
= 21930/6000 =3.65
2.6 Corporate Ratios
Earnings per Share - EPS
This represent portion of a company's profit which they allocate to each outstanding share of common stock. Earnings per share serve as an indicator of a company's profitability.
This is usually stated as pence per share
EPS are generally considered to be the most important variable which determines per share's price.
An important point of EPS that's often ignored is the capital that is required to generate the earnings in the calculation.
Two companies at the same time generate the same EPS number, but one could do so with less equity (investment) - that company would be efficient at using its capital to create income and, all other things being equal, would be a "better" company
Calculations for ABC Ltd.:
2002
= 5940000 = £0.14
2001
= 4914/32500 =£0.15
Price/Earnings Ratio - P/E Ratio:
A valuation ratio of a company's current share price compared to its per-share earnings.
Calculated as:
EPS is usually from the last four quarters, but often lye it can be taken from the estimates of earnings expected in the next four quarters.
Also sometimes known as "price multiple" or "earnings multiple
In general, a high Price/Earning indicates that investors are expecting higher earnings growth in the future compared to companies with a lower Price/Earning.
Dividend Yield
A financial ratio which shows how much a company pays out in dividends each year as compared to its share price. In the absence of capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows:
2.7 Financial Ratios
Return on Equity
This is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
ROE is expressed as a percentage and calculated as:
= Profit attributed to ordinary shareholders
Total assets
The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
Gearing Ratio
It is a financial ratio which compares some form of owner's equity to borrowed funds.
Gearing is a measure of financial leverage, demonstrating the degree up to which a firm's activities are funded by owner's funds versus creditor's funds.
A company which has high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.
A greater proportion of equity provides a measure of financial strength
= Debt Ã-100%
Equity
2.8 Summary of findings
Net profit margin is not good as it decreases by 69% (20,535/29,635*100) in 2002 as compare in 2001.Which is not good sign for the co.
Liquidity position of company also is not good
Current ratio which must be near to 2 it is below the dead level of 1 more over it decrease in 2002.
Acid test ratio must be near to 1 it's also below 1.and decrease in 2002.
EPS remains almost same for both years.
Chapter Three: Analysis of the Financial Performance of Jphones Ltd
3.1 Income Statement of J Phones Ltd for the period ending December 31...:
3.2
3.3 Profitability Analysis
Net Profit Margin:
Calculations for J phone Ltd.:
2002
= 144375/412500 =0.35
2001
= 125544/358695 =0.35
3.4 Liquidity Analysis
Current Ratio:
Calculations for J phone Ltd.:
2002
= 895000/350000 = 2.55
2001
=490000/200000 = 2.45
Acid Test Ratio:
Calculations for J phone Ltd.:
2002
15000+150000/350000 = 0.47
2001
= 16000+90000/200000 = 0.53
Creditors Ratio:
Calculations for J phones Ltd.:
2002
= 350000/268125*365 = 476 days
2001
= 200000/233151*365 =313 days
3.5 Management Efficiency Analysis
Stock Turn over Ratios:
Calculations for J phone Ltd.:
2002
=268125/730000 = 0.37
2001
= 233151/384000 = 0.61
3.6 Corporate Ratio Analysis
EPS:
Calculations for J Phones:
2002
= 53575/190000 =£0.28
2001
= 100544/180000 =£0.56
3.8 Summary of findings
Net profit margin remains same in both years
Current ratio is better in year 2002 then last year
Chapter Four: Conclusion and Recommendations
Recommendation is J phones because:
Its dividend is 10p for 2 years and next years its increasing 15p company sound hai.
EPS of J phones is more than ABC Ltd.
Dividend of ABC Ltd. is less whereas Liquidity ratio is also not in stable position
Common-size Financial Statement Analysis
This involves converting the figures reported in the financial statements into percentages taking some common base.
In the Common-size Income Statement, the net Sales could be assumed to be 100% and other items are expressed as a percentage of sales
In the common-size Balance Sheet, he total assets or liabilities are assumed to be 100% and other items of assets and liabilities are expressed as a percentage of the base item
Common-size statements are also called "component statements" or "100 per cent Statements" because each statement is reduced to the total of 100 and each item is expressed as a percentage of the total.
Common Size Balance Sheet of ABC Ltd. for Yr 2002 and 2001:
Interpretation:
The percentage of fixed assets to total assets increased from 20.21% in 2001 to 68.66% in 2002.
At the same time, the percentage of current assets decreased from 79.79% to 31.34%.
This indicates a poor current assets management policy.
The preference shares capital has decreased from 8.11% to 6.49%
and reserves increase from 14.86% to 18.18%,
But the long term as well as the current liabilities to total liabilities increased from 38.14% to 67.5%.
Compared to total current liabilities, the total current assets are inadequate.
Hence, the working capital position is not satisfactory.
In general, the financial policy of the firm is highly unsatisfactory.
Common size Income Statement of ABC Ltd. For 2002 and 2001:
Interpretations:
The gross profit of the company remains the same for both the year
Similarly, the net profit percentage increased from 17.6% to 17.7%.
Just a minute increase in net profit
In general, the overall operating efficiency of business is not that much satisfactory
Common Size Balance Sheet of J Phones Ltd. for Yr 2002 and 2001:
Interpretation:
The percentage of fixed assets to total assets increased from 20.21% in 2001 to 68.66% in 2002.
At the same time, the percentage of current assets decreased from 79.79% to 31.34%.
This indicates a poor current assets management policy.
The preference shares capital has decreased from 8.11% to 6.49%
and reserves increase from 14.86% to 18.18%,
But the long term as well as the current liabilities to total liabilities increased from 38.14% to 67.5%.
Compared to total current liabilities, the total current assets are inadequate.
Hence, the working capital position is not satisfactory.
In general, the financial policy of the firm is highly unsatisfactory.
Common size Income Statement of J Phones Ltd. For 2002 and 2001:
Interpretations:
The gross profit of the company remains the same for both the year
Similarly, the net profit percentage increased from 17.6% to 17.7%.
Just a minute increase in net profit
In general, the overall operating efficiency of business is not that much satisfactory
