At present time large industries are opening up in every country and it is very important that we need finance for working capital, plant and infrastructure. The amount of finance that is need to be invested in the business is called as financial management. The main features of Financial Managements are Analytical Thinking, Continuous Process, Basis of Managerial Decisions, Maintaining Balance between Risk and Profitability, Coordination between Processes, Centralized Nature
Financial management is maintaining, planning and controlling the firm financial resource . It is very necessary to maintain the financial resource of the computer to run the business. It still in the theory concept of it own even now.
J. F. Bradley(2000), "Financial management is the area of business management devoted to the judicious use of capital & careful selection of sources of capital in order to enable a spending unit to move in the direction of reaching its goals."
I have worked on the ABC income statement and balance sheet and I have worked on the ratio analysis and was able to find out the Return on Capital Employed,
Asset Turnover or Asset Utilisation Ratio, Net Profit Margin, Gross Profit Margin, Liquidity Ratio, Current Ratio, Stock turnover ratio, Corporate Ratios, Market to book ratio, Gearing Ratio, Common-Size Analysis. Then I have did the same steps for J Phone and was able to calculate the same ration. I have compared the Trend Analysis,
Comparative Statement Analysis, Cash Flow Analysis of both the company.
The recent economic turmoil has brought the idea of financial stability and financial performance to the forefront in financial field. No organisation great or small can now be seen to relax in its financial performance. The present scenario of economic turmoil along with rapidly changing business trends means that organisations need to have a constant track of relevant financial information to evaluate the situation and prepare for further business expansion.
The notion of financial analysis is not new to the human mind, even a very common farmer will compute crudely what he owes and owns. But such simple calculations are meaningless to companies that deal with financial transactions that are numerous and needs standardisation for legal and planning purposes. Another requirement for such crucial information is for the business owners to see whether the capital they have put in are generating proper returns, on the other handmanagers require information for future planning and to ensure that their departments are running efficiently according to accepted accounting standards. The same information is looked at from a different view by investors, financiers and tax departments. Thus it is quite clear that financial information and analysis serves a host of people intent on knowing about the status of an organisation. As such financial information and details is akin to a doctor feeling the pulse of a patient to elicit diagnosis.
Tools of Financial Analysis
Analysis financial information is not as simple as it is believed mainly due to the varied group of people accessing the information. The information needs to be in a standardised formation such that the group comes to the same conclusion after going through the information. A lot of studies have been undertaken to ascertain the effectiveness of financial analysis. Before making a judgement on the effectiveness, let us look at the parameters of analysis of performance.
The following broad parameters are used for financial analysis of a company at any point in time.
Profitability Ratio
Liquidity Ratio
Management Efficiency Ratio
Corporate Ratio
Financial Ratio
Employee Ratio
Income Statement of ABC Ltd for the period ending December 31...
2.1 Income Statement of ABC Ltd for the period ending December 31...:
2.2 Balance Sheet of ABC Ltd as December 31.....:
Profitability Ratio
Return on Capital Employed
One of the most commonly ratios to predict an organisations ability to generate earnings against its expenses (including relevant costs incurred for a specific period of time). The formula for calculating the ratio is as follows:
Return on Net Asset
=
Profit before interest and tax
x
100%
Capital employed (including long term loans)
Return on Net Asset
=
9100
x
100%
=
28.11%
Year 2002
32370
Return on Net Asset
=
7705
x
100%
=
22.80%
Year 2001
33789
Importance:
Low values means less profit that can be wiped out during an economic downturn
Departments with low values can be marked for closure or sale to prevent further war.
Asset Turnover or Asset Utilisation Ratio
As the name goes this looks at asset utilisation i.e., how an organisation is utilising its assets to generate income. The formula for calculating the same is as below
Asset Turnover
=
Sales
Net Assets
Asset Turnover
=
35000
=
0.94
Year 2002
37320
Asset Turnover
=
29634
=
0.88
Year 2001
33789
The value is not represented in percentage but in a ratio. A rising ratio usually denotes improving performance.
Net Profit Margin
This is the most utilised margin calculation that gives an overview of a firm's financial position. If this ratio is poor investors do not usually go beyond this.
Profit Margin
=
Profit before interest and tax
x
100%
Sales
Profit Margin
=
9100
x
100%
=
26.00%
Year 2002
35000
Profit Margin
=
7705
x
100%
=
26.00%
Year 2001
29634
Gross Profit Margin
Gross Profit Margin
=
Gross Profit
x
100%
Sales
Liquidity Ratio
The ratio largely looks at a firm's ability to repay its liabilities. The thumb rule is that the higher the ratio the better.
Current Ratio
Current Ratio
=
Gross Profit
x
100%
Sales
Acid Test Ratio
=
Current Ratio - Stock (liquid assets)
Current Liabilities
Management Efficiency Ratio
Stock turnover ratio
Stock Turnover
=
Cost of Sales
Stock
Corporate Ratios
Earnings per share: Measures the profit allotted to each share in the common stock category.
Earnings per Share
=
(Net profit after tax + preference dividend + extraordinary items
Number of shares in issue
Market to book ratio
Market to Book Ratio
=
Market Capitalisation
x
100%
Book value of equity
Dividend Yield
Dividend Yield
=
Dividend Declared
x
Dividend Rate
Market Price of Share
Financial Ratio
Gearing Ratio
Gearing Ratio
=
Total Assets
x
100%
Book Value of Assets
Common-Size Analysis (CSA)
One of the disadvantages of comparing balance sheet results is that the numbers give a quantitative weightage and no further information on efficiency. Common size analysis of balance sheets can be done by comparing two components of similar nature for the companies compared and based on the outcome a better company can be selected.
The formula for CSA is as follows
Common Size Ratio
=
Item of interest
Reference Item
If the formula above is to be modified for inventories then it can be stated as follows
Common Size Ratio for Inventory
=
Inventory
Total Assets
Limitations:
Different accounting principle used by different firms needs to be taken into consideration. The same applies for the difference in accounting calendars.
Income Statement of Jphones Ltd for the period ending December 31...:
3.2 Balance Sheet of Jphones Ltd as December 31.....:
Profitability Ratio
Return on Capital Employed
One of the most commonly ratios to predict an organisations ability to generate earnings against its expenses(including relevant costs incurred for a specific period of time). The formula for calculating the ratio is as follows:
Return on Net Asset
=
Profit before interest and tax
x
100%
Capital employed (including long term loans)
Return on Net Asset
=
144375
X
100%
=
75.39%
Year 2002
191500
Return on Net Asset
=
122719
X
100%
=
42.46%
Year 2001
289000
Importance:
Low values means less profit that can be wiped out during an economic downturn
Departments with low values can be marked for closure or sale to prevent further war.
Asset Turnover or Asset Utilisation Ratio
As the name goes this looks at asset utilisation i.e., how an organisation is utilising its assets to generate income. The formula for calculating the same is as below
Asset Turnover
=
Sales
Net Assets
Asset Turnover
=
412500
=
2.15
Year 2002
191500
Asset Turnover
=
350000
=
1.21
Year 2001
289000
The value is not represented in percentage but in a ratio. A rising ratio usually denotes improving performance.
Net Profit Margin
This is the most utilised margin calculation that gives an overview of a firm's financial position. If this ratio is poor investors do not usually go beyond this.
Profit Margin
=
Profit before interest and tax
x
100%
Sales
Profit Margin
=
95575
X
100%
=
23.17%
Year 2002
412500
Profit Margin
=
110719
X
100%
=
31.63%
Year 2001
350000
Gross Profit Margin
Gross Profit Margin
=
Gross Profit
x
100%
Sales
Liquidity Ratio
The ratio largely looks at a firm's ability to repay its liabilities. The thumb rule is that the higher the ratio the better.
Current Ratio
Current Ratio
=
Gross Profit
x
100%
Sales
Acid Test Ratio
=
Current Ratio - Stock (liquid assets)
Current Liabilities
Management Efficiency Ratio
Stock turnover ratio
Stock Turnover
=
Cost of Sales
Stock
Corporate Ratios
Earnings per share: Measures the profit allotted to each share in the common stock category.
Earnings per Share
=
(Net profit after tax + preference dividend + extraordinary items
Number of shares in issue
Market to book ratio
Market to Book Ratio
=
Market Capitalisation
x
100%
Book value of equity
Dividend Yield
Dividend Yield
=
Dividend Declared
x
Dividend Rate
Market Price of Share
Gearing Ratio
Gearing Ratio
=
Total Assets
x
100%
Book Value of Assets
Common-Size Analysis (CSA)
One of the disadvantages of comparing balance sheet results is that the numbers give a quantitative weightage and no further information on efficiency. Common size analysis of balance sheets can be done by comparing two components of similar nature for the companies compared and based on the outcome a better company can be selected.
The formula for CSA is as follows
Common Size Ratio
=
Item of interest
Reference Item
If the formula above is to be modified for inventories then it can be stated as follows
Common Size Ratio for Inventory
=
Inventory
Total Assets
Limitations:
Different accounting principle used by different firms needs to be taken into consideration. The same applies for the difference in accounting calendars.
Trend Analysis
Trend analysis is the comparison or relating the previous year values with the current year to forecast the future of the company. It provides information and clear ideas of the company's current position and the place where it is lacking behind .This is achieved by finding difference in cost and schedule performance. It is tool for setting a strategy for a company. Currently trend analysis also includes the trend, fashion, culture and consumer behavior which also will impact the company.
Formula:
20X0 is the earlier year so the amount in the 20X0 column is subtracted from the amount in the 20X1 column.
The percent change is the increase or decrease divided by the earlier amount (20X0 in this example) times 100. Written as a formula, the percent change is:
Trend Analysis:
Increase (decrease)
Increase (decrease)
%-ABC
%-Jphone
Particulars
ABC company
J Phone company
ABC
J Phone
2002
2001
2002
2001
Net sales
35000
29634
412500
350000
5366
62500
18.11%
17.86%
Dividends issued
3450
2900
58500
31000
550
27500
18.97%
88.71%
retained earnings
5059
2314
116794
79719
2745
37075
118.63%
46.51%
fixed asset
49300
38000
169000
180000
11300
-11000
29.74%
-6.11%
equity finance
54559
43314
531794
399719
11245
132075
25.96%
33.04%
Cash Flow Analysis
Cash flow analysis of your business is cash that come in and goes out with maintaining an necessary cash flow for you business and have a basic for cash flow management. Cash flow analysis is also known as Cash flow forecasting. It analysis the components that affect the cash flow of the business, They are inventory, account receivable, account payable and credit terms. From this analysis we can easily find the cash flow problem that affects your company and we can use it to improve the cash flow of the company
We can compare the total unpaid purchase to the total sale due of each month. If it is greater then you will spend more cash in the coming next month which will lead to cash flow problem.
ABC
J phones
2001
2002
2001
2002
Credit terms
2311
0
200000
350000
From the above case we are unable to find the cash flow analysis because we don't have all the components.
Advice
Checking from the ratio analysis we have a little rise in the return on the net assest for ABC company but we can see around 32.93% increase by J Phones.The asser turnover of ABC company is also less than the J Phones. So the profit margin of ABC company was the same in 2001 and 2002 but the profit margin has gone down for J Phones. As the profit margin was same for ABC company for both the years so there gross profit is the same but J phone has increased by 0.22% in 2002.The acid test ratio has gone down for ABC company but J phone has able to manage there acid test ratio.We dont have enough information to find the gearing ratio, market to book ratio and stock turnover for both the company.The earning per share for both the company has come down by 0.11%. From the trend analysis we are able to find ABC company has done better than J Phone in the net sales. Dividend issued by them is less than J phones. Retained earnings and fixed asset are well maintained but the Equity finance of the ABC company has come down. From the cash flow analysis we are unable to calculate it as we don't have the required information to do it. We only have credit iteam in it. If we need to find the cash flow analysis we need to capture the data of inventory, account receivable and account payable.
Ratio Analysis
Ratio analysis is the report on the financial ratio of the company. It actually gives the financial level of the company and it is very important in fundamental analysis. The comparesion of two companies earning ratio. We will be able to find out which company share is properly reflects the price and we can invest on those where we can gain most profit.
Trend analysis
The way of analysing the past data to predict the future stock is called as the trend analysis. The traders can judge by looking into the past data and predict the future and purchase the stock. . It provides information and clear ideas of the company's current position and the place where it is lacking behind .This is achieved by finding difference in cost and schedule performance. It is tool for setting a strategy for a company.
Cash Flow analysis
Cash flow analysis of your business is cash that come in and goes out with maintaining an necessary cash flow for you business and have a basic for cash flow management. Cash flow analysis is also known as Cash flow forecasting. It analysis the components that affect the cash flow of the business, They are inventory, account receivable, account payable and credit terms. If we feel to invest on a company we need to check the cash flow of the company to understand the strength of the company.
Common-Size Statement
Normally all the financial statement are shown in amounts but the common size statement show in percentage. This kind of statement is useful when you compare many companys. It is also called as one hundred percent analysis.
Comparative statement analysis
Comparing financial data of different time is called as comparative statement analysis. You can collect the data of income statement, balance sheet or cash flow statement of different period and compare it to get financial strength. We can also compare the data of different company to get the financial trend.
Fund flow analysis
The fund flow is calculated monthly or quarterly. The cash that come in and goes out in the different financial assets is called as fund flow analysis. The asset performance or fund is not consider, only the redemptions that goes out and the purchase of shares that comes in are taken into account.
Balanced Scorecard
Collection of data on growth, customer, finance and business process which can be reported to the management. It is like a internal inspection. We can improve the make necessary change in the organisation with this analysis. This is a report which is been done every year.
Conclusion
After comparing both the companies we have found that ABC company has done better in Financial Management and they were able to grow well in the year 2002. As mentioned earlier the main reason for looking at the ratios from time to time is to check the healthy nature of the organisation and take effective steps to improve the situation. However, great care needs to be emphasised during such analysis, as the outcome of the results only have values and do not suggest any alternatives. In a recent study on checking the effectiveness of ratio analysis in predicting an organisations failure led Johnson to conclude that there is no clear logical link between the results found in a ratio analysis to failure. Nonetheless, as the human mind links numbers to performance, ratio analysis is here to stay. The results need to be taken up with a pinch of salt with comparison of performance against other analytical methods to yield proper views and steps that needs to be taken from an organisational point of view. Another argument is that ratios do not given underlying economic turmoil or alternatives that can be taken by human mind. Thus ration analysis with application of sound decision making can go a long way in putting the organisation in the right path to success.
